<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 20, 1999
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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GLOBAL TELESYSTEMS GROUP, INC.
(Exact name of registrant as specified in charter)
<TABLE>
<S> <C> <C>
DELAWARE 4813 94-3068423
(State or other jurisdiction
of incorporation or (Primary Standard Industrial (I.R.S. Employer
organization) Classification Code Number) Identification Number)
</TABLE>
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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)
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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)
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Copies to:
DAVID J. BEVERIDGE, ESQ.
SHEARMAN & STERLING
199 BISHOPSGATE
LONDON ECZM 3TY, ENGLAND
(44) 171-920-9005
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If the securities being registered on this Form are being offered pursuant
to dividend or interest reinvestment plans, please check the following box. [ ]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ] .
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If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier registration statement for the same
offering. [ ] .
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If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
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PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO AGGREGATE OFFERING AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED BE REGISTERED PRICE PER SHARE OFFERING PRICE REGISTRATION FEE
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<S> <C> <C> <C> <C>
Common Stock, par value $.10
per share................. 13,909,753(1) $60.04(2) $835,141,570 $232,170
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</TABLE>
(1) Rights to purchase Series A Preferred Stock of the Company, which are also
being registered hereunder, were issued in a number equal to the shares of
Common Stock being registered hereby for no additional consideration and
therefore, no registration fee for such rights is required. Prior to the
occurrence of certain events, such rights will not be exercisable or
endorsed separately from the Common Stock. When exercisable, each such right
shall entitle the owner to purchase from the Company one one-thousandth of a
share of Series A Preferred Stock.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act, such that the market price
per share of GTS Common Stock is based on the average of the bid and asked
price per share of GTS Common Stock on the Nasdaq National Market on January
15, 1999.
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, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SUCH
SECTION 8(a), MAY DETERMINE.
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<PAGE> 2
SUBJECT TO COMPLETION, DATED JANUARY 20, 1999
PROSPECTUS
13,909,753 SHARES
GLOBAL TELESYSTEMS GROUP, INC.
[GLOBAL TELESYSTEMS GROUP, INC. LOGO]
COMMON STOCK
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This prospectus relates to 13,909,753 shares of common stock of Global
TeleSystems Group, Inc. which certain of our stockholders (whom we call the
Selling Stockholders in this prospectus) own and may offer and sell from time to
time. Our shares currently trade on the Nasdaq National Market under the symbol
"GTSG."
The Selling Stockholders may offer the shares for sale from time to time in
the over-the-counter market, in the Nasdaq National Market, in privately
negotiated transactions or otherwise at market prices prevailing at the time of
sale, at prices related to such prevailing market prices or at negotiated
prices. This prospectus also may be used by transferees of the Selling
Stockholders or by other persons acquiring Shares, including brokers who borrow
the Shares to settle short sales of shares of the common stock.
The Selling Stockholders will receive all of the net proceeds from the sale
of Shares and will pay all underwriting discounts and selling commissions, if
any. We will be responsible for paying all other expenses relating to the offer
and sale of the Shares.
INVESTING IN THE COMMON STOCK INVOLVES RISKS WHICH ARE DESCRIBED IN THE
"RISK FACTORS" SECTION BEGINNING ON PAGE 16 OF THIS PROSPECTUS.
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NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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The date of this Prospectus is January 20, 1999.
THE INFORMATION IN THIS PROSPECTUS IS INCOMPLETE AND MAY BE CHANGED. THE SELLING
STOCKHOLDERS MAY NOT SELL THESE SECURITIES 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.
<PAGE> 3
EXPLANATORY NOTE CONCERNING ESPRIT TELECOM
Except as otherwise set forth herein, the information concerning Esprit
Telecom Group plc contained in this prospectus, including financial information,
has been furnished by Esprit Telecom Group plc or has been taken from or based
upon publicly available documents and records on file with the Securities
Exchange Commission and other public sources. We assume no responsibility for
the accuracy or completeness of the information concerning Esprit Telecom Group
plc furnished by Esprit Telecom Group plc or contained in such documents and
records or for any failure by Esprit Telecom Group plc to disclose events which
may have occurred or may affect the significance or accuracy of any such
information but which are unknown to us. More comprehensive financial and other
information concerning Esprit Telecom Group plc is included in the documents
filed by it with the Securities and Exchange Commission. The information
concerning Esprit Telecom Group plc is qualified in its entirety by reference to
such reports. Such reports may be examined and copies may be obtained from the
offices of the Securities and Exchange Commission as set forth in "Where You Can
Find More Information."
<PAGE> 4
FORWARD-LOOKING STATEMENTS
This prospectus includes forward-looking statements as to how we and Esprit
Telecom Group may perform in the future. We have based these forward-looking
statements on our current expectations and projections about future events and
financial trends affecting the financial condition of our business. These
forward-looking statements are subject to risks, uncertainties and assumptions
about us and about Esprit Telecom Group, including, among other things:
- Risk of delay in implementing our business plan
- Risks of completing acquisitions and integrating acquired businesses
- Political, economic and legal changes in the markets where we
operate
- Heightened competition
- Our need for additional, substantial financing.
These forward-looking statements are principally contained in the following
sections of the prospectus:
- Risk Factors
- GTS Management's Discussion and Analysis of Financial Condition and
Results of Operations
- Esprit Telecom Management's Discussion and Analysis of Financial
Conditions and Results of Operations
- Business.
In addition, in those and other portions of this prospectus, the words and
phrases "will likely result", "are expected to", "will continue", "is
anticipated", "estimated", "intends", "plans", "projection" and "outlook", as
they relate to Global TeleSystems Group, Inc. or our management, are intended to
identify forward-looking statements. These statements should be viewed with
caution.
These forward-looking statements may differ materially from actual results
because they involve estimates, assumptions and uncertainties. In making these
forward-looking statements in this prospectus, we claim the protection of the
safe harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1998. We undertake no obligation to publicly update or
revise any forward-looking statements, whether as a result of new information,
future events or otherwise.
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Russia On Line(TM) is a trademark of the Company.
<PAGE> 5
SUMMARY
This summary highlights information contained elsewhere in this prospectus.
This summary is not complete and may not contain all the information you should
consider before investing in the Common Stock. The terms "we," "GTS" and the
"Company" refer to Global TeleSystems Group, Inc. and its subsidiaries, except
where it is clear from the context that we are referring to GTS' predecessor.
For the definitions of capitalized terms used in this prospectus, please see
Exhibit A to this prospectus.
THE COMPANY
We provide 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. In addition,
through our subsidiary, Hermes Europe Railtel B.V. ("HER"), we are developing
and operating the initial segments of a high capacity fiber optic network that
is designed to link a majority of the largest Western and Central European
cities. HER's network is intended to transport voice, data and multimedia/image
traffic for other telecommunication service providers, or carriers, throughout
Western and Central Europe.
In these regions, we own and operate the following types of telecommunications
businesses:
- - international long distance businesses,
- - local access networks,
- - cellular telecommunications networks,
- - a domestic long distance business,
- - data networks, and
- - carriers' carrier networks.
Western Europe. In Western Europe, we believe we are well positioned to
become the leading independent carriers' carrier (i.e., carrier of other
telecommunications service providers' traffic) through two ventures, HER and
GTS-Monaco Access S.A.M. ("GTS-Monaco Access").
HER's goal is to become the leading carriers' carrier throughout Europe by
providing carriers with cross-border telecommunications transmission capacity
over a high capacity fiber optic network covering approximately 25,000
kilometers that HER manages from a central location. HER's target customers are
traditional public telecommunications operators and new entrants, such as
alternative carriers, global consortia of telecommunications companies,
international carriers, Internet backbone networks, resellers of
telecommunications services, value-added networks and other providers of
telecommunications services.
HER's network is designed to link a majority of Western and Central
European cities. As of December 31, 1998, HER's network linked Brussels,
Antwerp, Rotterdam, Amsterdam, London, Paris, Frankfurt, Strasbourg, Zurich,
Geneva, Stuttgart, Munich, Dusseldorf, Milan, Berlin, Copenhagen and Stockholm.
HER commenced commercial service over the Brussels-Amsterdam portion of the
network in late 1996 and the London-Paris portion in
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November 1997. The rest of the cities were connected to the network in 1998. The
full 25,000 kilometer network is expected to become fully operational during the
year 2000.
HER also has leased capacity on a transatlantic cable linking the European
network with North America and is exploring various options for linking its
network to Russia. Our network connections to other continents will satisfy the
needs of HER's European customers who wish to transmit traffic to other
continents and will appeal to non-European customers with traffic terminating in
Europe.
GTS-Monaco Access, in partnership with the Principality of Monaco, operates
an international gateway in Monaco that carries and routes international calls
to other telecommunications operators.
Central Europe. In Central Europe, our goal is to become one of the leading
alternative telecommunications providers in the region. We currently provide
private data communications services to government and commercial customers in
Hungary, the Czech Republic, Slovakia and Romania. In the Czech Republic, we
provide outgoing voice services and operate an international gateway and a data
service network. In Hungary, we operate a nationwide microwave network and a
VSAT network, which we believe to be the largest VSAT network in Central Europe
as measured by number of VSAT sites. We have also signed an agreement to provide
international data services in Poland, subject to the receipt of necessary
governmental approvals. In Central Europe, we intend to expand our service
offerings as the regulatory environment permits, build on our existing VSAT and
international gateway infrastructure and provide a broad range of services to
our target markets.
Russia and CIS. In Russia and the CIS, our goal is to become the premier
alternative telecommunications service provider. To reach our goal, we have
partnered with regional telephone companies and with Rostelecom, the national
long distance carrier in Russia. We currently operate in 31 regions and the city
of Moscow in Russia, as well as in 14 cities in the CIS. We believe we are
well-positioned to become the leading independent telecommunications service
provider in Russia. We conduct our operations in Russia and the CIS through five
separate businesses:
- - EDN Sovintel ("Sovintel"), which provides Moscow, and recently St. Petersburg,
with international long distance and local telephone services and access to
domestic long distance carriers;
- - TeleCommunications of Moscow ("TCM"), which provides local access services in
Moscow;
- - TeleRoss, which provides domestic long distance services in fourteen cities in
Russia, including Moscow and very small aperture terminal service to customers
outside its primary long distance satellite network;
- - Sovam Teleport ("Sovam"), which provides data services, including high-speed
data transmission, electronic mail, Internet access services, and Russia On
Line, the first Russian language Internet service; and
- - Our cellular operations ("GTS Cellular"), which consist of cellular networks
in 14 regions in Russia and in Kiev, Ukraine, with licenses covering regions
with an aggregate population of approximately 48 million people at September
30, 1998.
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In total, our ventures in Russia and the CIS carried approximately 442
million minutes of traffic for the year ended December 31, 1997 and 462 million
minutes of traffic for the nine months ended September 30, 1998. In addition, we
had approximately 34,100 customers, including approximately 25,200 cellular
subscribers, as of September 30, 1998.
We do not currently own or operate significant telecommunication assets in
Asia.
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The following table provides you with certain information, as of September
30, 1998, about the principal ventures through which we conduct our business:
<TABLE>
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COUNTRY/REGION GTS PRINCIPAL
COMPANY NAME OF OPERATIONS OWNERSHIP PARTNER(S) BUSINESS
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<S> <C> <C> <C> <C>
WESTERN EUROPE
HER...................... Western Europe 89%(1) Two railways Carriers' Carrier
GTS-Monaco Access........ Monaco 50% Principality Carriers' Carrier;
of Monaco International
Gateway
CENTRAL EUROPE
GTS-Hungary.............. Hungary 99% -- VSAT Network
CzechNet................. Czech Republic 100% -- International Long
Distance; Data
and Internet
CIS
Sovintel................. Russia 50% Rostelecom International Long
Distance; Local
Access
TCM...................... Russia 95%(2) MTU Inform and Local Access Lines
others
TeleRoss................. Russia 50%(3) Various local Domestic Long
PTOs Distance
Sovam.................... Russia 100%(4) N/A Data and Internet
GTS Cellular............. CIS 50-100%(5) Primarily Basic Cellular
various local
PTOs
</TABLE>
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(1) As a result of the sales in March 1998 and October 1998 by two of the other
shareholders in HER of their ownership interests, we currently own
approximately 89.9% of HER.
(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, we have a 95% interest in TCM.
(3) TeleRoss consists of (i) a wholly owned subsidiary that operates a domestic
long distance network (the "TeleRoss Operating Company") and (ii) 14 joint
ventures that are 50% beneficially-owned by us (the "TeleRoss Ventures").
See "Business -- Russia and the CIS -- TeleRoss."
(4) During the first quarter of 1998, we purchased our minority partner's 33.3%
interest in Sovam, thereby making Sovam a wholly owned subsidiary of GTS.
(5) We conduct our cellular operations through (i) Vostok Mobile B.V. ("Vostok
Mobile"), a wholly owned GTS subsidiary, which owns between 50% and 100% of
a series of 13 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) Golden Telecom (formerly
Bancomsvyaz), an approximately 57% beneficially owned venture in Kiev,
Ukraine. We completed a restructuring of the capital and ownership of Golden
Telecom in June 1998. See "Business -- Russia and the CIS -- GTS Cellular."
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BUSINESS STRATEGY
We seek to develop businesses to meet the rapidly expanding market demand
for telecommunications services. We seek to become the leading independent
carriers' carrier in Europe through the development of a European fiber optic
network and an international gateway in Monaco. We have recently developed a
business plan to offer a broad range of integrated telecommunications services
to businesses and other high usage customers in certain metropolitan markets
throughout Europe. In addition, our goal in emerging markets is to become the
leading alternative to the incumbent telecommunications service providers and a
leading provider of value-added services.
We have developed specific market strategies to achieve our goals in both
Western Europe and emerging markets. We have developed and are implementing a
business plan to offer comprehensive telecommunication services to business end
users throughout Europe.
Western Europe. We believe we are well-positioned to become the leading
independent carriers' carrier within Western Europe through the development of
HER's European fiber optic network and the operation of GTS-Monaco Access's
international gateway. HER and GTS-Monaco Access seek to complement and enhance
the services that large established national carriers and new entrants, such as
alternative carriers, global consortia of telecommunications companies,
international carriers, Internet backbone networks, resellers or
telecommunications services, value-added networks and other providers of
telecommunications services, provide thereby enhancing their ability to satisfy
the needs of their end-user customers. HER entered the European market ahead of
its competition and has attracted a wide variety of carriers to use its network
with service offerings that meet their needs. HER intends to provide its
customers with high quality transmission and advanced network capabilities at a
competitive price by utilizing advanced, uniform technology across the entire
region. HER will also provide redundant routing for higher levels of
reliability.
European Services Strategy. In June 1998, we introduced a business plan
which we call our European Services Strategy. Under our European Services
Strategy, we will offer, through several new subsidiaries, facilities-based
telecommunications products and services to businesses and other high usage
customers in certain European cities. We believe that the European market is
sizable and offers the potential for significant growth. Also, European
telecommunications regulations are being liberalized. We believe the combination
of these factors provides us with an opportunity to develop local networks and
provide other services targeted at end-user customers. Through GTS Business
Services -- Western Europe, we intend to enter up to 50 metropolitan markets as
a reseller of services to end-users. Through GTS Access Services, we propose to
develop competitive local exchange carriers in up to 12 European cities.
We intend to implement our European Services Strategy in one or more of the
following ways:
- the construction of fiber loop networks,
- the purchase or lease of dark fiber,
- obtaining of high frequency microwave licenses for "wireless fiber,"
or
- partnership with, or acquisition of, resellers or facilities-based
competitive local exchange carriers.
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Our decision to enter a particular market will depend on various factors,
including:
- its business concentration,
- the national and local regulatory environment,
- the technical difficulties of local network construction, and
- the extent of existing competition.
See "-- Recent Developments", "Risk Factors -- Risks Specific to
GTS -- Risks Relating to European Services Strategy" and "Business -- Business
Strategy -- European Services Strategy."
Emerging Markets. We pursue our goals in emerging markets through a
three-stage approach of market entry, market expansion and market integration.
- - Market Entry. We identify a market as a suitable target for entry based upon:
(i) superior growth prospects for such market; (ii) the provision of
inadequate services by incumbent providers; and (iii) attractive regulatory
environments. Once we have identified a market as suitable for entry, we seek
to establish our presence in that market by establishing a venture with a
strong local partner or partners. In general, we maintain a significant degree
of operational control in such ventures.
- - Market Expansion. Having entered a market successfully and established a
limited service offering to its targeted customer base, we then seek to expand
the range of services we offer to existing and potential customers and to
further develop our relationships with local partners. We also seek to expand
our targeted geographic market by forming new partnerships and installing
infrastructure and offering services in additional geographic regions.
- - Market Integration. We ultimately intend to integrate and co-market our
service offerings in each of the markets in which we operate. We believe that
our integrated operations will represent an attractive service alternative for
customers seeking a single provider that can meet all their telecommunications
needs.
Restructuring.
In October 1998, we announced we would restructure our business operations
into five primary lines of business as follows:
- GTS Carrier Services, which will include HER's cross-border transport
carrier services in Europe, Ebone Internet transit services, transoceanic
infrastructure and services, and Internet service units;
- GTS Access Services, which will pursue our entry into the Western
European CLEC market;
- GTS Business Services -- Western Europe, which will offer voice, data,
Internet and other telecommunications services to businesses in Western
Europe, principally in locations not served by GTS Access Services;
- GTS Business Services -- CIS, which will incorporate all of our CIS
"wireline" assets, including Sovintel, Sovam, TeleRoss and TCM; and
- GTS Mobile Services, which will operate all of our cellular businesses in
Russia and the Ukraine.
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RECENT DEVELOPMENTS
NETSOURCE ACQUISITION
On November 30, 1998, we completed the acquisition of NetSource Europe ASA
for an initial purchase price consisting of up to 4,037,500 newly issued shares
of Common Stock and $46.1 million in cash. In addition to the initial
consideration paid at the closing, we have agreed to make additional payments of
up to $35 million in either cash or shares of Common Stock (up to a maximum of
1.4 million shares), contingent on NetSource's achieving certain performance
targets during the first two quarters of 1999. Based on the closing price of our
shares of $43.4062 on November 30, 1998, the aggregate initial purchase price
paid by us for NetSource was $141.3 million. NetSource is a pan-European
provider of long distance telecommunications services focusing primarily on
small- to medium-sized businesses, with operations in Norway, Sweden, Germany
and Ireland, as well as in The Netherlands, Belgium and Denmark. At June 30,
1998, NetSource had 27,900 business customers throughout Europe and 61,400
residential customers in Germany and The Netherlands. NetSource will become part
of GTS Business Services -- Western Europe. The acquisition of NetSource
provides our GTS Business Services -- Western Europe line of business with a
customer and revenue base in several key Western European countries, a portfolio
of licenses and interconnection agreements and an entrepreneurial management
team.
ESPRIT TELECOM ACQUISITION
On December 8, 1998, in a joint press announcement with Esprit Telecom
Group plc, we announced that we had agreed on the terms of a proposed offer by
GTS to purchase all of the outstanding ordinary shares and ADSs of Esprit
Telecom and that holders of 65% of the voting ordinary shares of Esprit Telecom
have agreed to accept the offer. Under the proposed offer, we will offer to
purchase all issued and to be issued Esprit Telecom Securities on the following
basis:
- for each Esprit Telecom ordinary share, 0.1271 of a share of Common
Stock; and
- for each Esprit Telecom ADS, 0.89 of a share of Common Stock.
Based on the Nasdaq closing price of $41.75 per share of our Common Stock
on December 7, 1998, the offer values each Esprit Telecom ordinary share at
$5.31 (L3.21), each Esprit Telecom ADS at $37.16 (L22.48) and the entire issued
share capital of Esprit Telecom, on a fully diluted basis, at approximately
$757.3 million (L458.2 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 December 7, 1998, being the last trading day before the
announcement of the offer (based on an exchange rate of L1 = $1.6530 being the
Noon Buying Rate on December 7, 1998).
The making of the offer is subject to certain pre-conditions, including
that we obtain waivers by the holders of Esprit Telecom Bonds of their rights
under the applicable indentures to require Esprit Telecom to repurchase these
bonds at 101% of the principal amount of the debt in connection with the change
of control of Esprit Telecom resulting from the consummation of the offer. This
pre-condition was satisfied on December 23, 1998 through a successful consent
solicitation. The results of the consent solicitation are binding on all holders
of Esprit Telecom Bonds.
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<PAGE> 12
Our obligation to complete the offer is subject to the satisfaction or
waiver of several conditions. These conditions include, among others, that:
- we have received valid acceptances representing not less than 90% (or
such lesser percentage above 50% as we may decide) of Esprit Telecom
Securities;
- our shareholders have approved resolutions authorizing us to issue Common
Stock in the offer; and
- there has been no material adverse change in the business, assets or
prospects of Esprit Telecom.
The transaction is expected to close in the first half of 1999. We expect
that the transaction will be accounted for as a pooling of interests.
Esprit Telecom is a rapidly growing European telecommunications company,
providing high quality, competitively priced, international and national long
distance telecommunications services to retail customers and other
telecommunications service providers. Esprit Telecom has a network and sales
office infrastructure in 31 locations 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 9,500 route kilometer SDH and DWDM fiber optic network
through six European countries. Esprit Telecom also has links to Washington and
New York via a transatlantic circuit owned by other carriers
We believe that the businesses of GTS and Esprit Telecom are complementary
and that benefits will result from combining them. In particular, we expect the
combined group to have:
- a presence in 19 countries through Europe;
- increased network capacity and resilience;
- a 500 person sales force, one of the largest among independent
telecommunications companies in Europe;
- the ability to provide a wide array of service offerings;
- increased management depth;
- reduced network operations and administrative costs; and
- capital expenditure savings.
We expect the combination will assist us and Esprit Telecom in realizing our
mutual goals of becoming the pre-eminent providers of carrier's carrier and
business communications services throughout Europe.
We are in the process of developing our business plan and strategy for
Esprit Telecom, including the manner in which Esprit Telecom will be integrated
into our overall business and corporate structure. We may elect to contribute
one or more of our businesses to Esprit Telecom as part of our strategy,
including NetSource. We also may have one or more other of our entities purchase
assets from Esprit Telecom as part of our strategy. Any such transaction will be
effected in accordance with the applicable covenants in the indentures
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<PAGE> 13
governing the Esprit Telecom Bonds. We may also decide in the future to effect a
tender or exchange offer or consent solicitations with respect to the Esprit
Telecom Bonds, if it were advisable to better integrate Esprit Telecom into our
overall corporate structure.
HER DEBT OFFERING
On January 4, 1999, HER completed its private placement of $200 million
principal amount of 10 3/8% Senior Notes due 2009 and Euro 85,000,000 principal
amount of 10 3/8% Senior Notes due 2006. The net proceeds of this offering,
approximately $289.7 million, will be used to finance the cost of HER network
assets, to expand the HER network beyond the currently contemplated scope,
including by adding transatlantic capacity, enhancing the speed of the HER
network and continuing the buildout of the HER network.
FLAG ATLANTIC-1 JOINT VENTURE
On January 13, 1999, GTS, through its subsidiary GTS Transatlantic Holdings
Ltd., entered into an agreement with FLAG Telecom to form a 50/50 joint venture,
to be known as FLAG Atlantic-1, that will build and operate a transoceanic fiber
optic link between Europe and the United States. FLAG Atlantic-1's link is
designed to carry voice, high-speed data and video traffic at speeds of 1.28
terabits per second, a 25-fold increase over current transatlantic cable
systems. By interconnecting to FLAG Atlantic-1, GTS Carrier Services and its
subsidiary HER will be able to provide their carrier and Internet service
provider customers with high-capacity cable access from major European cities to
New York City. The project is subject to financing, the execution of related
agreements and other conditions.
FINANCING PLAN
In general, our strategy is to finance general corporate cash needs, the
development of our start-up ventures and acquisitions through the parent
company. When possible and cost effective, we seek to finance ongoing operations
at the venture level.
We believe that our existing cash balances and cash flow from operations
will be sufficient to fund our expected capital needs under our current business
plan, excluding any funds that we spend to implement our European Services
Strategy. We contemplate that we will raise additional debt financing to
implement our European Services Strategy. We have not yet decided on how much
additional financing we will raise or when we will raise it. The actual amount
and timing of our future capital requirements, however, may be different from
our management's estimate. Thus, we may require additional capital to execute
our current business plan and fund any operating losses, as well as to expand
and develop our businesses. We expect our ventures will spend over $1.2 billion
in cash related to capital expenditures and investments in ventures during the
next three years, including an additional $654 million through 2000 in order to
complete the buildout of the HER network.
In addition, as part of our business strategy, we regularly evaluate
potential acquisitions and joint ventures. We believe that attractive
acquisition opportunities currently exist in our markets in Western and Central
Europe and the CIS. We continuously consider a number of potential transactions.
Some of these transactions may involve our contributing some of our Russian
businesses in exchange for an interest of equivalent or greater value in the
surviving entity. We do not have a definitive agreement with respect to any
acquisition or joint
9
<PAGE> 14
venture, although we periodically have discussions with other companies and
opportunities on an on-going basis.
* * *
We were founded in 1983 as a not-for-profit company under the name San
Francisco/ Moscow Teleport, Inc. We were 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. We were renamed Global TeleSystems Group, Inc., on
February 22, 1995. Our principal business office is located at 1751 Pinnacle
Drive, North Tower-12th Floor, McLean, Virginia 22102, United States, and our
telephone number is (703) 918-4500.
------------------------
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Selling Shareholders..... 13,909,753 shares
Common Stock to be outstanding after the Shelf
Offering(1)........................................ 78,651,263 shares
Trading.............................................. The Common Stock is traded on the
Nasdaq National Market and EASDAQ
under the symbol "GTSG."
</TABLE>
- -------------------------
(1) This amount represents Common Stock outstanding at December 31, 1998 of
64,577,715, which includes 3,873,705 shares of Common Stock issued to former
NetSource shareholders who had tendered their shares by December 31, 1998
and 163,795 of additional shares to be issued resulting from the NetSource
acquisition. Excluded from the calculation are: 4,444,443 shares of Common
Stock that is subject to the exercise of warrants in Common Stock; and
5,195,063 shares of Common Stock issued under GTS' option plans. Subject to
NetSource meeting certain performance targets during the first two quarters
of 1999, an additional 1.4 million shares of common stock may be issued.
RISK FACTORS
Investing in the Common Stock involves risks which are described in the
"Risk Factors" section beginning on page 16 of this prospectus.
10
<PAGE> 15
SUMMARY SELECTED FINANCIAL DATA
The summary below sets forth selected historical financial data. You should
read this together with the historical financial statements and notes of GTS and
Esprit Telecom contained elsewhere in this prospectus. See "Where You Can Find
More Information."
SELECTED HISTORICAL FINANCIAL DATA OF GTS
The following summary historical consolidated financial data as of and for
the years ended December 31, 1995, 1996 and 1997 are derived from our audited
Consolidated Financial Statements. The following unaudited summary historical
consolidated financial data as of June 30, 1998 and for the three and nine
months ended September 30, 1997 and 1998 are derived from our unaudited
Consolidated Financial Statements. The summary historical consolidated financial
data presented below should be read together with "GTS Management's Discussion
and Analysis of Financial Condition and Results of Operations," and the audited
Consolidated Financial Statements and their related notes appearing in this
prospectus.
Under generally accepted accounting principles, a majority of our ventures
are accounted for by the equity method of accounting. Under this method, the
operating results of the ventures are included in our Consolidated Statement of
Operations as a single line item, "Equity in earnings (losses) of ventures." We
recognize 100% of the losses in ventures where we bear all of the financial risk
(which includes all of our significant ventures except for Sovintel and,
historically, HER). Also, the assets, liabilities and equity of our ventures are
included in our Consolidated Balance Sheets as a single line item, "Investments
in and advances to ventures." See Note 3 to our audited Consolidated Financial
Statements and "GTS Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Overview." Financial information about our equity
ventures is included below under "-- Supplemental Information -- Summary
Historical Financial Data of GTS -- Combined Equity Investments."
<TABLE>
<CAPTION>
THREE MONTHS
ENDED NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
------------------------------- ------------------- --------------------
1995 1996 1997(1) 1997 1998 1997 1998
-------- -------- --------- -------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues, net............... $ 8,412 $ 24,117 $ 47,098 $ 12,921 $ 63,834 $ 30,216 $ 117,299
Gross margin................ 16 5,176 4,379 (2,468) 24,985 1,864 35,232
Operating expenses.......... 41,014 52,955 78,410 24,971 42,833 52,059 94,243
Equity in earnings (losses)
of ventures............... (7,871) (10,150) (14,599) (8,067) (3,485) (18,234) 4,142
Other income (expense)...... 11,034 (8,729) (29,551) (10,942) (15,484) (16,902) (34,857)
Loss before extraordinary
loss...................... (40,400) (67,991) (116,986) (48,185) (37,478) (87,872) (88,131)
Extraordinary loss(2)....... -- -- -- -- -- -- (12,704)
Net loss.................... (40,400) (67,991) (116,986) (48,185) (37,478) (87,872) (100,835)
Loss per share before
extraordinary loss........ (1.61) (2.22) (3.26) (1.34) (0.62) (2.49) (1.65)
Extraordinary loss per
share..................... -- -- -- -- -- -- (0.24)
Net loss per share.......... (1.61) (2.22) (3.26) (1.34) (0.62) (2.49) (1.89)
</TABLE>
11
<PAGE> 16
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA (AT END OF PERIOD):
Cash and cash equivalents................................... $318,766 $ 993,928
Property and equipment, net................................. 236,897 436,019
Investments in and advances to ventures..................... 76,730 61,705
Total assets................................................ 780,461 1,814,893
Total debt.................................................. 639,359 1,208,533
Minority interest and stock subject to repurchase........... 31,255 59,600
Shareholders' equity........................................ 26,967 351,409
</TABLE>
- -------------------------
(1) As a result of our increased ownership interest in HER and an amendment to
the HER Shareholders Agreement that was completed on July 16, 1997, we
account for our ownership interest in HER under the consolidation method of
accounting. Prior to this date, we accounted for HER under the equity method
of accounting.
(2) We recognized a $12.7 million extraordinary charge to earnings in the first
quarter of 1998, as a result of our early payment of certain related party
debt obligations. The extraordinary charge is comprised of the write-off of
$11.6 million of unamortized debt discount and $1.1 million of unamortized
debt issuance costs. We deferred the debt issuance costs as financing costs
and were amortizing them over the original maturity of the debt.
12
<PAGE> 17
SUPPLEMENTAL INFORMATION -- SUMMARY HISTORICAL
FINANCIAL DATA OF GTS -- COMBINED EQUITY INVESTMENTS
The following unaudited summary historical financial data -- equity
investments for the years ended December 31, 1995, 1996 and 1997, and for the
three and nine months ended September 30, 1997 and 1998, are derived from our
financial records. This financial data is intended to supplement the summary
historical consolidated financial data, which were derived from our audited
Consolidated Financial Statements.
We believe that this information will provide you with additional insight
into our unconsolidated equity method investments. Generally accepted accounting
principles prescribe the 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%) and cost interests
(generally interests of less than 20%). Further, equity accounting ordinarily
results in the same net income as consolidation; however, the net operating
results are reflected on one line within the income statement. More detailed
financial information about our equity investments is included under
"Supplemental Information -- Selected Historical Financial Data of
GTS -- Combined Equity Investments."
<TABLE>
<CAPTION>
THREE MONTHS
ENDED NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
----------------------------- ----------------- -------------------
1995 1996 1997 1997 1998 1997 1998
------- -------- -------- ------- ------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues, net.................. $54,051 $143,472 $226,160 $57,266 $50,477 $159,006 $187,544
Cost of revenues............... 33,011 80,426 127,732 29,324 33,417 87,694 110,475
Operating expenses............. 22,958 55,018 74,845 27,492 12,806 60,447 40,870
Net (loss) income.............. (6,380) (5,220) 4,330 (2,859) (6,700) (3,680) 13,480
Income (loss) recognized by
GTS.......................... (7,871) (10,150) (14,599) (8,067) (3,485) (18,234) 4,142
ADJUSTMENTS FOR INTER-AFFILIATE
TRANSACTIONS(1):
Revenues, net.................. (2,270) (15,385) (24,927) (7,192) (7,358) (17,049) (25,001)
Cost of revenues............... (2,215) (13,562) (23,250) (6,195) (7,958) (15,853) (23,960)
Operating expenses............. (6,967) (8,083) (8,357) (2,523) (8,194) (11,105) 1,493
</TABLE>
- -------------------------
(1) The adjustment amounts represent the effect of inter-affiliate transactions
between our consolidated and equity method ventures. More detailed
information about inter-affiliate transactions is included under "GTS
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Accounting Methodology."
13
<PAGE> 18
SELECTED HISTORICAL FINANCIAL INFORMATION OF ESPRIT TELECOM
The selected historical financial data of Esprit Telecom set forth below
are derived from the financial statements of Esprit Telecom as they appeared in
Esprit Telecom's Annual Report on Form 20-F filed with the SEC for the fiscal
year ended September 30, 1998, which appear elsewhere in this prospectus. See
"Esprit Telecom Added Historical Consolidated Financial Statements." The Esprit
Telecom Consolidated Financial Statements were prepared in accordance with UK
GAAP, which differs in certain respects with US GAAP. See Note 30 to the Esprit
Telecom Consolidated Financial Statements.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------
1995 1996 1997 1998 1998
------- ------- ------- -------- --------
L L L L $(1)
(IN THOUSANDS, EXCEPT PER ORDINARY SHARE AND
PER ADS AMOUNTS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA(2)
UK GAAP
Revenue, net.......................................... 13,950 24,880 45,466 82,588 140,350
Gross margin.......................................... 3,310 6,124 7,517 16,759 28,480
Operating expenses.................................... 5,490 11,015 19,070 47,191 80,196
Operating loss before interest........................ (2,180) (4,891) (11,553) (30,432) (51,716)
Net interest (expense)/income......................... (222) (203) 695 (12,213) (20,755)
Loss on ordinary activities before taxation........... (2,402) (5,094) (10,858) (42,445) (72,131)
Taxation on loss on ordinary activities............... -- -- (2) (2) (3)
Loss for the financial year........................... (2,402) (5,094) (10,860) (42,447) (72,134)
Loss per Ordinary Share............................... (0.05) (0.07) (0.10) (0.34) (0.58)
Loss per ADS(3)....................................... (0.35) (0.49) (0.70) (2.38) (4.04)
US GAAP
Net loss.............................................. (2,423) (5,325) (10,852) (42,447) (72,134)
Net loss per Ordinary Share........................... (0.05) (0.08) (0.10) (0.34) (0.58)
Net loss per ADS(3)................................... (0.35) (0.56) (0.70) (2.38) (4.04)
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
------------------------------------------------
1995 1996 1997 1998 1998
------ ------- ------- -------- --------
L L L L $
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
UK GAAP
Bank balances, cash, restricted securities and short
term deposits and investments........................ 5,615 6,430 24,525 184,749 313,962
Fixed assets, net...................................... 3,514 8,005 17,727 154,100 261,878
Total assets........................................... 13,178 24,101 59,543 394,537 670,476
Creditors: amounts falling due within one year......... (7,045) (12,122) (25,295) (72,930) (123,937)
Creditors: amounts falling due in more than one year... (631) (1,968) (2,874) (328,806) (558,773)
Total shareholders' funds.............................. 5,502 10,011 31,374 (7,199) (12,234)
US GAAP
Total assets........................................... 13,178 24,101 59,543 394,537 670,476
Long term debt......................................... (631) (1,968) (2,874) (328,806) (558,773)
Redeemable preference shares........................... 673 673 -- -- --
Shareholders' equity................................... 4,829 9,338 31,374 (7,199) (12,234)
</TABLE>
- ---------------
(1) Solely for the convenience of the reader, pounds sterling amounts have been
translated into US dollars at the Noon Buying Rate on September 30, 1998 of
$1.6994 per L1.00.
(2) Esprit Telecom's financial information has been restated from that published
prior to December 1997 in order to give effect to a change in UK GAAP
relating to the granting of employee stock options at a discount to the
market price. The financial value of such discounts are now recognized as
employee compensation and charged against net income. As required by UK
GAAP, this accounting change has been effected by restating the results of
previous periods. This change in accounting has no impact on the US GAAP
financials.
(3) Loss per Esprit Telecom ADS and net loss per Esprit Telecom ADS are
calculated by adjusting loss per Esprit Telecom ordinary share and net loss
per Esprit Telecom ordinary share, respectively, for the ratio of Esprit
Telecom Ordinary Shares per Esprit Telecom ADS.
14
<PAGE> 19
SUMMARY UNAUDITED PRO FORMA COMBINED FINANCIAL DATA
The following selected unaudited pro forma financial information presents
financial information of GTS and Esprit Telecom as if the GTS/Esprit Telecom
merger had occurred at the beginning of the periods indicated. The GTS/Esprit
Telecom merger will be treated as a pooling of interests for financial
accounting purposes. You should read this together with the consolidated
financial statements and accompanying notes of GTS and Esprit Telecom included
in the documents appearing elsewhere in this prospectus and the unaudited pro
forma combined financial statements and accompanying discussion and notes set
forth under "Unaudited Pro Forma Combined Financial Statements" included herein.
The pro forma amounts in the table below are presented for your information and
do not necessarily indicate what the financial position or the results of
operations of the combined company would have been had the merger date occurred
as of the dates or for the periods presented. The pro forma amounts also do not
necessarily indicate what the financial position or future results of operations
of the combined company will be. No adjustment has been included in the pro
forma amounts for any anticipated cost savings or other synergies. See
"Unaudited Pro Forma Combined Financial Statements."
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C>
GTS/ESPRIT TELECOM PRO FORMA COMBINED
Revenues............................................... $ 162,248 $ 272,193
Loss from operations................................... (161,344) (142,610)
Net loss before extraordinary items:
Total........................................ (215,969) (204,919)
Per share.................................... (3.87) (2.80)
Total assets......................................................... 2,636,167
Long-term debt....................................................... 1,680,032
Shareholders' equity................................................. 437,909
</TABLE>
15
<PAGE> 20
RISK FACTORS
Investing in Common Stock will provide you with an equity ownership
interest in GTS. As a GTS shareholder, you may be subject to risks inherent in
our business. The value of your investment may increase or decline and could
result in a loss. In the event that we consummate our proposed offer for all of
the issued share capital of Esprit Telecom, you may also be subject to risks
inherent in Esprit Telecom's business. You should carefully consider the
following factors relating to both GTS and Esprit Telecom as well as other
information contained in this prospectus before deciding to invest in shares of
Common Stock.
RISKS RELATING TO THE OFFER AND COMBINED OPERATIONS OF GTS AND ESPRIT TELECOM
NONREALIZATION OF SYNERGIES
Our combination with Esprit Telecom involves the integration of separate
companies that have previously operated independently. The process of combining
the companies may be disruptive to our respective businesses and may cause an
interruption of, or a loss of momentum in, our respective businesses as a result
of a number of obstacles such as:
- loss of key employees or customers;
- possible inconsistencies in standards, controls, procedures and policies
among the companies being combined and the need to implement common
company-wide financial, accounting, information, billing and other
systems;
- failure to maintain the quality of customer service that such companies
have historically provided;
- the need to coordinate geographically diverse organizations;
- incompatible equipment;
- limitations under existing Esprit Telecom debt covenants; and
- the resulting diversion of management's attention from our day-to-day
business and the need to hire management personnel to address such
obstacles.
We may fail to realize the expected cost savings, synergies and revenue
enhancements from such integration and may suffer material adverse short and
long-term effects on our operating results and financial condition.
Even if we are able to integrate the operations of the companies
successfully, there can be no assurance that we will realize the expected cost
savings, synergies or revenue enhancements from such integration or that we will
realize such benefits within the time frame that we currently expect.
- Whether we achieve expected economies of scale depends, in part, on
negotiations with third party providers of goods and services, the
results of which are difficult to predict. Accordingly, the amount and
timing of the resulting cost savings are inherently difficult to
estimate.
- Any cost savings and other synergies from the transaction will be offset
by costs incurred in integrating the companies.
16
<PAGE> 21
- The cost savings and other synergies may also be offset by increases in
other expenses, by operating losses or by problems unrelated to the
transaction.
See "-- Integration of Recent Acquisitions."
RISKS SPECIFIC TO GTS
ADDITIONAL CAPITAL REQUIREMENTS
We will need substantial capital to:
- implement our European Services Strategy,
- develop and expand the Esprit Telecom and HER networks,
- open new sales offices,
- introduce new telecommunications services,
- fund operating losses and net cash outflows, and
- make future acquisitions and investments in joint ventures.
As part of our business strategy, we regularly evaluate potential
acquisitions and joint ventures. We believe that additional attractive
acquisition opportunities currently exist in our markets in Western and Central
Europe and the CIS. We continuously consider a number of potential transactions,
some of which may involve us contributing some of our Russian businesses in
exchange for an interest of equal or greater value in the surviving entity and,
if consummated, may be material to our operations and financial condition. We do
not have a definitive agreement with respect to any material acquisition or
joint venture, although we periodically have discussions with other companies to
assess opportunities on an on-going basis. We may need to raise additional
capital to fund such acquisitions or joint ventures.
We believe that our existing cash balances and cash flows from operations
will be sufficient to fund our expected capital needs under our current business
plan excluding any funds that we spend to implement our European Services
Strategy. However, the actual amount and timing of our future capital needs may
differ materially from our estimates as a result of the following factors:
- The accuracy of our estimates of future capital needs is subject to
changes and fluctuations in our revenues, operating costs and development
expenses. Actual revenues and costs may vary materially from expected
amounts and depend on:
- Esprit Telecom's and HER's ability to effectively and efficiently manage
the expansion of their networks and operations;
- HER's ability to obtain infrastructure contracts, rights-of-way,
licenses and other regulatory approvals that it needs to complete and
operate its network;
- our ability to purchase equipment for building networks which support
products and services and to negotiate favorable contracts with
suppliers, including large volume discounts on our purchases of capital
equipment;
- our ability to access targeted customers and markets, attract sufficient
numbers of customers and provide and develop services for which
customers will subscribe; and
17
<PAGE> 22
- factors outside our control, such as political and economic developments
and trends, regulatory changes, changes in technology, increased
competition, strikes, weather, performance by third parties and other
factors in connection with our operations.
- If we expand our operations at an accelerated rate or acquire any
businesses, our funding needs may increase, possibly to a significant
degree, and we may spend our cash balances sooner than currently
expected.
- As a result of acquiring a majority interest in Ebone on June 24, 1998,
HER may need to fund Ebone if Ebone is not able to self-fund in
accordance with its business plan.
- As a result of acquiring a majority interest in NetSource on November 30,
1998, we may need to fund NetSource if NetSource is not able to self-fund
in accordance with its business plan.
We cannot estimate with any degree of certainty the amount and timing of
our future capital requirements to implement such strategy. We anticipate that
the amount of capital we need to continue to implement our European Services
Strategy will depend on several factors including, among others, the demand for
our services, the markets in which we build or buy networks and regulatory,
technological and competitive developments. As a result of the foregoing, in the
event that our plans or assumptions change or that our capital resources prove
to be insufficient to fund growth and operations in the manner and at the rate
we currently anticipate, we may be required to raise additional capital. If we
decide to raise additional funds by incurring debt, we may become subject to
additional or even more restrictive financial covenants (as a result of the
assumption of Esprit Telecom's outstanding debt securities) and our cash
interest expense obligations may increase. If we decide to raise additional
funds by issuing equity, your ownership of our stock may be diluted. We cannot
assure you that additional financing will be available to us on favorable terms
or at all. If we fail to generate sufficient funds in the future, whether from
operations or by raising additional debt or equity capital, we may have to delay
or abandon some or all of our development, expansion and acquisition plans, or
we may have to sell assets. As a result, we may not have the ability to develop
the necessary geographic reach, networks, offer products, services and compete
as effectively as contemplated. These outcomes could have a material adverse
effect on our operations and on the market price of Common Stock. See
"-- Government Regulation," "-- Competition," "-- Changes in Technology," "GTS
Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business -- Western Europe -- HER," and "Esprit Telecom
Management's Discussion and Analysis of Financial Condition and Results of
Operations" "-- HER Network Roll-out," "-- Risks Specific to Esprit
Telecom -- Need for Additional Financing."
SIGNIFICANT INDEBTEDNESS AND INTEREST PAYMENT OBLIGATIONS; RESTRICTIONS IN DEBT
AGREEMENTS ON OUR OPERATIONS
We are, and will continue to be, highly leveraged as a result of the
substantial indebtedness we have incurred and intend to incur to implement our
business plans. We have approximately $1.2 billion of debt outstanding at
September 30, 1998. On January 4, 1999, HER issued in a private placement US$200
million aggregate principal amount of 10 3/8% Senior Notes due 2009 and Euro 85
million aggregate principal amount of 10 3/8% Senior Notes due 2006. Upon
completion of the acquisition of Esprit Telecom, we will assume Esprit Telecom's
debt, which was $554.9 million at September 30, 1998. Our debt instruments
18
<PAGE> 23
permit us and our subsidiaries to incur certain additional indebtedness to fund
expansion of our businesses and for other permitted purposes. In addition, we
contemplate that we will raise additional debt financing to implement our
European Services Strategy. We, however, have not yet decided on the size and
timing of any additional financing. Esprit Telecom's debt instruments permit
Esprit Telecom, and upon completion of the acquisition, will permit us, to incur
certain additional indebtedness, including indebtedness incurred to finance the
expansion of the Esprit Network.
The high level of our indebtedness could have important consequences on our
operations, including that we:
- will need significant cash to service our debt, thereby reducing funds
available for operations, future business opportunities and investments
in new or developing technologies and making us more vulnerable to
adverse economic conditions;
- may have difficulty refinancing our existing debt or may be restricted
from obtaining additional financing to fund future working capital,
capital expenditures, debt service requirements, acquisitions or other
general corporate requirements;
- may have less flexibility in planning for, or reacting to, changes in our
business and in the telecommunications industry;
- may have less flexibility in responding to changes which affect how we
implement our financing, construction or operating plans;
- will be more highly leveraged than some of our competitors, which may
place us at a competitive disadvantage with respect to such competitors;
and
- will limit our ability to withstand adverse economic conditions or take
advantage of significant business opportunities that may arise.
In addition, we will be required to comply with certain financial covenants
and other restrictions contained in our existing debt agreements. Certain of the
covenants included in Esprit Telecom's debt agreements are more restrictive than
those in our existing debt agreements. Upon completion of the acquisition of
Esprit Telecom, we will assume Esprit Telecom's debt, and any of our businesses
contributing to Esprit Telecom will become subject to these more restrictive
covenants. Among other things, our financial covenants limit our ability to:
- incur additional indebtedness,
- make capital expenditures,
- pay dividends, make distributions on Common Stock or make certain other
restricted payments,
- create certain liens upon assets,
- dispose of certain assets, or
- enter into certain transactions with affiliates.
We cannot assure you that such covenants will not materially and adversely
affect our ability to finance our future operations or capital needs or to
engage in other business activities which we deem to be in our interest.
19
<PAGE> 24
We will need to substantially increase net cash flow in order to pay the
principal of and interest on our debt, including debt assumed as a result of the
Esprit Telecom acquisition, and we cannot assure you that we will be able to
meet such obligations. If we are unable to generate sufficient cash flow or to
otherwise obtain the funds necessary to make required payments, or if we
otherwise fail to comply with the various covenants under the debt, we would be
in default under the terms of such debt. A default under such debt may permit
the debtholders to accelerate the maturity of such debt, which in turn could
cause defaults under other of our indebtedness. We cannot assure you that under
these circumstances we would have sufficient funds or other resources to satisfy
all such obligations, on a timely basis or otherwise. Such default or
acceleration would also be likely to adversely affect the market price of our
Common Stock.
HISTORY OF OPERATING LOSSES
We have historically sustained substantial operating and net losses. For
the following periods, we reported net losses of:
<TABLE>
<CAPTION>
PERIOD NET LOSS
------ --------
<S> <C>
Year ended December 31, 1995........................ $ 40.4 million
Year ended December 31, 1996........................ $ 68.0 million
Year ended December 31, 1997........................ $117.0 million
Nine months ended September 30, 1998................ $100.8 million
Inception through September 30, 1998................ $343.7 million
</TABLE>
Our net losses in the first three quarters of 1998 exceeded those in the
comparable prior period in 1997, and we expect this trend to continue in the
fourth quarter of 1998. On a pro forma basis after giving effect to the
consummation of the offer for the shares of Esprit Telecom, our net losses for
the year ended December 31, 1997 and the nine months ended September 30, 1998
would have been $216.1 million and $205.0 million, respectively. Further
development of our business, including our European end-user services business,
will require significant additional expenditures and we expect that we will have
significant operating and net losses and will record significant net cash
outflow, before financing, in coming years. We cannot assure you that our
operations, including our European end-user services business, will achieve or
sustain profitability or positive cash flow in the future. If we cannot achieve
and sustain operating profitability or positive cash flow from operations, we
may not be able to meet our debt service obligations or working capital
requirements, which would have a material adverse effect on our operations and
would adversely affect the market price of our Common Stock. See "GTS
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
HER NETWORK ROLL-OUT
Risks Relating to Completing HER Network
HER's ability to achieve its strategic objective will depend in large part
on the successful, timely and cost-effective completion of the HER network. HER
currently operates commercially over a portion of the network linking Brussels,
Antwerp, Rotterdam, Amsterdam, London, Paris, Frankfurt, Strasbourg, Zurich,
Geneva, Stuttgart, Dusseldorf, Munich, Milan, Berlin, Copenhagen and Stockholm.
However, various factors, uncertainties and contingencies may delay or adversely
affect the development of the remainder of the network. Many of these factors,
such as strikes, natural disasters and other casualties, are beyond HER's
control. In addition, HER will need to negotiate and conclude additional
agreements with various parties regarding, among other things, rights-of-way and
development and mainte-
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nance of the network infrastructure and equipment. We cannot assure you that HER
will conclude necessary agreements. Any delays in concluding such agreements
would 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) third parties performing their contractual
obligations to engineer, design and construct portions of the network on a
timely basis and (ii) HER's ability to obtain and maintain applicable
governmental approvals.
HER is operating its network in Belgium, The Netherlands, the UK, France,
Germany, Switzerland, Italy, Denmark and Sweden, and HER expects that the 25,000
kilometer network will be operational by the end of the year 2000. HER believes
that its cost estimates and the build-out schedule are reasonable. However, the
actual construction costs or time required to complete the network build-out
could substantially exceed current estimates. Any significant delay or increase
in the costs to develop the HER network could have a material adverse effect on
HER and our operations.
Development of the HER network is capital intensive. HER expects that
approximately $835 million in additional capital expenditures, including capital
lease obligations, will be incurred through the end of the year 2000 in
connection with the buildout of the HER network. HER believes that the net
proceeds from the issuance of the New HER Notes and its current indebtedness,
combined with HER's projected internally generated funds, should be sufficient
to fund HER's expected capital expenditures. However, the accrual amount and
timing of HER's future capital requirements may differ materially from
management's estimates. Thus, additional financing may be needed to construct
the HER network, and we cannot assure you that such additional financing will be
available on terms acceptable to HER or at all. Failure to obtain necessary
financing may require HER to delay or abandon its plans for deploying the
remainder of the HER network, which may have a material adverse effect on HER
and on us. However, the actual amount and timing of HER's future capital
requirements may differ materially from our estimates. HER may need additional
financing to construct the HER network. We cannot assure you that such
additional financing will be available to HER on favorable terms or at all. If
HER fails to obtain necessary financing, HER might have to delay or abandon its
plans for deploying the remainder of the network, which would adversely affect
the viability of HER. HER's failure to obtain financing might also require us to
make additional capital contributions to HER at the expense of our other
operations. Either of these two outcomes could have a material adverse effect on
our operations and would adversely affect the value of Common Stock.
Risks Relating to HER's Operations
HER's revenues and the cost of deploying its network and operating its
business will depend upon a variety of factors including:
- HER's ability to effectively and efficiently manage the expansion of its
network and operations;
- HER's ability to negotiate favorable contracts with suppliers;
- HER's ability to obtain additional licenses, regulatory approvals,
rights-of-way and infrastructure contracts to complete and operate the
network;
- HER's ability to access markets and attract sufficient customers;
- HER's ability to provide and develop services for which customers will
subscribe; and
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- strikes, weather, performance by third parties and other factors that are
outside of HER's control.
Due to the uncertainty of these factors, actual costs and revenues may vary
from expected amounts, possibly to a material degree, and such variations would
likely affect HER's future capital requirements. See "GTS Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
HER must obtain additional 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 (known as infrastructure
providers) to build out the network. We cannot assure you that HER will be able
to maintain all of its existing agreements, rights and permits. Nor can we
assure you that HER will be able to obtain and maintain the additional
agreements, rights and permits it needs to implement its business plan on
acceptable terms. If HER lost substantial agreements, rights and permits or
failed to enter into and maintain required arrangements for the HER networks,
such events would have a material adverse effect on HER's business. In addition,
HER depends on third parties for leases of dark fiber for substantial portions
of its network. If HER is unable to enter into or maintain such leases, this
could have a material adverse effect on HER's business, as well as on our
operations and the market price of Common Stock.
We cannot assure you that the HER network will achieve the technical
specifications for which it was designed. HER also may be unable to upgrade the
network as technological improvements are introduced.
Falling Prices/Depressed Gross Margins
Prices in the European long distance industry have declined over the past
few years. We expect that prices will continue to decline as competition
increases and that continuing price cuts in certain retail markets will affect
the gross margins of certain of HER's customers. This, in turn, could affect
HER's gross margins, if not offset by increases in volume and reductions in
costs.
Risks Relating to Regulatory Approvals
To construct and operate the network in accordance with current plans, HER
must obtain the necessary regulatory approvals. Licenses, authorizations or
registrations have been obtained in Belgium, Denmark, France, Germany, Italy,
The Netherlands, Sweden, Switzerland, the UK and the United States. HER intends
to file applications in other countries (including Austria, Croatia, Czech
Republic, Hungary, Poland, Portugal, Slovakia and Russia) in anticipation of
service launch in accordance with the roll-out plan. With the exception of
Austria and Portugal, which are members of the EU and whose laws must comply
with European Commission directives, these other countries have not generally
liberalized their telecommunications sectors. We cannot assure you that they
will do so in a timely manner or at all.
In addition, the terms and conditions of the licenses, authorizations or
registrations granted to HER may limit or otherwise affect HER's scope of
operations. We cannot assure you 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, authoriza-
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tions or registrations or a substantial limitation upon the terms of these
licenses, authorizations or registrations could have a material adverse effect
on HER and could adversely affect the market price of Common Stock. See
"Business -- Western Europe -- HER -- Licenses and Regulatory Issues."
INTEGRATION OF RECENT ACQUISITIONS
We acquired NetSource in November 1998 and, upon the consummation of the
offer, will acquire Esprit Telecom, which in turn acquired the Plusnet business
in May 1998 and three other telecommunications businesses in 1997. In order to
integrate these businesses, we must continue to develop our financial and
management controls and informations systems. The integration of these
acquisitions has required and will continue to require additional expenditures.
Although we expect these acquisitions to result in operating synergies, we
cannot assure you that these acquisitions will achieve the expected benefits or
that such benefits will be realized within the time frames that we contemplate.
See "-- Risks Relating to the Offer and Combined Operations of GTS and Esprit
Telecom -- Nonrealization of Synergies."
RISKS RELATING TO EUROPEAN SERVICES STRATEGY
Early Stage of European Services Strategy. Although we have recently
completed the acquisition of NetSource, hired certain key personnel and filed
certain licensing applications, we are still in the early stages of implementing
our European Services Strategy. Our decision to proceed with the European
Services Strategy will depend on our ability to assess potential markets, obtain
required governmental authorizations, franchises and permits, identify
appropriate additional acquisition candidates, implement efficient information
processing systems for billing and customer service and develop a sufficient
customer base. If we fail to achieve any of the foregoing, we may need to
modify, delay or abandon some or all of our European Services Strategy. We
cannot estimate with certainty the amount and timing of our future capital
requirements to implement such strategy. See "-- Additional Capital
Requirements," "GTS Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Business -- Business Strategy -- European
Services Strategy."
Regulatory. Because we plan to provide, through GTS Business
Services -- Western Europe and GTS Access Services, an expanded array of
telecommunications services in Europe, we will become subject to significant
additional regulation at the EU, national and local levels. We have applied for
licenses to operate as a competitive local exchange carrier in seven cities in
Germany and the greater Paris metropolitan area. Delays in receiving regulatory
approvals, or the enactment of adverse regulations or regulatory requirements,
may have the following adverse consequences:
- delay or prevent us from offering our end-user services in certain
European markets;
- restrict the types of end-user services we can offer;
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- restrict us from deploying our local networks; and
- otherwise adversely affect our operations.
We cannot assure you that we will be able to obtain the necessary
regulatory approvals on a timely basis or that we will not otherwise be affected
by regulatory developments, any of which may have a material adverse effect on
our operations.
Competition. The business of providing telecommunications services in
Europe is extremely competitive. Our success depends upon our ability to compete
with a variety of telecommunications providers in each of our markets.
Competitors will include large established national carriers, alliances among
telecommunications companies (such as Global One, an alliance among Sprint,
Deutsche Telekom AG and France Telecom SA, and KPN/Qwest, an alliance between
KPN N.V. and Qwest Communications International, Inc.), facilities-based
competitors (including MCI WorldCom, Inc., Viatel, Inc., Econophone, Inc.,
Primus Telecommunications Group, Incorporated and Cable & Wireless, plc),
resellers, data providers, Internet service providers and other providers of
bundled services. We may also face competition in one or more of our markets
from competitors using new or alternative technologies or new applications of
existing technologies. These competitors include cable television companies,
wireless telephone companies, microwave carriers and satellite companies. Many
competitors will have established customer bases and extensive brand name
recognition. Many competitors will have greater financial, management and other
resources.
We will compete primarily on the basis of price and, to a lesser extent, on
the type and quality of services offered. Many potential competitors are able to
use their substantial financial resources to cause severe price competition in
the markets in which we plan to operate, which would force us to lower our
prices to remain competitive. We also expect to lose a significant number of
customers as a result of the highly competitive nature of the markets. It may be
difficult for us to attract and retain a sufficient number of customers to
sustain our business. We cannot assure you that we will be able to effectively
market our expanded service offerings or that competitive pressures will not
have a material adverse effect on our operations.
Entering New Markets. We will have to make additional significant operating
and capital investments to implement the European Services Strategy. We will
need to develop new products and services and to establish direct and/or
indirect sales channels to market our offerings. Sophisticated information and
processing systems will be vital to our success, and we will need to implement
and integrate the necessary provisioning, billing and collection systems for its
services. Prior to our acquisition of NetSource, we had no prior experience in
offering expanded services in Europe or in targeting European business and
government customers. We may also rely on third party vendors and contractors
for network buildouts and information systems upgrades and will need to obtain
rights-of-way and other consents to develop our networks. We cannot assure you
that we will be able to implement the European Services Strategy on a timely
basis or at all. Any delays in establishing our business in one or more of our
targeted markets may have a material adverse effect on our operations and on the
value of Common Stock.
Reliance on Other Telecommunications Service Providers. To implement the
European Services Strategy, we will need to enter into interconnection
agreements with large estab-
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lished national carriers and other local service providers operating in our
target markets. We may also need to enter into collocation agreements with, and
lease trunking capacity from, such third parties. We cannot assure you that we
will be able to enter into these interconnection and other agreements on terms
that are satisfactory.
With respect to long distance and international services, we will need to
enter into resale agreements with long distance and international carriers.
These agreements often contain minimum volume commitments. We may be obligated
to pay underutilization charges if we overestimate our need for transmission
capacity. If we underestimate our need for transmission capacity, we may need to
pay more for the extra capacity needed.
Acquisition-Related Risks. We may enter our targeted markets through
additional acquisitions following the NetSource and Esprit Telecom acquisitions.
Buying businesses will subject us to certain risks, including, among others:
- acquired operations and personnel may be difficult to integrate into our
operations;
- our ongoing operations may be disrupted;
- integrating the acquired businesses may divert resources and management
time from running our ongoing business; and
- changes in management may impair relationships with employees and
customers.
In addition, our high level of debt (which, upon consummation of the offer,
will include the assumed debt of Esprit Telecom) and the terms of our
outstanding debt agreements may limit our ability to consummate additional
acquisitions. We cannot assure you that we will complete any such acquisitions
or that we will be able to obtain any additional financing needed to finance
such acquisitions. Nor can we assure you that if we complete any acquisitions,
the acquired business will be successfully integrated into our operations or
will perform as expected.
Potential Adverse Impact on HER. Many of the services we plan to offer in
our European end-user services business will compete with the services offered
by the customers HER targets as an independent carriers' carrier. If GTS
Business Services -- Western Europe and GTS Access Services contract with HER
for capacity, we expect that they will enter into such arrangements on an
arms-length basis. However, the 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 a material
adverse effect on HER's operations.
RISKS RELATING TO REORGANIZATION OF RUSSIAN TELECOMMUNICATIONS INDUSTRY
The Russian government established Svyazinvest in 1994 to hold the
government's interest in 85 regional telecommunication companies. In April 1997,
President Yeltsin approved the transfer of additional government-owned
telecommunications assets to Svyazinvest. This transfer included the
government's 51% stake in Rostelecom (the government controlled international
and long distance operator). 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 certain entities affiliated with an affiliate of George Soros,
purchased a 25% stake in
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Svyazinvest for $1.87 billion. The President had also authorized the sale of
another 24% of Svyazinvest at a future date. This sale was scheduled to occur in
the second half of 1998. However, in view of the recent deterioration of the
Russian economy and political instability, the sale was cancelled. See "-- Risks
Relating to Operations in Russia and the CIS -- Political" and "-- Economic."
As a result of the government's actions, a single entity, Svyazinvest, now
owns a majority interest in most of our principal venture partners and other
telecommunications service providers in Russia. These companies 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 is likely to make Svyazinvest a stronger
competitor, and may lead to material adverse changes in the business
relationships between us and our Russian partners. The continuing privatization
of Svyazinvest and the evolution of Russia's government policy regarding
Svyazinvest and Rostelecom may have a material adverse effect on us and our
Russian ventures.
MANAGING RAPID GROWTH
We continue to construct segments of the HER network, expand our existing
operations and expand into additional geographic and service markets when
business and regulatory conditions warrant. We cannot assure you that we will be
able to construct and operate the entire HER network as currently planned, that
we will be able to expand with the markets in which our ventures are currently
operating or into additional markets at the rate we presently plan or that any
existing regulatory barriers to such expansion will be reduced or eliminated.
As a result of past and expected future growth and expansion, significant
demands have been placed on our management, operational and financial resources
and on our systems and controls. In order to manage our growth effectively,
including growth resulting from acquisitions, we must continue to implement and
improve our operational and financial systems and controls, purchase and utilize
additional telecommunications facilities and expand, train and manage the
employee base. Inaccuracies in our forecasts of market demand could result in
insufficient or excessive telecommunications facilities and disproportionate
fixed expenses for certain of our operations. As we proceed with our development
and expansion, there will be additional demands on our customer support, sales
and marketing and administrative resources and network infrastructure. We cannot
assure you that we and our ventures' operating and financial control systems and
infrastructure will be adequate to maintain and effectively manage future
growth. If we fail to continue to upgrade our administrative, operating and
financial control systems or unexpected expansion difficulties arise, there
could be a material adverse effect on our business, results of operations and
financial condition.
RISKS RELATING TO OPERATIONS IN EMERGING MARKETS
We derive substantial revenues from our operations in emerging markets.
Emerging markets subject us to numerous risks, including the following:
- underdeveloped and unstable banking systems;
- corruption;
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- unexpected changes in regulatory requirements, tariffs, customs and
duties and other trade barriers;
- difficulties in staffing and managing foreign operations;
- foreign exchange controls, which may restrict or prohibit funds from
being exchanged into US dollars and/or transferred abroad;
- potential adverse tax consequences from operating in multiple
jurisdictions with different tax laws;
- problems in collecting accounts receivable and devaluation of accounts
receivable in an inflationary economy;
- political risks and expropriation;
- technology export and import restrictions and prohibitions;
- delays from customs brokers or government agencies;
- seasonal reductions in business activity; and
- fluctuations in currency exchange rates.
The emerging market risks described above could have a material adverse
effect on our business, results of operations and financial condition.
The political systems of many of the emerging market countries in which we
operate or plan to operate are slowly emerging from an extended period 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 and investment. Expropriation of private
businesses in such jurisdictions remains a possibility. Seizures of businesses
or assets may take the form of an outright taking, a ban on the exercise of
foreclosure rights, a confiscatory tax, refusal to renew licenses or other
policies. Such factors or actions to expropriate or seize our operations could
have a material adverse effect on us or our operations or frustrate or deny the
exercise of our rights. We cannot assure you that free market reforms undertaken
in certain of the emerging market countries in which we operate will continue to
proceed, let alone succeed, and signs of economic instability, retrenchment and
scapegoating are evident. These factors may reduce and delay business activity,
economic development and foreign investment.
Judicial officials operating in legal systems in emerging market countries
frequently have little or no experience with commercial transactions between
private parties. The extent to which our contracts and other obligations owed to
us will be honored and enforced in emerging market countries is uncertain. We
may not be able to protect and enforce our rights in emerging market countries,
which could have a material adverse effect upon our operations. Additionally,
our businesses operate in uncertain regulatory environments. The laws and
regulations applicable to our activities in emerging market countries are in
general new and subject to change and, in some cases, inconsistent and
incomplete. We cannot assure you that local laws and regulations will become
stable in the future. Changes to such laws
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and regulations could materially adversely affect operations and our ability to
pay our debts. Such changes could adversely affect the value of Common Stock.
See "Business."
RISKS RELATING TO OPERATIONS IN RUSSIA AND THE CIS
To date, we have earned substantially all of our revenue from operations in
Russia and the CIS. Foreign companies conducting operations in the former Soviet
Union face significant political, economic, and legal risks. We continuously
evaluate a number of potential transactions, some of which may involve the
contribution of certain of our Russian businesses in exchange for an interest of
equal or greater value in the surviving entity. The completion of any such
transaction could be material to our operations and financial condition and
could increase our exposure to such risks.
Political. The political systems of Russia and the other independent
countries of the CIS are in a stage of transition. These systems have been and
may become more unstable due to political gridlock, as well as the populace's
dissatisfaction with reform, social and ethnic unrest, economic difficulties and
changes in government policies. Such instability could lead to events that could
have a material adverse effect on our operations in these countries.
In recent years, Russia has been undergoing a substantial political
transformation. During this transformation, the Russian parliament enacted
legislation to protect private property against expropriation and
nationalization. However, due to the lack of experience in enforcing these
provisions during the period they have been in effect and due to potential
political changes in the future, we cannot assure you that such protections
would be enforced. Expropriation or nationalization of all or a portion of our
business or our assets, whether by an outright taking, a ban on the exercise of
foreclosure rights or by confiscatory tax or other policies potentially without
adequate compensation, would have a material adverse effect on our operations
and the market price of Common Stock.
The various government institutions in Russia and the CIS 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. Any major changes in, or rejection of, previous policies favoring
political and economic reform by the President may have a material adverse
effect on our operations and the market price of Common Stock.
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. At that time, President
Yeltsin directed the formation of a new government led by Sergei Kireyenko, the
young Prime Minister committed to continuing political and economic reforms.
Since March 1998, dramatic political changes have occurred in Russia. In August
1998, Yeltsin dismissed the Kireyenko government and engaged in a struggle with
Parliament over leadership of the new government. Ultimately, under pressure
from Parliament, Yeltsin withdrew his nomination of Victor Chernomyrdin and
accepted Yevgeny Primakov as a compromise candidate. Primakov rapidly received
approval from the Duma.
Primakov has formed his government and is seeking to develop and implement
policies to address Russia's current economic crisis. Primakov is not expected
to follow the pro-market reform policies of his predecessors. His appointments
and policy pronouncements to date are mixed, suggesting that he favors lower
value-added and profit taxes, greater government intervention in the economy,
deficit spending and stricter currency controls. It is too soon to
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determine what impact Prime Minister Primakov's policies will have on our
business in Russia. The political situation remains very unsettled, especially
in view of President Yeltsin's deteriorating health and erratic stewardship of
the country. In addition, it is uncertain whether the resolution of these and
other issues could have a material adverse effect on our operations.
Furthermore, the political and economic changes in Russia have resulted in
significant dislocations of authority. As a result of the turmoil at the federal
government level and the continuing absence of a strong central government, the
regions of Russia are exercising more independence in both political and
economic policies. Significant organized criminal activity and high levels of
corruption among government officials exist where we operate. While we do not
believe we have been adversely affected by these factors to date, organized or
other crime could in the future have a material adverse effect on our operations
and the market price of Common Stock.
Economic. Russia's serious economic crisis places at risk the economic
reforms the Russian government has enacted. In particular, the government has
suffered serious setbacks in reducing inflation and stabilizing the currency.
These reforms were designed to create the conditions for a more market-oriented
economy. For some time, Russia has experienced generally rising unemployment and
underemployment, high government debt relative to gross domestic product and
high levels of corporate insolvency. Russia continues to experience chronic
problems in its tax collection policies. Low tax receipts, coupled with the
recent downturn in commodity prices on world markets, have created a serious
liquidity problem. The Russian stock market lost approximately 85% of its value
during the first ten months of 1998 over concerns about Russia's economy and
political instability. Under these circumstances, we cannot assure you that (i)
reform policies will continue to be implemented and, if implemented, will be
successful, (ii) Russia will remain receptive to foreign trade and investment or
(iii) the economy will not suffer additional substantial setbacks. If the
Russian economy does not improve, it is likely this will have a material adverse
effect on the demand for our services offered in Russia.
In response to these economic problems, in May and early June 1998, the
Russian Central Bank and other Russian governmental authorities adopted a number
of measures, including increasing the inter-bank lending rate charged by the
Russian Central Bank and the rate offered on sovereign debt obligations, in
order to maintain the value of the ruble and reduce the risk of the flight of
foreign capital from the Russian economy. On July 13, 1998, the International
Monetary Fund, the World Bank and the Japanese government announced a plan to
lend Russia $22.6 billion by the end of 1999. Since its disbursement of a first
tranche of $4.8 billion at the end of July 1998, the International Monetary Fund
has refused to release additional funds until the Russian government implements
a number of economic reforms, including measures to enhance tax collections and
narrow the budget deficit. The World Bank and the Japanese government appear to
be following the International Monetary Fund's lead with respect to their
remaining commitments under the $22.6 billion loan. The measures taken in May,
June and July 1998 failed to stabilize the economy and to provide adequate
liquidity.
On August 17, 1998, the Russian government and the Central Bank of Russia
announced emergency steps to improve liquidity (the "August 17 Decision").
Pursuant to this decision, the ruble's value was allowed to float between 6.0
and 9.5 rubles to the US Dollar. Also, a 90-day moratorium was placed on the
payment of foreign exchange to meet certain
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obligations of Russian entities. Finally, the Russian government announced that
it intended to restructure the payment terms of certain treasury bills. Since
the August 17 Decision, the ruble's value has declined substantially below the
9.5 ruble/US Dollar floor set in the August 17 Decision. As a result, our
financial performance has been negatively affected. We recorded a $13.1 million
pre-tax charge for the quarter ended September 30, 1998, which consisted
primarily of foreign currency exchange losses for ruble-denominated net monetary
assets. The remainder of the charge consists of estimates for uncollectible
accounts receivable and unrecoverable cash deposits in certain Russian banks.
In addition, the Russian government has defaulted on payments, and proposed
a restructuring, of certain commercial and 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.
Although the 90-day moratorium has not been extended, the consequences of
the August 17 Decision and its aftermath remain unclear. We cannot assure you
that these emergency measures, coupled with the policies of Russia's new
government, will be sufficient to stabilize the currency, enhance liquidity,
avoid hyperinflation, improve the collections, narrow the budget or prevent
further economic dislocation. In particular, there is a risk that there could be
a further significant and sudden decline in the value of the ruble resulting in
additional exchange-related losses and increased loss of investor confidence in
the Russian economy. Such consequences could have a material adverse effect on
us and our financial condition and results of operations and the Russian economy
generally. See "-- Risks of Conducting Business in Foreign Currencies."
The International Monetary Fund and the G-7 have thus far refused to
advance emergency funds to Russia to address the recent liquidity crisis. In
addition, the International Monetary Fund may not disburse the remaining
portions of the $22.6 billion loan referenced above, unless the Russian
government complies with the conditions of such loan. This underscores the
extent to which Russia, the CIS and other emerging countries in which we operate
are dependent upon substantial financial assistance from several foreign
governments and international organizations. If 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 lack of
liquidity. 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 our financial performance and the viability of our receivables, our
ability to recover funds deposited in Russian banks and on our operations. The
banking crisis could also adversely affect the value of Common Stock.
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
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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, Goskomsvyaz, the successor of
the Russian Ministry of Communications, has adopted the position that licensees
may enter into agreements with third parties to provide services under the
licensee's license. However, Goskomsvyaz does not generally review agreements
entered into by licensees. Current or future regulation of the Russian
telecommunications systems could have a material adverse effect on our
operations and on the market price of Common Stock.
Current Russian legislation governing foreign investment activities does
not prohibit or restrict foreign investment in the telecommunications industry.
However, press reports from Russia reveal that certain factions of the Russian
government are considering nationalizing certain strategic industries and
imposing foreign ownership restrictions as a result of the August 17 Decision
and its aftermath. Nationalization of industries or future regulation of foreign
investment in the telecommunications industry could have a material adverse
effect on our operations and on the market price of Common Stock.
In addition, members of the Russian government cannot agree on the manner
and scope of government control over the telecommunications industry. Because
the telecommunications industry is widely viewed as strategically important to
Russia, we cannot assure you that 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 our operations and
on the market price of Common Stock. See "Business -- Russia and the
CIS -- Licenses and Regulatory Issues."
Legal Risks. The Russian and CIS governments have made an effort to
transform their economies into more market-oriented economies. In particular
they 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:
- the untested nature of the independence of the judiciary and its immunity
from economic, political or nationalistic influence;
- the relative inexperience of judges and courts in commercial dispute
resolutions and legal interpretation;
- inconsistencies among laws, presidential edicts, government decrees and
ministerial orders;
- the lack of legislative, judicial or administrative guidance on
interpreting the applicable rules;
- 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; and
- problems in enforcing judicial and administrative decisions.
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, we cannot assure you
that we will be able to enforce our rights
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in any disputes with our joint venture partners or other parties in Russia or
the CIS. In addition, we cannot assure you that our 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 we will be
found to be in compliance with all applicable laws, rules and regulations.
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. In addition,
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 that they are
paid. 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 us.
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, our Russian taxes may
be in excess of the estimated amount expensed to date and accrued on our balance
sheets. It is our opinion that the ultimate resolution of our Russian tax
liability, to the extent not previously provided for, will not have a material
adverse effect on our Russian shareholding and financial condition. However,
depending on the amount and timing of an unfavorable resolution of this
contingency, it is possible that our future results of operations or cash flows
could be materially affected in a particular period.
In various foreign jurisdictions, we are obligated to pay value-added tax
on the purchase or importation of assets, and for certain other transactions. In
many instances, value-added tax liabilities can be offset against value-added
tax which we collect 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 we are obligated to pay additional amounts of
value-added tax. In our opinion, any additional value-added tax which we may be
obligated to pay would be immaterial.
ADEQUACY OF MANAGEMENT, LEGAL AND FINANCIAL CONTROLS IN EMERGING MARKETS
Many of the emerging market countries in which we operate, including Russia
and the CIS, are deficient in management and financial reporting concepts and
practices, and lack modern banking, computer and other control systems. We have
also historically had difficulty hiring and retaining a sufficient number of
qualified employees to work in these markets. As a result, we have had
difficulty:
- establishing management, legal and financial controls;
- collecting financial data;
- preparing financial statements, books of account and corporate records;
and
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- instituting business practices that meet Western standards.
We have a policy worldwide of complying with all applicable laws and
ensuring that all of our employees understand and comply with such laws. The
application of the laws of any particular country, however, is not always clear
or consistent. Emerging market countries often have commercial practices and
less developed legal and regulatory frameworks that differ significantly from
practices in the United States and other Western countries. 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 and other western countries. As a result of the difficulty we have
experienced in emerging markets in instituting business practices that meet
Western reporting and control standards, we have been unable to ascertain
whether certain practices by our ventures, which were not in accordance with our
policy, were in compliance with applicable US and foreign laws. If it were to be
determined that we or any of our ventures were involved in unlawful practices
and were the factual and legal issues relating thereto to be resolved adversely,
we or our ventures could be exposed, among other things, to significant fines,
risk of prosecution and loss of our licenses. See "-- Risks Relating to
Operations in Emerging Markets" and "-- Government Regulation."
In light of these circumstances, in the second half of 1996 we increased
our efforts to improve our management and financial controls and business
practices. We recruited a more experienced financial and legal team, including a
new Chief Financial Officer for GTS, a senior finance officer overseeing all of
the regions in which we operate, a senior finance officer for the CIS region,
and a senior legal officer for the CIS region. We also established a treasury
group and adopted a more rigorous Foreign Corrupt Practices Act compliance
program. We have developed and implemented a training program for employees
regarding US legal and foreign local law compliance. We also appointed a
Compliance Officer responsible for monitoring compliance with such laws and
training our personnel around the world. In connection with these developments,
we expanded our corporate business practices policy to include, in addition to
compliance with US laws such as the Foreign Corrupt Practices Act, compliance
with applicable local laws such as the conflict of interest rules under the 1996
Russian Joint Stock GTS Law, currency regulations and applicable tax laws.
In addition, in early 1997, we retained special outside counsel to conduct
a thorough review of certain of our business practices in the emerging markets
in which we operate to determine whether deficiencies existed that needed to be
remedied. As a result of this review, we replaced certain senior employees in
Russia and instituted additional and more stringent management and financial
controls. The review did not identify any violations of law that we believe
would have a material adverse effect on our financial condition. However, if we
were found by government authorities to have violated any law, depending on the
penalties assessed and the timing of any unfavorable resolution, future results
of operations and cash flows could be materially adversely affected in a
particular period.
Although we believe that the special counsel review was properly conducted
and was sufficient in scope, we cannot assure you that all potential
deficiencies have been identified or that the control procedures and compliance
programs initiated will be effective. We believe, however, that the actions
taken since the review to strengthen our management, financial controls and
legal compliance will be adequate to address any possible deficiencies. In
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addition, the Audit Committee of the GTS Board recently reviewed the legal
compliance procedures. The implementation of their recommendations and their
continued oversight of the compliance process in the future will help to ensure
that any problems in such procedures are addressed.
DEPENDENCE ON CERTAIN LOCAL PARTIES; ABSENCE OF CONTROL
We developed many of our operations, including joint ventures under GTS
Business Services -- CIS, such as Sovintel, TeleRoss and GTS Cellular, in
cooperation or partnership with key local parties, such as regional telephone
companies. We are substantially dependent on our local partners to provide us
with marketing expertise and knowledge of the local regulatory environment. This
local knowledge helps facilitate the acquisition of necessary licenses and
permits. Our failure to form or maintain alliances with local partners, or the
preemption or disruption of such alliances by our competitors or otherwise,
could adversely affect our ability to penetrate and compete successfully in the
emerging markets in which we operate or plan to enter. In addition, in the
uncertain legal environments in which we operate, certain of our 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 us.
Under the terms of various joint venture agreements we have the right to
nominate key employees, direct the operations and determine the strategies of
such joint ventures' governance. However, our partners in some ventures have the
ability to frustrate the exercise of such rights. Significant actions by most
ventures, such as approving budgets and business plans, declaring and paying
dividends, and entering into significant corporate transactions effectively
require the approval of our local partners. Further, we would be unlikely as a
practical matter to want to take significant actions without the approval of our
joint venture partners. Accordingly, our inability to unilaterally control the
operations of our joint ventures could have a material adverse effect on our
operations and on the market price of Common Stock.
In addition, we frequently compete with venture partners in the same
markets. For example, Rostelecom, our partner in Sovintel, is the dominant
international and domestic long distance carrier in Russia. Similarly, many of
our regional telephone company partners in the TeleRoss Ventures offer cellular
services in direct competition with certain of the operations of GTS Cellular.
Such competition may lead to conflicts of interest for us or our partners in the
operations of these ventures. We cannot assure you that any such conflicts will
be resolved in our favor. See "-- Risks Relating to Reorganization of Russian
Telecommunications Industry."
GOVERNMENT REGULATION
As a multinational telecommunications company, we are subject to varying
degrees of regulation in each of the jurisdictions in which our ventures provide
services. Local laws and regulations, and the interpretation of such laws and
regulations, differ significantly among the jurisdictions in which we operate.
Future regulatory, judicial and legislative changes could have a material
adverse effect on our operations and on the market price of Common Stock. In
addition, regulators or third parties may raise material issues with regard to
our compliance or noncompliance with applicable regulations.
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Many of our ventures require telecommunications licenses, most of which
were granted for periods of 3 to 10 years. The terms and conditions of these
licenses may limit or otherwise affect the ventures' scope of operations. We
have had favorable experience obtaining, maintaining and renewing licenses in
the past. However, we cannot assure you that we will be able to obtain, maintain
or renew licenses to provide the services we currently provide and plan to
provide or that such licenses will be issued or renewed on terms or with fees
that are commercially viable. In addition, we cannot assure you that we can
obtain licenses required by future ventures. The loss of or a substantial
limitation upon the terms of these telecommunications licenses could have a
material adverse effect. See each section under "Business" entitled "Licenses
and Regulatory Issues."
A substantial portion of HER's strategy is based upon the timely
implementation of regulatory liberalization of the EU telecommunications market.
This liberalization is occurring in accordance with existing EC directives.
Although EU member states had a legal obligation to liberalize their markets in
accordance with these directives by January 1, 1998, further measures may be
required to make markets fully competitive. In addition, the EC granted Ireland,
Portugal, Spain, Luxembourg and Greece extensions from the January 1, 1998
deadline. Ireland and Spain subsequently liberalized on December 1, 1998.
In order to give effect to EC directives in each member state, national
governments must pass legislation implementing the directives. Some EU member
states have yet to implement existing EC directives fully and similar delays may
occur in the implementation of any future directives. This could limit,
constrain or otherwise adversely affect HER's ability to provide certain
services. Even if an EU member state adopts liberalization measures in a timely
way, there may be significant resistance to the implementation of such measures
from established national or regional telecommunications operators, 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 international services between the EU and other countries 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. These
obstacles could also have a material adverse effect on our operations and on the
market price of Common Stock.
We cannot assure you 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 may not occur.
COMPETITION
We face significant competition in all of our existing telecommunications
businesses and for acquisition and development opportunities in both emerging
and Western European markets.
Our competitors in these markets include the following:
- established national or regional telecommunications operators,
- multinational telecommunications carriers,
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- other telecommunications developers,
- certain niche telecommunications providers and
- joint venture partners.
In addition, as a result of the recent combination under Svyazinvest of the
Russian government's majority interest in Rostelecom and 85 of the regional
telephone companies, we may be subject to more coordinated competition from our
partners in the Russian telecommunications market in the future. Although we
believe we have a favorable and cooperative relationship with our joint venture
partners, we cannot assure you that these partners will continue to cooperate
with us in the future or that they will not increase competitive pressures. Any
measures taken by the partners that reduce their level of cooperation with us
could jeopardize our ability to participate in the management and operation of
our joint ventures and could have a material adverse effect on our operations
and on the market price of Common Stock.
The European and international telecommunications industries are
competitive. Various telecommunications companies, including MCI WorldCom, Inc.,
Viatel, Inc., KPN N.V., Qwest Communications International, Inc., Deutsche
Telekom AG and France Telecom S.A., Global Crossing Ltd. and British
Telecommunications plc, have announced plans to construct, have begun to
construct or are operating fiber optic networks across various European
countries.
HER's "point-to-point" transborder service offering also competes with
circuits currently provided by large established national carriers through
international private leased circuits. The liberalization of the European
telecommunications market is likely to attract additional entrants to both the
"point-to-point" and other telecommunications markets. We cannot assure you that
HER will compete effectively against its current or future competitors.
Many of our competitors have substantially greater technical, financial,
marketing and other resources. We cannot assure you that we will be able to
successfully overcome the competitive pressures to which we are subject in our
present and future operating markets. See each section under "Business" entitled
"Competition."
Many of our current and potential competitors are not subject to, or
constrained by the prohibitions of, the Foreign Corrupt Practices Act, including
the prohibition against making payments to government officials in order to
obtain commercial benefits. We are subject to, and seek to comply with, the
limitations and prohibitions of such law, and accordingly may be subject to
competitive disadvantages to the extent that our competitors are able to secure
business, licenses or other preferential treatment through the making of such
payments. Accordingly, we cannot assure you that we 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."
CERTAIN STOCKHOLDERS MAY INFLUENCE MAJOR DECISIONS IN OUR BUSINESS
At December 31, 1998, the Soros Associates beneficially owned approximately
12.5% of Common Stock and Alan B. Slifka and certain of his affiliates
beneficially owned 5.8% of Common Stock. In addition, two persons who are
affiliated with the Soros Associates serve
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on the GTS Board. As a result, either of these two stockholder groups may
significantly influence decisions which stockholders must approve, such as the
election of directors and other decisions relating to the management of
business.
RISKS OF CONDUCTING BUSINESS IN FOREIGN CURRENCIES
We conduct all of our operations outside the United States. As a result, a
substantial portion of our revenues (as well as the majority of its operating
expenses) are in foreign currencies, which will subject us to significant
foreign exchange risks. In particular, because we do business in certain
countries that have "soft currencies", we may accumulate cash in currencies that
are not readily convertible into hard currency, significantly limiting our
ability to repatriate our profits from those countries. These factors may
adversely affect our operations, as well as limit our ability to reinvest
earnings from ventures in one country to fund the capital needs of our ventures
in other countries.
We have earned most of our revenue to date in Russia. The value of the
ruble against the US Dollar has steadily declined. As a result of the August 17
Decision and its aftermath, the value of the ruble against the US Dollar has
fallen even more significantly, negatively affecting our financial performance.
During the quarter ended September 30, 1998, we recorded a $13.1 million pre-tax
charge. The largest portion of the charge consisted of foreign currency exchange
losses on our net monetary assets that are denominated in rubles. The remainder
of the charge reflects our estimate on our ability to collect accounts
receivable and the potential loss of cash deposits in Russian banks.
The tariffs we set for our customers in Russia are generally denominated in
US Dollars, whereas we invoice and collects its charges in rubles. Our major
capital expenditures are generally denominated and payable in various foreign
currencies. When these capital expenditures involve importing equipment and the
like, current law permits us to convert our ruble revenues into foreign currency
to make such payments. However, as a result of the August 17 Decision and its
aftermath, it may become more difficult for us to convert rubles to US Dollars
or other "hard" currencies.
The ruble is generally non-convertible outside Russia, although, in late
April 1998, the Chicago Mercantile Exchange announced that the ruble is a
currency that will be available for futures and options trading. Within Russia,
the market for converting rubles into other currencies is limited and is subject
to rules that restrict the purposes for which conversion and payment are
allowed. This market may become even more restricted as a result of policies the
new Russian government may implement. The limited availability of other
currencies may tend to inflate their values relative to the ruble. It is
uncertain whether such a market in Russia will continue to exist.
The banking system in Russia is in crisis as a result of the August 17
Decision and its aftermath. Considerable delays may occur in the transfer of
funds within, and the remittance of funds out of, Russia. The 90-day moratorium
that the August 17 Decision imposed on certain foreign exchange payments delayed
transfers of funds. Although the 90-day moratorium has expired, it could be
renewed or established in another form if the Russian government and Central
Bank anticipate further liquidity crises. Any delay in converting rubles into
foreign currency to make a payment or delay in the transfer of such foreign
currency could have a material adverse effect on our operations and on the
market price of Common Stock.
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When the Russian government announced the August 17 Decision, it abandoned
its policy since November 1997 of pegging the ruble/US Dollar exchange rate to
fluctuate within a certain narrow range. Since the August 17 Decision, the
Russian authorities have been unable to maintain a stable exchange rate. Thus,
an additional significant and sudden decline in the value of the ruble might
occur. A significant and sudden devaluation of the ruble could have a material
adverse effect on us and our results of operations.
We historically have not used hedging transactions to limit our exposure to
risks from doing business in foreign currencies. We have developed risk
management policies that establish guidelines for managing foreign exchange
risk. As part of these policies, we have designed a reporting process to monitor
the potential exposure on an ongoing basis. We use the output of this process to
determine the materiality of foreign currency exposure and determine whether it
is practical and/or economically justified to execute financial hedges.
For those operating companies that transact their business in currencies
that are not readily convertible, our ability to hedge exposure is limited
because financial hedge instruments for these countries are nonexistent or
limited and also pricing of these instruments is often volatile and not always
efficient. We attempt to minimize our exposure by indexing our 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 US dollars. Although we are attempting to match revenues, costs,
borrowing and repayments in terms of their respective currencies, we have
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 US dollar. In April 1998, HER entered into a currency swap contract
to limit its exposure to currency risks from the $265 million of 11.5% senior
notes that HER issued in August 1997.
EXCHANGE CONTROLS AND RISKS OF NOT BEING ABLE TO REPATRIATE PROCEEDS FROM
RUSSIAN INVESTMENTS
Russia has adopted currency and capital transfer regulations to prevent the
flight of capital from its borders. These regulations require certain licenses
for the movement of capital. The incurrence and repayment of debt and the
payment of capital contributions in foreign currency to Russian entities are
subject to these regulations. We are resolving licensing issues with respect to
certain intercompany loans and capital contributions with the applicable
government agencies. We do not believe that the issues raised by these agencies
concerning our license will have a material adverse effect on our financial
condition or results of operations. It is possible, however, that the Russian
government authorities could take an unexpected adverse position on these issues
that could materially affect our business.
We cannot assure you that Russian foreign investment and currency
legislation will continue to permit us to repatriate the proceeds from our
investments. We also cannot be sure whether the Russian government authorities
will impose more restrictions on the conversion of ruble earnings into foreign
currency to pay dividends or repatriate profits. If further restrictions were
imposed, they would have a material adverse effect on our interests in Russia.
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DEPENDENCE ON KEY PERSONNEL
We believe that our growth and future success will depend in large part
upon a small number of key executive officers, as well as on our ability to
attract and retain highly skilled personnel to work in the emerging markets in
which we operate. The competition for qualified personnel in the
telecommunications industry is intense, particularly in the emerging markets
where we operate. We cannot assure you that we will be able to hire and retain
qualified personnel. Despite changes of personnel in Russia and the CIS, we
believe we have maintained a strong management team. However, we cannot assure
you as to what effect such personnel changes will have on our operations in
Russia and the CIS.
DEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS
We must record and process massive amounts of data quickly and accurately.
While we believe our ventures' management information systems are currently
adequate, these systems will have to grow as the businesses expand. We believe
that the successful expansion of our information systems and administrative
support will be important to our continued growth, as well as to our ability to
monitor and control costs, to bill customers accurately and on time and to
achieve operating efficiencies. We may, however, encounter delays or
cost-overruns or suffer adverse consequences in implementing these systems. Any
such delay or other malfunction of our management information systems could have
a material adverse effect on our business, financial condition and results of
operations.
TAXES; NET OPERATING LOSS CARRYFORWARDS MAY NOT BE USABLE
The tax rules and regimes which exist in certain emerging markets in which
we operate or plan to operate are, in many cases, new and rapidly changing. If
we repatriate profits from those countries, we may incur additional taxes. Also,
other taxes, such as value added tax, excise taxes and import duties are
changing at an unpredictable pace and could have an adverse effect on our
operations.
We rely on certain tax benefits in the countries in which we operate as
well as in the United States. Our ability to use these tax benefits is subject
to changes in the rules relating to tax holidays and in the provisions of tax
treaties with the United States. Some of our ventures in the CIS and Hungary
benefit from tax holidays granted by local governments. These tax holidays range
from five to several years, and go into effect once our operations achieve
profitability under local tax regulations. In addition to those tax holidays,
certain of our foreign ventures have accumulated foreign tax loss carryforwards
in excess of $60.0 million.
As of December 31, 1997, we had net operating loss carryforwards for US
federal tax purposes of approximately $110 million expiring in 2003 through
2012. Because of the "change in ownership" provisions of the Tax Reform Act of
1986, our ability to use the tax benefits from our net operating loss
carryforwards is subject to an annual limit as a result of the initial public
offering and the follow on stock offering and convertible senior subordinated
debenture due 2010 offering carried out in July 1998.
Our financial statements do not reflect any provision for the tax benefits
from the US and non-US loss carryforwards. We cannot assure you that local tax
authorities will allow us to apply these loss carryforwards, in part or full, to
reduce taxes on our future income.
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CHANGES IN TECHNOLOGY
The telecommunications industry has experienced rapid changes in
technology. These technological advances may reduce the effectiveness of
existing technology and equipment. The cost to implement emerging and future
technologies could be significant. Also, we buy or use telecommunications
equipment from a number of vendors. We depend on these vendors to adapt this
equipment to meet varying local telecommunications standards. We may be unable
to maintain competitive services or obtain new technology on a timely basis or
on satisfactory terms. If we fail to maintain competitive services, or obtain
new technologies, that could have a material adverse effect on business,
financial condition and results of operations.
Developing and operating the HER network also poses certain technological
risks. The network is designed to use SDH technology. While SDH is an advanced
new transmission technology, HER may need to upgrade its technology from the SDH
platform to be able to offer its services at a cheaper price than its
competitors. We cannot assure you that the HER network will achieve the
technical specifications for which it was designed. HER also may be unable to
upgrade the network as technological improvements are introduced. These factors
could materially and adversely affect the viability of the HER network, our
prospects, operations and the market price of our Common Stock.
RISKS ASSOCIATED WITH POTENTIAL FAILURE OF OUR SYSTEMS TO RECOGNIZE YEAR 2000
The Year 2000 issue is the result of computer programs using two digits
rather than four to define the applicable year. Because of this programming
convention, software, hardware or firmware may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in system failures,
miscalculations or errors causing disruptions of operations or other business
problems, including among others, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
We are undertaking a comprehensive program to address the Year 2000 issue
with respect to the following:
- Our information technology systems;
- Our non-information technology systems;
- Our business partners;
- The systems of our telecommunications, hardware and software vendors; and
- Our customers.
Our Year 2000 program involves four phases: (1) a wide ranging assessment
of Year 2000 problems that might affect us; (2) the development and
implementation of remedies to address discovered problems; (3) preventing future
Year 2000 problems from arising; and (4) the testing of our system. We completed
phase 1 at the end of the fourth quarter of 1998. We began phases 2, 3 and 4 of
this program during the first quarter of 1999. These phases are expected to be
completed during the second quarter of 1999. Both we and Esprit Telecom have
identified to each other individuals at each respective company who will work
together to assess and remedy Year 2000 problems that might affect the combined
business.
The proper functioning of our systems also depends on the proper
functioning of systems of third parties, such as our telecommunications,
hardware and software vendors and our customers. In addition to currently
identifying our own applications that will not be Year 2000 compliant, we are
taking steps to determine whether third parties are doing the same. The failure
of third parties to remedy their own Year 2000 problems may cause business
interruptions or shutdown, financial loss, regulatory actions, reputational harm
and/or legal liability. We cannot assure you that our
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Year 2000 program or the programs of third parties who do business with us will
be effective or that our estimates about the timing and cost of completing our
program will be accurate. See "GTS Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Year 2000 Compliance."
DIFFICULTY IN OBTAINING RELIABLE MARKET INFORMATION
We operate in markets in which it is difficult to obtain reliable market
information. We have based our business planning on certain assumptions
concerning total revenue, business and consumer breakdown revenue, revenue from
various products and services, pricing, competition, operating expenses and
capital expenditures and our own investigation of market size and conditions and
our experience in other markets. We cannot assure you that either our
assumptions or data provided by outside sources are accurate or that they are
indicative of actual market conditions.
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS; POTENTIAL ADVERSE IMPACT
ON MARKET PRICE FROM SALES OF COMMON STOCK
As of December 31, 1998, 64,577,715 shares of Common Stock were outstanding
excluding (v) 9,639,506 shares for which outstanding warrants and vested options
are exercisable, (w) 5,880,050 shares into which the Convertible Bonds are
convertible, (x) the 8,481,417 shares into which the Debentures are convertible,
and (y) 163,795 of additional shares to be issued resulting from the NetSource
acquisition. Further, subject to NetSource meeting certain performance targets
during the first two quarters of 1999, an additional 1.4 million shares of
unregistered common stock may be issued.
Of the 64,577,715 outstanding shares of Common Stock, the 12,765,000 shares
registered in the IPO and the 14,506,900 shares registered in the July 1998
Stock Offering will be freely tradable without restriction under the Securities
Act. However such shares held by "affiliates" may generally be resold only in
compliance with applicable provisions of Rule 144 under the Securities Act, as
described below. Of the remainder, approximately 20,000,000 additional shares
have been resold or may be resold under Rule 144 without restriction under the
Securities Act. An additional approximately 12,762,000 shares have been resold
or may be resold under Rule 144 subject to volume and manner limitations. In
addition, the 8,481,417 shares into which the Debentures are convertible will be
freely tradable without restriction under the Securities Act.
In addition, we filed and the SEC declared effective three registration
statements. One registration statement covers the resale of the Convertible
Bonds and the shares of Common Stock into which the Convertible Bonds are
convertible. Two registration statements on Form S-8 cover the resale of shares
of Common Stock issued to employees, officers and directors under our employee
benefit plans.
Furthermore, we have agreed to file with the SEC a shelf registration
statement (the "Shelf Registration Statement") covering all of the shares of
Common Stock (and securities convertible into or exercisable for shares of
Common Stock) owned by Alan B. Slifka and his affiliates and the Soros
Associates that were not sold in the July 1998 Stock Offering (the "Affiliate
Shares"). We agreed to file the Shelf Registration Statement in exchange for
these shareholders agreeing to certain restrictions on their ability to resell
such Affiliate Shares. These restrictions apply for specified periods after
closing of the July 1998 Offerings. Under these restrictions, holders of
Affiliate Shares cannot, subject to certain exceptions, sell any
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such shares during the first six months after the closing date of the July 1998
Offerings. They may, however, sell 50% of such shares six months after the
closing date of the July 1998 Offerings; 75% of such shares nine months after
the closing date of the July 1998 Offerings; and 100% of such shares twelve
months after the closing date of the July 1998 Offerings.
Certain limited partners of partnerships affiliated with Alan B. Slifka and
currently in dissolution may, upon giving advance notice, withdraw some or all
of their shares of Common Stock from registration under the Shelf Registration
Statement. By withdrawing their shares, those persons would no longer be bound
by the restrictions on sale. The number of shares of Common Stock that such
persons may withdraw is capped at 726,953 shares of Common Stock minus the
number of shares such persons sold in the July 1998 Stock Offering.
We have also agreed to file a shelf registration statement covering all of
the shares of Common Stock that may be issued to holders of NetSource stock in
connection with the acquisition of NetSource. We may issue up to a total of
5,437,500 shares in connection with this acquisition (including up to 1.4
million shares that may, at our option, be issued contingent on NetSource
achieving certain performance targets in the first two quarters of 1999).
In addition, we have agreed to file a shelf registration statement covering
all of the shares of Common Stock that may be issued to Apex Funds Nominees
Limited and Warburg, Pincus Ventures, L.P., two institutional shareholders of
Esprit Telecom Group plc, upon the closing of our offer for Esprit Telecom. We
will issue approximately 6.2 million shares of Common Stock to these two Esprit
Telecom shareholders if the offer is closed.
We cannot predict what effect, if any, that future sales of Common Stock or
the availability of Common Stock for sale would have on the market price for our
Common Stock. Sales of large numbers of shares of Common Stock in the public
market pursuant to Rule 144 or pursuant to an effective registration statement
under the Securities Act, or the perception that sales could occur, may have an
adverse effect on the market price for Common Stock. "Description of Capital
Stock -- Prior Purchase Agreements -- Registration Rights."
NO DIVIDEND PAYMENTS ARE EXPECTED
We do not intend to pay any cash dividends in the foreseeable future. Also,
our ability to pay dividends is prohibited under the terms of an existing debt
agreement. If we raise any capital in the future, we may be restricted from
paying dividends under the terms of such financings. In addition, the August 17
Decision and other actions that the Russian government may take in the future
may restrict the ability of the ventures in Russia to declare and pay dividends.
ANTI-TAKEOVER PROVISIONS
Certain anti-takeover provisions could delay or prevent a third party from
gaining control of GTS in a transaction that the GTS Board had not negotiated
and approved, even if such change in control would be beneficial to
stockholders. These anti-takeover provisions include:
- Section 203 of the Delaware General Corporations Law, which prohibits a
"business combination" between a corporation and an "interested
stockholder" within three
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years of the stockholder becoming an "interested stockholder" except in
certain limited circumstances.
- Certain provisions of our charter and by-laws, including:
- a classified GTS Board serving staggered three-year terms;
- restrictions on who may call a special meeting of stockholders;
- a prohibition on stockholder action by written consent;
- restrictions on the removal of directors;
- supermajority voting requirements with respect to certain amendments to
the Charter; and
- the authority to issue shares of preferred stock and to determine the
rights without stockholder approval.
- A shareholders' rights plan.
See "Description of Capital Stock -- Certain Charter and By-law
Provisions."
US JUDGMENTS MAY NOT BE ENFORCEABLE ABROAD
Substantially all of our assets (including all of the assets of our
operating ventures) are located outside the United States. As a result, it will
be necessary for you to comply with foreign laws in order to enforce judgments
obtained in a US court (including those with respect to federal securities law
claims) against the assets of our operating ventures. We cannot assure you that
any US judgments would be enforced under any such foreign laws.
STOCK PRICE MAY BE VOLATILE
The market price for Common Stock could fluctuate due to various factors.
These factors include:
- political and economic development in emerging markets (including Russia
and the CIS);
- announcements by us or our competitors of new contracts, technological
innovations or new products;
- other announcements concerning us or our competitors;
- changes in government regulations;
- fluctuations in our quarterly and annual operating results; and
- general market conditions.
In addition, the stock markets have, in recent years, experienced
significant price fluctuations. These fluctuations often have been unrelated to
the operating performance of the specific companies whose stock is traded.
Market fluctuations, as well as economic condi-
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tions, have adversely affected, and may continue to adversely affect, the market
price of Common Stock.
RISKS SPECIFIC TO ESPRIT TELECOM
Set out below is a description of certain risk factors that may affect
Esprit Telecom's business and results of operations from time to time as an
independent company. Should our proposed acquisition of Esprit Telecom be
completed, these risk factors could change in certain significant respects. In
addition, our announcement of the offer could impact the business of Esprit
Telecom in a variety of respects the effects of which are not yet known to
Esprit Telecom, but which could ultimately have adverse effects on Esprit
Telecom. In particular, should the proposed offer not be completed, the business
of Esprit Telecom may be materially adversely affected.
LIMITED OPERATING HISTORY; HISTORICAL AND ANTICIPATED FUTURE OPERATING LOSSES;
NEGATIVE EBITDA; NET LOSSES
Esprit Telecom commenced operations in June 1992 with limited business in
Spain and has since further expanded its operations to cover the United Kingdom,
Germany, The Netherlands, France, Belgium, Ireland and Italy. As a result of its
recent development, Esprit Telecom has generated limited revenue in markets
other than the United Kingdom, Germany and The Netherlands. Esprit Telecom, its
customer base and the Esprit Network have grown significantly in the last three
years as investments from its principal shareholders and proceeds from
financings have allowed Esprit Telecom to expand into key European markets. In
addition, Esprit Telecom intends to enter new European markets and offer new
telecommunications services. Accordingly, Esprit Telecom can offer no assurance
that Esprit Telecom's future operations will generate operating or net income,
and Esprit Telecom's prospects must therefore be considered in light of the
risks, costs and time constraints inherent in establishing operations and
introducing new telecommunications services in newly liberalizing markets.
Esprit Telecom has incurred and expects to continue to incur operating
losses, negative cash flow from operating activities and negative EBITDA while
it develops and expands the Esprit network, integrates the Plusnet business into
its current operations, opens new sales offices and introduces new
telecommunications services. Esprit Telecom could continue to generate net
losses even after Esprit Telecom begins to generate positive EBITDA. Although
Esprit Telecom has experienced net revenue growth in each of the last four
years, such growth should not be considered to be indicative of future net
revenue growth, if any. For the years ended September 30, 1997 and September 30,
1998, Esprit Telecom sustained, on a UK GAAP basis, net losses of approximately
L10.9 million and L42.3 million, respectively, and negative EBITDA of L8.7
million and L18.3 million, respectively. Furthermore, Esprit Telecom expects
that operations in new markets will sustain negative cash flows until an
adequate customer base and the related revenue stream have been established. In
addition, prices in the long distance industry in Europe have declined in recent
years and, as competition continues to increase, Esprit Telecom expects that
prices will continue to decline. Although Esprit Telecom believes that such
decreases in price will be at least partially offset by increased traffic volume
and decreases in the cost of providing telecommunication services, Esprit
Telecom can offer no assurance that it will achieve or, if achieved, will
sustain profitability or positive cash flow from operating activities in the
future. If Esprit Telecom
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cannot achieve and sustain operating profitability or positive cash flow, Esprit
Telecom may not be able to meet its debt service obligations or working capital
requirements without additional financing.
Esprit Telecom expects that due to continuing price cuts in certain retail
markets, its gross margins will be affected until such time as such price cuts
are offset by anticipated network cost savings arising from increased capacity
on the Esprit Network on certain key routes and Esprit Telecom derives the
benefits from expected reductions in interconnection charges. Price cuts from
PTOs have been and may continue to be significant in nature and network cost
reductions may take time to be brought into effect. For example, in Germany,
Deutsche Telekom has recently gained regulatory approval to implement
significant reductions in its national tariffs from January 1999, which Esprit
Telecom expects may have an adverse impact upon its national long distance
revenues and gross margins. In addition, Esprit Telecom intends to substantially
increase the capacity and reach of the Esprit Network and expects that the
resulting additional leased line costs operating and maintenance will depress
gross margins until additional traffic volume increases network utilization.
As a result of its limited revenue and significant expenses associated with
the expansion and development of the Esprit Network, the opening of new sales
offices and the introduction of new telecommunications services, and the
variations in international and national long distance traffic in certain
periods of the year, Telecom anticipates that its operating results could vary
significantly from quarter to quarter.
SUBSTANTIAL INDEBTEDNESS; LIQUIDITY
Esprit Telecom has substantial indebtedness. At September 30, 1998, under
UK GAAP, Esprit Telecom's total indebtedness was approximately L326.5 million,
its shareholders' funds were a deficit of approximately L7.2 million and its
total assets were approximately L394.5 million, of which approximately L99.0
million would have been intangible assets. For the years ended September 30,
1997 and September 30, 1998, under UK GAAP, Esprit Telecom's consolidated EBITDA
was negative L8.7 million and negative L18.3 million, respectively, and its
earnings would have been insufficient to cover fixed charges by L10.9 million
and L42.4 million, respectively. In addition, Esprit Telecom and its
subsidiaries may incur additional indebtedness in the future, subject to
limitations imposed by their debt instruments, including, without limitation,
the indentures governing the Esprit Telecom Bonds. The Esprit Telecom Bond
indentures do not limit the amount of indebtedness that may be incurred to
finance the cost of the expansion of the Esprit Network.
Esprit Telecom's net interest expense for the year ended September 30, 1998
was L12.2 million. Esprit Telecom will need to improve substantially its cash
flow from operating activities in order for Esprit Telecom to meet its debt
service obligations, including its obligations under the Esprit Telecom Bonds.
Esprit Telecom's ability to improve its operating performance and financial
results will depend not only on its ability to successfully implement its
business plan, but also upon economic, financial, competitive, regulatory and
other factors beyond its control, including fluctuations in exchange rates and
general economic conditions in Europe. Esprit Telecom can offer no assurance
that Esprit Telecom will generate sufficient positive cash flow from operating
activities in the future to service its debt and to allow Esprit Telecom to make
necessary capital expenditures. If Esprit Telecom is unable to generate
sufficient positive cash flow in the future, it may be required to refinance all
or a portion of its debt, including Esprit Telecom Bonds, to sell assets or to
obtain
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additional financing. Esprit Telecom can offer no assurance that any such
refinancing would be possible or that any such sales of assets or additional
financing could be achieved.
The high level of Esprit Telecom's indebtedness and the terms of such
indebtedness could have several important consequences in the future on Esprit
Telecom's operations, including the following:
- Esprit Telecom will have significant cash requirements to service
debt, thereby reducing funds available for operations and future
business opportunities and increasing the vulnerability of Esprit
Telecom to adverse general economic and industry conditions;
- Esprit Telecom may be restricted in the future from obtaining any
necessary financing for working capital, capital expenditures, debt
service requirements, acquisitions or other purposes;
- Esprit Telecom's flexibility in planning for, or reacting to, changes
in its business may be impeded;
- Esprit Telecom is more highly leveraged than some of its competitors,
which may place it at a competitive disadvantage; and
- Esprit Telecom will be required to comply with certain financial
covenants and other restrictions contained in its debt instruments,
including the Esprit Telecom Bond indentures.
If Esprit Telecom failed to meet its debt service obligations or to comply
with any of the covenants contained in any of its debt instruments Esprit
Telecom could trigger a default under those agreements, permitting the
acceleration of the maturity of the indebtedness under such agreements. Any
default or acceleration under such agreement could also result in other debt of
Esprit Telecom and its subsidiaries becoming immediately payable. Under any of
these circumstances, Esprit Telecom can offer no assurance that Esprit Telecom
and its subsidiaries would have sufficient funds or other resources to satisfy
all of such obligations on a timely basis or otherwise.
NEED FOR ADDITIONAL FINANCING
The development and expansion of the Esprit Network, the opening of new
sales offices and the introduction of new telecommunications services, future
acquisitions, as well as the funding of operating losses and net cash outflows,
will require substantial capital. During the years ended September 30, 1998,
1997 and 1996, Esprit Telecom made fixed asset investments of approximately
L41.2 million, L10.1 million and L6.0 million, respectively. Esprit Telecom has
historically been funded by equity contributions from certain principal
securityholders, financing from banks, vendors and other third parties and net
proceeds from financings. None of the principal securityholders has any
obligation to make additional investments in Esprit Telecom. Esprit Telecom does
not currently maintain lines of credit or similar facilities with commercial
banks, but has obtained credit through vendor financing and credit secured by
Esprit Telecom's receivables. Other future sources of capital for Esprit Telecom
could include additional public and private debt and equity financings. Esprit
Telecom can offer no assurance that such sources of financing would be available
to Esprit
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Telecom in the future or, if available, that they could be obtained on terms
acceptable to Esprit Telecom.
Esprit Telecom's future requirements will depend upon many factors. Some of
these factors include the performance of Esprit Telecom's business, the rate and
manner in which it expands the Esprit Network and opens new sales offices, makes
future acquisitions and increases staffing levels and customer growth, as well
as other factors that are not within Esprit Telecom's control, including
competitive conditions, regulatory or other government actions and capital
costs. In the event that Esprit Telecom's plans or assumptions change or prove
to be inaccurate or the funds from financings, internally generated funds,
working capital and financings by vendors prove to be insufficient to fund
Esprit Telecom's growth and operations in the manner and at the rate currently
anticipated, then some or all of Esprit Telecom's development and expansion
plans could be delayed or abandoned, or Esprit Telecom may be required to seek
additional funds earlier than currently anticipated, including from additional
debt and/or equity financings.
NETWORK DEVELOPMENT AND EXPANSION RISKS
Esprit Telecom's continued expansion and development of its network will
depend on, among other things, Esprit Telecom's ability to enter new markets,
access transmission backbone network routes, install service and sales
facilities, acquire rights-of-way and building access, obtain required
governmental licenses, authorizations and permits and interconnect with the
networks of the incumbent PTOs or other infrastructure providers, all in a
timely manner, at reasonable costs and on terms and conditions acceptable to
Esprit Telecom. The successful implementation of Esprit Telecom's expansion
strategy will be subject to a variety of risks, including operating and
technical problems, regulatory uncertainties, possible delays in the full
implementation of the EU Directives regarding telecommunications liberalization,
competition and the availability of capital.
Esprit Telecom's ability to achieve its strategic objective is in large
part dependent on the successful, timely and cost-effective expansion of its
network. The Esprit Network currently consists of leased fiber optic lines, dark
fiber, with associated SDH and WDM equipment, digital microwave transmission
facilities and MIUs and IRUs on undersea cables. The expansion and development
of the Esprit Network will focus on capacity that is owned or controlled by
Esprit Telecom. Such expansion and development may be delayed or adversely
affected by a variety of factors, uncertainties and contingencies many of which,
such as technical difficulties in an environment of multiple local technical
standards, are beyond Esprit Telecom's control. In addition, Esprit Telecom may
need to engage in time consuming negotiations for low cost access to networks
which may place Esprit Telecom at a disadvantage with respect to competitors who
have already entered into such agreements. Esprit Telecom can offer no assurance
that its network will grow and develop as planned or, if developed, that such
growth or development will be completed on schedule, at a commercially
reasonable cost or within Esprit Telecom's specifications. Although Esprit
Telecom believes that its cost estimates and the build-out schedule are
reasonable, Esprit Telecom can offer no assurance that the actual construction
or acquisition 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 the expansion and development of the Esprit Network could
have a material adverse impact on Esprit Telecom, including its ability
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to make payments on Esprit Telecom Bonds, and on Esprit Telecom's business,
results of operations and financial condition generally.
RISKS ASSOCIATED WITH THE OPERATION OF ESPRIT TELECOM'S NETWORK
Esprit Telecom's success is dependent on the seamless technical operation
of its network and on the management of traffic volumes and route preferences
over the same. Furthermore, as Esprit Telecom is continuously expanding its
network to increase both its capacity and reach, and as traffic volume continues
to increase in accordance with anticipated growth, Esprit Telecom will face
increasing demands and challenges in running and managing the network functions,
including its circuit capacity and traffic management systems. The Esprit
Network is subject to several risks which are outside of Esprit Telecom's
control, such as the risk of damage to software and hardware resulting from
fire, power loss, natural disasters and general transmission failures caused by
a number of additional factors. Any failure of the Esprit Network or other
systems or hardware that causes significant interruptions to Esprit Telecom's
operations could have a material impact on Esprit Telecom's business, financial
condition or results of operations. Esprit Telecom's operations are also
dependent on its ability to successfully integrate new and emerging technologies
and equipment, in particular the technology and equipment of the Plusnet
business, and the SDH and WDM equipment associated with Esprit Telecom's
broadband fiber network, into the Esprit Network, which could increase the risk
of system failure and result in further strains upon the Esprit Network. Esprit
Telecom attempts to minimize customer inconvenience in the event of a system
disruption by routing traffic to other circuits and switches which may be
controlled by other carriers. However, prolonged or significant system failures,
or difficulties for customers in accessing, and maintaining connection with, the
Esprit Network could threaten Esprit Telecom's relationship with its clients,
and would seriously damage the reputation of Esprit Telecom and result in
customer attrition and financial losses. Additionally, any damage to The Esprit
Network management center and major switching centers could have a material
negative impact on Esprit Telecom's ability to monitor and manage the network
operations and generate accurate call detail reports from which billing
information is derived.
The expansion and development of the Esprit Network will entail significant
expenditure and resources for projecting growth in traffic volume and routing
preferences, and determining the most cost-effective means of growing the Esprit
Network (i.e., through variable or fixed lease arrangements, the purchase of
transmission rights on fiber optic lines or digital microwave equipment, or the
construction of transmission infrastructure). If Esprit Telecom fails to project
traffic volume and route preferences correctly or to determine the optimal means
of expanding its network resulting in less than optimal utilization of the
network, Esprit Telecom's business, results of operations and financial
condition could be materially adversely affected.
DEPENDENCE ON FACILITIES PROVIDERS AND INTERCONNECT ARRANGEMENTS
At the present time, Esprit Telecom has completed a relatively small part
of its planned telecommunications transmission infrastructure and leases the
remainder under a variety of arrangements with facilities-based long distance
carriers. As a result, Esprit Telecom depends upon facilities-based carriers
such as the PTOs and other alternative telecommunications networks in each of
the countries in which Esprit Telecom operates. Some of these
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carriers are or may become competitors of Esprit Telecom. In addition, Esprit
Telecom's ability to connect its retail customers to the Esprit Network is
dependent on Esprit Telecom securing interconnection agreements with the local
PTOs in the markets where Esprit Telecom operates. Esprit Telecom has entered
into interconnection agreements in the United Kingdom, Germany, The Netherlands,
France and Belgium, and expects to secure additional agreements covering some of
its remaining markets as the EU telecommunications market continues to benefit
from the liberalization which took legal effect in January 1998. Esprit Telecom
can offer no assurance that it will be successful in securing such arrangements
at attractive rates. Esprit Telecom historically has not experienced material
difficulties with the quality of the services provided by facilities-based
carriers and, except for initial difficulties in Spain, has generally not
experienced material difficulties in accessing such carriers' transmission
infrastructure. Based on its experience in a number of other countries, Esprit
Telecom believes that facilities-based carriers often try to limit access to
their facilities by new competitors. Esprit Telecom's profitability depends in
part on its ability to obtain and utilize leased capacity arrangements on a
cost-effective basis and secure interconnection arrangements on a timely basis
and at favorable rates.
Esprit Telecom currently leases a substantial portion of its network
transmission capacity pursuant to agreements which generally have twelve-month
or longer fixed terms. These lease arrangements present Esprit Telecom with high
fixed costs, while the revenues generated by the utilization of such leases will
vary with traffic volumes and prices. Accordingly, if Esprit Telecom does not
generate the requisite traffic volume over the particular route or is unable to
charge an appropriate price for such traffic, Esprit Telecom could fail to
generate revenue sufficient to meet the lease costs, and may incur operating
losses on the particular route or routes. In addition, most of Esprit Telecom's
off-network transmission is obtained under a variety of volume-based
arrangements with facilities-based carriers including PTOs. Under these
arrangements, Esprit Telecom is subject to the risk of unanticipated price
fluctuations and service restrictions or cancellations.
Esprit Telecom believes that its arrangements and relationships with
carriers generally are satisfactory. However, the deterioration or termination
of Esprit Telecom's arrangements and relationships, or Esprit Telecom's
inability to enter into new arrangements and relationships with one or more
carriers could have a material adverse effect upon Esprit Telecom's cost
structure, service quality, network coverage, results of operations and
financial condition.
DEPENDENCE ON EFFECTIVE BILLING AND MANAGEMENT INFORMATION SYSTEMS
Esprit Telecom must record and process millions of call detail records
quickly and accurately in order to efficiently produce customer bills in a
timely and flexible manner. While the Esprit Telecom's existing billing system
is sufficient for its current operations, Esprit Telecom has selected a new
billing system which Esprit Telecom believes will provide the capability and
flexibility to support Esprit Telecom's anticipated growth. The introduction of
this system will be accompanied by additional systems designed to support the
critical service activation, customer care and service assurance processes, and
is expected to enable Esprit Telecom to bring most of its billing processes in
house. Esprit Telecom is also planning to introduce new management information
systems which it believes will allow Esprit Telecom to continuously monitor its
operations, thus enabling Esprit Telecom to achieve additional network and
operating efficiencies and to improve management control. Esprit Telecom expects
that a number of new systems will be implemented by mid-1999, and that such
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systems will require continuous enhancements and ongoing investments, especially
as traffic volume increases and as Esprit Telecom continues to improve its
systems to minimize problems common to the telecommunications industry, such as
call record losses, and to ensure the timely production of bills. While the
Plusnet business and IMS continue to use their own billing systems, Esprit
Telecom expects that these systems will be integrated into Esprit Telecom's new
billing process by mid-1999. Esprit Telecom can offer no assurance that Esprit
Telecom will not encounter difficulties in implementing and enhancing the new
billing and management information systems and in integrating new technology
into such systems. If Esprit Telecom were to be unable to implement the new
systems or any required system enhancement, to acquire new systems or to
integrate new technology in a timely and cost-effective manner, its business,
results of operations and financial condition could be materially adversely
affected.
YEAR 2000 TECHNOLOGY RISKS
A significant percentage of the software running on most of the computers
worldwide relies on two-digit date codes to perform a number of computation and
decision making functions. The date change from 1999 to 2000 may impair the
ability of these programs to interpret date codes properly, which could result
in system failures, miscalculations or errors, causing disruptions of operations
or other business problems, including the inability to process transactions,
send invoices or engage in similar normal business activities.
Esprit Telecom is undertaking a comprehensive program to address the Year
2000 issue with respect to:
- its transmission, switching, billing and management information
systems;
- its non-information technology systems (including buildings, plant,
equipment and other infrastructure that may contain embedded
technology); and
- systems of its primary traffic carriers and vendors.
Esprit Telecom is also trying to raise awareness of Year 2000 issues in its
customers' systems.
This program involves four phased steps:
- identifying and assessing potential Year 2000 problems which may
impact Esprit Telecom;
- developing remedial strategies and actions to address those problems;
- implementing those remedial strategies and actions; and
- testing the foregoing solutions.
The program also involves analyzing Esprit Telecom's most reasonably likely
worst-case Year 2000 scenario. Esprit Telecom expects that this would involve
either or both of the following:
- a loss of interconnect capacity from one or more major suppliers of
transmission capacity; and/or
- Esprit Telecom's inability to record, track or invoice billable
minutes which could ultimately cause it to temporarily stop carrying
traffic.
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Either scenario would adversely affect Esprit Telecom's revenue and, if not
quickly remedied, would have a material adverse effect on its business, results
of operations and financial condition.
Assessment
Esprit Telecom is currently in the process of auditing and testing its
systems to determine if they will suffer problems associated with the transition
to the Year 2000. Since a complete analysis of Esprit Telecom's systems would
require an interruption of service, Esprit Telecom is selectively testing
various elements of such systems. Esprit Telecom has an active in-house
assessment program, with a staff of six persons assigned to Year 2000 compliance
issues. Despite devoting these resources to addressing the Year 2000 compliance,
Esprit Telecom has not delayed the implementation of any projects related to
management information systems. Esprit Telecom's Year 2000 compliance team is in
the process of reviewing each of Esprit Telecom's switching sites and other
network points to identify equipment, hardware and software that is unlikely to
function through the Year 2000 transition. Esprit Telecom is also in the process
of having its Year 2000 program audited by an outside consulting firm.
In addition, Esprit Telecom actively cooperates with other carriers in a
global Year 2000 program through ITU-T Year 2000 Taskforce, and the UK Year 2000
Operators forum. As part of the latter forum Esprit Telecom is participating in
a voluntary and independent health check review of its Year 2000 program
(conducted by another operator).
Remedial Strategies and Actions
Following its assessment, Esprit Telecom expects to replace, rather than
upgrade, the majority of the problem equipment within its own network systems,
which includes information technology and non-information technology systems.
Esprit Telecom already requires that any systems being replaced or upgraded be
warranted as Year 2000 compliant by the vendors or suppliers of these systems.
Esprit Telecom is currently in the process of replacing its billing and
management information systems, which Esprit Telecom expects will be implemented
by mid-1999. Esprit Telecom also intends to provide back up power and other
equipment at switch sites, as well as alternative routing around switch sites
which experience problems despite these remedial actions.
To address its worst case scenarios, Esprit Telecom has also determined to
obtain supplemental interconnect and transmission capacity in the event that one
or more of its primary carriers experience system failures. Esprit Telecom has
undertaken joint Year 2000 compliance reviews through industry forums and with
several of its major carriers. Ultimately, however, Esprit Telecom has no
control of the Year 2000 readiness of any of its suppliers or customers, and
will be exposed to risks associated with their failure to assess and address
Year 2000 problems. Esprit Telecom cannot control many Year 2000 issues that
could affect it and, like most telecommunications service providers, Esprit
Telecom believes it is inappropriate to provide specific guarantees that service
will not be affected by the transition to the new millennium.
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Implementation
Esprit Telecom is in the process of securing supplemental interconnect and
transmission capacity from several carriers in addition to its current primary
carriers. Esprit Telecom has spent approximately $4.0 million for Year 2000
compliance on its own systems through September 30, 1998, and expects to spend
approximately an additional $4.0 million through the end of calendar year 1999.
Out of this total of $8.0 million in expenditures, Esprit Telecom expects to
spend a total of $1.0 million on repairing existing systems and the remainder on
testing and replacement.
Testing
Esprit Telecom expects to test numerous elements of its systems for Year
2000 compliance, as well as its ability to interconnect with and utilize back-up
carriers, throughout 1999. In particular, Esprit Telecom expects to test its new
billing and management information systems when the same become operational in
mid-1999. As noted above, however, Esprit Telecom will be unable to test its
network systems in their entirety since to do so would involve shutting down its
network for a period of time.
RISKS ASSOCIATED WITH A RAPIDLY CHANGING INDUSTRY; TECHNOLOGY; DEPENDENCE ON
EQUIPMENT AND TECHNOLOGY SUPPLIERS
The European telecommunications industry is changing rapidly due to, among
other factors, liberalization, privatization of PTOs, technological
improvements, expansion of telecommunications infrastructure and the
globalization of the world's economies and free trade. Such changes may happen
at any time and can significantly affect Esprit Telecom's operations from period
to period. Esprit Telecom can offer no assurance that one or more of these
factors will not have unforeseen effects, which could have a material adverse
effect on Esprit Telecom. Even if these factors turn out as anticipated, Esprit
Telecom can offer no assurance that it will be able to implement its strategy or
that its strategy will be accepted in this rapidly evolving market.
Much of Esprit Telecom's planned growth is predicated upon the
liberalization of telecommunications markets, and further, upon the
implementation and enforcement of existing EU directives. Esprit Telecom can
offer no assurance that such liberalization will occur as anticipated, or that
the effects of such liberalization will not be different than expected.
The telecommunications industry is in a period of rapid technological
evolution, marked by the introduction of new products and services, and
increased availability of transmission capacity, as well as the increasing
utilization of the Internet for voice and data transmission. Esprit Telecom's
success will depend substantially on its ability to predict which of the many
possible current and future networks, products and services will be important to
establish and maintain and which expenditures will be required to develop and
provide such networks, products and services. In particular, as Esprit Telecom
undertakes to further expand and develop its network, it will become
increasingly exposed to the risks associated with the relative effectiveness of
its technology and equipment. The cost of implementation of emerging and future
technologies could be significant, and Esprit Telecom can offer no assurance
that it will maintain competitive services or that it will obtain appropriate
new technology on a timely basis, or on satisfactory terms. If Esprit Telecom
failed to maintain
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competitive services or obtain new technologies, Esprit Telecom's business,
financial condition and results of operations could be materially adversely
affected. The current operational network has performed at or above design
specifications. However, as traffic continues to grow and the Esprit Network is
further expanded, Esprit Telecom can offer no assurance that the Esprit Network
will continue to achieve its technical specifications. If Esprit Telecom failed
to achieve such technical specifications the viability of the Esprit Network and
Esprit Telecom's business, financial condition and results of operations could
be materially adversely affected.
Esprit Telecom purchases its international and local equipment from
telecommunications equipment manufacturers that may provide vendor financing
for, and maintenance of, this equipment. Esprit Telecom's main suppliers are
Nortel, Ericsson and Siemens. Esprit Telecom could obtain equipment of
comparable quality from several alternative suppliers. However, if Esprit
Telecom failed to acquire switches that are compatible from an alternative
source, or acquire additional equipment (regardless of the vendor) on a timely
and cost-efficient basis, Esprit Telecom could face delays, operational problems
and increased expenses.
The Esprit Network is significantly dependent on the technology and
products which Esprit Telecom acquires from its main suppliers. In addition,
Esprit Telecom occasionally enters into turn-key contracts with specific
suppliers as a means of reducing its costs and development risks. If any of
Esprit Telecom's technologies and products became obsolete or incompatible with
industry standards, or if any of Esprit Telecom's turn-key contracts failed to
provide the expected benefits, Esprit Telecom's business, results of operations
and financial condition could be materially adversely affected.
CERTAIN RISKS OF THE WHOLESALE AND RESELLER BUSINESS
Wholesale customers connect with Esprit Telecom to carry their traffic to
destinations where Esprit Telecom's rates are competitive. Esprit Telecom's
contracts with these wholesale customers generally do not include minimum or
maximum usage levels, and such customers generally maintain relationships with a
number of telecommunications providers. As a result, wholesale customers
typically change their routing to take advantage of the lowest cost alternative,
resulting in potentially greater fluctuations in revenue generated by these
customers than for other categories of customers. Esprit Telecom's contracts
with its wholesale customers require Esprit Telecom to carry their traffic at a
contractually fixed price per minute for a designated time period. Esprit
Telecom contracts at prices which it believes are competitive and which provide
it with a projected acceptable margin over the anticipated cost of carrying such
traffic. However, Esprit Telecom, due to capacity and quality constraints on its
least-cost routes, has on occasion been forced to carry traffic over a
higher-cost route. In response to such constraints, Esprit Telecom decided to
reduce the volume of wholesale traffic on the Esprit Network until the third
quarter of the 1998 financial year when sufficient spare capacity became
available for the provision of such services to be profitable. Esprit Telecom
expects that in the medium term, revenue from wholesale services will increase
as network capacity is increased in connection with the expansion of its
network. Certain resellers who are connected to multiple providers may also
change routing to take advantage of lower costs, which results in greater
fluctuations in Esprit Telecom's revenue derived from such resellers. Esprit
Telecom's credit exposure to such resellers may also be greater since, unlike
wholesale customers, resellers do not typically furnish any services to Esprit
Telecom.
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<PAGE> 58
RISK OF FRAUD AND BAD DEBT
Esprit Telecom has experienced problems relating to the fraudulent use of
its access codes and the failure of certain of its customers to make full
payment for services rendered. However, Esprit Telecom does not believe that its
experiences with such problems are substantially different from what is
generally experienced in the telecommunications industry. Esprit Telecom may
have to make provisions for non-payment if it believes that it will not be able
to collect. Esprit Telecom expects that the credit risk characteristic of its
customer base may increase as the share of Esprit Telecom's revenue deriving
from SMEs increases. In addition, the revenue derived from its service
provider/reseller business has increased during the 1998 financial year. In
general, service provider/reseller customers, owing to the significant size of
their bills relative to their asset base, may present a different or greater
risk of non-payment than retail or wholesale customers. Any significant increase
in the levels of fraud and bad debt could have a material adverse impact on
Esprit Telecom's financial condition and results of operations.
ABILITY TO MANAGE GROWTH AND EXPANSION
Esprit Telecom's future performance will depend, in part, upon its ability
to manage its growth effectively. Esprit Telecom's rapid growth has placed, and
in the future will continue to place, a significant strain on its
administrative, operational and financial resources. Esprit Telecom's ability to
continue to manage its growth successfully will require Esprit Telecom to
further enhance its operational, management, financial and information systems
and controls and to expand, train and manage its employee base. As Esprit
Telecom evolves to a more mature phase of growth, increases its service
offerings and expands its targeted markets, there will be increasing demands on
Esprit Telecom's management, customer support, sales and marketing and
administrative resources and network infrastructure. In addition, Esprit Telecom
continues to examine opportunities to expand into other related
telecommunications services, such as Internet access and switched data services.
If Esprit Telecom expanded into such telecommunications services, it would face
certain additional risks in connection with such expansion, including
operational, financial and technological compatibility, legal and regulatory
risks and possible adverse reaction by some of its current customers.
INCREASING DEMAND FOR QUALIFIED PERSONNEL; NEW SENIOR MANAGEMENT AND
DEPENDENCE ON KEY PERSONNEL
Esprit Telecom competes with other telecommunications service providers for
qualified managerial, sales, marketing, administrative, operating and technical
personnel. Esprit Telecom's success will depend substantially upon its ability
to hire and retain such personnel. Competition for qualified employees and
personnel in the telecommunications industry in Europe is intense, and there are
generally a limited number of persons with the requisite knowledge and
experience in the particular sectors where Esprit Telecom operates. Esprit
Telecom can offer no assurance that it will be able to attract, recruit and
retain sufficient qualified personnel as Esprit Telecom grows and expands its
current operations and enters into new markets. In the past 20 months, Esprit
Telecom has hired a number of new senior managers, including a new Chief
Executive Officer, a new Chief Operations Officer and a new Managing
Director -- Sales and Marketing, to fill certain existing and newly created
positions. Esprit Telecom's senior management team therefore includes a number
of key people who have been with Esprit Telecom for a relatively short period of
time. Esprit Telecom has also retained the managers of the businesses it has
recently acquired to assist it
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<PAGE> 59
in integrating such businesses and in further developing certain lines of
business within Esprit Telecom. Although Esprit Telecom does not foresee any
difficulties in integrating such new managers into its senior management team,
any problems in integrating such managers could have a material adverse impact
on Esprit Telecom's business, its prospects and certain plans for expansion and
its results of operations. If Esprit Telecom failed to identify, attract and
retain the requisite personnel, Esprit Telecom's business, results of operations
and financial condition could be materially adversely affected. Further, Esprit
Telecom's business is currently managed by a small number of key management and
operating personnel, some of whom are only bound by six-month or other
short-term service agreements. If Esprit Telecom lost certain of these people,
Esprit Telecom's business, results of operations and financial condition could
be materially adversely affected.
ACQUISITION STRATEGY
The expansion of Esprit Telecom's business may involve investments,
acquisitions and strategic alliances which, if made, could divert the resources
and management time of Esprit Telecom and could require integration with Esprit
Telecom's operations. Esprit Telecom can offer no assurance that any desired
investment, acquisition or strategic alliance could be made in a timely manner
on terms and conditions acceptable to Esprit Telecom or that they could be
successfully integrated into Esprit Telecom's operations. Esprit Telecom can
offer no assurance that it will be successful in identifying attractive
acquisition candidates, completing and financing additional acquisitions on
favorable terms, or integrating the acquired businesses or assets, if any, into
its existing operations. Esprit Telecom's ability to make acquisitions may
depend on the availability of additional financing on acceptable terms and will
be subject to compliance with the covenants contained in its debt instruments.
In July 1998 Esprit Telecom completed the acquisition of the Plusnet business,
and paid a consideration of approximately L103.8 million (or approximately
DM 307 million), (based on the exchange rates ruling as at the date of the
acquisition), net of costs. Pursuant to the sale and purchase agreement between
Esprit Telecom and Thyssen, this consideration has since been recalculated at
approximately L90.0 million (or approximately DM 267 million based upon the
exchange rates ruling as at the date of the acquisition), based upon a final
determination of the revenues of the Plusnet business for the year ended
September 30, 1998. As part of the integration of the business, systems and
culture of the Plusnet business, among other things, Esprit Telecom will be
required to continue to develop its financial and management controls and
information systems and retrain existing personnel, all of which could place a
strain on the management resources of Esprit Telecom and require additional
expenditures. In addition, Esprit Telecom acquired three other
telecommunications businesses in 1997 for a minimum aggregate consideration
payable of approximately L9.4 million over the next two years. This amount could
increase to L13.9 million if these businesses achieve certain financial and
performance targets. Esprit Telecom has brought the senior managers of each of
the acquired businesses into its management team and is relying on such
individuals to assist Esprit Telecom in integrating such acquired businesses.
However, Esprit Telecom can offer no guarantee that Esprit Telecom will be able
to attract and retain managers from any additional acquired businesses or be
successful in integrating any such new managers and businesses. Although
management expects to realize operating synergies as a result of these
acquisitions, Esprit Telecom can offer no assurance that Esprit Telecom will
achieve the benefits that management expects to realize or that such benefits
will be realized within the time frames currently contemplated. In addition,
Esprit Telecom expects that the
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realization of certain acquisition-related benefits may be dependent upon Esprit
Telecom taking certain actions which will result in one-time charges or
expenses.
REGULATION
Esprit Telecom is subject to varying degrees of regulation in each of the
EU Member States where it currently operates or intends to operate. Esprit
Telecom's ability to penetrate several European markets, and its ability to
deploy and expand the Esprit Network and to universally provide certain services
such as indirect access to its retail customers, as well as the timing and cost
of providing such services, depends to a significant degree on the
implementation of liberalization initiatives in each such country. The European
Commission set January 1, 1998 as the deadline for mandatory liberalization of
public network infrastructure and of the provision of voice telephony services
throughout the EU. However, the European Commission guaranteed the following EU
Member States a delay in implementing this liberalization directive: Greece
(until December 31, 2000), Ireland (until January 1, 2000), Luxembourg (until
July 1, 1998) and Portugal (until January , 2000) and Spain (until November 30,
1998). Subject to the foregoing each EU Member State must enact its own laws to
implement the EU's liberalization and harmonization directives for
telecommunications such as the Full Competition Directive and Licensing
Directive. Ireland and Spain subsequently liberalized on December 1, 1998.
Esprit Telecom's ability to purchase ownership rights in transmission lines or
to build its own transmission lines depends upon the timely implementation by EU
Member States of the EU Directives. Each EU Member State's implementation and
enforceability of the EU Directives is dependent on the action taken by each EU
Member State and may be subject to delays and variances in specific countries.
If the implementation or enforceability of EU directives is challenged or
delayed in any of the markets in which Esprit Telecom currently operates or in
such other markets in which Esprit Telecom may establish operations, Esprit
Telecom's business, results of operations and financial condition could be
materially adversely affected. In addition, the terms and conditions of
interconnection to the PTOs' networks will have a material effect on the
competitive position of Esprit Telecom. Although the EU has issued a directive
governing the terms of such interconnection, Esprit Telecom can offer no
assurance that such directive will be implemented in a timely and consistent
manner or that it will provide Esprit Telecom with economical access to and
termination on the PTOs' networks. Accordingly, customers' ability to access
competitive telecommunications providers such as Esprit Telecom may be
restricted in some EU countries.
Esprit Telecom can offer no assurance that each EU Member State will
implement the EU directives within the time frame set by the European
Commission, or at all, or that the enforcement thereof will comply with the
intent and spirit of the EU Outstanding directives. In fact, in November 1997,
the European Commission initiated infringement proceedings against seven EU
Member States, including Belgium, Italy and Germany for failure to fully
implement the EU's directives. The EU previously initiated a proceeding against
Spain and has announced plans to take action against certain other Member States
for failure to implement properly more recent directives. Because implementation
of the various EU directives will vary from country to country, Esprit Telecom's
ability to provide a full range of telecommunications services may be affected
with respect to both timing and cost. Also, Esprit Telecom can offer no
assurance that future regulatory, judicial and legislative changes will not have
a material adverse effect on Esprit Telecom. Similarly, national or
international regulators or third parties may raise material issues with regard
to Esprit Telecom's
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compliance or noncompliance with applicable regulations, which may have a
material adverse effect on Esprit Telecom.
Esprit Telecom may also be permitted by the FCC to use leased private lines
between the United States and a country that is a party to the WTO's Basic
Telecommunications Services Agreement if it satisfies a "benchmark" test that
became effective on January 1, 1998. Under the benchmark test, use of
international private lines will be permitted by the FCC if at least half of the
settled traffic on a route in question to a WTO member is being settled at rates
that are at or below a benchmark set by the FCC. The FCC has established the
following benchmark rates: 15 cents per minute for upper income countries; 19
cents per minute for middle income countries; and 23 cents per minute for lower
income countries. The FCC has made an "equivalency" determination or held that
the settlement "benchmark" has been reached, and accordingly sanctioned the use
of interconnected leased private lines, from the United States to the United
Kingdom, Canada, New Zealand, Australia, Sweden, The Netherlands, France,
Germany, Belgium, Denmark, Norway, and Luxembourg. However, with respect to
other countries to which Esprit Telecom would like to route traffic from the
United States, Esprit Telecom can offer no assurance that the FCC will find that
"equivalent" opportunities for international private line resale exist in these
other countries, or that the FCC will find that its settlement benchmark test
has been satisfied. Esprit Telecom can offer no assurance that the FCC will make
similar "equivalency" or settlement rate compliance determinations for other
international routes, and the failure to make such findings may limit the
ability of Esprit Telecom to route traffic through the United States in
connection with the provision of its Indirect Access services outside the United
Kingdom. However, more generally, the application of these lower benchmarks for
international settlement rates will likely reduce traffic termination costs for
calls originated in or routed through the United States, but may also
substantially decrease profit margins on the routes.
Esprit Telecom's operations are dependent on licenses which it acquires
from governmental authorities in each jurisdiction in which it operates.
Currently, Esprit Telecom has network operator or international facilities
licenses or otherwise has authority which allow it to purchase ownership rights
in transmission lines or construct its own international facilities in the
United Kingdom, Germany, The Netherlands, France, Belgium, Spain and the United
States. Esprit Telecom also holds licenses or otherwise has authority to provide
public voice telephony services in the United Kingdom, Germany, The Netherlands,
France, Belgium and Spain as well as authorizations to provide value added
services in Spain, Italy and Ireland. These licenses and authorizations
generally contain clauses pursuant to which Esprit Telecom may be fined or its
license may be revoked. In such an event, authorities may revoke such licenses
on short or no notice. If government authorities revoked such licenses or levied
fines, Esprit Telecom's business, results of operations and financial condition
could be materially adversely affected.
COMPETITION
Until recently, the telecommunications market in each EU Member State has
been dominated by the national PTO. Since the implementation of a series of EU
directives beginning in 1990, the EU Member States have begun to liberalize
their respective telecommunications markets, thus permitting alternative
telecommunications companies to provide telecommunications services.
Liberalization has coincided with technological innovation to create an
increasingly competitive market, characterized by still-dominant PTOs as
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well as an increasing number of new market entrants. In addition, since the
implementation of the Full Competition Directive in 1998, the European
telecommunications market has become increasingly competitive. Nonetheless,
customers in most of these markets are not accustomed to alternative service
providers, and may be reluctant to switch from the dominant PTOs to competitors
such as Esprit Telecom. In particular, certain of Esprit Telecom's target
customers, which include medium-to-large-sized businesses and governmental
agencies and organizations, may be reluctant to entrust their telecommunications
needs to what they perceive to be a group of relatively new and unproven
operators.
Competition in the European long distance telecommunications industry is
based upon price, customer service, type and quality of services and customer
relationships. Esprit Telecom's strategy is predicated on its ability to price
its services at a discount to the prices charged by the PTOs or dominant
carriers in each of its markets, and to offer high-quality products and
telecommunications services. However, prices for international long distance
calls have decreased substantially over the last few years in most of the
markets in which Esprit Telecom currently maintains operations or in which it
expects to establish operations. Some of Esprit Telecom's larger competitors may
be able to use their greater financial resources to cause severe price
competition in the countries in which Esprit Telecom operates. Esprit Telecom
expects that prices for its services will continue to decrease for the
foreseeable future and that PTOs and other providers will continue to improve
their product offerings. Any price competition could have a material adverse
effect on Esprit Telecom's business, results of operations and financial
condition. The improvement in product offerings and service provision by the
PTOs, and indeed the liberalization of voice telephony and infrastructure in
1998, could similarly have a material adverse effect on Esprit Telecom's
competitiveness to the extent that Esprit Telecom is unable to provide similar
levels of offerings and service.
In each of its current markets, Esprit Telecom competes primarily with the
national PTOs and other providers which have established market presences,
fully-built networks and financial and other resources which are substantially
greater than those of Esprit Telecom. Additionally, such carriers own and
operate infrastructure which provides them with certain significant cost
advantages. Since Esprit Telecom utilizes such networks to provide its services,
if it failed to gain economical access to such networks, its business, results
of operations and financial condition could be materially adversely affected.
Such competitors include PTOs such as British Telecom (United Kingdom), KPN (The
Netherlands), Telefonica de Espana (Spain), Deutsche Telekom (Germany), France
Telecom (France), Belgacom (Belgium), Telecom Italia (Italy) and Telecom Eireann
(Ireland). Esprit Telecom believes that competition for telecommunications
services in Europe will continue to increase as a result of continuing
liberalization. Esprit Telecom also believes that other competitors in the
European markets include multinational consortia such as Unisource, Concert and
Global One, as well as resellers, microwave and satellite carriers, mobile
wireless telecommunications providers, cable television companies, utilities and
other competitive local telecommunications providers. In addition, the
development of new technologies could give rise to significant new competitors
to Esprit Telecom. Many of Esprit Telecom's competitors may have significantly
greater financial, managerial and operational resources and more experience than
Esprit Telecom.
Esprit Telecom has not achieved and does not expect to achieve a
significant market share for its services in any of its markets. The PTOs
generally have certain competitive advantages that Esprit Telecom and its other
competitors do not have due to their control over
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the intra-national transmission lines and connection to such lines. Esprit
Telecom relies on the PTOs for timely access to their public networks and the
provision of leased lines, and if the PTOs fail to provide such access, Esprit
Telecom's business, results of operations and financial condition could be
materially adversely affected. The reluctance of some national regulators to
accept liberalizing policies, grant regulatory approvals and to enforce access
to PTO networks may have a material adverse effect on Esprit Telecom's
competitive position. Esprit Telecom can offer no assurance that it will be able
to compete effectively in any of its markets.
Esprit Telecom expects that prices for its services will continue to
decrease for the foreseeable future. In addition, certain of Esprit Telecom's
customers, in particular wholesale carriers, may sometimes use more than one
service provider and may reduce their use of Esprit Telecom's services and
switch to other providers. In order to be competitive, Esprit Telecom believes
that it must, among other things, be able to offer additional services required
by its customers, reduce its prices and offer other incentives in order to meet
price reductions and incentives offered by its competitors.
INTERNATIONAL OPERATIONS AND FOREIGN EXCHANGE RATE RISKS
Esprit Telecom's operations are or may become subject to many of the risks
inherent in international business activities. Some of these risks include, in
particular, difficulties in staffing and managing foreign operations, general
economic conditions in each such country, burdens of complying with a variety of
regulatory regimes, subjection to multiple taxation regimes, longer accounts
receivables payment cycles in certain countries, receivable collection
difficulties, burdens of varying pricing restrictions, political risks, foreign
exchange controls which restrict or prohibit repatriation of funds, technology
export and import restrictions and prohibitions and delays from customers,
brokers or other government agencies, any of which could have a material adverse
effect on Esprit Telecom's business, financial condition and results of
operations. Currently, none of the markets where Esprit Telecom operates has
applicable foreign exchange restrictions.
Esprit Telecom is exposed, and as it expands into additional countries in
Europe may be increasingly exposed, to fluctuations in foreign currencies as its
revenue, and certain of its costs, assets and liabilities are denominated in
multiple local currencies, although these currencies will be reduced in number
upon the adoption of the Euro in certain countries. Esprit Telecom's proceeds
from its major financings were denominated and have been maintained in US
dollars and Deutschmarks, and Esprit Telecom expects to incur many of its
expenses in the expansion of its network and the opening of new sales offices in
the local European currency of the country in which it is expanding (which, in
many cases, will be the Euro) and in pounds sterling. The DM-denominated Esprit
Telecom Bonds will be effectively redenominated in Euros. A change in the
currency exchange rates that reduces the amount obtained in pounds sterling (or
other non-Euro European currencies) upon conversion of the US dollar and
Deutschmark proceeds from its major financings could have a material adverse
effect on Esprit Telecom and its ability to make the planned capital
expenditures. Currently, the revenues of Esprit Telecom are largely denominated
in pounds sterling and Euro countries' currencies, but principal and interest on
the US dollar-denominated Esprit Telecom Bonds and the DM-denominated Esprit
Telecom Bonds will be payable in US dollars and DM (or Euro), respectively.
Therefore, the ability of Esprit Telecom to pay interest and principal on the US
dollar-denominated Esprit Telecom Bonds
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and the DM-denominated Esprit Telecom Bonds when due is dependent on the then
current exchange rates between US dollars and DM (or Euro), on the one hand, and
pounds sterling (or other non-Euro European currencies), on the other hand,
which rates are and will be subject to fluctuation. Approximately 52.3% of
revenue during the year ended September 30, 1998 was denominated in the
currencies of Euro countries. Esprit Telecom expects that its share of revenue
in such currencies will continue to increase in future periods. Esprit Telecom
does not currently use financial hedging instruments, although in the future
Esprit Telecom may elect to manage the exchange rate exposure presented by the
US dollar Esprit Telecom bonds and the DM Esprit Telecom Bonds by entering into
certain hedging transactions. Esprit Telecom can offer no assurance however,
that exchange rate fluctuations will not have a material adverse effect on
Esprit Telecom's ability to make principal and interest payments when due.
Stage III of the European Economic and Monetary Union will commence on
January 1, 1999, in the following Member States of the EU: Austria, Belgium,
Finland, France, Germany, Ireland, Italy, Luxembourg, The Netherlands, Portugal
and Spain. Part of Stage III is the locking of exchange rates and the
introduction of a single currency, the Euro, which is intended to replace the
national currencies of the EU Member States participating in Stage III, and the
transfer of authority for conducting monetary policy for such EU Member States
to the European Central Bank. Esprit Telecom can offer no assurance that the
Euro will maintain its value relative to other currencies.
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USE OF PROCEEDS
The Selling Stockholders will receive all of the proceeds from the sale of
the Common Stock and the Company will not receive any proceeds from the sale
thereof.
PRICE RANGE OF COMMON STOCK
The Common Stock has been traded on the Nasdaq National Market since
February 5, 1998, the date of the IPO, under the symbol "GTSG." The following
table sets forth, for the periods indicated, the high and low closing bid prices
per share of the Common Stock as reported on the Nasdaq National Market.
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
Quarter ending March 31, 1998.................... $49.00 $25.94
Quarter ending June 30, 1998..................... $51.25 $35.38
Quarter ending September 30, 1998................ $64.25 $24.50
Quarter ending December 31, 1998................. $59.50 $21.13
------ ------
Quarter ending March 31, 1999 (through January
19, 1999)...................................... $63.75 $55.13
====== ======
</TABLE>
The closing bid price for the Common Stock as reported on the Nasdaq
National Market on January 19, 1999 was $60.75. As of December 31, 1998, there
were approximately 484 holders of record of the Company's Common Stock.
DIVIDEND POLICY
GTS has not paid any dividend on its Common Stock and does not intend to
pay dividends in the foreseeable future. In addition, the indenture governing
the Company's 9 7/8% Notes currently prohibits the payment of dividends. This
indenture 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 certain amounts.
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UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
The following unaudited pro forma combined financial statements have been
prepared from GTS' historical consolidated financial statements included in this
prospectus and Esprit Telecom's historical consolidated financial statements
included in this prospectus. The accompanying unaudited pro forma combined
statement of operations presents the historical results of operations of GTS and
Esprit Telecom giving effect to the combination as if it had occurred at the
beginning of the earliest period presented in accordance with US GAAP under the
"pooling of interests" method of accounting.
The pro forma combined statement of operations combines the results of GTS
for each of the three years in the period ended December 31, 1997 and for the
nine months ended September 30, 1998 with the results of Esprit Telecom for each
of the three years in the period ended September 30, 1998 and for the nine
months ended September 30, 1998. The unaudited pro forma combined income
statement gives effect to the combination as if it had occurred on January 1,
1997. The unaudited pro forma combined balance sheet gives effect to the
combination as if it had occurred on September 30, 1998, combining the balance
sheets of GTS and Esprit Telecom at September 30, 1998.
The unaudited pro forma combined financial statements have been prepared in
accordance with US GAAP. The financial statements of Esprit Telecom have been
converted from UK GAAP to US GAAP and translated into US dollars for purposes of
this presentation. UK GAAP differs in certain significant respects from US GAAP.
A reconciliation of Esprit Telecom's net loss and stockholders' equity from UK
GAAP to US GAAP is presented in Esprit Telecom's historical consolidated
financial statements.
As described in this prospectus, the exchange ratios are: (i) each
outstanding Esprit Telecom Ordinary Share will be converted into .1271 of a
share of Common Stock and (ii) each outstanding Esprit Telecom ADR will be
converted into .89 of a share of Common Stock. These exchange ratios were used
in the accompanying unaudited pro forma combined financial statements.
The unaudited pro forma combined financial statements are presented for
comparative purposes only and are not intended to be indicative of what the
actual results would have been if the combination occurred as of the dates
indicated above nor do they purport to be indicative of the results which may be
attained in the future. These unaudited pro forma combined financial statements
should be read in conjunction with the historical consolidated financial
statements of GTS and Esprit Telecom and the related notes thereto. See "Where
You Can Find More Information."
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GLOBAL TELESYSTEMS GROUP, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS(1)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
COMBINED
NETSOURCE PRO FORMA (GTS & ESPRIT
GTS(2) EUROPE(3) ADJUSTMENTS(4) NETSOURCE) TELECOM(2) PLUSNET(6)
--------- --------- -------------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
REVENUES, NET:
Telecommunication and other services... $ 111,195 $ 29,364 $ 140,559 $115,309 $12,456
Equipment sales........................ 6,104 -- 6,104 -- --
--------- -------- -------- --------- -------- -------
117,299 29,364 146,663 115,309 12,456
--------- -------- -------- --------- -------- -------
OPERATING COSTS AND EXPENSES
Cost of revenues:
Telecommunication and other
services........................... 77,525 31,089 108,614 91,131 8,559
Equipment sales...................... 4,542 -- 4,542 -- --
Selling, general and administrative.... 75,150 27,741 102,891 49,464 4,601
Depreciation and amortization.......... 13,953 3,077 7,295 24,325 17,758 1,613
Non-income taxes....................... 5,140 -- 5,140 -- --
--------- -------- -------- --------- -------- -------
176,310 61,907 7,295 245,512 158,353 14,773
Equity in (earnings) losses of
ventures............................. (4,142) -- (4,142) -- --
--------- -------- -------- --------- -------- -------
LOSS FROM OPERATIONS.................... (54,869) (32,543) (7,295) (94,707) (43,044) (2,317)
OTHER INCOME /(EXPENSE):
Interest income........................ 28,110 675 28,785 -- 246
Interest expense....................... (52,603) (1,319) (53,922) (19,872) --
Foreign currency losses................ (10,364) (10,364) -- --
--------- -------- -------- --------- -------- -------
(34,857) (644) -- (35,501) (19,872) 246
--------- -------- -------- --------- -------- -------
Net loss before income taxes, minority
interest and extraordinary loss........ (89,726) (33,187) (7,295) (130,208) (62,916) (2,071)
Income taxes............................ 2,151 -- 2,151 3 --
--------- -------- -------- --------- -------- -------
Net loss before minority interest and
extraordinary loss..................... (91,877) (33,187) (7,295) (132,359) (62,919) (2,071)
Minority interest....................... 3,746 -- 3,746 -- --
--------- -------- -------- --------- -------- -------
Net loss before extraordinary loss...... $ (88,131) $(33,187) $ (7,295) $(128,613) $(62,919) $(2,071)
Loss per share before extraordinary
loss...................................
Weighted average common shares
outstanding............................
<CAPTION>
PRO FORMA PRO FORMA
COMBINED COMBINED
(ESPRIT (GTS &
PRO FORMA TELECOM & PRO FORMA ESPRIT
ADJUSTMENTS(7) PLUSNET) ADJUSTMENTS(8) TELECOM)
-------------- ---------- -------------- ---------
<S> <C> <C> <C> <C>
REVENUES, NET:
Telecommunication and other services... $ (475) $127,290 $ (1,760) $ 266,089
Equipment sales........................ -- 6,104
-------- -------- -------- ---------
(475) 127,290 (1,760) 272,193
-------- -------- -------- ---------
OPERATING COSTS AND EXPENSES
Cost of revenues:
Telecommunication and other
services........................... (475) 99,215 (2,989) 204,840
Equipment sales...................... -- 4,542
Selling, general and administrative.... 54,065 156,956
Depreciation and amortization.......... 3,771 23,142 47,467
Non-income taxes....................... -- 5,140
-------- -------- -------- ---------
3,296 176,422 (2,989) 418,945
Equity in (earnings) losses of
ventures............................. -- (4,142)
-------- -------- -------- ---------
LOSS FROM OPERATIONS.................... (3,771) (49,132) 1,229 (142,610)
OTHER INCOME /(EXPENSE):
Interest income........................ 246 29,031
Interest expense....................... (8,774) (28,646) (82,568)
Foreign currency losses................ -- (10,364)
-------- -------- -------- ---------
(8,774) (28,400) -- (63,901)
-------- -------- -------- ---------
Net loss before income taxes, minority
interest and extraordinary loss........ (12,545) (77,532) 1,229 206,511
Income taxes............................ 3 2,154
-------- -------- -------- ---------
Net loss before minority interest and
extraordinary loss..................... (12,545) (77,535) 1,229 (208,665)
Minority interest....................... -- 3,746
-------- -------- -------- ---------
Net loss before extraordinary loss...... $(12,545) $(77,535) $ 1,229 $(204,919)
Loss per share before extraordinary
loss................................... $ (2.80)
=========
Weighted average common shares
outstanding............................ 73,192
=========
</TABLE>
See accompanying notes.
63
<PAGE> 68
GLOBAL TELESYSTEMS GROUP, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS(1)
YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PRO ESPRIT
FORMA TELECOM
COMBINED YEAR
NETSOURCE PRO FORMA (GTS & ENDED
GTS(2) EUROPE(3) ADJUSTMENTS(4) NETSOURCE) 9/30/97(2) PLUSNET(6)
--------- --------- -------------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
REVENUES, NET:
Telecommunication and other services... $ 41,300 $ 14,102 $ 55,402 $ 74,596 $ 27,072
Equipment sales........................ 5,798 5,798 -- --
--------- -------- -------- --------- -------- --------
47,098 14,102 -- 61,200 74,596 27,072
--------- -------- -------- --------- -------- --------
OPERATING COSTS AND EXPENSES
Cost of revenues:
Telecommunication and other
services........................... 37,206 13,593 50,799 62,263 28,799
Equipment sales...................... 5,513 -- 5,513 -- --
Selling, general and administrative.... 68,425 12,250 80,675 26,622 10,451
Depreciation and amortization.......... 6,227 2,120 9,726 18,073 4,653 6,017
Non-income taxes....................... 2,085 -- 2,085 -- --
--------- -------- -------- --------- -------- --------
119,456 27,963 9,726 157,145 93,538 45,267
Write-off of venture-related assets.... 1,673 -- 1,673 -- --
Equity in losses of ventures........... 14,599 -- 14,599 -- --
--------- -------- -------- --------- -------- --------
LOSS FROM OPERATIONS.................... (88,630) (13,861) (9,726) (112,217) (18,942) (18,195)
OTHER INCOME /(EXPENSE):
Interest income........................ 11,361 -- 11,361 1,890 --
Interest expense....................... (39,086) (538) (39,624) (750) --
Foreign currency losses................ (1,826) (1,826) -- --
--------- -------- -------- --------- -------- --------
(29,551) (538) -- (30,089) 1,140 --
--------- -------- -------- --------- -------- --------
Net loss before income taxes and
minority interest...................... (118,181) (14,399) (9,726) (142,306) (17,802) (18,195)
Income taxes............................ 2,482 (12) 2,470 3 --
--------- -------- -------- --------- -------- --------
Net loss before minority interest....... (120,663) (14,387) (9,726) (144,776) (17,805) (18,195)
Minority interest....................... 3,677 -- 3,677 -- --
--------- -------- -------- --------- -------- --------
NET LOSS................................ $(116,986) $(14,387) $ (9,726) $(141,099) $(17,805) $(18,195)
========= ======== ======== ========= ======== ========
Net loss per share......................
Weighted average common shares
outstanding............................
<CAPTION>
PRO FORMA PRO FORMA
COMBINED COMBINED
(ESPRIT (GTS &
PRO FORMA TELECOM & PRO FORMA ESPRIT
ADJUSTMENTS(7) PLUSNET) ADJUSTMENTS(8) TELECOM)
-------------- --------- -------------- ---------
<S> <C> <C> <C> <C>
REVENUES, NET:
Telecommunication and other services... $ (510) $101,158 (110) $ 156,450
Equipment sales........................ -- -- 5,798
-------- -------- ------ ---------
(510) 101,158 (110) 162,248
-------- -------- ------ ---------
OPERATING COSTS AND EXPENSES
Cost of revenues:
Telecommunication and other
services........................... (510) 90,552 (110) 141,241
Equipment sales...................... -- -- 5,513
Selling, general and administrative.... -- 37,073 117,748
Depreciation and amortization.......... 11,990 22,660 40,733
Non-income taxes....................... -- -- 2,085
-------- -------- ------ ---------
11,480 150,285 (110) 307,320
Write-off of venture-related assets.... -- -- 1,673
Equity in losses of ventures........... -- -- 14,599
-------- -------- ------ ---------
LOSS FROM OPERATIONS.................... (11,990) (49,127) (161,344)
OTHER INCOME /(EXPENSE):
Interest income........................ -- 1,890 13,251
Interest expense....................... (26,880) (27,630) (67,254)
Foreign currency losses................ -- -- (1,826)
-------- -------- ------ ---------
(26,880) (25,740) (55,829)
-------- -------- ------ ---------
Net loss before income taxes and
minority interest...................... (38,870) (74,867) (217,173)
Income taxes............................ -- 3 2,473
-------- -------- ------ ---------
Net loss before minority interest....... (38,870) (74,870) (219,646)
Minority interest....................... -- -- 3,677
-------- -------- ------ ---------
NET LOSS................................ (38,870) $(74,870) -- $(215,969)
======== ======== ====== =========
Net loss per share...................... $ (3.87)
=========
Weighted average common shares
outstanding............................ 55,772
=========
</TABLE>
See accompanying notes.
64
<PAGE> 69
GLOBAL TELESYSTEMS GROUP, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS(1)
YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
ESPRIT PRO FORMA
TELECOM COMBINED
YEAR ENDED (GTS & ESPRIT
GTS(2) 9/30/96(2) TELECOM)
-------- ---------- --------------
<S> <C> <C> <C>
REVENUES, NET:
Telecommunication and other services.................. $ 19,210 $38,402 $ 57,612
Equipment sales....................................... 4,907 -- 4,907
-------- ------- --------
24,117 38,402 62,519
-------- ------- --------
OPERATING COSTS AND EXPENSES
Cost of revenues:
Telecommunication and other services............... 14,741 28,950 43,691
Equipment sales.................................... 4,200 -- 4,200
Selling, general and administrative................... 47,940 11,590 59,530
Stock compensation costs.............................. 3,498 3,498
Depreciation and amortization......................... 4,165 2,270 6,435
Non-income taxes...................................... 850 -- 850
-------- ------- --------
71,896 46,308 118,204
Equity in losses of ventures.......................... 10,150 -- 10,150
-------- ------- --------
LOSS FROM OPERATIONS.................................... (57,929) (7,906) (65,835)
OTHER INCOME/(EXPENSE):
Interest income....................................... 3,569 219 3,788
Interest expense...................................... (11,122) (533) (11,655)
Foreign currency losses............................... (1,176) -- (1,176)
-------- ------- --------
(8,729) (314) (9,043)
-------- ------- --------
Net loss before income taxes and minority interest...... (66,658) (8,220) (74,878)
Income taxes............................................ 1,360 -- 1,360
-------- ------- --------
Net loss before minority interest....................... (68,018) (8,220) (76,238)
-------- ------- --------
Minority interest....................................... 27 -- 27
NET LOSS................................................ $(67,991) $(8,220) $(76,211)
======== ======= ========
Net loss per share...................................... $ (1.69)
========
Weighted average common shares outstanding.............. 45,130
========
</TABLE>
See accompanying notes.
65
<PAGE> 70
GLOBAL TELESYSTEMS GROUP, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS(1)
YEAR ENDED DECEMBER 31, 1995
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
ESPRIT PRO FORMA
TELECOM COMBINED
YEAR ENDED GTS & ESPRIT
GTS(2) 9/30/95(2) TELECOM
-------- ----------- ------------
<S> <C> <C> <C>
REVENUES, NET:
Telecommunication and other services.................... $ 5,979 $22,167 $ 28,146
Equipment sales......................................... 2,433 -- 2,433
-------- ------- --------
8,412 22,167 30,579
-------- ------- --------
OPERATING COSTS AND EXPENSES
Cost of revenues:
Telecommunication and other services................. 8,150 16,907 25,057
Equipment sales...................................... 246 -- 246
Selling, general and administrative..................... 37,291 6,534 43,825
Depreciation and amortization........................... 3,491 968 4,459
Non-income taxes........................................ 234 1,255 1,489
-------- ------- --------
49,412 25,664 75,076
Equity in losses of ventures............................ 7,871 -- 7,871
-------- ------- --------
LOSS FROM OPERATIONS...................................... (48,871) (3,497) (52,368)
OTHER INCOME/(EXPENSE):
Other non-operating income.............................. 10,270 41 10,311
Interest income......................................... 2,177 (394) 1,783
Interest expense........................................ (728) -- (728)
Foreign currency losses................................. (685) -- (685)
-------- ------- --------
11,034 (353) 10,681
-------- ------- --------
Net loss before income taxes and minority interest........ (37,837) (3,850) (41,687)
Income taxes.............................................. 2,565 -- 2,565
-------- ------- --------
Net loss before minority interest......................... (40,402) (3,850) (44,252)
Minority interest......................................... 2 -- 2
-------- ------- --------
NET LOSS.................................................. $(40,400) $(3,850) $(44,250)
======== ======= ========
Net loss per share........................................ $ (1.12)
========
Weighted average common shares outstanding................ 39,680
========
</TABLE>
See accompanying notes.
66
<PAGE> 71
GLOBAL TELESYSTEMS GROUP, INC.
UNAUDITED PRO FORMA COMBINED BALANCE SHEET(1)
AS OF SEPTEMBER 30, 1998
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA COMBINED
COMBINED (GTS &
NETSOURCE PRO FORMA (GTS & ESPRIT PRO FORMA ESPRIT
GTS(2) EUROPE(3) ADJUSTMENTS(5) NETSOURCE TELECOM(2) ADJUSTMENTS(8) TELECOM
---------- --------- -------------- ---------- ---------- -------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
CURRENT ASSETS
Cash and cash equivalents..... $ 993,928 $ 3,049 $(46,099) $ 950,878 $ 230,745 $1,181,623
Accounts receivable, net...... 59,822 13,602 73,424 50,037 123,461
Restricted cash............... 42,047 -- 42,047 83,218 125,265
Prepaid expenses.............. 22,122 3,255 25,377 -- 25,377
Other assets.................. 12,539 3,602 16,141 44,599 60,740
---------- -------- -------- ---------- --------- ----- ----------
TOTAL CURRENT ASSETS.... 1,130,458 23,508 (46,099) 1,107,867 408,599 1,516,466
Property and equipment, net..... 436,019 4,329 440,348 93,587 $ 876 534,811
Investments in and advances to
ventures...................... 61,705 -- 61,705 -- 61,705
Goodwill and intangible assets,
net........................... 161,893 22,068 145,894 329,855 168,290 498,145
Restricted cash and other
noncurrent assets............. 24,818 222 25,040 -- 25,040
---------- -------- -------- ---------- --------- ----- ----------
TOTAL ASSETS............ $1,814,893 $ 50,127 $ 99,795 $1,964,815 $ 670,476 $ 876 $2,636,167
========== ======== ======== ========== ========= ===== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued
expenses.................... $ 135,565 $ 27,296 $ 2,000 $ 164,861 $ 123,937 $ 288,798
Debt maturing within one
year........................ 23,741 13,302 37,043 -- 37,043
Current portion of capital
lease obligations........... 31,130 -- 31,130 -- 31,130
Related party debt maturing
within one year............. 8,333 8,333 -- 8,333
Other current liabilities..... 32,408 -- 32,408 -- $(353) 32,055
---------- -------- -------- ---------- --------- ----- ----------
TOTAL CURRENT
LIABILITIES........... 222,844 48,931 2,000 273,775 123,937 (353) 397,359
Long-term debt, less current
portion....................... 962,232 -- 962,232 526,370 1,488,602
Long-term portion of capital
lease obligations............. 187,900 -- 187,900 -- 187,900
Related party long-term debt,
less current portion.......... 3,530 -- 3,530 -- 3,530
Taxes and other non-current
liabilities................... 27,378 1,486 28,864 32,403 61,267
---------- -------- -------- ---------- --------- ----- ----------
TOTAL LIABILITIES....... 1,403,884 50,417 2,000 1,456,301 682,710 (353) 2,138,658
COMMITMENTS AND CONTINGENCIES
Minority interest............. 43,957 -- 43,957 -- 43,957
Common stock, subject to
repurchase.................. 15,643 -- 15,643 -- 15,643
SHAREHOLDERS' EQUITY
Common stock, 80,434,986 pro
forma combined shares issued
and outstanding............. 6,050 745 396 6,446 2,133 (536) 8,043
Additional paid-in capital.... 696,574 23,402 97,109 793,683 97,071 536 891,290
Accumulated other
comprehensive loss.......... (7,496) -- (7,496) -- (7,496)
Accumulated deficit........... (343,719) (24,437) (343,719) (111,438) 1,229 (453,928)
---------- -------- -------- ---------- --------- ----- ----------
TOTAL SHAREHOLDERS'
EQUITY................ 351,409 (290) 97,505 448,914 (12,234) 1,229 437,909
---------- -------- -------- ---------- --------- ----- ----------
TOTAL LIABILITIES AND
SHAREHOLDERS'
EQUITY................ $1,814,893 $ 50,127 $ 99,505 $1,964,815 $ 670,476 $ 876 $2,636,167
========== ======== ======== ========== ========= ===== ==========
</TABLE>
See accompanying notes.
67
<PAGE> 72
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
1. The accompanying unaudited pro forma combined financial statements do not
include any transition costs and expenses which are expected to be incurred
in connection with consummating the combination and integrating the
operations of GTS and Esprit Telecom. It is not feasible to determine the
actual amount of these costs and expenses until the combination is completed
and the related operational and transitional plans are complete. These costs
and expenses relate directly to completing the transaction, such as
professional and registration fees; employee benefit-related costs such as
severance, relocation and retention incentives, facility consolidations,
systems integration, and satisfaction of contractual obligations. It is
anticipated that a significant portion of these costs and expenses will
result in charges to the earnings of the combined businesses. The exact
timing of these charges cannot be determined; however, management of the
combined businesses anticipate that plans and decisions will be completed and
a substantial portion of the related charges recorded in 1999. Additionally,
while the pro forma combined statement of operations does not reflect any
anticipated cost savings or other synergies that may be achieved by the
combination, the combination is expected to result in reduced costs for the
combined businesses.
2. These columns represent historical results of operations and financial
position.
3. On November 30, 1998 GTS completed the acquisition of NetSource in a
transaction accounted for as a purchase. GTS's results of operations for the
year ended December 31, 1997 and the nine months ended September 30, 1998
have been adjusted to give effect to the acquisition of NetSource as if it
had occurred as of January 1, 1997. GTS' balance sheet as of September 30,
1998 has been adjusted to give effect to the acquisition of NetSource as if
it had occurred on that date.
4. This entry reflects the adjustment to amortization expense for the effect of
the excess of consideration over net assets acquired in the NetSource
acquisition. For purposes of the unaudited pro forma combined financial
statements, the excess consideration has been amortized over an estimated
life of 15 years. A final determination of the lives attributable to the
intangible assets has not yet been made. As discussed in Note 5, a portion of
the excess consideration may be allocated to certain in-process research and
development projects. To the extent amounts are allocated to certain
in-process research and development projects, pro forma amortization expense
would be reduced accordingly.
5. These adjustments reflect the acquisition of NetSource by GTS. A preliminary
allocation of the purchase price has been presented in the unaudited pro
forma combined financial statements. The excess of consideration over the
fair value of the net assets acquired from NetSource has been preliminarily
allocated to goodwill and other intangibles. A final allocation of the
purchase price to the fair value of the NetSource assets acquired and
liabilities assumed is dependent upon certain valuations and studies that
have not progressed to a stage where there is sufficient information to make
such an allocation in the accompanying pro forma financial information. GTS'
management believes that the consideration in excess of the historical book
value of NetSource's net assets acquired is comprised of goodwill, certain
in-process research and development projects and other intangible assets. To
the extent that a portion of the purchase price is allocated to in-process
research and development projects, a charge, which may be material to GTS'
results of operations, would be recognized in the quarter ended December 31,
1998. See Note 4.
6. During June 1998, Esprit Telecom completed the acquisition of Plusnet in a
transaction accounted for as a purchase. Esprit Telecom's results of
operations for the year ended September 30, 1997 and the nine months ended
September 30, 1998 have been adjusted to give effect to the acquisition of
Plusnet as if it had occurred as of October 1, 1996.
7. These adjustments reflect the elimination of intercompany revenue between
Esprit Telecom and Plusnet, the additional amortization expense associated
with amortizing the excess of consideration over net assets acquired in the
Plusnet acquisition, and the assumed interest expense incurred by Esprit
Telecom in order to finance the Plusnet acquisition.
68
<PAGE> 73
8. These adjustments reflect the following:
An adjustment to prepaid phone card revenue in order to conform Esprit
Telecom's revenue recognition policy to GTS' revenue recognition policy.
Esprit Telecom recognizes prepaid phone card revenue upon sale of the phone
card. GTS recognizes prepaid phone card revenue over the estimated service
period.
An adjustment to depreciation expense in order to conform Esprit
Telecom's fiber optic cable depreciation policy with GTS' policy. Esprit
Telecom depreciates fiber optic cable using an accelerated method whereas
GTS depreciates fiber optic cable on a straight-line basis.
To eliminate inter-company revenue.
To reclassify the stockholders' equity accounts as a result of the
pooling of interests.
69
<PAGE> 74
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA OF GTS
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
GTS' audited consolidated financial statements. The following unaudited selected
historical consolidated financial data as of September 30, 1998 and for the
three and nine months ended September 30, 1997 and 1998 are derived from GTS'
unaudited consolidated financial statements. The selected financial data
presented below should be read in conjunction with "GTS 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 GTS' ventures are
accounted for by the equity method of accounting. Under this method, the
operating results of the ventures are included in our consolidated statement of
operations as a single line item, "Equity in (losses) earnings of ventures." GTS
recognizes 100% of the losses in ventures where we bear all of the financial
risk (which includes all of our significant ventures except for Sovintel and,
historically, HER). Also, the assets, liabilities and equity of the ventures are
included in GTS' Consolidated Balance Sheets as a single line item "Investments
in and Advances to Ventures." See Note 3 to GTS' audited consolidated financial
statements and "GTS Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Overview." Financial information about GTS' equity
ventures is included below under "Supplemental Information -- Selected
Historical Financial Data of GTS -- Combined Equity Investments."
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------- ------------------- --------------------
1993 1994 1995 1996 1997(1) 1997 1998 1997 1998
------- -------- -------- -------- --------- -------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues, net................ $ 328 $ 2,468 $ 8,412 $ 24,117 $ 47,098 $ 12,921 $ 63,834 $ 30,216 $ 117,299
Gross margin................. 328 23 16 5,176 4,379 (2,468) 24,985 1,864 35,232
Operating expenses........... 3,340 12,863 41,014 52,955 78,410 24,971 42,833 52,059 94,243
Equity in earnings (losses)
of ventures................ 472 (135) (7,871) (10,150) (14,599) (8,067) (3,485) (18,234) 4,142
Other income (expense)....... 100 990 11,034 (8,729) (29,551) (10,942) (15,484) (16,902) (34,857)
Loss before extraordinary
loss....................... (2,440) (11,985) (40,400) (67,991) (116,986) (48,185) (37,478) (87,872) (88,131)
Extraordinary loss(2)........ -- -- -- -- -- -- -- -- (12,704)
Net loss..................... (2,440) (11,985) (40,400) (67,991) (116,986) (48,185) (37,478) (87,872) (100,835)
Loss per share before
extraordinary loss......... (0.26) (0.69) (1.61) (2.22) (3.26) (1.34) (0.62) (2.49) (1.65)
Extraordinary loss per
share(2)................... -- -- -- -- -- -- -- -- (0.24)
Net loss per share........... (0.26) (0.69) (1.61) (2.22) (3.26) (1.34) (0.62) (2.49) (1.89)
</TABLE>
<TABLE>
<CAPTION>
AT SEPTEMBER 30,
1993 1994 1995 1996 1997(1) 1998
------- -------- -------- -------- --------- -------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA (AT END OF PERIOD):
Cash and cash equivalents........................ $ 3,641 $ 29,635 $ 9,044 $ 57,874 $ 318,766 $ 993,928
Property and equipment, net...................... 829 8,393 29,523 35,463 236,897 436,019
Investments in and advances to ventures.......... 794 13,841 56,153 104,459 76,730 61,705
Total assets..................................... 5,968 61,957 115,621 237,378 780,461 1,814,893
Total debt....................................... 725 2,152 27,454 85,547 639,359 1,208,533
Minority interest and stock subject to
repurchase..................................... -- 8 5,273 6,248 31,255 59,600
Shareholders' equity............................. 4,685 54,684 55,322 113,668 26,967 351,409
</TABLE>
- ---------------
(1) As a result of GTS' increase in ownership interest and amendment to the HER
Shareholders Agreement that was completed on July 16, 1997, GTS accounts for
its ownership interest in HER under the consolidation method of accounting.
Prior to this date, GTS accounted for HER under the equity method of
accounting.
(2) GTS recognized a $12.7 million extraordinary charge to earnings in the first
quarter of 1998, as a result of GTS' 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.
70
<PAGE> 75
SUPPLEMENTAL INFORMATION -- SELECTED HISTORICAL
FINANCIAL DATA OF GTS -- COMBINED EQUITY INVESTMENTS
The following unaudited selected historical financial data -- equity
investments for the years ended December 31, 1995, 1996 and 1997 and for the
three and nine months ended September 30, 1997 and 1998, are derived from GTS'
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.
GTS believes that this information provides additional insight on GTS'
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%). Further, 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(1) 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%(2) 4,574 2,834 2,960 (2,165)
Other.............................................. 50%(2) 526 957 9,379 (9,874)
-------- -------- -------- --------
Total........................................ 54,051 33,011 22,958 (6,380)
ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(3).... (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%(2) 25,778 11,883 13,614 (3,406)
Other.............................................. 50%(2) 12,063 12,235 21,132 (22,471)
-------- -------- -------- --------
Total........................................ 143,472 80,426 55,018 (5,220)
ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(3).... (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%(2) 44,275 21,355 17,678 (906)
Other.............................................. 50%(2) 14,013 13,757 27,596 (26,591)
-------- -------- -------- --------
Total........................................ 226,160 127,732 74,845 4,330
ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(3).... (24,927) (23,250) (8,357)
</TABLE>
71
<PAGE> 76
<TABLE>
<CAPTION>
OWNERSHIP COST OF OPERATING NET
INTEREST(1) REVENUES REVENUES EXPENSES INCOME/(LOSS)
----------- -------- -------- --------- -------------
(IN THOUSANDS, EXCEPT OWNERSHIP INTEREST)
<S> <C> <C> <C> <C> <C>
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>
- ---------------
(1) The ownership interest column indicates GTS' legal ownership percentage for
the respective equity investments. The information is being provided to
assist an investor or analyst in determining GTS' legal rights associated
with the presented financial data.
(2) During the quarter ended September 30, 1998, GTS purchased the remaining
47.36% interest in GTS Vox Limited, the intermediate holding company of TCM.
As a result, effective July 1998, GTS will have a 95% 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) GTS generally maintains a 50% ownership interest in these equity
investments.
(5) Prior to July 1, 1998, GTS beneficially owned approximately 25% of Golden
Telecom and included its results within the GTS Cellular companies accounted
for under the equity method. During the second quarter of 1998, GTS
completed a restructuring of the capital and ownership of Golden Telecom,
which results in GTS beneficially owning approximately 57% of Golden
Telecom. As a result, effective June 30, 1998, Golden Telecom is accounted
for under the consolidation as opposed to equity method of accounting. The
results of Golden Telecom 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 GTS' consolidated and equity method ventures. More detailed
information about inter-affiliate transactions is included under "GTS
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Accounting Methodology."
72
<PAGE> 77
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA OF ESPRIT TELECOM
SELECTED HISTORICAL FINANCIAL DATA OF ESPRIT TELECOM
The table below sets forth selected historical consolidated financial data
for Esprit Telecom for each of the years in the five-year period ended September
30, 1998. The selected consolidated financial data set forth below for the years
ended September 30, 1994, 1995, 1996 and 1997 have been excerpted or derived
from, and are qualified by reference to, Esprit Telecom's historical
consolidated financial statements, which have been audited by
PricewaterhouseCoopers, independent public accountants. The selected
consolidated financial data set forth below for the year ended September 30,
1998 have been excerpted or derived from, and are qualified by reference to,
Esprit Telecom's historical consolidated financial statements, which have been
audited by PricewaterhouseCoopers, independent public accountants. The
historical consolidated financial statements have been prepared in accordance
with UK GAAP, which differs in certain respects from US GAAP. The principal
differences between UK GAAP and US GAAP are summarized in Note 30 to Esprit
Telecom's audited historical consolidated financial statements included
elsewhere in this prospectus. The following information should be read in
conjunction with (i) "Esprit Telecom Management's Discussion and Analysis of
Financial Condition and Results of Operations", (ii) the historical consolidated
financial statements of Esprit Telecom and (iii) "Unaudited Pro Forma
Consolidated Financial Statements" included elsewhere in this prospectus.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-----------------------------------------------
1994 1995 1996 1997 1998
------ ------- ------- ------- --------
<S> <C> <C> <C> <C> <C>
L L L L L
<CAPTION>
(IN THOUSANDS, EXCEPT PER ORDINARY SHARE
AND PER ADS AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED PROFIT AND LOSS ACCOUNT DATA(1)
UK GAAP
Revenue.......................................... 3,820 13,950 24,880 45,466 82,588
Cost of sales.................................... (3,924) (10,640) (18,756) (37,949) (65,829)
Gross (loss)/profit.............................. (104) 3,310 6,124 7,517 16,759
Other operating expenses:
Selling, general and administrative............ (2,833) (4,112) (7,509) (15,505) (35,178)
Stock compensation costs(1).................... (187) (588) (2,035) (417) (112)
Restructuring costs............................ -- -- -- (312) --
Depreciation and amortization(2)............... (447) (790) (1,471) (2,836) (11,901)
Operating loss................................... (3,571) (2,180) (4,891) (11,553) (30,432)
Profit on sale of investment..................... -- -- -- -- 200
Net interest expense/income...................... (305) (222) (203) 695 (12,213)
Loss on ordinary activities before taxation...... (3,876) (2,402) (5,094) (10,858) (42,445)
Taxation on loss on ordinary activities.......... -- -- -- (2) (2)
Loss for the financial year...................... (3,876) (2,402) (5,094) (10,860) (42,447)
Loss per Ordinary Share(3)....................... (0.09) (0.05) (0.07) (0.10) (0.34)
Los per ADS(3)(4)................................ (0.63) (0.35) (0.49) (0.70) (2.38)
US GAAP
Net loss......................................... -- (2,423) (5,325) (10,852) (42,447)
Net loss per Ordinary Share(5)................... -- (0.05) (0.08) (0.10) (0.34)
Net loss per ADS(4)(5)........................... -- (0.35) (0.49) (0.70) (2.38)
OTHER FINANCIAL DATA
EBITDA(6) (UK GAAP).............................. (3,124) (1,390) (3,420) (8,711) (18,331)
EBITDA(6) (US GAAP).............................. -- (1,411) (3,651) (8,703) (18,331)
Ratio of earnings to fixed charges(7)............ -- -- -- -- --
</TABLE>
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<PAGE> 78
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-----------------------------------------------
1994 1995 1996 1997 1998
------ ------- ------- ------- --------
<S> <C> <C> <C> <C> <C>
L L L L L
<CAPTION>
(IN THOUSANDS, EXCEPT PER ORDINARY SHARE
AND PER ADS AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED CASH FLOW STATEMENT DATA UK GAAP
Cash (outflow)/inflow from operating
activities..................................... (2,465) 187 (2,245) (2,999) (29,131)
Returns on investments and servicing of
finance........................................ (305) (222) (203) 695 (4,834)
Taxation......................................... -- -- -- (2) (2)
Capital expenditure and financial investment..... (1,101) (1,685) (3,594) (7,919) (22,478)
Acquisitions and disposals....................... -- -- -- (852) (91,643)
Management of liquid resources................... -- -- (2,335) (20,541) (158,058)
Financing........................................ 3,826 6,868 6,541 29,799 308,309
CONSOLIDATED BALANCE SHEET DATA
UK GAAP
Bank balances, cash, restricted securities and
short term cash deposits....................... 180 5,615 6,430 24,525 184,749
Net current (liabilities)/assets................. (1,677) 2,619 3,974 16,521 167,507
Fixed assets, net................................ 2,400 3,514 8,005 17,727 154,100
Total assets..................................... 4,266 13,178 24,101 59,543 394,537
Creditors: amounts falling due within one year... (3,543) (7,045) (12,122) (25,295) (72,930)
Creditors: amounts falling due in more than one
year........................................... (633) (631) (1,968) (2,874) (328,806)
Total shareholders' funds........................ 90 5,502 10,011 31,374 (7,199)
US GAAP
Total assets..................................... 13,178 24,101 59,543 394,537
Long term debt................................... (631) (1,968) (2,874) (328,806)
Redeemable preference shares..................... (673) (673) -- --
Shareholders' equity/(deficit)................... 4,829 9,338 31,374 (7,199)
</TABLE>
- ---------------
(1) Esprit Telecom's financial information has been restated from that
previously published prior to December 1997 in order to give effect to a
change in UK GAAP relating to the granting of employee stock options at a
discount to the market price. The financial value of such discounts are now
reorganized as employee compensation and charged against net income. As
required by UK GAAP, this accounting change has been effected by restating
the results of previous periods. This change in accounting has no impact on
the US GAAP financial information presented.
(2) Includes European network amortization.
(3) Under UK GAAP, Loss per Ordinary Share is calculated based upon the weighted
average number of shares outstanding during the period, adjusted to reflect
the redesignation of the 'A' ordinary shares as Ordinary Shares and the
fifty for one share split that occurred in February 1997.
(4) Loss per ADS and Net loss per ADS are calculated by adjusting Loss per
Ordinary Share and Net loss per Ordinary Share, respectively for the ratio
of seven Ordinary Shares per ADS.
(5) Previously reported loss per Ordinary Share and net loss per Ordinary Share
in accordance with US GAAP has been restated to reflect the adoption of
Financial Accounting Standard No. 128, "Earnings Per Share" for all periods
presented.
(6) Earnings before interest, taxes, depreciation and amortization ("EBITDA") is
presented because it is a measure commonly used in the telecommunications
industry and is presented solely to enhance the understanding of the Esprit
Telecom's operating results. EBITDA, however, should not be considered as an
alternative to operating income or income for the year as an indicator of
the operating performance of Esprit Telecom. Similarly, EBITDA should not be
considered as an alternative to cash flows from operating activities as a
measure of liquidity. EBITDA is not a measure of financial performance under
generally accepted accounting principles and may not be compatible to other
similarly titled measures of
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<PAGE> 79
other companies. EBITDA may not be indicative of the historic operating
results of Esprit Telecom; nor is it meant to be predictive of potential
future results.
(7) The ratio of earnings to fixed charges is calculated by dividing (i) income
(loss) from ordinary activities before income taxes ("Earnings") plus fixed
charges by (ii) fixed charges. Fixed charges consist of interest expense,
and one-third of rental expense on operating leases. On a UK GAAP basis,
earnings plus fixed charges were insufficient to cover fixed charges by
L3,876,000 in 1994; L2,402,000 in 1995; L5,094,000 in 1996, L10,858,000 in
1997 and L42,445,000 for the year ended September 30, 1998. On a US GAAP
basis, earnings plus fixed charges were insufficient to cover fixed charges
by L2,423,000 in 1995; L5,325,000 in 1996; L10,852,000 in 1997 and
L42,445,000 for the year ended September 30, 1998.
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<PAGE> 80
GTS 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 GTS as of September 30, 1998 and December 31, 1997 and 1996 and
for the three and nine months ended September 30, 1998 and 1997 and for the
years ended December 31, 1997, 1996 and 1995 (the following discussion should be
read in conjunction with GTS' Consolidated Financial Statements and the notes
related thereto included elsewhere in this prospectus).
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Certain statements contained in "GTS 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 GTS' competitive environment and (iv) the performance of future
equity-method investments, contain forward-looking statements concerning GTS'
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 operating and continuing to develop 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' 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. GTS' 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.
GTS 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. 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, GTS 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 GTS must generate additional capital
resources in order to continue its operations and meet its new development
initiatives. The ultimate recoverability of GTS' investments in
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<PAGE> 81
and advances to ventures is dependent on many factors including, but not limited
to, the ability of GTS 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 GTS to maintain the necessary
telecommunications licenses.
GTS' 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 "Risk Factors."
ACCOUNTING METHODOLOGY
Accounting for Business Ventures. Wholly owned subsidiaries and
majority-owned ventures where GTS has unilateral operating and financial control
are consolidated. Those ventures where GTS exercises significant influence, but
does not exercise unilateral operating and financial control, are accounted for
by the equity method. GTS 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 GTS from exercising unilateral control of the
venture.
Profit and Loss Accounting. GTS recognizes profits and losses in accordance
with its underlying ownership percentage or allocation percentage as specified
in the agreements with its partners; however, GTS recognizes 100% of the losses
in ventures where GTS bears all of the financial risk (which includes all of
GTS' 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 GTS. When such
ventures become profitable, GTS recognizes 100% of the profits until such time
as the Excess Losses previously recognized by GTS have been recovered. As of
September 30, 1998, $8.3 million and $7.6 million represent the net unrecovered
Excess Losses for GTS' consolidated and equity method investments, respectively,
that is expected to favorably benefit future period results from operations upon
GTS' 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 GTS' accounting records. For
the period from January 1, 1997, through August 31, 1997, GTS 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) GTS no longer considers
itself as the financing partner.
Inter-Affiliate Transactions. Several of GTS' 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. GTS' ventures within the CIS region incur a 4% turnover tax
that is based on the revenues earned. GTS includes these taxes as a component of
its operating expenses, since these taxes are incidental to the revenue cycle.
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<PAGE> 82
The following table, as of September 30, 1998, summarizes the accounting
methodology for the principal business ventures through which GTS conducts its
business.
<TABLE>
<CAPTION>
EFFECTIVE
COUNTRY/REGION GTS ACCOUNTING
COMPANY NAME OF OPERATIONS OWNERSHIP METHODOLOGY
------------ -------------- --------- -----------
<S> <C> <C> <C> <C>
Western Europe
HER..................................... Western Europe 89 %(1) Consolidated(1)
GTS-Monaco Access....................... Monaco 50 % Equity
Central Europe
GTS-Hungary............................. Hungary 99 % Consolidated
EuroHivo................................ Hungary 70 %(2) Equity
Czechnet................................ Czech Republic 100 % Consolidated
CzechCom................................ Czech Republic 100 % Consolidated
CIS
Sovintel................................ Russia 50 % Equity
TCM..................................... Russia 95 %(3) Consolidated(3)
TeleRoss Operating Company.............. Russia 100 %(4) Consolidated
TeleRoss Ventures....................... Russia 50 %(5) Equity
Sovam................................... Russia 100 %(6) Consolidated(6)
GTS Cellular............................ CIS 50%-75 %(7) Equity/Consolidated
Asia
V-Tech.................................. China 75 % Equity
Beijing Tianmu.......................... China 47 % Equity
CDI..................................... India 100 % Consolidated
</TABLE>
- ---------------
(1) 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 and October
1998, GTS's ownership interest in HER increased 10% and 0.5%, respectively.
(2) GTS sold its interest in EuroHivo in August 1998. The closing of this
transaction did not have a material effect on GTS' results from operations
and financial condition.
(3) During the quarter ended September 30, 1998, GTS purchased the remaining
47.36% interest in GTS Vox Limited, the intermediate holding company of TCM.
As a result, effective July 1998, GTS has a 95% interest in TCM and accounts
for its interest in TCM using the consolidation as opposed to the equity
method of accounting.
(4) 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 (5) 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.
(5) TeleRoss Ventures is comprised of 14 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 (Equity Investees)."
(6) 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.
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<PAGE> 83
(7) 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) Golden Telecom, an
approximately 57% beneficially owned venture in Kiev, Ukraine. GTS completed
a restructuring of the capital and ownership of Golden Telecom on June 30,
1998, which results in GTS beneficially owning approximately 57% of Golden
Telecom. As a result, effective June 30, 1998, Golden Telecom is accounted
for by the consolidation as opposed to equity method of accounting.
Russian Economic Crisis. GTS 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 GTS' principal business ventures, several of GTS'
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 GTS' 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, Golden Telecom, HER,
GTS-Hungary and the Czech Companies. Although GTS was not able to follow the
consolidation method of accounting for Sovam, TCM and Golden Telecom in the
three and nine months ended September 30, 1997, and TCM and Golden Telecom for
the first six months of 1998, GTS 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. GTS' 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 Golden Telecom in GTS' 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 Golden
Telecom third quarter revenues are included in GTS' 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
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<PAGE> 84
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.)
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 Golden Telecom 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.
(Golden Telecom 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.
Golden Telecom represented 17.6% of the consolidated gross margin for the
third quarter 1998 (Golden Telecom was an equity method company prior to July 1,
1998). Golden Telecom's gross margin was 62.9%
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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.
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 Golden Telecom 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 Golden Telecom no longer being equity method investees offset
by a $7.7 million charge to earnings associated with GTS' 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, GTS' 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 GTS'
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 GTS' 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 GTS' 1997 and 1998 capital raising 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
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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.
Provision for Income Taxes. GTS' 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. GTS' 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. GTS recognized a $12.7 million extraordinary charge to
earnings in the first quarter of 1998, as a result of GTS' 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.
Year Ended December 31, 1997 compared to Year Ended December 31, 1996 and
compared to Year Ended December 31, 1995
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. GTS' 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 GTS' 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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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. GTS 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. GTS' 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 GTS' 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 GTS provides technical and financial
assistance, and $0.9 million related to the write-off of inventories,
receivables, and other assets) which represented GTS' 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". GTS would have recognized earnings from its investments in
non-consolidated ventures of $5.2 million for the year ended December 31, 1997,
had GTS 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 GTS' 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, GTS' 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." GTS' 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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Other Non-Operating Income. Favorably affecting the 1995 results was the
non-recurring $10.3 million gain that GTS 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. GTS' 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. GTS' 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)
Three and Nine Months Ended September 30, 1998 compared to Three and Nine
Months Ended September 30, 1997
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.
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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.
GTS Cellular. GTS operates three cellular networks through differing
ownership structures: Vostok Mobile, PrimTelefone and Golden Telecom
(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.
Year Ended December 31, 1997 compared to Year Ended December 31, 1996 and
compared to Year Ended December 31, 1995
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
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$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 $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.
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GTS Cellular. GTS operates three cellular networks through differing
ownership structures: Vostok Mobile, PrimTelefone and Golden Telecom.
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.
Golden Telecom did not have significant operations until 1997. Revenue for
Golden Telecom 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 $10.6 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 GTS.
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, GTS recorded a $2.4 million
charge to recognize the liabilities associated with the planned liquidation and
discontinuance of EuroHivo's operations. See Footnote 3 in GTS audited financial
statements for additional disclosures related to EuroHivo.
ASIA
Most of GTS' 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. GTS 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
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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 GTS' audited
financial statements for additional disclosures related to GTS' Asia operations
and "Business -- Asia."
LIQUIDITY AND CAPITAL RESOURCES
CORPORATE
The telecommunications business is capital intensive. GTS 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.
GTS 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, GTS 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, GTS 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, GTS as a result of their (or their affiliates) ownership of
GTS' Common Stock, of which $70.0 million was repaid in 1998.
GTS had working capital of $907.6 million and $353.4 million as of
September 30, 1998 and 1997, respectively. GTS 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, GTS 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 $1.2 billion in cash related to capital expenditures
and investments in ventures during the next three years. GTS obtained funds in
1998 through a variety of financing arrangements, including (i) approximately
$255.3 million in gross proceeds from the IPO, (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 GTS' 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
the Debentures. The Debentures are redeemable from July 1, 2001 at the option of
GTS, at redemption prices set forth in the agreement relating to the Debentures
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 GTS, except for the
Bonds, with which they rank pari passu in right of payment.
GTS believes that its existing cash balances, after giving effect to the
New HER Notes Offering, which notes are on substantially similar terms as HER's
existing senior notes, and cash flow from operations will be sufficient to fund
its expected capital needs under its current business plan, excluding any funds
expended in
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connection with the implementation of GTS' European Services Strategy. See
"-- Liquidity and Capital Resources -- European Services Strategy". GTS
contemplates that it will raise additional debt financing through a newly formed
subsidiary of GTS, the proceeds of which will be applied toward the
implementation of GTS' European Services Strategy. GTS has not yet determined
the actual amount and timing of such financing.
The actual amount and timing of GTS' 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 GTS' revenues,
operating costs and development expenses, which can be affected by GTS' 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. GTS' revenues and costs are also dependent upon
factors that are not within GTS' 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 GTS' 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 GTS' future capital requirements.
Historically, GTS has experienced liquidity problems resulting in part from GTS'
need to meet the capital requirements of certain of its ventures in excess of
forecast amounts. In addition, certain of GTS' 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 GTS expands its operations at an accelerated rate
or consummates acquisitions, GTS' funding needs will increase, possibly to a
significant degree, and it will expend its capital resources sooner than
currently expected. GTS may also be required to repay the Bonds upon maturity on
June 30, 2000 to the extent the Bonds are not converted into Common Stock. As a
result of the foregoing, or if GTS' capital resources otherwise prove to be
insufficient, GTS 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 GTS will be able to consummate additional
financing on favorable terms. As a result, GTS 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 GTS 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 GTS.
HER
Construction of the HER fiber optic network is one of GTS' most significant
business activities. HER has spent approximately $136 million in cash on network
capital expenditures through September 30, 1998 and expects to incur an
additional $654 million in cash through 2000 in order to complete the buildout
of the network. The total capital expenditures required for the buildout of the
network has increased as a result of additional routes being planned, including
transatlantic capacity, and for enhancing the speed and capacity of the network.
Additionally, as of September 30, 1998, GTS has capitalized $242.2 million in
connection with long-term fiber lease arrangements and expects to capitalize an
additional $181 million through 2000 in order to complete the buildout of the
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. GTS
believes that the net proceeds from the Senior Notes and the offering of New HER
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
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fiber lease arrangements and other cash needs. 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 GTS to make additional capital contributions to HER at the
expense of GTS' other operations, either of which could have a material adverse
effect on the operations of GTS. 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 early stage of implementation of GTS' European Services
Strategy, GTS cannot estimate with any degree of certainty the amount and timing
of GTS' future capital requirements for its implementation, which will be
dependent on many factors, including the success of GTS' European end-user
services business, the rate at which GTS expands its networks and develops new
networks, the types of services GTS offers, staffing levels, acquisitions and
customer growth, as well as other factors that are not within GTS' control,
including competitive conditions, regulatory developments and capital costs.
Management believes that it is likely that GTS will need to raise additional
capital above that raised through July 31, 1998. GTS 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
end-user services business. There can be no assurance that GTS' operations,
including the Company's European end-user services business, will achieve or
sustain profitability or positive cash flow in the future.
LIQUIDITY ANALYSIS
GTS had cash and cash equivalents of $993.9 million and $366.8 million as
of September 30, 1998 and 1997, respectively. GTS 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 GTS and $265 million of the Senior Notes of HER.
During the three and nine months ended September 30, 1998, GTS' 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 GTS' operations will achieve or sustain profitability or positive
cash flow in the future. If GTS 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, GTS 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, GTS as a result of their (or their
affiliates) ownership of Common Stock.
Substantially all of GTS' operations are in foreign countries and therefore
GTS' 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, GTS
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 GTS is attempting to match revenues,
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costs, borrowing and repayments in terms of their respective currencies, GTS 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 GTS' 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. GTS may also
experience economic loss and a negative impact on earnings related to these
monetary assets and liabilities.
GTS has developed risk management policies that establish guidelines for
managing foreign exchange risk. GTS is currently evaluating the materiality of
foreign exchange exposures in different countries and the financial instruments
available to mitigate this exposure. GTS' 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. GTS is designing reporting processes to
monitor the potential exposure on an ongoing basis and expects to implement this
process before the end of 1998. GTS will use the output of this process to
execute financial hedges to cover foreign exchange exposure when practical and
economically justified.
In April 1998, GTS consummated an economic transaction to hedge the foreign
exchange exposure resulting from the issuance of $265 million Senior Notes by
HER.
In the August 17 Decision the Russian government and the Russia Central
Bank announced the following measures: a) The repayment of GKO treasury bills
and OFZ federal bonds was suspended; subsequently, secondary trading therein was
halted. Since many Russian banks had substantial investments in these
securities, severe liquidity problems resulted for the banks. b) 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. c) 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 and December 18, 1998 was 16.0645 and 20.7 rubles
per US dollar, respectively. 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, GTS 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 GKO treasury bills and OFZ federal bonds 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 GTS 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
GTS and its financial condition and results of operations.
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YEAR 2000 COMPLIANCE
The "Year 2000" issue is the result of computer programs using two digits
rather than four to define the applicable year (the "Year 2000 Issue"). Because
of this programming convention, software, hardware or firmware may recognize a
date using "00" as the year 1900 rather than the year 2000. Use of non-Year 2000
compliant programs could result in system failures, miscalculations or errors
causing disruptions of operations or other business problems, including, among
others, a temporary inability to process transactions and invoices or engage in
similar normal business activities.
Issues Posed by the Year 2000 Issue. GTS is exposed to the Year 2000 Issue
in a number of ways. Among other things, the Year 2000 Issue might affect GTS':
(i) computer hardware and software; (ii) telecommunications equipment and other
systems with embedded logic (among other things, this includes GTS' fire
detection, access control systems, heating, ventilation and air conditioning,
and uninterruptible power supply); (iii) operating partners and organizations
upon which GTS is dependent; (iv) local access connections, upon which GTS is
dependent; and (v) supply chain.
Global TeleSystems Group Inc.'s Year 2000 Compliance Program. GTS has
initiated a Year 2000 compliance program to address the aforementioned risks
which the Year 2000 Issue poses and to avoid any material loss or impact to GTS
or its customers due to these risks (the "Year 2000 Compliance Program"). The
object of the Year 2000 Compliance Program is to ensure that neither the
performance nor functionality of GTS' operations are affected by dates, prior
to, during and after 2000. The scope of the Year 2000 Compliance Program
includes all of the business functions, locations and resources which are
essential to GTS. The resources which are within the scope of the Year 2000
Compliance Program are, among other things, GTS' computer systems, software,
vendor supplied software, telecommunications equipment, third party
telecommunications partners and other Network service suppliers, environmental
and building control systems, internal communication systems and other
interfaces with third party services. As explained below, GTS' efforts to assess
its systems as well as non-system areas related to Year 2000 compliance involve
(i) a wide-ranging assessment of the Year 2000 problems that may affect GTS,
(ii) the development of remedies to address the problems discovered in the
assessment phase and (iii) testing of the remedies.
Assessment Phase. 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. During the
assessment phase GTS has identified substantially all of its major hardware and
software platforms, applications, telecommunications equipment and other non-IT
resources that support the business functions. The assessment phase of the Year
2000 Compliance Program further identified the internal and external technical
interfaces, third party business relationships and internally developed systems
which might be materially impacted by Year 2000 issues. GTS' observations from
the assessment phase during the third and fourth quarters of 1998 is that most
of GTS' telecommunications equipment and software has been purchased within the
past three years and the majority is already compliant or can be made compliant
with minor upgrades. GTS completed the assessment phase of its Year 2000
readiness in the fourth quarter of 1998.
Remediation, Prevention and Testing Phases. Based on those resources
identified in the assessment phase, GTS developed a detailed plan in the fourth
quarter of 1998, that will then be followed by an upgrade, a remediation, a
prevention and a testing phase in early 1999. These phases are expected to be
completed during the second quarter of 1999.
Assessment of Third Party Compliance. As noted above, GTS has also
undertaken under its Year 2000 Compliance Program to assess and monitor the
progress of third party vendors in resolving Year 2000 issues. To ensure the
compliance of vendors of hardware and software applications used by GTS, GTS is
obtaining confirmations from GTS' primary telecommunication vendors, business
partners and hardware and software vendors as to what plans, if any, are being
developed or are already in place to address their ability to process
transactions in the Year 2000. GTS intends to continue follow up with any
vendors who indicate any material problems in their replies. GTS expects to
receive statements of intended compliance by mid-1999.
Worst Case Scenario for GTS. The worst case scenario for GTS would be the
failing of its telecommunications equipment, power providers and/or interfaces
with other telecommunication vendors. These cases
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would create business interruption at some of GTS' operations and would
adversely affect GTS' revenues. For example, the Moscow power authorities have
publicly stated that they do not intend to address Year 2000 issues until
problems arise. However, GTS has operations that are geographically diversified;
therefore, it is not anticipated that the worst case scenario would affect all
operations at the same time. Additionally, if power failures occur, GTS
currently has diesel generators at certain of its major sites. Based on its
assessment during the third and fourth quarters of 1998, GTS does not foresee a
material loss due to these conditions and management is hopeful that its
remediation and testing efforts will ensure that it has addressed its Year 2000
readiness. However, there can be no assurance that Year 2000 non-compliance by
GTS' systems or the systems of vendors, customers, partners or others will not
result in a material adverse effect.
Contingency Plans. GTS 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 ability to have access to diesel
fuel or large generators should power failures occur, the ability to quickly
replace telecommunications equipment and the ability to contract with
alternative telecommunication and maintenance providers at reasonable terms.
Moreover, GTS is further limited in resources in certain geographical regions
due to the market volatility and weak economies in which GTS has business
operations. See "Risk Factors -- Risks Specific to GTS -- Risks Relating to
Operations in Russia and the CIS".
Costs Related to the Year 2000 Issue. GTS expects that it will incur
between $2.0 million to $3.5 million in expenses to complete the assessment,
detailed planning, remediation, prevention and testing phases, exclusive of
replacement costs for telecommunications equipment and software, of which
approximately $0.6 million had 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. GTS 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 the early stage of the Year 2000 readiness review.
These costs will be funded from operating cash flows and expensed as incurred.
In addition, the preceding cost estimate does not include amounts associated
with the accelerated acquisition of replacement systems as none are included in
the initial assessment during the third and fourth quarters of 1998. GTS does
not expect that the costs of addressing its Year 2000 readiness will have a
material effect on GTS' financial condition or results of operations. However,
there can be no assurance that Year 2000 non-compliance by GTS' systems or the
systems of vendors, customers, partners or others will not result in a material
adverse effect on GTS.
Risks Related to the Year 2000 Issue. Although GTS' efforts to be Year 2000
compliant are intended to minimize the adverse effects of the Year 2000 issue on
GTS' business and operations, the actual effects of the issue will not be known
until 2000. Difficulties in implementing the remediation or prevention phases or
failure by GTS to fully implement the planning or remediation phases or the
failure of its major vendors, third party network service providers, and other
material service providers and customers to adequately address their respective
Year 2000 issues in a timely manner would have a material adverse effect on GTS'
business, results of operations, and financial condition. See "Risk
Factors -- Risks Specific to GTS -- Risks Associated with Potential Failure of
GTS' Systems to Recognize Year 2000".
INTRODUCTION OF THE EURO
On January 1, 1999, certain countries of the EU are scheduled to establish
fixed conversion rates between their existing sovereign currencies and a new
currency to be called the "Euro." The Euro is now trading on currency exchanges
and is 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, GTS
has significant operations within the EU, including many of the countries that
are scheduled to adopt the Euro. GTS 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. GTS has not yet completed its evaluation of the potential impact
likely to be caused by the Euro adoption.
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ESPRIT TELECOM MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion of the financial condition and results of
operation of Esprit Telecom for each of the years in the three-year period ended
September 30, 1998 (the following discussion should be read in conjunction with
Esprit Telecom's Consolidated Financial Statements and the notes related thereto
included elsewhere in this prospectus).
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Certain statements contained in "Esprit Telecom 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 Esprit Telecom's competitive environment and (iv)
the performance of future equity-method investments, contain forward-looking
statements concerning Esprit Telecom'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.
REVENUE
Revenue is based primarily on the volume of traffic minutes billed by
Esprit Telecom and, to a lesser extent, on the additional services and products
provided through the Esprit Network. Esprit Telecom provides both national and
international long distance telecommunications services to its customers. In
addition, Esprit Telecom has recently introduced two new categories of service
to its established telecommunications services and products: bandwidth services
and enhanced services. Esprit Telecom currently provides services and products
to three targeted customer segments: retail, wholesale, and service
provider/reseller.
Most of Esprit Telecom's retail revenue is currently derived from SMEs and
medium- to large-sized businesses, governmental agencies and other
organizations. Contracts are typically for one year, although shorter periods
may apply to certain customers or market segments. Esprit Telecom provides both
national and international long distance telecommunication services to its
retail service customers. Revenues are derived from the number of minutes of use
(or fractions thereof) billed by Esprit Telecom and are recorded upon completion
of calls. Esprit Telecom has experienced, and expects to continue to experience,
declining revenue per minute in all of its markets as a result of increasing
competition in telecommunications services and an increasing proportion of
lower-priced national traffic, which Esprit Telecom expects will be partially
offset by increased minute volumes and additional product introductions. Esprit
Telecom maintains local market pricing structures for its services and offers
its retail services at rates which it believes represent an attractive discount
from the rates generally offered by PTOs. This category also includes revenues
from the sale of enhanced services to retail customers, which include toll free
services and calling cards. Though currently relatively small, Esprit Telecom
expects the range of enhanced services to expand substantially as Esprit Telecom
increases the capabilities of the its network through additional intelligence
capabilities.
Wholesale revenues are derived from customers that are long distance
carriers that connect with Esprit Telecom to carry their traffic to
destinations, where Esprit Telecom's rates are competitive, both on the Esprit
Network and on other off-network routes. Contracts with wholesale customers
generally do not include minimum or maximum usage levels. As a result, wholesale
customers typically change their routing to take advantage of the lowest cost
alternative, resulting in potentially greater fluctuations in revenue from these
customers than from other categories of customers. In several cases, Esprit
Telecom also uses its wholesale customers as suppliers for termination of its
off-network calls, although there are not usually formal contracts requiring any
balancing of traffic between the parties. Wholesale traffic supports the
expansion of the Esprit Network by increasing the capacity utilization of a
particular network route. Also included in this segment is revenue generated
from the sale of bandwidth services to wholesale customers. Currently this
represents a relatively small revenue source as only the first ring of Esprit
Telecom's SDH broadband fiber network is in
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service. However, as further rings are brought into service during 1999 these
revenues are expected to increase and may in the future be reported as a
separate category once they are significant.
Esprit Telecom provides its service provider/reseller customers with
network management and termination services. Service Providers generally provide
value-added services such as calling cards, and together with resellers,
generally target customers with products or at spend levels different to those
currently targeted by Esprit. Revenue from service provider/reseller services is
based upon the number of service provider/reseller customers and on the volumes
from such customers' underlying clients. Revenue from service provider/ reseller
services has grown rapidly and is expected to continue to grow as Esprit Telecom
increases its customer base and its service offerings in different markets, and
as Esprit Telecom's service provider/reseller customers increase their own
client base.
Esprit Telecom competes based on its ability to offer the best value in
terms of quality and price to customers that desire reliable, high quality and
cost effective services. Prices in the long distance industry in Europe have
declined in recent years and, as competition continues to increase, Esprit
Telecom expects that prices will continue to fall. Esprit Telecom believes,
however, that the impact on its results from such decreases in price will be at
least partially offset by increased traffic volume, continuing decreases in the
cost of providing telecommunications services and the introduction of new
products and services.
In addition, Esprit Telecom expects to benefit from the continuing
liberalization of the European telecommunication markets, to the extent that it
will be able to introduce new services and reduce its costs. The Plusnet
business has added substantially to Esprit Telecom's revenue and is expected to
provide opportunities for significant growth following the liberalization of the
German telecommunications market.
COST OF REVENUE
Esprit Telecom's costs of revenue fall into four general categories: access
costs, network costs, termination costs and direct sales costs. Access costs
represent the cost of bringing the traffic from the customer's premises to the
nearest point on the Esprit Network. In the case of larger retail customers who
have direct access to the Esprit Network, the access is via dedicated leased
lines, and hence this cost is fixed for each customer, but variable with the
number of customers. The rental costs of these access lines depend upon the
bandwidth and the distance to the customer site. There are substantial
differences in leased line rental costs within Europe, which in most cases have
to be leased from the PTOs. Esprit Telecom believes that there will be a
reduction in the effective cost per minute of such bandwidth as alternative
infrastructure providers compete in providing leased lines and EU directives
requiring cost-oriented pricing by PTOs are enforced. However, in the event that
leased circuit rental costs were to fall at a slower rate than Esprit Telecom's
price per minute, Esprit Telecoms's gross margins would be likely to be
adversely impacted. In the case of retail customers which connect to the Esprit
Network using indirect access codes, Esprit Telecom is charged on a usage basis
for bringing calls from customer sites onto the Esprit Network pursuant to its
intercompany arrangement with the local PTO. Access costs for wholesale services
and for certain service provider and reseller customers may be low since these
customers either provide their own access equipment within the Esprit Telecom
switch site or are, in many cases, located in close proximity to Esprit
Telecom's switch sites.
Network costs represent the costs of bringing the call over the Esprit
Network from its point of entry to its point of exit. Currently, these costs are
comprised primarily of the rental costs for national and international leased
circuits, which are largely fixed over the short term. These costs will be
variable over the longer term as circuit capacity and network scope are
expanded. When the demand for Esprit Telecom's leased circuits exceeds capacity,
calls must be rerouted over alternative routes purchased from other carriers on
a spot rate per minute ("overflow") basis, which costs are recorded as
termination costs. Acquiring capacity on an overflow basis may have a negative
impact on margins, but enables Esprit Telecom to maintain uninterrupted service
to its customers. Until European liberalization in 1998, with the exception of
in the United Kingdom, national and international capacity could only be leased
from local PTOs. Such capacity is costly in comparison to markets in which
competition in infrastructure is established, such as the United States. As
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with access circuit rental costs, Esprit Telecom also believes that there will
be a reduction in the effective rental cost per minute of such bandwidth in the
future. As Esprit Telecom's SDH broadband fiber network is established and
expanded, its direct operating and maintenance expenses will be recognized in
network costs. Certain direct third party billing costs are also included in the
category of network costs.
Esprit Telecom intends to expand substantially the reach and scope of its
SDH broadband fiber network and expects that the resulting higher operating and
maintenance costs will have a depressing effect on gross margins until circuit
utilization is increased through higher traffic volumes. Additionally, following
price cuts which are due to be implemented by Deutsche Telekom on German
national traffic in January 1999, and which are likely to result in lower
selling prices by Esprit Telecom and other competitors in that market, gross
margins in Germany may be negatively impacted until such time as Esprit Telecom
is able to establish a lower cost base network in Germany.
Termination costs currently represent the largest category of costs to
Esprit Telecom, comprising approximately 65.5% of revenue for the year ended
September 30, 1997 and 60.3% of revenue for the year ended September 30, 1998.
These represent the costs Esprit Telecom pays to other carriers for taking calls
from the final point at which they leave the Esprit Network to their ultimate
destination. Termination costs are variable with traffic volumes. If the call is
terminated in a city in which Esprit Telecom has a point of presence, the call
is usually passed to the local PTO for termination via the local loop. If it is
to a destination where Esprit Telecom does not have a point of presence, then
the call must be passed to another carrier with which Esprit Telecom connected.
As the latter is typically an international leg, whereas the former is a local
leg, the cost of the latter is usually a greater proportion of the call revenue
than the former. Using least-cost routing technologies, the Esprit Telecom
switch is programmed to select the most cost efficient route and carrier for the
required destination. Esprit Telecom believes that there should be a reduction
in the unit cost of termination, as Esprit Telecom builds out the Esprit Network
to additional points of presence thus increasing the proportion of traffic that
may be carried on the Esprit Network, and interconnects with additional PTOs or
other infrastructure providers thus incurring lower local termination costs. In
addition, Esprit Telecom believes that, over time, unit termination costs will
also decrease as the emergence of new telecommunication service providers and
the construction of new transmission facilities result in increased competition.
Esprit Telecom expects that an increasing amount of its total operating costs
will be fixed in the medium term, as the capacity of Esprit Telecom's SDH
broadband fiber network, and certain of its MIUs and IRUs, is significantly
greater than current traffic volumes.
Direct sales costs represent commissions payable to external agents for
customer contracts generated by such agents. These commissions may be set as a
fixed cost per contract or may be set as a percentage of revenues generated for
a defined period. Prior to the acquisitions of the Plusnet business and IMS,
Esprit Telecom's use of such agents was minimal.
SALES, GENERAL AND ADMINISTRATIVE EXPENSES
Indirect expenses are comprised primarily of salaries, commissions and
other employee benefits, office and administrative expenses and professional
fees, as well as marketing costs, provision for bad debt, travel costs and other
support costs. These expenses have increased as Esprit Telecom has developed and
expanded its workforce, and are expected to continue to increase as new
operations are established and the Esprit Network is expanded. Selling, general
and administrative expenses as a percentage of revenue will continue to vary
from period to period as a result of start-up costs relating to new sales
offices. Selling, general and administrative expenses also include gains or
losses on foreign currency transactions excluding financing facilities, where
such gains or losses are shown in net interest. See Note 3 to Esprit Telecom's
Consolidated Financial Statements.
Esprit Telecom has grown and intends to continue to grow by establishing
sales offices in additional European cities. Each of Esprit Telecom's local
sales offices is in a different stage of development. The development and
expansion of these sales offices involves substantial start-up costs, a large
portion of which will be reflected as fixed costs and recorded as selling,
general and administrative charges. Accordingly, Esprit
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Telecom's consolidated results of operations will vary depending on the timing
and speed of Esprit Telecom's expansion strategy and, during a period of rapid
expansion, selling, general and administrative expenses will be relatively
higher than during more stable periods of growth.
DEPRECIATION
The broadband fiber network and associated SDH broadband fiber network
equipment will be depreciated using an accelerated method over a ten-year
period. Esprit Telecom capitalizes its own direct costs, and third party costs
which are related specifically to the construction of its SDH broadband fiber
network, and expenses its own overhead costs related to the establishment of new
sales offices and terminating sites or the expansion of other elements of the
Esprit Network. The increased level of capital expenditure related to the
expansion and development of this network, including the broadband SDH fiber
network, and the establishment of sales offices and terminating sites in new and
existing markets and amortization of goodwill from the addition of the Plusnet
business, is expected to result in an increased level of depreciation in future
periods.
FOREIGN EXCHANGE RATES
Esprit Telecom is exposed, and as it expands into additional countries in
Europe, may be increasingly exposed, to fluctuations in foreign currencies as
its revenue, and certain of its costs, assets and liabilities are denominated in
local currencies, although these currencies will be reduced in number upon the
adoption of the Euro in Euro countries. Esprit Telecom's proceeds from the
Financings, and the principal and interest amounts payable under the Esprit
Telecom Bonds, are denominated in US Dollars and Deutschmarks (until
redenominated as Euros). Additionally, Esprit Telecom may maintain significant
cash, cash balances or short term loans in currencies other than pounds
sterling. As a result, Esprit Telecom's financial condition and results of
operations, as reported in pounds sterling, are and will continue to be affected
by fluctuations in the value of the local currencies in which Esprit Telecom
transacts business and in particular, Esprit Telecom's ability to make principal
and interest payments in US Dollars and Deutschmarks (or Euros) may be adversely
impacted by fluctuation in exchange rates. Approximately 52.3% of revenue during
the year ended September 30, 1998 was denominated in the currencies of Euro
countries. Esprit Telecom expects that its share of revenue in such currencies
will continue to increase in future periods.
INFLATION
Inflation has not had a significant effect on Esprit Telecom's results of
operations and financial condition during the three financial years ended
September 30, 1998.
SEASONALITY
The level of Esprit Telecom's revenue in a given month is substantially
influenced by the number of business days in that month. In addition, Esprit
Telecom experiences reduced levels of revenue in the months of July, August,
December and January, as these months are traditional holiday periods in most
European countries.
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RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain turnover
and cost data as a percentage of revenue.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------------------
1996 1997 1998
-------------- -------------- --------------
L % L % L %
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C>
TURNOVER
Retail...................................... 12,460 50.1 18,926 41.6 51,616 62.5
Wholesale................................... 10,870 43.7 19,425 42.7 14,869 18.0
Service Provider/Reseller................... 1,550 6.2 7,115 15.7 16,103 19.5
------ ----- ------ ----- ------ -----
24,880 100.0 45,466 100.0 82,588 100.0
COST OF SALES
Access costs................................ 1,328 5.3 2,266 5.0 7,152 8.6
Network costs............................... 3,407 13.7 5,921 13.0 8,565 10.4
Termination costs........................... 14,021 56.4 29,762 65.5 49,780 60.3
Direct sales costs.......................... -- -- -- -- 332 0.4
------ ----- ------ ----- ------ -----
18,756 75.4 37,949 83.5 65,829 79.7
------ ----- ------ ----- ------ -----
GROSS MARGIN................................ 6,124 24.6 7,517 16.5 16,759 20.3
</TABLE>
The following table sets forth, for the periods indicated, revenue by major
geographic region served by The Esprit Network:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------------------
1996 1997 1998
-------------- -------------- --------------
L % L % L %
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C>
REVENUE
United Kingdom.............................. 17,846 71.7 31,088 68.4 39,411 47.7
The Netherlands............................. 5,229 21.0 8,825 19.4 16,289 19.7
Germany..................................... -- -- 215 0.5 15,950 19.3
Rest of Europe(1)........................... 1,805 7.3 5,338 11.7 10,938 13.3
------ ----- ------ ----- ------ -----
24,880 100.0 45,466 100.0 82,588 100.0
</TABLE>
- ---------------
(1) Includes Belgium, Spain, France and, since 1998, Italy.
YEAR 2000 COMPLIANCE
A significant percentage of the software running on most of the computers
worldwide relies on two-digit date codes to perform a number of computation and
decision making functions. The date change from 1999 to 2000 may impair the
ability of these programs to interpret date codes properly, which could result
in system failures, miscalculations or errors, causing disruptions of operations
or other business problems, including the inability to process transactions,
send invoices or engage in similar normal business activities.
Esprit Telecom is undertaking a comprehensive program to address the Year
2000 issue with respect to:
- its transmission, switching, billing and management information systems;
- its non-information technology systems (including buildings, plant,
equipment and other infrastructure that may contain embedded technology);
and
- systems of its primary traffic carriers and vendors.
Esprit Telecom is also trying to raise awareness of Year 2000 issues in its
customers' systems.
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This program involves four phased steps:
- identifying and assessing potential Year 2000 problems which may impact
Esprit Telecom;
- developing remedial strategies and actions to address those problems;
- implementing those remedial strategies and actions; and
- testing the foregoing solutions.
The program also involves analyzing Esprit Telecom's most reasonably likely
worst-case Year 2000 scenario. Esprit Telecom expects that this would involve
either or both of the following:
- a loss of interconnect capacity from one or more major suppliers of
transmission capacity; and/or
- Esprit Telecom's inability to record, track or invoice billable minutes
which could ultimately cause it to temporarily stop carrying traffic.
Either scenario would adversely affect Esprit Telecom's revenue and, if not
quickly remedied, would have a material adverse effect on its business, results
of operations and financial condition.
Assessment
Esprit Telecom is currently in the process of auditing and testing its
systems to determine if they will suffer problems associated with the transition
to Year 2000. Since a complete analysis of Esprit Telecom's systems would
require an interruption of service, Esprit Telecom is selectively testing
various elements of such systems. Esprit Telecom has an active in-house
assessment program, with a staff of six persons assigned to Year 2000 compliance
issues. Despite devoting these resources to addressing Year 2000 compliance,
Esprit Telecom has not delayed the implementation of any projects related to
management information systems. Esprit Telecom's Year 2000 compliance team is in
the process of reviewing each of Esprit Telecom's switching sites and other
network points to identify equipment, hardware and software that is unlikely to
function through the Year 2000 transition.
In addition, Esprit Telecom actively cooperates with other carriers in a
global Year 2000 program through ITU-T Year 2000 Taskforce, and the UK Year 2000
Operators forum. As part of the latter forum Esprit Telecom is participating in
a voluntary and independent health check review of our Year 2000 program
(conducted by another operator).
Remedial Strategies and Actions
Following its assessment, Esprit Telecom expects to replace, rather than
upgrade, the majority of the problem equipment within its own network systems,
which includes information technology and non-information technology systems.
Esprit Telecom will require that any systems being replaced or upgraded be
warranted as Year 2000 compliant by the vendors or suppliers of these systems.
Esprit Telecom is currently in the process of replacing its billing and
management information systems, which Esprit Telecom expects will be fully
operational by mid-1999. Esprit Telecom also intends to ensure that it is
capable of providing back up power and other equipment at switch sites, as well
as alternative routing around switch sites which experience problems despite
these remedial actions.
To address its worst case scenarios, Esprit Telecom has also determined to
obtain supplemental interconnect and transmission capacity in the event that one
or more of its primary carriers experience system failures. Esprit Telecom has
undertaken joint Year 2000 compliance reviews through industry forums and with
several of its major carriers. Ultimately, however, Esprit Telecom has no
control of the Year 2000 readiness of any of its suppliers or customers, and
will be exposed to risks associated with their failure to assess and address
Year 2000 problems. There are many Year 2000 issues outside of the control of
Esprit Telecom, and like most telecommunications service providers, Esprit
Telecom believes it is inappropriate to provide specific guarantees that service
will not be affected by the transition to the new millennium.
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Implementation
Esprit Telecom is in the process of securing supplemental interconnect and
transmission capacity from several carriers in addition to its current primary
carriers. With respect to its own systems, Esprit Telecom has spent
approximately $4.0 million for Year 2000 compliance through September 30, 1998,
and expects to spend approximately an additional $4.0 million through the end of
calendar year 1999. Out of this total of $8.0 million in expenditures, Esprit
Telecom expects to spend a total of $1.0 million on repairing existing systems
and the remainder on testing and replacement.
Testing
Esprit Telecom expects to test numerous elements of its systems for Year
2000 compliance, as well as its ability to interconnect with and utilize back-up
carriers, throughout 1999. In particular, Esprit Telecom expects to test its new
billing and management information systems when the same become operational in
mid-1999. As noted above, however, Esprit Telecom will be unable to test its
network systems in their entirety since to do so would involve shutting down its
network for a period of time.
IMPACT OF EURO
In accordance with the Treaty on EU, signed at Maastricht on February 7,
1992, Stage III of the Economic and Monetary Union ("EMU") will commence on
January 1, 1999. At that time, a single currency, the 'Euro', will be
introduced. The Euro will exist in parallel with national currencies, and
transactions may be denominated in either currency until December 31, 2001
(though only notes and coins of the national currencies will be available for
physical exchange). From January 1, 2002, Euro notes and coins will be
introduced and national currencies will be withdrawn by June 30, 2002. Those
participating member states will also transfer authority for conducting monetary
policy to a European Central Bank. From January 1, 1999, the value of the Euro
as against the currencies of each of the participating member states will be
irrevocably fixed.
On May 3, 1998, European governments and central banks announced that the
following eleven member states would participate in the third stage of EMU:
Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, The
Netherlands, Portugal and Spain. They also announced the bilateral exchange
rates at which the eleven currencies of these participating member states are
expected to be fixed against one another on January 1, 1999. Although it is
expected that the relevant central banks will take market action to ensure that
market exchange rates on December 31, 1998 will be equal to the announced rates,
this is not certain.
Esprit Telecom has significant operations within the EU. The implications
are currently being considered by a working party which includes representatives
from each of the relevant business functions. These include: preparing business
systems for trading in Euros and converting the accounting systems of companies
in the common currency area from their national currency to Euros; the benefit
of the elimination of exchange rate risk in cross border transactions within the
common currency area; the potential impact of increases in pricing transparency
on price differentials between member states; and training and human resources
issues. Esprit Telecom is working actively with key business suppliers and
customers to prepare for EMU. In addition, monetary union may have a significant
impact on macroeconomic factors, including interest and foreign exchange rates.
Esprit Telecom's readiness is being managed as a discrete business project
across the group; all businesses expect to have systems and procedures in place
which will enable them to conduct Euro transactions appropriate to their local
market requirements. Equally, Euro capability requirements are being
incorporated into the financial system and projects of the corporate centre. The
principal business system which will be most affected by EMU is billing; a new
billing system has been contracted and is in the process of implementation. This
system is fully Euro-compatible. Costs in other areas have not been quantified.
Looking forward, key commercial risks, such as pricing transparency, are
being analyzed by each business, with a view to minimizing any impact through
active management in these areas over the EMU transition period and beyond.
However, there can be no assurance that the Euro will not have a negative
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impact. The impact of future entry to EMU of other European countries
(particularly the United Kingdom)is being similarly analyzed.
US GAAP RECONCILIATION
Esprit Telecom's financial statements are prepared in accordance with UK
GAAP, which differ in certain significant respects from US GAAP. The main
differences relevant to Esprit Telecom relate to stock based compensation.
For further explanation of the differences between UK GAAP and US GAAP, see
Note 30 to Esprit Telecom's Consolidated Financial Statements.
RESULTS OF OPERATIONS FOR THE YEARS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER
30, 1998
REVENUE
Revenue increased from approximately L45.5 million for the year ended
September 30, 1997 to approximately L82.6 million for the year ended September
30, 1998, representing an increase of 81.6%. This increase was mainly due to the
increase in Esprit Telecom's retail customer base and customer traffic in all of
its European operations, particularly in the United Kingdom, The Netherlands and
Germany partially offset by a decline in prices for Esprit Telecom's products
and services and a reduction in wholesale revenues. Revenue from Belgium, Spain,
France and Italy increased by 104.9% between the two periods due to the increase
in Esprit Telecom's retail and service provider/reseller customer base and
customer traffic.
Revenue from retail services increased from approximately L18.9 million for
the year ended September 30, 1997 to approximately L51.6 million for the year
ended September 30, 1998, representing an increase of 172.7%. This increase was
due mainly to the increase in Esprit Telecom's customer base resulting from an
expanded direct sales force throughout Europe and to the launch of national long
distance and retail indirect Access service in several countries, particularly
The Netherlands and Germany. In addition, the acquisition of the Plusnet
business contributed approximately L12.5 million of net revenue to the results
for the year ended September 30, 1998. Revenue from service provider/reseller
services increased from approximately L7.1 million for the year ended September
30, 1997 to approximately L16.1 million for the year ended September 30, 1998,
representing an increase of 126.3%. This increase was mainly due to both the
increase in Esprit Telecom's base of service provider/reseller customers and an
increase in such customers' underlying client base and traffic. Revenue from
wholesale services decreased from approximately L19.4 million for the year ended
September 30, 1997 to approximately L14.9 million for the year ended September
30, 1998, representing a decrease of 26.9%. This decrease was mainly due to
deliberate action taken by Esprit Telecom to reduce the volume of such traffic
until sufficient spare capacity was present on the Esprit Network for the
profitability of wholesale services to be improved. Esprit Telecom began
re-establishing its wholesale business during the third quarter ended June 30,
1998 and wholesale revenue in the fourth quarter rose by 177.3% to L8.0 million
compared with a total of L2.9 million in the previous quarter.
COST OF REVENUE
Cost of revenue increased from approximately L37.9 million for the year
ended September 30, 1997, to approximately L65.8 million for the year ended
September 30, 1998, an increase of 73.5%. As a percentage of revenue, cost of
revenue decreased from 83.5% for the year ended September 30, 1997 to 79.7% for
the year ended September 30, 1998. This is primarily as a result of (i) an
increase in the efficiency of the Esprit Network as bottlenecks on key routes
were resolved and interconnect arrangements were implemented in The Netherlands
and Germany, (ii) the increased proportion of higher margin retail revenue, and
(iii) network and termination costs falling more rapidly than selling prices.
During the period from May 1, 1998 to September 30, 1998, the cost of revenue
for the Plusnet business was 57.1%. The Company anticipates that its continued
planned investment in the expansion of the Esprit Network, and the
implementation of further interconnect arrangements, will result in a
significant improvement in unit network and termination costs in the medium
term.
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Access costs increased from approximately L2.3 million for the year ended
September 30, 1997, to approximately L7.2 million for the year ended September
30, 1998, an increase of 215.6%. This increase was mainly due to the increased
number of retail customers. Access costs as a percentage of revenue increased
from 5.0% for the year ended September 30, 1997, to 8.6% for the year ended
September 30, 1998, primarily due to the higher proportion of retail services
revenue and the increase in the proportion of such revenue generated in markets
outside the United Kingdom where access costs may be higher. Network costs
increased from approximately L5.9 million for the year ended September 30, 1997,
to approximately L8.6 million for the year ended September 30, 1998, an increase
of 44.7%. This increase was mainly due to an increase in national and
international leased lines obtained to satisfy the increased volume of traffic
minutes and the expansion of the Esprit Network. Network costs as a percentage
of revenue decreased from 13.0% for the year ended September 30, 1997, to 10.4%
for the year ended September 30, 1998, due primarily to the increased efficiency
of the Esprit Network and to reductions in unit lease line rental costs.
Termination costs increased from approximately L29.8 million for the year
ended September 30, 1997, to approximately L49.8 million for the year ended
September 30, 1998, an increase of 67.3%. This increase was primarily due to the
increase in traffic volume. As a percentage of revenue, termination costs
decreased from 65.5% for the year ended September 30, 1997, to 60.3% for the
year ended September 30, 1998, as cost reductions outpaced selling price
reductions, as interconnect arrangements were brought into service in The
Netherlands and Germany, and as the proportion of higher margin retail traffic
increased.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased from approximately
L15.5 million for the year ended September 30, 1997, to approximately L35.2
million for the year ended September 30, 1998, an increase of 126.9%. This
increase was primarily attributable to the increase in the number of staff and
sales offices, as well as administrative and marketing costs required for
acquiring and supporting the increased customer base, the addition of the
Plusnet business, and to an investment in operational staff in advance of the
establishment of the Esprit Network fibre ring infrastructure and the
implementation of new billing systems.
Selling, general and administrative expenses in the year ended September
30, 1998 are net of foreign exchange gains on non financing assets and
liabilities of approximately L1.1 million.
STOCK OPTION COMPENSATION COST
Esprit Telecom has adopted UK accounting standard UITF17, requiring
recognition of the costs associated with the issue of stock and options at
discounted values. This treatment realized a compensation cost of approximately
L112,000 in the year ended September 30, 1998, compared to a cost of
approximately L417,000 in the year ended September 30, 1997.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses increased from approximately L2.8
million for the year ended September 30, 1997, to approximately L11.9 million
for the year ended September 30, 1998, an increase of 319.6%. This increase was
primarily due to the addition of fixed assets to support the expansion of the
Esprit Network and its operations throughout Europe, and to amortisation of
goodwill related to the acquisition of the Plusnet business which accounted for
approximately L1.6 million of the depreciation and amortisation expenses in the
twelve month period ended September 30, 1998. Depreciation of Esprit Telecom's
SDH broadband fiber network infrastructure, which was established in May 1998,
totalled approximately L1.5 million in the period up to September 30, 1998. The
capital value of these assets is depreciated using an accelerated method over a
10 year period, reflecting the anticipated useful economic life of the asset.
NET INTEREST EXPENSE
Net interest expense increased from a gain of approximately L695,000 for
the twelve month period ended September 30, 1997 to an expense of approximately
L12.2 million for the twelve month period ended September 30, 1998. The increase
was principally due to interest payable on the 1997 Notes, which were
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issued in December 1997 and on the 1998 Notes, which were issued in June 1998,
partially offset by interest earned on cash deposits. Approximately L22.8
million, net of ordinary bank interest paid, was accrued as interest on both
series of Notes during the twelve month period ended September 30, 1998. The
interest paid on finance leases amounted to approximately L1.2 million for the
twelve month period ended September 30, 1998. In addition there was a foreign
exchange gain of approximately L3.6 million arising from the effect of currency
movements on both series of Notes during the twelve month period ended September
30, 1998.
RESULTS OF OPERATIONS FOR THE YEARS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER
30, 1996
REVENUE
Revenue increased from approximately L24.9 million for the year ended
September 30, 1996 to approximately L45.5 million for the year ended September
30, 1997, representing an increase of 82.7%. This increase was mainly due to the
increase in Esprit Telecom's customer base and customer traffic in all of its
European operations, particularly in the United Kingdom and The Netherlands,
partially offset by a decline in prices for Esprit Telecom's products and
services. Revenue from Belgium, Spain, France and Germany increased by 207.6%
between the two periods.
Revenue from retail services, both direct and indirect, increased from
approximately L12.5 million for the year ended September 30, 1996 to
approximately L18.9 million for the year ended September 30, 1997, representing
an increase of 51.9%. This increase was due mainly to the increase in Esprit
Telecom's customer base resulting from an expanded direct sales force throughout
Europe and to the launch of the retail indirect access service in the UK. In
addition, the acquisition of Telecom Europa and Swift Global contributed
approximately L557,000 of net revenue to the results for the year ended
September 30, 1997. Revenue from wholesale services increased from approximately
L10.9 million for the year ended September 30, 1996 to approximately L19.4
million for the year ended September 30, 1997, representing an increase of
78.7%. This increase was mainly due to the increase in the number of wholesale
customers and increased volume of traffic minutes from such customers to
destinations both on and off the Esprit Network. Revenue from service
provider/reseller services increased from approximately L1.6 million for the
year ended September 30, 1996 to approximately L7.1 million for the year ended
September 30, 1997, representing an increase of 359.0%. This increase was mainly
due to both the increase in Esprit Telecom's base of resellers and service
provider customers and an increase in such customers' underlying client base and
traffic.
COST OF REVENUE
Cost of revenue increased from approximately L18.8 million for the year
ended September 30, 1996, to approximately L37.9 million for the year ended
September 30, 1997, an increase of 102.3%. As a percentage of revenue, cost of
revenue increased from 75.4% for the year ended September 30, 1996 to 83.5% for
the year ended September 30, 1997, primarily as a result of an increase in the
percentage of revenue from wholesale services for the first three quarters of
the 1997 financial year and from service provider/reseller services over all of
the 1997 financial year, a shift in wholesale traffic mix towards lower margin
routes, a decrease in the efficiency of the Esprit Network as key routes were
congested and the strengthening of the pound sterling against other European
currencies and the US dollar. The currency effect reflected the higher
percentage of Esprit Telecom's cost base denominated in pounds sterling relative
to the percentage of its revenue base denominated in pounds sterling.
Access costs increased from approximately L1.3 million for the year ended
September 30, 1996, to approximately L2.3 million for the year ended September
30, 1997, an increase of 70.6%. This increase was mainly due to the increased
number of retail customers. Access costs as a percentage of revenue decreased
slightly from 5.3% for the year ended September 30, 1996, to 5.0% for the year
ended September 30, 1997, primarily due to the decreasing proportion of retail
service revenue over the first three quarters of the 1997 financial year.
Network costs increased from approximately L3.4 million for the year ended
September 30, 1996, to approximately L5.9 million for the year ended September
30, 1997, an increase of 73.8%. This increase was mainly due to an increase in
national and international leased lines contracted for to satisfy the increased
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volume of traffic minutes and the expansion of the Esprit Network. Network costs
as a percentage of revenue decreased slightly from 13.7% for the year ended
September 30, 1996, to 13.0% for the year ended September 30, 1997, primarily
due to lower leased line costs and increased line utilization.
Termination costs increased from approximately L14.0 million for the year
ended September 30, 1996, to approximately L29.8 million for the year ended
September 30, 1997, an increase of 112.3%. This increase was primarily due to
the increase in traffic volume. As a percentage of revenue, termination costs
increased from 56.4% for the year ended September 30, 1996, to 65.5% for the
year ended September 30, 1997, primarily due to the increased proportion of
wholesale service revenue for the first three quarters of the 1997 financial
year and the increased proportion of service provider/reseller services revenue
for the 1997 financial year, both of which carry lower termination margins than
retail revenue, a shift in wholesale traffic mix towards lower margin routes, a
decrease in the efficiency of the Esprit Network as key routes were congested
and the strengthening of the pound sterling against other European currencies
and the US Dollar. Esprit Telecom has taken a number of actions to address the
problems it has experienced in its wholesale business, and expects that revenue
from wholesale will decline over the remainder of calendar 1997. Due to delays
in activating certain MIUs and IRUs previously purchased, Esprit Telecom
experienced significant congestion on key routes and overflow to higher-cost
alternatives during the second, third and fourth quarters of financial 1997.
Esprit Telecom expects that its gross margin will continue to be adversely
affected over the remainder of calendar 1997 until new network capacity becomes
available.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased from approximately
L7.5 million for the year ended September 30, 1996, to approximately L15.5
million for the year ended September 30, 1997, an increase of 106.5%. This
increase was primarily attributable to the increase in the number of staff and
sales offices, as well as administrative and marketing costs required for
acquiring and supporting the increased customer base. Selling, general and
administrative expenses for the year ended September 30, 1997 include an
unrealized foreign exchange loss of approximately L960,000, reflecting the
effect of the appreciation of the pound sterling against other currencies on
Esprit Telecom's non-sterling cash deposits and intercompany obligations. In the
year ended September 30, 1996, there was a foreign exchange loss of
approximately L163,000. In addition, Esprit Telecom made a provision against bad
debt of approximately L1.3 million during 1997, of which approximately L880,000
related to service provider/reseller customers in the fourth quarter of 1997.
During the year ended September 30, 1997, Esprit Telecom incurred
restructuring costs of approximately L312,000 related to the reorganization and
reincorporation of Esprit Telecom, and the redesign of its stock ownership
programs, prior to Esprit Telecom's initial public offering ("IPO") in February
1997.
STOCK COMPENSATION COST
Esprit Telecom has adopted a newly promulgated accounting policy under UK
GAAP requiring recognition of the costs associated with the issue of stock and
options at discounted values. Such costs amounted to approximately L417,000 in
the year ended September 30, 1997, significantly lower than the costs recognized
for the 1996 financial year of approximately L2.0 million, primarily as a result
of old variable option plans being closed and the adoption of a revenue-approved
savings scheme in 1997 which does not attract a charge on the issuance of
options. See Notes 4 and 6 to the Consolidated Financial Statements of Esprit
Telecom. As required by UK GAAP, this accounting change has been effected by
restating the results of previous periods.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses increased from approximately L1.5
million for the year ended September 30, 1996, to approximately L2.8 million for
the year ended September 30, 1997, an increase of 92.8%. This increase was
primarily due to the addition of fixed assets to support the expansion of the
Esprit Network and its operations throughout Europe.
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NET INTEREST RECEIVABLE/EXPENSE
Net interest moved from payables of approximately L203,000 for the year
ended September 30, 1996 to receivables of approximately L695,000 for the year
ended September 30, 1997. The change from the year ended September 30, 1996 to
the year ended September 30, 1997, was principally due to interest received on
cash balances resulting from the IPO, partially offset by interest charges on a
vendor finance lease arrangement on which Esprit Telecom drew down initially in
the second quarter of 1996 to fund the purchase of its central office switches
in London and further in the third quarter of 1997 to fund the purchase of its
central office switch in Amsterdam. The interest paid on this finance lease
amounted to approximately L315,000 for the year ended September 30, 1997.
LIQUIDITY AND CAPITAL RESOURCES
Esprit Telecom's statement of cash flow for the periods indicated is
summarized below:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-----------------------------
1996 1997 1998
------ ------- --------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Cash (outflow)/inflow from operating activities............. (2,245) (2,999) (29,133)
Returns on investments and servicing of finance............. (203) 695 (4,834)
Taxation.................................................... -- (2) (2)
Capital expenditure and financial investment................ (3,594) (7,919) (22,478)
Acquisitions and disposals.................................. -- (852) (91,643)
------ ------- --------
Cash outflow before financing............................... (6,042) (11,077) (148,090)
Management of liquid resources.............................. (2,335) (20,541) (158,058)
Financing................................................... 6,541 29,799 308,309
------ ------- --------
Decrease/(increase) in cash in the period................... (1,836) (1,819) 2,161
====== ======= ========
</TABLE>
Esprit Telecom's liquidity requirements arise from net cash used in
operating activities, servicing of financial obligations (principally, interest
on financing leases, bank facilities and the Notes), financial investments,
funding of acquisitions and for capital expenditures for the expansion of Esprit
Telecom's activities.
Esprit Telecom's net cash used in operating activities was approximately
L29.1 million for the year ended September 30, 1998, approximately L3.0 million
for the year ended September 30, 1997 and approximately L2.2 million for the
year ended September 30, 1996. Net funds utilized for the servicing of financial
obligations amounted to a payable of approximately L4.8 million for the year
ended September 30, 1998, a receivable of approximately L695,000 for the year
ended September 30, 1997 and a payable of approximately L203,000 for the year
ended September 30, 1996.
For the year ended September 30, 1998, capital expenditures, including
finance leases, totaled approximately L41.2 million, of which approximately
L19.1 million related to telecommunications equipment and approximately L16.3
million related to the capital value of the London -- Paris ring network
infrastructure. The cash usage in respect of capital expenditure, net of the
impact of capital lease funding thereon, was approximately L21.2 million in the
year ended September 30, 1998, approximately L7.9 million in the year ended
September 30, 1997 and approximately L3.6 million in the year ended September
30, 1996.
On November 19, 1997 Esprit Telecom acquired IMS, a telecommunications
services company operating in The Netherlands. The minimum aggregate
consideration payable by Esprit Telecom for the acquisition is approximately
L6.8 million over the next two years. Esprit Telecom has also agreed to pay
additional amounts in respect of the acquisition over a two year period
contingent in part upon the achievement of certain financial and performance
targets. These additional amounts may increase Esprit Telecom's total investment
to a maximum aggregate of approximately L10.8 million dependent upon future
performance.
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In July 1998, Esprit Telecom completed the acquisition of the Plusnet
business, and paid a consideration of approximately L103.8 million (or
approximately DM307 million, based upon the exchange rates ruling as at the date
of the acquisition) net of costs. Pursuant to the sale and purchase agreement
between Esprit Telecom and Thyssen, this consideration has since been
recalculated at approximately L90.0 million (or approximately DM267 million,
based upon the exchange rates ruling as at the date of the acquisition) based
upon a final determination of the revenues of the Plusnet business for the year
ended September 30, 1998.
Cash, deposits and restricted securities increased during the twelve month
period ended September 30, 1998 by approximately L160.2 million, from
approximately L24.5 million to approximately L184.7 million. In December 1997,
Esprit Telecom completed its offering of US$230 million 11.500% Senior Notes and
DM125 million 11.500% Senior Notes, both due 2007, realizing net cash proceeds
of approximately L175.1 million, before other costs in connection with the
offering of approximately L0.6 million. In June 1998, Esprit Telecom completed
its offering of US$150 million 10.875% Senior Notes and DM150 million 11.000%
Senior Notes, both due 2008, realizing net cash proceeds of approximately L136.0
million. The first six semi-annual interest payments on the 1997 Notes will be
funded from restricted securities and interest thereon, the total balance of
which was approximately L49.0 million as at September 30, 1998.
Esprit Telecom has entered into commitments to purchase equipment from
Nortel, Ericsson and Nera amounting to approximately L23.0 million related to
the expansion and development of its network and sales operations.
Esprit Telecom currently anticipates spending approximately L97 million
over the next two years for capital expenditures related to the expansion and
development of its network and sales operations. In addition, Esprit Telecom
currently anticipates further investment in its SDH broadband fiber network
infrastructure, to a capital value of approximately L100 million, which is
expected to be financed mainly by long term vendor lease arrangements.
If the proposed acquisition by GTS is completed, Esprit Telecom's financing
plans and liquidity requirements could change in significant respects. In
particular, GTS is in the process of developing its business plan and strategy
for Esprit Telecom, including the manner in which Esprit Telecom will be
integrated into the overall GTS business and corporate structure. GTS may elect
to contribute one or more GTS businesses to Esprit Telecom as part of its
strategy including the recently acquired NetSource Europe ASA. GTS also may have
one or more other GTS entities purchase assets from Esprit Telecom as part of
its strategy. Any such transactions will be effected in accordance with the
applicable covenants in Esprit Telecom's indentures. GTS may also decide in the
future to effect a tender or exchange offer or additional consent solicitations
with respect to the Esprit Telecom Bonds, including if it were advisable to
better integrate Esprit Telecom into the overall GTS corporate structure.
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BUSINESS
INTRODUCTION
GTS provides a broad range of telecommunications services to businesses,
other telecommunications service providers and consumers in Central Europe,
Russia and the CIS. Through its subsidiary HER, GTS is developing and operating
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' strategy in emerging
markets 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. GTS' 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, which are
wired and wireless, and (vi) carriers' carrier networks, which provide high
volume transmission capacity to other carriers. In addition, GTS has recently
developed a business plan to offer facilities-based telecommunications products
and services to businesses and other high-usage customers in certain
metropolitan markets throughout Europe. See "-- Business Strategy -- European
Services Strategy."
In Western Europe, GTS believes that it is well-positioned to establish
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 is one
of the leading carriers' carriers providing centrally managed cross-border
telecommunications transmission capacity in Europe. Its network, when completed
by the end of 2000, will extend approximately 25,000 kilometers, with points of
presence in approximately 50 cities in 20 European countries. 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' 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, Slovakia and Romania. In the Czech Republic, GTS
provides outgoing voice services and operates an international gateway and a
data services network. In Hungary, GTS operates a nationwide microwave network
and a VSAT network, which GTS believes is the largest VSAT network in Central
Europe as measured by number of VSAT sites. In Slovakia and Romania, GTS
provides VSAT services using its VSAT hub in Hungary. Subject to certain
regulatory approvals, GTS has also obtained a license to provide international
data services in Poland and expects to begin operations during the first quarter
of 1999. GTS' 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."
In Russia and the CIS, GTS' objective is to become the premier alternative
telecommunications operator. To attain its objective, GTS has partnered with
regional telephone companies and with Rostelecom, the national long distance
carrier in Russia. GTS currently operates in 34 regions and the city of Moscow
in Russia, as well as in 14 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 fifteen cities in Russia, including
Moscow, as well as VSAT service to customers outside its primary long distance
satellite network; (iv) Sovam Teleport ("Sovam"), which
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provides data services, including high-speed data transmission, electronic mail,
Internet access services, as well as Russia On Line, the first Russian language
Internet service; and (v) GTS' cellular operations ("GTS Cellular"), which
operate cellular networks in 14 regions in Russia and also in Kiev, Ukraine,
with licenses covering regions with an aggregate population of approximately 48
million people at September 30, 1998. Whenever practical, GTS' 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' Russian and CIS ventures carried approximately 442
million and 462 million minutes of traffic for the year ended December 31, 1997
and the nine months ended September 30, 1998, respectively, and had
approximately 34,100 customers, including approximately 25,200 cellular
subscribers, as of September 30, 1998. See "-- Russia and the CIS."
GTS does not currently own or operate significant telecommunication assets
in Asia. See "-- Asia."
RESTRUCTURING
In October 1998, GTS announced it would restructure its business operations
into five primary lines of business as follows:
- GTS Carrier Services, which will include HER's cross-border transport
carrier services in Europe, Ebone Internet transit services, transoceanic
infrastructure and services, and Internet service units;
- GTS Access Services, which will pursue GTS's entry into the Western
European CLEC market;
- GTS Business Services -- Western Europe, which will offer voice, data,
Internet and other telecommunications services to businesses in Western
Europe, principally in locations not served by GTS Access Services;
- GTS Business Services -- CIS, which will incorporate all of GTS's CIS
"wireline" assets, including Sovintel, Sovam, TeleRoss and TCM; and
- GTS Mobile Services, which will operate all of GTS's cellular businesses
in Russia and the Ukraine.
RECENT DEVELOPMENTS
NETSOURCE ACQUISITION
On November 30, 1998, GTS completed the acquisition of NetSource for an
initial purchase price consisting of 4,037,500 newly issued shares of GTS common
stock and $46.1 million in cash. Based on the closing price of Common Stock of
$43.4062 on November 30, 1998, the aggregate initial purchase price paid by GTS
for NetSource was $141.3 million. In addition to the initial consideration paid
at the closing, GTS has agreed to make additional payments of up to $35 million
in either cash or shares of GTS common stock (up to a maximum of 1.4 million
shares), contingent on NetSource's achieving certain performance targets during
the first two quarters of 1999. NetSource is a pan-European provider of long
distance telecommunications services focusing primarily on small- to
medium-sized businesses, with operations in Norway, Sweden, Germany and Ireland,
as well as in The Netherlands, Belgium and Denmark. At June 30, 1998, NetSource
had 27,900 business customers throughout Europe and 61,400 residential customers
in Germany and The Netherlands. NetSource will become part of GTS Business
Services -- Western Europe. The acquisition of NetSource provides the GTS
Business Services -- Western Europe line of business with a customer and revenue
base in several key Western European countries, a portfolio of licenses and
interconnection agreements and an entrepreneurial management team.
ESPRIT TELECOM ACQUISITION
On December 8, 1998, GTS and Esprit Telecom announced in a joint press
announcement that they had agreed on the terms of a proposed offer by GTS to
purchase all of the outstanding ordinary shares and ADSs of Esprit Telecom and
that holders of 65% of the voting ordinary shares of Esprit Telecom
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have agreed to accept the offer. Under the proposed offer, GTS will offer to
purchase all issued and to be issued Esprit Telecom Securities on the following
basis:
- for each Esprit Telecom ordinary share, 0.1271 of a share of Common
Stock; and
- for each Esprit Telecom ADS, 0.89 of a share of Common Stock.
Based on the Nasdaq closing price of $41.75 per share of Common Stock on
December 7, 1998, the Offer values each Esprit Telecom Ordinary Share at $5.31
(L3.21), each Esprit Telecom ADS at $37.16 (L22.48) and the entire issued share
capital of Esprit Telecom, on a fully diluted basis, at approximately $757.3
million (L458.2 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 December 7, 1998, being the last trading day before the announcement
of the Offer (based on an exchange rate of L1 = $1.6530 being the Noon Buying
Rate on December 7, 1998).
The making of the offer is subject to certain pre-conditions, including
that GTS obtain waivers by the holders of Esprit Telecom Bonds of their rights
under the applicable indentures to require Esprit Telecom to repurchase these
Bonds at 101% of the principal amount of the debt in connection with the change
of control of Esprit Telecom resulting from the consummation of the offer. This
pre-condition was satisfied on December 23, 1998 through a successful consent
solicitation. The results of the consent solicitation are binding on all holders
of the Esprit Telecom Bonds.
GTS's obligation to complete the offer is subject to the satisfaction or
waiver of several conditions. These conditions include, among others, that:
- GTS has received valid acceptances representing not less than 90% (or
such lesser percentage above 50% as GTS may decide) of Esprit Telecom
Securities;
- the GTS shareholders have approved resolutions authorizing the issuance
of GTS shares in the offer; and
- there has been no material adverse change in the business, assets or
prospects of Esprit Telecom.
The transaction is expected to close in the first half of 1999. GTS expects
that the transaction will be accounted for as a pooling of interests.
Esprit Telecom is a rapidly growing European telecommunications company,
providing high quality, competitively priced, international and national long
distance telecommunications services to retail customers and other
telecommunications service providers. Esprit Telecom has a network and sales
office infrastructure in 31 locations 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 9,500 route kilometer SDH and DWDM fiber optic network
through six European countries. Esprit Telecom also has links to Washington and
New York via a transatlantic circuit owned by other carriers
GTS believes that the businesses of GTS and Esprit Telecom are
complementary and that benefits will result from combining them. In particular,
the combined group expects to have:
- a presence in 19 countries through Europe;
- increased network capacity and resilience;
- a 500 person sales force, one of the largest among independent
telecommunications companies in Europe;
- the ability to provide a wide array of service offerings;
- increased management depth;
- reduced network operations and administrative costs;
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- capital expenditure savings.
GTS expects the combination will assist the companies in realizing their
mutual goals of becoming the pre-eminent providers of carrier's carrier and
business communications services throughout Europe.
GTS is in the process of developing its business plan and strategy for
Esprit Telecom, including the manner in which Esprit Telecom will be integrated
into the overall GTS business and corporate structure. GTS may elect to
contribute one or more GTS businesses to Esprit Telecom as part of its strategy,
including NetSource. GTS also may have one or more other GTS entities purchase
assets from Esprit Telecom as part of its strategy. Any such transaction will be
effected in accordance with the applicable covenants in the indentures governing
the Esprit Telecom Bonds. GTS may also decide in the future to effect a tender
or exchange offer or consent solicitations with respect to the Esprit Telecom
Bonds, if it were advisable to better integrate Esprit Telecom into the overall
GTS corporate structure.
HER DEBT OFFERING
On January 4, 1999, HER issued in a private placement $200 million
principal amount of 10 3/8% Senior Notes due 2009 and Euro 85,000,000 principal
amount of 10 3/8% Senior Notes due 2006. The net proceeds of this offering,
approximately $289.7 million, will be used to finance the cost of HER network
assets, to expand the HER network beyond the currently contemplated scope,
including by adding transatlantic capacity, enhancing the speed of the HER
network and continuing the buildout of the HER network.
FLAG ATLANTIC-1 JOINT VENTURE
On January 13, 1999, GTS, though its subsidiary GTS Transatlantic Holdings
Ltd., entered into an agreement with FLAG Telecom to form a 50/50 joint venture,
to be known as FLAG Atlantic-1, that will build and operate a transoceanic fiber
optic link between Europe and the United States. FLAG Atlantic-1's link is
designed to carry voice, high-speed data video traffic at speeds of 1.28
terabits per second, a 25-fold increase over current transatlantic cable
systems. The joint venture will also provide backhaul links from the European
landing points of the transatlantic link to Paris and London. By interconnecting
to FLAG Atlantic-1, GTS Carrier Services and its subsidiary HER will be able to
provide their carrier and Internet service provider customers with high-capacity
cable access from major European cities to New York City. GTS's investment in
FLAG Atlantic-1 is designed to enable it to participate in the growth
opportunity represented by the rapid increase in demand by business customers
for Internet Protocol-based telecommunications services. The high-capacity fiber
optic link will be based on synchronous digital hierarchy and use dense wave
division multiplexing technology. Flag Atlantic-1 is expected to be offering
service by the end of the year 2000. The project is subject to financing, the
execution of related agreements and other conditions.
BUSINESS STRATEGY
GTS seeks to develop businesses to meet the rapidly expanding market demand
for telecommunications services. GTS seeks to position itself as the leading
independent telecommunication service provider in Europe through the development
of a pan-European fiber optic network and an international gateway in Monaco. In
addition, GTS has introduced a business plan to offer a broad range of
integrated telecommunications services to businesses and other high-usage
customers in certain metropolitan markets throughout Europe. See "-- Western
Europe" and "-- European Services Strategy." GTS' 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.
GTS has developed market strategies to achieve its goals in both emerging
markets and Western Europe. It has developed and is implementing a business plan
to offer comprehensive telecommunications services to business end users
throughout Europe.
Western Europe. GTS believes it is well-positioned to establish itself as
the leading independent carriers' carrier within Western Europe through the
development of HER's pan-European fiber optic network and the operation by GTS
of international gateway switching capacity. HER and the international gateway
switching
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capacity are complementary 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 has been able 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.
European Services Strategy. In June 1998, GTS introduced a business plan to
offer, through several new subsidiaries, a broad range of integrated
telecommunications services to businesses and other high usage customers in
certain metropolitan markets throughout Europe. GTS believes that the size and
growth potential of the European market combined with increasing liberalization
of European telecommunications regulations provides GTS with the opportunity to
successfully develop local networks and other end-user services. Through GTS
Business Services -- Western Europe, GTS intends to enter up to 50 metropolitan
markets as a reseller of services to end-users. Through GTS Access Services, GTS
proposes to develop CLECs in up to 12 European cities. Implementation of the
European Services Strategy may involve one or more of the following: (i) the
construction of fiber loop networks, (ii) the purchase or lease of dark fiber,
(iii) obtaining high frequency microwave licenses for "wireless fiber," or (iv)
partnership with, or acquisition of, resellers or facilities-based CLECs. In
evaluating potential markets GTS will consider among others the following
characteristics of each market: (i) its business concentration, (ii) the
national and local regulatory environment, (iii) the technical difficulties of
local network construction and (iv) the extent of existing competition. See
"Risk Factors -- Risks Relating to European Services Strategy," "-- Recent
Developments," "-- Western Europe" and " -- European Services Strategy."
Emerging Markets. GTS 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 are expected 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, GTS 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, GTS 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'
strategy is to provide its customers with service of higher quality than
that provided by incumbents.
- 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 and providing a bundled service
offering, GTS expects to both expand its customer base and increase GTS'
share of each customer's telecommunications spending. GTS also expects to
achieve increased economies of scale through the common use of
administrative and operating functions already in place. GTS also seeks
to expand its targeted geographic market by forming new partnerships and
installing infrastructure and offering services in additional geographic
regions, allowing GTS 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. GTS
believes such integration will enable it to enhance its operating
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efficiency by leveraging its distribution channels, infrastructure,
networks and management information systems. As customers develop a need
for a broader variety of telecommunications services, GTS believes that
GTS' integrated operations will represent an attractive service
alternative for customers seeking a single provider that can meet all
their telecommunications needs.
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 is one of the leading carriers' carriers providing
centrally managed cross-border telecommunications transmission capacity in
Europe. Its high capacity fiber optic network, when completed by the end of
2000, will extend approximately 25,000 kilometers, with points of presence in
approximately 50 cities in 20 European countries. 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.
GTS 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. GTS 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 HER 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 IPLCs which are
provisioned by combining half-circuits on the networks of two or more PTOs. GTS
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. See "Risk Factors --
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Risks Specific to GTS -- HER Network Roll-out" and "Risk Factors -- Risks
Specific to GTS -- Competition."
HER
HER is one of the leading carriers' carriers providing centrally managed
cross-border telecommunications transmission capacity in Europe. Its network,
when completed by the end of 2000, will extend approximately 25,000 kilometers,
with points of presence in approximately 50 cities in 20 European countries.
HER's customers include traditional PTOs and New Entrants such as alternative
carriers, global consortium of telecommunications operators, international
carriers, Internet backbone networks, resellers, value-added networks and other
service providers. HER offers these customers a superior transport system than
is currently available in Europe through PTOs with a higher and more consistent
level of transmission quality, redundancy, network functionality and service at
lower prices. HER currently operates in Belgium, The Netherlands, the UK,
France, Germany, Switzerland, Italy, Denmark and Sweden. At present, the network
links 17 cities: Brussels, Antwerp, Rotterdam, Amsterdam, London, Paris,
Frankfurt, Strasbourg, Zurich, Geneva, Stuttgart, Dusseldorf, Munich, Milan,
Berlin, Copenhagen and Stockholm. In November 1998, HER leased capacity on a
transatlantic cable linking the HER network with North America and is exploring
various interconnectivity options to Russia. 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 the completion of the HER network could
have a material adverse effect on HER and GTS.
HER intends to continue to build the network using an accessible and
cost-efficient infrastructure of railways, motorways, pipeline companies,
waterways and power companies. HER has 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) timely performance by various third parties of their
contractual obligations to engineer, design and construct portions of the
network and (ii) HER's ability to obtain and maintain applicable licenses and
authorizations.
HER has entered into agreements for the construction and/or lease of fiber
optic routes for the network in Belgium, The Netherlands, the UK, France,
Germany, Switzerland, Italy, Denmark, Sweden and Spain. HER continues to
negotiate rights-of-way and other infrastructure arrangements in order to extend
its network in Western Europe and 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 infeasible. See "Risk Factors -- Risks Relating to HER Network
Roll-out."
On June 24, 1998, HER completed the acquisition of a 75% interest in Ebone
for ECU 90 million (approximately $99.5 million based on the ECU/US dollar
exchange rate in effect on that date). Headquartered in Copenhagen, Denmark,
Ebone is a Tier 1 Internet backbone provider focused on connecting Internet
service providers in Europe to the Internet. As of September 30, 1998, Ebone
served more than 89 customers in 23 cities. As part of the transaction, Ebone
purchased under a transmission capacity agreement long-term capacity rights on
the HER network valued at ECU 90 million. The transmission capacity agreement is
expected to provide for the majority of Ebone's current and forecasted capacity
requirements. HER will provide Ebone with capacity of up to 622 megabits per
second between the majority of European cities that Ebone serves. In addition to
the majority interest held by HER, Ebone's new ownership structure will continue
to include many of Ebone's existing customers, which own the balance of Ebone's
shares through an association.
HIT Rail B.V. ("HIT Rail") formed HER on July 6, 1993. HIT Rail was
incorporated in 1990 by eleven national railways to carry out telecommunications
engineering activities in order to construct and exploit a
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data communications network for railway traffic. GTS-Carrier Services, Inc.
(formerly GTS-Hermes, Inc.), a Delaware corporation ("GTS-CSI"), purchased a
34.4% interest in HER in 1994 and increased its interest to 50% in 1995 and to
79.1% in 1997. In March 1998, GTS-CSI increased its ownership of HER to
approximately 89.4% by purchasing a portion of HIT Rail's ownership interest in
HER. GTS-CSI currently owns an 89.9% equity interest in HER. GTS-CSI is a wholly
owned subsidiary of GTS. In an effort to expand its presence in Europe, HER has
formed wholly owned subsidiaries in The Netherlands, Ireland, the UK, Germany,
France, Italy and Spain to conduct marketing and other activities. In Belgium,
the activities of the Network Operations Center have been transferred to HER
Network Services B.V.B.A. (formerly Hermes Europe Railtel N.V.), a wholly owned
subsidiary of HER. Following the development of its corporate structure, HER
will be a holding company with limited assets and will operate its business
through subsidiaries.
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's primary service offerings are large-capacity
circuits for "wholesale" customers such as PTOs and New Entrants. HER designed
its focus on carriers to complement and not compete with carriers' own business
objectives in providing services to end-users.
Following the acquisition of Ebone and given the increased market demand
for transatlantic low cost city-to-city services, HER now plans to expand its
objective to become a leading player in the provision of seamless transatlantic
city-to-city services. In November 1998 HER leased capacity on a transatlantic
cable linking the European network to North America. To meet its objective it
now needs to further augment its transatlantic capacity and invest further in
extending its network, as well as increasing the capacity of the network.
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 Cross Border Network Facilities. The HER network is designed
to offer its customers access to high capacity network facilities outside their
domestic markets, providing cross-border capabilities without requiring
customers to invest in network infrastructure or being constrained by a narrow
range of capacity offerings. With DWDM upgrades, HER's fiber deployment plan
provides for a minimum of 800 Gigabits on all major routes. Options are in place
to expand fiber capacity further on a number of routes.
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 99.9% 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. Customers can quickly obtain additional capacity on the
HER network. 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.
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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 and DWDM technology which 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 IP Services.
Innovative Pricing. Currently the price of high-bandwidth 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.
GTS intends to offer comprehensive, facilities-based telecommunications
products and services to business and other high-usage customers in certain
metropolitan markets in Europe. See "-- European Services Strategy." Many of
GTS' planned service offerings will compete directly with services offered by
HER's customers, which may affect the perception of HER as an independent
carrier's carrier. There can be no assurance that GTS' European Services
Strategy will not negatively impact HER's ability to attract and retain
customers which would have a material adverse affect on HER and GTS.
Managed Bandwidth Services
HER's primary service is large capacity cross-border European circuits and
transatlantic services provided to carriers and service providers over an
integrated, managed pan-European network structure for wholesale customers such
as PTOs and New Entrants. The HER network, based on SDH and DWDM technology,
provides digital transmission capability upon which a broad range of advanced
functionality may be built and which offers network availability, flexibility,
bandwidth speeds and error performance not otherwise available to carriers for
transport of telecommunications traffic across national borders in Western and
Central Europe. The network is designed to provide customers with a wide variety
of bandwidth speeds, ranging from VC12/E1 Standard (equivalent to 2.048 Mbps) to
STM-16 Standard (2-S Gigabits) (equivalent to 155 Mbps).
Point-to-Point Transmission Capacity. The current market for cross-border
transport is served by IPLCs provided by PTOs. Traditionally, 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. GTS
believes that its Point-to-Point Transmission Capacity is a major improvement to
the PTO-based approach because it provides a greater range of bandwidths (from 2
Mbps (E1 or VC-12) to multiple 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 Transmission Capacity 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 "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. The customer can choose flexible contract terms from one to
ten or more years' duration, with discount schemes designed to ensure that HER
remains a cost-effective solution.
Virtual Network Transmission Services. 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-
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effective means of telecommunications transport. Such service providers have
traditionally obtained 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. See "Risk Factors -- Risks Specific to GTS --
Competition."
HER's Network Transmission Service will offer a new solution and an
attractive alternative to leasing IPLCs or building infrastructure. This service
enables 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.
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.
All VC-4 paths within a ring are routed via physically diverse fibers to allow
the customer to have reliable and direct control over the configuration of its
VC-3 and VC-12 paths within the ring, and have 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.
Internet-Based Services
Ebone Internet Services. ISPs have been buying Internet access from Ebone
since 1991. Building on the expertise developed since these early days of the
Internet in Europe, Ebone now offers ISPs a carriers' grade Internet access
service with the following significant features:
- Reliable access to Internet service throughout the European and American
backbone of Ebone, which is made possible by always oversizing the
bandwidth capacity on HER's backbone that is allocated to Ebone's
Internet network;
- Access to one of the largest installed bases of ISP customers in Europe;
- Access to the other Internet networks with multi-point high speed
peerings with major Tier 1 Internet backbone providers in Europe and in
the US; and
- Access speeds ranging up to 140 Mbps.
IP Services. This new line of HER services is being developed for service
providers that focus on Internet, Intranet or voice over IP services. This IP
traffic has been traditionally supported by a combination of managed bandwidth
services (like the ring or the point-to-point services of HER) and Internet
backbone services (like the Ebone Internet services).
Today, service providers building their IP backbones demand the speed
offered by fiber infrastructure, the reliability of HER managed bandwidth
services and the flexibility of Internet backbone services.
The IP services will carry the international Internet traffic of service
providers between their private points of presence and/or Internet exchange
points. These services combine the quality of a carrier class transmission
service with the easy bandwidth upgrades that are the strength of large Internet
backbone providers.
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Pricing and Distribution
Sales of HER's services are conducted through its subsidiary Hermes Europe
Railtel (Ireland) Limited. HER accesses additional distribution channels using
local or regional network access providers.
Currently, the price of cross-border pan-European calls is 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 one to three
years in length. 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 up front 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 and DWDM-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 September 30, 1998, 48 customers contracted
for service on the HER network including PTOs, global consortia of PTOs, ISPs,
alternative carriers, an international carrier, VANs and resellers. For the
three months ended September 30, 1998, HER installed and sold capacity of
approximately 1,209 and 5,157 E1 equivalents, respectively. As of September 30,
1998, the HER backlog, cumulative contractually obligated future revenues, was
$257.3 million. 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 the existing 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. HER provided and continues to provide a vehicle for
PTOs to compete in non-domestic markets. As of January 1, 1998, both reserved
and non-reserved traffic could 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
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.
Existing customers in this segment include Teleglobe and GTS-Monaco Access.
Targeted future customers include the US Regional Bell Operating Companies. HER
can
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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 GTS
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. On June 24, 1998, HER
entered into an agreement with Ebone, a Tier 1 Internet backbone provider which
at September 30, 1998 served 89 ISPs in 23 European countries, to provide long-
term transmission capacity of up to 622 megabits per second across the majority
of European cities that Ebone serves. As part of the transaction, HER purchased
a majority interest in Ebone.
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 US, 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.
Network Design
The network design is based on a layered architecture separating physical,
optical and telecom layers of the HER network with standard interfaces in order
to optimize design and operation and provide flexibility for introducing new
technologies such as IP.
The physical layer of the HER network is based on a mesh of dark fiber
routes interconnecting cities on the network via at least two or three
physically diverse paths for maximum resilience against fiber or facilities
failures. In each major city there will additionally be two customer access
sites for resilience.
The optical layer of the HER network, which is expected to be extended
during 1999 to cover ten countries, representing the core of the HER network, is
based on DWDM. This layer supports the provision of optical services direct to
customers at 2.5 Gbps and provides for the operation of multiple SDH and/or IP
systems to run concurrently on a single fiber pair in a highly cost efficient
manner. The HER network, currently in seven countries, is based on Ciena 40
wavelength systems with a capacity of 100 Gbps on a fiber pair.
The SDH layer of the HER network, running via DWDM channels in the core of
the network, and directly on the fiber elsewhere supports the provision of
point-to-point services to customers at speeds of
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E1/VC-12 (2 Mbps) up to STM-1 (155 Mbps). The SDH layer is itself a multilayered
architecture consisting of multiple SDH rings optimized for different traffic
characteristics. Each SDH ring supports full automatic re-routing of traffic in
the case of a break in the ring. This layer is based on Alcatel STM-16 (2.5
Gbps) systems which are installed throughout the operational HER network.
An IP layer is expected to be added to the HER network starting in the
second quarter of 1999. This layer will support high capacity IP routers, which
can deliver IP services to customers at speeds from 1 Mbps to 622 Mbps. These
routers will be supported on the DWDM layer of the network directly and/or via
ATM in the core of the HER network, and on top of the SDH layer elsewhere. HER
plans to extend IP service delivery capabilities to all cities on the network by
the end of the year 2000. This layer will be able to handle failures
independently of the lower layers via re-routing at the IP level.
The HER network is controlled by a single active Network Operations Center
in Brussels, Belgium, with a backup center, with equivalent management systems
continuously synchronized with the primary center, being maintained in
Amsterdam.
The Network Operations Center can pinpoint potential service impacting
problems and deal with service re-routing if required much more effectively than
in networks controlled by multiple operators in different countries. HER's
advanced operational support systems also provide comprehensive capabilities for
managing the large number of network components and local repair organizations
required in an extensive international network of this size, as well as for
advanced customer care in managing the large number of network components and
local repair organizations required in an extensive international network of
this size, as well as for advanced customer care in managing customer
operational activities.
Overall the combination of high levels of redundancy of physical and
management components and the ability to recover from individual failures at the
optical, SDH and IP layers provides for a high degree of network performance. As
a result, HER is able to enter into strong performance commitments with its
customers and services on most routes of its network has performed at above
99.9% availability.
HER expects to operate the 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
equipment vendors and infrastructure providers and other third parties to supply
and/or maintain the equipment for the HER network. See "Risk Factors -- Risks
Specific to GTS -- HER Network Roll-out."
Network Capacity
The HER network is being built to include 40 wavelength DWDM systems on all
routes. This allows for incremental SDH and IP systems of 2.5 Gbps to be
installed when and only when required, thus providing for efficient management
of capital investment.
Should capacity be required beyond the initial 100 Gbps on the first fiber
pair, additional fiber pair(s) can be brought into operation utilizing either
higher capacity DWDM systems at 2.5 Gbps or at 10 Gbps. Such systems will be
available from 1999. HER plans to have a minimum of two fiber pairs on all
routes and to extend capacity both via additional routes providing further
resilience, as well as on selecting existing routes where available over time.
This approach to fiber utilization again provides for an optimal management of
fiber investment.
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 require the infrastructure provider to provide a certain
number of pairs of dark fiber and in some cases, facilities 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 may
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also provide space for the location of HER equipment and related maintenance.
The infrastructure provider is responsible for maintenance of the cable
facilities. An agreement also provides for an annual price for the provision of
fiber and for the facilities and maintenance. The agreements typically provide
for termination by the parties only for material breach, with a 90-day minimum
cure period. The agreements typically contain a transition period after
termination of the agreement to allow HER to continue to serve its customers
until it can reach agreement with an alternative infrastructure provider. In
certain areas of the network, where it is not possible to lease dark fiber, HER
has signed agreements or letters of intent for indefeasible right of use to
managed bandwidth. The terms of these agreements typically range from 10 to 25
years.
Local Access. Access to the HER network will be primarily 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 for optical service STM-16 level. In each city, as a HER point of
presence is deployed, HER may contract with one or more local access network
suppliers 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,
HER has contracted with a number of local access providers to connect the HER
network to intra-city networks. Pursuant to such agreements, 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, GTS believes that the
relationships between HER and local access network suppliers can benefit both
parties. Set forth below is an illustration of the connection between the HER
network and local access providers.
[SDH/WDM NETWORK CHART]
The portion of the HER network currently in operation extends approximately
9,200 kilometers. When completed by the end of 2000, the network will extend
approximately 25,000 kilometers. In November 1998, HER also leased capacity on a
transatlantic cable linking the European network with North America. During the
first quarter of 1999, the network is planned to be expanded through France,
Madrid and Barcelona in
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Spain, and in the second quarter of 1999, extended further in Italy and to
Luxembourg. By the end of 1999, the HER network will be further extended to
Austria, the Czech Republic and Portugal.
The routes to be completed by the first half of 1999 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 GTS. See "Risk Factors -- Risks Specific
to GTS -- HER Network Roll-out."
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.
See "Risk Factors -- Risks Specific to GTS -- HER Network Roll-Out."
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, (ii) global alliances among some of the world's largest
telecommunications carriers; and (iii) global operators. 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 additional entrants to the market and increase the intensity of
competition. Competitors in the market compete primarily on the basis of price
and quality. HER intends to focus on these factors and on service innovation as
well. HER's business plan anticipates substantial head-to-head competition as
well as indirect competition.
Various telecommunications companies, including MCI WorldCom, Inc., Viatel,
Inc., KPN N.V., Deutsche Telekom AG, France Telecom S.A., Global Crossing Ltd.,
British Telecommunications plc and Esprit plc, have announced plans to
construct, have begun to construct or are operating fiber optic networks across
various European countries. Some of these networks include, or their promoters
have expressed their intentions to include, transatlantic connectivity. The
Company also competes with respect to its "point-to-point" transborder service
offering against circuits currently provided by PTOs through IPLCs.
If HER's competitors, many of whom possess greater technical, financial and
other resources than HER, devote significant resources to the provision of
pan-European, cross-border telecommunications transport services to carriers,
such action could have a material adverse effect on HER's business, financial
condition and results of operations. There can be no assurance that HER will be
able to compete successfully against such new or existing competitors. See "Risk
Factors -- Risks Specific to GTS -- Competition."
Licenses and Regulatory Issues
A summary discussion of the regulatory framework in certain countries where
HER has developed and is developing the HER 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 construction and operation 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 construction and operation of telecommunications infrastructure in the
countries of the EU and Switzerland where HER currently has operations.
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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 operates or plans to operate. Licenses,
authorizations or registrations have been obtained in Belgium, Denmark, France,
Germany, Italy, The Netherlands, Sweden, Switzerland, the UK and the United
States. HER intends to file applications in other countries in anticipation of
service launch in accordance with the network roll-out plan.
EU. On June 28, 1990, the European Commission, in an effort to promote
competition and efficiency in the EU, issued 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 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. Deferrals
of the obligations to liberalize were 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, is eligible
for a special transitional period of up to two years.
On November 5, 1997, the European Commission initiated several infringement
proceedings against those Member States which had not implemented the relevant
transposition measures of the 1990 Directive and other liberalization
directives. The Member States concerned were Denmark, Greece, Italy, Luxembourg,
Germany, Portugal and Belgium. The European Commission also decided to continue
the infringement procedure it had already opened against Spain. Subsequently, in
March 1998, it was reported in the press that several of these infringement
proceedings had been closed because the Member States concerned had properly
implemented the relevant provisions.
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 be restricted only 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.
On June 11, 1997, the European Parliament and the Council of Ministers
adopted a directive on interconnection with regard to ensuring universal service
and interoperability through application of ONP principles; among other things
this requires Member States to ensure that PTOs with significant market power
should provide interconnection on the basis of cost-oriented charges.
On February 26, 1998, the European Parliament and the Council of Ministers
adopted a directive on the application of ONP to voice telephony and on
universal service.
The European Commission has also recently initiated several infringement
proceedings for incomplete or wrong transposition into national law of the April
1997 Licensing Directive (against Austria, Italy, Belgium, France and
Luxembourg) and the June 1997 ONP Interconnection Directive (against Belgium,
France and Luxembourg).
Notwithstanding the above-mentioned infringement proceedings, 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.
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As a multinational telecommunications company, HER is subject to varying
degrees of regulation in each of the jurisdictions in which it provides its
services. Local laws and regulations and the interpretation of such laws and
regulations, differ significantly among the jurisdictions in which HER operates.
There can be no assurance that future regulatory, judicial and legislative
changes will not have a material adverse effect on HER, that domestic or
international regulators or third parties will not raise material issues with
regard to HER's compliance or noncompliance with applicable regulations or that
regulatory activities will not have a material adverse effect on HER. See "Risk
Factors -- Risks Specific to GTS -- Government Regulation." The regulatory
framework in certain jurisdictions in which HER provides its services is briefly
described below.
Belgium. Belgium has implemented the "alternative infrastructure" provider
provision of the Full Competition Directive. Most of the EC telecommunications
liberalization package was adopted at the end of December 1997. The implementing
legislation (Royal Decrees) regarding the licensing regimes for the provision of
voice telephony services and the establishment of public network infrastructure
was approved by the Council of Ministers at the end of June 1998. The official
publication and the entry into force of that implementing legislation took place
in July 1998. Until such entry into force, the Belgian Telecommunication
Authority will continue to work with the system of provisional licenses. HER has
already obtained, through a wholly owned subsidiary, a license in February 1997
from the Belgian regulatory authority to build infrastructure between major
Belgian population centers and the relevant border crossings. HER also has an
authorization to provide liberalized services using alternative infrastructure.
The liberalization legislation requires all previously licenced operators to
apply for new licenses or authorizations. HER applied for a new license in
October 1998. HER expects that its existing license will be renewed in due
course although there can be no assurance that this will be the case or that
such license will be granted on terms acceptable to HER.
Denmark. With the liberalization of infrastructure as of July 1, 1997,
Denmark has fully liberalized its telecommunications markets in accordance with
the requirements of the relevant EC Directives. According to the Danish rules,
HER will not require any regulatory approval in order to install or operate the
network in Denmark.
France. A new regulatory agency, the Autorite de Regulation des
Telecommunications, 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. In
October 1997, HER obtained authorization to operate its network in specific
regions of France. In August 1998, HER was granted an extension of its license
in order to extend its network in France to reach Italy and Spain. Such
authorization requires prior notification to and approval of the Autorite de
Regulation des Telecommunications of any substantial changes in the capital of
HER or its controlling shareholder.
Germany. Germany has approved legislation to implement the Full Competition
Directive and remove all remaining restrictions on competition from August 1996.
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 border. In 1998, HER was granted extensions to its
license to include operation of routes linking Hamburg, Hanover, Munich and
Berlin and of routes to Denmark.
Italy. Although in the past Italy has been dilatory in implementing EC
liberalization measures, Italy enacted legislation on July 31, 1997 creating an
independent national regulatory authority for the telecommunications and
audiovisual sectors. On September 19, 1997, Italy enacted a regulation
implementing all EC directives in the telecommunications sector and since then
specific laws relating to licensing and interconnection have been approved. HER
was granted a license by the Italian authorities in August 1998, enabling the
development of its network in the northwest region of Italy, including Milan.
Luxembourg. A new Telecommunication Act entered into force in April 1997,
and a Royal Decree on licensing conditions entered into force in July 1998. HER
applied to the Luxembourg regulatory authority for a license to build and
operate its network in Luxembourg in October 1998. HER expects to be granted a
license in Luxembourg by the first quarter of 1999. There can be no assurance,
however, that such license will be granted on terms acceptable to HER.
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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 an
authorization for the installation, maintenance and use of a fixed
telecommunications infrastructure.
A new Telecommunications Act was adopted on October 13, 1998, but is not
yet in force. The new Act confirms the full liberalization of the
telecommunications market according to EC standards. It is not expected that the
new Telecommunications Act will detrimentally affect the conduct of business by
HER.
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. In April 1998, Spain adopted the LGT, its new telecommunications law.
The LGT was implemented through the use of secondary legislation. The LGT and
the secondary legislation resulted in the full liberalization of the Spanish
telecommunications market on December 1, 1998. On December 3, 1998, the Spanish
regulatory authority began to issue licenses under the new regime. HER applied
in October 1998 for a license to establish and exploit a telecommunications
network in Spain. HER expects a ruling on the application during the first
quarter of 1999. However, there can be no assurance that such a license will be
granted on terms acceptable to HER or at all.
Sweden. Full liberalization of the Swedish telecommunications market
occurred in 1993. A new Telecommunications Act was passed in 1997 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 certain services. HER registered with Swedish
authorities has been able to provide service in Sweden since July 1998.
Switzerland. The Swiss Parliament has passed a Telecommunications Law which
entered 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. From that date, voice telephony
monopoly was abolished and services fully liberalized. In September 1998, the
Swiss regulatory authority granted HER a definitive concession (replacing an
earlier provisional concession) to build and operate its network in Switzerland.
United Kingdom. Since the elimination in 1991 of the UK telecommunications
duopoly consisting of British Telecommunications and Mercury, it has been the
stated goal of Oftel, the UK telecommunications regulatory authority, to create
a competitive marketplace from which detailed regulation could eventually be
withdrawn. The UK 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 dated December 18, 1996 which grants
it the right to run a telecommunications system or systems in the UK 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 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 to facilitate reforms to the licensing regime which
are expected in 1999. The Department of Trade and Industry has confirmed that it
intends to replace the initial licenses with new licenses and that it would not
revoke an initial license without replacing it with another license giving an
equivalent authorization. The Department of Trade and Industry is currently
discussing with license holders the arrangements to put these new licenses into
effect. Although the Department of Trade and Industry 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.
United States. HER was granted a license by the FCC pursuant to section 214
of the Communications Act of 1934 authorizing it to provide limited global
facilities-based and global resale services (except US services, subject to
items and conditions imposed by law and the authorization, to and from Hungary,
Poland, the Czech Republic, Romania, Monaco, Russia, Ukraine, Kazakhstan,
Uzbekistan, Azerbaijan, China and India) effective October 23, 1998.
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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.
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
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 through its network. GTS believes that
this partnership provides it with the opportunity to build a strong
international gateway presence 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' partner in GTS-Monaco Access is an investment fund designated by the
Principality of Monaco to represent its interests. GTS-Monaco Access functions
in cooperation with MT under a commercial agreement governing, among other
things, the terms of use of existing facilities, access to and acquisition of
new international infrastructure. 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 September 30, 1998, GTS and its partner had each made equity contributions
of $0.8 million to GTS-Monaco Access. In addition, GTS-Monaco Access had
outstanding loans of $2.9 million to GTS as of September 30, 1998. See "GTS
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. MT, 50% partner in GTS-Monaco Access and the local telephone
operator for the Principality of Monaco, is presently seeking a partner to
purchase a minority stake in MT. The sale of such stake, if undertaken, should
not be dilutive to the economic interest of GTS in GTS-Monaco Access although
the impact of such sale on the strategic view of MT toward GTS-Monaco Access
cannot be determined at this time.
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Business and Marketing Strategy
GTS' 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' 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' Western European activities are
not allied with any of the major consortia or large Western European
telecommunications companies, GTS-Monaco Access may be considered 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' Indian venture, already route
international traffic through GTS-Monaco Access's gateway.
Customers
Targeted customers for GTS-Monaco Access include:
Non-Aligned PTOs. GTS believes that various large American and Western
European PTOs that lack adequate international switching and transport
facilities of their own may be persuaded to purchase international services
from GTS-Monaco Access, rather than from competing PTOs or consortia.
Mobile Carriers. GTS believes that some of the non-PTO mobile
carriers, which currently provide only a small percentage of Western
European mobile telecommunications traffic, may prefer the "independent"
international gateway service offerings of GTS-Monaco Access to those of
their PTO competitors.
Internet Service Providers. Growth in Internet usage creates a
significant opportunity for a nonaligned Internet access provider such as
GTS-Monaco Access, since many ISPs 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' non-aligned status to route traffic between rivals or to displace
incumbents for transit relationships.
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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 expected that the venture would lose
approximately $6 million of revenues in 1998. GTS-Monaco Access has put in place
plans to replace such revenues from other sources.
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 licenced 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 directly
subject to EC law. However, GTS-Monaco Access will have to comply with EU
regulation to the extent it does business in EU member states or its business
has an effect on trade between 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. In certain of GTS' existing
and target markets, there are laws and regulations which affect the number and
types of customers which GTS 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 country of termination to be treated as if it originated in the third country
that enjoys lower settlement rates with the destination country, thereby
resulting in lower overall costs on an end-to-end basis. Re-filing is prevalent
in the industry even though the practice is technically in contravention of ITU
regulations. In practice, because of the widespread non-observance of these
regulations, such a contravention normally does not give rise to specific legal
problems. However, their enforceability essentially depends on the status given
to ITU obligations by 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.
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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-Monaco Access 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-Monaco Access 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.
EUROPEAN SERVICES STRATEGY
General. In order to capitalize on the increasing liberalization of
telecommunications regulation in Europe, GTS intends to become a leading
provider of a broad range of integrated telecommunications services to business
and other high-usage customers in certain metropolitan markets throughout
Europe. 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. Through GTS
Business Services -- Western Europe, GTS intends to establish service
capabilities as a reseller in up to 50 additional European metropolitan markets.
In furtherance of its European Services Strategy, in October 1998 GTS hired Les
Harris and Philip Blanchette as President and Vice President, Network Operations
and Engineering, respectively, of GTS Access Services. Since such date, GTS
Access Services has hired certain other key management and technical personnel.
Through GTS Access Services, GTS intends to leverage its experience in
developing and operating local, national and international telecommunications
networks by building, acquiring or leasing technologically advanced fiber optic
networks and establishing CLEC service capabilities in up to 12 metropolitan
markets throughout Europe, as regulatory conditions permit, within three years
after GTS commences implementing its European Services Strategy. Currently, the
regulatory regimes in Europe vary from country to country and some countries do
not permit competitive local exchange carriers to operate. See "Risk
Factors -- Risks Specific to GTS -- Risks Relating to European Services
Strategy."
Recent Developments. On November 30, 1998, GTS completed the acquisition
of NetSource. NetSource is a pan-European provider of long-distance
telecommunications services focusing primarily on small-to medium-sized
businesses, with operations in Norway, Sweden, Germany and Ireland, as well as
in The Netherlands, Belgium and Denmark. The acquisition of NetSource provides
the GTS Business Services -- Western Europe line of business with a customer and
revenue base in several key Western European countries, a portfolio of licenses
and interconnection agreements and an entrepreneurial management team.
If the acquisition of Esprit Telecom is consummated, the combined business
will have (i) presence in 19 countries throughout Europe, (ii) increased network
capacity and resilience; (iii) a 500-person sales force, one of the largest
among independent telecommunications providers in Europe, (iv) the ability to
provide a wide array of services, and (v) increased management depth.
Furthermore, the combined business is expected to benefit from reduced network
operations costs, reduced administrative costs and capital expenditure savings.
Market and Business Strategy. GTS believes that the size and growth
potential of the European telecommunications market, and the increasing
liberalization of telecommunications regulations in Europe, offer considerable
opportunities to expand into end-user services into metropolitan markets
throughout Europe.
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The size of the European telecommunications services market is estimated to
be approximately $188 billion in 1998. GTS estimates that the total European
addressable market (defined as non-residential core voice, enhanced voice,
non-residential international voice, data, leased line voice and internet) in
1998 is approximately $96.5 billion, which is estimated to grow at a compound
annual growth rate of approximately 13.7% to approximately $306.7 billion by
2007.
Through construction of owned facilities or acquisition or partnership with
other providers, GTS intends to enter up to 12 European metropolitan markets as
a CLEC. GTS' strategy with respect to entry into a specific market will be
determined through an analysis of a number of demographic, economic and
telecommunications demand and spending characteristics, including business
concentration; presence of governmental, financial and business end-user
customers; local economic trends and prospects; demand for switched and
non-switched telecommunications services; feasibility of construction; presence
of existing and potential competitors; the regulatory environment; the market's
proximity to HER's network; and the presence of potential CLEC or reseller
acquisition candidates. In targeting cities in which its entry strategy will be
the construction of a fiber network, GTS, through GTS Access Services, will
initially focus on cities in which there are no CLEC competitors or only one
other such competitor. GTS Access Services' current intention is to enter six
metropolitan markets by the end of 1999 and to provide services in up to 12
target metropolitan markets within three years after it initiates implementing
the European Services Strategy. GTS Business Services -- Western Europe's
current intention is to enter 50 metropolitan markets as a reseller of retail
services over the same time period.
GTS expects to use one or more of the following strategies to enter a
market: (i) construction of a fiber-loop network; (ii) purchase or long-term
lease of dark fiber; (iii) obtaining of high frequency microwave licenses for
"wireless fiber," (iv) partnership with or acquisition of a local
facilities-based CLEC or (v) acquisition or development of a local reseller. In
the case of market entry through a reseller, it is GTS' objective to build or
acquire facilities when economically justifiable. There are a number of risks
attendant with each of these strategies and there can be no assurance that GTS
will be successful in pursuing any of these strategies. See "Risk
Factors -- Risks Specific to GTS -- Risks Relating to European Services
Strategy."
Customers. GTS plans to offer its products and services primarily to
telecommunications-intensive businesses for which reliable telecommunications
services are critical, using GTS' facilities where available and/or reselling
other carriers' facilities as needed. These business segments include financial
services companies, multi-national companies, governmental agencies, resellers,
ISPs, disaster recovery service providers and wireless communications companies.
Products and Services. GTS intends to offer a broad array of competitively
priced, comprehensive services to meet customer telecommunications service
requirements, including private line services, local, national and international
switched telephony services, high-speed LAN interconnection services, virtual
private network services, video transmission services and IP-based services,
including IP telephony, Web hosting and data transmission services. According to
industry sources, bandwidth demand for data in the United States is currently
growing significantly faster than voice, and GTS expects that this trend will
develop in Europe as competitively priced capacity becomes available.
Additionally, GTS intends to develop competitively priced value-added
telecommunications services that are tailored to the specific needs of
individual customers. The types of services that GTS intends to offer include:
Switched Services. Switched services involve the transmission of voice,
data or video to locations specified by end-users or carriers. GTS expects to
have the technological capability to offer a full range of switched service,
including local, national and international calls as well as enhanced services.
GTS intends to own and operate switches and enter into interconnection
agreements with other telecommunication service providers, including HER, in
order to offer to customers cost- effective local, national and international
calling services. Switched service features are expected to include, as allowed
by local regulations, enhanced services such as conference calling, call
forwarding, analog or digital connectivity, desk-to-desk calling, four digit
dialing full network monitoring and maintenance, caller ID, voice mail/messaging
and E-mail to voice-mail conversion.
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Non-Switched Services. Non-switched services involve a fixed, dedicated
communications link between two or more specific locations. Commonly this
service is utilized by an end-user to provide a private communications medium
between multiple business facilities or to another end-user/carrier. GTS expects
to provide high capacity, advanced technology to deliver customer traffic with a
lower cost and higher reliability as compared to the local PTO. Through its high
capacity, high reliability and cost-efficient network, GTS intends to provide
non-switched voice, data and video transmission between (i) end users, (ii) end
users and carriers and (iii) multiple carriers, allowing its customers the
option to bypass the older, less efficient technology and higher-priced services
of the incumbent PTOs.
Other Services. GTS also intends to develop service offerings to take
advantage of emerging market opportunities. Such services are expected to
involve one or more of the following: frame relay, ISDN and ATM services;
IP-based services, including intranet and extranet services, high capacity
internet for multi-media applications, Web hosting, voice over IP and the
establishment of a pan-European IP backbone in alliance with others; calling
card services; and enhanced voice services. These products are expected to be
developed and offered as customer demand dictates and as the relevant regulatory
environment permits. GTS believes that there will be substantial demand for data
and internet services by large business and other high-usage customers, and that
a bundled service offering of national and international data and voice services
will be attractive to this targeted customer base.
Regulatory. GTS' European Services Strategy will subject GTS to significant
additional regulation at the EU, national and local level. GTS Access Services
has applied for licenses to operate as a CLEC in seven major cities in Germany
and in the greater Paris metropolitan area. GTS' determination as to which
markets it may enter will depend in part on GTS' evaluation of the regulatory
regime in such market. The detailed regulation varies from country to country.
Delays in receiving required regulatory approvals and licenses, or the enactment
of adverse regulations or regulatory requirements, may delay or prevent GTS from
entering a particular market or offering its services in any European market,
restrict the types of services offered by GTS, constrain GTS' deployment of its
networks or otherwise adversely affect GTS' operations. There can be no
assurance that GTS will be able to obtain the necessary regulatory approvals on
a timely basis or that GTS will not otherwise be affected by regulatory
developments, either of which may have a material adverse affect on GTS. See
"Risk Factors -- Risks Specific to GTS -- Risks Relating to European Services
Strategy."
Competition. The telecommunications industry is highly competitive.
Competition in the telecommunications industry is based largely on price,
customer service, network quality, value-added services and customer
relationships. Competition for the provision of local services in Europe is in
its early stages of development. Generally, PTOs offer both local and long
distance services and benefit greatly from their position as sole historic
provider in the markets they serve. PTOs generally have a number of competitive
advantages over emerging competitors, such as GTS and other CLECs, due to
substantially greater economic and human resources, close ties to local and
national regulatory authorities and control over virtually all local
telecommunications connectivity. Additionally, GTS believes that the market for
the provision of local services is sufficiently attractive to cause additional
CLECs, including multi-national carriers, to enter the market to offer products
and services which would compete with GTS.
GTS will compete with PTOs and, in certain markets, CLECs in the provision
of high quality, integrated telecommunications services to end-users and
resellers. CLEC competitors include, among others, COLT TeleCom Group plc, which
is providing service through networks in London, Frankfurt, Munich, Hamburg,
Berlin, Paris, Zurich, Amsterdam, Brussels, Madrid and Dusseldorf and MCI
WorldCom, whose pan-European fiber network connects London, Amsterdam, Brussels,
Frankfurt and Paris. Reseller competitors include RSL Communications, Viatel and
Facilicom. GTS believes, based on its experience in providing end-user services
in Russia, the CIS and Central Europe and carrier's services in Western Europe
and in developing cross-border networks in Western Europe through HER, that it
has the knowledge and ability to develop products and services which will be
competitive with other CLECs and resellers in terms of content, quality and
price. However, there can be no assurance that GTS will be able to translate
such experience in other markets in order to compete effectively with PTOs,
CLECs or resellers in the European markets it has targeted. See"Risk
Factors -- Risks Specific to GTS -- Risks Relating to European Services
Strategy."
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Network. In those markets which GTS determines to enter as a
facilities-based CLEC, GTS intends to construct, acquire or lease facilities to
operate advanced, competitive local telecommunications networks employing
current transmission technology with dual ring architecture and central system
monitoring and maintenance. GTS believes that a base of uniform, reliable
networks, which employ the most current technology and support a broad array of
high quality services, will allow GTS to compete cost-effectively against
products and services offered by PTOs and, in certain markets, other CLECs.
GTS' plan for its basic transmission platform is optical fiber deployed in
rings, equipped with high-capacity SDH equipment. Such rings will provide
redundancy by using dual paths for telecommunications transmissions and will
extend to a customer facility either directly or on a point-to-point link from
the rings. Such rings will finally connect to the customer through
customer-dedicated or shared electronics on or near the customer premises.
Network Construction. Prior to undertaking acquisition or construction of a
network in a particular market, GTS will undertake an analysis of a number of
factors, as discussed above, to determine whether such acquisition or
construction is economically justifiable. Wherever appropriate, GTS will seek to
purchase or lease dark fiber or utilize high-frequency short-haul microwave as a
method of accelerated entry into a selected market.
GTS expects that construction and installation services will be provided by
independent contractors selected through a competitive bidding process. GTS
personnel are expected to provide project management services, including
contract negotiation, construction supervision, testing and certification of
installed facilities. The construction period of a network is expected to vary
greatly, depending on such factors as network route kilometers, number of
buildings involved in the initial installation and local construction
regulations. Upon completion of the first phase of construction, or the initial
loop, GTS expects to commence generating revenue. Further expansion of the
network will be dictated by customer growth and customers' relative proximity to
the initial loop.
The initial capital requirement for GTS Access Services and GTS Business
Services -- Western Europe to implement the European Services Strategy will be
financed with a majority of the proceeds of the July 1998 Offerings received by
GTS. In addition, GTS contemplates that it will raise additional debt financing
through a newly formed subsidiary of GTS, the proceeds of which will be applied
toward the implementation of GTS' European Services Strategy. The size and
timing of such financing has not yet been determined by GTS. GTS cannot estimate
with any degree of certainty the amount and timing of GTS' future capital
requirements for implementing the European Services Strategy, which will be
dependent on many factors, including the success of GTS' European services
business, the rate at which GTS expands its networks and develops new networks,
the types of services GTS offers, staffing levels, acquisitions and customer
growth, as well as other factors that are not within GTS' control including
competitive conditions, regulatory developments and capital costs. GTS believes,
however, that if the European Services Strategy is implemented, it is likely
that GTS will need to raise additional capital. See "Risk Factors -- Risks
Specific to GTS -- Additional Capital Requirements" and "GTS Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- European Services Strategy."
Sales and Marketing. In each of its target markets, GTS intends to
establish its own direct sales force. As GTS will be targeting large financial,
corporate and governmental customers with demanding telecommunications service
requirements, GTS expects that its internal sales force will include dedicated
sales and customer service representatives. The acquisition of NetSource
provides GTS with a sales force for its retail services business of 40 direct
sales personnel and 182 sales agents throughout Europe. If consummated, the
acquisition of Esprit Telecom will add an additional 230 direct sales personnel,
which is expected to grow to 350 in 1999.
Billing and Information Systems. Sophisticated information and processing
systems will be vital to GTS' success. Specifically, GTS will need to develop
systems to enter, schedule, provision, and track a customer's order from the
point of sale to the initiation of service and such systems will need to
include, or interface with, trouble-shooting systems, management, billing,
collection and customer service systems. GTS expects the development of its
systems to require substantial capital and management resources.
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CENTRAL EUROPE
In Central Europe, GTS' 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, the Czech Republic, Slovakia and Romania. In the Czech Republic, GTS
provides outgoing voice services and operates an international gateway and a
data services network. In Hungary, GTS operates a nationwide microwave network
and a VSAT network, which GTS believes is the largest VSAT network in Central
Europe as measured by number of VSAT sites. In Slovakia and Romania, GTS
provides VSAT services using its VSAT hub in Hungary. Subject to certain
regulatory approvals, GTS has also obtained a license to provide international
data services in Poland and expects to begin operations during the first quarter
of 1999. GTS' 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 99.9% 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 and in Hungary's 18 county capitals. 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) an excellent maintenance and technical support service,
which include "rapid response" service calls and 24-hour hub service operations
support, which can be backed by financial guarantees when required.
As of September 30, 1998, GTS-Hungary's VSAT network consisted of
approximately 993 owned and operated VSAT sites which GTS 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, GTS 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
has recently completed a nationwide expansion of its microwave-based Budapest
overlay network and plans to develop two fiber loops in Budapest. 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 this development 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 and the nine months ended September 30, 1998. 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 US
dollars) on a monthly basis. 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. Additionally, at least three new joint
ventures, all with international partners, have announced their intentions to
compete in the Hungarian telecommunications industry by leveraging existing
assets from the utility (electric, oil and gas), railway and cable industries.
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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 a good reputation for
customer service.
CZECH REPUBLIC
Czechnet. Czechnet, a wholly owned subsidiary of GTS, offers 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, Czechnet provides all of the same VSAT services offered by
GTS-Hungary. In addition, Czechnet offers high-speed Internet access service.
Czechnet is also targeting opportunities in Slovakia, based upon the historic
relationship between the Czech and Slovak markets.
The Czechnet network consists 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 Czechnet and individual VSATs based on, and controlled by,
GTS-Hungary's hub in Budapest.
Czechnet's target customers include real estate developers, hotels and
multinational companies which require international voice or data services or
Internet connectivity, where both GTS' own services and the services of GTS
partners are sold. Czechnet provides outgoing international voice services and
high-speed Internet access to large commercial buildings in Prague. As of
September 30, 1998, Czechnet had connected 35 buildings in Prague to its private
voice network. International voice services are offered at prices similar to
those of the Czech PTO. Czechnet plans to pursue customers who require
value-added services which may be offered at higher prices and better margins.
Czechnet is licenced to provide international satellite services, leased
line services and data services. It received its 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.
Czechnet is the only alternative international telephony provider licenced
in the Czech Republic. As such, its only licenced competitor is SPT Telecom, the
Czech PTO. Should SPT Telecom decide to compete aggressively with Czechnet, it
has the ability to discount prices below those which could be easily sustained
by Czechnet. Czechnet's international telephony business is also subject to
competition from unlicenced callback services, Internet telephony services and
services provided by unlicenced operators. In data services, Telenor, GITY and
Nextel (a subsidiary of SPT Telecom) are Czechnet's 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 Czechnet with a competitive advantage. Additionally,
GTS' 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.
NEW VENTURES
In September 1998 certain affiliates of GTS acquired 100% of the ownership
interests in Datanet kft., one of the leading Internet service providers in
Hungary. This acquisition has substantially increased GTS' market share in the
residential and business Internet markets in Hungary.
In July 1998, GTS became the largest single shareholder of Dattel, a.s., a
competitive local exchange carrier in the Czech Republic providing portions of
downtown Prague with telephony and leased line services. Dattel is also the
leading member of a consortium of Czech companies operating a fiber optic ring
in Prague.
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In September 1998, GTS acquired a substantial minority stake in Catalina
Sp.z.o.o., a Polish company holding an international data services license. This
acquisition is subject to certain regulatory approvals. Catalina, however,
expects to begin operations in the first quarter of 1999.
RUSSIA AND THE CIS
OVERVIEW
GTS is a leading provider of a broad range of telecommunications services
in Russia. GTS' 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.
GTS 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 Sovtelecom 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 domestic long distance service within their service region. Domestic
long distance calls to and from areas outside the companies' service area, as
well as international calls, are switched to and from Rostelecom, which forwards
the calls to and from another regional company or a foreign carrier for
international calls. Exceptions to this rule include the seven city operators.
In Moscow and St. Petersburg, the trunk operators have been isolated into
separate, long distance companies called Moscow MMT and St. Petersburg MMT. All
domestic long distance and international calls originating from or terminating
in Moscow and St. Petersburg are switched through the MMTs, which forward the
calls to and from Rostelecom.
Following the former Soviet Union's transformation from a centralized
economy to a more market-oriented economy, increased demand from emerging
private businesses and from individuals, together with the poor state of the
public telephone network, has led to rapid growth in the telecommunications
sector in Russia and the CIS. In 1991 the MOC was established as the Russian
successor to the Soviet Ministry of Posts and Communications to regulate and
improve the Russian telecommunications industry. In 1998, Goskomsvyaz was
established as the successor to the MOC. As a result, Goskomsvyaz succeeded to
the MOC's role as the government's representative for its ownership share of the
88 regional operating companies, the assets currently held by Svyazinvest (then
the monopoly international and domestic long distance service provider), and the
principal regulatory authority for national radio, television and satellite
operating companies. This enabled first the MOC and later Goskomsvyaz 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
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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 Goskomsvyaz to a growing number of customers throughout Russia.
Judging from the sequential numbering of licenses issued since 1992 more than
10,000 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, among other reasons.
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 Limited, a Cyprus-based company that represents the interests
of a consortium which includes ICFI Cyprus, Renaissance International Limited,
Deutsche Morgan Grenfell, Morgan Stanley, and certain entities affiliated with
an affiliate of George Soros, purchased a 25% stake in Svyazinvest for $1.87
billion. The President had also authorized the sale of another 24% of
Svyazinvest at a future date. This sale was scheduled to occur in the second
half of 1998 and was subsequently opened to foreign investors. However, this
sale was cancelled because of the overall decline in the Russian economy. See
"Risk Factors -- Risks Specific to GTS -- Risks Relating to Operations in Russia
and the CIS -- Economic." The Russian government has announced that it will
retain a controlling 51% interest in Svyazinvest.
Goskomsvyaz votes the Russian government's interest in Svyazinvest, which
was reclassified as the State Committee on Telecommunications and Informatics
during a recent government reorganization. Goskomsvyaz 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 the infrastructure.
Businesses in Moscow requiring international and domestic long distance
voice and data services and consumers using mobile telephony have principally
driven growth in the Russian telecommunications industry. This growth has been
most significant as multinational corporations have established a presence in
Moscow and Russian businesses have begun to expand beyond the country's
political and financial capital. The service
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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. 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.
It is unclear, however, what the effects of the August 17 Decision and its
consequences will be on the Russian economy. See "Risk Factors -- Risks Specific
to GTS -- Risks Relating to Operations in Russia and the CIS -- Economics."
GTS 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.
STRATEGY
GTS' objective is to become the premier alternative carrier in Russia and
other key growth markets of the CIS. To attain this objective, GTS has developed
and implemented the following strategy:
Develop Strong Local Partnerships. GTS has developed and continues to
develop its Russian and CIS business through alliances with experienced local
partners. 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. GTS 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,
GTS' 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, GTS 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. Subject
to stabilization of the political and economic situation in Russia, GTS will
continue to invest in and build sophisticated high-speed digital networks and
other infrastructure through which customers can gain local access to GTS'
services. In addition to providing advanced, high quality network
infrastructure, GTS emphasizes and offers its customers a level of customer
service which GTS believes cannot be found elsewhere in the market.
To date, GTS has made substantial progress employing this strategy. GTS
provides digital voice, data, Internet and local services in Moscow through its
Sovintel, Sovam and TCM ventures and provides these same services to fourteen
additional Russian cities through its TeleRoss long distance network. GTS
believes that attractive acquisition opportunities currently exist in the
markets in which it operates in Russia and the CIS. GTS continuously considers a
number of potential transactions, some of which may involve the contribution of
certain of its Russian businesses in exchange for an interest of equivalent or
greater value in the surviving entity and, if consummated, may be material to
GTS' operations and financial condition.
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
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and billing, and other value-added capabilities that leverage GTS' investment in
advanced switching, data collection and processing equipment. GTS also provides
customized systems integration, including PABXs, key systems, wiring and
interconnectivity. Dedicated and leased capacity supplements GTS' own
infrastructure, allowing GTS to bypass the severely congested and poorly
maintained local, domestic and long distance circuits of the Russian carriers.
Whenever practical, GTS' 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. This integrated marketing approach enables GTS 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.
The following table sets forth certain operating data related to GTS'
operating ventures in Russia and the CIS.
<TABLE>
<CAPTION>
AT AND FOR THE
AT AND FOR THE NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
-------------- --------------
1996 1997 1997 1998
----- ----- ----- -----
<S> <C> <C> <C> <C>
Cities In Service................................... 33 40 40 58
Total Voice Minutes (millions)
Inter-city........................................ 15.8 57.1 35.8 73.4
Local............................................. 133.0 269.1 174.4 306.5
International Outgoing............................ 20.5 46.0 31.8 46.8
Incoming.......................................... 33.2 69.9 50.0 35.1
Total Data Customers (thousands).................... 6.2 9.9 8.3 9.0
Total Active Paying Subscribers (thousands)......... 9.8 20.4 14.9 25.2
</TABLE>
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 180 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 continues construction of its St. Petersburg network which 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 51,410 Moscow telephone numbers, or "ports," for business
customers and cellular providers and had over 350 employees as of September 30,
1998.
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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 430 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 430 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 competitive advantage
because it allows Sovintel to connect customers to its network more quickly than
alternative methods. As these customers are provided permanent connections to
Sovintel's network through direct connections to the PABXs, additional customers
are rolled onto the wireless local loop.
[GTS SOVINTEL MOSCOW NETWORK CHART]
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 local
telephone network, which is operated by 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. The Sovintel international
gateway primarily provides international service, transmitting international
traffic via dedicated international leased long distance channels. Sovintel's
customers also can receive high speed data services through Sovintel's
interconnection with the Sovam data network. Sovintel has obtained a license to
provide large business customers in Moscow and St. Petersburg high speed data
services and Internet access through private line channels, thus
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complementing Sovam's regional offering and supporting its customer base in
Moscow and St. Petersburg. 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
AT AND FOR THE YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
---------------------------- -----------------
1995 1996 1997 1997 1998
------- ------- -------- ------- -------
<S> <C> <C> <C> <C> <C>
Minutes Of Use(1)
International
Number of Minutes.............. 10,516 20,839 43,664 30,628 43,400
Average Rate Per Minute........ $ 2.06 $ 1.55 $ 1.12 $ 1.19 $ 0.96
Domestic Long Distance
Number of Minutes.............. 2,047 10,098 26,606 16,946 35,663
Average Rate Per Minute........ $ 0.86 $ 0.65 $ 0.52 $ 0.55 $ 0.45
Moscow (Local) Fixed Line
Number of Minutes.............. -- -- 3,501 2,302 5,113
Average Rate Per Minute........ -- -- $ 0.05 $ 0.06 $ 0.03
Moscow (Local) Cellular
Number of Minutes.............. 21,478 83,673 118,447 82,333 76,835
Average Rate Per Minute........ $ 0.06 $ 0.08 $ 0.08 $ 0.08 $ 0.08
Incoming
Number of Minutes.............. 3,839 24,306 43,626 34,571 20,841
Average Rate Per Minute........ $ 0.58 $ 0.28 $ 0.30 $ 0.29 $ 0.29
Ports
Approximate Number of Ports
(cumulative)................... 6,079 29,646 43,976 40,563 51,410
Approximate Number Of Private Line
Channels (cumulative)
International..................... 26 89 201 162 306
Inter- and Intra-City............. 26 103 243 184 438
Approximate Equipment Sales
(thousands)....................... $ 1,400 $ 2,200 $ 3,400 $ 2,500 $ 3,651
</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 180
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, GTS 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, GTS trains its employees to
provide customer service at a level which is comparable to that provided by
Western telecommunications companies.
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
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inter-city service between Moscow and St. Petersburg via fiber optic line or
channel leased by Sovintel, in each case benefitting from Sovintel's high
quality infrastructure. Private line domestic long distance service is provided
through TeleRoss and, for cities not served by TeleRoss, through Rostelecom.
International private line service is provided through dedicated leased fiber
channels from Rostelecom.
Equipment Sales, Installation Services and Project Planning and Management
Services. In providing the above services to its customers, Sovintel installs
and maintains equipment on its customers' premises, including PABXs, key systems
and wiring. Sovintel also provides project planning and management services,
including system design and management, to its customers.
World Access Service. Customers are able to access Sovintel's international
long distance services through the World Access Card, which provides customers
either direct or calling-card-based portable access to domestic and
international long distance service. The calling card can be used in 18 Russian
cities, including Moscow and St. Petersburg, and 25 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 (Bee-Line), 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
an "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 on the duration 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 MGTS begins to charge for completion of such calls. Sovintel prices its
international long distance services competitively with those of its principal
competitors. 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 $0.96 per minute for the nine
months ended September 30, 1998. Sovintel is experiencing increased pricing
pressure from competitors. Sovintel prices domestic long distance services in
line with those of its principal competitors. Due to its obligations under
certain agreements with affiliated entities, however, Sovintel's margins for
these services had been declining, though Sovintel recently succeeded in
reversing this trend by achieving lower settlements through least-cost routing.
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. Sovintel
leases the lines from Rostelecom at wholesale rates and to its customers at
prices in line with Rostelecom's retail rate. In addition, Sovintel provides
private line channels through "one-stop shopping" arrangements with
international carriers, such as AT&T, British Telecom and Cable & Wireless.
Customers are billed monthly, with larger-volume customers receiving
discounts of up to 25%. GTS bills customers using Sovintel services, either in
US Dollars or Russian rubles. All underlying pricing is based on US Dollar
tariffs. For customers invoiced in rubles, Sovintel has the contractual ability
to recover devaluation losses that exceed 3% by re-invoicing the customer. To
the extent permitted by law, payment is made either in US 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. To the extent
Sovintel receives remittances in rubles, Sovintel will have higher ruble cash
and receivable balances which will expose it to correspondingly greater exchange
risk. See "Risk Factors -- Risks Specific to GTS -- Risks of Conducting Business
in Foreign Currencies." In addition, due to the ruble devaluation that was part
of the August 17 Decision and the attendant scarcity of US Dollars, there may be
a lower general level of remittances to Sovintel in US Dollars.
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Sovintel currently bills on an invoicing system that was internally developed.
Currently, the system is adequate for Sovintel's present customer base; however,
GTS 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),
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 17 account managers, all of whom
specialize in serving specific targeted industries. Dedicated marketing, project
management and customer support comprised of 23 personnel provide technical
support, customer service, training, market monitoring and promotional functions
for Sovintel. Sovintel's sales and marketing personnel are paid through a
combination of salary, commissions and incentive bonuses.
Ownership and Control. Sovintel is a joint venture between a wholly owned
entity of GTS and Rostelecom, with each having a 50% ownership interest. Under
Sovintel's charter, GTS and Rostelecom each have the right to appoint three of
the six members of Sovintel's managing board. Rostelecom has the right to
nominate the Director General (the highest ranking executive officer at
Sovintel), while GTS has the right to nominate the First Deputy Director General
(the next-highest ranking executive officer at Sovintel). In practice, the
Director General and the First Deputy Director General together perform the role
of a chief executive officer. Certain business decisions, including the adoption
of Sovintel's annual budget and business plan as well as the distribution of
profits and losses, require the approval of both GTS and Rostelecom. Neither GTS
nor Rostelecom are obligated to fund Sovintel's operations or capital
expenditures. Losses and profits of Sovintel are allocated to the partners in
accordance with their ownership percentages, in consideration of funds at risk.
As of September 30, 1998, 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 "Risk Factors -- Risks Specific to GTS -- Dependence on
Certain Local Parties; Absence of Control" and "GTS Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Accounting
Methodology -- Profit and Loss Accounting."
TCM
Subsequent to June 30, 1998, GTS increased its beneficial ownership of TCM
to 95%. TCM, a joint venture founded in 1994, provides a licensed numbering plan
and interconnection to the Moscow city telephone network for carriers needing
basic local access service in Moscow. GTS' partner in TCM is MTU-Inform, a
Russian telecom operator. TCM is currently licensed to provide 100,000 numbers
in Moscow, of which over 78,000 have been leased. However, TCM was unable to
lease an additional 22,000 numbers to VimpelCom, TCM's primary customer, during
1998 as it had previously expected it would. TCM is seeking alternative lessees
for these numbers, but there can be no assurance that these numbers will be
leased in a timely manner. TCM has completed agreements required to construct
and provide an additional 50,000 numbers. The construction started in 1998 and
is expected to be completed in the third quarter of 1999. 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."
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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 GTS. 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 $360 installation fee and a $15 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 Sovintel bills and collects for
TCM-Sovintel joint customers, 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' indirect interest in TCM is represented by its
100% interest in a holding company, which owns 95% of TCM. This structure
provides GTS with 95% beneficial ownership interest in 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.
None of the operative charters and agreements relating to the holding company or
TCM have expiration dates. See "Risk Factors -- Risks Specific to
GTS -- Dependence on Certain Local Parties; Absence of Control" and "GTS
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 a wholly owned
subsidiary of GTS that operates a domestic long distance network (the "TeleRoss
Operating Company") and 14 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 15 major Russian cities,
including Moscow and, through VSAT technology, 21 customers located outside
these cities. TeleRoss provides digital domestic long distance services and
other value-added services through its own infrastructure as well as access to
Sovintel's international gateway services and access to the Moscow city
telephone network through TCM's switching facilities. Sovam uses the TeleRoss
digital channels to provide regional data service and has co-located its access
facilities with TeleRoss. As of September 30, 1998, TeleRoss employed
approximately 231 persons of which approximately 98 people were based in Moscow
and approximately 133 people were deployed in the regions in which TeleRoss
operates.
TeleRoss's licenses cover the city of Moscow and a total of 38 regions
throughout Russia. Most of the 14 cities in which TeleRoss primarily operates
are regional capitals, with an aggregate population of approximately 13 million.
TeleRoss's licenses cover the entire region surrounding these cities, with
populations totaling approximately 41 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, Samara, Syktyvkar, Tyumen, Ufa, Vladivostok,
Volgograd and Voronezh.
The TeleRoss network architecture involves local city switches connected to
remote earth stations which communicate via satellite or satellite connection 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
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network, TeleRoss currently serves 21 customers in additional sites through VSAT
technology which links the customers via satellite to the Moscow hub.
The following table sets forth certain operating data related to TeleRoss's
operations:
<TABLE>
<CAPTION>
AT AND FOR THE AT AND FOR THE
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
---------------- -----------------
1996 1997 1997 1998
------ ------- ------- -------
<S> <C> <C> <C> <C>
Minutes of Use(1)
Domestic Minutes (thousands).................. 4,035 23,233 14,440 31,244
Average Rate Per Domestic Minute.............. $ 0.99 $ 0.63 $ 0.66 $ 0.51
International Minutes (thousands)............. 272 744 486 806
Average Rate Per International Minute......... $ 2.76 $ 2.47 $ 2.56 $ 2.01
Number of Cities Served(2)...................... 13 14 14 15
World Connect Dial/Russia
Number of Connect Dial Ports.................. 472 1,112 961 2,106
Average Revenue Per Port Per Month............ $ 767 $ 370 $ 378 $ 339
Moscow Connect
Number of Ports............................... 49 78 56 66
Average Revenue Per Port Per Month............ $1,165 $ 1,358 $ 1,513 $ 1,295
Dedicated Circuits
Number of Dedicated Channels.................. 33 60 43 109
Average Price Per Channel..................... $4,553 $ 4,140 $ 4,264 $ 2,816
World Access Service
Number of World Access Card Users............. 3,929 4,595 4,360 3,675
Average Revenue Per Card Per Month............ $ 52 $ 48 $ 45 $ 57
VSAT Services
Number of VSATs............................... 12 24 20 21
</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 sites 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 and 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
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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.
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 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 18 Russian cities,
including Moscow and St. Petersburg, and 25 countries. TeleRoss provides this
service 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. TeleRoss provides both dedicated and switched services 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 June 30, 1998, TeleRoss,
in conjunction with regional joint venture partners, has installed approximately
30 kilometers of fiber optic cable in three cities and had plans to install an
aggregate of approximately 100 kilometers of additional fiber optic cable in up
to an additional six cities over the next 21 to 27 months. Because of the
economic crisis in Russia, GTS is reconsidering the advisability of proceeding
with such plans. Customers who obtain local phone numbers from TeleRoss's
venture partners are directly interconnected to the local telephone company and
to GTS' long distance network and Sovintel's international gateway and may
obtain a broad range of value-added services offered by GTS.
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 years. During the
first nine months of 1998, TeleRoss increased sales to carriers, which sales
were made at wholesale rates, resulting in a decrease in the average rate per
minute for TeleRoss. The financial crisis and consequent ruble devaluation
versus the US Dollar has affected the competitiveness of TeleRoss's business.
The regional operations, whose prices are defined in rubles need local
government approval for price increases. It is uncertain that substantial
increases will be granted soon, implying that TeleRoss may have to reduce its
tariffs substantially to remain competitive. Rostelecom may be more able to
raise its prices to higher levels. TeleRoss, however, also anticipates that to
remain competitive, it may have to reduce its wholesale tariffs for the
carriers' carrier business.
Although its tariffs are set in US Dollars, TeleRoss historically has
billed its customers in rubles. Since August 17, 1998, TeleRoss has signed new
contracts with the majority of customers to return to US Dollar invoicing. To
the extent permitted by law, payment is made either in US 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
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currency fluctuations. To the extent it receives remittances in rubles, TeleRoss
will have higher ruble cash and receivable balances which will expose it to
correspondingly greater exchange risks. See "Risk Factors -- Risks Specific to
GTS -- Currency and Exchange Risks." In addition, due to the ruble devaluation
that was part of the August 17 Decision and the attendant scarcity of US
Dollars, there may be a lower general level of remittances to TeleRoss in US
Dollars.
Sales and Marketing. TeleRoss markets its services to carriers and
businesses through direct sales channels. As of September 30, 1998, TeleRoss
employed 42 sales and marketing personnel, approximately 15 of whom are based in
Moscow with the remainder 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. One or two sales representatives typically serve each region. 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 markets many of the other service offerings of GTS'
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' 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' partner's approval. See "Risk
Factors -- Risks Specific to GTS -- Dependence on Certain Local Parties; Absence
of Control." Neither GTS nor its respective joint venture partners are obligated
to fund operations or capital expenditures of the TeleRoss Ventures. Losses and
profits are allocated to the partners in accordance with their ownership
percentages, in consideration of funds at risk. As of September 30, 1998, GTS
and its partners had each made equity contributions aggregating $1.9 million to
the various TeleRoss Ventures. Contributions made by the partners include
contributions of cash and intangible assets, such as local support and
assistance with respect to the issuance of licenses in the name of the TeleRoss
Operating Company. In addition, the various TeleRoss Ventures had outstanding
loans and interest of $0.44 million to GTS and $2.3 million to Citibank as of
September 30, 1998. In addition, as of September 30, 1998, GTS had made equity
contributions of $5.8 million to the TeleRoss Operating Company and the TeleRoss
Operating Company had outstanding loans and interest of $34.0 million to GTS and
$7.0 million to Citibank. See "GTS 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 IAS. In 1992, Cable & Wireless
acquired a 33% ownership interest in Sovam, which interest was subsequently
acquired by GTS in 1994, bringing GTS' 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 47 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 GTS.)
As of September 30, 1998, Sovam had approximately 1,500 data service customers
and approximately 3,914 Russia On Line customers (which includes approximately
345 trial subscribers). Sovam employed
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approximately 158 persons in Moscow and other regions of the CIS as of September
30, 1998. Sovam provides equipment and maintains marketing and technical support
personnel at each location either through its own infrastructure or through the
infrastructure of partners, including 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 32 additional cities in Russia and the CIS.
Sovam operates under its own license within Russia while applicable local
partner licenses provide services elsewhere in the CIS. 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.
The following table sets forth certain operating data related to Sovam's
operations:
<TABLE>
<CAPTION>
AT AND FOR THE
NINE MONTHS
AT AND FOR THE YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
--------------------------- ---------------
1995 1996 1997 1997 1998
------- ------- ------- ------ ------
<S> <C> <C> <C> <C> <C>
Basic Data Service
Percentage of Total Sovam Revenue....... 91% 79% 81% 80% 83%
Number of Customers..................... 1,587 1,726 1,571 1,667 1,500
Average Revenue Per Month Per
Customer............................. $ 201 $ 446 $ 728 $ 675 $1,077
Number of Cities in Service............. 11 25 30 30 47
Equipment and Hardware Sales Percentage of
Total Sovam Revenue..................... 8% 14% 8% 10% 6%
Russia on Line Service Percentage of Total
Sovam Revenue........................... 1% 7% 11% 10% 11%
Number of Subscribers(1)................ 407 1,854 3,159 2,606 3,569
Average Revenue Per Month Per
Subscriber........................... $ 49 $ 52 $ 64 $ 67 $ 65
</TABLE>
- ---------------
(1) In addition to the subscribers included above, Sovam frequently connects
potential Russia On Line subscribers on a complimentary one-month trial
basis. As of September 30, 1998, there were approximately 345 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 1,500 customers as of
September 30, 1998, 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 electronic 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 47 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.
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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' 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 3,914 Russia On Line subscribers (which includes
approximately 345 trial subscribers) as of September 30, 1998. 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 an affiliate of
Motorola, to include Russia On Line software with their products.
Customers and Pricing. Sovam's data communications customers consist
primarily of banking and financial services organizations and large
multinational companies, while Sovam's Russia On Line customers consist of a
wide variety of commercial enterprises. Continued deterioration in the political
and economic environment in Russia may adversely affect Sovam's customer base.
See "Risk Factors -- Risks Specific to GTS -- Risks Relating to Operations in
Russia and the CIS." 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. Sovam prices data services on a two-tier structure with high volume users
generally negotiating a flat-rate fee and lower volume users 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. Sovam bills customers in US dollars and,
customers remit payment in rubles and, to the extent permitted by law, in
dollars, with a 2% to 5% conversion fee added to ruble-denominated payments. To
the extent it receives remittances in rubles, Sovam will have higher ruble cash
balances which will expose it to correspondingly greater exchange risks. See
"Risk Factors -- Risks Specific to GTS -- Risks of Conducting Business in
Foreign Currencies." In addition, the ruble devaluation that was part of the
August 17 Decision and the attendant scarcity of US Dollars may cause a lower
general level of remittances to Sovam in US Dollars.
Sales and Marketing. Sovam employs a dedicated sales and marketing force
comprised of three non-Russian nationals and 33 Russian nationals, 28 of which
are based in Moscow with the remainder deployed in the other Russian and CIS
regions. Sovam pays salespersons a fixed salary supplemented by sales
commissions and performance-based bonuses. Sovam's sales 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. See "GTS
Management's Discussion and Analysis of Financial Condition and Results of
Operation -- Accounting Methodology -- Profit and Loss Accounting."
GTS CELLULAR
GTS Cellular operates 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 AMPS cellular companies in Russian
regions located primarily west of the Urals under the trade name Unicel. Vostok
Mobile owns between 50% and 100% of these cellular joint ventures (the "Unicel
Ventures") in Russia. In addition, GTS participates in PrimTelefone, a 50%-owned
joint venture that operates an NMT network in Vladivostok and other cities in
the Primorsky region of Russia. In April 1998, PrimTelefone was also awarded a
license to operate GSM-1800 in 14 regions of the Russian Far East, including
Vladivostok, Khabarovsk and Irkutsk. In
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Ukraine, GTS has an approximately 57% beneficial interest in Golden Telecom
which operates a GSM-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 42 million people.
GTS currently offers cellular services in the following regions as of
September 30, 1998:
<TABLE>
<CAPTION>
GTS' NUMBER OF
ECONOMIC ACTIVE
OPERATING COMPANY INTEREST(1)(2) CITY SUBSCRIBERS
----------------- -------------- ---- -----------
<S> <C> <C> <C>
Russia
Vostok Mobile(2)
Arkhangelsk Mobile Networks............... 50.0% Arkhangelsk 646
Astrakhan Mobile.......................... 50.0% Astrakhan 871
Altaisvyaz(3)............................. 50.0% Barnaul 330
Chuvashia Mobile.......................... 70.0% Cheboksary 785
Lipetsk Mobile............................ 70.0% Lipetsk 809
Murmansk Mobile Network................... 50.0% Murmansk 859
Penza Mobile.............................. 60.0% Penza 517
Saratov Mobile............................ 50.0% Saratov 1,638
Parma Mobile.............................. 50.0% Syktyvkar 476
Volgograd Mobile.......................... 50.0% Volgograd 1,724
Votec Mobile.............................. 50.0% Voronezh 2,055
Mar Mobile................................ 50.0% Yoshkar-ola 339
Novotel(4)................................ 100% Novgorod 169
PrimTelefone................................. 50.0% Vladivostok(5) 5,112
Ukraine
Golden Telecom............................... 56.8%(6) Kiev 8,836
------
Total................................ 25,166
======
</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
100% of a series of 13 operational cellular joint ventures in various
regions in Russia. As of June 30, 1998, GTS' Vostok Mobile had established
new joint ventures which had received additional licenses to operate AMPS
networks in the regions of Bashkurtia (Ufa), Yaroslavl, Bryansk and
Kostroma. Because of the current Russian economic crisis, GTS may decide not
to pursue operating under these licenses. In June 1998, GTS entered into a
non-binding letter of intent to acquire an approximately 80% interest in a
Russian company which is operating and developing cellular operations in the
Khabarovsk, Kamchatsk and Amursk regions. The transaction is subject to
conditions including the completion of due diligence, execution of
definitive agreements and Anti-Monopoly Committee approval.
(3) Joint venture acquired in October 1997; cellular operations commenced in
February 1998.
(4) Acquired and started commercial service in April 1998.
(5) Includes Vladivostok and other cities in the Primorsky region.
(6) GTS has completed a restructuring of the capital and ownership of Golden
Telecom, which gives GTS an approximately 57% beneficial ownership.
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The following table sets forth certain operating data related to GTS
Cellular's operations:
<TABLE>
<CAPTION>
AT AND FOR THE
AT AND FOR THE NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
----------------- -----------------
1996 1997 1997 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
Vostok Mobile
Total Active Paying Subscribers.............. 6,884 11,527 9,562 11,218
Average Service Revenue Per Subscriber Per
Month..................................... $ 128 $ 159 $ 158 $ 145
Minutes of Use(1)(thousands)................. 10,561 27,771 18,800 26,262
Population Covered by Licenses (thousands)... 18,400 18,400 18,400 30,192
Population Covered by Networks (thousands)... 6,500 6,500 6,500 8,198
Subscriber Penetration of Population Covered
by Networks............................... 0.11% 0.18% 0.15% 0.14%
PrimTelefone
Total Active Paying Subscribers.............. 2,822 5,162 3,907 5,112
Average Service Revenue Per Subscriber Per
Month(2).................................. $ 236 $ 201 $ 199 $ 174
Minutes of Use(1)(thousands)................. 6,919 14,270 9,108 16,204
Population Covered by Licenses (thousands)... 2,200 2,270 2,200 13,334
Population Covered by Networks (thousands)... 1,175 1,175 1,175 1,170
Subscriber Penetration of Population Covered
by Networks(2)............................ 0.24% 0.44% 0.39% 0.44%
Golden Telecom Cellular Network Total Active
Paying Subscribers........................... 121 3,664 1,438 8,836
Average Service Revenue Per Subscriber Per
Month..................................... $ 62 $ 160 $ 185 $ 152
Minutes of Use(1)(thousands)................. 9 5,085 2,261 23,214
Population Covered by Licenses (thousands)... 4,500 4,536 4,500 4,536
Population Covered by Networks (thousands)... 1,669 2,507 1,669 2,507
Subscriber Penetration of Population Covered
by Networks............................... 0.01% 0.15% 0.09% 0.35%
Overlay Network Minutes of Use(1)(thousands)... -- 4,909 2,232 13,381
Number of Ports.............................. -- 751 555 1,566
Average Revenue Per Minute................... -- $ 0.34 $ 0.36 $ 0.25
</TABLE>
- ---------------
(1) Includes minutes among affiliates.
(2) Active Paying Subscribers differ from previously reported totals, which
included blocked subscribers. Active Paying Subscribers is the more accurate
portrayal of true revenue base. Vostok Mobile and PrimTelefone 1997 numbers
have been adjusted to reflect this difference.
Vostok Mobile. Through Vostok Mobile, GTS currently operates 13 cellular
joint ventures in Russia. Vostok Mobile owns between 50% and 100% interests in
each of the 13 Unicel Ventures with, in most cases, regional telephone companies
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. GTS believes
that the Unicel Ventures' AMPS-based networks can be upgraded to D-AMPS for an
incremental capital investment; however, because of the current Russian economic
crisis such additional investment is unlikely at this time. 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.
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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. In the
first quarter of 1998, Vostok Mobile, Vimpelcom and Millicom entered into an
agreement in principle to cooperate to establish a clearing center to support
nationwide automatic AMPS roaming. Since executing the agreement, such
operators, in conjunction with other AMPS operators, have been cooperating with
Goskomsvyaz to define the terms and conditions under which AMPS operators may
offer automated roaming services under their current licenses. GTS is unable to
predict the final terms and conditions under which AMPS operators will be
allowed to offer automated roaming, but believes that the clearing center will
be established and that AMPS operators will be permitted to introduce automated
roaming in the first half of 1999.
Each region in which the Unicel Ventures operate has the potential for at
least five licensed operators, including one operator for each of the AMPS, NMT
and GSM cellular standards and two operators in the DCS cellular standard, and
GTS is experiencing increased competition and expects such competition to
increase further. 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 approximately 443 persons as of September 30,
1998, with 390 persons employed regionally.
PrimTelefone. PrimTelefone, a 50% owned GTS subsidiary, conducts GTS'
cellular operations in Vladivostok with the local electrosvyaz which owns 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 active subscriber base was 5,112 as of September 30,
1998, capturing approximately half of the Vladivostok cellular market.
PrimTelefone has also updated its switch and billing systems, which allows it to
offer automated roaming. PrimTelefone competes with a GSM operator and an AMPS
operator, both of which are fully interconnected to the city telephone network
and provide wide city coverage. PrimTelefone employs approximately 65 persons
which include dedicated sales, marketing and customer service personnel.
PrimTelefone holds licenses for NMT-450 and GSM-1800 to provide cellular
service to regions having populations of approximately 2.2 and 11.1 million
people and, as of September 30, 1998, its cellular network covered an area with
a population of approximately 1.2 million people. PrimTelefone received the
GSM-1800 license for the Russian Far East in April 1998. PrimTelefone had plans
to expand its NMT network's coverage and to deploy a GSM-1800 network to include
all major population centers in the Russian Far East over the next five years.
PrimTelefone is reconsidering these plans in light of the current economic
crisis in Russia.
On April 27, 1998, the PKGCN issued the PKGCN Letters. As requested in the
PKGCN Letters, on April 28, 1998, PrimTelefone's management submitted a
compliance plan to the PKGCN specifying measures to be undertaken to bring
PrimTelefone's network into compliance with Gossvyaznadzor requirements and a
timetable for doing so. On April 29, 1998 the PKGCN agreed to the compliance
plan. To date, PrimTelefone's management has continued to timely perform its
obligations under the compliance plan and believes that the plan will be
completed on schedule. PrimTelefone's management has obtained approvals for new
frequency plans for certain base stations cited in the PKGCN orders. See
"-- Russia and the CIS -- GTS Cellular" and "-- Licenses and Regulatory Issues."
On May 13, 1998, a local division of the Ministry for Internal Affairs
opened the PKMIA Investigation, a criminal investigation under Article 327 of
the Russian Federation Criminal Code against certain employees of PrimTelefone
concerning the use of forged state documents in connection with an application
for a frequency plan submitted (and subsequently abandoned) by PrimTelefone. On
June 22, 1998, several employees of PrimTelefone, among others, were interviewed
by a militia investigator in connection with this matter. On November 15, 1998
the investigator decided to suspend the investigation for lack of a person to be
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charged and recommended that the matter be closed, subject to the concurrence of
the local prosecutor. PrimTelefone's management intends to cooperate fully in
this investigation until the matter is closed.
Although no assurance can be provided, GTS does not believe that either the
PKGCN Letters or the PKMIA Investigation will have a material adverse effect on
GTS' business, results of operations or financial condition.
Golden Telecom. GTS owns 75% of an intermediate holding company which holds
an approximately 49% interest in Golden Telecom, giving GTS an indirect
approximately 37% economic interest in Golden Telecom. The remaining
approximately 52% interest in Golden Telecom is owned by three Ukrainian
companies and a Ukranian national. One of the Ukrainian companies, which is a
wholly owned indirect subsidiary of GTS, owns 20% of Golden Telecom. As a
result, GTS' total economic interest in Golden Telecom is approximately 57%.
Golden Telecom is co-managed by GTS and its Ukrainian partners, with such
partners 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 Golden Telecom, GTS participates in the operation
of a cellular network and an international overlay network. With approximately
153 employees, Golden Telecom markets its services and closely monitors
technical and quality-related issues.
Cellular network. Golden Telecom operates a cellular network in Kiev under
the trade name Golden Telecom GSM. The operation utilizes DCS-1800 cellular
technology and operates under a cellular license that covers Kiev City and Kiev
Oblast. Golden Telecom began cellular operations in 1996 by covering the city
center of Kiev and expanded its coverage to include the entire city in 1997.
Golden Telecom provides GSM cellular roaming with 25 cellular operators
worldwide, with the majority of roaming traffic coming from European countries.
Roaming agreements have also been signed with another nine operators and the
Iridium consortium.
Golden Telecom holds a license to provide cellular service to a region
having a population of approximately 4.5 million people and, as of June 30,
1998, its cellular network covered an area with approximately 2.5 million
people. Golden Telecom has also received the right to acquire frequencies to
operate GSM-1800 networks in four additional cities in the Ukraine.
Overlay network. Golden Telecom provides local exchange carrier services
and international gateway services through its overlay network in Kiev. Golden
Telecom currently owns and operates a partitioned mobile switch for both its
cellular and overlay businesses. A second switch has been ordered and was
commissioned in 1998.
Golden Telecom has 14 central offices in the city and also provides last
mile connections (both copper and fiber optic) from the central offices to
customers. A 50-Kilometer fiber optic ring consisting of a main loop and two
sub-rings has been constructed in Kiev. Golden Telecom plans to extend the total
fiber optic network. Local traffic is routed to the local telephone network.
International outgoing and incoming traffic is routed via fiber optic cable to
the GTS-Monaco Access international gateway, Sovintel in Moscow and several
other international operators. Golden Telecom emphasizes its high quality
service and markets primarily to multinational companies, real estate developers
and hotels.
Sales and Marketing. The GTS Cellular entities have direct sales teams and
have also 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 larger
cellular organization rather than as lone, regional operators. Golden Telecom
operates under the trade name Golden Telecom.
Customers and Pricing. The customers of the various GTS Cellular Ventures
are primarily large, mid-sized and start-up businesses and wealthy individuals.
Increases in the number of customers for GTS Cellular's ventures are typically
linked to the economic health of the region in which such ventures operate.
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Cellular service is generally a premium service in the cities in which GTS
Cellular operates and is priced as such. All GTS Cellular Ventures price their
service in U.S. dollars and accept payment in local currency. Each venture
begins with at least 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. GTS
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. The GTS Russian and Ukrainian cellular ventures record cellular
accounts in U.S. dollars, and customers remit payment in rubles and hryvnas,
respectively, at the exchange rate on the date of the bill and, in instances
permitted by law, in U.S. dollars. Payments in hryvnas are applied at the rate
of exchange on the date of payment. In order to lessen risks to its receivables,
GTS and its cellular ventures typically require advance payment from customers
with prepayments averaging approximately six to eight weeks of service per
customer. To the extent remittance is made by customers in rubles and hryvnas,
the GTS Cellular Ventures will have higher ruble cash and receivables balances
which will expose them to correspondingly greater exchange risks. See "Risk
Factors -- Risks Specific to GTS -- Risks of Conducting Business in Foreign
Currencies." In addition, the ruble devaluation that was part of the August 17
Decision and the attendant scarcity of US Dollars may cause a lower general
level of remittances to GTS Cellular in US Dollars. The ruble devaluation in
Russia since August 1998 also caused a significant price increase in ruble terms
(prices are recorded in dollars and paid in rubles) and a resulting adverse
effect on the customer base development.
Ownership and Control. GTS Cellular's Russian and Ukrainian operations are
conducted through ventures which require partner approval for most decisions.
The applicable foundation agreements and charters do not have expiration dates.
See "Risk Factors -- Risks Specific to GTS -- Dependence on Certain Local
Parties; Absence of Control." Neither GTS nor any of its respective partners in
its Russian or Ukrainian operations are obligated to fund operations or capital
expenditures. Losses and profits of all such ventures are allocated to the
partners in accordance with their ownership percentages, in consideration of
funds at risk. As of September 30, 1998, 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 local support and
assistance with respect to the issuance of licenses in the names of each of the
GTS Cellular Ventures. In addition, the various GTS Cellular Ventures had
outstanding loans of $22.0 million to GTS as of September 30, 1998. See "GTS
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 Goskomsvyaz, the successor of the Russian Ministry of
Communications, and its subordinated bodies, Gossvyaznadzor and the State Radio
Frequency Commission. As a practical matter, these national telecommunications
authorities as well as certain regional and local authorities generally regulate
telecommunications operators in their jurisdictions 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. Separate
legislation implements this institutional framework.
Goskomsvyaz issues licenses to provide telecommunications services on the
basis of a decision by the Licensing Commission at Goskomsvyaz. Goskomsvyaz has
issued no new licensing regulations since the enactment of the Communications
Law, and in practice Goskomsvyaz continues to issue licenses based on the
Licensing Regulations, except licenses to provide cellular services (the
"Cellular 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.
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Under the Cellular Licensing Regulations, licenses for rendering cellular
services may be issued only on the basis of a competitive tender for longer
periods ranging from five to 15 years. 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 Goskomsvyaz and verification by appropriate government
authorities that the licensee has conducted its activities in accordance with
the licenses. Officials of Goskomsvyaz 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. Regional
authorities directly influence the issuance of AMPS licenses because AMPS has
been designated a "regional standard." 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.
Entities at the oblast and krai levels (administrative regions within Russia)
and Moscow and St. Petersburg exercise significant control over their respective
local telephone networks.
License procedures for GTS' cellular services include frequency licensing
from Goskomsvyaz through a two step process. A license must first be obtained
from Goskomsvyaz 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 Cellular Licensing Regulations require GTS to
obtain additional 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' Ukrainian joint venture
agreements provide it with the option of purchasing an additional 1% 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 Golden Telecom has paid a $2.9 million frequency license
fee on Golden Telecom's license. There can be no assurance that additional fees
will not be imposed in the future. See also "Risk Factors -- Risks Specific to
GTS -- Risks Relating to Operations in Russia and the CIS."
GTS' subsidiaries and ventures hold the following licenses in Russia and
Ukraine:
Switched Services. In Russia, GTS indirectly 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 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, Limited, a wholly owned subsidiary of GTS in
February 1997, for provision of intercity services in 38 regions and in Moscow
with ability to interconnect with the PSTN. In Kiev, Ukraine, GTS holds a
license for provision of overlay network services, including international
services, in the name of its affiliate, Golden Telecom. In addition, Sovintel is
an ITU 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, the Moscow region and St. Petersburg, valid until September 2001. The
total number of circuits leased is in excess of 500 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 on January 1, 1999. GTS' purchase of
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IAS's 33.3% interest in Sovam requires that Sovam re-register its license. GTS
expects that the license will be re-registered.
Local Access Services. In January 1997, the MOC 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 received authorization
from Goskomsvyaz to construct an additional 50,000 numbers. TCM has also
completed negotiations with MGTS to interconnect these numbers with the Moscow
city telephone network. TCM is currently discussing with Goskomsvyaz whether an
amendment to its license is necessary to add these numbers to its license.
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 US 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. However, AMPS licenses are issued by the MOC based on
the recommendations of regional administrations. 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. It is unclear whether the competitive tender
requirement in the new Cellular Licensing Regulations will apply to all cellular
operators or only those utilizing the GSM and NMT-450 standards.
GTS' 14 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, five companies
initially received an operating license in 1996 and one company initially
received an operating license in 1997. Additionally, Vostok Mobile has received
licenses for five cities where it intends to begin operations later this year.
Golden Telecom 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 GTS' competitors and
potential competitors, which include large multinational telecommunications
companies, have substantially greater financial and technical resources than GTS
and have the ability to operate independently or with global or local partners
and to obtain a dominant position in these markets. GTS believes that it has
certain competitive advantages 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. GTS also believes that its
local partnerships and reliance on nationals in the management of its businesses
and joint ventures provide it with better knowledge of local political and
regulatory structures, cultural awareness and access to customers.
International Services. Sovintel faces significant competition from more
than ten other existing service providers in Moscow, including Rostelecom and
joint ventures between local parties and multinational telecommunications
providers. Large competitors include the "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 GTS, 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. Golden Telecom competes in the switched international traffic market
with the Kiev electrosvyaz 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. GTS expects that market consolidation will
take place among the competitive field in international services.
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Domestic Long Distance Services. GTS believes its major competitors in the
Russian domestic long distance market consist of Rostelecom, the electrosvyazs,
including those which are partners in GTS' 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
electrosvyazs, 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 electrosvyazs 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 electrosvyazs, 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. GTS 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.
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.
Several voice operators including Sovintel have also announced the intention to
provide Internet access and other data services. Although Sovam's business has
grown quickly, GTS believes that Global One is the market leader. GTS believes
that other potential competitors, including foreign PSTNs, Infotel, Infocom and
Glasnet, are also active in this market.
Although GTS faces significant competition in this market, it believes that
it enjoys certain competitive advantages, including the ability to reach a wide
area throughout Russia, 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.
Local Access Services. GTS 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
150,000 numbers, GTS 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 at
least five licenced operators, including one operator for each of the GSM and
NMT-450 cellular standards, which Russia has adopted as national standards, one
operator using the AMPS cellular standard, which has been set as a regional
standard
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and two operators in the DCS Cellular 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 recently occurred which could result in one or more
CDMA "fixed wireless" providers entering the markets, where GTS has cellular
operations. GTS is currently pursuing the development of CDMA operations in the
CIS. In Ukraine, Golden Telecom 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.
ASIA
GTS does not currently own or operate significant telecommunications assets
in Asia.
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 GTS owns a 25% interest. GTS China Investments LLC
holds an indirect 63% interest in Beijing Tianmu Satellite Communications
Technology Co. Limited ("Beijing Tianmu"), which provides technical, operational
and financial support for the VSAT network. In addition, through Shanghai V-Tech
Telecommunications Systems Co., Limited ("V-Tech"), a venture in which GTS holds
a 75% interest, GTS provides financing, operational consulting, technical and
engineering services to a Shanghai-based VSAT network operator.
With respect to V-Tech, in addition to GTS' 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 "GTS 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' ownership interest in V-Tech. GTS has reached an agreement to sell its
ownership interest in V-Tech in consideration of an equity interest in the
purchaser of GTS' interest in such venture. Consummation of such sale is subject
to certain conditions precedent.
With respect to Beijing Tianmu, in addition to GTS' 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. GTS has no
plans to make additional investments or to arrange additional investments in
Beijing Tianmu. The joint venture expires in March 2021, and profits and losses
are allocated according to ownership interests, in consideration of funds at
risk. See "GTS Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Accounting Methodology -- Profit and Loss Accounting."
INDIA
GTS' operations in India are conducted through C-Datacom International,
Inc., a wholly owned subsidiary which provides digital international private
line communications to targeted business customers to and from India for
multiple applications, including data and voice.
EMPLOYEES
On September 30, 1998, GTS, its consolidated subsidiaries and joint
ventures in which GTS participates, employed approximately 1,935 persons. GTS
believes its future success will depend on its continued ability to attract and
retain highly skilled and qualified employees. GTS believes that its relations
with its employees are good.
Although GTS' employees are not unionized, unions represent employees of
GTS' railroad partners in HER. Under the agreements contemplated between HER and
its railroad partners, some of these employees
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will be required to construct and maintain certain portions of the HER network.
There can be no assurances that unionized employees of HER's partners will not
experience labor unrest.
PROPERTIES
GTS 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. GTS has
entered into a new lease for its headquarters in McLean covering 33,000 square
feet, which lease will expire September, 2005. GTS expects to relocate to the
new space in the first quarter 1999 and plans to sublease its current offices.
GTS maintains regional headquarters offices in Moscow and Budapest, as well as
facilities in McLean, Virginia and London. HER is headquartered just outside of
Brussels, Belgium.
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."
LITIGATION
In addition to routine legal proceedings incidental to the conduct of its
business, GTS, 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. On May 21, 1998, the Superior Court of the State
of Delaware denied GTS' motion to dismiss the claim. 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,
GTS does not believe that the outcome of this litigation will have a material
adverse effect upon the financial condition of GTS.
On March 27, 1998, V-Tech brought a claim for approximately $1.1 million
against Gilat Satellite Networks, Limited, 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. On June 2, 1998 Gilat filed a counterclaim
against V-Tech seeking the balance due under the contract and other alleged
damages, in the aggregate amount of $685,000. Gilat has stated its intention to
join GTS as a third-party respondent to its counterclaim. Although it is not
possible at this time to make an assessment of the outcome of the arbitration
proceeding, GTS does not believe that Gilat's counterclaim, even if successfully
asserted against GTS, would have a material adverse effect upon GTS' financial
condition.
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MANAGEMENT
The following table sets forth the name, current business address,
citizenship and present principal occupation or employment, and material
occupations, positions, offices or employments and business addresses thereof
for the past five years of each director and executive officer of the Company.
Unless otherwise indicated, the current business address of each person is 1751
Pinnacle Drive, North Tower -- 12th floor, McLean, VA 22102. Unless otherwise
indicated, each such person is a citizen of the US.
DIRECTORS
<TABLE>
<CAPTION>
PRESENT PRINCIPAL OCCUPATION OR EMPLOYMENT;
NAME, CITIZENSHIP MATERIAL POSITIONS HELD DURING THE PAST
AND CURRENT BUSINESS ADDRESS AGE FIVE YEARS AND BUSINESS ADDRESSES THEREOF
---------------------------- --- -------------------------------------------
<S> <C> <C>
Robert J. Amman...................... 60 Mr. Amman was elected to the Company's Board of
Directors in May 1998. Mr. Amman was Chairman, President
and Chief Executive Officer of John H. Harland Company,
a printing firm, from 1995 to 1998. Previously, from
1994 to 1995, he served as Vice Chairman of First
Financial Management Corporation, where he was
responsible for the merchant services businesses
consisting of Western Union, NaBanco, Telecheck,
Nationwide Credit and International Banking
Technologies. From 1988 to 1994, Mr. Amman served as
President and Chief Executive Officer of Western Union
Corporation, where he oversaw the transformation of the
firm from a telecommunications to a financial services
company. Mr. Amman is a member of the Executive and
Governance Committees of the Board of Directors.
David Dey............................ 60 Mr. Dey was elected to the Company's Board of Directors
in May 1998. Since 1995, Mr. Dey has served as an
independent consultant, particularly to high technology
start-up companies in Europe. In that capacity, he
serves as Chairman of World Telecom and as Chairman of
STARTECH Scotland. 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. Mr. Dey is a
member of the Audit and Budget, and Compensation
Committees of the Board of Directors. Mr. Dey is a
citizen of the United Kingdom.
</TABLE>
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<TABLE>
<CAPTION>
PRESENT PRINCIPAL OCCUPATION OR EMPLOYMENT;
NAME, CITIZENSHIP MATERIAL POSITIONS HELD DURING THE PAST
AND CURRENT BUSINESS ADDRESS AGE FIVE YEARS AND BUSINESS ADDRESSES THEREOF
---------------------------- --- -------------------------------------------
<S> <C> <C>
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. Mr. Greeley is also a director of American
Capital Access Holdings, LLC, Crescent Communications,
Fuelman, Inc. and Teletrac, 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.
Roger W. Hale........................ 54 Mr. Hale was elected to the Company's Board of Directors
in May 1998. Mr. Hale is Chairman, President and Chief
Executive Officer of LG&E Energy Corp., a diversified
energy services company with businesses in retail gas
and electric utility services, energy marketing 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 Corp. and 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. Mr. Hale is a member of the
Executive and Governance Committees of the Board of
Directors.
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 HER. Mr.
McFadden's career in international telecommunications
includes 32 years with ITT Corporation, where he served
as President and Chief Executive Officer of ITT's
Telecom International Group, and a four and one-half
year assignment as President and Chief Operating Officer
of Alcatel Trade International, S.A. Mr. McFadden is a
member of the Executive, Compensation, and Governance
Committees of the Board of Directors.
</TABLE>
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<TABLE>
<CAPTION>
PRESENT PRINCIPAL OCCUPATION OR EMPLOYMENT;
NAME, CITIZENSHIP MATERIAL POSITIONS HELD DURING THE PAST
AND CURRENT BUSINESS ADDRESS AGE FIVE YEARS AND BUSINESS ADDRESSES THEREOF
---------------------------- --- -------------------------------------------
<S> <C> <C>
Stewart J. Paperin................... 50 Mr. Paperin has served as a director of GTS since March
1997. Mr. Paperin serves as Chief Financial Officer of
the Soros Foundations. 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 a member of the Audit and Budget,
Compensation, and Governance 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 Hainan Airlines and Phoenix Information
Systems Corporation. Mr. Peet served as director of
Viatel, Inc. from November 1995 until June 1998.
Immediately prior to joining The Chatterjee Group, Mr.
Peet spent six years with McKinsey & Company. By
contractual arrangement, The Chatterjee Group has the
right to designate one person for nomination to the
Board of Directors to serve a term of five years. Mr.
Peet is the designee of The Chatterjee Group to the
Board of Directors. Mr. Peet is a member of the
Executive Committee of the Board of Directors.
Jean Salmona......................... 62 Mr. Salmona has served as a director of GTS since March
1996. Between December 1989 and November 1998, Mr.
Salmona was Chairman and C.E.O. of CESIA Consulting
Group ("CESIA"), of which he is now Honorary Chairman
and member of the Board. He is President and C.E.O. of
J&P Partners, a consulting concern for high-tech
companies which invest in Europe, India and China. 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 Nationale 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. Mr. Salmona is a
citizen of France.
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.
</TABLE>
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<TABLE>
<CAPTION>
PRESENT PRINCIPAL OCCUPATION OR EMPLOYMENT;
NAME, CITIZENSHIP MATERIAL POSITIONS HELD DURING THE PAST
AND CURRENT BUSINESS ADDRESS AGE FIVE YEARS AND BUSINESS ADDRESSES THEREOF
---------------------------- --- -------------------------------------------
<S> <C> <C>
Alan B. Slifka....................... 68 Mr. Slifka has served as a director of GTS since 1990.
Mr. Slifka is a New York investment banker and the
Managing Principal of Halcyon/Alan B. Slifka Management
Company LLC, an equity asset management firm
specializing in nontraditional investments, specifically
corporate event investing. Previously, Mr. Slifka was a
partner of L.F. Rothschild, Unterberg, Towbin from 1961
to 1982. He is a director of Pall Corporation and is
active in other business, civic and philanthropic
affairs as founder, director or officer of numerous
for-profit and not-for-profit corporations and
foundations. Mr. Slifka served as acting Chief Executive
Officer of GTS during most of 1993. Mr. Slifka is a
member of the Executive and Governance Committees 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 Properties 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 Executive and Compensation Committees 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. He was elected Vice Chairman of the Board
of Directors in 1998. 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.
</TABLE>
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EXECUTIVE OFFICERS
<TABLE>
<CAPTION>
PRESENT PRINCIPAL OCCUPATION OR EMPLOYMENT;
NAME, CITIZENSHIP MATERIAL POSITIONS HELD DURING THE PAST
AND CURRENT BUSINESS ADDRESS AGE FIVE YEARS AND BUSINESS ADDRESSES THEREOF
---------------------------- --- -------------------------------------------
<S> <C> <C>
Bruno d'Avanzo....................... 56 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. Mr. d'Avanzo
is a citizen of Italy.
Gerard Essing........................ 35 Mr. Essing is the Chief Executive Officer -- GTS Mobile
Services (CIS). Mr. Essing has been general director of
Vostok Mobile, a GTS subsidiary, since 1994. Prior to
that, Mr. Essing held a variety of management positions
with what is now Lucent Technologies from 1989 to 1994.
Mr. Essing holds a Master's Degree in International
Management from American Graduate School of
International Management in the United States. He has
also received post-graduate telecommunications training
at Technical University Delft in the Netherlands.
Leslie M. Harris..................... 49 Mr. Harris joined GTS in October 1998 as President of
GTS Access Services, which is based in London. Since
1995, he was President and Chief Executive Officer of
New T&T (Hong Kong) Ltd., the leading competitive local
exchange carrier in Hong Kong. From September 1992 to
December 1994, Mr. Harris was Joint Managing Director of
BT. Australasia Ltd. Prior to that, Mr. Harris held a
variety of senior executive positions with British
Telecom in the United Kingdom and Australia.
Jan Loeber........................... 54 Mr. Loeber is President, GTS Carrier Services, and
Managing Director of 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.
</TABLE>
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<PAGE> 167
<TABLE>
<CAPTION>
PRESENT PRINCIPAL OCCUPATION OR EMPLOYMENT;
NAME, CITIZENSHIP MATERIAL POSITIONS HELD DURING THE PAST
AND CURRENT BUSINESS ADDRESS AGE FIVE YEARS AND BUSINESS ADDRESSES THEREOF
---------------------------- --- -------------------------------------------
<S> <C> <C>
Raymond I. Marks..................... 51 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.
Kevin Power.......................... 44 Mr. Power is currently serving as Interim Head of GTS
Business Services (Western Europe). Prior to joining GTS
Monaco Access in October 1995, Mr. Power was Vice
President, Carrier Relations for GTS 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...................... 46 Mr. Raclin joined GTS as its Senior Vice President and
General Counsel in September, 1997, and was elected
Corporate 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 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.
</TABLE>
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<PAGE> 168
<TABLE>
<CAPTION>
PRESENT PRINCIPAL OCCUPATION OR EMPLOYMENT;
NAME, CITIZENSHIP MATERIAL POSITIONS HELD DURING THE PAST
AND CURRENT BUSINESS ADDRESS AGE FIVE YEARS AND BUSINESS ADDRESSES THEREOF
---------------------------- --- -------------------------------------------
<S> <C> <C>
William H. Seippel................... 41 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.
Eileen K. Sweeney.................... 46 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.
Gerald W. Thames..................... 51 See biographical information under "Directors" above.
Louis T. Toth........................ 55 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.
</TABLE>
EXECUTIVE COMPENSATION AND OTHER INFORMATION
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
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.
For the year ended December 31, 1997, the aggregate compensation paid by
the Company to its directors and executive officers for services in all
capacities was approximately $4.7 million.
GTS maintains the Global TeleSystems Group, Inc. Non-Employee Directors'
Stock Option Plan that permits directors to share in the growth of the value of
GTS through the grant and exercise of nonqualified stock options. See "-- Global
TeleSystems Group, Inc. Non-Employee Directors' Stock Option Plan." In addition,
on February 27, 1998 the Board of Directors granted to each of certain of its
then incumbent members options to purchase 15,000 shares of Common Stock at an
exercise price of $20 per share.
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<PAGE> 169
GLOBAL TELESYSTEMS GROUP, INC. NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
The purpose of the Global TeleSystems Group, Inc. Non-Employee Directors'
Stock Option Plan (the "Directors' Plan") is to permit eligible non-employee
directors of GTS (each a "Non-Employee Director") to share in the growth of the
value of GTS through the grant and exercise of nonqualified stock options.
The total number of shares of Common Stock presently reserved and available
for delivery under the Directors' Plan is 1,275,000. The Directors' Plan is
administered by the compensation committee of the Board of Directors (the
"Committee"). Only directors of GTS who are not employees of GTS or any
subsidiary of GTS on the date on which an option is to be granted are eligible
to participate in the Directors' Plan on such date.
An option (a "Directors' Option") to purchase shares of Common Stock was
granted to each Non-Employee Director on the effective date of the Directors'
Plan and a Director's Option is granted to each new Non-Employee Director when
he or she is first elected or appointed to serve as a director of GTS. One-half
of the Directors' Options vests six months after the date of grant. An
additional one quarter become exercisable on the date six months following the
first annual meeting of GTS's shareholders to occur after such date of grant,
and the remaining one quarter shares become exercisable on the date six months
following the second annual meeting of GTS's shareholders to occur after such
date of grant. An initial Directors' Option represents 22,250 shares of Common
Stock. On the date of each annual meeting of GTS's shareholders, an additional
Directors' Option to purchase 9,000 shares will be granted each year on the date
of the Company's annual meeting to the individuals who will serve as elected
Non-Employee Directors of the Company during the next year.
Directors' Options are nonqualified stock options which are subject to
certain terms and conditions including those summarized below. The exercise
price per share of Common Stock purchasable under a Directors' Option will be
equal to 100% of the fair market value of Common Stock on the date of grant.
Each Directors' Option will expire upon the earliest of (a) the tenth
anniversary of the date of grant, (b) one year after the Non-Employee Director
ceases to serve as a director of GTS due to death or disability (except that, in
the case of disability, if the Non-Employee Director dies within that one-year
period, the Directors' Option is exercisable for a period of one year from the
date of death), (c) three months after the Non-Employee Director ceases to serve
as a director of GTS for any reason other than death or disability (except that,
if the Non-Employee Director dies within that three-month period, his or her
Directors' Options are exercisable for a period of one year from the date of
such death), and (d) three months after the Non-Employee Director ceases to be
employed by GTS if such Non-Employee Director had become an employee of GTS
(except that, if the Non-Employee Director dies within that three-month period,
his or her Directors' Options are exercisable for a period of one year from the
date of such death). Each Directors' Option may be exercised in whole or in part
by giving written notice of exercise to GTS specifying the Directors' Option to
be exercised and the number of shares to be purchased. Such notice must be
accompanied by payment in full of the exercise price in cash or by surrender of
shares of Common Stock or a combination thereof. Directors' Options granted
under the Directors' Plan may not be sold, pledged, assigned or otherwise
disposed of in any manner other than by will or by the laws of descent and
distribution.
At the time of grant, the Board of Directors may provide in connection with
any grant made under the Directors' Plan that the shares of Common Stock
received as a result of such grant are subject to a right of first refusal by
GTS.
The Board of Directors may amend, alter, suspend, discontinue or terminate
the Directors' Plan at any time, except that any such action will be subject to
the approval of GTS shareholders at the next annual meeting following such Board
of Directors' action if such shareholder approval is required by any federal or
state law or regulation or the rules of any stock exchange or automated
quotation system on which Common Stock may then be listed or quoted, or if the
Board of Directors determines in its discretion to seek such shareholder
approval.
The following table sets forth certain information regarding ownership of
the Common Stock and rights to acquire Common Stock by (i) each of the Company's
directors and (ii) each of the named officers and all
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<PAGE> 170
directors and executive officers of the Company as a group as of December 31,
1998. For the purposes of this table, a person or a 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.
BENEFICIAL STOCK OWNERSHIP OF DIRECTORS AND OFFICERS
<TABLE>
<CAPTION>
NUMBER OF
SHARES PERCENTAGE
BENEFICIALLY BENEFICIALLY
NAME OF BENEFICIAL OWNER OWNED(1)(2) OWNED(1)
------------------------ ------------ ------------
<S> <C> <C>
Alan Slifka and affiliates................................ 3,752,112(3) 5.81 %
Robert J. Amman........................................... 10,500(5) *
David Dey................................................. 7,900(5) *
Michael A. Greeley........................................ 26,000(5) *
Roger W. Hale............................................. 7,108(5) *
Bernard McFadden.......................................... 50,000 *
Stewart J. Paperin........................................ 26,000(4) *
W. James Peet............................................. 8,000(4) *
Jean Salmona.............................................. 26,000 *
Joel Schatz............................................... 512,750 *
Adam Solomon.............................................. 65,414 *
Gerald W. Thames.......................................... 863,722 1.34 %
Bruno d'Avanzo............................................ 48,212 *
Jan Loeber................................................ 20,000(6) *
Raymond I. Marks.......................................... 211,625 *
Louis T. Toth............................................. 204,275 *
Other officers............................................ 399,687 *
All Directors and Executive Officers as a group (23
persons)................................................ 6,196,306 9.55 %
</TABLE>
- ---------------
* Less than 1%
(1) The percentage of ownership is based upon 60,577,715 shares of Common Stock
issued and outstanding at December 31, 1998. Excluded from the calculation
are: 4,444,443 shares of Common Stock that is subject to the exercise of
warrants in Common Stock; 5,195,063 shares of Common Stock issued under the
Company's option plans; and an additional 163,795 shares of Common Stock
that will be issued in exchange for NetSource shares that will be tendered
in connection with such acquisition. Subject to NetSource meeting certain
performance targets during the first two quarters of 1999, an additional 1.4
million shares of Common Stock may be issued. See "Shares Eligible for
Future Sale."
(2) Includes shares of Common Stock issuable upon the exercise of stock options
and stock warrants within 60 days of December 31, 1998.
(3) Includes 2,530,562 shares of Common Stock owned by Mr. Slifka, 644,072
shares of Common Stock held in various trusts, options to purchase 8,000
shares of Common Stock owned by Mr. Slifka, 214,478 shares of Common Stock
held by various Halcyon partnerships which are managed by Halcyon/ Alan B.
Slifka Management Company (over which Mr. Slifka disclaims beneficial
ownership), 130,000 shares of Common Stock issuable upon the conversion of
Convertible Bonds held by various Halcyon partnerships which are managed by
Halcyon/Alan B. Slifka Management Company (over which Mr. Slifka disclaims
beneficial ownership), and options to purchase 225,000 shares of Common
Stock held by Halcyon/Alan B. Slifka Management Company (over which Mr.
Slifka disclaims beneficial ownership). The Company has filed a shelf
registration statement covering such shares not previously registered by the
Company of which this prospectus is a part.
(4) Excludes the shares of Common Stock held by the Soros Associates over which
Stewart J. Paperin and W. James Peet disclaim ownership.
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<PAGE> 171
(5) These directors were elected at the Company's May 20, 1998 annual
shareholders' meeting. Share ownership of those directors listed above is
after such date.
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.
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
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<PAGE> 172
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.
THE GTS 401(k) PLAN
The GTS 401(k) Plan (the "401(k) Plan") is a defined contribution
retirement benefit plan that is qualified for favorable tax treatment under
Section 401 of the Code. All employees of GTS, subject to certain regulatory
qualifications, including the Named Executive Officers, who are at least 21
years of age and have completed the minimum service requirement are eligible to
participate in the 401(k) Plan. The 401(k) Plan participants may defer pre-tax
income by contributing to the plan up to the maximum amount permitted by law.
After-tax contributions are also permitted under the 401(k) Plan. GTS matches
50% of each participant's pre-tax contribution to the 401(k) Plan up to 5% of
the participant's total compensation. In addition, GTS may, in its sole
discretion and in a nondiscriminatory manner, contribute additional amounts as
profit sharing to each participant's account. The amounts that are deposited
into each participant's account are invested among various investment options
according to the direction of the participant. Each participant's pre-tax and
after-tax contributions are immediately vested and nonforfeitable. GTS's
matching contribution and profit sharing allocations to each participant's
account do not vest until the participant has completed three years of service
with GTS, at which time the matching contribution and profit sharing allocations
become 100% vested. Each participant is eligible to begin receiving benefits
under the 401(k) Plan on the first day of the month coincident with or following
the attainment of normal retirement age. There is no provision for early
retirement benefits under the 401(k) Plan.
THE SFMT, INC. EQUITY COMPENSATION PLAN
The purpose of the SFMT, Inc. Equity Compensation Plan (the "Equity
Compensation Plan") is to attract, retain and motivate key employees, officers
and eligible independent contractors of GTS and to enable such individuals to
own Common Stock and to have a mutuality of interest with other shareholders of
GTS through the grant of restricted stock and other equity-based awards.
The total number of shares of Common Stock that may be issued or
transferred under the Equity Compensation Plan is four percent of the total
number of shares of Common Stock outstanding at the beginning of the calendar
year, subject to certain adjustments, which are described below. This threshold
number may be increased by the number of shares (a) that were issued under the
Equity Compensation Plan with respect to which no dividends were paid and (b)
that were subsequently forfeited, in accordance with the terms of the Equity
Compensation Plan.
The Equity Compensation Plan is administered by the Committee. The chief
executive officer of GTS has the authority to recommend the individuals to whom
awards will be granted, subject to approval by the Committee. The Committee has
full and binding authority to determine the fair market value of the Common
Stock and the number of shares included in any awards, to establish terms and
conditions of any award, to interpret the Equity Compensation Plan, to prescribe
rules relating to the Equity Compensation Plan and to make all other
determinations necessary to administer the Equity Compensation Plan. The
Committee may condition the vesting of restricted stock upon the attainment of
specified performance goals or such other factors as the Committee may determine
in its sole discretion. In the event that the Committee determines, in its sole
discretion, that an award of restricted stock would not be appropriate with
respect to any individual who has been recommended for an award by the chief
executive officer, the Committee has the authority to grant to any such
individual any other variety of equity-based compensation award, including, but
not limited to, phantom stock, phantom units, stock appreciation rights,
performance shares and performance units. The
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<PAGE> 173
Committee does not, however, have the authority to grant stock options pursuant
to the Equity Compensation Plan.
Grants under the Equity Compensation Plan are determined by the Committee
in its sole discretion. For this reason, it is not possible to determine the
benefits or amounts that will be received by any individual employee or group of
employees in the future. The Equity Compensation Plan will remain effective
until November 14, 2004, unless earlier terminated by GTS. No restricted stock
may be granted under the Equity Compensation Plan on or after November 14, 2000.
During a specified period set by the Committee commencing with the date of
any restricted stock award, the participant is not permitted to sell, transfer,
pledge or otherwise encumber shares of restricted stock. Within these limits,
the Committee, in its sole discretion, may provide for the lapse of such
restrictions or may accelerate or waive such restrictions in whole or in part,
based on service, performance and such other factors. Unless the Committee
specifically determines otherwise, a restricted stock award granted under the
Equity Compensation Plan vests one-third on the second anniversary of the date
of grant, one-third on the third anniversary of the date of grant and one-third
on the fourth anniversary of the date of grant.
The Committee may impose such other restrictions on shares of Common Stock
issued under the Equity Compensation Plan, including a right of first refusal by
GTS that requires the participant to offer GTS any shares that the participant
wishes to sell.
The Equity Compensation Plan provides that, in the event of a change to the
Common Stock (whether by reason of merger, consolidation, reorganization,
recapitalization, stock dividend, stock split, combination or exchange of
shares, or other change in the capital structure made without receipt of
consideration), the Board of Directors will preserve the value of outstanding
awards by making certain equitable adjustments in its discretion.
The Board of Directors may amend, alter, suspend, discontinue or terminate
the Equity Compensation Plan at any time, except that any such action will be
subject to the approval of GTS shareholders at the first annual meeting
following such action if such shareholder approval is required by any federal or
state law or regulation or the rules of any stock exchange or automated
quotation system on which Common Stock may then be listed or quoted, or if the
Board of Directors determines in its discretion to seek such shareholder
approval.
THE AMENDED AND RESTATED 1992 STOCK OPTION PLAN OF GLOBAL TELESYSTEMS GROUP,
INC.
The 1992 Stock Option Plan of Global TeleSystems Group, Inc. (the "1992
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 (the "Amended 1992
Stock Option Plan") subject to stockholder approval at the May 20, 1998 annual
shareholders 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 1992 Stock Option Plan; (ii) to extend eligibility under the
1992 Stock Option Plan to nonemployee directors and independent contractors of
the Company (as defined in the 1992 Stock Option Plan), its subsidiaries and
affiliates; (iii) to provide the Stock Option Committee (as defined in the 1992
Stock Option Plan) with more flexibility to specify the terms of options granted
under the 1992 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 1992 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 June 30,
1998, there were approximately 1,800 employees, nonemployee directors and
independent contractors of GTS and its subsidiaries and affiliates who were
eligible to participate in the Amended 1992 Stock Option Plan. The Amended 1992
Stock Option Plan received stockholder approval at the May 20, 1998 annual
stockholders meeting.
The principal provisions of the Amended 1992 Stock Option Plan, as amended,
are summarized below. A copy of the Amended 1992 Stock Option Plan is an exhibit
to the Registration Statement in which this
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<PAGE> 174
Prospectus is included and this summary does not purport to be complete and is
qualified in its entirety by the terms of the Amended 1992 Stock Option Plan.
The Amended 1992 Stock Option Plan 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 are
reserved for issuance to employees, non-employee directors and independent
contractors under the Amended 1992 Stock Option Plan representing 18.5% of the
outstanding shares of Common Stock on June 30, 1998. The Amended 1992 Stock
Option Plan provides that the number of shares available for issuance under
options granted pursuant to the Amended 1992 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 for tax purposes as incentive options under the Amended 1992
Stock Option Plan.
The Amended 1992 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 Amended 1992 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
owning 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 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 Amended 1992 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 Amended
1992 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).
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<PAGE> 175
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 Amended 1992 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 Amended 1992 Stock Option Plan
and the options issued thereunder will terminate, unless provision is made in
connection with such transaction for the continuation of the Amended 1992 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.
The Board of Directors may further amend the Amended 1992 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 Amended
1992 Stock Option Plan. Unless previously terminated, the Amended 1992 Stock
Option Plan will terminate automatically on April 9, 2008. No termination,
suspension or amendment of the Amended 1992 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 Amended 1992 Stock Option
Plan.
THE GTS 1996 TOP TALENT RETENTION PROGRAM
GTS implemented the GTS 1996 Top Talent Retention Program (the "Program")
which, for 1996 only, alters the terms offered to certain employees under the
1992 Option Plan. Employees who are offered participation in the Program must
sign a "retention agreement," the terms of which are described below, in order
to receive any 1992 Options during 1996. The Program has been offered to
approximately 28 employees, and it provides that any 1992 Options granted to
such participants will vest as follows: (i) one-half of any 1992 Option granted
under the Program will vest at a rate of 25% per year beginning on the first
anniversary of the initial date of grant and (ii) the remaining portion of any
1992 Option granted under the Program will vest one-quarter according to the
achievement of performance revenue levels, and one-quarter according to the
achievement of price levels of Common Stock, provided that all options will vest
on the fifth anniversary of the date of grant regardless of whether such
performance revenue and pricing levels are attained.
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OPTION GRANTS IN THE LAST FISCAL YEAR
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 $597,000
52,500(1) 2.43 15.67 10-10-07 415,300
Bruno d'Avanzo...................... 66,975(1) 3.11 13.33 02-03-07 450,700
37,500(1) 1.74 15.67 10-10-07 296,600
Jan Loeber.......................... -- -- -- -- --
Raymond I. Marks.................... 27,750(1) 1.29 13.33 02-03-07 186,800
Louis T. Toth....................... 22,500(1) 1.04 13.33 02-03-07 151,400
22,500(1) 1.04 15.67 10-10-07 178,000
</TABLE>
- ---------------
(1) Each option vests one-fourth on each of the first four anniversaries of the
date of grant.
(2) The present value of each grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions: dividend yield 0%, expected volatility of 0.50, risk-free
interest rate of 5.79% and expected life of five years.
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES
The following table provides information on the number of options under the
Stock Option Plan held by the Named Executive Officers at December 31, 1997, and
the value of all unexercised options held by such persons as of that date.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FY-END(#)(1) AT FY-END($)(2)
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- ---- ------------------------- -------------------------
<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............................. 4,812 47.3 $83.12 2006 $2,234,019
</TABLE>
172
<PAGE> 177
- ---------------
(1) Each stock option vests one-third on each of the first three anniversaries
of the date of grant. During the fourth quarter of 1997, HER established the
HER Stock Option Plan to replace the GTS-Hermes Stock Option Plan. The
options outstanding under the GTS-Hermes Plan were cancelled and replaced by
options under the HER Stock Option Plan.
(2) The present value of each grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions: dividend yield 0%, expected volatility of 0.50, risk-free
interest rate of 5.79% and expected life of five years.
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND
FISCAL YEAR-ENDED OPTION VALUES -- HER STOCK OPTION PLAN
The following table provides information on the number of options held by
Mr. Loeber under the HER Stock Option Plan at December 31, 1997, and the value
of all unexercised options held by Mr. Loeber as of that date.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FY-END(#) AT FY-END($)(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.
HER STOCK OPTION PLAN
In the fourth quarter of 1997, HER established a stock option plan (the
"New Plan") to replace the GTS-Hermes Plan for the purpose of incentivizing HER
key employees. The aggregate number of shares of HER stock subject to the New
Plan is approximately 13% of the total shares of HER stock issued and
outstanding including options. During 1997, HER issued 10,166 options in
replacement of those outstanding under a stock option plan maintained by HER's
parent, GTS-Hermes, Inc., a wholly owned subsidiary of the Company, as well as
additional options to certain employees. The issuance of these options resulted
in a non-cash charge of $3.7 million of which $2.6 million was recorded during
the fourth quarter of 1997 and the remaining $1.1 million will be recognized
principally ratably over fiscal 1998. The GTS-Hermes Plan is intended to be
terminated. The Company is considering whether to eliminate, and alternative
ways of eliminating, share option plans in subsidiaries, such as the HER Stock
Option Plan. The Company may eliminate such Plans in the future while
incorporating such beneficiaries into the Company's Employee Stock Option Plan
or providing them with alternative equivalent value.
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
173
<PAGE> 178
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.
174
<PAGE> 179
CERTAIN RELATED PARTY TRANSACTIONS
Alan B. Slifka, the Chairman of the Board of Directors, owns an interest in
an office building in New York in which GTS leased office space until the
corporate headquarters were moved to McLean, Virginia on March 1, 1995. Until
April 1, 1998, GTS retained a small office space in New York City that it 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.
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. The shares of Common Stock underlying such
options have been registered under a registration statement that has been
declared effective by the Commission.
In addition, Joel Schatz, a director of GTS, and Ms. Sandler, the wife of
Morris A. Sandler, a former 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. The
shares of Common Stock underlying such options have been registered under a
registration statement that has been declared effective by the Commission.
Bernard McFadden, Director, has a consulting agreement with GTS pursuant to
which he is paid $100,000 in consulting fees each year.
In August and September 1997, the Soros Associates and Mr. Slifka purchased
319,149 and 57,015 shares of Common Stock, respectively, at a price of $15.67
per share in the Company's private stock offering. In addition, affiliates of
Mr. Slifka purchased $2.9 million of Convertible Bonds in September 1997.
Pursuant to the terms of the indenture related to the Convertible Bonds, the
Convertible Bonds will be convertible into such shares of Common Stock as is
equal to the principal amount of such Convertible Bonds divided by the
applicable conversion price, which conversion price shall be equal to the public
offering price of the Common Stock in the July 1998 Offerings. See "Principal
GTS Stockholders."
The Soros Associates purchased $40 million of notes from GTS in 1996, which
notes bore 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), approximately 14% of
the Company's Common Stock. In accordance with the terms of the warrant
agreement, the exercise price of the warrants was reduced from $10.27 per share
to $9.33 per share as the outstanding debt had not been repaid prior to December
31, 1996. In February 1998, the Company repaid the $40 million of notes, plus
accrued interest, using part of the proceeds of an offering of senior notes and
the IPO completed at that time. 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,
excluding countries in the former Soviet Union, and pursuant to this right, one
of these affiliates holds a 25% interest in GTS China Investments LLC. See
"Business -- Asia."
175
<PAGE> 180
The Company has filed the shelf registration statement of which this
Prospectus is a part covering all of the Affiliate Shares owned by the
affiliates of Mr. Slifka and the Soros Associates that were not sold in the
Stock Offerings in consideration of such shareholders' undertaking to be bound
by the Restrictions. It is the Company's belief, after consultation with its
financial advisors, that this agreement relating to the Affiliate Shares will
contribute toward assuring the market of an orderly manner for such Affiliate
Shares to be sold over a period of time. Under the Restrictions, holders of
Affiliate Shares will be prevented from selling any such shares during the first
six months after the closing date of the Offerings and will be able to sell (i)
50% of such shares after the six month anniversary of the closing date of the
Offerings, (ii) 75% of such shares after the nine month anniversary of the
closing date of the Offerings and (iii) 100% of such shares after the twelve
month anniversary of the closing date of the Offerings. In connection with this
agreement, the Company also has agreed to permit certain of the Soros Associates
to resell, immediately after the closing date of the Stock Offerings, up to
100,000 of any shares that they are unable to resell in the Stock Offering as a
result of any cut-back that may be imposed by the underwriters (subject to a
waiver by the underwriters in the Company's IPO of the lockup agreement entered
into by such affiliates to the extent of such 100,000 shares). Certain limited
partners of partnerships affiliated with Alan B. Slifka and currently in
dissolution may, upon advance notice to the Company, withdraw some or all of
their shares of Common Stock from registration under the shelf registration
statement and from the Restrictions. The number of shares of Common Stock
subject to this withdrawal may not exceed the total of 726,953 shares of Common
Stock minus the number of shares sold by such limited partners in the Stock
Offerings.
Affiliates of Capital Research International purchased $30 million of notes
from GTS in 1996, which notes bore interest at 10% per annum, in partial
consideration of which it received warrants to purchase 3,333,333 shares of
Common Stock. In accordance with the terms of the warrant agreement, the
exercise price of the warrants was reduced from $10.27 per share to $9.33 per
share as the outstanding debt had not been repaid prior to December 31, 1996. In
February 1998, the Company repaid the $30 million of notes, plus accrued
interest, using part of the proceeds of an offering of senior notes and IPO
completed at that time. Affiliates of Capital Research International exercised
their warrants on June 3, 1998 under a cashless exercise procedure and received
approximately 2.5 million shares in accordance therewith.
Jean Salmona, a director of GTS, is the former Chairman and Chief Executive
Officer of CESIA. CESIA also provides consultancy services for CDI and for HER.
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.
Pursuant to a 1995 purchase agreement, the Company received its interest in
GTS-Vox Limited, the intermediate holding company of TCM, in exchange for a note
in the principal amount of $693,380 issued to the sellers and certain additional
consideration to its partners payable in the form of either cash or Common Stock
based upon its financial performance. The Company paid the note in 1996. On
January 17, 1997, the agreement was amended such that the consideration would
only be in the form of the issuance of Common Stock and as such, GTS is
obligated under these arrangements to issue up to a maximum of 1,121,640 shares
of Common Stock. In the first quarter of 1997, pursuant to this agreement the
Company issued 504,600 common shares, which was valued at the Company's current
fair market value of $13.33 per share. In addition, the Company was credited
37,480 shares of Common Stock under the amended agreement, for purposes of
applying against the 1,121,640 maximum number of shares of Common Stock, for the
Company's payment of its note to the sellers in 1996. In April 1998, pursuant to
this agreement, the Company issued 336,630 shares of common stock, which was
valued at the Company's current fair market value of $40.25 per share. Common
Stock issued pursuant to the agreement must be held for a minimum holding
period. In certain circumstances, if GTS's partners are unable to sell their
shares of Common Stock, GTS is obligated to assist in locating a purchaser for
the Common Stock, and, if unable to do so, to repurchase these shares. GTS's
repurchase obligations are at the following prices: (i) if shares of Common
Stock are then being publicly traded, at the average trading price of such
shares for the 10 trading days preceding such repurchase or (ii) if shares of
Common Stock are not then publicly traded, at the price shares of Common Stock
were most recently offered to individual investors in a private placement, or,
if no such private placement has occurred
176
<PAGE> 181
within the three months preceding the repurchase of such shares, at a price
determined by an independent financial institution to be agreed upon by GTS and
the seller. As a result of their receipt of shares of Common Stock in 1997, the
sellers became shareholders of GTS. Subsequent to June 30, 1998, 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 buyout, the Company
will be accelerating the issuance of the remaining shares under the 1995
purchase agreement to the former GTS-Vox Limited partners.
Affiliates of Baring International Investment Management Limited
("Barings"), which affiliates consist primarily of investment funds and trusts,
are shareholders of the Company. In April 1996, GTS entered into an agreement
with First NIS Regional Fund SICAF, an affiliate of Barings, to organize GTS
Ukrainian TeleSystems, L.L.C. (the "LLC"), a Delaware limited liability company
60% owned by GTS, which in turn entered into a stock purchase agreement to
acquire 49% of all the ownership interests in Golden Telecom, a Ukrainian
limited liability company. See "Business -- Russia and the CIS." Such
acquisition closed in May 1996. By contractual arrangement, Barings designates
one member of the board of directors of Golden Telecom. Barings funded $4.5
million to be applied towards the LLC's purchase of the interest in Golden
Telecom and for the LLC's $1.5 million contribution to the registered capital of
Golden Telecom. Prior to March 1, 1999, Barings may exercise an option (the
"Initial Option") to convert its initial investment into 438,311 shares of
Common Stock at an exercise price of $10.27. In June 1997 the agreement was
amended, such that Barings funded an additional $4.1 million to be applied
toward Golden Telecom's capital expenditure and operating capital requirements.
On September 30, 2000, Barings may exercise an option (the "2000 Option") to
convert such additional investment into 275,000 shares of Common Stock at an
exercise price of $15.00. In connection with the restructuring of Golden
Telecom, which has been completed, the agreement was further amended in June
1998 to restructure the capital and ownership of the LLC. See
"Business -- Russia and the CIS -- GTS Cellular -- Golden Telecom." Pursuant to
such amendment Barings exercised the Initial Option and the 2000 Option (the
exercisability of which was accelerated by the Company) and received 713,311
shares of Common Stock and made an additional investment of $5.75 million to be
applied toward Golden Telecom's capital expenditure and operating capital
requirements. Barings has no put right in connection with such additional
investment. As a result of the June 1998 amendment, GTS increased its ownership
interest in the LLC to 75% and in Golden Telecom to approximately 57%.
On March 26, 1998, Gerald W. Thames, the Company's Vice Chairman, President
and Chief Executive Officer, exercised non-qualified options to purchase 487,500
shares of Common Stock at an exercise price of $2.75 per share. Mr. Thames
borrowed funds from a brokerage firm in order to pay the exercise price and the
tax liabilities resulting from such exercise (the "Margin Loan"). The shares of
Common Stock resulting from such exercise served as collateral for the Margin
Loan. Subsequently, the market price of the Common Stock declined and
consequently the brokerage firm required Mr. Thames to reduce the size of the
Margin Loan or increase the collateral securing the Margin Loan. Mr. Thames was
unable to sell any of the shares of Common Stock collateralizing the Margin Loan
(and thereby reduce the Margin Loan) because of lock-up arrangements with the
underwriters of the Stock Offerings. As a result, the Company loaned Mr. Thames
$3.5 million in September and October 1998, so he could use the proceeds of such
loans to repay a corresponding portion of the Margin Loan. These loans from the
Company bear interest at a rate of 7% per annum and mature on February 3, 1999.
The Company has agreed to lend Mr. Thames up to an aggregate of $4 million to
meet additional margin calls on his Margin Loan. Mr. Thames contemplates that he
will enter into a separate loan agreement with a commercial bank to repay the
loans from the Company and to meet any subsequent margin calls in connection
with the Margin Loan. The Company has agreed to guarantee Mr. Thames'
obligations under such bank loan.
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<PAGE> 182
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding ownership of
the Common Stock and rights to acquire Common Stock by (i) stockholders that
manage or own, either beneficially or of record, five percent or more of the
Common Stock of the Company and (ii) each of the Selling Stockholders under this
Prospectus. For the purposes of this table, a person or group of persons is
deemed to have "beneficial ownership" of any shares which such has the right to
acquire within 60 days after such date, but such shares are not deemed to be
outstanding for the purpose of computing the percentage ownership of any other
person.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
PRIOR TO SHELF OFFERING AFTER THE SHELF OFFERING
--------------------------- NUMBER OF --------------------------
NUMBER OF SHARES BEING NUMBER OF
NAME OF BENEFICIAL OWNER SHARES(1)(2) PERCENT(1) OFFERED SHARES PERCENT
- ------------------------ ------------ ---------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
George Soros Associates........... 8,099,047(3) 11.93 8,099,047 0 0
c/o Soros Fund Management
888 Seventh Avenue, 31st Floor
New York, NY 10106
Mutuelles AXA/AXA-UAP/............ 7,989,930(4) 11.58 0 7,989,930 13.21
The Equitable Companies
Incorporated
9 Place Vendome
75001 Paris France
Fidelity Management and Research
Corporation..................... 7,145,670(5) 10.35 0 7,145,670 11.81
82 Devonshire Street
Boston, MA 02109
Fidelity International Limited.... 23,640(6) * 0 23,640 *
P.O. Box H.M. 670
Hamilton, Bermuda
Alan B. Slifka and affiliates..... 3,752,112(7) 5.44 3,752,112 0 0
c/o Halcyon/Alan B. Slifka
Management Company, LLC
477 Madison Avenue, 8th Floor
New York, NY 10022
Winston Partners II LDC........... 760,764(8) 1.17 760,764 0 0
c/o Curacao Corporation Company
N.V.
Kaya Flamboyan 9
Willemstad, Curacao
Netherlands Antilles
Winston Partners II LLC........... 378,882(9) * 378,882 0 0
c/o Chatterjee Advisers L.L.C.
c/o The Chatterjee Group
888 Seventh Avenue, 30th Floor
New York, New York 10106
Chatterjee Fund Management........ 555,555(10) * 555,555 0 0
888 Seventh Avenue, 30th Floor
New York, New York 10106
Jacqueline Slifka................. 12,000 * 12,000 0 0
Barbara J. Slifka................. 116,877 * 116,877 0 0
Miriam Alford..................... 21,428 * 21,428 0 0
</TABLE>
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<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
PRIOR TO SHELF OFFERING AFTER THE SHELF OFFERING
--------------------------- NUMBER OF --------------------------
NUMBER OF SHARES BEING NUMBER OF
NAME OF BENEFICIAL OWNER SHARES(1)(2) PERCENT(1) OFFERED SHARES PERCENT
- ------------------------ ------------ ---------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Gray Capital Corp. ............... 27,043 * 27,043 0 0
Carolyn Chaliff & Carl T. Wolff... 4,023 * 4,023 0 0
Molly and Merwin Bayer............ 3,277 * 3,277 0 0
Ronald Claman..................... 1,596 * 1,596 0 0
Monica Saurma..................... 25,868 * 25,868 0 0
Donald Zucker..................... 44,130 * 44,130 0 0
Janice Bayer...................... 3,750 * 3,750 0 0
Riane Gruss....................... 11,033 * 11,033 0 0
James and Shira Levin............. 2,038 * 2,038 0 0
Barbaralee
Diamondstein-Spielvogel......... 5,013 * 5,013 0 0
David Dove........................ 7,500 * 7,500 0 0
Susan Ginsberg.................... 1,803 * 1,803 0 0
Myron Simon....................... 5,214 * 5,214 0 0
Stephen K. Rush................... 150 * 150 0 0
Philip Rush....................... 150 * 150 0 0
Ruth Shuman....................... 15,000 * 15,000 0 0
David Jaffee...................... 8,325 * 8,325 0 0
Elliot Jaffee..................... 22,200 * 22,200 0 0
Jaffee Family Limited
Partnership..................... 24,975 * 24,975 0 0
</TABLE>
- ---------------
* Less than 1%
(1) The percentage of ownership is based upon 69,022,158 shares of Common
Stock. This amount represents Common Stock outstanding at 12/31/98 of
64,577,715 and 4,444,443 shares of Common Stock that is subject to exercise
of warrants in Common Stock. Excluded from the calculation are: 5,195,063
shares of Common Stock issued under the Company's option plans and an
additional 163,795 shares of Common Stock that will be issued in exchange
for NetSource shares that will be tendered in connection with such
acquisition. Subject to NetSource meeting certain performance targets
during the first two quarters of 1999) an additional 1.4 million shares of
common stock may be issued. See "Shares Eligible for Future Sale."
(2) Includes shares of Common Stock issuable upon the exercise of stock options
and stock warrants within 60 days of December 31, 1998.
(3) Comprised of 3,074,199 shares of Common Stock held by the Soros
Foundation-Hungary; 656,849 shares of Common Stock held by the Soros
Charitable Foundation; 37,718 shares of Common Stock held by Soros
Humanitarian Foundation and 996,948 shares and warrants to purchase
3,333,333 shares of Common Stock held by The Open Society Institute. The
inclusion of such shares shall not be deemed an admission that Mr. George
Soros is the beneficial owner of such shares. Information in the above
entry excludes 26,000 and 8,000 shares of, and options for the purchase of,
Common Stock held by Stewart J. Paperin and W. James Peet, respectively,
over which the George Soros Associates disclaim ownership. See "Shares
Eligible for Future Sale."
(4) Ownership information, that represents holdings of several separately
managed funds, is based on a Schedule 13G dated December 10, 1998, a copy
of which was furnished to the Company. Number of shares as to which such
holder has: sole voting power -- 2,329,558 shares; shared voting power --
5,651,676 shares; sole dispositive power -- 7,981,705 shares; and shared
dispositive power --
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<PAGE> 184
8,225 shares. The shareholding disclosed includes 1,774,405 shares receivable
upon conversion of convertible bonds.
(5) Ownership information, that represents holdings of several separately
managed funds, is based on a Schedule 13F-E dated as of September 30, 1998
that was filed with the SEC on November 6, 1998.
(6) Ownership information is based on a Schedule 13F-E dated as of September
30, 1998 that was filed with the SEC on November 3, 1998.
(7) Includes 2,530,562 shares of Common Stock owned by Mr. Slifka, 644,072
shares of Common Stock held in various trusts, options to purchase 8,000
shares of Common Stock owned by Mr. Slifka, 214,478 shares of Common Stock
held by various Halcyon partnerships which are managed by Halcyon/Alan B.
Slifka Management Company (over which Mr. Slifka disclaims beneficial
ownership), 130,000 shares of Common Stock issuable upon the conversion of
Convertible Bonds held by various Halcyon partnerships which are managed by
Halcyon/Alan B. Slifka Management Company (over which Mr. Slifka disclaims
beneficial ownership), and options to purchase 225,000 shares of Common
Stock held by Halcyon/Alan B. Slifka Management Company (over which Mr.
Slifka disclaims beneficial ownership). The Company has filed a shelf
registration statement covering such shares not previously registered by
the Company.
(8) Comprised of 390,393 shares of Common Stock and warrants to purchase
370,371 shares of Common Stock. Information in the above entry excludes
26,000 and 8,000 shares of, and options for the purchase of, Common Stock
held by Stewart J. Paperin and W. James Peet, respectively, over which
Winston Partners II LDC disclaims ownership. The Company has filed a shelf
registration statement covering such shares of which this prospectus is a
part. See "Shares Eligible for Future Sale."
(9) Comprised of 193,698 shares of Common Stock and warrants to purchase
185,184 shares of Common Stock. Information in the above entry excludes
26,000 and 8,000 shares of, and options for the purchase of, Common Stock
held by Stewart J. Paperin and W. James Peet, respectively, over which
Winston Partners II LLC disclaims ownership. The Company has filed a shelf
registration statement covering such shares of which this prospectus is a
part. See "Shares Eligible for Future Sale."
(10) Comprised of warrants to purchase 555,555 shares of Common Stock.
Information in the above entry excludes 26,000 and 8,000 shares of, and
options for the purchase of, Common Stock held by Stewart J. Paperin and W.
James Peet, respectively, over which Chatterjee Fund Management disclaims
ownership. The Company has filed a shelf registration statement covering
such shares of which this prospectus is a part. See "Shares Eligible for
Future Sale."
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<PAGE> 185
DESCRIPTION OF CERTAIN INDEBTEDNESS
SENIOR NOTES DUE 2005
Concurrently with the IPO, GTS offered $105 million of 9 7/8% Notes. The
9 7/8% Notes were issued pursuant to an indenture between GTS and The Bank of
New York as trustee, dated February 10, 1998. The 9 7/8% Notes mature in 2005
and bear interest, payable semi-annually, at 9 7/8% per annum. The indenture
governing the 9 7/8% Notes does not provide for a sinking fund. The 9 7/8% Notes
are subject to redemption at any time on or after February 15, 2002, at the
option of GTS, in whole or in part, at declining redemption prices set forth in
the indenture governing the 9 7/8% Notes. Notwithstanding the foregoing, during
the first three years after the date of the indenture governing the 9 7/8%
Notes, GTS will be permitted to redeem up to 33 1/3% of the aggregate principal
amount of the 9 7/8% Notes with the net proceeds of any public equity offerings
or strategic equity investments (as such terms are defined in the indenture
governing the 9 7/8% Notes) at 109.875% of the principal amount thereof. GTS
placed net proceeds of US$19.6 million from the offering of the 9 7/8% Notes
representing funds that, together with the proceeds from the investment thereof,
are sufficient to pay the first four scheduled interest payments (but not
additional interest) on the 9 7/8% Notes, into an escrow account to be held by
The Bank of New York as trustee for the benefit of the holders of the 9 7/8%
Notes. GTS granted to the Trustee for the benefit of the holders of the 9 7/8%
Notes, a first priority and exclusive security interest in the escrow account
and the proceeds thereof. Funds will be disbursed from the escrow account for
interest payments (but not additional interest) on the 9 7/8% Notes. Pending
such disbursement, all funds contained in the escrow account are invested in
cash equivalents.
Upon a change of control (as defined in the related indenture) of GTS, or
in the event of asset sales (as defined in the related indenture) in certain
circumstances, GTS is required by the terms of the indenture to make an offer to
purchase the outstanding 9 7/8% Notes at a purchase price equal to 101% and
100%, respectively, of the principal amount thereof plus accrued and unpaid
interest thereon to the date of repurchase.
The indebtedness of GTS evidenced by the 9 7/8% Notes ranks pari passu in
right of payment with all other existing and future unsubordinated indebtedness
of GTS and senior in right of payment to all existing and future obligations of
GTS expressly subordinated in right of payment to the 9 7/8% Notes. The
indenture governing the 9 7/8% Notes contains a number of covenants restricting
the operations of GTS and its restricted group members (as defined in the
indenture governing the 9 7/8% Notes), including those restricting: the
incurrence of indebtedness; the making of restricted payments unless no default
or event of default exists, its leverage ratio does not exceed 6.0 to 1.0 and
such restricted payments do not exceed the basket (as defined in the indenture
governing the 9 7/8% Notes); transactions with stockholders and affiliates; the
incurrence of liens; sale-leaseback transactions; issuances and sales of capital
stock of subsidiaries; the incurrence of guarantees by subsidiaries; dividend
and other payment restrictions affecting subsidiaries; consolidation, merger or
sale of substantially all of GTS' assets; and requiring the purchase of 9 7/8%
Notes, at the option of the holder, upon the occurrence of a change of control
and certain asset sales.
The events of default under the indenture governing the 9 7/8% Notes
include provisions that are typical of senior debt financings, including a
cross-acceleration to a default by GTS or any restricted group member on any
indebtedness that has an aggregate principal amount in excess of certain levels.
Upon the occurrence of such an event of default, the trustee or the holders of
not less than 25% in principal amount at maturity of the outstanding 9 7/8%
Notes may immediately accelerate the maturity of all the Notes as provided in
the related indenture.
THE CONVERTIBLE BONDS
In July, 1997, GTS issued $144.8 million principal amount of Senior
Subordinated Convertible Bonds. The Convertible Bonds were initially issued
under an indenture dated as of July 14, 1997 between GTS, The Bank of New York,
as trustee, registrar and paying, conversion and transfer agent. The Convertible
Bonds mature on June 30, 2000. At September 30, 1998, US$119.4 million aggregate
principal amount of the
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<PAGE> 186
Convertible Bonds was outstanding. An aggregate principal amount of US$25.4
million had been converted at that date into Common Stock. The conversion price
of the Convertible Bonds is US$20 per share.
The Convertible Bonds bear interest payable at the rate of 8.75% per annum
from and including the date of their issuance. Interest is payable semiannually
in arrears on July 15 and January 15 of each year commencing January 15, 1998.
The Convertible Bonds are redeemable at the option of GTS, in whole but not in
part on or after the second anniversary of a complying public equity offering
(as defined in the indenture governing the Convertible Bonds), at the principal
amount thereof plus accrued interest to the redemption date. The IPO in February
1998 constituted a complying public equity offering.
Upon the occurrence of a change of control (as defined in the indenture
governing the Convertible Bonds), GTS will be obligated to make an offer to
purchase all of the outstanding Convertible Bonds at a purchase price equal to
113.5%, (if the date of such purchase occurs after June 30, 1998 but on or
before June 30, 1999) or 121.0%, (if the date of such purchase occurs after June
30, 1999), as applicable, of the principal amount thereof plus accrued and
unpaid interest, if any, to the date of repurchase.
DEBENTURES DUE 2010
On July 8 and July 22, 1998, GTS issued approximately US$466.9 million of
Debentures. The Debentures will mature on July 1, 2010 and are unsecured senior
subordinated obligations of GTS. In the event of a change of control of GTS,
holders of the Debentures will have the right to require GTS to purchase such
holder's Debentures at a price equal to 100% of the principal amount plus
accrued interest. The Debentures will bear interest payable semiannually at a
rate of 5 3/4% per annum.
Each Debenture will be convertible into such number of shares of Common
Stock as is equal to the principal amount of such Debenture divided by US$55.05.
GTS, at its option, may elect to redeem all or a portion of the Debentures
commencing on July 1, 2001, at redemption prices beginning at 104.025% of
principal amount for the twelve-month period commencing July 1, 2001 declining
to par at July 1, 2008 and thereafter.
HER NOTES
HER sold US$265 million aggregate principal amount of HER Notes in August
1997. The HER Notes have a ten year maturity and are unsecured, senior
obligations of HER. HER placed approximately $56.6 million of the net proceeds
in escrow for the first two years' interest payments on the HER Notes. The HER
Notes were issued pursuant to an indenture containing certain covenants for the
benefit of the holders of HER Notes, including, among other things, covenants
limiting the incurrence of indebtedness, restricted payments, liens, payment
restrictions affecting certain subsidiaries and joint ventures, transactions
with affiliates, assets sales and mergers. The HER Notes are redeemable in whole
or part, at the option of HER at any time on or after August 15, 2002 at a price
ranging from 105.75% to 100.0% of the principal amount.
A portion of the HER Notes are also redeemable at any time or from time to
time prior to August 15, 2000 at a redemption price equal to 111.5% of the
principal amount of the HER Notes so redeemed, plus accrued and unpaid interest
thereon, if any, to the date of redemption with the net cash proceeds of one or
more public equity offerings or strategic equity investments resulting in
aggregate gross cash proceeds to HER of at least US$75 million. In the event of
a change of control of HER, holders of the HER Notes have the right to require
HER to purchase such holder's HER Notes at a price equal to 101% of the
aggregate principal amount plus accrued and unpaid interest thereon to the date
of repurchase.
NEW HER NOTES
On December 21, 1998, HER sold US$200 million aggregate principal amount of
US dollar New HER Notes and Euro 85 million aggregate principal amount of Euro
New HER Notes. This transaction will close in early January 1999. The US dollar
New HER Notes have a ten year maturity, and the Euro New HER Notes have seven
year maturity. The New HER Notes are unsecured, senior obligations of HER. The
New HER Notes will be issued pursuant to two indentures substantially similar to
the indenture governing the HER
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Notes. The US dollar New HER Notes are redeemable in whole or in part, at the
option of HER at any time on or after January 15, 2004 at a price ranging from
105.188% to 100.0% of the principal amount. The Euro New HER Notes are
redeemable in whole or in part, at the option of HER at any time on or after
January 15, 2003 at a price ranging from 105.188% to 100.0% of the principal
amount.
A portion of the New HER Notes are also redeemable at any time prior to or
from time to time prior to January 15, 2002 at a redemption price equal to
110.375% of the principal amount of the New HER Notes so redeemed, plus accrued
and unpaid interest thereon, if any, to the date of redemption with the net cash
proceeds of one or more public equity offerings or strategic equity investments
resulting in aggregate gross cash proceeds to HER of at least US$75 million,
provided, however, that following such redemption at least two-thirds of the
principal amount of each of the original US dollar New HER Notes and Euro New
HER Notes remain outstanding. In the event of a change of control of HER or GTS,
holders of the New HER Notes have the right to require HER to purchase such
holder's New HER Notes at a price equal to 101% of the aggregate principal
amount plus accrued and unpaid interest thereon to the date of repurchase.
EQUIPMENT FINANCING
In connection with the purchase of equipment and services for certain
cellular ventures in the CIS region, GTS entered into a credit agreement with a
bank providing for up to $30.7 million financing. The facility is guaranteed by
the vendor of such equipment and services, and is insured against certain
political risks by the Overseas Private Investment Corporation. The loans under
the facility bear interest at LIBOR plus 35 basis points, with principal and
interest payments due semiannually in June and December of each year through
December 15, 2002. At September 30, 1998, an initial US$18.6 million was funded
under the facility.
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DESCRIPTION OF CAPITAL STOCK
The Company's authorized capital stock consists of 135,000,000 shares of
Common Stock, par value $0.10 per share, of which 64,577,715 shares were issued
and outstanding as of December 31, 1998, and 10,000,000 shares of preferred
stock, par value $0.0001 per share (the "Preferred Stock"), none of which is
outstanding. In addition, the Company (i) agreed to issue up to 5,437,500 shares
of Common Stock in connection with its acquisition of NetSource (of which
3,873,705 shares of Common Stock were issued as of December 31, 1998 and up to
1.4 million shares may be issued, at the option of the Company, contingent on
NetSource achieving certain performance targets in the first two quarters of
1999) and (ii) agreed to issue 15,973,158 shares of Common Stock to holders of
Esprit Telecom shares and ADSs, subject to the completion of an exchange offer
and other conditions precedent. See "Risk Factors -- Risks Specific to
GTS -- Shares Eligible for Future Sale; Registration Rights; Potential Adverse
Impact on Market Price from Sales of Common Stock." The following summary of the
rights, privileges, restrictions and conditions of each of the classes of shares
issued by the Company does not purport to be complete and is subject to the
detailed provisions of, and qualified in its entirety by reference to, the
Certificate of Incorporation and By-laws, and to the applicable provisions of
the General Corporation Law of the State of Delaware (the "DGCL").
COMMON STOCK
Holders of Common Stock are entitled to one vote for one share held of
record on all matters upon which shareholders have the right to vote. There are
no cumulative voting rights. All issued and outstanding shares of Common Stock
are, and the Offered Shares, when issued and paid for, will be, validly issued,
fully paid and non-assessable. Holders of Common Stock are entitled to such
dividends as may be declared from time to time by the Board of Directors out of
funds legally available for that purpose. See "Dividend Policy." Upon
dissolution, holders of Common Stock are entitled to share pro rata in the
assets of the Company remaining after payment in full of all of its liabilities
and obligations, including payment of the liquidation preference, if any, of any
Preferred Stock then outstanding.
PREFERRED STOCK
The Board of Directors may authorize the issuance of one or more series of
Preferred Stock having such rights, including voting, conversion and redemption
rights, and such preferences, including dividend and liquidation preferences, as
the Board may determine, without further action by the stockholders of the
Company.
The issuance of Preferred Stock by the Board of Directors could adversely
affect the rights of holders of Common Stock. For example, the issuance of
Preferred Stock could result in a series of securities outstanding that would
have preferences over the Common Stock with respect to dividends and in
liquidation and that could, upon conversion or otherwise, enjoy all the rights
appurtenant to the Common Stock. As of the date of the July 1998 Offerings, the
Company has authorized 200,000 shares of Series A Junior Participating Preferred
Stock, par value $.0001 per share (the "Series A Preferred Stock"). No other
series of Preferred Stock has been authorized. There are no issued and
outstanding shares of Series A Preferred Stock and no such shares are being
offered hereby. A Right (as defined below) to purchase shares of Series A
Preferred Stock, however, is attached to each share of Common Stock pursuant to
the Rights Agreement discussed below. The Company has authorized 200,000 shares
of Series A Preferred Stock initially for issuance upon exercise of such Rights.
The Units (as defined herein) of Series A Preferred Stock that may be
acquired upon exercise of the Rights will be nonredeemable and subordinate to
any other shares of preferred stock that may be issued by the Company. Each Unit
of Series A Preferred Stock will have a minimum preferential quarterly dividend
of $.01 per Unit or any higher per share dividend declared on the Common Stock.
In the event of liquidation, the holder of a Unit of Series A Preferred Stock
will receive a preferred liquidation payment equal to the greater of $.01 per
Unit and the per share amount paid in respect of a share of Common Stock.
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<PAGE> 189
Each Unit of Series A Preferred Stock will have one vote, voting together
with the Common Stock. The holders of Units of Series A Preferred Stock, voting
as a separate class, shall be entitled to elect two directors if dividends on
the Series A Preferred Stock are in arrears for six fiscal quarters.
In the event of any merger, consolidation or other transaction in which
shares of Common Stock are exchanged, each Unit of Series A Preferred Stock will
be entitled to receive the per share amount paid in respect of each share of
Common Stock. The rights of holders of the Series A Preferred Stock to
dividends, liquidation and voting, and in the event of mergers and
consolidations, are protected by customary antidilution provisions. Because of
the nature of the Series A Preferred Stock's dividend, liquidation and voting
rights, the economic value of one Unit of Series A Preferred Stock that may be
acquired upon the exercise of each Right is expected to approximate the economic
value of one share of Common Stock.
PRIOR PURCHASE AGREEMENTS
The Company and certain investors ("Prior Shareholders") have previously
entered into stock purchase agreements on (i) April 23, 1993 (the "1993 Stock
Purchase Agreement"), (ii) April 22, 1994 and June 17, 1994 (collectively, the
"1994 Stock Purchase Agreements"), (iii) a series of dates in 1995 (the "1995
Stock Purchase Agreements"), (iv) a series of dates in 1996 (the "1996 Stock
Purchase Agreements"), (v) a series of dates in 1997 (the "1997 Stock Purchase
Agreements" and, together with the 1993 Stock Purchase Agreement, the 1994 Stock
Purchase Agreements, the 1995 Stock Purchase Agreements and the 1996 Stock
Purchase Agreements, the "Prior Purchase Agreements"). The Prior Purchase
Agreements contain, among other things, certain registration and other rights
granted by the Company with respect to such Common Stock described below.
Registration Rights. Pursuant to the terms of the Prior Purchase
Agreements, Prior Shareholders holding an aggregate of 29,623,784 shares of
Common Stock are entitled to certain demand registration rights with respect to
the Common Stock held by them ("Demand Registration Rights") following the
consummation of the IPO. In addition to the Demand Registration Rights, Prior
Shareholders are, subject to certain limitations, entitled to register shares of
Common Stock in connection with a registration statement prepared by the Company
to register its equity securities. Holders who purchased pursuant to the 1993
Stock Purchase Agreement may also register their shares of Common Stock in
connection with a registered sale of Common Stock by a Major Shareholder (as
that term is defined in the 1993 Stock Purchase Agreement). All of the
registration rights of the Prior Shareholders are subject to certain conditions
and limitations described in the Prior Purchase Agreements.
Rights of First Refusal and Tag-Along Rights. Under the Prior Purchase
Agreements, Prior Shareholders have certain rights of first refusal to purchase
pro rata any issue of New Securities (as that term is defined in the Prior
Purchase Agreements) which the Company thereafter may from time to time propose
to issue and sell, other than in connection with certain types of transactions
and to certain types of excluded purchasers. Termination of such rights will
occur upon the earlier of the closing of an initial public offering pursuant to
an effective registration statement under the Act or, as to any Prior
Shareholder, when such Prior Shareholder no longer owns all the shares it
originally purchased.
The Prior Purchase Agreements further provide that, in the case of a sale
by the Major Shareholders as a group of all their Major Shareholders' Shares (as
those terms are defined in the Prior Purchase Agreements), holders under the
Prior Purchase Agreements may elect to participate in that sale as well.
SECTION 145 OF DGCL AND CERTAIN CHARTER PROVISIONS
Section 145 of the DGCL provides that a corporation may indemnify any
person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding whether civil,
criminal or investigative (other than an action by or in the right of the
corporation) by reason of the fact that he is or was a director, officer,
employee or agent of the corporation, or is or was serving at the request of the
corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, against expenses
(including attorneys' fees), judgments, fines and amounts paid in settlement
actually and reasonably incurred by him in connection with such action, suit or
proceeding if he
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<PAGE> 190
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 director's duty of loyalty to the corporation or its stockholders, (ii) for
acts or omission not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) under Section 174 of the DGCL (relating to
unlawful payment of dividends and unlawful stock purchase and redemption) or
(iv) for any transaction from which the director derived an improper personal
benefit.
The Company's Certificate of Incorporation provides that the Company's
Directors shall not be liable to the Company or its stockholders for monetary
damages for breach of fiduciary duty as a director provided, however, that such
exculpation from liabilities is not permitted with respect to liability arising
from items described in clauses (i) through (iv) in the preceding paragraph. The
Certificate and the Company's By-Laws further provide that the Company shall
indemnify its directors and officers to the fullest extent permitted by the
DGCL.
The directors and officers of the Company are covered under directors' and
officers' liability insurance policies maintained by the Company.
CERTAIN CHARTER AND BY-LAW PROVISIONS
Shareholders' rights and related matters are governed by the DGCL, the
Certificate of Incorporation and By-laws. Certain provisions of the Certificate
of Incorporation and the By-laws, which are summarized below, may discourage or
make more difficult a takeover attempt that a shareholder might consider in its
best interest, although certain of such provisions in the By-laws are subject to
final approval by the Company's Board of Directors. Such provisions may also
adversely affect prevailing market prices for the Common Stock. See "Risk
Factors -- Risks Specific to GTS -- Anti-takeover Provisions."
Classified Board of Directors and Related Provisions. The Certificate of
Incorporation provides that the Board of Directors of the Company be divided
into three classes of directors serving staggered three-year terms. The classes
of directors (designated Class I, Class II and Class III) shall be, as nearly as
possible, equal in number. Accordingly, one-third of the Company's Board of
Directors will be elected each year. The terms of the Initial Class I directors
terminated at the May 20, 1998 annual meeting of stockholders and such directors
were re-elected to a three-year term terminating on the date of the 2001 annual
meeting of stockholders; the term of the initial Class II directors shall
terminate on the date of the 1999 annual meeting of stockholders; and the term
of the initial Class III directors shall terminate on the date of the 2000
annual meeting of stockholders. At each annual meeting of stockholders beginning
in 1998, successors to the class of directors whose term expires at that annual
meeting shall be elected for a three-year term. The classified board provision
may prevent a party who acquires control of a majority of the outstanding voting
stock of the Company from obtaining control of the Board of Directors until the
second annual shareholders meeting following the date such party obtains the
controlling interest.
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Subject to the rights of the holders of any series of Preferred Stock or
any other class of capital stock of the Company (other than the Common Stock)
then outstanding, directors may only be removed for cause by a majority vote of
the holders of capital stock of the Company issued and outstanding and entitled
to vote generally in the election of directors, voting together as a single
class.
No Shareholder Action by Written Consent; Special Meetings. The Certificate
of Incorporation prohibits shareholders from taking action by written consent in
lieu of an annual or special meeting, and thus shareholders may take action at
an annual or special meeting called in accordance with the By-laws. The
Certificate of Incorporation and By-laws provide that special meetings of
shareholders may only be called only by the Chairman of the Board of Directors,
the Chief Executive Officer or a majority of the Board of Directors. Special
meetings may not be called by the shareholders, except as permitted by the
Shareholder Rights By-law described below.
Amendments to the Certificate of Incorporation. The provisions of the
Certificate of Incorporation described above may not be amended, altered,
changed or repealed without the affirmative vote of the holders of at least 75%
of the shares of capital stock of the Company issued and outstanding and
entitled to vote.
SECTION 203 OF DELAWARE GENERAL CORPORATION LAW AND CERTAIN PROVISIONS OF THE
CERTIFICATE OF INCORPORATION
Section 203 of the DGCL prohibits certain transactions between a Delaware
corporation and an "interested stockholder", which is defined as a person who,
together with any affiliates or associates of such person, beneficially owns,
directly or indirectly, 15% or more of the outstanding voting shares of a
Delaware corporation. This provision prohibits certain business combinations
(defined broadly to include mergers, consolidations, sales or other dispositions
of assets having an aggregate value in excess of 10% of the consolidated assets
of the corporation, and certain transactions that would increase the interested
stockholder's proportionate share ownership in the corporation) between an
interested stockholder and a corporation for a period of three years after the
date the interested stockholder becomes an interested stockholder, unless (i)
the business combination is approved by the corporation's board of directors
prior to the date the interested stockholder becomes an interested stockholder,
(ii) the interested stockholder acquired at least 85% of the voting stock of the
corporation (other than stock held by directors who are also officers or by
certain employee stock plans) in the transaction in which it becomes an
interested stockholder or (iii) the business combination is approved by a
majority of the board of directors and by the affirmative vote of 66 2/3% of the
outstanding voting stock that is not owned by the interested stockholder.
In addition, the Company's Certificate of Incorporation grants the Board of
Directors of the Company the authority to issue up to 10,000,000 shares of
preferred stock in one or more series and to determine the rights, voting
powers, dividend rate, conversion rights, redemption price, liquidation
preference and other terms of such preferred stock without any further vote or
action by the stockholders. The foregoing provisions of Section 203 of the DGCL
and the Company's Certificate of Incorporation, and any issuance of preferred
stock with voting or conversion rights, may adversely affect the voting power of
the holders of Common Stock and may have the effect of delaying or preventing a
change of control of the Company or adversely affect the market price of the
Company's Common Stock.
SHAREHOLDER RIGHTS AGREEMENT AND SHAREHOLDER RIGHTS BY-LAW
Shareholder Rights Plan. The Company has entered into a Rights Agreement
(the "Rights Agreement"). In connection with the Rights Agreement, the Board of
Directors of the Company declared a distribution of one right (a "Right") for
each outstanding share of Common Stock, each share of Common Stock offered
hereby and each share of Common Stock issued (including shares distributed from
treasury) by the Company thereafter and prior to the Distribution Date (as
defined below). Each Right will entitle the registered holder, subject to the
terms of the Rights Agreement, to purchase from the Company one one-thousandth
of a share (a "Unit") of Series A Preferred Stock at a purchase price of $75 per
Unit, subject to adjustment.
Initially, the Rights will attach to all certificates representing shares
of outstanding Common Stock, and no separate Rights Certificates will be
distributed. The Rights will separate from the Common Stock and the
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"Distribution Date" will occur upon the earlier of (i) 10 days following a
public announcement (the date of such announcement being the "Stock Acquisition
Date") that a person or group of affiliated or associated persons (other than
the Company, any subsidiary of the Company or any employee benefit plan of the
Company or such subsidiary) (an "Acquiring Person") has acquired, obtained the
right to acquire, or otherwise obtained beneficial ownership of 15% or more of
the then outstanding shares of Common Stock and (ii) 10 business days (or such
later date as may be determined by action of the Board of Directors prior to
such time as any person becomes an Acquiring Person) following the commencement
of a tender offer or exchange offer that would result in a person or group
beneficially owning 15% or more of the then outstanding shares of Common Stock.
The Soros Associates and Alan B. Slifka and his affiliates are excluded from the
definition of "Acquiring Person" under the Rights Agreement unless such persons
increase the aggregate percentage of their ownership interest in the Company to
20%.
Until the Distribution Date, (i) the Rights will be evidenced by Common
Stock certificates and will be transferred with and only with such Common Stock
certificates, (ii) new Common Stock certificates issued after date of
consummation of the July 1998 Offerings (also including shares distributed from
treasury) will contain a notation incorporating the Rights Agreement by
reference and (iii) the surrender for transfer of any certificates representing
outstanding Common Stock will also constitute the transfer of the Rights
associated with the Common Stock represented by such certificates.
The Rights will not be exercisable until the Distribution Date and will
expire at the close of business on the tenth anniversary of the Rights Agreement
unless earlier redeemed by the Company as described below.
In the event that (i) the Company is the surviving corporation in a merger
with an Acquiring Person and shares of Common Stock shall remain outstanding,
(ii) a Person becomes an Acquiring Persons, (iii) an Acquiring Person engages in
one or more "self-dealing" transactions as set forth in the Rights Agreement or
(iv) during such time as there is an Acquiring Person, an event occurs which
results in such Acquiring Person's ownership interest being increased by more
than 1% (e.g., by means of a recapitalization), then, in each such case, each
holder of a Right (other than such Acquiring Person) will thereafter have the
right to receive, upon exercise, Units of Series A Preferred Stock (or, in
certain circumstances, Common Stock, cash, property or other securities of the
Company) having a value equal to two times the exercise price of the Right. The
exercise price is the Purchase Price multiplied by the number of Units of Series
A Preferred Stock issuable upon exercise of a Right prior to the events
described in this paragraph.
In the event that, at any time following the Stock Acquisition Date, (i)
the Company is acquired in a merger or other business combination transaction
and the Company is not the surviving corporation (other than a merger described
in the preceding paragraph), (ii) any Person consolidates or merges with the
Company and all or part of the Common Stock is converted or exchanged for
securities, cash or property of any other Person or (iii) 50% or more of the
Company's assets or earning power is sold or transferred, each holder of a Right
(other than an Acquiring Person) shall thereafter have the right to receive,
upon exercise, common stock of the ultimate parent of the Acquiring Person
having a value equal to two times the exercise price of the Right.
The Purchase Price payable, and the number of Units of Series A Preferred
Stock issuable, upon exercise of the Rights are subject to adjustment from time
to time to prevent dilution (i) in the event of a stock dividend on, or a
subdivision, combination or reclassification of, the Series A Preferred Stock,
(ii) if holders of the Series A Preferred Stock are granted certain rights or
warrants to subscribe for Series A Preferred Stock or convertible securities at
less than the current market price of the Series A Preferred Stock or (iii) upon
the distribution to the holder of the Series A Preferred Stock of evidences of
indebtedness, cash or assets (excluding regular quarterly cash dividends) or of
subscription rights or warrants (other than those referred to above).
At any time until ten business days following the Stock Acquisition Date,
either (i) 75% of the Company's Board of Directors or (ii) a majority of the
Company's Board of Directors and a majority of the Continuing Directors (as
defined below), may redeem the Rights in whole, but not in part, at a nominal
price. Immediately upon the action of a majority of the Company's Board of
Directors ordering the redemption of the Rights, the Rights will terminate and
the only right of the holders of Rights will be to receive such
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redemption price. As used in the Rights Agreement, a Continuing Director means
any person (other than an Acquiring Person or an affiliate or associate of an
Acquiring Person or a representative of an Acquiring Person or of any such
affiliate or associate) who was a director prior to the date of the Rights
Agreement and any person (other than an Acquiring Person or an affiliate or
associate of an Acquiring Person or a representative of an Acquiring Person or
of any such affiliate or associate) nominated for selection or elected to the
Board of Directors pursuant to the approval of a majority of the Continuing
Directors.
At its option, either (i) 75% of the Company's Board of Directors or (ii) a
majority of the Company's Board of Directors and a majority of the Continuing
Directors, may exchange each Right for (i) one Unit of Series A Preferred Stock
or (ii) such number of Units of Series A Preferred Stock as will equal the
spread between the market price of each Unit to be issued and the purchase price
of such Unit set forth in the Rights Agreement.
Any of the provisions of the Rights Agreement may be amended without the
approval of either (i) 75% of the Company's Board of Directors or (ii) a
majority of the Company's Board of Directors and a majority of Continuing
Directors in order to cure any ambiguity, defect or inconsistency, to make
changes which do not adversely affect the interests of holders of Rights
(excluding the interests of any Acquiring Person), or to shorten or lengthen any
time period under the Rights Agreement; provided, however, that no amendment to
adjust the time period governing redemption shall be made at such time as the
Rights are not redeemable.
Shareholder Rights By-Law. If a fully financed tender offer is made
publicly to purchase all the Company's outstanding shares of Common Stock for
cash or Marketable Securities (as defined below) at a price that is at least 40
percent greater than the average closing price of such shares on the principal
exchange on which such shares are listed during the 30 days prior to the date on
which such offer is first published or sent to security holders (the "Offer
Date") and the Board of Directors opposes such offer, the holders of more than
50% of the outstanding shares of Common Stock may, at any time subsequent to the
date that is nine calendar months after the Offer Date, call a special meeting
of the stockholders, notwithstanding the provisions described in "-- Certain
Charter and By-law Provisions -- No Shareholder Action by Written Consent;
Special Meetings," at which meeting stockholders may be asked to vote upon a
proposal to request that the Board of Directors amend the Rights Agreement to
exempt such offer from the terms of the Rights Agreement; provided, however, if
prior to the expiration of such nine-month period, the Board of Directors
determines that it is in the best interests of the shareholders to undertake
efforts to sell the Company, such period shall be extended as long as the Board
of Directors continues its efforts to solicit, evaluate and negotiate
alternative bids to acquire the Company. If the proposal to amend the Rights
Agreement is approved by a vote of 70% of the votes cast for or against such
proposal at such meeting of stockholders at which a quorum is present, the Board
of Directors shall amend the Rights Agreement to exempt such offer from its
terms no later than 60 days after the date of such stockholders' meeting.
"Marketable Securities" means any securities that are traded on a
nationally recognized exchange and, in the opinion of an independent investment
bank, provide sufficient value and liquidity so that they would be treated as
substantially equivalent to cash consideration.
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SHARES ELIGIBLE FOR FUTURE SALE
As of December 31, 1998, 64,577,715 shares of Common Stock were outstanding
excluding (v) 9,639,506 shares for which outstanding warrants and options are
exercisable, (w) 5,880,050 shares into which the Convertible Bonds are
convertible, (x) the 8,481,417 shares into which the Debentures are convertible,
and (y) 163,795 of additional shares to be issued resulting from the NetSource
acquisition. Further, subject to NetSource meeting certain performance targets
during the first two quarters of 1999, an additional 1.4 million shares of
unregistered Common Stock may be issued.
Of the 60,495,446 outstanding shares of Common Stock, the 12,765,000 shares
registered in the IPO and the 14,506,900 shares registered in the July 1998
Stock Offering will be freely tradable without restriction under the Securities
Act. However such shares held by "affiliates" may generally be resold only in
compliance with applicable provisions of Rule 144 under the Securities Act, as
described below. Of the remainder, approximately 20,000,000 additional shares
have been resold or may be resold under Rule 144 without restriction under the
Securities Act. An additional approximately 12,762,000 shares have been resold
or may be resold under Rule 144 subject to volume and manner limitations. In
addition, the 8,481,417 shares into which the Debentures are convertible will be
freely tradable without restriction under the Securities Act.
In addition, GTS has filed and the SEC has declared effective three
registration statements. One registration statement covers the resale of the
Convertible Bonds and the shares of Common Stock into which the Convertible
Bonds are convertible. Two registration statements on Form S-8 cover the resale
of shares of Common Stock issued to employees, officers and directors under our
employee benefit plans.
Furthermore, GTS has agreed to file with the SEC a shelf registration
statement (the "Shelf Registration Statement") covering all of the shares of
Common Stock (and securities convertible into or exercisable for shares of
Common Stock) owned by Alan B. Slifka and his affiliates and the Soros
Associates that were not sold in the July 1998 Stock Offering (the "Affiliate
Shares"). The registration statement of which this prospectus is a part
constitutes the Shelf Registration Statement. GTS agreed to file the Shelf
Registration Statement in exchange for these shareholders agreeing to certain
restrictions on their ability to resell such Affiliate Shares. These
restrictions apply for specified periods after closing of the July 1998
Offerings. Under these restrictions, holders of Affiliate Shares cannot, subject
to certain exceptions, sell any such shares during the first six months after
the closing date of the July 1998 Offerings. They may, however, sell 50% of such
shares six months after the closing date of the July 1998 Offerings; 75% of such
shares nine months after the closing date of the July 1998 Offerings; and 100%
of such shares twelve months after the closing date of the July 1998 Offerings.
Certain limited partners of partnerships affiliated with Alan B. Slifka and
currently in dissolution may, upon giving us advance notice, withdraw some or
all of their shares of Common Stock from registration under the Shelf
Registration Statement. By withdrawing their shares, those persons would no
longer be bound by the restrictions on sale. The number of shares of Common
Stock that such persons may withdraw is capped at 726,953 shares (including up
to 1.4 million shares issuable contingent on NetSource achieving certain
performance targets during the first two quarters of 1999) of Common Stock minus
the number of shares such persons sold in the July 1998 Stock Offering.
GTS has also agreed to file a shelf registration statement covering all of
the shares of Common Stock that may be issued to holders of NetSource stock in
connection with the acquisition of NetSource. Up to a total of 5,437,500 shares
may be issued by GTS in connection with this acquisition.
Pursuant to a registration rights agreement between GTS and certain
Institutional Securityholders, GTS is required to file a registration statement
with the SEC that includes a prospectus which provides for resales by such
Institutional Securityholders of the Common Stock received by them in the offer
for Esprit Telecom. Approximately 6.2 million shares of Common Stock will be
issued to the Institutional Securityholders if the offer for Esprit Telecom is
closed. GTS has also agreed to keep such registration statement effective until
the earliest of the date on which (i) such Institutional Securityholders are
able to sell such Common Stock 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
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period, such shorter period, (ii) GTS obtains written confirmation from the
Division of Corporate Finance of the SEC recommending that no action be taken by
the SEC in connection with the resale of Common Stock by such Institutional
Securityholders without regard to volume or other restrictions under the
Securities Act upon resale or (iii) all of the Common Stock is resold pursuant
to the registration statement subject to certain provisions. The registration
rights agreement contains customary indemnification provisions.
Pursuant to the registration rights agreement with the Institutional
Securityholders and in order to allow the acquisition of Esprit Telecom to be
accounted for as a "pooling of interests" transaction, the Institutional
Securityholders agreed 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 Institutional Securityholder's risk
relating to such Institutional Securityholder's Esprit Telecom Securities or any
Common Stock to be received by such Institutional Securityholder in connection
with the Offer, for a period commencing 30 days before the date that the
acquisition of Esprit Telecom is deemed consummated in connection with
determining whether such acquisition will receive "pooling of interests"
accounting treatment and ending on the date GTS has prepared, published and
otherwise publicly disclosed financial reports of GTS, which include a period of
at least 30 days of combined operations of GTS and Esprit Telecom.
GTS cannot predict what effect, if any, that future sales of Common Stock
or the availability of Common Stock for sale would have on the market price for
Common Stock. Sales of large numbers of shares of Common Stock in the public
market pursuant to Rule 144 or pursuant to an effective registration statement
under the Securities Act, or the perception that sales could occur, may have an
adverse effect on the market price for Common Stock. See "Description of Capital
Stock -- Prior Purchase Agreements -- Registration Rights."
The Company and its directors, executive officers and certain stockholders
have agreed, subject to certain exceptions, not to (i) grant any option to
purchase or otherwise transfer or dispose of any Common Stock or securities
convertible into or exercisable or exchangeable for Common Stock or (ii) enter
into any swap or other agreement or transaction that transfers, in whole or in
part, the economic consequences of ownership of the Common Stock without the
prior written consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated, on
behalf of the Underwriters in the Offerings for a period of 90 days after the
date of the consummation of the Stock Offerings.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares of the Company are required to be aggregated) who has been deemed
to have owned shares of an issuer for at least one year, including an
"affiliate," is entitled to sell, within any three-month period, a number of
shares that does not exceed the greater of 1% of the then outstanding number of
shares of such class or the average weekly trading volume in composite trading
in all national securities exchanges during the four calendar weeks preceding
the filing of the required notice of such sale. A person (or persons whose
shares of the Company are required to be aggregated) who is not deemed an
affiliate of an issuer at the time of the sale and for at least three months
prior to the sale and who has owned shares for at least two years is entitled to
sell such shares under Rule 144 without regard to the volume limitations
described above. Affiliates continue to be subject to such limitations. As
defined in Rule 144, an "affiliate" of an issuer is a person that directly or
indirectly, through one or more intermediaries, controls or is controlled by, or
is under common control with, such issuer.
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CERTAIN UNITED STATES FEDERAL TAX CONSEQUENCES
TO NON-U.S. STOCKHOLDERS
The following is a summary of the principal United States federal income
and estate tax considerations with respect to the ownership and disposition of
shares of Common Stock by "Non-U.S. Holders." This summary is based on the
Internal Revenue Code of 1986, as amended (the "Code"), existing and proposed
Treasury regulations thereunder and administrative and judicial interpretations
thereof (all as currently in effect and all of which are subject to change,
possibly with retroactive effect). This summary does not address all United
States federal income and estate tax consequences that may be relevant to a
non-U.S. Holder in light of its particular circumstances or to certain Non-U.S.
Holders that may be subject to special treatment under United States federal
income tax laws, such as banks, insurance companies, tax-exempt entities and
certain United States expatriates. Furthermore, the following discussion does
not discuss any aspects of foreign, state or local taxation. As used herein, the
term "Non-U.S. Holder" means a holder of Common Stock that for U.S. federal
income tax purposes is not (i) a citizen or individual resident of the United
States; (ii) a corporation or partnership created or organized in or under the
laws of the United States or any political subdivision thereof; (iii) an estate
the income of which is subject to United States federal income tax regardless of
its source; or (iv) a trust if both: (A) a court within the United States is
able to exercise primary supervision over the administration of the trust and
(B) one or more United States persons have the authority to control all
substantial decisions of the trust. EACH PROSPECTIVE NON-U.S. HOLDER IS URGED TO
CONSULT ITS OWN TAX ADVISER WITH RESPECT TO THE UNITED STATES FEDERAL INCOME AND
ESTATE TAX CONSEQUENCES OF OWNING AND DISPOSING OF SHARES OF COMMON STOCK, AS
WELL AS ANY TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY STATE, LOCAL OR OTHER
TAXING JURISDICTION.
DIVIDENDS
Dividends that are paid by a U.S. corporation to a Non-U.S. Holder and that
are not effectively connected with a trade or business carried on by such
Non-U.S. Holder in the United States (or, if one or more of certain tax treaties
apply, are attributable to a permanent establishment in the United States
maintained by the Non-U.S. Holder) generally are subject to a 30% U.S.
withholding tax. An exemption from such withholding exists with respect to
dividends paid to Non-U.S. Holders by a U.S. corporation (an "80/20 company") if
at least 80% of the gross income derived by such corporation (either directly or
through certain of its subsidiaries) during the applicable testing period is
"active foreign business income," as defined in section 861 of the Code. Under
the provisions of the Code applicable to 80/20 companies, the proportion of an
80/20 company's dividends equal to such company's total gross income from
foreign sources over its total gross income is exempt from U.S. withholding tax.
At present, the Company believes that it qualifies as an 80/20 company. However,
the 80% active foreign business income test is applied on a periodic basis, and
operations and business plans of the Company may change in subsequent taxable
years. Therefore, no assurances can be made regarding the Company's future
status as an 80/20 company. If, for any period or periods, the Company fails to
satisfy the requirements applicable to an 80/20 company, then, for payments made
prior to January 1, 2000, the withholding agent generally would be required to
withhold tax from all distributions paid on the Common Stock regardless of the
Company's earnings and profits. For payments made after January 1, 2000, a
withholding agent may elect not to withhold on a distribution to the extent it
is not paid out of current or accumulated earnings and profits, based on the
Company's reasonable estimate of the extent to which the distribution will be
out of such earnings and profits. Holders could, however, apply for refunds if
such Common Stock's share of the Company's earnings and profits is less than the
amount of the distributions. Additionally, the rate of withholding may be
reduced to the extent provided by a tax treaty between the United States and the
country of which the Non-U.S. Holder is a resident for tax purposes.
In order to claim the benefit of an applicable tax treaty rate, a
Non-United States Holder may have to file with the Company or its dividend
paying agent an exemption or reduced treaty rate certificate or letter in
accordance with the terms of such treaty. Under United States Treasury
regulations currently in effect, for purposes of determining whether tax is to
be withheld at a 30% rate or at a reduced rate as specified by an income tax
treaty, the Company ordinarily will presume that dividends paid to an address in
a foreign country
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are paid to a resident of such country absent knowledge that such presumption is
not warranted. However, as of January 1, 2000, a Non-United States Holder
seeking a reduced rate of withholding under an income tax treaty generally would
be required to provide to the Company a valid Internal Revenue Service Form W-8
certifying that such Non-United States Holder is entitled to benefits under an
income tax treaty. The final regulations also provide special rules for
determining whether, for purposes of assessing the applicability of an income
tax treaty, dividends paid to a Non-United States Holder that is an entity
should be treated as being paid to the entity itself or to the persons holding
an interest in that entity. A Non-United States Holder who is eligible for a
reduced withholding rate may obtain a refund of any excess amounts withheld by
filing an appropriate claim for a refund with the Internal Revenue Service.
In the case of dividends that are effectively connected with the Non-United
States Holder's conduct of a trade or business with the United States or, if an
income tax treaty applies, attributable to a United States permanent
establishment of the Non-United States Holder, the Non-United States Holder
generally will be subject to regular U.S. income tax in the same manner as if
the Non-United States Holder were a United States resident. A Non-United States
corporation receiving effectively connected dividends also may be subject to an
additional "branch profits tax" which is imposed, under certain circumstances,
at a rate of 30% (or such lower rate as may be specified by an applicable
treaty) of the Non-United States corporation's "effectively connected earnings
and profits," subject to certain adjustments.
GAIN ON DISPOSITION OF COMMON STOCK
A Non-United States Holder generally will not be subject to U.S. federal
income tax with respect to gain realized on a sale or other disposition of
Common Stock unless (i) the gain is effectively connected with a trade or
business of such Non-United States Holder in the U.S., (ii) in the case of
certain Non-United States Holders who are non-resident alien individuals and
hold the Common Stock as a capital asset, such individuals are present in the
U.S. for 183 or more days in the taxable year of the disposition and either (a)
such individuals have a "tax home" (as defined for United States Federal income
tax purposes) in the U.S., or (b) the gain is attributable to an office or other
fixed place of business maintained by such individuals in the U.S. (iii) the
Non-United States Holder is subject to tax, pursuant to the provisions of U.S.
tax law applicable to certain U.S. expatriates whose loss of U.S. citizenship
has as one of its principal purposes the avoidance of U.S. taxes, or (iv) under
certain circumstances if the Company is or has been during certain time periods
a "United States real property holding corporation" within the meaning of
Section 897(c)(2) of the Code and, assuming that the Common Stock is regularly
traded on an established securities market for tax purposes, the Non-United
States Holder held, directly or indirectly, at any time within the five-year
period preceding such disposition more than 5% of the outstanding Common Stock.
The Company is not, and does not anticipate becoming, a United States real
property holding corporation.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING
Under the United States Treasury regulations, the Company must report
annually to the Internal Revenue Service and to each Non-United States Holder
the amount of dividends paid to such holder and any tax withheld with respect to
such dividends. These information reporting requirements apply regardless of
whether withholding is required because the dividends were effectively connected
with a trade or business in the United States of the Non-United States Holder or
withholding was reduced or eliminated by an applicable income tax treaty. Copies
of the information returns reporting such dividends and withholding may also be
made available to the tax authorities in the country in which the Non-United
States Holder is a resident under the provisions of an applicable income tax
treaty or agreement.
United States backup withholding (which generally is a withholding tax
imposed at the rate of 31% on certain payments to persons that fail to furnish
certain information under the United States information reporting requirements)
generally will not apply to (i) dividends paid to Non-United States Holders that
are subject to the 30% withholding discussed above (or that are not so subject
because a tax treaty applies that reduces or eliminates such 30% withholding) or
(ii) under current law, dividends paid to a Non-United States Holder at an
address outside of the United States. However, as of January 1, 2000, a
Non-United States Holder will generally be subject to United States withholding
tax at a 31% rate unless certain certification
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procedures (or, in the case of payments made outside the United States with
respect to an offshore account, certain documentary evidence procedures) are
satisfied, directly or through a foreign intermediary.
Backup withholding and information reporting generally will apply to
dividends paid to addresses inside the United States on shares of Common Stock
to beneficial owners that are not "exempt recipients" and that fail to provide
in the manner required certain identifying information.
The payment of the proceeds of the disposition of Common Stock to or
through the U.S. office of a broker is subject to information reporting unless
the disposing holder, under penalty of perjury, certifies its Non-United States
status or otherwise establishes an exemption. Generally, U.S. information
reporting and backup withholding will not apply to a payment of disposition
proceeds if the payment is made outside the U.S. through a Non-United States
office of a Non-United Sates broker. However, information reporting requirements
(but probably, prior to January 1, 2000, not backup withholding) will apply to a
payment of disposition proceeds outside the U.S. if (A) the payment is made
through an office outside the U.S. of a broker that is either (i) a U.S. person,
(ii) a foreign person which derives 50% or more of its gross income for certain
periods from the conduct of a trade or business in the U.S., (iii) a "controlled
foreign corporation" for U.S. Federal income tax purposes, or (iv) effective
January 1, 2000, but probably not prior to such date, a foreign broker that is
(1) a foreign partnership, one or more of whose partners are U.S. persons who,
in the aggregate, hold more than 50% of the income or capital interest in the
partnership at any time during its tax year, or (2) a foreign partnership
engaged at any time during its tax year in the conduct of a trade or business in
the United States, and (B) the broker fails to maintain documentary evidence
that the holder is a Non-United States Holder and that certain conditions are
met, or that the holder otherwise is entitled to an exemption.
Backup withholding is not an additional tax. Rather the tax liability of
persons subject to backup withholding will be reduced by the amount of tax
withheld. If withholding results in an overpayment of taxes, a refund may be
obtained, provided that the required information is furnished to the Internal
Revenue Service.
FEDERAL ESTATE TAX
An individual Non-United States Holder who is treated as the owner of or
has made certain lifetime transfers of an interest in the Common Stock will be
required to include the value thereof in his gross estate for U.S. federal
estate tax purposes, and may be subject to U.S. Federal estate tax unless an
applicable estate tax treaty provides otherwise. Estates of non-resident aliens
are generally allowed a statutory credit which generally has the effect of
offsetting the U.S. Federal estate tax imposed on the first $60,000 of the
taxable estate.
THE FOREGOING DISCUSSION IS INCLUDED FOR GENERAL INFORMATION ONLY.
ACCORDINGLY, EACH PROSPECTIVE PURCHASER IS URGED TO CONSULT HIS TAX ADVISOR WITH
RESPECT TO THE UNITED STATES FEDERAL INCOME TAX AND FEDERAL ESTATE TAX
CONSEQUENCES OF THE OWNERSHIP AND DISPOSITION OF COMMON STOCK, INCLUDING THE
APPLICATION AND EFFECT OF THE LAWS OF ANY STATE, LOCAL, FOREIGN, OR OTHER TAX
JURISDICTION.
194
<PAGE> 199
PLAN OF DISTRIBUTION
The Shares may be sold from time to time to purchasers directly by the
Selling Stockholders. Alternatively, the Selling Stockholders may from time to
time offer the Shares to or through underwriters, broker/dealers or agents, who
may receive compensation in the form of underwriting discounts, concessions of
commissions from the Selling Stockholders or the purchasers of such securities
for whom they may act as agents. The Selling Stockholders and any underwriters,
broker/dealers or agents that participate in the distribution of the Shares may
be deemed to be "underwriters" within the meaning of the Securities Act and any
profit on the sale of such securities and any discounts commissions, concessions
or other compensation received by any such underwriter, broker/dealers or agents
may be deemed to be underwriting discounts and commissions under the Securities
Act.
The Shares may be sold from time to time in one or more transactions at
fixed prices, at prevailing market prices at the time of sale, at varying prices
determined at the time of sale or at negotiated prices. Such prices will be
determined by the Selling Stockholders or by agreement between such Selling
Stockholders and underwriters or dealers who receive fees or commissions in
connection therewith. The sale of the Shares may be effected in transactions
(which may involve crosses, block transactions and borrowings, returns and
reborrowings of the Shares pursuant to stock loan agreements to settle short
sales of the common stock) (i) on any national securities exchange or quotation
service on which the Shares may be listed or quoted at the time of the sale,
(ii) in the over-the-counter markets, (iii) in transactions otherwise than on
such exchange or in the over-the-counter market or (iv) through the writing of
options. Shares also may be delivered in connection with the issuance of
securities by issuers other than the Company that are exchangeable for (whether
optional or mandatory) or payable in, such Shares or pursuant to which such
Shares may be distributed. At the time a particular offering of the Shares is
made, a Prospectus Supplement, if required, will be distributed which will set
forth the aggregate amount and type of the Shares being offered and the terms of
the offering, including the name or names of any underwriter, broker/dealers or
agents, any discounts, commissions and other terms constituting compensation
from the Selling Stockholders and any discounts, commissions or concessions
allowed or reallowed or paid to broker/dealers. This prospectus also may be used
by transferees of the Selling Stockholders or by other persons acquiring Shares,
including brokers who borrow the Shares to settle short sales of shares of the
common stock.
To comply with the securities laws of certain jurisdictions, if applicable
the Shares will be offered or sold in such jurisdictions only through registered
or licensed brokers or dealers. In addition, in certain jurisdictions the Shares
may not be offered or sold unless they have been registered or qualified for
sale in such jurisdictions or any exemption from registration or qualification
is available and is complied with.
The Selling Stockholders will be subject to applicable provisions of the
Exchange Act and the rules and regulations thereunder, which provision may limit
the timing of purchases and sales of any of the Shares by the Selling
Stockholders. The foregoing may affect the marketability of such securities.
Pursuant to the Registration Rights Agreement, all expenses of the
registration of the Shares will be paid by the Company, including without
limitation, Commission filing fees and expense of compliance with state
securities or "blue sky" laws; provided, however, that the Selling Stockholders
will pay all underwriting discounts and selling commissions, if any. The Selling
Stockholders and any underwriters will be indemnified by the Company against
certain civil liabilities, including certain liabilities under the Securities
Act, or will be entitled to contribution in connection therewith. The Company
will be indemnified by the Selling Stockholders severally against certain civil
liabilities including certain liabilities under the Securities Act, or will be
entitled to contribution in connection therewith.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Shearman & Sterling, New York, New York.
195
<PAGE> 200
WHERE YOU CAN FIND MORE INFORMATION
We and Esprit Telecom file reports, proxy statements and other information
with the Securities and Exchange Commission. In addition, we have filed a
Registration Statement on Form S-1 (as amended, the "Registration Statement") of
which this Prospectus is a part. All of the references in this Prospectus to
contracts, agreements and other documents are summaries of the actual documents
which are contained as exhibits in the Registration Statement. Since the
prospectus may not contain all the information that you may find important, you
should review the full text of these documents.
You may read and copy these reports, proxy statements and other information
at the public reference facilities maintained by the SEC at Room 1024, 450 Fifth
Street, N.W., Washington, D.C. 20549, and at the SEC's Regional Offices located
at 7 World Trade Center, 13th floor, New York, New York 10048 and 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. You may also obtain copies
of such material at prescribed rates from the Public Reference Section of the
SEC at 450 Fifth Street, Washington, D.C. 20549. You may obtain copies from the
Public Reference Room by calling the SEC at (800) 732-0330. In addition, we are
required to file electronic versions of such material with the SEC through the
SEC's Electronic Data Gathering, Analysis and Retrieval (EDGAR) system. The SEC
maintains a World Wide Web site at http://www.sec.gov that contains reports,
proxy and information statements and other information regarding registrants
that file electronically with the SEC. GTS Stock and Esprit Telecom ADSs are
listed on Nasdaq and EASDAQ and reports and other information concerning us and
Esprit Telecom can also be inspected at the offices of the National Association
of Securities Dealers, Inc. at 1735 K Street, N.W., Washington, D.C. 20001-1500
U.S.A. and the EASDAQ Market Authority, Rue des Colonies 56, Brussels 1000,
Belgium.
EXPERTS
The consolidated financial statements of Global TeleSystems Group, Inc. as
of December 31, 1996 and 1997, and for each of the three years in the period
ended December 31, 1997 appearing in this prospectus and Registration Statement,
have been audited by Ernst & Young, LLP, independent auditors, as set forth in
their report appearing elsewhere herein and are included in reliance upon such
report given upon the authority of such firm as experts in accounting and
auditing.
The financial statements of EDN Sovintel as of December 31, 1997 and 1996,
and for each of the three years in the period ended December 31, 1997, appearing
in this prospectus and Registration Statement, have been audited by Ernst &
Young (CIS) Ltd., independent auditors, as set forth in their report appearing
elsewhere herein and are included in reliance upon such report given upon the
authority of such firm as experts in accounting and auditing.
The consolidated financial statements of Esprit Telecom plc as of September
30, 1998, and for the year ended September 30, 1998, appearing in this
prospectus and Registration Statement, have been audited by
PricewaterhouseCoopers, independent auditors, as set forth in their report
appearing elsewhere herein and are included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.
The consolidated financial statements of Esprit Telecom plc as of September
30, 1996 and 1997, and for each of the two years in the period ended September
30, 1997 appearing in this prospectus and Registration Statement, have been
audited by Price Waterhouse, independent auditors, as set forth in their report
appearing elsewhere herein and are included in reliance upon such report given
upon the authority of such firms as experts in accounting and auditing.
The financial statements of the Plusnet Business as of September 30, 1996
and 1997, and for each of the three years in the period ended September 30,
1997, appearing in this Prospectus and Registration Statement, have been audited
by KPMG, independent auditors, as set forth in their report appearing elsewhere
herein and are included in reliance upon such report given upon the authority of
such firm as experts in accounting and auditing.
196
<PAGE> 201
INDEX TO
FINANCIAL INFORMATION CONCERNING GTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
YEAR END FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors......... F-2
Consolidated Balance Sheets as of December 31, 1996 and
1997................................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 1995, 1996, and 1997...................... F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996, and 1997...................... F-5
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1995, 1996, and 1997.......... F-6
Notes to Consolidated Financial Statements................ F-7
THIRD QUARTER FINANCIAL STATEMENTS
Condensed, Consolidated Balance Sheets as of December 31,
1997 and September 30, 1998............................ F-27
Condensed, Consolidated Statements of Operations for the
Three and Nine Months ended September 30, 1997 and
1998................................................... F-28
Condensed, Consolidated Statements of Cash Flows for the
Three and Nine Months Ended September 30, 1997 and
1998................................................... F-29
Notes to Condensed, Consolidated Financial Statements..... F-30
EDN SOVINTEL
YEAR END FINANCIAL STATEMENTS
Report of Ernst & Young (CIS) Limited, Independent
Auditors............................................... F-36
Balance Sheets as of December 31, 1997 and 1996........... F-37
Statements of Income and Retained Earnings for the years
ended December 31, 1997, 1996, and 1995................ F-38
Statements of Cash Flows for the years ended December 31,
1997, 1996, and 1995................................... F-39
Notes to Financial Statements............................. F-40
THIRD QUARTER FINANCIAL STATEMENTS
Condensed Balance Sheets as of December 31, 1997 and
September 30, 1998..................................... F-49
Condensed Statements of Operations for the Three and Nine
Months ended September 30, 1997 and 1998............... F-50
Condensed Statements of Cash Flows for the Three and Nine
Months ended September 30, 1997 and 1998............... F-51
Notes to Condensed Financial Statements................... F-52
</TABLE>
F-1
<PAGE> 202
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.
/s/ Ernst & Young LLP
Vienna, Virginia
February 26, 1998, except for
Note 17, as to which the date
is November 12, 1998
F-2
<PAGE> 203
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.
F-3
<PAGE> 204
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.
F-4
<PAGE> 205
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.
F-5
<PAGE> 206
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.
F-6
<PAGE> 207
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 exercising 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
F-7
<PAGE> 208
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
F-8
<PAGE> 209
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").
F-9
<PAGE> 210
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.
F-10
<PAGE> 211
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
F-11
<PAGE> 212
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.
F-12
<PAGE> 213
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
Golden Telecom)........................................... 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").
F-13
<PAGE> 214
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>
F-14
<PAGE> 215
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,
F-15
<PAGE> 216
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.
F-16
<PAGE> 217
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
F-17
<PAGE> 218
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.
F-18
<PAGE> 219
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.
F-19
<PAGE> 220
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.
F-20
<PAGE> 221
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.
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.
F-21
<PAGE> 222
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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").
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
F-22
<PAGE> 223
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
F-23
<PAGE> 224
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.
F-24
<PAGE> 225
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.
<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,
F-25
<PAGE> 226
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 (UNAUDITED)
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 GKO treasury bills
and OFZ federal bonds was 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 rubles 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.
F-26
<PAGE> 227
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.
F-27
<PAGE> 228
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.
F-28
<PAGE> 229
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.
F-29
<PAGE> 230
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 GKO treasury bills
and OFZ federal bonds was 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 and December 18, 1998 was
16.0645 and 20.7 rubles per US dollar, respectively. 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
F-30
<PAGE> 231
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
F-31
<PAGE> 232
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
F-32
<PAGE> 233
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 Golden Telecom, 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, Golden Telecom 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
Golden Telecom 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 Golden Telecom 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.
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
F-33
<PAGE> 234
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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-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.
F-34
<PAGE> 235
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
On October 16, 1998, 6,248 shares of common stock were issued as a result
of certain employees exercising vested options under the Company's stock option
plan. On October 31, 1998, GTS Hermes, Inc. acquired AB Swed Carrier's ownership
interest of 6,551 common shares in the Company for approximately $5.8 million.
In connection with this purchase, GTS Hermes, Inc. paid approximately $5.3
million to a company, which is affiliated with a board member, for negotiating
with AB Swed Carrier and SNCB/NMBS on behalf of GTS Hermes, Inc., to purchase
their respective ownership interest in the Company. Further, on October 26,
1998, the name of GTS Hermes, Inc. was changed to GTS Carrier Services, Inc.
The ownership of the Company as a result of the subsequent events is as
follows:
<TABLE>
<CAPTION>
SHARES OWNERSHIP %
------- -----------
<S> <C> <C>
GTS Carrier Services, Inc. ................................. 176,858 89.9
NMBS........................................................ 13,610 6.9
Employees................................................... 6,248 3.2
------- -----
196,716 100.0%
======= =====
</TABLE>
F-35
<PAGE> 236
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.
/s/ Ernst & Young (CIS) Ltd.
Moscow, Russia
February 16, 1998
except for Note 12,
as to which the date is
November 12, 1998
F-36
<PAGE> 237
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>
The accompanying notes are an integral part of these financial statements.
F-37
<PAGE> 238
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>
The accompanying notes are an integral part of these financial statements.
F-38
<PAGE> 239
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>
The accompanying notes are an integral part of these financial statements.
F-39
<PAGE> 240
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 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 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 rubles) 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 ruble 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 ruble 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
F-40
<PAGE> 241
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 ruble
on monetary assets and liabilities has not been determined.
On January 1, 1998, the CBR introduced a new ruble to replace existing
rubles. The new ruble has been redenominated so that one new ruble is equivalent
to one thousand old rubles. The old ruble will continue in circulation until
December 31, 1998 and will be accepted as legal tender until December 31, 2002.
All ruble amounts reflected in these financial statements are stated in old
rubles.
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.
F-41
<PAGE> 242
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.
F-42
<PAGE> 243
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>
F-43
<PAGE> 244
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>
F-44
<PAGE> 245
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 rubles:
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.
F-45
<PAGE> 246
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Retained earnings available for distribution at December 31, 1997 amounted
to 256 billion rubles 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 rubles 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
F-46
<PAGE> 247
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 GKO treasury bills
and OFZ federal bonds was 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 rubles 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.
F-47
<PAGE> 248
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.
F-48
<PAGE> 249
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.
F-49
<PAGE> 250
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.
F-50
<PAGE> 251
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.
F-51
<PAGE> 252
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 GKO treasury bills
and OFZ federal bonds was 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
F-52
<PAGE> 253
EDN SOVINTEL
NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
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 and December 18, 1998 was 16.0645 and 20.7 rubles per US
dollar, respectively. 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.
F-53
<PAGE> 254
INDEX TO FINANCIAL STATEMENTS CONCERNING ESPRIT
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
ESPRIT TELECOM GROUP PLC
AUDITED HISTORICAL CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Accountants.......................... F-55
Consolidated Profit and Loss Accounts for the three years
ended September 30, 1996, 1997 and 1998................... F-57
Consolidated Balance Sheet as of September 30, 1996, 1997
and 1998.................................................. F-58
Consolidated Cash Flow Statements for the three years ended
September 30, 1996, 1997 and 1998......................... F-59
Statement of Total Recognized Gains and Losses for the three
years ended September 30, 1996, 1997 and 1998............. F-60
Reconciliations of Movements in Shareholders' Funds for the
three years ended September 30, 1996, 1997 and 1998....... F-61
Notes to the Consolidated Financial Statements.............. F-62
PLUSNET BUSINESS
AUDITED HISTORICAL FINANCIAL STATEMENTS
Report of Independent Accountants........................... F-95
Profit and Loss Accounts for the three years ended September
30, 1995, 1996 and 1997................................... F-96
Balance Sheets as of September 30, 1996 and 1997............ F-97
Cash Flow Statements for the three years ended September 30,
1995, 1996 and 1997....................................... F-98
Statement of Total Recognized Gains and Losses and
Reconciliations of Movements in Invested Equity for the
three years ended September 30, 1995, 1996 and 1997....... F-99
Notes to the Financial Statements........................... F-100
</TABLE>
F-54
<PAGE> 255
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of Esprit Telecom Group plc
We have audited the accompanying consolidated balance sheets of Esprit
Telecom Group plc and its subsidiaries ("Company") as of September 30, 1996 and
1997 and the related consolidated profit and loss accounts, cash flow
statements, statements of total recognized gains and losses and reconciliations
of movements in shareholders' funds for each of the two years in the period
ended September 30, 1997 all expressed in pounds sterling. 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 United Kingdom generally
accepted auditing standards which do not differ in any material respect from
auditing standards generally accepted in the United States. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
as of September 30, 1996 and 1997 and the results of the Company's operations
and its cash flows for each of the two years in the period ended September 30,
1997 in conformity with generally accepted accounting principles in the United
Kingdom.
Accounting principles generally accepted in the United Kingdom differ in
certain significant respects from accounting principles generally accepted in
the United States. The application of the latter would have affected the
determination of the consolidated loss expressed in pounds sterling for each of
the two years in the period ended September 30, 1997 and the determination of
consolidated shareholders' funds and consolidated financial position also
expressed in pounds sterling as of September 30, 1996 and 1997. Note 30 to the
consolidated financial statements summarizes this effect for each of the two
years in the period ended September 30, 1997 and as of September 30, 1996 and
1997.
Price Waterhouse
London, England
December 10, 1997
F-55
<PAGE> 256
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of Esprit Telecom Group plc
We have audited the accompanying consolidated balance sheet of Esprit
Telecom Group plc and its subsidiaries ("Company") as of September 30, 1998 and
the related consolidated profit and loss account, cash flow statement, statement
of total recognized gains and losses and reconciliation of movements in
shareholders' funds for the year ended September 30, 1998 all expressed in
pounds sterling. 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 audit.
We conducted our audit in accordance with United Kingdom generally accepted
auditing standards which do not differ in any material respect from auditing
standards generally accepted in the United States. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
as of September 30, 1998 and the results of the Company's operations and its
cash flows for the period ended 30 September 30, 1998 in conformity with
generally accepted accounting principles in the United Kingdom.
Accounting principles generally accepted in the United Kingdom differ in
certain significant respects from accounting principles generally accepted in
the United States. The application of the latter would have affected the
determination of the consolidated loss expressed in pounds sterling for the year
ended September 30, 1998 and the determination of consolidated shareholders'
funds and consolidated financial position also expressed in pounds sterling as
of September 30, 1998. Note 30 to the consolidated financial statements
summarizes this effect for the year ended September 30, 1998 and as of September
30, 1998.
PricewaterhouseCoopers
London, England
December 21, 1998
F-56
<PAGE> 257
ESPRIT TELECOM GROUP PLC
CONSOLIDATED PROFIT AND LOSS ACCOUNTS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------------
CONTINUING 1998
NOTES 1996 1997 OPERATIONS ACQUISITIONS TOTAL
----- ------- ------- ---------- ------------ -------
(IN THOUSANDS, EXCEPT PER ORDINARY SHARE)
L L L L L
<S> <C> <C> <C> <C> <C> <C>
TURNOVER............................ 1,2 24,880 45,466 62,876 19,712 82,588
COST OF SALES....................... (18,756) (37,949) (52,351) (13,478) (65,829)
------- ------- ------- ------- -------
GROSS PROFIT........................ 6,124 7,517 10,525 6,234 16,759
OTHER OPERATING EXPENSES:
Selling, general and
administrative.................... (7,509) (15,505) (29,873) (5,305) (35,178)
Stock compensation costs............ 6 (2,035) (417) (112) -- (112)
Restructuring costs................. 8 -- (312) -- -- --
Depreciation and amortisation....... (1,471) (2,836) (8,477) (1,905) (10,382)
European network amortisation....... (1,519) -- (1,519)
Operating loss...................... 3 (4,891) (11,553) (29,456) (976) (30,432)
Profit on sale of investment........ 9 -- -- 200 -- 200
Interest receivable................. 10 142 1,152 11,821
Interest payable and similar
charges........................... 11 (345) (457) (24,034)
Loss on ordinary activities before
taxation.......................... (5,094) (10,858) (42,445)
------- ------- -------
Taxation on loss on ordinary
activities........................ 12 -- (2) (2)
------- ------- -------
LOSS FOR THE FINANCIAL YEAR......... (5,094) (10,860) (42,447)
======= ======= =======
LOSS PER ORDINARY SHARE............. 13 (0.07) (0.10) (0.34)
======= ======= =======
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-57
<PAGE> 258
ESPRIT TELECOM GROUP PLC
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
AS AT SEPTEMBER 30,
---------------------------------
NOTES 1996 1997 1998
----- --------- --------- ---------
(IN THOUSANDS)
L L L
<S> <C> <C> <C> <C>
FIXED ASSETS
Intangible assets..................................... 14 600 3,312 99,029
Tangible assets....................................... 15 7,374 14,284 55,071
Investments........................................... 16 31 131 --
--------- --------- ---------
8,005 17,727 154,100
CURRENT ASSETS
Stock................................................. 5 -- --
Trade debtors......................................... 7,309 15,395 29,444
Other debtors, prepayments and accrued income......... 17 2,352 1,896 26,244
Restricted Securities................................. 23 -- -- 48,969
Short term cash deposits.............................. 2,335 22,876 131,547
Bank balances and cash................................ 4,095 1,649 4,233
--------- --------- ---------
16,096 41,816 240,437
Creditors: Amounts falling due within one year........ 18 (12,122) (25,295) (72,930)
--------- --------- ---------
Net current assets.................................... 3,974 16,521 167,507
--------- --------- ---------
Total assets less current liabilities................. 11,979 34,248 321,607
Creditors: Amounts falling due in more than one
year................................................ 19 (1,968) (2,874) (328,806)
--------- --------- ---------
Net assets/(liabilities).............................. 10,011 31,374 (7,199)
========= ========= =========
CAPITAL AND RESERVES
Called up share capital............................... 20 1,487 1,219 1,255
Other capital reserves................................ 20 18,182 50,108 53,411
Shares to be issued................................... 20 -- -- 2,168
Other reserves........................................ 20 2,810 3,295 1,542
Profit and Loss account............................... 20 (12,468) (23,248) (65,575)
--------- --------- ---------
Total shareholders' funds/(deficit)................... 20 10,011 31,374 (7,199)
--------- --------- ---------
TOTAL SHAREHOLDERS' FUNDS/(DEFICIT) REPRESENT
Equity interest..................................... 9,338 31,374 (7,199)
Non-equity interest................................. 673 -- --
--------- --------- ---------
10,011 31,374 (7,199)
========= ========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-58
<PAGE> 259
ESPRIT TELECOM GROUP PLC
CONSOLIDATED CASH FLOW STATEMENTS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------
NOTES 1996 1997 1998
----- ------ ------- --------
(IN THOUSANDS)
L L L
<S> <C> <C> <C> <C>
Cash (outflow) from operating activities (see table
below).................................................. (2,245) (2,999) (29,133)
Returns on investments and servicing of finance........... 23 (203) 695 (4,834)
Taxation.................................................. -- (2) (2)
Capital expenditure and financial investment.............. 23 (3,594) (7,919) (22,478)
Acquisitions and disposals................................ -- (852) (91,643)
------ ------- --------
Cash outflow before financing............................. (6,042) (11,077) (148,090)
Management of liquid resources............................ 23 (2,335) (20,541) (158,058)
Financing................................................. 23 6,541 29,799 308,309
------ ------- --------
(Decrease) / Increase in cash in the period............... (1,836) (1,819) 2,161
------ ------- --------
RECONCILIATION OF CASH FLOW MOVEMENT IN NET FUNDS/(DEBT)
(Decrease) / Increase in cash in the period............... 24 (1,836) (1,819) 2,161
Cash (inflow) / outflow from decrease / (increase) in debt
and lease financing..................................... 24 970 594 (308,002)
Cash outflow from the increase in liquid resources........ 2,335 20,541 158,058
------ ------- --------
Changes in net (funds/(debt)) resulting from cash flows... 1,469 19,316 (147,783)
Amortisation of Senior Notes Issue Costs.................. -- -- (658)
Loans and finance leases acquired with subsidiary......... -- (135) --
New finance leases........................................ 24 (2,595) (2,003) (18,346)
Translation differences................................... 24 71 (64) 842
------ ------- --------
Movement in net funds / (debt) in the period.............. (1,055) 17,114 (165,945)
Net funds at start of period.............................. 4,387 3,332 20,446
------ ------- --------
NET FUNDS / (DEBT) AT END OF PERIOD....................... 3,332 20,446 (145,499)
====== ======= ========
RECONCILIATION OF OPERATING LOSS TO CASH FLOWS
Operating loss............................................ (4,891) (11,553) (30,432)
Depreciation.............................................. 1,419 2,737 8,782
Provision for stock option compensation................... 2,035 417 112
Amortisation of goodwill.................................. 52 99 3,119
Loss on sale of fixed assets.............................. 18 4 85
Decrease in stocks........................................ (2) 5 --
Increase in debtors....................................... (5,615) (6,979) (35,279)
Increase in creditors..................................... 4,544 11,681 25,222
Unrealised exchange loss / (profit)....................... 195 590 (742)
------ ------- --------
NET CASH (OUTFLOW) FROM OPERATING ACTIVITIES.............. (2,245) (2,999) (29,133)
====== ======= ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-59
<PAGE> 260
ESPRIT TELECOM GROUP PLC
STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
----------------------------
NOTES 1996 1997 1998
----- ------ ------- -------
(IN THOUSANDS)
L L L
<S> <C> <C> <C> <C>
Loss for the financial year.......................... 20 (5,094) (10,860) (42,447)
Differences on exchange.............................. 203 148 120
------ ------- -------
Total losses recognised in the year.................. (4,891) (10,712) (42,327)
====== ======= =======
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
F-60
<PAGE> 261
RECONCILIATIONS OF MOVEMENTS IN SHAREHOLDERS' FUNDS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
----------------------------
NOTES 1996 1997 1998
----- ------ ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
GROUP
Loss for the financial year.......................... (5,094) (10,860) (42,447)
Net proceeds from issue/redemption of shares......... 7,365 -- --
Redemption of preference shares...................... -- (673) --
Shares issued under warrants......................... -- 437 --
Net proceeds of initial public offering.............. -- 32,054 --
Other costs associated with the initial public
offering........................................... -- (1,072) --
Net proceeds of options exercised in the period...... -- 158 307
Nominal value of shares issued for acquisitions...... -- 11 8
Satisfaction of deferred consideration on prior year
acquisitions:
Nominal value of shares......................... -- -- 5
Share Premium................................... -- -- 772
Estimated fair value of shares to be issued to
satisfy deferred consideration of current year
acquisitions:...................................... -- -- 2,168
Movement in merger reserve........................... -- 743 381
Movement in other reserves........................... 2,035 417 113
Exchange differences................................. 203 148 120
------ ------- -------
Net increase/(decrease) in shareholders' funds....... 4,509 21,363 (38,573)
Opening shareholders' funds.......................... 5,502 10,011 31,374
------ ------- -------
Closing shareholders' funds/(deficit)................ 10,011 31,374 (7,199)
====== ======= =======
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
F-61
<PAGE> 262
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements of the Company have been prepared
under the historical cost convention as modified by the revaluation of certain
forward currency contracts and in accordance with accounting principles
generally accepted in the United Kingdom ("UK GAAP").
The directors consider that the accounting policies set out below are
suitable, have been consistently applied and are supported by reasonable and
prudent judgements and estimates.
As described in Note 30, these principles differ in certain significant
respects from those that the Company would have followed had its consolidated
financial statements been prepared in accordance with accounting principles
generally accepted in the United States ("US GAAP").
The directors believe that cash from operations, together with the
borrowings under Senior Notes 2007 and 2008 and the credit facilities currently
available, will be sufficient to settle the Company's projected liabilities as
they fall due. Accordingly these statements have been prepared on a going
concern basis.
The significant accounting policies adopted in arriving at the consolidated
financial statements are summarised below.
A) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements incorporate the financial statements
of the Company and its subsidiary undertakings. Intercompany transactions and
balances have been eliminated. The accounts include the results of subsidiary
undertakings acquired from the relevant date of acquisition, or incorporation.
B) TURNOVER
Turnover in respect of telecommunications services is recorded on the basis
of minutes of traffic processed. Turnover represents the invoiced value of goods
and services supplied by the Company, net of Value Added Tax. Turnover is
recorded when the traffic is processed and the communications services are
rendered.
C) COST OF SALES
Network expenses are charged to income in the period in which the related
turnover is recognised.
D) TANGIBLE FIXED ASSETS
Tangible fixed assets comprising computers, telecommunications equipment
(including installation costs), furniture and office equipment are stated at
historical cost less accumulated depreciation. Installation costs consist of
third party preparation costs at client premises related to the installation of
telecommunications equipment.
Except for infrastructure assets depreciation is calculated using the
straight line method to write off the cost of each asset over its estimated
useful economic life according to the following lives:
<TABLE>
<S> <C>
Computer equipment 3 years
Telecom and switching equipment 5-10 years
Installation costs 3 years
Furniture and office equipment 3 years
</TABLE>
For infrastructure assets, depreciation is calculated using an accelerated
method to write off the cost of each asset over a 10 year period.
F-62
<PAGE> 263
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Ongoing maintenance and other network costs are expensed as incurred.
Assets under construction relate to an Indefeasible Right of Use "IRU"
cable which will be transferred to telecom and switching equipment once
operational.
E) LEASED ASSETS
Fixed tangible assets financed by leasing agreements which give rights
approximating to ownership, are treated as if they had been purchased outright.
The amount capitalised is the present value of the minimum lease payments
payable during the lease term. The corresponding leasing commitments are shown
as obligations to the lessor. Depreciation is charged to the profit and loss
account. Lease payments are treated as consisting of capital and interest
elements and the interest is charged to the profit and loss account using the
annuity method.
Rental costs associated with operating leases are charged to the profit and
loss account as they arise over the lease term.
F) GOODWILL
Goodwill, being the excess of the purchase price over the fair values of
the net identifiable assets of businesses acquired, is capitalised as an
intangible asset. These amounts are being amortised by the use of the straight
line method over fifteen years. Where management considers that there has been a
permanent impairment in the value of goodwill, this element of goodwill is
charged to the profit and loss account immediately.
G) DEFERRED TAXATION
Provision is made for taxation deferred as a result of material timing
differences between the incidence of income/expenditure for taxation and
accounts purposes, using the liability method, only to the extent that, in the
opinion of the directors, there is a reasonable probability that a liability or
asset will arise in the near future.
H) FOREIGN CURRENCIES
Transactions in foreign currencies are translated into sterling at the
rates of exchange ruling at the date of the transaction. Differences arising
from changes in exchange rates on transactions denominated in foreign currencies
are taken into the profit and loss account in the year in which they arise.
Differences on exchange arising from the translation of the net investments
of foreign subsidiaries denominated in foreign currency, together with the
differences between profit and loss accounts translated at rates ruling at the
period end and average rates, respectively, are taken directly to reserves.
Where net investments are matched in whole or in part by foreign currency
borrowings the exchange differences arising on the re-translation of such
borrowings are also recorded within reserves and any excess taken to the Profit
and Loss Account.
I) PENSION AND OTHER POST RETIREMENT BENEFITS
The Company has no defined benefit pension plan for its employees. With
respect to certain Esprit Telecom UK employees, the Company contributes a fixed
percentage, based upon the salary earned, to the employees' nominated pension
insurance policy or other pension arrangements.
F-63
<PAGE> 264
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
J) INCENTIVE OPTION AND SHARE AWARDS
The Company awards options and shares to employees under its employee share
option plans or as approved by the directors. Such awards are accounted for in
accordance with the Urgent Issue Task Force Abstract 17.
Under the requirements of Abstract 17, any difference between the quoted
market price and the price at which shares or options are awarded to employees,
is regarded as employee compensation and recorded as a charge against net income
at the date of grant. This requirement does not apply to the 15% discount
permitted in respect of awards under the Company's Savings Related Share Option
Scheme.
K) CASHFLOW STATEMENTS
The consolidated cashflow statements are presented in accordance with
Financial Reporting Standard 1 (Revised 1996).
2 SEGMENTAL ANALYSIS
TURNOVER
The Company is primarily engaged in providing international and national
long distance telecommunications services mainly to businesses, government
agencies, and other organisations located principally in Europe.
The Company's turnover analysed by geographical source is as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
1996 1997 1998
------ ------ ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
U.K......................................................... 17,846 31,088 39,411
Netherlands................................................. 5,229 8,825 16,289
Germany..................................................... -- 215 15,950
Rest of Europe(1)........................................... 1,805 5,338 10,938
------ ------ ------
Total....................................................... 24,880 45,466 82,588
====== ====== ======
</TABLE>
The company's turnover analysed by class of business is as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
1996 1997 1998
------ ------ ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Retail...................................................... 12,460 18,926 51,616
Wholesale................................................... 10,870 19,425 14,869
Service provider/reseller................................... 1,550 7,115 16,103
------ ------ ------
24,880 45,466 82,588
====== ====== ======
</TABLE>
F-64
<PAGE> 265
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
LOSS ON ORDINARY ACTIVITIES
Loss on ordinary activities before taxation analysed by location of
operating entity is as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
----------------------------
1996 1997 1998
------ ------- -------
L L L
<S> <C> <C> <C>
U.K......................................................... (1,670) (3,463) (21,332)
Netherlands................................................. (962) (2,067) (3,824)
Germany..................................................... (85) (829) (10,216)
Rest of Europe(1)........................................... (2,098) (4,031) (6,829)
Other(2).................................................... (279) (468) (244)
------ ------- -------
Total....................................................... (5,094) (10,858) (42,445)
====== ======= =======
</TABLE>
NET ASSETS/(LIABILITIES)
Net assets/(liabilities) are located in the following territories:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-----------------------------
1996 1997 1998
------ ------- --------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
U.K......................................................... 14,765 29,809 (139,329)
Netherlands................................................. (1,560) 484 18,576
Germany..................................................... (61) (866) 108,393
Rest of Europe(1)........................................... (1,777) 1,970 5,161
Other(2).................................................... (1,356) (23) --
------ ------- --------
Total....................................................... 10,011 (31,374) (7,199)
====== ======= ========
</TABLE>
TOTAL ASSETS
Total assets are located in the following territories:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------
1996 1997 1998
------ ------ -------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
U.K......................................................... 18,070 37,993 219,968
Netherlands................................................. 2,673 7,041 27,101
Germany..................................................... 35 1,007 128,744
Rest of Europe(1)........................................... 2,791 11,713 18,724
Other(2).................................................... 532 1,789 --
------ ------ -------
Total....................................................... 24,101 59,543 394,537
====== ====== =======
</TABLE>
- ---------------
(1) Includes Belgium, Spain, France and Italy
(2) Icomnet SA
F-65
<PAGE> 266
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3 OPERATING LOSS
The operating loss is stated after charging:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER, 30
------------------------
1996 1997 1998
----- ----- ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Employee costs (including stock compensation costs)......... 6,718 7,992 22,460
Depreciation of tangible fixed assets:
Owned....................................................... 1,280 2,454 6,481
Leased -- Infrastructure.................................... -- -- 1,519
Leased -- Other............................................. 139 283 782
Amortisation of intangible fixed assets..................... 52 99 3,119
Operating Lease rentals:
Buildings................................................... 478 651 1,494
Telephone lines............................................. 3,949 4,663 10,587
Other....................................................... 361 282 422
Rent and utilities.......................................... 812 1,184 2,587
Remuneration of group auditors:
Audit services.............................................. 50 100 169
Non-audit services.......................................... 187 423 259
Exchange losses/(gains) (other than on the retranslation of
Senior Notes)............................................. 163 960 (1,115)
===== ===== ======
</TABLE>
4 EMPLOYEE NUMBERS AND COSTS
Average number of employees including executive directors employed by the
Company during the period.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER, 30
-------------------------
1996 1997 1998
----- ----- -----
NO. NO. NO.
<S> <C> <C> <C>
U.K......................................................... 43 117 215
Netherlands................................................. 26 41 135
Germany..................................................... 4 5 104
Rest of Europe(1)........................................... 30 65 100
Other(2).................................................... 2 2 --
--- --- ---
Total....................................................... 105 230 554
=== === ===
</TABLE>
- ---------------
(1) Includes Belgium, Spain, France and Italy
(2) Incomnet SA
F-66
<PAGE> 267
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Aggregate payroll costs for those persons amounted to:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER, 30
------------------------
1996 1997 1998
----- ----- ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Wages and salaries.......................................... 4,206 6,720 19,866
Social security costs....................................... 384 648 2,120
Other pension costs......................................... 93 207 362
Stock compensation costs.................................... 2,035 417 112
----- ----- ------
Total....................................................... 6,718 7,992 22,460
===== ===== ======
</TABLE>
5 DIRECTORS EMOLUMENTS
Amounts paid and accrued for the services of directors were as follows:
<TABLE>
<CAPTION>
YEAR ENDED 30 SEPTEMBER
-----------------------
1996 1997 1998
----- ----- -----
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Remuneration as executives.................................. 587 701 786
Pension contributions....................................... 4 27 17
--- --- ---
Total....................................................... 591 728 803
=== === ===
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED 30 SEPTEMBER
-----------------------
1996 1997 1998
----- ----- -----
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Chairman.................................................... 192 191 182
Highest paid director....................................... 192 165 250
</TABLE>
The Company purchased the services of the outgoing Chairman Walter Anderson
from Entree International.
The beneficial interests of the directors and their families in the options
over the ordinary shares of the Company as at September 30, 1998 were:
<TABLE>
<CAPTION>
AS AT AS AT AS AT
1 OCTOBER GRANTED 1 OCTOBER GRANTED LAPSED EXERCISED 30 SEPTEMBER
1996 IN YEAR 1997 IN YEAR IN YEAR IN YEAR 1998
--------- --------- --------- ------- ------- --------- ------------
NO. NO. NO. NO. NO. NO. NO.
<S> <C> <C> <C> <C> <C> <C> <C>
Walter Anderson..................... 327,550 15,420 342,970 -- -- -- 342,970
David Oertle........................ -- 2,450,665 2,450,665 722,097 -- -- 3,172,762
Michael Potter...................... 475,850 32,120 507,970 145,342 -- -- 653,312
Roy Merritt......................... 1,181,900 27,088 1,208,988 250,770 -- -- 1,459,758
John McMonigall..................... -- -- -- -- -- -- --
Dominic Shorthouse.................. -- -- -- -- -- -- --
William Johnston.................... -- -- -- -- -- -- --
Jonathan Hudson..................... 813,850 15,638 829,488 -- (4,438) (825,050)
</TABLE>
F-67
<PAGE> 268
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
No options were exercised during the twelve month period ended September
30, 1997.
The following table sets forth certain information with respect to the
directors' interest in the Company's ordinary shares at September 30, 1998.
<TABLE>
<CAPTION>
NUMBER OF ORDINARY SHARES
----------------------------------------
AS AT AS AT
NOTE SEPTEMBER 30, 1997 SEPTEMBER 30, 1998
---- ------------------ ------------------
<S> <C> <C> <C>
Walter Anderson.................................. a 20,073,600 32,968,520
John McMonigall.................................. b 32,294,100 33,557,600
Dominic Shorthouse............................... c 15,442,150 15,442,150
William Johnston................................. d 10,131,400 --
Michael Potter................................... e 3,985,000 3,985,000
Jonathan Hudson.................................. 1,051,850 827,053
Roy Merritt...................................... -- --
David Oertle..................................... -- --
</TABLE>
- ---------------
(a) Includes 32,637,901 Ordinary Shares beneficially held by Gold & Appel
Transfer S.A. ("Gold & Appel") and 330,619 Ordinary Shares held by Mr.
Anderson personally. Mr. Anderson disclaims "beneficial ownership" of the
shares held by Gold & Appel within the Rule of 13d-3 under the Exchange Act.
Excludes 1,515,900 Ordinary Shares held by the Foundation for the
International Non-Governmental Development of Space ("FINDS"). Mr. Anderson
disclaims "beneficial ownership" of the shares held by FINDS within the Rule
of 13d-3 under the Exchanges Act.
(b) All of the Ordinary Shares are owned directly by Apax Funds Nominees Limited
("Apax Nominees"). Apax Nominees is the nominee shareholder for Apax
Ventures IV International Partners LP, Apax Ventures IV, Apax UK V-A, LP and
Apax UK V-B, investment funds managed by Apax Partners & Co. Ventures Ltd.
("Apax Partners") on behalf of investors comprising mainly pension funds,
insurance companies and endowment funds principally in the United States and
the United Kingdom. Mr. McMonigall is a Director of Apax Partners. The
Ordinary Shares shown are included because of Mr. McMonigall's affiliation
with Apax Partners.
(c) The sole general partner of Warburg, Pincus Ventures LP ("Warburg Pincus")
is Warburg, Pincus & Co. a New York general partnership ("WP"). EM
Warburg,Pincus & Co. LLC a New York limited liability company ("EMW
LLC")manages Warburg Pincus. The members of EMW LLC are substantially the
same as the partners of WP. Lionel I. Pincus is the managing partner of WP
and the managing member of EMW LLC and may be deemed to control both WP and
EMC LLC. WP has a 15% interest in the profits of Warburg Pincus as the
general partner and also owns approximately 1.5% of the limited partnership
interests in Warburg Pincus. Mr. Shorthouse is a Managing Director and
member of EMW LLC and a general partner of WP. The Ordinary Shares are owned
by Warburg Pincus and are included because of Mr. Shorthouse's affiliation
with Warburg Pincus.
(d) The sole general partner of Hancock International Private Equity Partners II
-- Direct Fund LP ("Hancock") is Back Bay Partners XVI LP, the managing
partner of which is HarbourVest Partners LLC. Mr. Johnston is one of the
general partners of Hancock. All the Ordinary Shares are owned by Hancock
and are disclosed as a result of Mr. Johnston's affiliation with Hancock.
(e) The Ordinary Shares are held by Abacus (F.T.) Limited but included because
Mr. Potter was the settlor of the Trust.
F-68
<PAGE> 269
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6 EMPLOYEE SHARE OPTION PLANS
Share options issued or granted were as follows:
<TABLE>
<CAPTION>
SERVICE AND PURCHASE AND
BONUS AWARDS INVESTMENT OPTIONS
------------ ------------------
<S> <C> <C>
Balance granted at October 1, 1996.......................... 3,693,500 2,647,150
Granted in the year......................................... 548,500 77,350
Cancelled or repurchased.................................... (17,950) (89,200)
Exercised in the year....................................... (146,850) (563,650)
---------- ---------
Balance granted at September 30, 1997....................... 4,077,200 2,071,650
Granted in the year......................................... 60,000 --
Exercised in the year....................................... (1,492,550) (859,750)
---------- ---------
Balance granted at October 1, 1998.......................... 2,644,650 1,211,900
---------- ---------
</TABLE>
(i) Company Share Option Plan 1997 ("CSOP")
Under this UK Inland Revenue approved plan, the Board of Directors may, at
their discretion, grant options to any UK based employee, including full-time
directors, that are employed by the Company or a subsidiary and work at least 25
hours or more per week.
The Company grants one option over 7 ordinary shares for each L125 of gross
salary (including base salary, commissions and annual bonus). The options are
accrued on a monthly basis and are granted formally by the Company on a
bi-annual basis. The exercise price of the options is approved by the UK Inland
Revenue based on the market price of the shares on or about the date of grant.
Participants who leave the Company may only exercise their options if they
leave because of ill health, redundancy, retirement, or if their employing
company ceases to be a participating company under the terms of the Plan.
Options in these circumstances may be exercised up to six months after the date
the employee leaves the Company. Participants whose employment with the Company
terminates for any other reason may only exercise their options after the date
their employment terminates at the Board's discretion.
In all cases, options do not vest until one year after grant, and
favourable tax treatment is only available if options are not exercised until at
least three years after grant.
(ii) Savings Related Share Option Scheme 1997 ("SAYE Scheme")
Under this UK Inland Revenue approved plan all UK based employees of the
Company (including directors who work 25 hours or more per week employed by the
Company) or a subsidiary are eligible to participate in the SAYE Scheme.
Any employee with at least six months' continuous service with the Company,
when invitations are made to participate in the Plan, will be eligible to
participate.
Participants may choose to save a fixed amount of between L5-L250 a month
for a period of three years (the "Savings Contract") with the Company's
nominated Building Society. The number of options that participants will be
entitled to, will be based on the monthly savings amount and will be made at the
commencement of the Savings Contract. Options will be granted with an exercise
price approved by the UK Inland Revenue that is at a discount of 15% to the
market price of the shares on or about the date of grant.
Any options granted will be exercisable for six months after the end of the
Savings Contract. Participants who leave the Company may only exercise their
options early if they leave because of ill health, redundancy, retirement or if
the employing company ceases to be a participating company under the terms of
the Plan.
F-69
<PAGE> 270
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Options in these circumstances may be exercised up to six months after the date
the employee leaves the company.
Options granted will lapse if a participant's employment with the Company
terminates for any other reason and the participant's savings with the Building
Society will be returned when requested. Options will be valid for six months
following the end of the Savings Contract and following this time they will
lapse.
Participants may either choose to exercise their option or receive their
saved amount from the Building Society. An amount of interest equivalent to
three months' savings will be paid (provided that participant has completed the
Savings Contract).
(iii) Executive and Employee Share Option Plan 1997 ("Executive Plan")
The Executive and Employee Share Option Plan 1997 is not approved by the UK
Inland Revenue. This plan is used to provide non-UK based employees options on
substantially the same terms as the Company Share Option Plan and the Savings
Related Share Option Scheme. It is also used to provide discretionary incentive
schemes to management. The timing of option grants, the number of shares for
which options are granted, and the exercise price of the options are determined
at the sole discretion of the Board of Directors. Specifically, the exercise
price could range from the nominal value of the shares to amounts in excess of
the share price at the date of grant. The Executive Plan will not be submitted
for Inland Revenue approval.
On February 26, 1998, the Remuneration Committee of the Board of Directors
approved a new sub-plan under the Executive and Employee Share Option Plan, the
Management Share Option Plan ("MSOP"). Eligibility only extends to specified
persons who are employed by an Esprit Telecom group company before February 26,
1999.
Options shall vest three years from February 26, 1998 or three years from
the date of employment, whichever is later, on the following two conditions: (i)
the specified employees must still be employed by an Esprit Telecom group
company, and (ii) the in the case of those persons already employed on February
26, 1998, the market price is at least US$24.1875 per seven ordinary shares (50%
higher than the exercise price) or in the case of those persons employed after
February 26, 1998, the market price is at least 50% higher than it was on the
date of commencement of employment. All other terms shall be governed by the
rules of the Executive and Employee Share Option Plan 1997.
<TABLE>
<CAPTION>
SAYE EXECUTIVE
CSOP SCHEME PLAN
-------- -------- ----------
<S> <C> <C> <C>
Balance at September 30, 1997........................... 146,482 528,526 3,148,250
Granted in the year..................................... 532,455 403,342 4,375,000
Lapsed.................................................. (69,755) (16,646) (498,750)
Exercised in the year................................... (22,176) (1,843) (42,000)
Balance at September 30, 1998........................... 586,466 913,379 6,982,500
</TABLE>
The following options were vested during the year:
<TABLE>
<CAPTION>
SAYE EXECUTIVE
CSOP SCHEME PLAN
-------- ------ ----------
<S> <C> <C> <C>
Balance at September 30, 1997............................. -- -- 409,500
Vested in year............................................ 148,344 1,843 1,027,500
Exercised in the year..................................... (2,725) (1,843) (42,000)
Balance at September 30, 1998............................. 145,619 -- 1,395,000
</TABLE>
F-70
<PAGE> 271
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7 STOCK INCENTIVE SCHEME
The Company maintained a stock incentive scheme for executives and
employees. Under the scheme, the directors periodically awarded shares to
employees based upon contract and/or performance. The scheme was terminated
during 1997 and no additional shares will be awarded. The number of ordinary
shares issued during 1995, 1996 and 1997 (which represents the total of the
shares issued through September 30, 1997), is as follows:
<TABLE>
<CAPTION>
NUMBER OF
ORDINARY SHARES
ISSUED
---------------
<S> <C>
1995........................................................ 1,206,500
1996........................................................ 640,000
1997........................................................ 70,000
1998........................................................ --
</TABLE>
8 RESTRUCTURING COSTS
During the year ended September 30, 1997, the Company incurred
restructuring costs of approximately L312,000 relating to the reorganisation and
reincorporation of the Group, and the redesign of its stock ownership programs
prior to the Company's Initial Public Offering in February 1997. Restructuring
costs were not incurred in the twelve month period ended September 30, 1998.
9 PROFIT ON SALE OF INVESTMENT
Profit on disposal of fixed asset investments arose on the disposal of the
20% shareholding in Long Distance International Limited, as described in Note
16.
10 INTEREST RECEIVABLE AND SIMILAR INCOME
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
1996 1997 1998
----- ------ -------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Interest Receivable......................................... 142 1,152 8,264
Net foreign exchange gain................................... -- -- 3,557
--- ----- ------
142 1,152 11,821
=== ===== ======
</TABLE>
F-71
<PAGE> 272
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11 INTEREST PAYABLE AND SIMILAR CHARGES
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------
1996 1997 1998
----- ----- -------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Interest Payable on loans and other borrowings wholly
repayable
within 5 years:
Bank loans and overdrafts................................... 149 142 1,606
Obligations under finance leases............................ 196 315 1,205
Interest on Senior Notes.................................... -- -- 20,565
--- --- ------
Amortisation of Senior Notes issue costs.................... -- -- 658
--- --- ------
Total 345 457 24,034
=== === ======
</TABLE>
12 TAXATION ON LOSS ON ORDINARY ACTIVITIES
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------
1996 1997 1998
----- ----- -----
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Corporation tax............................................. -- 2 2
== == ==
</TABLE>
As of September 30, 1998 the Company has unrecognised tax losses carried
forward, which can be used to offset future taxable income of the Company. These
amount to approximately L54,955,000 (1997: L16,005,000 and 1996: L7,684,000) and
are available to reduce future tax liabilities. The tax losses have the expiry
dates shown below.
The expiry date of the losses which would have been available as at
September 30, 1997 and September 30, 1996 are respectively shown below for
comparative purposes only; those losses which have not since expired are
included within the 1998 analysis.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------
1996 1997 1998
----- ------ ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
1999........................................................ 315 263 66
2000........................................................ 338 284 63
2001........................................................ 785 512 428
2002........................................................ 449 859 521
2003........................................................ 763 580 856
2004........................................................ -- 1,274 1,908
2005........................................................ -- -- 6,539
----- ------ ------
Indefinite carry forward.................................... 5,034 12,233 44,574
----- ------ ------
7,684 16,005 54,955
===== ====== ======
</TABLE>
F-72
<PAGE> 273
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13 LOSS PER SHARE
The loss per share represents the loss attributable to shareholders in each
year divided by the weighted average number of Ordinary Shares outstanding
during each year.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------------
1996 1997 1998
-------- -------- --------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Loss for the year....................................... (5,094) (10,860) (42,447)
-------- -------- --------
Weighted average number of shares (thousands)........... 68,397 104,900 124,095
-------- -------- --------
Loss per share.......................................... L (0.07) L (0.10) (0.34)
-------- -------- --------
</TABLE>
14 INTANGIBLE FIXED ASSETS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------------
1996 1997 1998
-------- -------- --------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
GOODWILL
Cost
At October 1............................................ 775 775 3,586
Acquisitions............................................ -- 2,811 95,274
Currency translation adjustment......................... -- -- 3,660
-------- -------- --------
Balance at September 30................................. 775 3,586 102,520
======== ======== ========
Accumulated Amortization
At October 1............................................ 123 175 274
Amortization............................................ 52 99 3,119
Currency translation adjustment......................... -- -- 98
-------- -------- --------
Balance at September 30................................. 175 274 3,491
-------- -------- --------
Net book value at September 30.......................... 600 3,312 99,029
======== ======== ========
</TABLE>
Goodwill arose on (i) the purchase of Interaktieve Media Services BV with
the total consideration before expenses expected to be L7,131,000, (ii) the
purchase of Plusnet GmbH & Co KG with the total consideration before expenses of
L90,068,000 (iii) the purchase of the trade assets and liabilities of Budget
Phone Card BV with a total consideration before expenses of L586,000.
The following movements occurred on the consideration in respect of prior
year acquisitions: (a) L46,000 is due as contingent consideration for Swift
Global Nederlands BV (b) the value of the deferred share consideration due in
respect of Telecom Europa Limited increased by L277,000 during the year.
F-73
<PAGE> 274
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15 TANGIBLE FIXED ASSETS
<TABLE>
<CAPTION>
TELECOM- TELECOM- OFFICE COMPUTER ASSETS UNDER
EQUIPMENT INFRASTRUCTURE FIXTURES EQUIPMENT CONSTRUCTION TOTAL
L'000 L'000 L'000 L'000 L'000 L'000
<S> <C> <C> <C> <C> <C> <C>
COST
At September 30, 1995......... 2,912 154 310 353 -- 3,729
Capital additions............. 5,433 9 162 357 -- 5,961
Disposals..................... (41) -- -- -- -- (41)
Currency translation
adjustment.................. (35) (6) (5) (11) -- (57)
------ ------ ----- ------ ---- ------
At October 1, 1996............ 8,269 157 467 699 -- 9,592
Capital additions............. 7,063 35 530 1,215 999 9,842
Acquired with subsidiaries.... 196 -- 102 -- -- 298
Disposals..................... (71) (1) (12) (24) -- (108)
Currency translation
adjustment.................. (428) (19) (42) (95) -- (584)
------ ------ ----- ------ ---- ------
At October 1, 1997............ 15,029 172 1,045 1,795 999 19,040
Capital additions............. 19,080 16,335 2,243 3,213 284 41,155
Transfers..................... 999 -- -- -- (999) --
Acquired with subsidiaries.... 10,682 795 1,972 401 -- 13,850
Disposals..................... (1) (220) (8) (83) -- (312)
Currency translation
adjustment.................. 263 174 (267) (75) -- 95
------ ------ ----- ------ ---- ------
At September 30, 1998......... 46,052 17,256 4,985 5,251 284 73,828
------ ------ ----- ------ ---- ------
ACCUMULATED DEPRECIATION
At September 30, 1995......... 634 46 58 129 -- 867
Depreciation.................. 1,080 30 147 162 1,419
Disposals..................... (24) -- -- -- -- (24)
Currency translation
adjustment.................. (38) (2) (1) (3) -- (44)
------ ------ ----- ------ ---- ------
At October 1, 1996............ 1,652 74 204 288 -- 2,218
Depreciation.................. 2,087 1 243 406 -- 2,737
Acquired with subsidiaries.... 59 -- 32 -- -- 91
Disposals..................... (50) (1) (12) (21) -- (84)
Currency translation
adjustment.................. (124) (9) (21) (52) -- (206)
------ ------ ----- ------ ---- ------
At October 1, 1997............ 3,624 65 446 621 -- 4,756
Depreciation.................. 6,044 1,519 362 857 -- 8,782
Acquired with subsidiaries.... 4,049 306 926 89 -- 5,370
Disposals..................... (179) -- (48) -- -- (227)
Currency translation
adjustment.................. 205 68 (138) (59) -- 76
------ ------ ----- ------ ---- ------
At September 30, 1998......... 13,743 1,958 1,548 1,508 -- 18,757
------ ------ ----- ------ ---- ------
NET BOOK VALUE
At September 30, 1996......... 6,617 83 263 411 -- 7,374
------ ------ ----- ------ ---- ------
At September 30, 1997......... 11,405 107 599 1,174 999 14,284
------ ------ ----- ------ ---- ------
At September 30, 1998......... 32,309 15,298 3,437 3,743 284 55,071
------ ------ ----- ------ ---- ------
</TABLE>
Telecom equipment includes installation costs and customer software
upgrades primarily in the UK, with a net book value of L5,276,000 (L1,416,000 at
September 30, 1997, L594,000 at September 30, 1996).
The net book value of telecom equipment includes L23,467,213, L3,134,036
and L2,322,399 in respect of assets held under finance leases as at September
30, 1998, 1997, and 1996 respectively.
F-74
<PAGE> 275
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16 INVESTMENTS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
1996 1997 1998
----- ----- ----
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Investments................................................. 31 131 --
-- --- ---
</TABLE>
This amount represented a 20% investment in Long Distance International Ltd
("LDI")-a company incorporated in the UK.
This investment was sold during the year resulting in a gain of L200,000.
The Company's co-investor in LDI benefited from a controlling shareholding.
Consequently, in view of the disposition of the shareholdings in LDI, the Board
does not believe that the Company was able to exercise a significant influence
over LDI's financial and operating policies. Accordingly, the Board does not
believe that it is appropriate for the Company to account for its share of
losses of LDI on an equity basis. During the prior year, the Company made an
unsecured loan advance to LDI of L100,000 repayable after two years, at a
commercial rate of interest. This loan was repaid during the year.
17 OTHER DEBTORS: AMOUNTS DUE WITHIN ONE YEAR
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------
1996 1997 1998
----- ------ ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Other debtors............................................... 86 78 17,174
Prepayments and accrued income.............................. 2,266 1,818 9,070
----- ------ ------
2,352 1,896 26,244
----- ------ ------
</TABLE>
Trade debtors is reflected net of allowances for uncollectible accounts of
L2,200,000, L1,296,500, and L165,000 as of September 30, 1998, 1997 and 1996,
respectively.
Included within other debtors is L14,568,000 relating to monies recoverable
from Thyssen Telecom TG as part of the Plusnet acquisition.
18 CREDITORS: AMOUNTS DUE WITHIN ONE YEAR
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
1996 1997 1998
------ ------ ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Bank loans and overdrafts................................... 666 101 516
Trade creditors............................................. 7,741 19,678 42,132
Social security and other taxation.......................... 818 388 2,097
Accruals.................................................... 2,433 4,024 24,956
Obligations under finance leases............................ 464 1,104 3,229
------ ------ ------
12,122 25,295 72,930
====== ====== ======
</TABLE>
The Company has two secured bank financing facilities through its UK and
Dutch subsidiaries as at September 30, 1998. These are set out below:
F-75
<PAGE> 276
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
ESPRIT TELECOM UK LTD -- L1,000,000 credit facility repayable on demand
with Lloyds TSB plc in the UK, agreed on December 21, 1995. As the facility is
secured by the receivables of the Company, the amount of the facility that is
available at any time varies directly in relation to the Company's pledged
receivables (70% thereof), subject to the L1 million facility limit. As at
September 30, 1998, LNil of this facility had been utilized. This facility bears
interest on outstanding borrowings at LIBOR plus 2.25% per annum (9.75% at
September 30, 1998) and remains in effect until notice of termination is given
by the Company or Lloyds TSB plc.
ESPRIT TELECOM BENELUX BV -- NLG 1,200,000 credit facility repayable on
demand with ABN Amro in the Netherlands, dated August 23, 1996, which is subject
to a credit limit representing 69% of the total amount of pledged receivables.
As at September 30, 1998, NLG Nil of this facility had been utilized. This
facility bears interest on outstanding borrowings of the promissory note
discount rate plus a debit interest sub-charge of a minimum of 5%, plus 2.5%,
enhanced for certain facility fees (7.5% at September 30, 1998), and remains in
effect until notice of termination by the Company or ABN Amro.
19 CREDITORS: AMOUNTS DUE AFTER ONE YEAR
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------
1996 1997 1998
----- ----- -------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Obligations under finance leases
repayable between one and two years....................... 642 1,257 3,610
repayable between two and five years...................... 1,326 1,571 8,988
repayable after five years................................ -- -- 4,166
Bank loans and other debt:
repayable between one and two years....................... -- 46 2,303
Senior Notes due 2007 and 2008.............................. -- -- 309,739
----- ----- -------
1,968 2,874 328,806
===== ===== =======
</TABLE>
At September 30, 1998, the Company has the following obligations under a
finance lease:
A lease agreement with Ericsson in respect of telecommunication equipment,
against which the obligations are secured. A lease agreement with GE
capital in respect of telecommunication equipment. A lease agreement with
GPT in respect of telecommunication equipment.
In connection with the London/Paris SDH fibre infrastructure, the Company
has entered into three lease agreements with suppliers. Maturity for these
leases is 2007 and the effective interest rate applicable under these
agreements is 11.50%.
The Senior Notes 2007 comprise US$230 million and DM 125 million. The
coupon on both transactions is payable bi-annually at 11.50%. These Notes
rank pari-passu with other ordinary creditors.
The Senior Notes 2008 comprise US$150 million and DM 150 million. The
coupon on both transactions is payable bi-annually at 10.875% and 11.00%
respectively. These Notes rank pari-passu with other ordinary creditors.
F-76
<PAGE> 277
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
20 SHARE CAPITAL AND RESERVES
<TABLE>
<CAPTION>
ORDINARY AND 'A' PREFERENCE SHARE SHARES PROFIT AND
ORDINARY SHARES SHARES MERGER PREMIUM TO BE OTHER LOSS
----------------- ------------- RESERVE (1) ACCOUNT ISSUED RESERVES (2) ACCOUNT
NUMBER L NUMBER L L L L L L
-------- ------ ------ ---- ----------- ------- ------ ------------ ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
At October 1, 1995............... 65,700 657 673 673 10,974 -- -- 775 (7,577)
Retained loss for the year....... -- -- -- -- -- -- -- -- (5,094)
Issue of new shares.............. 20,800 208 -- -- 7,208 -- -- -- --
Repurchase of shares............. (5,100) (51) -- -- -- -- -- -- --
Net differences on exchange...... -- -- -- -- -- -- -- -- 203
Issue of new options............. -- -- -- -- -- -- -- 2,035 --
------- ----- ---- ---- ------ ------ ----- ----- -------
At October 1, 1996............... 81,400 814 673 673 18,182 -- -- 2,810 (12,468)
Retained loss for the year....... -- -- -- -- -- -- -- -- (10,860)
Redemption of preference
shares......................... -- -- (673) (673) -- -- -- -- --
Issue of new shares.............. 40,471 405 -- -- 1,126 30,800 -- -- --
Merger reserve arising from
reorganisation................. -- -- -- -- -- -- -- 68 (68)
Net differences on exchange...... -- -- -- -- -- -- -- -- 148
Issue of new options............. -- -- -- -- -- -- -- 417 --
------- ----- ---- ---- ------ ------ ----- ----- -------
At October 1, 1997............... 121,871 1,219 -- -- 19,308 30,800 -- 3,295 (23,248)
Retained loss for the year....... -- -- -- -- -- -- -- 113 (42,447)
Issue of new shares.............. 3,658 36 -- -- 381 2,014 -- (958) --
Other movements.................. -- -- -- -- 908 -- -- (908) --
Net differences on exchange...... -- -- -- -- -- -- -- -- 120
Deferred share consideration..... -- -- -- -- -- -- 2,168 -- --
------- ----- ---- ---- ------ ------ ----- ----- -------
At September 30, 1998............ 125,529 1,255 -- -- 20,597 32,814 2,168 1,542 (65,575)
======= ===== ==== ==== ====== ====== ===== ===== =======
</TABLE>
- ---------------
(1) The merger reserve represents contributed capital in excess of the nominal
value of the shares issued by predecessor companies.
(2) Other reserves primarily represent the capital element relating to the issue
of options at a discount to the fair value at the date of grant.
AUTHORIZED SHARE CAPITAL
On January 31, 1997, the Company effected a share for share exchange to
acquire all of the outstanding share capital of Esprit Telecom (Jersey) Limited,
the Company's predecessor. Differences in the nominal value of shares exchanged
have been reflected in the table above on a pro forma basis from October 1,
1995.
After giving retroactive effect to the above, and prior to the February
1997 fifty for one share split explained below, (i) the authorised share capital
of the Company consisted of L1,791,719 divided into 2,123,438 Ordinary and "A"
ordinary shares of 50p each, and 730,000 preference shares of L1 each, and (ii)
the issued and paid-in share capital of the Company at September 30, 1996
consisted of L1,487,448 divided into 1,628,097 ordinary and "A" ordinary shares
and 673,400 preference shares.
At the time of the Company's February 1997 Offering: (i) the Company's "A"
ordinary shares were converted into ordinary shares of 50p to provide a single
class of ordinary share, (ii) each of the Company's authorized and unissued
ordinary shares of 50p were split into fifty Ordinary Shares of 1p each, and
(iii) each of the Company's authorized and unissued preference shares were split
into 100 preference shares of 1p each and redesignated as Ordinary Shares of 1p
each.
F-77
<PAGE> 278
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PURCHASE OF OWN SHARES AND CHANGE IN CAPITAL STRUCTURE
On or immediately prior to the Company's initial public offering, on March
4, 1997 the Company (1) redeemed and cancelled all outstanding issued Preference
Shares of L1 each; (2) redesigned each "A" Ordinary Share of L0.50 each as an
Ordinary Share of L0.50 each; (3) subdivided each Ordinary Share of L0.50 into
fifty Ordinary Shares of one pence each; (4) subdivided each Preference Share of
L1 each into one hundred Preference Shares of one pence each; (5) redesignated
each Preference Share of one pence each as Ordinary Share of one pence each; and
(6) increased the Company's share capital and amended Article 6 of the
Memorandum and Articles of Association to read: "The share capital of the
Company is 2,000,000 divided into 200,000,000 Ordinary Shares of one pence
each".
PREFERENCE SHARES
The non-voting, non-dividend bearing preference shares were redeemable at
their face value (which equals carrying value) by the Company in whole or in
part at the Company's option on or before February 25, 1998. The Company was
obliged to redeem the preference shares upon (i) the listing of the ordinary
share capital of the Company on any recognized investment exchange or stock
exchange, or (ii) the unconditional acquisition by a buyer of more than 50% of
the Ordinary Shares of the Company.
On January 31, 1997, the Company redeemed 437,337 preference shares for
L437,337 and the remaining preference shares were redeemed on March 4, 1997 out
of the proceeds of the Offering.
WARRANTS
On February 25, 1994, concurrent with a subscription for "A" ordinary
shares the Company also issued to its "A" ordinary shareholder (i) class "A"
share warrants that entitled the holder to purchase 56,518 "A" ordinary shares
of Esprit Telecom (Jersey) Limited for an exercise price of $1.00 per share and
(ii) class "B" share warrants that entitled the holder to purchase an additional
50,000 "A" ordinary shares of Esprit Telecom (Jersey) Limited for issuance at an
exercise price of $13.00 per share. The warrants were exercisable up to the date
that the preference shares were redeemed in full or cancelled.
Effective January 31, 1997, the warrants were exercised for a total
consideration amount of $706,518 (L437,337) which was applied against the
partial redemption of outstanding preference shares.
F-78
<PAGE> 279
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
21 PURCHASE OF SUBSIDIARY UNDERTAKINGS
With effect from May 1, 1998, the group acquired whole of the issue Share
capital of Thyssen Festnetz Management GmbH and the whole limited partnership
interest in Thyssen Festnetz GmbH & Co. KG for an estimated cash consideration
of L90,068,000 before expenses. This has been accounted for as an acquisition.
Goodwill arising has been capitalized in the balance sheet and amortised over 15
years as this is the period over which the directors estimate that the value of
the underlying business acquired is expected to exceed the value of the
underlying assets. Following the completion of the 1998 financial year the total
consideration has been adjusted downwards by approximately DM 40 million, based
upon the billed revenues of the business, as prescribed in the agreed
contractual terms of the acquisition.
The loss after tax of the Plusnet business for the years ended September
30, 1997 was DM 30,596,000. The loss after tax of the Plusnet business for the
period to acquisition on May 1, 1998 was DM 8,309,000.
The assets and liabilities acquired at that date were as follows:
<TABLE>
<CAPTION>
FAIR VALUE FAIR VALUE TO
BOOK VALUE ADJUSTMENTS COMPANY
---------- ----------- -------------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Tangible fixed assets.................................. 7,440 -- 7,440
Debtors................................................ 4,135 -- 4,135
Cash at Bank and in Hand............................... 1 -- 1
------ ------
Total assets........................................... 11,576 -- 11,576
Creditors due within one year.......................... (7,624) -- (7,624)
Creditors due after more than one year................. (40) -- (40)
------ ------
Total Liabilities...................................... (7,664) -- (7,664)
Net assets............................................. 3,912 -- 3,912
Goodwill arising on acquisition........................ -- 87,151
------
91,063
======
Represented by:
Cash paid.............................................. 90,068
Cost associated with the acquisition................... 995
------
91,063
======
</TABLE>
On November 18, 1997, the Company acquired the whole share capital of IMS
Interaktieve Media Services BV for an estimated consideration before costs of
L7,131,000 satisfied by the issue of 752,804 ordinary shares, cash of L1,518,000
and deferred consideration of L5,085,000. This has been accounted for as an
acquisition.
Goodwill has been capitalised in the balance sheet and amortised over 15
years as this is the period over which the directors estimate that the value of
the underlying business acquired is expected to exceed the value of the
underlying assets.
The profit after tax of IMS in the year ended December 31, 1996 was NLG
542,476. The loss after tax of IMS in the period ended November 17, 1997 was NLG
450,463.
F-79
<PAGE> 280
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The assets and liabilities acquired at that date were as follows.
<TABLE>
<CAPTION>
FAIR VALUE FAIR VALUE TO
BOOK VALUE ADJUSTMENTS COMPANY
---------- ----------- -------------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Tangible Fixed Assets.................................. 1,041 -- 1,041
Debtors................................................ 493 -- 493
------ ------
Total Assets........................................... 1,534 -- 1,534
Overdrafts............................................. (118) -- (118)
Creditors due within one year.......................... (1,174) -- (1,174)
Creditors due after one year........................... (336) -- (336)
------ ------
Total Liabilities...................................... (1,628) -- (1,628)
Net Liabilities........................................ (94) -- (94)
Goodwill arising on acquisition........................ 7,225
------
7,131
======
Represented by:
Cash consideration..................................... 1,518
Estimated deferred cash consideration.................. 3,339
Fair Value of shares issued............................ 389
Estimated fair value of deferred share consideration... 1,746
Cost associated with the acquisition................... 139
------
7,131
======
</TABLE>
With effect from 1 February 1998, the Group acquired the trade, assets and
liability to the curator-in-bankruptcy of Budget Phone Card BV, a customer in
liquidation. The Company regards the amount receivable from Budget Phone Card BV
at the time of acquisition as the fair value of the purchase consideration.
<TABLE>
<CAPTION>
FAIR VALUE FAIR VALUE TO
BOOK VALUE ADJUSTMENTS COMPANY
---------- ----------- -------------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Cash................................................... 60 -- 60
Debtors................................................ 109 (38) 71
--- --- ---
Total Assets........................................... 169 (38) 131
Creditors due within one year.......................... (50) (49) (99)
Creditors due after one year........................... -- -- --
--- --- ---
Total Liabilities...................................... (50) (49) (99)
Net Assets............................................. 119 (87) 32
Goodwill arising on acquisition........................ 575
---
607
===
Represented by:
Net debt receivable at liquidation..................... 586
Costs associated with acquisition...................... 21
---
607
===
</TABLE>
Fair value adjustments represent revaluations of the acquired amounts,
principally providing against certain debtors and recognizing other unrecorded
liabilities.
F-80
<PAGE> 281
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
ADJUSTMENT TO PRIOR YEAR ACQUISITIONS.
No adjustment has been necessary to the fair value acquisition adjustments
in respect of all the prior years' acquisitions.
22 FINANCIAL AND CAPITAL COMMITMENTS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
1996 1997 1998
------ ------ ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Capital expenditure authorized and contracted for........... -- 3,159 64,302
Capital expenditure authorized and not contracted for....... 2,200 2,747 5,797
</TABLE>
The Company and its subsidiaries are party to various operating leases for
dedicated switch access lines, dedicated national and international lines,
office space, furniture and office equipment which expire at various times
through to the year 2002.
Operating lease payments payable within one year of the balance sheet date
were in respect of operation leases expiring:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30, 1996
-----------------------------
LAND AND
BUILDINGS OTHER TOTAL
--------- ------ ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Operating leases which expire:
within one year............................................. 20 391 411
between one and five years.................................. 260 2,333 2,593
after five years............................................ 162 -- 162
--- ----- -----
442 2,724 3,166
=== ===== =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30, 1997
-----------------------------
LAND AND
BUILDINGS OTHER TOTAL
--------- ------ ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Operating leases which expire:
within one year............................................. 93 5,528 5,621
between one and five years.................................. 409 235 644
after five years............................................ 275 -- 275
--- ----- -----
777 5,763 6,540
=== ===== =====
</TABLE>
F-81
<PAGE> 282
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30, 1998
-----------------------------
LAND AND
BUILDINGS OTHER TOTAL
--------- ------ ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Operating leases which expire:
within one year............................................. 154 3,819 3,973
between one and five years.................................. 885 909 1,794
after five years............................................ 482 155 637
----- ----- -----
1,521 4,883 6,404
===== ===== =====
</TABLE>
The future minimum lease payments under non-cancellable leases as of
September 30, 1998 are:
<TABLE>
<CAPTION>
FINANCE LEASES
------------------------------------------
PAYABLE IN THE YEAR ENDED SEPTEMBER 30, OPERATING CAPITAL INTEREST TOTAL
- --------------------------------------- --------- ------- -------- ------
L L L L
(IN THOUSANDS)
<S> <C> <C> <C> <C>
1999................................................. 6,404 3,230 1,993 11,627
2000................................................. 2,418 3,610 1,633 7,661
2001................................................. 2,162 2,548 1,286 5,996
2002................................................. 1,734 1,575 1,118 4,427
2003................................................. 1,398 1,628 975 3,996
Thereafter........................................... 351 7,408 2,135 9,894
------ ------ ----- ------
14,467 19,999 9,140 43,601
====== ====== ===== ======
</TABLE>
F-82
<PAGE> 283
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
23 ANALYSIS OF CASH FLOWS FOR HEADINGS NETTED IN THE CASH FLOW STATEMENT
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------
1996 1997 1998
------ ------ -------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
RETURNS ON INVESTMENTS AND SERVICING OF FINANCE
Interest received........................................... 142 1,152 8,264
Interest paid............................................... (149) (142) (1,606)
Interest element of finance lease rental payments........... (196) (315) (1,205)
Interest paid on Senior Notes............................... -- -- (10,287)
------ ------ -------
Net cash (outflow)/inflow for returns on investments and
servicing of finance...................................... (203) 695 (4,834)
====== ====== =======
CAPITAL EXPENDITURE AND FINANCIAL INVESTMENT
(Purchase)/Sale of investment............................... (31) (100) 331
Purchase of tangible fixed assets........................... (3,563) (7,819) (22,809)
------ ------ -------
Net cash outflow from capital expenditure and financial
investment................................................ (3,594) (7,919) (22,478)
====== ====== =======
ACQUISITIONS
Net overdrafts acquired with subsidiary (Note 25)........... -- (85) (118)
Cash acquired with subsidiary............................... -- -- 61
Purchase of subsidiary undertaking (Note 25)................ -- (767) (91,586)
------ ------ -------
Net cash outflow for acquisitions........................... -- (852) (91,643)
====== ====== =======
FINANCING
Issue of ordinary share capital............................. 7,365 30,629 307
Redemption of preference shares............................. -- (673) --
Proceeds from warrants exercised............................ -- 437 --
Proceeds from bridging loans................................ -- -- 25,000
Repayment of bridging loans................................. -- -- (25,000)
Proceeds from Senior Notes 2007 and 2008.................... -- -- 311,036
Repayments of short-term borrowings......................... -- -- --
Proceeds from long-term borrowings.......................... -- -- --
Repayment of long-term borrowings........................... (631) (91) (46)
Capital element of finance lease repayments................. (193) (503) (2,988)
------ ------ -------
Net cash inflow from financing.............................. 6,541 29,799 308,309
====== ====== =======
</TABLE>
Management of liquid resources represents the movement on both short term
cash deposits and restricted securities. Restricted securities represent escrow
funds that are used to finance a proportion of the interest payments on Senior
Notes 2007.
F-83
<PAGE> 284
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
24 ANALYSIS OF NET DEBT
<TABLE>
<CAPTION>
ACQUISITIONS
(EXCLUDING OTHER
AT CASH AND NON CASH EXCHANGE AT
OCTOBER 1, CASH FLOW OVERDRAFTS) CHANGES(1) MOVEMENTS SEPTEMBER 30,
---------- --------- ------------ ---------- --------- -------------
L L L L L L
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
1996
Bank balances and cash............... 5,615 (1,574) -- -- 54 4,095
Overdrafts........................... (404) (262) -- -- -- (666)
------ -------- ---- ------- ------ --------
5,211 (1,836) -- -- 54 3,429
Debt due after one year.............. (631) 614 -- -- 17 --
Debt due within one year............. -- -- -- -- -- --
Finance leases....................... (193) 356 -- (2,595) -- (2,432)
------ -------- ---- ------- ------ --------
4,387 (866) -- (2,595) 71 997
Short term cash deposits............. -- 2,335 -- -- 2,335
------ -------- ---- ------- ------ --------
Total................................ 4,387 1,469 -- (2,595) 71 3,332
====== ======== ==== ======= ====== ========
1997
Bank balances and cash............... 4,095 (2,383) -- -- (63) 1,649
Overdrafts........................... (666) 564 -- -- 1 (101)
------ -------- ---- ------- ------ --------
3,429 (1,819) -- -- (62) 1,548
Debt due after one year.............. -- 12 (12) -- -- --
Debt due within one year............. -- 79 (123) -- (2) (46)
Finance leases....................... (2,432) 503 -- (2,003) -- (3,932)
------ -------- ---- ------- ------ --------
997 (1,225) (135) (2,003) (64) (2,430)
Current assets Short term cash
deposits........................... 2,335 20,541 -- -- -- 22,876
------ -------- ---- ------- ------ --------
Total................................ 3,332 19,316 (135) (2,003) (64) 20,446
====== ======== ==== ======= ====== ========
1998
Bank balances and cash............... 1,649 2,575 -- -- 9 4,233
Overdrafts........................... (101) (414) -- -- (1) (516)
------ -------- ---- ------- ------ --------
1,548 2,161 -- -- 8 3,717
Debt due within one year............. (46) 46 -- -- -- --
Senior Notes due 2007 and 2008....... -- (311,036) -- (658) 1,955 (309,739)
Finance leases....................... (3,932) 2,988 -- (18,346) (703) (19,993)
------ -------- ---- ------- ------ --------
(2,430) (305,841) -- (19,004) (1,260) (326,015)
Current assets
Short term cash deposits............. 22,876 108,573 -- -- 98 131,547
------ -------- ---- ------- ------ --------
Restricted securities................ -- 49,485 -- -- (516) 48,969
Total................................ 20,446 (147,783) -- (19,004) 842 (145,499)
====== ======== ==== ======= ====== ========
</TABLE>
- ---------------
(1) Other non cash changes, see note 26.
(2) Restricted securities are those securities held to pay the first three years
of interest on the Senior Notes 2007 as required under the covenants of the
Senior Notes 2007.
F-84
<PAGE> 285
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
25 PURCHASE OF SUBSIDIARY UNDERTAKINGS
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
1998
-------------
L'000
<S> <C>
Net assets acquired:
Tangible fixed assets....................................... 8,481
Debtors..................................................... 4,699
Cash at bank and in hand.................................... 61
Creditors................................................... (9,275)
Bank overdrafts............................................. (118)
------
Net assets.................................................. 3,848
Goodwill.................................................... 94,953
------
98,801
======
Satisfied by:
Shares allotted............................................. 389
Cash paid................................................... 91,586
Cash payable................................................ 1,746
Estimated deferred cash consideration....................... 3,339
Net debt receivable at liquidation.......................... 586
Costs associated with the acquisition....................... 1,155
------
98,801
======
</TABLE>
The subsidiary undertakings acquired during the year contributed L5,888,000
to the Company's net operating cash flows and utilised L6,392,000 for capital
expenditure.
26 OTHER NON-CASH CHANGES
Other non-cash changes represent finance leases entered into by the
Company. At the start of 1995, the Company entered into a finance lease with
COLT Telecom for the purchase of equipment. This was repaid in full during 1996.
On October 13, 1995, the Company entered into a five-year finance lease with
Ericsson to acquire a telecommunications switch. During the year the Company
entered into an additional finance lease with Ericsson to acquire a second
telecommunications switch. Additional amounts were also spent on capital
additions from Ericsson to upgrade their existing switch which has been
capitalised as part of the first lease.
Other non-cash changes to the Senior Notes 2007 and 2008 of L658,000
represent the year's amortisation of the issue costs. Other non cash charges for
finance represent additional lease facilities and accounts for the
infrastructure. During the year the Company utilized additional finance lease
facilities with Ericsson to acquisition additional telecommunications switching
equipment.
27 SUBSEQUENT EVENTS
In the period since September 30, 1998 the following additional subsequent
events occurred:
A) Under the Executive Plan, between October, 5 and November, 2 1998. October,
the Board approved the granting of share options to key employees as
follows:
F-85
<PAGE> 286
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
NUMBER OF SHARE OPTIONS ISSUED ADS EQUIVALENT EXERCISE PRICE PER ADS
<S> <C> <C>
245,000 35,000 US$16.125
140,000 20,000 US$17.25
140,000 20,000 US$17.25
</TABLE>
B) SPANISH LICENSE:
Esprit Telecom de Espana has class B1 licences for Madrid, Barcelona and
Gerona. These permit the provision of public telephony services and the
operation of a network in the named cities. A B1 licence for Bilbao has been
applied for and is expected to be issued before the end of December. A class C1
licence (allowing the running of a national network, but not the provision of
public telephony services) was granted on December 17, 1998.
C) NEW LEASES IN READING:
The Company has contracted in November 1998 additional office space at its
Reading offices (UK) through a 5 year lease that expires in March 2008, with a
tenant only option to break in March 2003, for a total consideration of
L850,777. Additionally, the Company has committed to a leases at its Reading
offices (UK) starting in December 98 and starting in April 99 for a total
consideration of L938,920 expiring in 2008 and 2009 respectively, with a tenant
only option to break in 2003.
D) APPOINTMENT OF SIR ROBIN BIGGAM
On October 5, 1998 the Board of Directors elected Sir Robin Biggam as
Director, and appointed him Chairman of the Company in place of Walter Anderson.
Subsequently, on November 23, 1998 at an Extraordinary General Meeting, the
Members of the Company voted to remove Walter Anderson as a Director.
E) PROPOSED MERGER WITH GLOBAL TELESYSTEMS GROUP, INC.
The Boards of GTS and Esprit Telecom announced on December 8, 1998 that
agreement has been reached on the terms of a proposed recommended 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.
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 December 7,
1998, the Offer values each Esprit Telecom Share at $5.31 (L3.21) and each
Esprit Telecom ADS at $37.16 (L22.48).
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
December 7, 1998, being the last dealing day before the announcement of the
Offer.
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 (L458.2 million).
F-86
<PAGE> 287
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
The Board of Esprit Telecom intends unanimously to recommend the Offer.
The posting of the Offer Document to Esprit Telecom Security holders 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.
The Offer will be conditional, inter alia, on the approval of GTSs
shareholders and the announcement by NASDAQ and EASDAQ of their decision to
admit the New GTS Shares for quotation.
F) NORTEL EQUIPMENT FINANCING AGREEMENT
On November 17, 1998 the Company entered into a senior secured amortising
loan facility with Northern Telecom to manufacture, install and commission
SDH/DWDM equipment in five separate rings within Western Europe. The total
consideration is DM 37 million with the final maturity being December 31, 2002.
G) ERICSSON EQUIPMENT FINANCING AGREEMENT
On December 1, 1998 the Company entered into a senior secured amortising
loan facility with Ericsson to manufacture, install and commission
telecommunication switches and equipment. Total consideration is L9 million
pounds sterling, with the final maturity being December 31, 2002.
28 RELATED PARTY TRANSACTIONS
The Company purchased the services of the outgoing Chairman Walt Anderson
from Entree International.
During the year, the Company acquired Plusnet, IMS and the trade and assets
of Budget Phone Card. (see Note 21). The Company did not trade with IMS prior to
the acquisition.
Until October 13, 1997, Gold and Appel owned 17% of the capital stock of
Telco Communications Group, Inc. ("Telco"), a long distance telecommunications
company. The Company purchased certain long distance telecommunications services
from, and sells certain services to, Telco. In addition the Company engages Tel
Labs Inc., a wholly owned subsidiary of Telco ("Tel Labs"), for the final
processing of its customer billing records.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------
1996 1997 1998
----- ----- -----
(IN THOUSANDS)
<S> <C> <C> <C>
Sales to Plusnet...................................... -- 180 267
Purchases from Plusnet................................ -- 71 185
Sales to Budget Phone Card............................ 83 997 430
Purchases from Entree International................... -- -- 250
Sales to Telco........................................ 1,958 593 476
Purchases from Telco.................................. 1,947 4,007 1,419
Purchases from Tel Labs............................... 311 402 45
</TABLE>
F-87
<PAGE> 288
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Balances receivable and payable in respect of the above related parties,
were as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------
1996 1997 1998
----- ----- -----
L'000 L'000 L'000
<S> <C> <C> <C>
Net receivable from Plusnet.............................. -- 3 --
Net receivable from Budget Phone Card.................... 65 440 586
Net payable to Entree International...................... -- -- 4
Net payable/(receivable) to/from Telco................... 158 114 (94)
Payable to Tel Labs...................................... 29 38 --
</TABLE>
29 SUBSIDIARY UNDERTAKINGS
The following companies were the principal subsidiary undertakings as at
September 30, 1998.
<TABLE>
<CAPTION>
CLASS AND
COUNTRY OF PERCENTAGE OF
NAME LEGAL SEAT INCORPORATION OWNERSHIP
- ---- ----------- ---------------------- -------------
<S> <C> <C> <C>
Esprit Telecom (Jersey) Limited.............. St Helier Jersey 100% ordinary
Esprit Jersey Management Limited (including
its Dutch branch).......................... St Helier Jersey 100% ordinary
Esprit Telecom UK Limited.................... London United Kingdom 100% ordinary
Telecom Europa Limited....................... London United Kingdom 100% ordinary
Esprit Telecom Holdings Limited.............. London United Kingdom 100% ordinary
Esprit Telecom Europe BV..................... Amsterdam The Netherlands 100% ordinary
Esprit Telecom Benelux BV (including its
Belgian branch)............................ Amsterdam The Netherlands 100% ordinary
Swift Global Netherlands BV.................. Zoeterwoude The Netherlands 100% ordinary
Esprit Telecom France SA..................... Paris France 100% ordinary
Esprit Telecom de Espana SA.................. Madrid Spain 100% ordinary
Icomnet SA (including its Washington, DC, US
branch).................................... Tortola British Virgin Islands 100% ordinary
Esprit Telecom Deutschland GmbH.............. Frankfurt Germany 100% ordinary
Esprit Telecom Italia Srl.................... Milan Italy 100% ordinary
IMS Interaktieve Media Services BV........... Amsterdam The Netherlands 100% ordinary
IMS Plus BV.................................. Amsterdam The Netherlands 100% ordinary
Plusnet Management GmbH...................... Dusseldorf Germany 100% ordinary
Plusnet GmbH & Co. KG........................ Dusseldorf Germany 100% ordinary
Esprit Telecom Netzwerk GmbH................. Dusseldorf Germany 100% ordinary
Esprit Telecom Deutschland Holding GmbH...... Dusseldorf Germany 100% ordinary
Plusnet Telecom GmbH Company KG.............. Dusseldorf Germany 100% ordinary
</TABLE>
F-88
<PAGE> 289
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
30 DIFFERENCES BETWEEN UK AND US GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
("GAAP")
The Company's financial statements have been prepared in accordance with UK
GAAP which differ in certain respects from US GAAP. The material differences as
they apply to the Company are summarized below:
(A) SHARE OPTION AWARDS
As required under Urgent Issue Task Force Abstract 17 (UITF 17), under UK
GAAP, share options granted to employees are recognized in the Company's
financial statements when the share options have been granted. Such grants give
rise to compensation expense measured by reference to the fair value of shares
only on date of grant, and at no subsequent date even for variable plans. Under
US GAAP, Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees," compensation expense resulting from awards under variable
plans measures compensation costs as the difference between the quoted market
price at the date when the number of shares of stock are known (the date the
performance conditions are satisfied) and the exercise price; the cost is
recognised over the period the employee performs related services. Since the
ultimate compensation cost is unknown until the performance conditions are
satisfied, estimates of compensation cost are recorded before the measurement
date based on the quoted market price of the stock at intervening dates in
situations where it is probable that the performance conditions will be
attained. The Company deemed that the performance conditions were likely to be
satisfied at September 30, 1998, however the compensation cost as of September
30, 1998 was immaterial to the Company.
In October 1995, the US Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," (FAS 123) which provides companies with a fair value method of
recognising stock-based compensation expense in the financial statement, but
permits the use of the recognition principles previously prescribed by APB
Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25) as long as
disclosure of the effects of the fair-value method are included in the notes to
the financial statements. The Company adopted FAS 123 in 1997 but has continued
to use the recognition principles of APB 25.
If the Company had elected to recognise compensation expense based upon the
fair value at the grant date for awards under its various option plans,
consistent with the methodology prescribed by FAS 123, the Company's US GAAP net
loss and loss per share would be altered to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
----------------------------
1996 1997 1998
------ ------- -------
L L L
(THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C> <C>
US GAAP Net loss:
As reported............................................... (5,325) (10,852) (42,447)
Pro forma................................................. (5,053) (11,362) (44,135)
US GAAP loss per ordinary share:
As reported............................................... (0.08) (0.10) (0.34)
Pro forma................................................. (0.07) (0.11) (0.36)
US GAAP loss per ADS:
As reported............................................... (0.56) (0.70) (2.38)
Pro forma................................................. (0.49) (0.77) (2.52)
</TABLE>
These pro forma amounts may not be representative of future disclosures
since the estimated fair value of stock options is amortized to expense over the
vesting period, and additional options may be granted in future years. The fair
value for these options was estimated at the date of grant using the
Black-Scholes option-
F-89
<PAGE> 290
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
pricing model with the following assumptions for the years ended September 30,
1996, 1997 and 1998: dividend yields of 0.0%; expected volatility of 150% for
1996 and 1997 and 100% for 1998; risk-free interest rate of 7.3% for 1996 and
1997 and a weighted average interest rate 5.4% for 1998; expected lives for
options exercisable at L0.01 from 3 years to 5 years; expected lives for options
exercisable between LNil and L1.05 from 5 to 8.5 years; and expected lives for
options exercisable at L0.57 and L0.68 of 3 and 4 years respectively for 1996
and 1997. In 1998, the expected life for MSOP options exercisable at $2.30 and
$2.40 of 3.5 years and expected lives for options exercisable ranging from L0.54
- -- L2.45 of 3 to 3.5 years.
The weighted average fair value of options granted during the years ended
September 30, 1997 and 1996 for which the exercise price is L0.01 was L0.79 and
L0.31 respectively. The weighted average fair value of options granted during
the year ended September 30, 1997 for which the exercise price is between LNil
and L1.05 was L0.60. The weighted average fair value of options granted during
the year ended September 30, 1998 was L0.94.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's stock option plans have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock option plans.
Transactions involving stock options are summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
STOCK EXERCISE PRICE
OPTIONS OF OPTIONS
DESCRIPTION OUTSTANDING OUTSTANDING
- ----------- ----------- --------------
L
<S> <C> <C>
Balance, September 30, 1995................................. 883,250 0.01
Granted................................................... 5,515,650 0.01
Exercised................................................. (58,250) 0.01
Cancelled................................................. -- --
---------- ----
Balance, September 30, 1996................................. 6,340,650 0.01
Granted................................................... 4,449,108 0.31
Exercised................................................. (710,500) 0.01
Cancelled................................................. (107,150) 0.01
---------- ----
Balance, September 30, 1997................................. 9,972,108 0.06
Granted................................................... 5,370,797 1.37
Exercised................................................. (2,418,859) 0.12
Cancelled................................................. (585,151) 1.14
---------- ----
Balance, September 30, 1998................................. 12,338,895 0.78
========== ====
</TABLE>
(B) REDEEMABLE PREFERENCE SHARES
Under UK GAAP, redeemable preference shares are included in shareholders'
funds. Under US GAAP, because these shares have a mandatory redemption feature,
they are not classified as shareholders' equity.
F-90
<PAGE> 291
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(C) DEFERRED TAXATION
Under UK GAAP, deferred income taxes are accounted for to the extent that
it is probable that a liability or asset will arise in the foreseeable future as
a result of reversing timing differences. Under US GAAP, deferred taxes are
accounted for on all temporary differences, and a valuation allowance is
established to reduce deferred tax assets to the amount which "more likely than
not" will be realized in future tax returns. The deferred tax asset under UK
GAAP can be reconciled to the deferred tax asset under US GAAP as follows:
<TABLE>
<CAPTION>
AS AT SEPTEMBER 30,
---------------------------
1996 1997 1998
------ ------ -------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Deferred tax asset under UK GAAP............................ -- -- --
Tax effects of timing differences
Tax losses................................................ 2,764 5,122 18,296
Capital allowances........................................ -- -- --
Other timing differences deferred......................... -- -- --
------ ------ -------
Gross deferred tax assets in accordance with US GAAP........ 2,764 5,122 18,296
Valuation allowance......................................... (2,764) (5,122) (18,296)
Net deferred tax assets in accordance with US GAAP.......... -- -- --
====== ====== =======
</TABLE>
A valuation allowance has been provided against the full amount of the
deferred tax assets arising from tax loss carry forwards as, in light of the
Company's start-up nature and lack of profitable operations to date, management
believes it is conservative to consider it more likely than not that sufficient
taxable income will not be generated to utilize these loss carry forwards.
(D) EFFECT ON NET LOSS OF DIFFERENCES BETWEEN UK GAAP AND US GAAP
<TABLE>
<CAPTION>
AS AT SEPTEMBER 30,
----------------------------
1996 1997 1998
------ ------- -------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Loss for the financial year in accordance with UK GAAP...... (5,094) (10,860) (42,447)
US GAAP adjustments:
Share option awards......................................... (231) 8 --
------ ------- -------
Loss for the financial year in accordance with US GAAP(2)... (5,325) (10,852) (42,447)
====== ======= =======
Basic and diluted loss per Ordinary Share in accordance with
US GAAP(1)................................................ (0.08) (0.10) (0.34)
====== ======= =======
Number of Ordinary Shares used for calculating US GAAP basic
loss per Ordinary Share (in thousands).................... 68,397 104,900 124,095
====== ======= =======
</TABLE>
- ---------------
(1) Previously reported basic loss per Ordinary Share in accordance with US GAAP
has been restated to reflect the adoption of Statement of Financial
Accounting Standard No. 128 "Earnings Per Share" and re-determination of the
number of Ordinary Shares used for calculating US GAAP loss per Ordinary
Share for all periods presented.
(2) No adjustment has been reflected as at September 30, 1997 or 1998 in respect
of contingent purchase consideration related to the acquisitions, which is
accrued as a liability under UK GAAP but not under US GAAP, as this
difference is not material to the loss or net shareholders' funds/(deficit)
for the periods and dates presented.
F-91
<PAGE> 292
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(E) EFFECT ON SHAREHOLDERS' FUNDS/(DEFICIT) OF DIFFERENCES BETWEEN UK GAAP AND
US GAAP
<TABLE>
<CAPTION>
AS AT SEPTEMBER 30,
--------------------------
1996 1997 1998
------ ------ ------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Shareholders' funds (deficit) in accordance with UK GAAP.... 10,011 31,374 (7,199)
US GAAP adjustments
Share option awards....................................... (252) (244) (244)
Cumulative increase in share premium from share
incentive.............................................. 252 244 244
Redeemable preference shares.............................. (673) -- --
------ ------ ------
Shareholders' funds/(deficit) in accordance with US GAAP.... 9,338 31,374 (7,199)
====== ====== ======
</TABLE>
(F) CONSOLIDATED STATEMENT OF CASH FLOWS
The Company's consolidated cash flow statement is prepared in accordance
with Financial Reporting Standard No. 1 (Revised 1996), "Cash Flow Statements,"
and presents substantially the same information as that required under Statement
of Financial Accounting Standards No. 95. However, there are certain differences
in classification of items within the cash flow statement and with regard to the
definition of cash equivalents between UK and US GAAP.
Cash flows from (i) operating activities; (ii) returns on investments and
servicing of finance; (iii) taxation; (iv) capital expenditure and financial
investment; (v) management of liquid resources; and (vi) financing activities
are presented separately under UK GAAP. However, US GAAP only requires
presentation of cash flows from three activities: operating, investing and
financing.
Cash and cash equivalents under UK GAAP include cash in hand and deposits
repayable on demand less any bank loans and overdrafts repayable on demand.
Under US GAAP overdrafts are included in financing activities.
Cash flows from taxation and returns on investments and servicing of
finance are, included as operating activities under US GAAP. The payment of
dividends is included under financing activities and capitalized interest is
included under investing activities for US GAAP purposes.
F-92
<PAGE> 293
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes the statement of cash flows for the Company
as if they had been presented in accordance with US GAAP and include the
adjustments which reconcile cash and cash equivalents under US GAAP to cash and
cash equivalents under UK GAAP.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-----------------------------
1996 1997 1998
------ ------- --------
L L L
(IN THOUSANDS)
<S> <C> <C> <C>
Net cash outflow from operating activities.................. (2,448) (2,306) (33,969)
Net cash used in investing activities....................... (3,594) (8,686) (114,003)
Net cash provided by financing activities................... 6,803 29,150 259,218
------ ------- --------
Net increase in cash and cash equivalents under US GAAP..... 761 18,158 111,246
Effects of exchange rates on cash and cash equivalents...... 54 (63) 9
Cash and cash equivalents under US GAAP at beginning of
year...................................................... 5,615 6,430 24,525
------ ------- --------
Cash and cash equivalents under US GAAP at end of year...... 6,430 24,525 135,780
Short term cash deposits.................................... (2,335) (22,876) (131,547)
------ ------- --------
Bank balances and cash under UK GAAP at end of year......... 4,095 1,649 4,233
====== ======= ========
</TABLE>
(G) OTHER US GAAP DISCLOSURES
Accounting estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Concentrations of credit risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of accounts receivable and
cash and equivalents. Management believes the concentration of credit risk
associated with accounts receivable is minimal due to the dispersion over many
customers and different industries. Cash and liquid resources are invested in
short-term money market instruments with two U.K. commercial banks. The risk
associated with the Company's cash and liquid resources is mitigated by the fact
that these amounts are placed in what it believes to be high quality financial
institutions. The Company has not experienced any losses to date on its
deposited cash.
Fair value of financial instruments
The Company enters into foreign currency forward contracts (principally
Deutsche mark and US dollar) to eliminate foreign exchange risk. The Company
utilizes foreign currency forward contracts which are short-term in duration
(generally one week or less), accordingly, the fair value of the forward
contracts at September 30, 1998 approximated to contract value.
F-93
<PAGE> 294
ESPRIT TELECOM GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Acquisitions
The following unaudited pro forma consolidated results of operations for
the years ended September 30, 1997 and 1998 assumes the acquisitions had
occurred on October 1 of each year:
<TABLE>
<CAPTION>
PRO FORMA INFORMATION 1997 1998
- --------------------- -------- --------
UNAUDITED (IN THOUSANDS,
EXCEPT PER SHARE
DATA)
<S> <C> <C>
Revenues.................................................... 70,054 106,905
Income (loss) for the financial year........................ (21,749) (45,372)
-------- --------
Loss per ordinary share..................................... (0.21) (0.36)
======== ========
</TABLE>
Recently issued accounting standards
In June 1997, the FASB issued Statement of Financial Accounting Standards
(FAS) No. 130, "Reporting Comprehensive Income" and No. 131, "Disclosure about
Segments of an Enterprise and Related Information". FAS 130 and 131 are required
to be adopted by the Company during the 1999 financial year.
FAS 130 establishes standards for presenting other comprehensive income,
which is conceptually similar to the Statement of Total Recognised Gains and
Losses presented under UK GAAP. FAS 130 does not prescribe any new measurement
standards. As such, the Company does not believe that the adoption of FAS 130
will have a material impact on the reported results of operations or financial
position of the Company.
FAS 131 prescribes a management approach to the determination of reportable
segments and supersedes FAS 14. The Company is currently evaluating the impact
of FAS 131 on its segment disclosures but does not expect the adoption of the
standard to have a material impact on its reported results of operations and
financial position.
In February 1999, the FASB issued FAS 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits -- an amendment of FASB Statements
No. 87, 88, and 106." FAS 132 is required to be adopted in the Company's 1998
financial year, and attempts to streamline the disclosure requirements for
pension and post retirement benefit plans. Since the Company operates only a
defined contribution pension scheme, the adoption of this standard will not have
a material impact on the results of operation or financial position of the
Company.
In June 1999, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 is effective for all fiscal
quarters of all fiscal years beginning after June 15, 1999. SFAS No. 133
requires that all derivative instruments be recorded on the balance sheet at
their fair value. Changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the type
of hedge transaction. Management of the Company anticipates that, due to its
limited use of derivative instruments, the adoption of SFAS No. 133 will not
have a significant effect on the Company's results of operations or its
financial position.
31 COMPANIES ACT 1985
The Consolidated Financial Statements do not constitute "statutory
accounts" within the meaning of the United Kingdom Companies Act 1985 for any of
the periods presented. These Consolidated Financial Statements exclude certain
parent company statements and other information required by the Companies Act
1985. However, they include all material disclosures required by generally
accepted accounting principles in the United Kingdom including those Companies
Act 1985 disclosures relating to the profit and loss account and balance sheet
items.
F-94
<PAGE> 295
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of Esprit Telecom Group plc
We have audited the accompanying balance sheets of the switch-based
telecommunications services business operated by Plusnet Gesellschaft fur
Netzwerk Services mbH, Dusseldorf (the "Plusnet Business"), as of September 30,
1996 and 1997 and the related profit and loss accounts, cash flow statements,
statements of total recognized gains and losses and reconciliations of movements
in invested equity for each of the years in the three-year period ended
September 30, 1997. These financial statements are the responsibility of the
Plusnet Business's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Plusnet Business as of
September 30, 1996 and 1997 and the results of the Plusnet Business's operations
and its cash flows for each of the years in the three-year period ended
September 30, 1997 in conformity with accounting principles generally accepted
in the United Kingdom.
Accounting principles generally accepted in the United Kingdom vary in
certain significant respects from accounting principles generally accepted in
the United States. Application of accounting principles generally accepted in
the United States would have affected the determination of the loss for each of
the years in the three-year period ended September 30, 1997 and the
determination of invested equity as of September 30, 1996 and 1997 to the extent
summarized in note 16 to the financial statements.
Dusseldorf, June 10, 1998
KPMG Deutsche Treuhand-Gesellschaft
Aktiengesellschaft
Wirtschaftsprufungsgesellschaft
F-95
<PAGE> 296
PLUSNET BUSINESS
PROFIT AND LOSS ACCOUNTS
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
------------------------------------
NOTES 1995 1996 1997 1997
----- ------ ------- ------- -------
DM'000 DM'000 DM'000 $'000
<S> <C> <C> <C> <C> <C>
Turnover........................................ 2 8,782 31,451 45,521 24,614
Cost of sales................................... 2 (9,609) (35,481) (48,426) (26,185)
------ ------- ------- -------
Gross margin.................................... (827) (4,030) (2,905) (1,571)
Other operating expenses:
Selling, general and administrative........... 3,4 (6,574) (18,022) (13,402) (7,247)
Depreciation and amortization................. 3 (1,482) (4,900) (10,118) (5,471)
Restructuring costs........................... 5 -- -- (4,490) (2,428)
Other operating income.......................... 52 574 319 173
------ ------- ------- -------
LOSS ON ORDINARY ACTIVITIES BEFORE TAXATION..... (8,831) (26,378) (30,596) (16,544)
Extraordinary income............................ 6 -- 6,000 -- --
------ ------- ------- -------
Loss before taxation............................ (8,831) (20,378) (30,596) (16,544)
Taxation........................................ 7 -- -- -- --
------ ------- ------- -------
LOSS FOR THE FINANCIAL YEAR..................... (8,831) (20,378) (30,596) (16,544)
====== ======= ======= =======
</TABLE>
The entire turnover and loss for the three years ended September 30, 1997
arose from continuing operations.
The accompanying notes are an integral part of the financial statements.
F-96
<PAGE> 297
PLUSNET BUSINESS
BALANCE SHEETS
<TABLE>
<CAPTION>
AS AT SEPTEMBER 30,
--------------------------
NOTES 1996 1997 1997
----- ------- ------- ------
DM'000 DM'000 $'000
<S> <C> <C> <C> <C>
FIXED ASSETS
Tangible fixed assets..................................... 8 21,934 22,519 12,176
-- ------- ------- ------
CURRENT ASSETS
Debtors................................................... 9 7,201 7,432 4,019
Cash at bank and in hand.................................. -- -- --
------- ------- ------
7,201 7,432 4,019
CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR............ 10 (15,656) (15,374) (8,313)
------- ------- ------
NET CURRENT LIABILITIES................................... (8,455) (7,942) (4,294)
------- ------- ------
TOTAL ASSETS LESS CURRENT LIABILITIES..................... 13,479 14,577 7,882
PROVISIONS FOR LIABILITIES AND CHARGES.................... 11 (1,468) (1,424) (770)
------- ------- ------
NET ASSETS................................................ 12,011 13,153 7,112
======= ======= ======
INVESTED EQUITY........................................... 12,011 13,153 7,112
======= ======= ======
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-97
<PAGE> 298
PLUSNET BUSINESS
CASH FLOW STATEMENTS
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
----------------------------------------
NOTES 1995 1996 1997 1997
----- ------- ------- ------- -------
DM'000 DM'000 DM'000 $'000
<S> <C> <C> <C> <C> <C>
NET CASH OUTFLOW FROM OPERATING ACTIVITIES
(SEE NOTE BELOW)........................... (381) (19,520) (22,804) (12,330)
CAPITAL EXPENDITURE.......................... 14 (10,634) (11,024) (8,934) (4,831)
-- ------- ------- ------- -------
CASH OUTFLOW BEFORE FINANCING................ (11,015) (30,544) (31,738) (17,161)
FINANCING.................................... 14 11,014 30,540 31,738 17,161
-- ------- ------- ------- -------
DECREASE IN CASH IN THE PERIOD............... 15 (1) (4) -- --
== ======= ======= ======= =======
</TABLE>
RECONCILIATION OF OPERATING LOSS TO CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
---------------------------------------
1995 1996 1997 1997
------ ------- ------- -------
DM'000 DM'000 DM'000 $'000
<S> <C> <C> <C> <C>
Operating loss...................................... (8,831) (26,378) (30,596) (16,544)
Depreciation charge................................. 1,482 4,900 10,118 5,471
Profit on disposal of fixed assets.................. (1) (24) (1,769) (956)
Increase in debtors................................. (4,695) (2,301) (231) (125)
Increase/(decrease) in creditors.................... 11,664 4,283 (326) (176)
------ ------- ------- -------
Net cash outflow from operating activities.......... (381) (19,520) (22,804) (12,330)
====== ======= ======= =======
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-98
<PAGE> 299
STATEMENT OF TOTAL RECOGNIZED GAINS AND LOSSES
Total gains and losses recognized during the period are fully reflected in
the profit and loss accounts.
RECONCILIATIONS OF MOVEMENTS IN INVESTED EQUITY
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
---------------------------------------
1995 1996 1997 1997
------ ------- ------- -------
DM'000 DM'000 DM'000 $'000
<S> <C> <C> <C> <C>
Loss for the financial year......................... (8,831) (20,378) (30,596) (16,544)
Net equity contributions............................ 11,014 30,540 31,738 17,161
------ ------- ------- -------
Net increase in invested equity..................... 2,183 10,162 1,142 617
Opening invested equity............................. (334) 1,849 12,011 6,495
------ ------- ------- -------
Closing invested equity............................. 1,849 12,011 13,153 7,112
====== ======= ======= =======
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-99
<PAGE> 300
PLUSNET BUSINESS
NOTES TO THE FINANCIAL STATEMENTS
1. THE BUSINESS
The Plusnet Business has been operated during the period covered by these
financial statements by Plusnet Gesellschaft fur Netzwerk Services mbH, a
subsidiary of the Thyssen AG group. In a transaction which has yet to be legally
effected, Plusnet Gesellschaft fur Netzwerk Services mbH will transfer (with
retrospective effect from April 30, 1998) to Thyssen Netzwerk GmbH & Co. KG its
business operations and substantially all its assets and liabilities but
excluding any financial liabilities to the Thyssen AG group.
These financial statements reflect the financing provided to the business
by the Thyssen AG group in the past as a component of invested equity and
exclude certain other non-operating assets and liabilities of Plusnet
Gesellschaft fur Netzwerk Services mbH which are not reflected in the business
transfer to Thyssen Netzwerk GmbH & Co. KG.
The Plusnet Business is engaged in the provision of telecommunications
services in the Republic of Germany. All assets are located in Germany and
substantially all revenue arises from customers located in Germany.
2. BASIS OF PREPARATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The financial statements of the Plusnet Business have been prepared under
the historical cost convention and in accordance with accounting principles
generally accepted in the United Kingdom.
The Plusnet Business has been financed in the past by capital
contributions, loans and a "cash pool" facility made available by the Thyssen AG
group which are reflected in the enclosed financial statements as part of
invested equity. Net cash inflows to the Plusnet Business from the Thyssen AG
group are reported in these financial statements under "net equity
contributions".
Solely for the convenience of the reader, certain German Mark amounts in
these financial statements have been translated into US dollars at the rate of
1.8493 German Marks to the US dollar, which was the noon buying rate in the City
of New York for cable transfers in German Marks as certified for customs
purposes by the Federal Reserve Bank of New York ("DM Noon Buying Rate") on
March 31,1998. Such translations should not be construed as representations that
the German Mark amounts could have been or could be converted into US dollars at
that or any other rate.
The following principal accounting policies have been applied consistently
in dealing with items which are considered material in relation to the Plusnet
Business's results.
(a) Turnover
Turnover for telecommunications services is recorded on the basis of
minutes of traffic processed. Turnover represents the invoiced value of goods
and services supplied by the Plusnet Business, net of value added tax. Turnover
is recorded when the traffic is processed and the communications services are
rendered.
(b) Cost of sales
Network expenses are charged to income in the period in which the related
revenue is recognized.
(c) Fixed assets and depreciation
Tangible fixed assets comprising land and buildings, telecommunications
equipment, computers, furniture and office equipment are stated at historical
costs less accumulated depreciation.
F-100
<PAGE> 301
PLUSNET BUSINESS
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
Depreciation is calculated using the straight line method to write off the
cost less estimated residual value of each asset over the following estimated
useful economic lives:
<TABLE>
<S> <C>
Freehold building........................................... 25 years
Telecommunications equipment................................ 5 years
Furniture and office equipment.............................. 3-10 years
</TABLE>
Improvements to leasehold property are depreciated over the term of the
lease. Freehold land is not depreciated.
Software is amortized over its estimated useful economic life of between 3
and 5 years using the straight line method.
(d) Leased assets
Operating lease rentals are charged to the profit and loss account as they
arise over the period of the lease.
(e) Foreign currencies
Transactions in foreign currencies are recorded in deutschmarks at the
exchange rate ruling at the date of the transaction. Monetary assets and
liabilities denominated in foreign currency are translated into deutschmarks at
the exchange rate ruling at the balance sheet date, or at the forward exchange
rate where appropriate. Exchange gains and losses arising have been recorded in
the profit and loss account.
(f) Pension benefits
The Plusnet Business does not provide general pension benefits to its
employees. However, one current senior manager (in prior years two managers) has
been granted pension benefits under a defined benefit plan which is unfunded. A
balance sheet provision for the estimated future liability under this scheme is
established by the Plusnet Business on the basis of annual actuarial valuations.
The actuarial valuations of the future liability are made following assumptions
and methods prescribed by German tax regulations, which do not differ materially
in their impact on the financial statements from those prescribed by UK GAAP.
3. LOSS ON ORDINARY ACTIVITIES BEFORE TAXATION
The loss on ordinary activities before taxation is stated after charging:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------------
1995 1996 1997 1997
------ ------ ------ -----
DM'000 DM'000 DM'000 $'000
<S> <C> <C> <C> <C>
Depreciation of tangible fixed assets.............. 1,482 4,900 10,118 5,471
Net profit on disposal of tangible fixed assets.... (1) (24) (1,769) (956)
Operating lease rentals
Telecommunications equipment..................... 1,477 1,826 1,443 780
Cars............................................. 33 28 33 18
Rent of premises and utilities..................... 530 1,753 2,919 1,578
</TABLE>
F-101
<PAGE> 302
PLUSNET BUSINESS
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
4. STAFF NUMBERS AND COSTS
The average numbers of persons (including executive directors) employed by
the Plusnet Business during the year, analyzed by category were as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Sales and distribution...................................... 10 29 25
Technical support........................................... 11 29 26
Administration.............................................. 4 8 8
-- -- --
25 66 59
== == ==
</TABLE>
The aggregate payroll costs for these persons were as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------------
1995 1996 1997 1997
------ ------ ------ -----
DM'000 DM'000 DM'000 $'000
<S> <C> <C> <C> <C>
Wages and salaries................................. 2,711 7,206 6,396 3,458
Social security costs.............................. 360 1,039 1,003 542
Other pension costs................................ 28 29 17 10
----- ----- ----- -----
3,099 8,274 7,416 4,010
===== ===== ===== =====
</TABLE>
5. RESTRUCTURING COSTS
The restructuring costs in 1996/97 mainly comprise costs incurred in
connection with the fundamental restructuring of the Plusnet Business's network
technology. In this connection the Plusnet Business also incurred exceptional
depreciation charges on telecommunications equipment totalling DM 3,141,000
(included in the depreciation charge for the year).
6. EXTRAORDINARY INCOME
The Plusnet Business originally traded under the name T-Net Gesellschaft
fur Netzwerk Services GmbH. The rights to the name "T-Net" were sold to Deutsche
Telekom AG in 1996 resulting in extraordinary income of DM 6 million.
7. TAXATION
The Plusnet Business has incurred trading losses in the three years ended
September 30, 1997 and no charges to German income taxation have arisen.
No deferred taxation has been recognized on the tax loss carry-forwards as
the Plusnet Business has a history of trading losses and these will not be able
to be utilized following the transfer of the Plusnet Business to Thyssen
Netzwerk GmbH & Co. KG.
F-102
<PAGE> 303
PLUSNET BUSINESS
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
8. TANGIBLE FIXED ASSETS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
1996 1997 1997
------ ------ ------
DM'000 DM'000 $'000
<S> <C> <C> <C>
LAND AND BUILDINGS
COST
At October 1, ............................................ 183 1,504 812
Additions................................................. 1,321 689 373
Disposals................................................. -- (59) (32)
----- ----- -----
At September 30, ......................................... 1,504 2,134 1,153
----- ----- -----
DEPRECIATION
At October 1, ............................................ 7 105 56
Charge for the year....................................... 98 792 428
Disposals................................................. -- (3) (1)
----- ----- -----
At September 30, ......................................... 105 894 483
----- ----- -----
NET BOOK VALUE AT SEPTEMBER 30, .......................... 1,399 1,240 670
===== ===== =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
1996 1997 1997
------ ------ ------
DM'000 DM'000 $'000
<S> <C> <C> <C>
TELECOMMUNICATIONS EQUIPMENT
COST
At October 1, ............................................. -- 21,139 11,431
Additions.................................................. 11,972 12,153 6,571
Disposals.................................................. (136) (5,796) (3,134)
Transfers.................................................. 9,303 -- --
------ ------ ------
At September 30, .......................................... 21,139 27,496 14,868
------ ------ ------
DEPRECIATION
At October 1, ............................................. -- 4,775 2,582
Charge for year............................................ 3,670 7,877 4,259
Disposals.................................................. (30) (3,328) (1,799)
Transfers.................................................. 1,135 -- --
------ ------ ------
At September 30, .......................................... 4,775 9,324 5,042
------ ------ ------
NET BOOK VALUE AT SEPTEMBER 30, ........................... 16,364 18,172 9,826
====== ====== ======
</TABLE>
F-103
<PAGE> 304
PLUSNET BUSINESS
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
1996 1997 1997
------- ------- ------
DM'000 DM'000 $'000
<S> <C> <C> <C>
SOFTWARE
COST
At October 1, .............................................. 121 269 145
Additional.................................................. 148 144 78
Disposals................................................... -- (8) (4)
------ ----- -----
At September 30, ........................................... 269 405 219
------ ----- -----
DEPRECIATION
At October 1, .............................................. 35 104 56
Charged in year............................................. 69 115 62
Disposals................................................... -- (8) (4)
------ ----- -----
At September 30, ........................................... 104 211 114
------ ----- -----
NET BOOK VALUE AT SEPTEMBER 30, ............................ 165 194 105
====== ===== =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
1996 1997 1997
------- ------- ------
DM'000 DM'000 $'000
<S> <C> <C> <C>
FIXTURES, FITTINGS, TOOLS AND EQUIPMENT
COST
At October 1,............................................... 10,962 5,086 2,750
Additions................................................... 3,749 290 157
Disposals................................................... (322) (104) (56)
Transfers................................................... (9,303) -- --
------ ----- -----
At September 30,............................................ 5,086 5,272 2,851
------ ----- -----
DEPRECIATION
At October 1,............................................... 1,438 1,080 584
Charge for year............................................. 1,063 1,334 722
Disposals................................................... (286) (55) (30)
Transfers................................................... (1,135) -- --
------ ----- -----
At September 30,............................................ 1,080 2,359 1,276
------ ----- -----
NET BOOK VALUE AT SEPTEMBER 30,............................. 4,006 2,913 1,575
====== ===== =====
</TABLE>
9. DEBTORS
<TABLE>
<CAPTION>
SEPTEMBER 30,
-----------------------
1996 1997 1997
------ ------ -----
DM'000 DM'000 $'000
<S> <C> <C> <C>
Trade debtors............................................... 3,548 5,188 2,805
Amounts owed by related parties (note 13)................... 3,423 2,177 1,177
Other debtors............................................... 192 60 33
Prepayments and accrued income.............................. 38 7 4
----- ----- -----
7,201 7,432 4,019
===== ===== =====
</TABLE>
All amounts are due within one year.
F-104
<PAGE> 305
PLUSNET BUSINESS
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
Trade debtors are stated net of allowances for specifically identified
doubtful accounts of DM 111,000 at September 30, 1996 (no allowances made at
September 30, 1997).
10. CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR
<TABLE>
<CAPTION>
SEPTEMBER 30,
-----------------------
1996 1997 1997
------ ------ -----
DM'000 DM'000 $'000
<S> <C> <C> <C>
Trade creditors............................................. 13,718 11,424 6,177
Amounts owed to related parties (note 13)................... 17 86 47
Other creditors including taxation and social security...... 1,475 1,284 694
Accruals and deferred income................................ 446 2,580 1,395
------ ------ -----
15,656 15,374 8,313
====== ====== =====
</TABLE>
11. PROVISIONS FOR LIABILITIES AND CHARGES
<TABLE>
<CAPTION>
SEPTEMBER 30,
-----------------------
1996 1997 1997
------ ------ -----
DM'000 DM'000 $'000
<S> <C> <C> <C>
Pensions.................................................... 226 111 60
Other provisions............................................ 1,242 1,313 710
----- ----- ---
1,468 1,424 770
===== ===== ===
</TABLE>
Other provisions mainly comprise losses incurred on sales contracts to
customers, where the contracted revenue is lower than the cost of sales.
12. COMMITMENTS
Operating lease payments payable within one year of the balance sheet date
where in respect of operating leases expiring as follows:
<TABLE>
<CAPTION>
LAND &
BUILDINGS OTHERS TOTAL TOTAL
--------- ------ ------ -----
DM'000 DM'000 DM'000 $'000
<S> <C> <C> <C> <C>
At September 30, 1996
-- expiring within one year...................... 859 803 1,662 899
-- expiring between one year and five years...... 1,102 1,300 2,402 1,299
-- expiring after five years..................... 47 -- 47 25
----- ----- ----- -----
2,008 2,103 4,111 2,223
===== ===== ===== =====
At September 30, 1997
-- expiring within one year...................... 1,186 1,965 3,151 1,704
-- expiring between one and five years........... 218 -- 218 118
-- expiring after five years..................... 84 -- 84 45
----- ----- ----- -----
1,488 1,965 3,453 1,867
===== ===== ===== =====
</TABLE>
F-105
<PAGE> 306
PLUSNET BUSINESS
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
The future minimum lease payments under non-cancellable operating leases as
of September 30, 1997 are:
<TABLE>
<CAPTION>
PAYABLE IN THE YEARS ENDING SEPTEMBER 30, DM'000 $'000
- ----------------------------------------- ------ -----
<S> <C> <C>
1998........................................................ 3,453 1,867
1999 to 2002................................................ 407 220
2003 and thereafter......................................... 447 242
----- -----
4,307 2,329
===== =====
</TABLE>
At September 30, 1997, the Plusnet Business had contractual commitments for
capital expenditure totalling approximately DM 2 million.
13. RELATED PARTY TRANSACTIONS
The Plusnet Business was operated up until April 30, 1998 by Plusnet
Gesellschaft fur Netzwerk Services mbH, a wholly owned subsidiary of Thyssen
Telecom AG and part of the Thyssen AG group.
The Plusnet Business's transactions with respect of the above related
parties were as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------------
1995 1996 1997 1997
------ ------ ------ -----
DM'000 DM'000 DM'000 $'000
<S> <C> <C> <C> <C>
Sales to Thyssen group companies..................... 8,149 18,434 16,662 9,009
Services purchased from Thyssen group companies...... 1,529 3,229 3,315 1,792
</TABLE>
Balances receivable from and payable to the above related parties are
analyzed under notes 9 and 10 above.
14. ANALYSIS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------
1995 1996 1997 1997
------- ------- ------- ------
DM'000 DM'000 DM'000 $'000
<S> <C> <C> <C> <C>
CAPITAL EXPENDITURE
Purchase of tangible fixed assets................ (10,635) (17,190) (13,276) (7,179)
Sale of brand name............................... -- 6,000 -- --
Sale of fixed assets............................. 1 166 4,342 2,348
------- ------- ------- ------
Net cash outflow from capital expenditure........ (10,634) (11,024) (8,934) (4,831)
======= ======= ======= ======
FINANCING
Net equity contributions......................... 11,014 30,540 31,738 17,161
======= ======= ======= ======
</TABLE>
F-106
<PAGE> 307
PLUSNET BUSINESS
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
15. RECONCILIATION OF NET CASH FLOW TO MOVEMENT IN NET FUNDS
Net funds are represented by the balance of cash at bank and in hand which
has developed as follows:
<TABLE>
<CAPTION>
NET
OPENING CASH CLOSING
BALANCE OUTFLOW BALANCE
------- ------- -------
DM'000 DM'000 DM'000
<S> <C> <C> <C>
Year ended September 30,
1995..................................................... 5 (1) 4
1996..................................................... 4 (4) --
1997..................................................... -- -- --
== == ==
</TABLE>
16. MATERIAL DIFFERENCES BETWEEN UK AND US GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES
(a) Impact on net income and invested equity
The Plusnet Business's financial statements have been prepared in
accordance with UK GAAP which differ in certain respect from US GAAP. In
relation to the Plusnet Business, these differences would not materially affect
the Plusnet Business's loss or invested equity reported as at and for the years
ended September 30, 1995, 1996 and 1997.
(b) Impact on statement of cash flows
The Plusnet Business's cash flow statement is prepared in accordance with
Financial Reporting Standard No. 1 (Revised 1996), "Cash Flow Statements", and
presents substantially the same information as that required under Statement of
Financial Accounting Standards No. 95. However, there are certain differences in
classification of items within the cash flow statement and with regard to the
definition of cash equivalents between UK and US GAAP.
(c) Extraordinary item
Certain items of income and expense which are classified as extraordinary
under UK GAAP may not meet the criteria for this classification under US GAAP.
(d) Depreciation
If at any time there is a permanent diminution in the value of a fixed
asset, UK GAAP require that the net book value should be written down
immediately to the estimated recoverable amount. Such exceptional writedowns are
recorded in these financial statements as part of the depreciation charge. Under
US GAAP these circumstances may require the recognition of an impairment loss.
There may be circumstances which require write-downs under UK GAAP but which
would not require the recognition of an impairment loss under US GAAP.
17. COMPANIES ACT 1985
The financial statements do not constitute "statutory accounts" within the
meaning of the United Kingdom Companies Act 1985 for any periods presented and,
therefore, omit certain disclosures which would be required by the Companies Act
1985. However, they include all material disclosures required by generally
accepted accounting principles in the United Kingdom including those Companies
Act 1985 disclosures relating to the profit and loss accounts and balance sheet
items.
F-107
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EXHIBIT A
GLOSSARY OF TELECOMMUNICATIONS INDUSTRY TERMS
"Accounting Principles Board Opinion No. 16" - Accounting Board Opinion No.
16, "Business Combinations," and the related published interpretations of the
American Institute of Certified Public Accountants, the Financial Accounting
Standards Board, and the published rules and regulations of the Securities and
Exchange Commission or its staff.
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.
"ADMs" - Add-Drop Multiplexers.
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.
"ATM" - Asynchronous Transfer Mode , a switching and transmission
technology that is one of a general class of packet technologies that relay
traffic by way of an address contained within the first five bits of a standard
fifty-three bit-long packet or cell. ATM switching was specifically developed to
allow switching and transmission of mixed voice, data and video (sometimes
referred to as "multimedia" information) at varying rates. The ATM format can be
used by many different information systems, including local area networks.
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.
"Authorizations" - all filings, applications, authorizations, orders,
recognitions, grants, consents, licences, confirmations, clearances, permissions
and approvals under any applicable legislation or regulations of any
jurisdiction.
"bandwidth" - the range of frequencies that can be passed through a medium
such as glass fibers, without distortion and a measure of the communication
capacity or the data transmission rate of a telecommunications circuit. The
greater the bandwith, the greater the information-carrying capacity of such
medium.
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.
"CIENA" - Ciena Corporation.
"CIS" - the Commonwealth of Independent States.
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"CLEC" - competitive local exchange carrier , a category of telephone
service provider (carrier) that offers services similar to the former monopoly
local telephone company. A CLEC may also provide other types of
telecommunications services (long distance, etc.).
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).
"Convertible Bonds" - the US$135 million aggregate principal amount of
8.75% Senior Subordinated Convertible Bonds of GTS due 2000.
"D-AMPS" - Digital Advanced Mobile Phone System, a recognized standard for
mobile telephony.
Dark Fiber -- Fiber that lacks the requisite electronic and optronic
equipment necessary to use the fiber for transmission.
"Debentures" - the US$450 million aggregate principal amount of 5 3/4%
Convertible Senior Subordinated Debentures of GTS due 2010, and the offering of
the Debentures is the "Debenture Offering." The Debenture Offering together with
the July 1998 Stock Offering are the "July 1998 Offerings."
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).
"DCS" - Digital Cellular System, a recognized standard for mobile
telephony.
"DGCL" - the General Corporation Law of the State of Delaware.
"digital" - a method of storing, processing and transmitting information
through the use of distinct electronic or optical pulses that represent the
binary code digits 0 and 1. Digital transmission and switching technologies
employ a sequence of these pulses to represent information as opposed to the
continuously variable analog signal.
"DWDM" - Dense Wavelength Division Multiplexing.
E1 -- Data transmission rate of approximately 2 Mbps.
E3 -- Data transmission rate of approximately 34 Mbps.
"EASDAQ" - the computerized pan-European quotation system sponsored by the
European Association of Securities Dealers Automated Quotation.
"EBITDA" - earnings before interest, taxes, depreciation and amortization.
"Ebone" - Ebone A/S, a Tier 1 Internet backbone provider in Europe.
"EC" - the EC, the predecessor of the EU, established by the Treaty of
Rome.
Electrosviaz -- regional telephone company.
"11.5% Notes" - the US$265 million aggregate principal amount of 11.5%
Senior Notes due 2007.
Enhanced Network Services -- Telecommunications services providing digital
connectivity, primarily for data applications, via frame relay, ATM, or digital
interexchange private line facilities. Enhanced network services also include
applications on such networks, including Internet access and other Internet
services.
ERMES -- A standard for a pan-European radio message system sponsored by
the EC.
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"Esprit Network" -- Esprit Telecom's communication network linking 31
switches or points of presence in eight European countries, as well as
Washington, D.C. and New York through arrangements with US carriers.
"Esprit Telecom ADSs" -- American Depositary Shares of Esprit Telecom, each
representing seven Esprit Telecom Shares.
"Esprit Telecom Bonds" -- the US$ 230 million aggregate principal amount of
11.5% Senior Notes due 2007, the US$ 150 million aggregate principal amount of
10.875% Senior Notes due 2008, the DEM125 million aggregate principal amount of
11.5% Senior Notes due 2007 and the DM150 million aggregate principal amount due
2008.
"Esprit Telecom Securities" - collectively the Esprit Telecom ADSs, and the
Esprit Telecom Shares.
"Esprit Telecom 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 to acquire Esprit
Telecom by GTS remains open for acceptance.
"EU" - the EU established by the Treaty of Maastricht and developed from
the EC comprising 15 member states being Austria, Belgium, Denmark, Finland,
France, Germany, Greece, Ireland, Italy, Luxembourg, The Netherlands, Portugal,
Spain, Sweden and the UK.
Eutelsat -- European Telecommunications Satellite Organization; an
international satellite organization in which members of the EU hold an 88%
combined investment.
"European Services Strategy" - GTS plans to enter the business end-user
market in Western Europe through the development of competitive local exchange
carriers in up to 12 metropolitan markets and through the development of
reseller activities in up to 50 metropolitan markets.
"Exchange Act" - the United States Securities Exchange Act of 1934, as
amended, and the rules thereunder.
"FCC" - the US Federal Communications Commission.
"fiber optics" - technology which involves sending signals as laser light
pulses across glass strands in order to transmit digital information.
"fiber optic ring" - a network configuration to provide redundancy where if
one segment of the network is damaged or cut, the traffic is capable of being
re-routed and sent to its destination in the opposite direction.
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.
"Full Competition Directive" - the directive adopted by the European
Commission in March 1996 that required full liberalization of all
telecommunications services in most EU member states by January 1, 1998.
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.
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"GTS" - Global TeleSystems Group, Inc.
"GTS Board" - the board of directors of GTS.
"GTS By-laws" - the by-laws of GTS.
"GTS Certificate" - the certificate of incorporation of GTS, as amended.
"GTS Group" - GTS, its subsidiary undertakings and associated undertakings,
as those respective terms are defined in the Companies Act 1985.
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.
"Goskomsvyaz" - the successor to the Russian Ministry of Communications.
"HER" - Hermes Europe Railtel B.V., a wholly owned subsidiary of GTS.
"HER Notes" - US$265 million aggregate principal amount of 11 1/2% senior
notes due 2007, sold in August 1997.
"IAS" - Institute for Automated Systems
"ILEC" - Independent Local Exchange Carrier.
Inmarsat -- The International Maritime Satellite service, which provides
mobile communications to ships at sea, aircraft in flight and vehicles on the
road.
Intelsat -- International Telecommunications Satellite Organization; a
worldwide consortium of national satellite communications organizations.
Interconnect -- Connection of a telecommunications device of service to the
PSTN.
Interconnection -- Connection of a piece of telephone equipment to the
telephone network, or a data terminal to a data communications network. Also
refers to the connection of one communications network to another so that users
of one network can communicate with users of another network.
International Simple Resale -- Refers to the wholesale purchase of IPLCs
from facilities-based carriers and the reselling of such capacity to customers
for switched telephone service.
"ISPS" or "Internet service provider" - provides customers with access to
the Internet, normally for dial access customers, by linking its network
directly or through other providers to the Internet backbone network.
"IP" or "Internet Protocol" -- a compilation of network and transport-level
protocols that allow computers with different architectures and operating system
software to communicate with other computers on the Internet.
IPLC -- International Private Leased Circuits.
"IPO" - the initial public offering of common stock of GTS completed on
February 10, 1998.
"IRU" - Indefeasible Right of Use - the right to use capacity in a
telecommunication system, usually an undersea cable, with most of the rights and
interests of ownership for the life of the cable with a liability to pay
maintenance charges.
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.
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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.
"July 1998 Stock Offering" - the follow-on public offering of common stock
of GTS in July 1998.
"July 1998 Offerings" - the July 1998 Stock Offering and the Debenture
Offering.
Kbps -- Kilobits per second, which is a measurement of speed for digital
signal transmission expressed in thousands of bits per second.
"leased line" - point-to-point fixed line connections leased from another
operator.
"LANs" - Local Access Network Suppliers.
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.
"MIUs" - Minimum Investment Units.
MGTS -- Moscow city telephone network.
"MOC" - the Russian Ministry of Communications, succeeded by Goskomsvyaz.
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.
"Nasdaq" - the computerized quotation system sponsored by the National
Association of Securities Dealers.
"NetSource" - NetSource Europe ASA, a Norwegian company.
"New Entrants" - new entrants to the telecommunications market, such as
alternative carriers, global consortia of telecommunications operators,
international carriers, Internet backbone networks, resellers, value-added
networks and other service providers
"New Euro HER Notes" - Euro 85 million aggregate principal amount of
10 3/4% Senior Notes due 2006, sold on December 21, 1998, which transaction will
close in January 1999.
"New Common Stock" - new shares of Common Stock proposed to be issued,
credited as fully paid, pursuant to the Offer.
"New HER Notes" - US dollar New HER Notes and Euro New HER Notes.
"New HER Notes Offering" - the offering of the New HER Notes.
"9 7/8% Notes" - the US$105 million aggregate principal amount of 9 7/8%
Senior Notes due 2005.
"1990 Directive" - a directive issued on June 28, 1990 by the European
Commission requiring EU member states to liberalize by January 1, 1998 all
telecommunications services with the exception of voice telephony to the general
public.
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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.
"ONP" - Open Network Provision, the principles established by European
Council Directive 90/387/EEC.
"PABX" - Private Automatic Branch Exchange - a switch on customer premises
used to connect customer telephones (and related equipment) to the PSTN and to
switch internal calls within the customer's telephone system.
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.
"PKGCN" - Primorsky Krai branch of the Gossvyaznadzor, the local authority
in Vladivostok responsible for monitoring compliance with regulatory and
technical norms of the telecommunications industry.
"PKGCN Letters" - three letters issued by the PKGCN to PrimTelefone
concerning certain compliance irregularities.
"PKMIA" - Primorsky Krai branch of the Ministry for Internal Affairs.
"PKMIA Investigation" - a criminal investigation opened by the PKMIA under
Article 327 of the Russian Federation Criminal Code against certain employees of
PrimTelefone concerning the use of forged state documents in connection with an
application for a frequency plan submitted (and subsequently abandoned) by
PrimTelefone.
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.
"Preferred Stock" - all shares of preferred stock, par value $0.0001 per
share, of GTS.
"PSTN" - Public Switched Telephone Network refers to the telephone networks
accessible by the public at large through private lines, wireless systems and
pay phones.
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.
"Right" - the right attached to each share of Common Stock, that gives the
holder of Common Stock the right to purchase shares of Series A Preferred Stock.
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.
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"RPOA" - Recognized Private Operating Agency
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.
"SEC" - the US Securities and Exchange Commission.
"Securities Act" - the United States Securities Act of 1933, as amended,
and the rules thereunder.
"Series A Preferred Stock" - shares of Series A junior participating
preferred stock, par value $0.0001 per share, authorized by GTS.
"SNCB/NMBS" - Societe Nationale des Chemins de Fer Belges S.A. de Droit
Public Nationale Maatschappij der Belgische Spoorwegen N.Y. Van Publick Recht,
the Belgian national railway.
"Soros Associates" - certain entities associated with George Soros,
collectively.
"STM" - Synchronous Transfer Mode V , a transport and switching method that
depends upon information occurring in regular and fixed patterns with respect to
a reference such as a frame pattern. A time division multiplex and switching
technique to be used across the user's network interface for a broadband ISDN.
It gives each user up to 50 million bits per second simultaneously, regardless
of the number of users.
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.
"UK" - the United Kingdom of Great Britain and Northern Ireland.
"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.
"Units" - one-thousandth of a share of Series A Preferred Stock that may be
acquired upon the exercise of one Right.
"US Depositary" - The Bank of New York, in its capacity as US Depositary.
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'US dollar New HER Notes - US$265 million aggregate principal amount of
10 3/8% Senior Notes due 2009, sold on December 21, 1998, which transaction will
close in January 1999.
"US Holder" - any beneficial owner of Esprit Telecom Securities and New
Common Stock that is (i) a citizen or resident of the United States, (ii) a
corporation or partnership created or organized in the United States or under
the laws of United States or of any state, (iii) an estate whose income is
includable in gross income for United States federal income tax purposes
regardless of its source, or (iv) a trust if a court within the United States is
able to exercise primary supervision over the administration of the trust and
one or more United States persons have the authority to control all substantial
decisions of the trust.
"US Person" - a US person as defined in Regulation S of the United States
Securities Act 1933 as amended.
"VANs" - Value-Added Networks, a communication network that provides
features other than transmission of information, such as transmission of one
type of computer signal to another type of computer signal.
"VAT" - Value-Added Tax.
VSAT -- Very Small Aperture Terminal; a satellite communications technology
that employs frequencies in the Ku band or C band and very small receiving
dishes. VSAT systems employ satellite transponders; the receiving dishes may be
leased or owned by the VSAT user.
Wavelength Division Multiplexing (WDM) -- A multiplexing technique allowing
multiple different signals to be carried simultaneously on a fiber by allocating
resources according to frequency on non-overlapping frequency bands.
X.25 -- A CCITT standard governing the interface between data terminals and
data circuit termination equipment for terminals on packet-switched data
networks.
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EXHIBIT B
SUPPLEMENTAL EASDAQ INFORMATION
APPROVAL BY THE BELGIAN COMMISSION FOR BANKING AND FINANCE
This Prospectus will be submitted for approval by the Belgian Banking and
Finance Commission ("Commissie voor bet Banken Financiewezen/Commission Bancaire
et Financiere") ("BFC") in accordance with Article 29ter. sec. 1. par.1 of Royal
Decree No. 185 of July 9, 1935 and Article 11 of the Royal Decree of 31 October,
1991 on the publication of prospectuses in connection with public issues of
securities. The approval of this Prospectus by the BFC does not imply any
judgement as to the appropriateness of the quality of this Offering or the Offer
Shares nor of the situation of the Company.
On December 23, 1997, the Market Authority of EASDAQ approved the admission
to trading of all of the Common Stock on EASDAQ under the symbol "GTSG."
Admission to EASDAQ is subject to certain adequacy and liquidity requirements
determined by the EASDAQ Market Authority. Companies applying for admission to
trading on EASDAQ are required to publish relevant financial and other
information regularly and to keep the public informed of all events likely to
affect the market price of their securities. Price sensitive information is made
available to investors in Europe through the EASDAQ Reuters Regulatory Company
Reporting System and international information vendors.
The documents referred to above will also be made available to Belgian
investors upon prior written request addressed to the principal executive office
of the Company.
PERSONS RESPONSIBLE FOR THE PROSPECTUS AND DECLARATION
The Company, represented by Mr. William H. Seippel, Chief Financial
Officer, takes responsibility for the contents of this Prospectus.
The Company, having made all reasonable inquiries, accepts responsibility
for, and confirms that this Prospectus contains all information with regard to
the Company and the Common Stock that is material in the context of the offering
and sale of the Common Stock, that the information contained in this Prospectus
is true and correct in all material respects and is not misleading, that the
opinions and intentions of the Company expressed herein are honestly held and
that there are no other facts the omission of which makes this Prospectus as a
whole or any of such information or the expression of any such opinions or
intentions materially misleading.
Global TeleSystems Group, Inc.
by William H. Seippel
Chief Financial Officer
THE CLEARING SYSTEMS
INTERSETTLE
Transactions executed on EASDAQ will be settled by delivery through
INTERSETTLE. INTERSETTLE holds securities for its direct participants, which
include banks, securities brokers and dealers, other professional intermediaries
and foreign depositories, and facilitates the clearance and settlement of
securities transactions between INTERSETTLE participants through electronic
book-entry changes in the accounts of INTERSETTLE participants. Book-entry
settlement is mandatory for all financial instruments traded on EASDAQ. Physical
certificates cannot be used to settle a market transaction. Investors must hold
a securities account with a financial institution which directly or indirectly
has access to INTERSETTLE's clearing and settlement system. INTERSETTLE conducts
a real-time gross payment system in connection with its clearance operation,
payments being made simultaneously with the book-entry transfers between
securities accounts.
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DTC
DTC is a limited-purpose trust company organized under the laws of the
State of New York, a member of the Federal Reserve System, a "clearing
corporation" within the meaning of the New York Uniform Commercial Code, and a
"clearing agency" registered pursuant to the provisions of Section 17A of the
Securities Exchange Act of 1934. DTC was created to hold securities of its
participants and to facilitate the clearance and settlement of securities
transactions among its participants in such securities through electronic
book-entry changes in accounts of the participants, thereby eliminating the need
for physical movement of securities certificates. DTC participants include
securities brokers and dealers, banks, trust companies, clearing corporations
and certain other organization, some of whom (and/or their representatives) own
DTC. Access to the DTC book-entry system is also available to others, such as
banks, brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a participant, either directly or indirectly. DTC
agrees with and represents to its participants that it will administer its
book-entry system in accordance with its rules and by-laws and requirements of
law.
TRANSFERS BETWEEN INTERSETTLE AND DTC PARTICIPANTS
Common Stock will be held through DTC. Common Stock held directly or
indirectly by INTERSETTLE participants will be registered on the books of DTC in
the name of the nominee company of Brown Brothers Harriman, acting as custodian
for INTERSETTLE.
Transfers of Common Stock will be effected in the following manner:
(i) transfers of Common Stock between INTERSETTLE participants will be
effected in accordance with procedures established for this purpose by
INTERSETTLE;
(ii) transfer of Common Stock between DTC participants will be effected in
accordance with procedures established for the purpose by DTC; and
(iii) transfers of Common Stock between INTERSETTLE participants and DTC
participants will be effected by an increase or a reduction of the
quantity of Common Stock held in INTERSETTLE's account at Brown
Brothers Harriman and a corresponding reduction or increase of the
quantity of Common Stock held by the other relevant DTC participant
or participants.
Investors should inquire with the financial intermediary with whom the
investor has opened a securities account for the purpose of holding and trading
Common Stock, as to the cost of such trading as well as the terms and conditions
on which the financial service of the Common Stock will be delivered by such
financial intermediary.
The Common Stock has the following identification number:
CUSIP 379 36 U104, ISIN US379 36 U1043
The clearing costs, if any, will be at the cost of the investors. Investors
are requested to inform themselves about such costs.
POSSIBILITY OF SHARE REPURCHASES
The Company is not prohibited by its Certificate of Incorporation, By-laws
or Delaware General Corporation Law from repurchasing or otherwise acquiring
outstanding shares of Common Stock and, accordingly, the Company may exercise
its right to repurchase Common Stock.
AUTHORIZATION OF INCREASE IN AUTHORIZED CAPITAL OF THE COMPANY; AUTHORIZATION OF
THE ISSUANCE OF COMMON STOCK IN THE STOCK OFFERINGS
Effective December 1, 1997, the Board of Directors and stockholders of the
Company approved amendments to the Certificate of Incorporation which (i)
increased the authorized number of shares of capital stock to 145,000,000 (of
which 135,000,000 shares are Common Stock and 10,000,000 shares are preferred
stock) and (ii) effected a 3-for-2 stock split of all then-outstanding shares of
the Company's Common Stock. In addition, the Board of Directors of the Company
has adopted a resolution approving the offering and
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issuance of 12,765,000 shares of Common Stock in the IPO and 2,801,000 shares of
Common Stock in the Stock Offerings.
TAXATION OF BELGIAN INVESTORS
The following generally summarizes the material Belgian tax consequences of
the sequisition, ownership and disposition of Common Stock. It is based on the
tax laws applicable in Belgium and France as in effect at the date of this
Prospectus, and is subject to changes in Belgium and French law, including
changes that could have retroactive effect. The following summary does not take
into account or discuss the tax laws of any country other than Belgium and
France nor does it take into account the individual circumstances of each
investor. The summary uses the term "Eligible Belgian Holders" to refer to
beneficial owners of Common Stock who hold directly less than 10% of the share
capital of the Company and whose ownership of such Common Stock is not
attributable to a permanent establishment or a fixed base in France, are
considered residents of Belgium for purposes of the income tax convention
between Belgium and France dated March 10, 1964 (the "Belgian-French Treaty")
and are fully entitled to benefits under the Belgian-French Treaty.
There are currently no procedures available for Holders of Common Stock
that are not U.S. residents to claim or receive from the French tax authorities
any tax treaty benefits in respect of dividends (including payment of avoir
fiscal and availability of a reduced withholding tax rate) that a Holder may be
entitled to receive pursuant to the Belgian-French Treaty.
Prospective Belgian Investors in Common Stock are advised to consult their
own tax advisers as to the Belgian and other tax consequences of the
acquisition, ownership and disposition of Common Stock.
TAXATION OF DIVIDENDS ON COMMON STOCK
French tax considerations
Dividends paid to non-residents of France generally are subject to French
withholding tax at a 25% rate and are not eligible for the benefit of the avoir
fiscal (a tax credit available to French residents equal to 50% of the amount of
dividends received from French companies such as the Company). However, under
the Belgian-French Treaty, Eligible Belgian Holders can claim the benefit of a
reduced withholding tax rate on dividends of 15%.
An individual Eligible Belgian Holder generally will also be entitled to
receive a payment of the avoir fiscal, after deduction of withholding tax of
15%. This payment will not be made available to such individual Eligible Belgian
Holder until after the close of the calendar year in which the dividend was paid
and only upon receipt by the French tax authorities of a claim made by the
individual Eligible Belgian Holder for such payment in accordance with the
procedure set forth below.
A Belgian company that is an Eligible Belgian Holder under the
Belgian-French Treaty (a "Belgian Resident Company") will not benefit from the
refund of the avoir fiscal but will be entitled to obtain from the French tax
authorities a refund of any precompte paid in cash in respect of such dividends
less the 15% French withholding tax. Amounts distributed as dividends by French
companies out of profits which have been taxed at the ordinary corporate income
tax rate or which have been earned and taxed more than five years before the
distribution and which give rise to the avoir fiscal are subject to a
"precompte" or prepayment by such companies. The precompte is paid by the
distributing company to the French tax authorities and is equal to one-half of
the nominal dividend distributed.
Dividends paid to an individual Eligible Belgian Holder will be subject to
the reduced withholding tax rate of 15% at the time the dividend is paid if (i)
such holder duly completes and provides the French tax authorities with French
Treasury Form 5200 RFI Belgique (the "Form") duly certified by the Belgian tax
authorities before the date of payment of the relevant dividend, or (ii) if
completion of the Form is not possible prior to the payment of dividends, such
holder duly completes and provides the French tax authorities with a simplified
certificate (the "Certificate") duly certified by the Belgian tax authorities
stating that (a) such holder is a Belgian resident as defined pursuant to the
provisions of the Belgian-French Treaty,
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<PAGE> 319
(b) such holder's ownership of the Common Stock is not effectively connected
with a permanent establishment or fixed base in France, and (c) such holder
meets all the requirements of the Belgian-French Treaty for obtaining the
benefit of the reduced rate of withholding tax and the right to payment of the
French avoir fiscal. For example, the Company pays a dividend of 100, an
individual Eligible Belgian Holder will initially receive 85, but will be
entitled to an additional payment of 42.50, consisting of the avoir fiscal of
50, less a 15% withholding tax on that amount (equal to 7.5). Dividends paid to
an individual Eligible Belgian Holder that has not filed a completed Form or
Certificate before the dividend payment date will be subject to French
withholding tax at the rate of 25%. Such a holder may claim a refund of the
excess withholding tax and the avoir fiscal by completing and providing the
French tax authorities with the Form before December 31st of the calendar year
following the year during which the dividend is paid.
Dividends paid to a Belgian Resident Company will be subject to the reduced
withholding tax rate of 15% at the time the dividend is paid if such holder duly
completes and provides the French tax authorities with French Treasury 5207 RF2
Belgique form before the date of payment of the relevant dividend duly certified
by the Belgian tax authorities. Dividends paid to such Belgian Resident Company
that has not filed a completed form before the dividend payment date will be
subject to French withholding tax at the rate of 25%. Such a holder may claim a
refund of the excess withholding tax by completing and providing the French tax
authorities with such 5207 RF2 Belgique form before December 31st of the
calendar year following the year during which the dividend is paid. The claim
for refund of the precompte is made on the form RF 5207 RF2 Belgique referred to
above.
Belgian withholding tax
Dividends distributed on Common Stock are subject in Belgium to a
withholding tax at the rate of 25%, when paid or attributed through a
professional intermediary in Belgium. However, no dividend withholding tax is
due if the Eligible Belgian Holder is a company subject to Belgian corporate
income tax.
In a case where dividends are paid outside Belgium without any intervention
of a paying agent in Belgium, no dividend withholding tax is, in principle, due.
However, where the Eligible Belgian Holder is a Belgian resident entity subject
to the legal entities tax (e.g. a pension fund), the Holder itself has to pay
the dividend withholding tax at the rate of 25%.
In certain cases the above-mentioned 25% rate of dividend withholding tax
will be reduced to 15%. The reduced rate applies in particular to (i) dividends
distributed on shares publicly issued after January 1, 1994 and (ii) dividends
distributed on shares that have been privately issued after January 1, 1994 in
exchange for cash contributions, provided the shares are registered or bearer
shares placed in open custody to a financial institution in Belgium as of the
date of their issuance. This reduced rate should in principle also apply to
dividends on shares issued by the Company. The Company may however irrevocably
reject the application of the reduced withholding tax rate.
Income tax for Belgian resident individuals
In the hands of an Eligible Belgian Holder who is an individual holding
Common Stock as a private investment, the Belgian dividend withholding tax is a
final tax and the dividends need not be reported in the individual's annual
income tax return. If no withholding tax has been levied (i.e. in case of
payment or attribution outside Belgium), the individual has to report the
dividends in his tax return. Such Holder will be taxed at the separate rate of
25%, to be increased with a municipal surcharge (varying, as a rule, from 6% to
9%).
In the hands of an individual Eligible Belgian Holder whose holding of
Common Stock is effectively connected with a business, the dividends are taxable
at the ordinary rates for business income (i.e. varying from 25% to 55% to be
increased with the municipal surcharge and a crisis contribution of 3% of the
tax due). Any Belgium withholding tax is creditable against the final income tax
due, provided that the Holder has the full ownership of the Common Stock at the
time of payment of the dividends.
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<PAGE> 320
Income tax for Belgian Resident Companies
Dividends received by Belgian Resident Companies are, in principle, subject
to corporate income tax at the rate of 40.17% (i.e. the standard rate of 39%
increased by the additional tax of 3% of the corporate income tax due).
However, provided that the dividends benefit from the so-called
"dividend-received deduction", only 5% of the dividends received will be
taxable. In order to benefit from the deduction, the Company must not fall
within one of the categories which are expressly excluded from the "dividend
received deduction" (e.g. tax haven companies) and the beneficiary should hold,
at the time of payment of the dividends, a participation of at least 5% in the
Company or a participation which has a acquisition value of at least BEF 50
million.
Any Belgian dividend withholding tax can, in principle, be credited against
the company's final income tax, provided that the company has the full ownership
of the shares at the time of payment or attribution of the dividends and
provided that the dividend distribution does not entail a reduction in value or
capital loss on the Shares.
Income tax for Belgian resident entities subject to the Belgian legal entities
tax (pension funds, etc.)
The Belgian dividend withholding tax is a final tax.
CAPITAL GAINS TAXATION
French tax considerations
In general, a Belgian holder who is a resident of Belgium under the
Belgian-French Treaty will not be subject to French tax on any capital gain
derived from the sale or exchange of Common Stock, unless the gain is
attributable to a permanent establishment or fixed place of business maintained
by the holder in France.
Belgian tax considerations
Individual Eligible Belgian Holders holding the Common Stock as a private
investment and entities subject to legal entities tax are not subject to the
Belgian capital gains taxation on the disposal of the Common Stock.
Individual Eligible Belgian Holders may, however, be subject to a 33% tax
(to be increased with the municipal surcharge and the crisis contribution) if
the capital gain is deemed to be "speculative."
Individual Eligible Belgian Holders whose holding of Common Stock is
effectively connected with a business are taxable at the ordinary rates on any
capital gains realized on the disposal of Common Stock.
Belgian resident companies are not subject to capital gains taxation
provided that the dividends received on the shares qualify for the "dividend
received deduction" (except for the minimum holding requirement).
FRENCH ESTATE AND GIFT TAX
Under the estate tax convention between Belgium and France, a transfer of
Common Stock by reason of the death of an individual Eligible Belgian Holder
entitled to benefits under that convention will not be subject to French
inheritance tax, unless the decedent was domiciled in France at the time of his
or her death.
FRENCH WEALTH TAX
The French wealth tax (impot de solidare sur la fortune) does not apply to
an Eligible Belgian Holder.
BELGIAN INDIRECT TAXES
Stamp tax on securities transactions
In principle, a stamp tax is levied upon the subscription of shares of
Common Stock and the purchase and sale in Belgium of Common Stock through a
professional intermediary. The rate applicable to subscriptions of
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new shares of Common Stock is 0.35% but there is a limit of BEF 10,000 per
transaction. The rate applicable for secondary sales and purchases in Belgium of
Common Stock through a professional intermediary is 0.17% but there is a limit
of BEF 10,000 per transaction.
An exemption is available to professional intermediaries (e.g. credit
institutions), insurance companies, pension funds and collective investment
vehicles who are acting for their own account. A non-resident holder of Common
Stock who is acting for his own account will also be entitled to an exemption
from this stamp tax, provided that he delivers to the issuer or the professional
intermediary in Belgium, as the case may be, an affidavit confirming his
non-resident status in Belgium.
Tax on delivery of bearer securities
A tax is levied upon the physical delivery of Common Stock pursuant to
their subscription or their acquisition for consideration through a professional
intermediary. This tax is also due upon the delivery of Common Stock pursuant to
a withdrawal of these Common Stock from "open custody."
The tax is due, at the rate of 0.2%, on the sums payable by the subscriber
or the acquiror in case of subscription or acquisition or the sales value of the
Common Stock, as estimated by the custodian in case of withdrawal from "open
custody."
However, an exemption is available for deliveries to recognized
professional intermediaries (such as credit institutions) acting for their own
account. An exemption is also available for delivery of Common Stock, which are
held in "open custody", to a non-resident.
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NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE SECURITIES IN ANY
JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS
NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS PROSPECTUS OR IN THE AFFAIRS
OF THE COMPANY SINCE THE DATE HEREOF.
-----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary..................... 1
Risk Factors........................... 16
Use of Proceeds........................ 61
Price Range of Common Stock............ 61
Dividend Policy........................ 61
Unaudited Pro Forma Combined Financial
Statements........................... 62
Selected Historical Consolidated
Financial Data of GTS................ 70
Supplemental Information -- Selected
Historical Financial Data of GTS..... 71
Selected Historical Consolidated
Financial Data of Esprit Telecom..... 73
GTS Management's Discussion and
Analysis of Financial Condition and
Results of Operations................ 76
Esprit Telecom Management's Discussion
and Analysis of Financial Condition
and Results of Operations............ 94
Business............................... 107
Management............................. 158
Executive Compensation and Other
Information.......................... 164
Certain Related Party Transactions..... 175
Principal and Selling Stockholders..... 178
Description of Certain Indebtedness.... 181
Description of Capital Stock........... 184
Shares Eligible for Future Sale........ 190
Certain U.S. Federal Tax Consequences
to Non-U.S. Stockholders............. 192
Plan of Distribution................... 195
Legal Matters.......................... 195
Where You Can Find More Information.... 196
Experts................................ 196
Index to Financial Statements.......... F-1
Exhibit A -- Glossary of
Telecommunications Industry Terms.... A-1
Exhibit B -- Supplemental EASDAQ
Information.......................... B-1
</TABLE>
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13,909,753 SHARES
[GLOBAL TELESYSTEMS GROUP, INC. LOGO]
GLOBAL TELESYSTEMS GROUP, INC.
COMMON STOCK
-------------------
PROSPECTUS
-------------------
JANUARY 20, 1999
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<PAGE> 323
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the estimated expenses to be borne by the
Company in connection with the offering of the securities being hereby
registered.
<TABLE>
<CAPTION>
ITEM
----
<S> <C>
SEC Registration Fee........................................ $232,170
Accounting Fees and Expenses................................ 30,000
Legal Fees and Expenses..................................... 50,000
Printing Expenses........................................... 150,000
Miscellaneous............................................... 62,830
--------
TOTAL............................................. $525,000
========
</TABLE>
ITEM 14. 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 director's duty of loyalty to the corporation or its stockholders, (ii) for
acts or omission not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) under Section 174 of the DGCL (relating to
unlawful payment of dividends and unlawful stock purchase and redemption) or
(iv) for any transaction from which the director derived an improper personal
benefit.
The Company's Certificate of Incorporation (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.
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<PAGE> 324
The directors and officers of the Company are covered under directors' and
officers' liability insurance policies maintained by the Company.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
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 1997.
Within the past three years the Company issued securities which were not
registered under the Securities Act of 1933, as amended (the "Securities Act")
as follows:
On March 13, 1995, the Company issued 400,000 shares of common stock, par
value $0.10 per share, pursuant to a stock purchase agreement. The shares were
issued to CIBV Liquidating B.V., a closed company with limited liability
organized under the laws of the Netherlands in exchange for the Company's
interest in PrimTelefone. No underwriter or underwriting discount was involved
in the offering. Exemption from registration was claimed under Section 4(2) of
the Securities Act regarding transactions by an issuer not involving any public
offering.
On June 21, 1995, the Company issued 5,090,876 shares of common stock, par
value $0.10 per share, at a purchase price of $9.00 per share, for an aggregate
offering price of $45.8 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. No underwriter or
underwriting discount was involved in the offering. Exemption from registration
was claimed under Section 4(2) of the Securities Act regarding transactions by
an issuer not involving any public offering.
On January 19, 1996, and June 6, 1996, the Company granted the Soros
Associates an aggregate of 4,444,443 warrants, each warrant to purchase one
share of common stock, par value $0.10 per share, at an exercise price of $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 were issued in connection with the Company's issuance
for cash of $40 million of notes to the Soros Associates, which notes bear
interest at a rate of 10% per annum and mature on March 3, 2001. No underwriter
or underwriting discount was involved in the offering. Exemption from
registration was claimed under Section 4(2) of the Securities Act regarding
transactions by an issuer not involving any public offering.
On February 2, 1996, the Company granted affiliates of Capital Research
International an aggregate of 3,333,333 warrants, each warrant to purchase one
share of common stock, par value $0.10 per share, at an exercise price of $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 were issued in connection with the Company's issuance
for cash of $30 million of notes to affiliates of Capital Research
International, which notes bear interest at a rate of 10% per annum and mature
on March 31, 2001. No underwriter or underwriting discount was involved in the
offering. Exemption from registration was claimed under Section 4(2) of the
Securities Act regarding transactions by an issuer not involving any public
offering.
On July 23, 1996, July 31, 1996, August 8, 1996, August 22, 1996 and
September 12, 1996 the Company issued an aggregate of 8,348,532 shares of common
stock, par value $0.10 per share, at a purchase price of $13.33 per share, for
an aggregate offering price of $111 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 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
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<PAGE> 325
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 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.
In connection with the acquisition of NetSource discussed in Item 2 of this
report on December 31, 1998, the Company issued 3,873,705 shares of its common
stock, par value of $.10 ("Common Shares"), to holders of NetSource stock who
accepted, as of October 30, 1998, the Company's offer to purchase the NetSource
stock owned by such holders. The Company received the NetSource shares tendered
as consideration for the Common Shares. No underwriters were involved in the
issuance of the Common Shares. The Company issued the Common Shares pursuant to
Rule 903 under the Securities Act and the Company's offer was made exclusively
to non US persons, within the meaning of Rule 902 under the Securities Act, not
in the United States. The Company extended its offer to purchase the NetSource
stock to December 15, 1998 and, consequently, additional shares of the Company's
common stock will be issued pursuant to this transaction. That additional
issuance also will be effected in accordance with Rule 903 of the Securities Act
and will be disclosed in a subsequent filing with the SEC.
ITEM 16. 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>
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
2.3(a)++++ -- Amendment to the Irrevocable Undertaking by Apax Funds
Nominees Limited dated as of December 8, 1998, dated
December 12, 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 Porter 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.
</TABLE>
II-3
<PAGE> 326
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
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
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.
4.10+++++ -- Form of Outstanding Dollar Note for 10 3/8% Senior Notes due
2009 of Hermes Europe Railtel B.V. (contained in Dollar
Indenture filed as Exhibit 4.5)
4.11+++++ -- Form of Outstanding Euro Note for 10 3/8% Senior Notes due
2006 of Hermes Europe Railtel B.V. (contained in Euro
Indenture filed as Exhibit 4.6)
4.12+++++ -- Form of Dollar Exchange Note for 10 3/8% Senior Notes due
2009 of Hermes Europe Railtel B.V. (contained in Dollar
Indenture filed as Exhibit 4.5)
4.13+++++ -- Form of Euro Exchange Note for 10 3/8% Senior Notes due 2006
of Hermes Europe Railtel B.V. (contained in Euro Indenture
filed as Exhibit 4.6)
4.14+++++ -- Dollar Indenture, dated as of January 4, 1999, between
Hermes Europe Railtel B.V. and The Bank of New York, as
Trustee
</TABLE>
II-4
<PAGE> 327
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
4.15+++++ -- Euro Indenture dated as of January 4, 1999, between Hermes
Europe Railtel B.V. and The Bank of New York, as Trustee
4.16+++++ -- Dollar Registration Rights Agreement, dated as of January 4,
1999, between Hermes Europe Railtel B.V. and Initial
Purchasers named therein
4.17+++++ -- Euro Registration Rights Agreement dated as of January 4,
1999, between Hermes Europe Railtel B.V. and Initial
Purchasers named therein
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
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
</TABLE>
II-5
<PAGE> 328
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
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
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-6
<PAGE> 329
<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 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
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 24, 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)
23.2* -- Consent of Ernst & Young LLP, Independent Auditors
23.3* -- Consent of Ernst & Young (CIS) Ltd., Independent Auditors
23.4* -- Consent of PricewaterhouseCoopers, Independent Auditors
23.5* -- Consent of Price Waterhouse, Independent Auditors
23.6* -- Consent of KPMG, Independent Auditors
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
99.1*** -- Form of Proxy for voting GTS Common Stock
</TABLE>
II-7
<PAGE> 330
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
99.2*** -- Form of Acceptance
99.3*** -- Form of Letter of Transmittal
99.4*** -- Form of Notice of Guaranteed Delivery
99.5*** -- Form of Letter to Brokers
99.6*** -- Form of Letter to Clients
99.7+++++ -- Supplemental Indenture, dated 12/23/98 of $230,000,000
11 1/2% Senior Notes due 2007, supplementing the indenture
dated as of 12/18/97, among Esprit Telecom Group, PLC, as
Issuer, and The Bank of New York, as Trustee, Registrar and
Paying Agent
99.8+++++ -- Supplemental Indenture, dated 12/23/98 of DM 150,000,000 11%
Senior Notes due 2008, supplementing the indenture dated as
of 6/24/98, among Esprit Telecom Group, PLC, as Issuer and
The Bank of New York, as Trustee, Registrar and Paying Agent
99.9+++++ -- Supplemental Indenture, dated 12/23/98 of $150,000,000
10 7/8% Senior Notes due 2008, supplementing the indenture
dated as of 6/24/98, among Esprit Telecom Group, PLC, as
Issuer, and The Bank of New York, as Trustee, Registrar and
Paying Agent
99.10+++++ -- Supplemental Indenture, dated 12/23/98 of DM 125,000,000
11 1/3% Senior Notes due 2007, supplementing the indenture
dated as of 12/18/97, among Esprit Telecom Group, PLC, as
Issuer, and The Bank of New York, as Trustee, Registrar and
Paying Agent
</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.
*** To be filed by amendment.
+ 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.
+++ Incorporated by reference to the corresponding exhibit to the Company's
Registration Statement on Form S-4 (File No. 333-68511) filed on December
8, 1998.
++++ Incorporated by reference to the corresponding exhibit to the Company's
Pre-effective Amendment No. 1 to the Registration Statement on Form S-4
(File No. 333-68511) filed on December 24, 1998.
+++++ Incorporated by reference to the corresponding exhibit to Hermes Europe
Railtel B.V.'s Registration Statement on Form S-4 (File No. 333-70723)
filed on January 15, 1999.
(b) Financial Statements and Schedules:
(1) Financial Statements
The financial statements filed as part of this Registration Statement are
listed in the Index to Financial Statements on page F-1.
(2) Schedules
The Company has furnished Schedule II -- Valuation and Qualifying Accounts
on page S-1 of the Registration Statement. 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.
ITEM 17. 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
14 -- 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
II-8
<PAGE> 331
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)(1) 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 deemed to be the initial bona fide offering thereof.
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-9
<PAGE> 332
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 20th day of January, 1999.
GLOBAL TELESYSTEMS GROUP, INC.
By: /s/ WILLIAM H. SEIPPEL
----------------------------------
Name: William H. Seippel
Title: Executive Vice President
and
Chief Financial Officer
We, the undersigned officers and directors of Global Telesystems Group,
Inc. hereby severally constitute and appoint, Gerald W. Thames, William H.
Seippel, Alan Krenek and Grier C. Raclin, 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-1 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 20th day of January, 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ GERALD W. THAMES President, Chief Executive Officer January 20, 1999
- ----------------------------------------------------- and Director (principal
Gerald W. Thames executive officer)
/s/ WILLIAM H. SEIPPEL Executive Vice President of January 20, 1999
- ----------------------------------------------------- Finance and Chief Financial
William H. Seippel Officer (principal financial and
accounting officer)
/s/ ALAN B. SLIFKA Chairman of the Board of Directors January 20, 1999
- -----------------------------------------------------
Alan B. Slifka
/s/ MICHAEL GREELEY Director January 20, 1999
- -----------------------------------------------------
Michael Greeley
/s/ BERNARD MCFADDEN Director January 20, 1999
- -----------------------------------------------------
Bernard McFadden
</TABLE>
II-10
<PAGE> 333
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ STEWART J. PAPERIN Director January 20, 1999
- -----------------------------------------------------
Stewart J. Paperin
Director January 20, 1999
- -----------------------------------------------------
W. James Peet
/s/ JEAN SALMONA Director January 20, 1999
- -----------------------------------------------------
Jean Salmona
/s/ JOEL SCHATZ Director January 20, 1999
- -----------------------------------------------------
Joel Schatz
/s/ ADAM SOLOMON Director January 20, 1999
- -----------------------------------------------------
Adam Solomon
/s/ DAVID DEY Director January 20, 1999
- -----------------------------------------------------
David Dey
/s/ ROGER W. HALE Director January 20, 1999
- -----------------------------------------------------
Roger W. Hale
Director January 20, 1999
- -----------------------------------------------------
Robert Amman
</TABLE>
II-11
<PAGE> 334
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
Allowance for doubtful accounts at
9/30/98............................... 4,085 3,888 2,924 5,049
</TABLE>
S-1
<PAGE> 335
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
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
2.3(a)++++ -- Amendment to the Irrevocable Undertaking by Apax Funds
Nominees Limited dated as of December 8, 1998, dated
December 12, 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 Porter 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
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.
</TABLE>
<PAGE> 336
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
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.
4.10+++++ -- Form of Outstanding Dollar Note for 10 3/8% Senior Notes due
2009 of Hermes Europe Railtel B.V. (contained in Dollar
Indenture filed as Exhibit 4.5)
4.11+++++ -- Form of Outstanding Euro Note for 10 3/8% Senior Notes due
2006 of Hermes Europe Railtel B.V. (contained in Euro
Indenture filed as Exhibit 4.6)
4.12+++++ -- Form of Dollar Exchange Note for 10 3/8% Senior Notes due
2009 of Hermes Europe Railtel B.V. (contained in Dollar
Indenture filed as Exhibit 4.5)
4.13+++++ -- Form of Euro Exchange Note for 10 3/8% Senior Notes due 2006
of Hermes Europe Railtel B.V. (contained in Euro Indenture
filed as Exhibit 4.6)
4.14+++++ -- Dollar Indenture, dated as of January 4, 1999, between
Hermes Europe Railtel B.V. and The Bank of New York, as
Trustee
4.15+++++ -- Euro Indenture dated as of January 4, 1999, between Hermes
Europe Railtel B.V. and The Bank of New York, as Trustee
4.16+++++ -- Dollar Registration Rights Agreement, dated as of January 4,
1999, between Hermes Europe Railtel B.V. and Initial
Purchasers named therein
4.17+++++ -- Euro Registration Rights Agreement dated as of January 4,
1999, between Hermes Europe Railtel B.V. and Initial
Purchasers named therein
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
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.
</TABLE>
<PAGE> 337
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
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
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
</TABLE>
<PAGE> 338
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
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
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
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
</TABLE>
<PAGE> 339
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
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 24, 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)
23.2* -- Consent of Ernst & Young LLP, Independent Auditors
23.3* -- Consent of Ernst & Young (CIS) Ltd., Independent Auditors
23.4* -- Consent of PricewaterhouseCoopers, Independent Auditors
23.5* -- Consent of Price Waterhouse, Independent Auditors
23.6* -- Consent of KPMG, Independent Auditors
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
99.1*** -- Form of Proxy for voting GTS Common Stock
99.2*** -- Form of Acceptance
99.3*** -- Form of Letter of Transmittal
99.4*** -- Form of Notice of Guaranteed Delivery
99.5*** -- Form of Letter to Brokers
99.6*** -- Form of Letter to Clients
99.7+++++ -- Supplemental Indenture, dated 12/23/98 of $230,000,000
11 1/2% Senior Notes due 2007, supplementing the indenture
dated as of 12/18/97, among Esprit Telecom Group, PLC, as
Issuer, and The Bank of New York, as Trustee, Registrar and
Paying Agent
99.8+++++ -- Supplemental Indenture, dated 12/23/98 of DM 150,000,000 11%
Senior Notes due 2008, supplementing the indenture dated as
of 6/24/98, among Esprit Telecom Group, PLC, as Issuer and
The Bank of New York, as Trustee, Registrar and Paying Agent
99.9+++++ -- Supplemental Indenture, dated 12/23/98 of $150,000,000
10 7/8% Senior Notes due 2008, supplementing the indenture
dated as of 6/24/98, among Esprit Telecom Group, PLC, as
Issuer, and The Bank of New York, as Trustee, Registrar and
Paying Agent
99.10+++++ -- Supplemental Indenture, dated 12/23/98 of DM 125,000,000
11 1/3% Senior Notes due 2007, supplementing the indenture
dated as of 12/18/97, among Esprit Telecom Group, PLC, as
Issuer, and The Bank of New York, as Trustee, Registrar and
Paying Agent
</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.
*** To be filed by amendment.
+ 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.
+++ Incorporated by reference to the corresponding exhibit to the Company's
Registration Statement on Form S-4 (File No. 333-68511) filed on December
8, 1998.
++++ Incorporated by reference to the corresponding exhibit to the Company's
Pre-effective Amendment No. 1 to the Registration Statement on Form S-4
(File No. 333-68511) filed on December 24, 1998.
+++++ Incorporated by reference to the corresponding exhibit to Hermes Europe
Railtel B.V.'s Registration Statement on Form S-4 (File No. 333-70723)
filed on January 15, 1999.
<PAGE> 1
EXHIBIT 23.2
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and 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-1) and related Prospectus of Global TeleSystems
Group, Inc. dated on or about January 20, 1999.
/s/ Ernst & Young LLP
Vienna, Virginia
January 15, 1999
<PAGE> 1
EXHIBIT 23.3
CONSENT OF ERNST & YOUNG (CIS) LTD., INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to
the use of our report 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-1) and related Prospectus of Global TeleSystems Group, Inc. dated on or
about January 20, 1999.
/s/ Ernst & Young (CIS) Ltd.
Moscow, Russia
January 15, 1999
<PAGE> 1
EXHIBIT 23.4
[PRICEWATERHOUSECOOPERS LETTERHEAD]
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this registration statement of Global
Telesystems Group, Inc. on Form S-1 (File No. ) of our report dated
December 21, 1998, on our audit of the consolidated financial statements of
Esprit Telecom plc (the 'Company'), as of September 30, 1998, and for the year
ended September 30, 1998. We also consent to the references to our firm under
the captions 'Experts' and 'Selected Historical Consolidated Financial Data'.
/s/ PRICEWATERHOUSECOOPERS
PricewaterhouseCoopers
London, England
January 20, 1999
<PAGE> 1
EXHIBIT 23.5
[PRICE WATERHOUSE LETTERHEAD]
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this registration statement of Global
Telesystems Group, Inc. on Form S-1 (File No. ) of our report dated
December 10, 1997, on our audits of the consolidated financial statements of
Esprit Telecom plc (the "Company"), as of September 30, 1996 and 1997, and for
each of the two years in the period ended September 30, 1997. We also consent to
the references to our firm under the captions "Experts" and "Selected Historical
Consolidated Financial Data".
/s/ PRICE WATERHOUSE
Price Waterhouse
London, England
January 20, 1999
<PAGE> 1
EXHIBIT 23.6
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this registration statement of Global
Telesystems Group, Inc. on Form S-1 (File No. ) of our report dated June
10, 1998, on our audit of the financial statements of the Plusnet Business, as
of September 30, 1996 and 1997 and for each of the three years in the period
ended September 30, 1997. We also consent to the reference to our firm under the
heading "Experts".
Dilsseldorf
20, January 1999
KPMG Deutsche Treuhand-Gesellschaft
Alslengasellschaft
Wirtschaftsprifingesellschaft
KPMG Deutsche Treuhand-Gesellschaft
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM 09/30/98 UNAUDITED CONDENSED FINANCIAL STATEMENTS AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 993,928
<SECURITIES> 0
<RECEIVABLES> 64,871
<ALLOWANCES> (5,049)
<INVENTORY> 0
<CURRENT-ASSETS> 1,130,458
<PP&E> 481,399
<DEPRECIATION> (45,380)
<TOTAL-ASSETS> 1,814,893
<CURRENT-LIABILITIES> 222,844
<BONDS> 1,208,533
0
0
<COMMON> 6,050
<OTHER-SE> 345,359
<TOTAL-LIABILITY-AND-EQUITY> 1,814,893
<SALES> 6,104
<TOTAL-REVENUES> 117,299
<CGS> 4,542
<TOTAL-COSTS> 82,067
<OTHER-EXPENSES> 100,465
<LOSS-PROVISION> 3,888
<INTEREST-EXPENSE> 52,603
<INCOME-PRETAX> (89,726)
<INCOME-TAX> 2,151
<INCOME-CONTINUING> (88,131)
<DISCONTINUED> 0
<EXTRAORDINARY> (12,704)
<CHANGES> 0
<NET-INCOME> (100,835)
<EPS-PRIMARY> (1.89)
<EPS-DILUTED> (1.89)
</TABLE>
