GLOBAL TELESYSTEMS INC - S-1 - 19971223 - FORWARD_LOOK
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Any statements that express, or involve discussions as to, expectations,
beliefs, plans, objectives, assumptions or future events or performance (often,
but not always, through the use of words or phrases such as "will likely
result," "are expected to," "will continue," "is anticipated," "estimated,"
"intends," "plans," "projection" and "outlook") are not historical facts and may
be forward-looking and, accordingly, such statements involve estimates,
assumptions and uncertainties which could cause actual results to differ
materially from those expressed in the forward-looking statements. Accordingly,
any such statements are qualified in their entirety by reference to, and are
accompanied by, the factors discussed throughout this Prospectus, and
particularly in the risk factors set forth herein under "Risk Factors." Among
the key factors that have a direct bearing on the Company's results of
operations are the potential risk of delay in implementing the Company's
business plan; the political, economic and legal aspects of the markets in which
the Company operates; competition and the Company's need for additional
substantial financing. These and other factors are discussed herein under "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Business" and elsewhere in this Prospectus.
The risk factors described herein could cause actual results or outcomes to
differ materially from those expressed in any forward-looking statements of the
Company made by or on behalf of the Company, and investors, therefore, should
not place undue reliance on any such forward-looking statements. Further, any
forward-looking statement speaks only as of the date on which such statement is
made, and the Company undertakes no obligation to update any forward-looking
statement or statements to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrence of unanticipated
events. New factors emerge from time to time, and it is not possible for
management to predict all of such factors. Further, management cannot assess the
impact of each such factor on the Company's business or the extent to which any
factor, or combination of factors, may cause actual results to differ materially
from those contained in any forward-looking statements.
Russia On Line(TM) is a trademark of the Company.
iii
SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements appearing elsewhere in this Prospectus
(this "Prospectus"). Unless otherwise indicated, (i) the term "GTS" or the
"Company" refers to Global TeleSystems Group, Inc. (and, when appropriate, to
its predecessor) and its subsidiaries, (ii) references to the number of shares
of common stock outstanding after the Stock Offerings assume the Underwriters'
over-allotment option has not been exercised and (iii) the information in this
Prospectus (other than the audited financial statements) gives effect to a
3-for-2 stock split of the common stock effected on December 1, 1997. See
"Exhibit A -- Glossary of Telecommunications Industry Terms" for definitions of
acronyms and technical telecommunications terms used in this Prospectus.
THE COMPANY
GTS is a provider of a broad range of telecommunications services to
businesses, other telecommunications service providers and consumers in Russia,
the Commonwealth of Independent States ("CIS") and Central Europe. Through its
subsidiary Hermes Europe Railtel B.V. ("HER"), GTS is developing, and operating
the initial segments of, a pan-European high capacity fiber optic network that
is designed to interconnect a majority of the largest Western and Central
European cities and to transport international voice, data and multimedia/image
traffic for other carriers throughout Western and Central Europe. GTS's strategy
to develop its businesses generally has been to establish joint ventures with a
strong local partner or partners while maintaining a significant degree of
operational control. The Company's business activities consist of the ownership
and operation of (i) international long distance businesses, which operate
through international gateways that provide international switching services and
transmission capacity, (ii) local access networks, which provide local telephone
service, (iii) cellular networks, which provide wireless telecommunications
services, (iv) a domestic long distance business, (v) data networks and (vi)
carriers' carrier networks, which provide high volume transmission capacity to
other carriers.
In Russia and the CIS, GTS's objective is to become the premier alternative
telecommunications operator. To attain its objective, the Company has partnered
with regional telephone companies and with Rostelecom, the national long
distance carrier in Russia. The Company currently operates in 24 oblasts
(regions) and the city of Moscow in Russia, as well as in 11 additional cities
in the CIS, and believes it is well-positioned to become the leading independent
telecommunications service provider in Russia. These businesses include: (i) EDN
Sovintel ("Sovintel"), which provides Moscow, and recently St. Petersburg, with
international long distance and local telephone services and access to the major
domestic long distance carriers; (ii) TeleCommunications of Moscow ("TCM"),
which provides local access services in Moscow; (iii) TeleRoss (as defined
herein), which provides domestic long distance services in fourteen cities in
Russia, including Moscow, as well as Very Small Aperture Terminal ("VSAT")
service to customers outside its primary long distance satellite network; (iv)
Sovam Teleport ("Sovam"), which provides data services, including high-speed
data transmission, electronic mail, Internet access services, as well as Russia
On Line, the first Russian language Internet service; and (v) the Company's
cellular operations ("GTS Cellular"), which operate cellular networks in twelve
regions in Russia and also in Kiev, Ukraine, with licenses covering regions with
an aggregate population of approximately 25 million people at the end of 1996.
Whenever practical, GTS's businesses integrate and co-market their service
offerings in Russia and the CIS, utilizing TeleRoss as the domestic long
distance provider, Sovintel as the international gateway, TCM and GTS Cellular
for local access, and Sovam as the data communications and Internet access
network for business applications and on-line services. Together, GTS's Russian
and CIS ventures carried 202.5 million and 291.3 million minutes of traffic for
the year ended December 31, 1996 and the nine months ended September 30, 1997,
respectively, and had approximately 24,600 customers, including approximately
16,300 cellular subscribers, as of September 30, 1997. See "Business -- Russia
and the CIS."
In Western Europe, GTS seeks to position itself as the leading independent
carriers' carrier through the development of two ventures, HER and GTS-Monaco
Access S.A.M. ("GTS-Monaco Access"). HER's objective is to become the leading
pan-European carriers' carrier by providing centrally managed cross-border
telecommunications transmission capacity to telecommunications companies
including traditional Public
1
Telecommunications Operators ("PTOs") and new entrants, such as alternative
carriers, global consortia of telecommunications operators, international
carriers, Internet backbone networks, resellers, value-added networks and other
service providers ("New Entrants") on an approximately 18,000 kilometer high
capacity fiber optic network designed to interconnect a majority of the largest
Western and Central European cities. HER is currently operating over an
approximately 1,700-kilometer portion of the network linking Brussels, Antwerp,
Rotterdam, Amsterdam, London and Paris. HER expects to roll out full
telecommunications transport service over approximately 2,900 kilometers of
fiber optic cable linking the cities of London, Rotterdam, Amsterdam, Antwerp,
Brussels, Paris, Dusseldorf and Frankfurt (the "initial five country network")
in the second quarter of 1998. The full 18,000 kilometer network is expected to
become fully operational during the year 2000. HER also plans to lease capacity
on a transatlantic cable linking the European network to North America and is
exploring various interconnectivity options to Russia and Asia. Such
intercontinental interconnectivity will help HER satisfy the needs of its
European customers with respect to outgoing traffic and attract additional
non-European customers with traffic terminating in Europe. HER commenced
commercial service over the Brussels-Amsterdam portion of the network in late
1996 and the London-Paris portion in November 1997. GTS-Monaco Access operates
an international gateway in Monaco in partnership with, and utilizing the
existing gateway infrastructure of, the Principality of Monaco and provides
transit and routing of international calls to other telecommunications
operators. Through its HER and GTS-Monaco Access ventures, GTS is building a new
network for transporting voice, data and multimedia/image traffic for other
carriers throughout Western and Central Europe and for worldwide international
voice, data and multimedia/image traffic that either originates or terminates
in, or transits through, Western and Central Europe. See "Business -- Western
Europe."
In Central Europe, GTS's objective is to become one of the leading
alternative telecommunications providers in the region. GTS currently provides
private data communications services to government and commercial customers in
Hungary and the Czech Republic. In the Czech Republic, the Company provides
outgoing voice services and operates an international gateway and a data
services network. In Hungary, GTS operates a VSAT network, which GTS believes is
the largest VSAT network in Central Europe as measured by number of VSAT sites.
The Company has also signed an agreement to provide international data services
in Poland, subject to the receipt of necessary governmental approvals. GTS's
strategy is to expand its service offerings as the regulatory environment
permits, leverage its existing VSAT and international gateway infrastructure
where possible and provide a broad range of services to its target markets.
Although GTS does not currently own or operate significant
telecommunication assets in Asia, GTS's objective is to become an established
and diversified telecommunications provider in China and India. GTS seeks to
leverage its position in these countries to capitalize on opportunities as they
arise.
2
The following table sets forth certain information for the principal
ventures through which the Company conducts its business:
COUNTRY/REGION GTS PRINCIPAL
COMPANY NAME OF OPERATIONS OWNERSHIP PARTNER(S) BUSINESS
------------ -------------- ------------ ------------------- ------------------
CIS
Sovintel......................... Russia 50% Rostelecom International Long
Distance; Local
Access
TCM.............................. Russia 50%(1) MTU Inform and Local Access Lines
others
TeleRoss......................... Russia 50%(2) Various local PTOs Domestic Long
Distance
Sovam............................ Russia 67%(3) Institute for Data and Internet
Automated Systems
GTS Cellular..................... CIS 25-70%(4) Primarily various Basic Cellular
local PTOs
WESTERN EUROPE
HER.............................. Western Europe 79%(5) Various Carriers' Carrier
GTS-Monaco Access................ Monaco 50% Principality of Carriers' Carrier;
Monaco International
Gateway
CENTRAL EUROPE
GTS-Hungary...................... Hungary 99% -- VSAT Network
EuroHivo......................... Hungary 70% Microsystems Paging Services
Telecom Rt.;
Gerard Aircraft
Sales and Leasing
Company
CzechNet......................... Czech Republic 100% -- International Long
Distance
CzechCom......................... Czech Republic 100% -- Data and Internet
ASIA
V-Tech........................... China 75% Shanghai Science VSAT Network
and Technology
Investment
Corporation
Beijing Tianmu................... China 47% China International VSAT Network
Travel Service
Telecom Co.,
Ltd.(6)
CDI.............................. India 100% -- Voice, Data and
Internet
(1) GTS holds a 50% indirect interest in TCM through its 52.6% interest in
GTS-Vox Limited, an intermediate holding company.
(2) TeleRoss consists of (i) two wholly-owned holding companies and a 99% owned
subsidiary that operates a domestic long distance network (collectively,
"TeleRoss Operating Company") and (ii) thirteen joint ventures that are 50%
beneficially-owned by GTS (the "TeleRoss Ventures"). See "Business -- Russia
and the CIS -- TeleRoss."
(3) GTS has reached an agreement in principle to purchase its minority partner's
33% interest in Sovam and expects to consummate the transaction in January
1998, thereby making Sovam a wholly owned subsidiary of GTS.
(4) GTS conducts its cellular operations through (i) Vostok Mobile B.V. ("Vostok
Mobile"), a wholly owned GTS subsidiary, which owns between 50% and 70% of a
series of 11 cellular joint ventures in various regions in Russia, (ii)
PrimTelefone, a 50% owned venture in Vladivostok and four other cities in
the Primorsky region of Russia and (iii) Bancomsvyaz, an approximately 25%
beneficially-owned venture in Kiev, Ukraine. GTS intends to enter into the
cellular markets of additional Russian regions through Vostok Mobile. See
"Business -- Russia and the CIS -- GTS Cellular."
(5) GTS currently owns approximately 79% of HER. The Company's interest is
expected to decrease due to the issuance of shares to certain HER executives
under the proposed HER stock option plan. See "Executive Compensation and
Other Information -- HER 1994 Stock Option Plan."
(6) GTS owns 75% of GTS China Investments LLC ("GCI"), which owns 90% of
American China Investment Corporation ("ACIC"). ACIC owns 70% of the Beijing
Tianmu China joint venture company.
3
BUSINESS STRATEGY
GTS seeks to develop businesses to meet the rapidly expanding market demand
for telecommunications services. GTS's goal in emerging markets is to establish
itself as the leading alternative to the incumbent telecommunications service
providers and as a premier provider of value-added services. In addition, the
Company seeks to position itself as the leading independent carriers' carrier
within Western and Central Europe through the development of a pan-European
fiber optic network and an international gateway in Monaco.
GTS believes that it will be able to successfully operate its businesses
and develop business opportunities by pursuing the following strategies:
- Identify and Seize Early Market Opportunities. GTS's primary strategy is
to identify less developed markets in which the incumbent operator offers
inadequate service and where liberalization of telecommunications
regulations may be pending. The Company believes that entering these less
developed markets quickly is a key competitive advantage in the global
telecommunications market. GTS leverages its management's knowledge of the
markets in which the Company operates to assess and react quickly when
attractive business opportunities arise.
- Establish Joint Ventures with Experienced Local Partners. GTS seeks to
establish and maintain strategic partnerships and relationships with key
telecommunications operators and service providers in the countries in
which it operates. The Company believes that these relationships increase
its ability to anticipate and respond to changes in the regulatory and
legal environment and assist with license renewal and expansion of its
operating companies.
- Retain Significant Operational Control. In general, GTS actively
participates in the management of its ventures by (i) providing most of
the funding for the ventures' operations, (ii) selecting key members of
the local management team, (iii) developing business plans and marketing
strategies together with local management, (iv) monitoring operating
functions, (v) maintaining close working relationships with local partners
and (vi) integrating its networks and businesses in a manner which is
consistent with the Company's overall strategic objectives.
- Build Infrastructure to Provide High Quality Services. GTS continues to
develop and expand its network infrastructure. The Company believes that
its networks offer service, quality and cost advantages over incumbent
providers as a result of the Company's customer support, network
monitoring, management systems and its ability to integrate and co-market
its service offerings.
- Leverage Management Depth and Experience. GTS's management has
significant experience in the development and operation of
telecommunications businesses outside the United States. The Company
believes that this experience, together with the Company's extensive
operations, has provided its management with the ability to identify,
evaluate and pursue international telecommunications business
opportunities. Additionally, GTS has assembled a management team comprised
of executives with extensive experience managing telecommunications
companies in the respective local markets. GTS believes that its
management team possesses a broad knowledge of relevant political and
regulatory structures, as well as the cultural awareness and fluency with
international and local business practices necessary to implement the
Company's objectives.
- Ability to Access Capital. In general, the Company's financing strategy
is to establish parent level funding to meet general corporate needs and
the costs of start-ups and acquisitions and, when it is possible and
cost-effective, to finance ongoing operations at the venture level. Since
1993, the Company has raised approximately $268 million in equity and
approximately $215 million of debt (of which approximately $74 million
was raised through shareholders). In addition, HER completed a $265
million private placement of senior notes (of which $56.5 million was
placed into escrow for the first two years' interest payments) in 1997.
The Company's principal investors include affiliates of George Soros and
Alan B. Slifka and certain of his affiliates.
4
In addition to its overall business strategy, GTS has developed specific
market strategies to achieve its goals in emerging markets and Western Europe.
Emerging Markets. The Company pursues its goals in emerging markets through
a three-stage approach of market entry, market expansion and market integration.
- Market Entry. GTS identifies a market as a suitable target for entry
based upon: (i) superior growth prospects for such market, demonstrated
by growing demand for high quality telecommunications services; (ii) the
provision of inadequate services by incumbent providers, typically
resulting from the incumbents' unwillingness to offer high quality
services with reliable customer support at attractive prices; and (iii)
attractive regulatory environments in which emerging alternative
telecommunications providers such as GTS have, or expect to have over a
clearly defined time horizon, the ability to compete on a substantially
equal basis with the incumbent providers in terms of certain services and
the cost of providing those services. Once GTS has identified a market as
suitable for entry, the Company seeks to establish its presence in that
market by establishing a venture with a strong local partner or partners.
In general, GTS maintains a significant degree of operational control in
such ventures. Through such ventures, the Company benefits from its
partners' ability to provide infrastructure, regulatory expertise and
personnel that will provide GTS with a competitive advantage in entering
that market. When entering a new market, GTS's strategy is to provide its
customers with higher quality service as compared to the services offered
by incumbent providers.
- Market Expansion. Having entered a market successfully and established a
limited service offering to its targeted customer base, GTS then seeks to
expand the range of services it offers to existing and potential
customers and to further develop its relationships with local partners.
By broadening its service offerings, GTS anticipates achieving increased
economies of scale through the common use of administrative and operating
functions already in place, increasing the Company's share of its
customers' telecommunications spending and expanding GTS's base of
potential customers through the provision of a bundled service offering.
The Company also seeks to expand its targeted geographic market by
forming new partnerships, installing infrastructure and offering services
in additional geographic regions, allowing the Company to further enhance
its operating leverage and ability to service its customers'
telecommunications needs.
- Market Integration. GTS ultimately intends to integrate and co-market its
service offerings in each of the markets in which it operates. The
Company believes such integration enables it to enhance its operating
efficiency by leveraging its distribution channels, infrastructure and
networks, and management information systems. As customers develop a need
for a broader variety of telecommunications services, the Company
believes GTS's integrated operations will represent an attractive service
alternative for customers seeking a single provider with the ability to
meet all their telecommunications needs.
Western Europe. The Company seeks to position itself as the leading
independent carriers' carrier within Western Europe through the development of
HER's pan-European fiber optic network and the operation of GTS-Monaco Access's
international gateway in partnership with, and utilizing the gateway
infrastructure of, the Principality of Monaco. The overall strategy of GTS in
Western Europe is to complement and enhance the services provided by PTOs and
New Entrants in a way that helps them to more successfully meet the needs of
their end-user customers. HER seeks to enter the market ahead of competition and
encourage a wide variety of carriers to use its network with service offerings
that meet their needs. To establish itself as the leading carriers' carrier for
international telecommunications within Europe, HER intends to provide its
customers with significantly higher quality transmission and advanced network
capabilities at a competitive price by utilizing advanced, uniform technology
across the region and providing redundant routing for higher levels of
reliability.
5
FINANCING PLAN
In general, the Company's strategy is to finance general corporate cash
needs, the development of start-up ventures and acquisitions through the parent
company and, when possible and cost effective, to finance ongoing operations at
the venture level. Since 1993, the Company has raised approximately $268 million
in equity and approximately $215 million of debt (of which approximately $74
million was raised through shareholders). In addition, HER completed a $265
million private placement of senior notes (of which $56.5 million was placed
into escrow for the first two years' interest payments) in 1997.
Concurrently with the Notes Offering, the Company is undertaking the Stock
Offerings, which offerings will be made by separate prospectuses. The
consummation of both the Note Offering and the Stock Offerings are conditioned
upon the consummation of the other.
The Company believes that the net proceeds from the Offerings, together
with existing cash, will be sufficient to fund its expected capital needs until
at least June 1999. GTS expects that it may require additional capital to
execute its current business plan and to fund expected operating losses, as well
as to consummate future acquisitions and exploit opportunities to expand and
develop its businesses. Management expects that GTS and its ventures will incur
over $515 million of capital expenditures during the next three years, of which
approximately $235 million will be incurred in 1998. Of these amounts,
approximately $290 million will be used to fund construction of the HER network,
with approximately $35 million required for the roll out of the initial five
country network that is expected to be completed in the second quarter of 1998.
The Company also will need to fund operating losses of its ventures for at least
the next 12 months. In addition, as part of its business strategy, the Company
regularly evaluates potential acquisitions and joint ventures. The Company has
no definitive agreement with respect to any acquisition or joint venture,
although from time to time it has discussions with other companies and assesses
opportunities on an on-going basis. The Company may fund these acquisitions or
joint ventures with a portion of the net proceeds from the Offerings. See "Risk
Factors -- Additional Capital Requirements" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
As of September 30, 1997, after giving effect to the Stock Offerings,
certain affiliates of George Soros, Alan B. Slifka and certain affiliates, and
certain affiliates of Capital Research International are expected to own
approximately 20.4%, 10.8% and 10.1% of the Common Stock on a fully-diluted
basis, respectively. See "Principal Stockholders."
* * *
The Company was founded in 1983 as a not-for-profit company under the name
San Francisco/Moscow Teleport, Inc. The Company was incorporated as a California
for-profit corporation on September 25, 1986, and by way of a reincorporation
merger, merged with and into SFMT, Inc., a Delaware corporation formed for that
purpose on September 13, 1993. The Company was renamed Global TeleSystems Group,
Inc., on February 22, 1995. The Company's principal business office is located
at 1751 Pinnacle Drive, North Tower-12th Floor, McLean, Virginia 22102, United
States, and its telephone number is (703) 918-4500.
6
THE OFFERING
NOTES OFFERED....................... $ million principal amount of
% Senior Notes Due 2005.
Maturity Date....................... , 2005 (the "Maturity Date").
Interest Payment Dates.............. and , commencing
, 1998.
Escrow Account...................... The Company will place approximately
$20.0 million of the net proceeds of
the Notes Offering, representing funds
that together with the proceeds from
the investment thereof will be
sufficient to pay the first four
scheduled interest payments (but not
additional interest) on the Notes, into
an escrow account (the "Escrow
Account") to be held by the Trustee (as
defined) for the benefit of the holders
of the Notes. The Company will grant to
the Trustee for the benefit of the
holders of the Notes, a first priority
and exclusive security interest in the
Escrow Account and the proceeds
thereof. Funds will be disbursed from
the Escrow Account for interest
payments (but not additional interest)
on the Notes. Upon acceleration of the
maturity of the Notes, the Escrow
Agreement will provide for the payment
of the amount remaining in the Escrow
Account to the Trustee to be applied on
account of amounts owing on the Notes
as provided in the Indenture. Pending
such disbursement, all funds contained
in the Escrow Account will be invested
in Cash Equivalents (as defined). See
"Description of Notes -- Escrow
Account."
Optional Redemption................. Except as set forth below, the Notes
are not redeemable prior to ,
2002. The Notes will be redeemable, at
the Company's option, in whole or in
part, at any time or from time to time
on or after , 2002 upon not less
than 30 nor more than 60 days' prior
notice mailed by first class mail to
each Holder's registered address, at
the redemption prices (expressed as a
percentage of principal amount) set
forth below, plus accrued and unpaid
interest thereon, if any, to the date
of redemption, if redeemed during the
12-month period beginning on
of the years indicated below:
YEAR REDEMPTION PRICE
---- ----------------
2002.............................. %
2003.............................. %
2004 and thereafter............... 100.000%
In addition, at any time or from time
to time prior to , 2001, upon not
less than 30 nor more than 60 days'
prior notice mailed by first class mail
to each Holder's registered address,
the Company may redeem up to 33 1/3% of
the original aggregate principal amount
of the Notes at a redemption price
equal to % of
7
the principal amount of the Notes, plus
accrued and unpaid interest thereon, if
any, to the date of redemption with the
net cash proceeds of one or more
additional Public Equity Offerings or
Strategic Equity Investments resulting
in aggregate gross proceeds to the
Company of at least $ million;
provided, however, that at least
66 2/3% of the original aggregate
principal amount of Notes remains
outstanding immediately after giving
effect to any such redemption
(excluding any Notes owned by the
Company or any of its Affiliates).
Notice of any such redemption must be
given within 60 days after the date of
a Public Equity Offering or Strategic
Equity Investment resulting in gross
cash proceeds to the Company, when
aggregated with all prior Public Equity
Offerings or Strategic Equity
Investments, of at least $ million.
Change of Control................... Upon the occurrence of a Change of
Control, each holder of the Notes may
require the Company to repurchase such
holder's Notes, in whole or in part, at
a purchase price in cash equal to 101%
of their principal amount plus accrued
and unpaid interest, if any, to any
repurchase date. The failure of the
Company to repurchase Notes of any
holder exercising such right will
constitute an Event of Default. See
"Description of the Notes -- Change of
Control."
Ranking............................. The Notes will constitute senior
unsecured debt obligations of the
Company. The Company is a holding
company which conducts its operations
entirely through its subsidiaries and
affiliates. The Notes will be
effectively subordinated to all
liabilities of the Company's
subsidiaries and affiliates. The
Indenture dated as of ,
1998 between the Company and The Bank
of New York, as trustee (the
"Trustee"), under which the Notes will
be issued will permit the incurrence or
issuance by Restricted Group Members
(as defined) of the Company of
substantial additional indebtedness.
The aggregate amount of outstanding
obligations of the Company's Restricted
Group Members that would have ranked
effectively senior to the Notes was
approximately $[ ] as of September
30, 1997. See "Description of the
Notes -- Ranking."
Certain Covenants................... The Indenture contains covenants that,
among other restrictions, limit the
ability of the Company and the
Restricted Group Members to incur
additional indebtedness, pay dividends
or make distributions in respect of
capital stock of the Company or make
certain other restricted payments, make
certain investments, engage in
transactions with the affiliates and,
in the case of the Company, engage in
certain mergers and consolidations and
asset dispositions. These covenants are
subject to a
8
number of significant exceptions and
qualifications. See "Description of the
Notes -- Certain Covenants."
Settlement.......................... The Notes will trade in The Depository
Trust Company's ("DTC") Same-Day Funds
Settlement.
USE OF PROCEEDS
The Company primarily intends to use the net proceeds from the Offerings to
provide working capital for existing telecommunications ventures, particularly
in Russia and the CIS, to expand the Company's operations, and for general
corporate purposes. The Company also intends to use a portion of the net
proceeds to repay shareholder loans of $70 million (plus accrued interest).
Also, a portion of the net proceeds may be used by the Company in connection
with one or more acquisitions. Approximately $20.0 million of the net proceeds
from the Notes Offering will be placed in the Escrow Account. See "Use of
Proceeds."
RISK FACTORS
Prospective investors should consider carefully the factors discussed in
detail elsewhere in this Prospectus under the caption "Risk Factors."
9
SUMMARY HISTORICAL CONSOLIDATED FINANCIAL DATA
The following summary historical consolidated financial data as of December
31, 1996 and September 30, 1997 and for the years ended December 31, 1994, 1995
and 1996 and for the nine months ended September 30, 1997 are derived from the
Company's audited Consolidated Financial Statements. The following unaudited
summary historical consolidated financial data for the nine months ended
September 30, 1996 are derived from the Company's unaudited Consolidated
Financial Statements. The summary historical consolidated financial data
presented below should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and the audited
Consolidated Financial Statements and related notes thereto appearing elsewhere
in this Prospectus.
Under generally accepted accounting principles, a majority of the Company's
ventures are accounted for by the equity method of accounting. Under this
method, the operating results of the ventures are included in the Company's
Consolidated Statement of Operations as a single line item, "Equity in losses of
ventures." The Company recognizes 100% of the losses in ventures where the
Company bears all of the financial risk (which includes all of the Company's
significant ventures except for Sovintel and, historically, HER). Also, the
assets, liabilities and equity of the ventures are included in the Company's
Consolidated Balance Sheets as a single line item, "Investments in and advances
to ventures." See Note 2 to the Company's audited Consolidated Financial
Statements and "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Overview." Financial information about the Company's
equity ventures is included below under "Supplemental Information -- Summary
Historical Financial Data -- Equity Investments."
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------ ----------------------
1994 1995 1996 1996 1997(1)
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues, net........................... $ 2,468 $ 8,412 $ 24,117 $ 14,639 $ 30,216
Gross margin............................ 23 16 5,176 1,758 1,864
Operating expenses...................... 12,863 41,014 52,928 35,725 52,059
Equity in losses of ventures............ (135) (7,871) (10,150) (6,999) (18,234)
Other income (expense).................. 990 11,034 (8,729) (6,535) (16,902)
Net loss................................ (11,985) (40,400) (67,991) (48,473) (87,872)
Loss per share.......................... (0.70) (1.64) (2.26) (1.71) (2.39)
Deficiencies of earnings available to
cover fixed charges(2)............... (11,985) (37,835) (66,631) (47,496) (86,034)
DECEMBER 31, SEPTEMBER 30,
1996 1997(1)
------------ -------------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 57,874 $366,841
Property and equipment, net............................... 35,463 60,728
Investments in and advances to ventures................... 104,459 84,068
Total assets.............................................. 237,378 647,788
Total debt................................................ 85,547 502,482
Minority interest and stock subject to repurchase......... 6,248 32,764
Shareholders' equity...................................... 113,668 57,403
(1) As a result of the Company's increase in ownership interest and amendment to
the HER Shareholders Agreement that was completed on July 16, 1997, the
Company accounts for its ownership interest in HER under the consolidation
method of accounting. Prior to this date, the Company accounted for HER
using the equity method of accounting.
(2) Because of the Company's historic losses, the Company has experienced a
deficiency of earnings available to cover fixed charges throughout its
existence. The deficiency of earnings available to cover fixed charges has
been computed by adding loss from continuing operations before income taxes
minus undistributed earnings of associated companies and fixed charges.
Fixed charges consist of interest on all indebtedness and amortization of
discount on all indebtedness.
10
SUPPLEMENTAL INFORMATION -- SUMMARY HISTORICAL FINANCIAL DATA
[THE COMPANY IS CURRENTLY EVALUATING THE DISCLOSURE THAT IT INTENDS TO PRESENT.]
11
RISK FACTORS
ADDITIONAL CAPITAL REQUIREMENTS
GTS expects that it may require additional capital to execute its current
business plan and to fund expected operating losses, as well as to consummate
future acquisitions and exploit opportunities to expand and develop its
businesses. Management expects that GTS and its ventures will incur over $515
million of capital expenditures during the next three years, of which
approximately $235 million will be incurred in 1998. Of these amounts,
approximately $290 million will be used to fund construction of the HER network,
with approximately $35 million required for the roll out of the initial five
country network that is expected to be completed in the second quarter of 1998.
The Company also will need to fund operating losses of its ventures for at least
the next 12 months. In addition, as part of its business strategy, the Company
regularly evaluates potential acquisitions and joint ventures. The Company has
no definitive agreement with respect to any material acquisition or joint
venture, although from time to time it has discussions with other companies and
assesses opportunities on an on-going basis. The Company may fund such
acquisitions or joint ventures with a portion of the net proceeds from the
Offerings.
The Company believes that the net proceeds from the Offerings, together
with existing cash, will be sufficient to fund its expected capital needs until
at least June 1999. The actual amount and timing of the Company's future capital
requirements, however, may differ materially from management's estimates. In
particular, the accuracy of management's estimates are subject to changes and
fluctuations in the Company's revenues, operating costs and development
expenses, which can be affected by the Company's ability to (i) effectively and
efficiently manage the expansion of the HER network and operations, (ii) obtain
infrastructure contracts, rights-of-way, licenses and other regulatory approvals
necessary to complete and operate the HER network, (iii) negotiate favorable
contracts with suppliers, including large volume discounts on purchases of
capital equipment and (iv) access markets, attract sufficient numbers of
customers and provide and develop services for which customers will subscribe.
The Company's revenues and costs are also dependent upon factors that are not
within the Company's control such as regulatory changes, changes in technology,
increased competition and various factors such as strikes, weather, and
performance by third-parties in connection with the Company's operations. Due to
the uncertainty of these factors, actual revenues and costs may vary from
expected amounts, possibly to a material degree, and such variations are likely
to affect the Company's future capital requirements. Historically, GTS has
experienced liquidity problems resulting in part from the Company's need to meet
the capital requirements of certain of its joint ventures in excess of forecast
amounts. In addition, certain of the Company's joint ventures have not met
management's financial performance expectations or have not been able to secure
local country financing and thus have not been able to generate the expected
cash inflows. In addition, if the Company expands its operations at an
accelerated rate or consummates acquisitions, the Company's funding needs will
increase, possibly to a significant degree, and it will expend its capital
resources sooner than currently expected. The Company may also be required to
repay its Convertible Bonds upon maturity in the year 2000 to the extent such
bonds are not converted into Common Stock. As a result of the foregoing, or if
the Company's capital resources otherwise prove to be insufficient, the Company
may need to raise additional capital. See "-- Government Regulation,"
"-- Competition," "-- Technology," "-- HER Network Roll-out," "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
"Use of Proceeds."
If the Company decides to raise additional funds through the incurrence of
debt, it may become subject to additional or more restrictive financial
covenants and its interest obligations will increase. If the Company decides to
raise additional funds through the issuance of equity, the interests of holders
of the Common Stock, will be diluted. There can be no assurance that additional
financing will be available to GTS on favorable terms or at all, and failure to
generate sufficient funds in the future, whether from operations or by raising
additional debt or equity capital, may require the Company to delay or abandon
some or all of its anticipated expenditures, to sell assets, or both, and could
affect the Company's ability to compete, either of which could have a material
adverse effect on the operations of the Company, and could affect the value of
the Notes. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Use of Proceeds."
12
SUBSTANTIAL LEVERAGE
GTS is, and will continue to be, highly leveraged as a result of the
substantial indebtedness it has incurred and intends to incur to pursue the
implementation of its business plans. On a pro forma consolidated basis, after
giving effect to the issuance of the Notes, the Company would have had
approximately $533.7 million aggregate principal amount of indebtedness
outstanding at September 30, 1997. GTS's debt instruments permit the Company and
its subsidiaries to incur certain additional indebtedness to fund expansion of
the Company's businesses and for other permitted purposes. The degree to which
the Company is leveraged could have important consequences for holders of the
Notes, including (i) limiting the Company's ability to refinance its existing
indebtedness or obtain additional financing to fund future working capital,
capital expenditures and other general corporate requirements, (ii) requiring
the dedication of a substantial portion of the Company's cash flow from
operations to the payment of principal of, and interest on, its indebtedness,
thereby reducing the availability of such cash flow to fund working capital,
capital expenditures or other general corporate purposes, (iii) limiting the
Company's flexibility in planning for, or reacting to, changes in its business
and the telecommunications industry, (iv) limiting the Company's ability to
obtain additional financing to make capital expenditures and acquisitions, (v)
limiting the Company's ability to withstand adverse economic conditions or take
advantage of significant business opportunities that may arise, (vi) limiting
the Company's ability to invest in new or developing technologies, (vii)
limiting the Company's ability to respond to changes affecting the
implementation of its financing, construction or operating plans and (viii)
placing the Company at a competitive disadvantage with respect to less-leveraged
competitors. In addition, the Company's operating and financial flexibility will
be limited by covenants contained in agreements governing the indebtedness of
the Company. Among other things, these covenants limit or may limit the ability
of the Company and its subsidiaries to incur additional indebtedness, make
capital expenditures, pay dividends or make distributions on capital stock of
the Company or make certain other restricted payments, create certain liens upon
assets, dispose of certain assets or enter into certain transactions with
affiliates. There can be no assurance that such covenants will not materially
and adversely affect the Company's ability to finance its future operations or
capital needs or to engage in other business activities which may be in the
interest of the Company.
The Company must substantially increase its net cash flow in order to meet
its debt service obligations, and there can be no assurance that the Company
will be able to meet such obligations, including the obligations of the Company
under the Notes. If the Company is unable to generate sufficient cash flow or
otherwise obtain funds necessary to make required payments, or if it otherwise
fails to comply with the various covenants under its indebtedness, it would be
in default under the terms thereof, which would permit the holders of such
indebtedness to accelerate the maturity of such indebtedness and could cause
defaults under other indebtedness of the Company, including the Notes. Such
defaults could result in a default on the Notes and could delay or preclude
payments of interest or principal thereon.
RANKING; UNSECURED STATUS OF THE NOTES
The Notes will represent unsecured, senior obligations of the Company, and
will rank senior in right of payment to all subordinated indebtedness of the
Company and at least pari passu in right of payment with all other present and
future unsecured, senior indebtedness of the Company. On September 30, 1997, on
a pro forma consolidated basis after giving effect to the Notes Offering, GTS
would have had approximately $533.7 million of total indebtedness, of which
$433.7 million ($450.1 million on a combined basis) would have ranked senior to
the Notes. The Notes will be effectively subordinated to all indebtedness of the
Company's subsidiaries and joint ventures. On September 30, 1997, the Company's
equity investees had $16.4 million of indebtedness. Although the Indenture will
limit the ability of the Company and its subsidiaries to incur additional
indebtedness, the Company may incur significant amounts of indebtedness pursuant
to certain exceptions in the Indenture. In the event of a bankruptcy,
liquidation or reorganization of the Company or any default in the payment of
any indebtedness under any senior secured credit facility or other secured
indebtedness, holders of such secured indebtedness will be entitled to payment
in full from the proceeds of all assets of the Company pledged to secure such
indebtedness prior to any payment of such proceeds to holders
13
of the Notes. Consequently, there can be no assurance that the Company will have
sufficient funds to make payments to holders of the Notes. See "Description of
the Notes."
HOLDING COMPANY STRUCTURE; SIGNIFICANT LIMITATIONS ON ACCESS TO SUBSIDIARIES'
AND JOINT VENTURES' CASH FLOW
GTS is a holding company which has no significant business operations or
assets other than its interests in joint ventures and its subsidiaries.
Accordingly, GTS must rely entirely upon distributions from the joint ventures
and its subsidiaries and investments to generate the funds necessary to meet its
obligations, including payments on the Notes. The joint ventures and the
Company's subsidiaries are separate and distinct legal entities which have no
obligation, contingent or otherwise, to pay any amount due pursuant to the Notes
or to make any funds available therefor, whether by dividends, loans or other
payments. In addition, should the Company receive dividends or other
distributions from its joint ventures, subsidiaries or investments, the ability
of the Company to repatriate such profits and capital is dependent upon the
provisions of the applicable foreign investment and exchange laws and
availability of foreign exchange in sufficient quantities in those countries.
The amount of such dividends and other distributions from these entities will be
affected by the current tax systems in these jurisdictions, primarily the
provisions relating to corporate profits and withholding taxes. See "-- Taxes;
Availability of Net Operating Loss Carryforwards." Furthermore, because consent
is required of the joint venture partners in some of the Company's joint
ventures for distributions from such joint ventures, the Company's ability to
receive dividends and other distributions is to some degree dependent on
cooperation from its joint venture partners. See "-- Dependence on Certain Local
Parties; Absence of Control." Thus, there can be no assurance that the Company
will be able to realize benefits from its joint ventures, subsidiaries and
investments through the receipt of dividends or other distributions at such
times and amounts it desires. Any failure by GTS to receive dividends or other
distributions from its joint ventures, subsidiaries or investments would
restrict the Company's ability to repay the Notes and could otherwise have a
material adverse effect on the Company's business, results of operations and
financial condition. In the event that the Company were unable to meet its
working capital needs and capital expenditure requirements with cash generated
from operations or borrowings from other sources, the Company would have to
consider various options, such as refinancing outstanding indebtedness,
obtaining additional equity capital or selling certain assets. There can be no
assurance that the Company will be able to raise new equity capital, refinance
its outstanding indebtedness, or obtain new financing in the future, or that, if
the Company is able to do so, the terms available will be favorable to the
Company. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
ABILITY TO SERVICE DEBT; ABILITY TO REPURCHASE NOTES UPON A CHANGE OF CONTROL
In the event of a Change of Control (as defined herein), each holder of
outstanding Notes may require the Company to repurchase all or a portion of such
holder's Notes. The ability of the Company to make payments in connection with
such redemptions or repurchases, and the ability of the Company to meet its debt
service obligations generally, including its principal and interest obligations
under the Notes, will depend on the future operating performance and financial
results of the Company. There can be no assurance that the cash generated from
operations, together with any cash available from any financing alternatives and
asset sales, will allow the Company to meet its debt service obligations,
including its obligations with respect to the Notes. In the event the Company is
unable to make such payments out of cash generated from operations, it would
need to consider various alternatives such as refinancing the Notes, raising
additional equity capital or selling certain assets.
HISTORY OF OPERATING LOSSES
The Company has historically sustained substantial operating and net
losses. The Company had net losses of $0.4 million in 1992, $2.4 million in
1993, $12.0 million in 1994, $40.4 million in 1995, $68.0 million in 1996 and
$87.9 million for the nine months ended September 30, 1997. The Company's
cumulative net losses totalled $213.8 million from inception through September
30, 1997. Further development of the Company's business will require significant
additional expenditures and the Company expects that it will have significant
operating and net losses and will record significant net cash outflow, before
financing, in coming years. There
14
can be no assurance that the Company's operations will achieve or sustain
profitability or positive cash flow in the future. If the Company cannot achieve
and sustain operating profitability or positive cash flow from operations, it
may not be able to meet its debt service obligations or working capital
requirements. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
HER NETWORK ROLL-OUT
HER's ability to achieve its strategic objective will depend in large part
on the successful, timely and cost-effective completion of the HER network.
Although HER currently operates commercially over an approximately 1,700
kilometer portion of the network linking Brussels, Antwerp, Rotterdam,
Amsterdam, London and Paris, the development of the remainder of the network may
be delayed or adversely affected by a variety of factors, uncertainties and
contingencies. Many of these factors, such as strikes, natural disasters and
other casualties, are beyond HER's control. In addition, HER will need to
negotiate and conclude additional agreements with various parties regarding,
among other things, rights-of-way and development and maintenance of the network
infrastructure and equipment. Historically, HER has experienced substantial
delays in concluding these agreements and developing its network. There can be
no assurance that HER will be successful in concluding necessary agreements, or
that delays in concluding such agreements will not materially and adversely
affect the speed or successful completion of the network. The successful and
timely completion of the network will also depend on, among other things, (i)
the availability to HER of substantial amounts of additional capital and
financing, (ii) timely performance by various third parties of their contractual
obligations to engineer, design and construct portions of the network and (iii)
HER's ability to obtain and maintain applicable governmental approvals.
HER expects to roll out full telecommunications service over the initial
five country network in the second quarter of 1998, and the 18,000 kilometer
network to be operational during the year 2000. Although HER believes that its
cost estimates and the build-out schedule are reasonable, there can be no
assurance that the actual construction costs or time required to complete the
network build-out will not substantially exceed current estimates.
Any significant delay or increase in the costs associated with development
of the HER network could have a material adverse effect on HER and the Company.
Development of the HER network is capital intensive. Management expects
that approximately $290 million in capital expenditures will be incurred in
connection with the buildout of the HER network, with approximately $35 million
required for the roll out of the initial five country network that is expected
to be completed in the second quarter of 1998. While HER raised approximately
$265 million in a private placement of its senior notes in August 1997 (of which
$56.5 million has been placed in escrow for the first two years' interest
payments on the notes), additional financing must be obtained to construct the
HER network and there can be no assurance that such additional financing will be
completed. Failure to obtain necessary financing may require HER to delay or
abandon its plans for deploying the remainder of the network and would adversely
affect the viability of HER, or may require the Company to make additional
capital contributions to HER at the expense of the Company's other operations,
either of which could have a material adverse effect on the operations of the
Company. HER's revenues and the cost of deploying its network and operating its
business will depend upon a variety of factors including, among other things,
HER's ability to (i) effectively and efficiently manage the expansion of its
network and operations, (ii) negotiate favorable contracts with suppliers, (iii)
obtain additional licenses, regulatory approvals, rights-of-way and
infrastructure contracts to complete and operate the network, (iv) access
markets and attract sufficient numbers of customers and (v) provide and develop
services for which customers will subscribe. HER's revenues and costs are also
dependent upon factors that are not within HER's control such as regulatory
changes, changes in technology, increased competition and various factors such
as strikes, weather and performance by third-parties in connection with the
development of the network. Due to the uncertainty of these factors, actual
costs and revenues may vary from expected amounts, possibly to a material
degree, and such variations would likely affect HER's future capital
requirements. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources." HER must obtain
additional infrastructure provider agreements for the long-term lease of dark
fiber, rights-of-way and other permits to install fiber optic
15
cable from railroads, utilities and governmental authorities to build out the
network. There can be no assurance that HER will be able to maintain all of its
existing agreements, rights and permits or to obtain and maintain the additional
agreements, rights and permits needed to implement its business plan on
acceptable terms. Loss of substantial agreements, rights and permits or the
failure to enter into and maintain required arrangements for the HER network
could have a material adverse effect to enter on HER's business. In addition,
HER depends on third parties for leases of dark fiber for substantial portions
of its network. There can be no assurance that HER will be able to enter into
and maintain required arrangements for leased portions of the HER network, which
could have a material adverse effect on HER's business.
In order to operate and, in the case of some countries, even to construct
the network in accordance with current plans, HER must obtain the necessary
regulatory approvals. To date, HER has obtained licenses, authorizations and/or
registrations in the United Kingdom, the Netherlands, Belgium, Germany and
France and has obtained a trial concession to operate in Switzerland. In
addition, HER intends to file applications in other countries in anticipation of
service launch in accordance with the HER network roll-out plan. The terms and
conditions of these licenses, authorizations or registrations may limit or
otherwise affect HER's scope of operations. There can be no assurance that HER
will be able to obtain, maintain or renew licenses, authorizations or
registrations to provide the services it currently provides and plans to
provide, that such licenses, authorizations or registrations will be issued or
renewed on terms or with fees that are commercially viable, or that the
licenses, authorizations or registrations required in the future can be obtained
by HER. The loss of, or failure to obtain, these licenses, authorizations or
registrations or a substantial limitation upon the terms of these licenses,
authorizations or registrations could have a material adverse effect on HER. See
"Business -- Western Europe -- HER -- Licenses and Regulatory Issues."
RISKS RELATING TO REORGANIZATION OF RUSSIAN TELECOMMUNICATIONS INDUSTRY
Svyazinvest was established by the Russian government in 1994 to hold the
government's interest in 88 regional telecommunication companies. In April 1997,
President Yeltsin approved the transfer of additional government-owned
telecommunications assets, including the government's 51% stake in Rostelecom
(the government controlled international and long distance operator), to
Svyazinvest. On July 30, 1997, Mustcom Ltd., a Cyprus-based company that
represents the interests of a consortium which includes ICFI Cyprus, Renaissance
International Ltd., Deutsche Morgan Grenfell, Morgan Stanley, and an affiliate
of George Soros, purchased a 25% stake in Svyazinvest for $1.87 billion. As of
September 30, 1997, affiliates of George Soros beneficially owned 25.8% of the
Company's Common Stock. The President has also authorized the sale of another
24% of Svyazinvest at a future date. This sale is scheduled to occur in the
first half of 1998 and is currently reserved solely for Russian investors. The
Russian government has announced that it will retain a controlling 51% interest
in Svyazinvest. As a result of the government's actions, a single entity,
Svyazinvest, now owns a majority interest in most of the Company's principal
venture partners and other telecommunication service providers in Russia which
together provide a range of international and domestic long distance and local
telecommunications services throughout Russia. The consolidation of many of its
partners under Svyazinvest and the possible sale of a significant interest in
Svyazinvest to foreign and/or Russian investors will likely subject the Company
to more coordinated competition from Svyazinvest, and may lead to material
adverse changes in the business relationships between the Company and such
partners, which business relationships represent a material component of the
Company's business strategy in Russia. There can be no assurance that the
continuing privatization of Svyazinvest, or the evolution of government policy
regarding Svyazinvest and Rostelecom, will not have a material adverse effect on
the Company or its ventures. See "-- Competition," "-- Dependence on Certain
Local Parties; Absence of Control" and "Business -- Russia and the
CIS -- Overview" and "Principal Stockholders."
MANAGING RAPID GROWTH
As a result of the Company's past and expected continued growth and
expansion, significant demands have been placed on the Company's management,
operational and financial resources and on its systems and controls. The Company
continues to construct segments of the HER network, expand its operations within
Russia and the CIS and expand into additional geographic and service markets
when business and regulatory conditions warrant. In order to manage its growth
effectively, the Company must continue to implement and
16
improve its operational and financial systems and controls, purchase and utilize
additional telecommunications facilities and expand, train and manage its
employee base. Inaccuracies in the Company's forecasts of market demand could
result in insufficient or excessive telecommunications facilities and
disproportionate fixed expenses for certain of its operations. There can be no
assurance that the Company will be able to construct and operate the entire HER
network as currently planned, expand with the markets in which its ventures are
currently operating or expand into additional markets at the rate presently
planned by the Company, or that any existing regulatory barriers to such
expansion will be reduced or eliminated. As the Company proceeds with its
development and expansion, there will be additional demands on the Company's
customer support, sales and marketing and administrative resources and network
infrastructure. There can be no assurance that the operating and financial
control systems and infrastructure of the Company and its ventures will be
adequate to maintain and effectively manage future growth. The failure to
continue to upgrade the administrative, operating and financial control systems
or the emergence of unexpected expansion difficulties could materially and
adversely affect the Company's business, results of operations and financial
condition.
RISKS RELATING TO EMERGING MARKETS
Substantially all of the Company's revenue is derived from operations in
emerging markets, where the Company's businesses are subject to numerous risks
and uncertainties, including political, economic and legal risks, such as
unexpected changes in regulatory requirements, tariffs, customs, duties and
other trade barriers, difficulties in staffing and managing foreign operations,
problems in collecting accounts receivable, political risks, fluctuations in
currency exchange rates, foreign exchange controls which restrict or prohibit
repatriation of funds, technology export and import restrictions or
prohibitions, delays from customs brokers or government agencies, seasonal
reductions in business activity, and potentially adverse tax consequences
resulting from operating in multiple jurisdictions with different tax laws,
which could materially adversely impact the Company's business, results of
operations and financial condition.
The political systems of many of the emerging market countries in which the
Company operates or plans to operate are slowly emerging from a legacy of
totalitarian rule. Political conflict and, in some cases, civil unrest and
ethnic strife may continue in some of these countries for a period of time. Many
of the economies of these countries are weak, volatile and reliant on
substantial foreign assistance. Expropriation of private businesses in such
jurisdictions remains a possibility, whether by an outright taking or by
confiscatory tax or other policies. There can be no assurance that GTS's
operations will not be materially and adversely affected by such factors or by
actions to expropriate or seize its operations. The success of free market
reforms undertaken in certain of the emerging market countries in which the
Company operates is also uncertain, and further economic instability may occur.
These factors may reduce and delay business activity, economic development and
foreign investment.
Legal systems in emerging market countries frequently have little or no
experience with commercial transactions between private parties. The extent to
which contractual and other obligations will be honored and enforced in emerging
market countries is largely unknown. Accordingly, there can be no assurance that
difficulties in protecting and enforcing rights in emerging market countries
will not have a material adverse effect upon GTS and its operations.
Additionally, the Company's businesses operate in uncertain regulatory
environments. The laws and regulations applicable to GTS's activities in
emerging market countries are in general new and subject to change and, in some
cases, incomplete. There can be no assurance that local laws and regulations
will become stable in the future, or that changes thereto will not materially
adversely affect the operations of GTS. Additionally, telecommunications
regulations in the more developed Western European markets in which GTS
participates are currently undergoing changes initiated by the Commission of the
European Union. See "Business."
RISKS RELATING TO RUSSIA AND THE CIS
Substantially all of the Company's revenue is derived from operations in
Russia and the CIS. Foreign companies conducting operations in the former Soviet
Union face significant political, economic, and legal risks.
17
Political. The political systems of Russia and the other independent
countries of the CIS, which are in a stage of relative infancy, are vulnerable
to instability due to the populace's dissatisfaction with reform, social and
ethnic unrest and changes in government policies. Such instability could lead to
events that could have a material adverse effect on the Company's operations in
these countries. In recent years, Russia has been undergoing a substantial
political transformation. During this transformation, legislation has been
enacted to protect private property against expropriation and nationalization.
However, due to the lack of experience in enforcing these provisions in the
short time they have been in effect and due to potential political changes in
the future, there can be no assurance that such protections would be enforced in
the event of an attempted expropriation or nationalization. Expropriation or
nationalization of the Company, its assets or portions thereof, whether by an
outright taking or by confiscatory tax or other policies potentially without
adequate compensation, would have a material adverse effect on the Company.
The various government institutions and the relations between them, as well
as the government's policies and the political leaders who formulate and
implement them, are subject to rapid and potentially violent change. For
example, the Constitution of the Russian Federation gives the President of the
Russian Federation substantial authority, and any major changes in, or rejection
of, current policies favoring political and economic reform by the President may
have a material adverse effect on the Company. Furthermore, the political and
economic changes in Russia have resulted in significant dislocations of
authority. The local press and international press have reported that
significant organized criminal activity has arisen and high levels of corruption
among government officials exist where the Company operates. While the Company
does not believe it has been adversely affected by these factors to date, no
assurance can be given that organized or other crime will not in the future have
a material adverse effect on the Company.
Economic. Over the past five years the Russian government has enacted
reforms to create the conditions for a more market-oriented economy. Despite
some progress in implementing its reforms, including progress in reducing
inflation and stabilizing the currency and industrial production, there remains
generally rising unemployment and underemployment, high government debt relative
to gross domestic product and high levels of corporate insolvency. No assurance
can be given that reform policies will continue to be implemented and, if
implemented, will be successful, that Russia will remain receptive to foreign
trade and investment or that the economy will improve.
In addition, Russia, the CIS and other emerging countries in which the
Company operates currently receive substantial financial assistance from several
foreign governments and international organizations. To the extent any of this
financial assistance is reduced or eliminated, economic development in Russia,
the CIS and such other countries may be adversely affected.
Russian and CIS businesses have a limited operating history in
market-oriented conditions. The relative infancy of the business culture is
reflected in the Russian banking system's under-capitalization and liquidity
crises. There have been concerns about rumors that many Russian banks continue
to have cash shortages. The Russian Central Bank has reduced banks' reserve
requirements in order to inject more liquidity into the Russian financial
system, but has stressed that it will not bail out the weaker banks. Many of
these banks are expected to disappear over the next several years as a result of
bank failure and anticipated consolidation in the industry. A general Russian
banking crisis could have a material adverse effect on the Company's operations
and financial performance and on the viability of the Company's receivables.
Regulation of the Telecommunications Industry. The Russian
telecommunications system is currently regulated largely through the issuance of
licenses. There is currently no comprehensive legal framework with respect to
the provision of telecommunications services in Russia, although a number of
laws, decrees and regulations govern or affect the telecommunications sector. As
a result, ministry officials have a fairly high degree of discretion to regulate
the industry. Although telecommunication licenses may not be transferred under
Russian law, the Russian Ministry of Communications (the "MOC") has adopted the
position that licensees may enter into agreements with third parties in
connection with the provision of services under the licensee's license; however,
the MOC does not generally review agreements entered into by licensees. There
can be no assurances that the current or future regulation of the Russian
telecommunications systems will not have a material adverse effect on the
Company.
18
Current Russian legislation governing foreign investment activities does
not prohibit or restrict foreign investment in the telecommunications industry.
However, on February 28, 1997, the State Duma, the lower house of parliament,
approved, on the first reading, draft foreign investment legislation which would
restrict any significant future foreign investment in numerous sectors of the
Russian economy, including telephone and radio communications. It is unlikely
that such restrictive legislation will be enacted, unless the political climate
changes dramatically. See "-- Political." More likely is the emergence of
restrictions on foreign investment in strategic industries, which could result
in foreign ownership limitations in industries such as telecommunications which
are not uncommon in many countries. The draft legislation has been referred to
the Russian government for comment. For such draft legislation to become Federal
law, it must be passed by a majority vote of the State Duma at another two
readings, then be approved by a majority of the Federation Council, the upper
house of parliament, and signed by the President of the Russian Federation.
Rejection of such legislation by the Federation Council can be overridden by a
two-thirds majority of the State Duma. Rejection of such legislation by the
President can be overridden by a two-thirds majority of each of the Federation
Council and the State Duma. There can be no assurance that future regulation of
foreign investment in the telecommunications industry will not have a material
adverse effect on the Company.
In addition, a lack of consensus exists over the manner and scope of
government control over the telecommunications industry. Because the
telecommunications industry is widely viewed as strategically important to
Russia, there can be no assurance that recent government policies liberalizing
control over the telecommunications industry will continue. Any change in or
reversal of such governmental policies could have a material adverse effect on
the Company. See "Business -- Russia and CIS -- Licenses and Regulatory Issues."
Legal Risks. As part of the effort to transform their economies into more
market-oriented economies, the Russian and other CIS governments have rapidly
introduced laws, regulations and legal structures intended to give participants
in the economy a greater degree of confidence in the legal validity and
enforceability of their obligations. Risks associated with the legal systems of
Russia and the other independent republics of the CIS include (i) the untested
nature of the independence of the judiciary and its immunity from economic,
political or nationalistic influence; (ii) the relative inexperience of judges
and courts in commercial dispute resolutions and generally in interpreting legal
norms; (iii) inconsistencies among laws, presidential decrees, government
resolutions and ministerial orders; (iv) frequently conflicting local, regional
and national laws, rules and regulations; (v) the lack of legislative, judicial
or administrative guidance on interpreting the applicable rules; and (vi) a high
degree of discretion on the part of government authorities and arbitrary
decision making which increases, among other things, the risk of property
expropriation. The result has been considerable legal confusion, particularly in
areas such as company law, commercial and contract law, securities and antitrust
law, foreign trade and investment law and tax law. Accordingly, there can be no
assurance that the Company will be able to enforce its rights in any disputes
with its joint venture partners or other parties in Russia or the CIS or that
its ventures will be able to enforce their respective rights in any disputes
with partners, customers, suppliers, regulatory agencies or other parties in
Russia or that the Company can be certain that it will be found to be in
compliance with all applicable laws, rules and regulations.
Russia has adopted currency and capital transfer regulations designed to
prevent the flight of capital from its borders. These regulations require
certain licenses for the movement of capital, which includes the incurrence and
repayment of indebtedness and the payment of capital contributions in foreign
exchange to Russian entities. The Company is resolving licensing issues with
respect to certain intercompany loans and capital contributions with the
applicable government agencies and believes that any licensing irregularities
that may arise will not have a material adverse effect on its financial
condition or results of operations. There can be no assurance, however, that
Russian government authorities will not take an unexpected adverse position
which could materially adversely affect the Company's business.
Taxes. Generally, taxes payable by Russian companies are substantial. In
addition, taxes payable by Russian companies are numerous and include taxes on
profits, revenue, assets and payroll as well as value-added tax ("VAT").
Moreover, statutory tax returns of Russian companies are not consolidated and
therefore, each company must pay its own Russian taxes. Because there is no
consolidation provision, dividends are subject to Russian taxes at each level.
Currently, dividends are taxed at 15% and the payor is required to
19
withhold the tax when paying the dividend, except with respect to dividends to
foreign entities that qualify for an exemption under treaties on the avoidance
of double taxation. To date, the system of tax collection has been relatively
ineffective, resulting in the continual imposition of new taxes in an attempt to
raise government revenues. This history, plus the existence of large government
budget deficits, raises the risk of a sudden imposition of arbitrary or onerous
taxes, which could adversely affect the Company.
Because of uncertainties associated with the laws and regulations of the
Russian tax system and the increasingly aggressive interpretation, enforcement
and collection activities of the Russian tax authorities, the Company's Russian
taxes may be in excess of the estimated amount expensed to date and accrued on
the Company's balance sheets. It is the opinion of management that the ultimate
resolution of the Company's Russian tax liability, to the extent not previously
provided for, will not have a material adverse effect on the financial condition
of the Company. However, depending on the amount and timing of an unfavorable
resolution of this contingency, it is possible that the Company's future results
of operations or cash flows could be materially affected in a particular period.
In various foreign jurisdictions, the Company is obligated to pay VAT on
the purchase or importation of assets, and for certain other transactions. In
many instances, VAT can be offset against VAT which the Company collects and
otherwise would remit to the tax authorities, or may be refundable. Because the
law in some jurisdictions is unclear, the local tax authorities could assert
that the Company is obligated to pay additional amounts of VAT. In the opinion
of management, any additional VAT which the Company may be obligated to pay
would not be material.
ADEQUACY OF MANAGEMENT, LEGAL AND FINANCIAL CONTROLS IN EMERGING MARKETS
Many of the emerging market countries in which the Company operates,
particularly in Russia and the CIS where the Company has to date derived most of
its revenues, are deficient in management and financial reporting concepts and
practices, as well as in modern banking, computer and other control systems. The
Company historically has had difficulty in hiring and retaining a sufficient
number of qualified employees to work in these markets. As a result of these
factors, the Company has experienced difficulty in establishing management,
legal and financial controls, collecting financial data and preparing financial
statements, books of account and corporate records and instituting business
practices that meet Western standards.
The Company has a policy worldwide of complying with all applicable laws
and seeks to ensure that all persons in its employ comprehend and comply with
such laws. The application of the laws of any particular country, however, is
not always clear, particularly in emerging market countries where commercial
practices differ significantly from practices in the United States and other
Western countries and the legal and regulatory frameworks are less developed. In
addition, some practices, such as the payment of fees for the purpose of
obtaining expedited customs clearance and other commercial benefits, that may be
common methods of doing business in these markets might be unlawful under the
laws of the United States. As a result of the difficulty the Company
historically has experienced in emerging markets in instituting business
practices that meet Western reporting and control standards, it historically has
been unable to ascertain whether certain practices by its ventures, which were
not in accordance with Company policy, were in compliance with applicable U.S.
and foreign laws. If it were to be determined that the Company or any of its
ventures were involved in unlawful practices and were the factual and legal
issues relating thereto to be resolved adversely, the Company or its ventures
could be exposed, among other things, to significant fines, risk of prosecution
and loss of its licenses. See "-- Risks Relating to Emerging Markets" and
"-- Government Regulation."
In light of these circumstances, in the second half of 1996 the Company
increased its efforts to improve its management and financial controls and
business practices. The Company recruited a more experienced financial and legal
team, including a new Chief Financial Officer of the Company, a senior finance
officer overseeing all of the regions in which the Company operates, a senior
finance officer for the CIS region, and a senior legal officer for the CIS
region. The Company also established a Treasury group and adopted a more
rigorous Foreign Corrupt Practices Act ("FCPA") compliance program. The Company
has developed and implemented a training program for employees regarding U.S.
legal and foreign local law compliance. The Company also appointed a Compliance
Officer responsible for monitoring compliance with such laws and
20
training Company personnel around the world. In connection with these
developments, the Company expanded its corporate business practices policy to
include, in addition to compliance with U.S. laws such as the FCPA, compliance
with applicable local laws such as the conflict of interest rules under the 1996
Russian Joint Stock Company Law, currency regulations and applicable tax laws.
In early 1997, the Company retained special outside counsel to conduct a
thorough review of certain business practices of the Company in the emerging
markets in which the Company operates in order to determine whether deficiencies
existed that needed to be remedied. As a result of this review, the Company
replaced certain senior employees in Russia and instituted additional and more
stringent management and financial controls. As a result of the review, the
Company has not identified any violations of law that management believes would
have a material adverse effect on the Company's financial condition. There can
be no assurances, however, that if the Company or any of its ventures were found
by government authorities to have committed violations of law that, depending on
the penalties assessed and the timing of any unfavorable resolution, the
Company's future results of operations and cash flows would not be materially
adversely affected in a particular period.
Although the Company believes that this review was properly conducted and
was sufficient in scope, there can be no assurance that all potential
deficiencies have been identified or that the control procedures and compliance
programs initiated by the Company will be effective. If the Company or any of
its ventures are ever found to have committed violations of law, depending on
the penalties assessed and the timing of any unfavorable resolution, the
Company's future results of operations and cash flows could be materially
adversely affected in a particular period. Management believes, however, that
the actions taken during the past twelve months to strengthen the Company's
management, financial controls and legal compliance, coupled with the
implementation of the recent recommendations from the review and the oversight
provided through the Audit Committee of the Board of Directors of the Company to
ensure compliance, will be adequate to address the recurrence of any past
possible deficiencies.
DEPENDENCE ON CERTAIN LOCAL PARTIES; ABSENCE OF CONTROL
Many GTS operations including Sovintel, TeleRoss and GTS Cellular have been
developed in cooperation or partnership with key local parties, such as regional
PTOs. The Company is substantially dependent on its local partners to provide
marketing expertise and knowledge of the local regulatory environment in order
to facilitate the acquisition of necessary licenses and permits. Any failure by
the Company to form or maintain alliances with local partners, or the preemption
or disruption of such alliances by the Company's competitors or otherwise, could
adversely affect the Company's ability to penetrate and compete successfully in
the emerging markets it operates in or enters. In addition, in the uncertain
legal environments in which GTS operates, certain GTS businesses may be
vulnerable to local government agencies or other parties who wish to renegotiate
the terms and conditions of, or terminate, their agreements or other
understandings with GTS.
While the Company may have the right to nominate key employees, direct the
operations and determine the strategies of such joint ventures, under the terms
of their respective constituent documents, the Company's partners in some of the
ventures have the ability to frustrate the exercise of such rights. Significant
actions by most of GTS's ventures, such as approving budgets and business plans,
declaring and paying dividends, and entering into significant corporate
transactions effectively require the approval of GTS's local partners. Further,
the Company would be unlikely as a practical matter to want to take significant
initiatives without the approval of its joint venture partners. Accordingly, the
absence of unilateral control by the Company over the operations of its joint
ventures could have a material adverse effect on the Company.
In addition, the Company and its venture partners frequently compete in the
same markets. For example, Rostelecom, GTS's partner in Sovintel, is the
dominant international and domestic long distance carrier in Russia. In
addition, many of the regional telephone companies partnered with GTS in the
TeleRoss Ventures offer cellular services in direct competition with certain of
the operations of GTS Cellular. Such competition with its partners may lead to
conflicts of interest for GTS and its partners in the operations of their
ventures. There can be no assurance that any such conflicts will be resolved in
favor of GTS. In addition, the
21
combination under Svyazinvest of the Russian government's majority interest in
Rostelecom and 85 of the regional telephone companies gives Svyazinvest a
majority interest in entities that provide international and domestic long
distance and local telecommunications services throughout Russia and may expose
the Company to more coordinated competition from its partners in the Russian
telecommunications market. See "-- Risks Relating to Reorganization of Russian
Telecommunications Industry."
GOVERNMENT REGULATION
As a multinational telecommunications company, GTS through its ventures is
subject to varying degrees of regulation in each of the jurisdictions in which
its ventures provide services. Local laws and regulations, and the
interpretation of such laws and regulations, differ significantly among the
jurisdictions in which the Company and its ventures operate. There can be no
assurance that future regulatory, judicial and legislative changes will not have
a material adverse effect on the Company, that regulators or third parties will
not raise material issues with regard to the Company's or its ventures'
compliance or noncompliance with applicable regulations or that any changes in
applicable laws or regulations will not have a material adverse effect on the
Company or any of its ventures.
Many of GTS's ventures require telecommunications licenses, most of which
have been granted for periods of three to ten years. The terms and conditions of
these licenses may limit or otherwise affect the ventures' scope of operations.
The Company has had favorable experience obtaining, maintaining and renewing
licenses in the past. However, there can be no assurance that it will be able to
obtain, maintain or renew licenses to provide the services it currently provides
and plans to provide, that such licenses will be issued or renewed on terms or
with fees that are commercially viable, or that licenses required by future
ventures can be obtained by the Company or its partners. The loss of or a
substantial limitation upon the terms of these telecommunications licenses could
have a material adverse effect on the Company. See each section under "Business"
entitled "Licenses and Regulatory Issues."
A substantial portion of HER's strategy is based upon the timely
implementation of regulatory liberalization of the European Union ("EU")
telecommunications market on January 1, 1998 under existing European Community
("EC") directives. Although EU member states have a legal obligation to
liberalize their markets in accordance with their requirements, certain more
detailed aspects of the EU regulatory framework to apply in the liberalized
environment after January 1, 1998 still remain to be adopted. In addition,
Ireland, Portugal, Spain, Luxembourg and Greece have been granted extensions
from the January 1, 1998 deadline. There can be no assurance that each EU member
state will proceed with the expected liberalization on schedule, or at all, or
that the trend toward liberalization will not be stopped or reversed in any of
the countries. Accordingly, HER faces the risk that it will establish the HER
network and make capital expenditures in a given country in anticipation of
regulatory liberalization which does not subsequently occur.
In order to give effect to EC directives in each member state, national
governments must pass legislation liberalizing their respective markets. This
applies not only to the liberalization requirements set out in existing EC
directives, but also to requirements set out in directives which have yet to be
adopted. The implementation of EC directives in the telecommunications sector
has been inconsistent or ambiguous in some EU member states. Such implementation
could limit, constrain or otherwise adversely affect HER's ability to provide
certain services. Furthermore, national governments may not necessarily pass
legislation implementing an EC directive in the form required, or at all, or may
pass such legislation only after a significant delay. Even if a national
legislature enacts appropriate regulation within the time frame established by
the EU, there may be significant resistance to the implementation of such
legislation from PTOs, regulators, trade unions and other sources. Further,
HER's provision of services in Europe may be materially adversely affected if
any EU member state imposes greater restrictions on non-EU international
services than on international services within the EU. These and other potential
obstacles to liberalization could have a material adverse effect on HER's
operations by preventing HER from establishing its network as currently
intended, as well as a material adverse effect on the Company.
22
COMPETITION
GTS faces significant competition in all of its existing telecommunications
businesses and for the types of acquisition and development opportunities it
seeks in both emerging and Western European markets. GTS's competition in these
markets includes national PTOs, multinational telecommunications carriers, other
telecommunications developers and certain niche telecommunications providers. In
addition, certain of the Company's joint venture partners, including Rostelecom
and the regional telephone companies in Russia, certain of HER's rail-based
shareholders and other entities in the emerging markets in which the Company
operates, are also competitors of the Company. As a result of the recent
combination under Svyazinvest of the government's majority interest in
Rostelecom and 85 of the regional telephone companies, the Company may in the
future be subject to more coordinated competition from its partners in the
Russian telecommunications market. Although the Company believes it has a
favorable and cooperative relationship with its joint venture partners, there
can be no assurance that these partners will continue to cooperate with the
Company in the future or that they will not increase competitive pressures on
the Company. Any measures taken by the partners that reduce the level of
cooperation with the Company could jeopardize the Company's ability to
participate in the management and operation of its joint ventures and could have
a material adverse effect on the Company.
WorldCom, Inc. ("WorldCom") recently announced the construction of a
pan-European fiber network, the first phase of which is expected to connect
London, Amsterdam, Brussels, Frankfurt and Paris by early 1998. Although the
Company believes that the proposed WorldCom pan-European network is primarily
intended to carry WorldCom traffic, WorldCom has stated that any excess capacity
on such network will be used to provide a competitive "carriers' carrier"
service.
HER also competes with respect to its "point-to-point" transborder service
offering against circuits currently provided by PTOs through International
Private Leased Circuits. In addition, the liberalization of the European
telecommunications market is likely to attract additional entrants to both the
"point-to-point" and other telecommunications markets. There can be no assurance
that HER will compete effectively against its current or future competitors.
Many of the Company's competitors have technical, financial, marketing and
other resources substantially greater than those of GTS. There can be no
assurance that the Company will be able to overcome successfully the competitive
pressures to which it is subject, both in the markets in which it currently
operates and in markets into which it might expand. See each section under
"Business" entitled "Competition." In addition, many of the Company's current
and potential competitors are not subject to, or constrained by the prohibitions
of, the FCPA, including the prohibition against making payments to government
officials in order to obtain commercial benefits. The Company is subject to and
seeks to comply with the limitations and prohibitions of such law, and
accordingly may be subject to competitive disadvantages to the extent that its
competitors are able to secure business, licenses or other preferential
treatment through the making of such payments. Accordingly, there can be no
assurances that the Company will be able to compete effectively against
companies free from such limitations in the emerging markets where such
commercial practices are commonplace. See "-- Adequacy of Management, Legal and
Financial Controls in Emerging Markets."
CONTROL BY CERTAIN STOCKHOLDERS
Certain persons control substantial portions of the Company's voting stock.
After giving effect to the Stock Offerings, Soros Foundation-Hungary and certain
of its affiliates (collectively the "Soros Foundations"), Alan B. Slifka and
certain of his affiliates, and affiliates of Capital Research International are
expected to beneficially own, or have rights to acquire, approximately 20.4%,
10.8% and 10.1%, respectively, of the Common Stock on a fully diluted basis. See
"Principal Stockholders." In addition, three persons affiliated with the Soros
Foundations currently serve on the Company's Board of Directors (the "Board of
Directors"). Consequently, these entities are in a position to exercise control
over the outcome of matters submitted for stockholder actions, including the
election of members to the Board of Directors, and are able to influence the
management and affairs of the Company. Additionally, affiliates of the Soros
Foundations and of Capital International, Inc. have purchased debt securities of
the Company that include covenants that restrict the
23
operating and financing activities of the Company. In certain situations, the
interests of holders of the Company's equity securities may diverge from the
interests of the holders of the Company's debt securities, and holders of both
equity and debt securities of the Company may be in a position to require GTS to
act in a way that is not consistent with the general interests of the holders of
the Common Stock. See "-- Substantial Additional Capital Requirements,"
"Management," "Principal Stockholders" and "Certain Related Party Transactions."
CURRENCY AND EXCHANGE RISKS
All of GTS's operations are conducted outside the United States. A
substantial portion of the Company's anticipated revenues (as well as the
majority of its operating expenses) will be in foreign currency. As a result,
the Company will be subject to significant foreign exchange risks. In
particular, GTS's ventures in countries whose currencies are considered "soft
currencies" subject the Company to the risk that it will accumulate currencies
which may not be readily convertible into hard currency and which may be subject
to significant limitations on repatriation. The Company does not enter into
hedging transactions to limit its foreign currency risk exposure, although the
Company may implement such practices in the future. There can be no assurance
that GTS's operations will not be adversely affected by such factors. In
addition, these factors may limit the ability of the Company to reinvest
earnings from ventures in one country to fund the capital requirements of
ventures in other countries.
In Russia, where the Company derives most of its revenue, the ruble has
generally experienced a steady depreciation relative to the U.S. Dollar over the
past three years, although there has been some instability in the ruble exchange
rate over this period of time. The Company's tariffs are denominated in U.S.
Dollars but charges are invoiced and collected in rubles, while the Company's
major capital expenditures are generally denominated and payable in various
foreign currencies. To the extent such major capital expenditures involve
importation of equipment and the like, current law permits the Company to
convert its ruble revenues into foreign currency to make such payments. The
ruble is generally not convertible outside Russia. A market exists within Russia
for the conversion of rubles into other currencies, but it is limited in size
and is subject to rules limiting the purposes for which conversion and payment
may be effected. The limited availability of other currencies may tend to
inflate their values relative to the ruble and there can be no assurance that
such a market will continue to exist indefinitely. Moreover, the banking system
in Russia is not yet as developed as its Western counterparts and considerable
delays may occur in the transfer of funds within, and the remittance of funds
out of, Russia. Any delay in converting rubles into a foreign currency in order
to make a payment or delay in the transfer of such foreign currency could have a
material adverse effect on the Company.
EXCHANGE CONTROLS AND REPATRIATION RISKS RELATING TO RUSSIAN SECURITIES
Russia has adopted currency and capital transfer regulations designed to
prevent the flight of capital from its borders. These regulations require
certain licenses for the movement of capital, which includes the incurrence and
repayment of indebtedness and the payment of capital contributions in foreign
exchange to Russian entities. The Company is resolving licensing issues with
respect to certain intercompany loans and capital contributions with the
applicable government agencies and believes that any licensing irregularities
that may arise will not have a material adverse effect on its financial
condition or results of operations. There can be no assurance, however, that
Russian government authorities will not take an unexpected adverse position
which could materially affect the Company's business.
No assurance can be given that Russian foreign investment and currency
legislation will continue to permit repatriation of the proceeds from
investments. Furthermore, no assurance can be given that further restrictions
will not be imposed on the conversion of ruble earnings into foreign currency
for purposes of making dividend payments or on the repatriation of profits. If
any such further restrictions were imposed, they would have a material adverse
effect on the Company's interests in Russia.
TRANSACTIONS WITH AFFILIATES
The Company has entered into financing agreements with certain of its
affiliates. It is the Company's view that each such transaction has been on
terms no less favorable to the Company than other similar transactions available
to the Company with unaffiliated parties, if available at all. Generally, such
transactions
24
have been the Company's only recourse to meet financing needs and/or business
goals. Despite the foregoing, prospective purchasers may wish to consider the
circumstances in which such transactions were made, the terms of such
transactions and the Company's possible alternative courses of action. The
Company may enter into transactions in the future with affiliates in order to
meet its financing needs and/or business goals. See "Certain Related Party
Transactions" and "Description of Certain Indebtedness."
DEPENDENCE ON KEY PERSONNEL
The Company believes that its growth and future success will depend in
large part upon the efforts of a small number of key executive officers, as well
as on its ability to attract and retain highly skilled and qualified personnel
to work in the emerging markets in which it operates. Henry Radzikowski, who
served as Chief Executive Officer -- CIS and Eastern Europe Operations from
February 1994 until January 1997 and who has extensive experience in the
telecommunications industry in Russia, resigned in 1997. Stewart Reich became
Senior Vice President-Russia effective September 1, 1997. The Company has also
replaced or reassigned executive officers and senior personnel. The competition
for qualified personnel in the telecommunications industry is intense,
particularly in emerging markets where the Company operates and, accordingly,
there can be no assurance that the Company will be able to hire and retain
qualified personnel. Although the Company believes it has maintained a strong
management team, despite the change of personnel in Russia and the CIS, there
can be no assurance as to what effect such personnel changes will have on the
Company's operations in Russia and the CIS.
DEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS
To complete its billing, the Company must record and process massive
amounts of data quickly and accurately. While the Company believes its ventures'
management information systems are currently adequate, certain of such systems
will have to grow as the ventures' businesses expand. The Company believes that
the successful expansion of its information systems and administrative support
will be important to its continued growth, its ability to monitor and control
costs, to bill customers accurately and in a timely fashion and to achieve
operating efficiencies. There can be no assurance that the Company will not
encounter delays or cost-overruns or suffer adverse consequences in implementing
these systems. Any such delay or other malfunction of the Company's management
information systems could have a material adverse effect on the Company's
business, financial condition and results of operations.
TAXES; AVAILABILITY OF NET OPERATING LOSS CARRY FORWARDS
The tax rules and regimes prevailing in certain emerging market countries
in which the Company operates or plans to operate are, in many cases, new and
rapidly changing. Repatriation of profits may result in additional taxes. In
addition, other forms of taxation, including VAT, excise taxes and import
duties, change at an unpredictable pace and may have an adverse effect on the
Company's operations.
Availability of tax holidays and provisions of tax treaties with the United
States are subject to changes which may affect GTS's utilization of certain tax
benefits in the countries in which it operates as well as in the United States.
Certain ventures in the CIS and Hungary are operating under tax holidays granted
by local governments. Tax holidays are for periods ranging from up to five to
several years after achieving profitability under local tax regulations. In
addition to these holidays, certain of the Company's foreign ventures have
foreign tax loss carryforwards in excess of $25.0 million.
As of December 31, 1996, the Company had net operating loss carryforwards
for U.S. federal income tax purposes of approximately $60.9 million expiring in
fiscal years 2003 through 2011. Because of the "change in ownership" provisions
of the Tax Reform Act of 1986, the utilization of the Company's net operating
loss carryforwards will be subject to an annual limitation as a result of the
consummation of the Offerings.
The Company's financial statements do not reflect any provision for
benefits that might be associated with the U.S. and non-U.S. loss carryforwards.
There can be no assurance that such loss carryforwards will be allowed, in part
or full, by local tax authorities against future income.
25
TECHNOLOGY
The telecommunications industry is subject to rapid and significant changes
in technology and such technological advances may reduce the relative
effectiveness of existing technology and equipment. The Company obtains
telecommunications equipment from a number of vendors, upon whom it is dependent
for the adaptation of such equipment to meet varying local telecommunications
standards. The cost of implementation of emerging and future technologies could
be significant. There can be no assurance that the Company will maintain
competitive services or that the Company will obtain appropriate new technology
on a timely basis or on satisfactory terms. Any failure by the Company to
maintain competitive services or obtain new technologies could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Development and operation of the HER network are also subject to certain
technological risks. The network has been designed to utilize SDH technology.
While SDH represents an advanced, new transmission technology, HER's ability to
upgrade technology from this platform may be important in establishing and/or
maintaining a cost advantage over competitive carriers. There can be no
assurance that the HER network will achieve the technical specifications for
which it was designed or that HER will be able to upgrade the network as
technological improvements in telecommunications equipment are introduced.
Failure to achieve current specifications for, or future upgrades of, the
network may materially and adversely affect the viability of the HER network and
could have a material adverse effect on the business and prospects of GTS.
DIFFICULTY IN OBTAINING RELIABLE MARKET INFORMATION
The Company operates in markets in which it is difficult to obtain reliable
market information. The Company's business planning has been based on certain
assumptions concerning subscriber base, usage levels, pricing and operating
expenses based on the Company's experience and the Company's own investigation
of market conditions in the emerging market countries in which it operates. No
assurances can be given as to the accuracy of such assumptions, and such
assumptions may not be indicative of the actual performance of the Company's
operations.
ENFORCEABILITY OF JUDGMENTS
Substantially all of the assets of the Company (including all of the assets
of the Company's operating ventures) are located outside the United States. As a
result, it will be necessary for investors to comply with foreign laws in order
to enforce judgments obtained in a United States court (including those with
respect to federal securities law claims) against the assets of the operating
ventures, including foreclosure upon such assets, and there can be no assurance
that any U.S. judgments would be enforced under any such foreign laws.
NO PRIOR PUBLIC MARKET
The Company does not intend to apply for a listing of the Notes on any
national securities exchange or for quotation of the Notes through the Nasdaq
National Market in the United States. The Company has been advised by the
Underwriters that, following completion of the initial offering of the Notes,
the Underwriters intend to make a market in the Notes, although they are under
no obligation to do so and may discontinue any market-making activities at any
time without notice. No assurances can be given as to the liquidity of the
trading market for the Notes or that an active public market for the Notes will
develop. If an active public market does not develop, the market price and
liquidity of the Notes may be adversely affected.
26
USE OF PROCEEDS
The aggregate net proceeds of the Notes Offering are estimated to be
approximately $96.0 million after deducting estimated expenses of the Notes
Offering payable by the Company. Concurrently with the sale of the Notes, the
Company intends to complete the Stock Offerings, the net proceeds of which is
expected to be approximately $186.8 million after deducting estimated expenses
of the Stock Offerings payable by the Company.
The Company primarily intends to use the net proceeds from the Offerings to
provide working capital for existing telecommunications ventures, particularly
in Russia and the CIS, to expand the Company's operations, and for general
corporate purposes. The Company also intends to use a portion of the net
proceeds to repay loans of $70 million (plus accrued interest) from shareholders
which bear interest at 10% per annum and mature on January 19, 2001 and February
2, 2001. Also, as part of its business strategy, the Company regularly evaluates
potential acquisitions and joint ventures, including the acquisition of minority
interests in existing joint ventures. The Company has no definitive agreement
with respect to any material acquisition or joint venture, although from time to
time it has discussions with other companies and assesses opportunities on an
on-going basis. A portion of the net proceeds from the Offerings may be used to
fund such acquisitions. Approximately $20.0 million of the net proceeds of the
Notes Offering will be placed in the Escrow Account. Pending any use of its net
proceeds from the Offerings in the manner described above, the Company intends
to invest the proceeds in short-term investment grade obligations, bank deposits
or similar instruments.
27
CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Company as of September 30, 1997 and as adjusted to give effect to the Offerings
and the application of the net proceeds thereof.
ACTUAL(3) AS ADJUSTED(4)
---------- ---------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Cash and cash equivalents(1)........................ $ 366,841 $ 547,285
========= =========
Related party debt maturing within one year......... 11,760 --
Debt maturing within one year....................... 14,815 14,815
--------- ---------
Current debt.............................. 26,575 14,815
Long-term obligations (net of current portion)
Related party debt, less current portion.......... 64,715 7,656
HER Senior Notes due 2007......................... 265,000 265,000
Convertible bonds................................. 141,256 141,256
Capital Leases.................................... 1,452 1,452
Senior Notes due 2005............................. -- 100,000
Other long-term debt, less current portion........ 3,484 3,484
--------- ---------
Long term debt............................ 475,907 518,848
--------- ---------
Total debt................................ 502,482 533,663
--------- ---------
Minority interest................................... 20,275 20,275
Common stock subject to repurchase.................. 12,489 14,346
Shareholders' equity(2):
Common stock, $0.10 par value (135,000,000 shares
authorized; 37,606,814 shares issued and
outstanding, actual; 48,706,814 shares issued
and outstanding, as adjusted).................. 3,761 4,871
Additional paid-in capital.......................... 274,433 458,264
Accumulated deficit................................. (213,770) (229,064)
Other............................................... (7,021) 7,021
--------- ---------
Total shareholders' equity................ 57,403 227,050
--------- ---------
Total capitalization................................ $ 592,649 $ 795,334
========= =========
(1) Excludes restricted cash of approximately $59.8 million as of September 30,
1997. The September 30, 1997 data, as adjusted, also excludes an additional
$20.0 million to be placed in the Escrow Account.
(2) Excludes (i) 7,777,776 shares of Common Stock reserved for issuance upon
exercise of outstanding warrants at an exercise price of $9.33 per share,
(ii) 6,328,782 shares of Common Stock reserved for issuance upon exercise of
outstanding stock options at a weighted average exercise price of $9.33 per
share, (iii) 713,311 shares of Common Stock reserved for issuance upon
exercise of a put right associated with a 1996 financing agreement, as
amended, (iv) 8,044,444 shares issuable upon conversion of the Convertible
Bonds (assuming a public offering price in the Offerings of $18.00 per
share) and (v) 617,040 shares of Common Stock reserved for issuance pursuant
to the TCM business partnership agreement as deferred consideration to TCM's
partners. See "Certain Related Party Transactions."
(3) As a result of the Company's increase in ownership interest and amendment to
the HER shareholders agreement that was completed as July 16, 1997, the
Company accounts for its ownership interest in HER under the consolidation
method of accounting. Prior to this date, the Company accounted for HER
using the equity method of accounting.
(4) Anticipates $199.8 million gross proceeds from the Stock Offerings
(11,100,000 shares at $18.00 per share), with estimated offering expenses of
6.5% or $13.0 million. Amount also includes $100.0 million gross proceeds
from the Notes Offering with estimated offering expenses of 4.1% or $4.1
million as well as the repayment of $70.0 million, plus accrued interest of
$12.3 million and the write-off of unamortized debt discount and issuance
costs of $15.3 million, of loans from shareholders which bear interest at
10% per annum and mature on January 19, 2001 and February 2, 2001. Further,
amount also recognizes the accretion of the outstanding common stock that is
subject to repurchase (797,100 shares at September 30, 1997) for the fair
value of the Company's Common Stock at September 30, 1997, $15.67 per share,
to the $18.00 per share offering price in the Stock Offerings.
28
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following selected historical consolidated financial data as of and for
the years ended December 31, 1992, 1993, 1994, 1995 and 1996 and as of and for
the nine months ended September 30, 1997 are derived from the Company's audited
Consolidated Financial Statements. The following unaudited selected historical
consolidated financial data as of and for the nine months ended September 30,
1996 are derived from the Company's unaudited Consolidated Financial Statements.
The selected financial data presented below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the audited Consolidated Financial Statements and related notes
thereto appearing elsewhere in this Prospectus.
Under generally accepted accounting principles, most of the Company's
ventures are accounted for by the equity method of accounting. Under this
method, the operating results of the ventures are included in the Company's
Consolidated Statement of Operations as a single line item, "Equity in (losses)
earnings of ventures." The Company recognizes 100% of the losses in ventures
where the Company bears all of the financial risk (which includes all of the
Company's significant ventures except for Sovintel and, historically, HER).
Also, the assets, liabilities and equity of the ventures are included in the
Company's Consolidated Balance Sheets as a single line item "Investments in and
advances to ventures." See Note 2 to the Company's audited Consolidated
Financial Statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview." Financial information about
the Company's equity ventures is included below under "Supplemental
Information -- Selected Historical Financial Data -- Equity Investments."
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------------------------- -------------------
1992 1993 1994 1995 1996 1996 1997(1)
------ ------ ------- ------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues, net......................... $1,690 $ 328 $ 2,468 $ 8,412 $24,117 $ 14,639 $ 30,216
Gross margin.......................... 1,690 328 23 16 5,176 1,758 1,864
Operating expenses.................... 1,992 3,340 12,863 41,014 52,928 35,725 52,059
Equity in (losses) earnings of
ventures........................... (134) 472 (135) (7,871) (10,150) (6,999) (18,234)
Other (expense) income................ (2) 100 990 11,034 (8,729) (6,535) (16,902)
Net loss.............................. (437) (2,440) (11,985) (40,400) (67,991) (48,473) (87,872)
Loss per share........................ (0.06) (0.26) (0.70) (1.64) (2.26) (1.71) (2.39)
Deficiencies of earnings available to
cover fixed charges(2)............. (437) (2,440) (11,985) (37,835) (66,631) (47,496) (86,034)
BALANCE SHEET DATA (AT END OF PERIOD):
Cash and cash equivalents............. $1,597 $3,641 $29,635 $ 9,044 $57,874 $ 86,504 $366,841
Property and equipment,
net................................ 41 829 8,393 29,523 35,463 34,599 60,728
Investments in and advances to
ventures........................... 270 794 13,841 56,153 104,459 83,341 84,068
Total assets.......................... 2,051 5,968 61,957 115,621 237,378 233,879 647,788
Total debt............................ -- 725 2,152 27,454 85,547 76,518 502,482
Minority interest and stock subject to
repurchase......................... -- -- 8 5,273 6,248 6,271 32,764
Shareholders' equity.................. 1,659 4,685 54,684 55,322 113,668 120,979 57,403
(1) As a result of the Company's increase in ownership interest and amendment to
the HER Shareholders Agreement that was completed on July 16, 1997, the
Company accounts for its ownership interest in HER under the consolidation
method of accounting. Prior to this date, the Company accounted for HER
under the equity method of accounting.
(2) Because of the Company's historic losses, the Company has experienced a
deficiency of earnings available to cover fixed charges throughout its
existence. The deficiency of earnings available to cover fixed charges has
been computed by adding loss from continuing operations before income taxes
minus undistributed earnings of associated companies and fixed charges.
Fixed charges consist of interest on all indebtedness and amortization of
discount on all indebtedness.
29
SUPPLEMENTAL INFORMATION -- SELECTED HISTORICAL FINANCIAL DATA
[THE COMPANY IS CURRENTLY EVALUATING THE DISCLOSURE THAT IT INTENDS TO PRESENT.]
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following is a discussion of the financial condition and results of
operations of the Company as of September 30, 1997 and 1996, December 31, 1996
and 1995 and for the nine months ended September 30, 1997 and 1996 and for the
years ended December 31, 1996, 1995 and 1994. The following discussion should be
read in conjunction with the Company's Consolidated Financial Statements and the
notes related thereto. Certain statements contained in "Management's Discussion
and Analysis of Financial Condition and Results of Operations" including,
without limitation, those concerning (i) projected traffic volume, (ii) future
revenues and costs, (iii) changes in the Company's competitive environment and
(iv) the performance of future equity-method investments, contain
forward-looking statements concerning the Company's operations, economic
performance and financial condition. Because such statements involve risks and
uncertainties, actual results may differ materially from those expressed or
implied by such forward-looking statements.
OVERVIEW
Business. GTS is a provider of a broad range of telecommunications services
to businesses, other telecommunications service providers and consumers in
Russia and the CIS and Central Europe. Through HER, GTS is developing, and
operating the initial segments of, a pan-European high capacity fiber optic
network which is designed to interconnect a majority of the largest Western and
Central European cities and to transport international voice, data and
multimedia/image traffic for other carriers throughout Western and Central
Europe. GTS's strategy to develop its businesses generally has been to establish
joint ventures with a strong local partner or partners while maintaining a
significant degree of operational control. The Company's business activities
consist of the ownership and operation of (i) international long distance
businesses, which operate through international gateways that provide
international switching services and transmission capacity, (ii) local access
networks, which provide local telephone service, (iii) cellular networks, which
provide wireless telecommunications services, (iv) a domestic long distance
business, (v) data networks and (vi) carriers' carrier networks, which provide
high volume transmission capacity to other carriers.
The Company began to acquire interests in numerous telecommunications
ventures beginning in 1994 and continued to acquire such interests throughout
1995 and 1996. Ventures with significant financial results in 1994 included
Sovintel (an international long distance and domestic and local access
telecommunications service provider) and GTS-Hungary (a VSAT network
telecommunications service provider); ventures that incurred start-up costs
associated with building out their business infrastructure in 1994 included
Sovam (a data and internet telecommunications service provider) and EuroHivo (a
paging telecommunications service provider). In 1995, TeleRoss (a domestic long
distance telecommunications service provider) and GTS Cellular (a basic cellular
telecommunications service provider) began operations and expanded into numerous
regions within the CIS by the end of 1996. Telecommunications of Moscow ("TCM")
(a local access telecommunications service provider) began operations in 1996.
HER (a carriers' carrier telecommunications service provider) began its network
build-out in 1995, began limited operations at the end of 1996 and expects to
continue to develop its network during 1998 and beyond. The fact that these
ventures are in various stages of development affects the discussion of
comparative results below.
GTS has invested significantly in its ventures through capital
contributions and loans. In addition, the Company has made a significant
commitment to its businesses and ventures through the provision of management
assistance and training. GTS has also incurred significant expenses in
identifying, negotiating and pursuing new telecommunications opportunities. GTS
and certain of its ventures are experiencing continuing losses and negative
operating cash flow primarily because the businesses are in the developmental
and start-up phases of operations. Management recognizes that the Company must
generate additional capital resources in order to continue its operations and
meet its new development initiatives. The ultimate recoverability of the
Company's investments in and advances to ventures is dependent on many factors
including, but not limited to, the ability of the Company to obtain sufficient
financing to continue to meet its capital and operational commitments, the
economies of the countries in which it does business and the ability of the
Company to maintain the necessary telecommunications licenses.
31
The Company's businesses are developing rapidly. Some of the businesses
operate in countries with emerging economies which have uncertain economic,
political and regulatory environments. The general risks of operating businesses
in the CIS and other developing countries include the possibility for rapid
change in government policies including telecommunications regulations, economic
conditions, the tax regime and foreign currency regulations.
ACCOUNTING METHODOLOGY
Accounting for Business Ventures. Wholly-owned subsidiaries and
majority-owned ventures where the Company has unilateral operating and financial
control are consolidated. Those ventures where the Company exercises significant
influence, but does not exercise unilateral operating and financial control, are
accounted for by the equity method. The Company has certain majority-owned
ventures that are accounted for by the equity method as a result of
super-majority voting conditions or other governmentally imposed uncertainties
so severe that they prevent the Company from obtaining unilateral control of the
venture.
Profit and Loss Accounting. The Company recognizes profits and losses in
accordance with its underlying ownership percentage or allocation percentage as
specified in the agreements with its partners; however, the Company recognizes
100% of the losses in ventures where the Company bears all of the financial risk
(which includes all of the Company's significant ventures except for Sovintel
and, historically, HER). Accordingly, the portion of the losses that would
normally be assigned to the minority interest partner ("Excess Losses") is
recognized by the Company. When such ventures become profitable, the Company
recognizes 100% of the profits until such time as the Excess Losses previously
recognized by the Company have been recovered. As of September 30, 1997, $5.3
million and $9.7 million represents the net unrecovered Excess Losses for the
Company's consolidated and equity method investments, respectively, that is
expected to favorably benefit future period results from operations upon the
Company's existing business ventures becoming profitable. This accounting policy
was adopted prior to 1995; however, 1995 was the first year that the excess loss
amount was deemed material for recognition within the Company's accounting
records. For the period from January 1, 1997, through August 31, 1997, the
Company recognized 100% of HER's losses due to GTS being the financing partner
during this period. As a result of HER's completion of a private placement of
$265.0 million of senior notes (of which $56.5 million was placed in escrow for
the first two years' interest payments) in August 1997, management no longer
considers itself as the financing partner.
Inter-Affiliate Transactions. Several of the Company's ventures have
entered into business arrangements through which they provide integrated
solutions for their customers by leveraging each others' telecommunications
infrastructure. These arrangements have historically been focused primarily
within a region; however, as GTS has increased its geographic coverage and
telecommunication capabilities, these arrangements have expanded between
regions. In accordance with generally accepted accounting principles, all
significant intercompany accounts and transactions are eliminated upon
consolidation.
Turnover Taxes. The Company's ventures within the CIS region incur a 4%
turnover tax that is based on the revenues earned. The Company includes these
taxes as a component of its operating expenses, since these taxes are incidental
to the revenue cycle.
32
The following table summarizes the accounting methodology for the principal
business ventures through which the Company conducts its business.
EFFECTIVE
COUNTRY/REGION GTS ACCOUNTING
COMPANY NAME OF OPERATIONS OWNERSHIP METHODOLOGY
------------ -------------- --------- -----------
RUSSIA/CIS
Sovintel Russia 50% Equity
TCM Russia 50% Equity
TeleRoss Operating Company Russia 100%(1) Consolidated
TeleRoss Ventures Russia 50%(2) Equity
Sovam Russia 67%(3) Equity
GTS Cellular CIS 25%-70%(4) Equity
WESTERN EUROPE
HER Western Europe 79% Consolidated(5)
GTS-Monaco Access Monaco 50% Equity
CENTRAL EUROPE
GTS-Hungary Hungary 99% Consolidated
EuroHivo Hungary 70% Equity
CzechNet Czech Republic 100% Consolidated
CzechCom Czech Republic 100% Consolidated
ASIA
V-Tech China 75% Equity
Beijing Tianmu China 47% Equity
CDI India 100% Consolidated
(1) The TeleRoss Operating Company is comprised of two wholly-owned holding
companies and a 99% owned subsidiary that operates a domestic long distance
network and holds the applicable operating license for TeleRoss and performs
the customer invoicing and collection functions for telecommunications
services. TeleRoss Operating Company is accounted for under the
consolidation method of accounting because GTS has unilateral control over
the operations and management decisions. TeleRoss Operating Company's
operations are further discussed in "-- Results of
Operations -- Consolidated Ventures." A significant portion of TeleRoss
Operating Company's costs of revenue consists of settlement fees paid to the
TeleRoss Ventures, with such fees being recorded as revenue by the TeleRoss
Ventures. In 1996 and for the nine months ended September 30, 1997, all of
the TeleRoss Ventures' revenue was derived from such fees. Any decline in
the business or operations of the TeleRoss Ventures would have a material
adverse effect on the results of TeleRoss Operating Company.
(2) TeleRoss Ventures is comprised of thirteen joint ventures that are 50%
beneficially owned by GTS, which originate traffic and provide local
termination of calls through agency arrangements with TeleRoss Operating
Company. GTS does not exercise unilateral control over the TeleRoss Ventures
and therefore, they are appropriately accounted for under the equity method
of accounting. TeleRoss Ventures' operations are further discussed in
"-- Results of Operations -- Non-Consolidated Ventures."
(3) GTS has reached an agreement in principle to purchase its minority partner's
33% interest in Sovam and expects to consummate the transaction in January
1998, thereby making Sovam a wholly owned subsidiary of GTS.
(4) GTS conducts its cellular operations through (i) Vostok Mobile, a wholly
owned GTS venture which owns between 50% and 70% of a series of 11 cellular
joint ventures in various regions in Russia, (ii) PrimTelefone, a 50% owned
venture in Vladivostok, Russia and (iii) Bancomsvyaz, an approximately 25%
beneficially-owned venture in Kiev, Ukraine.
(5) As of July 16, 1997, HER is accounted for by the consolidation as opposed to
the equity method of accounting.
33
RESULTS OF OPERATIONS -- CONSOLIDATED VENTURES
Management's discussion included within "-- Results of
Operations -- Consolidated Ventures" reflects the following significant
operating ventures: TeleRoss Operating Company, GTS-Hungary, CzechNet and
CzechCom (collectively the "Czech Companies") and HER (for fiscal 1997). See
"Results of Operations -- Non-Consolidated Ventures (Equity Investees)" for a
discussion of the operating results of Sovintel, TCM, Sovam, TeleRoss Ventures,
GTS Cellular, HER (prior to fiscal 1997), GTS-Monaco Access, EuroHivo and the
Asia business ventures.
Nine Months Ended September 30, 1997 compared to Nine Months Ended September
30, 1996
Revenue. The Company's consolidated revenue for the nine months ended
September 30, 1997 increased by $15.6 million to $30.2 million, an increase of
over 100% from the comparable period in 1996. TeleRoss Operating Company's
growth accounted for approximately 54.3% of the Company's total growth over the
nine months ended September 30, 1997.
The CIS region's consolidated revenue was $19.0 million for the nine months
ended September 30, 1997, of which TeleRoss' revenue comprised 86.3%. TeleRoss
Operating Company's revenue increased by $10.3 million to $16.4 million for the
nine months ended September 30, 1997, from the comparable period in 1996.
Service revenue represented approximately 69.5% of the total TeleRoss Operating
Company revenue for the nine months period ended September 30, 1997. The
remaining revenue generated by TeleRoss Operating Company was primarily related
to equipment sales and installation revenue of $2.9 million and $1.8 million for
the nine months ended September 30, 1997 and 1996, respectively.
Within the Central Europe region, GTS-Hungary and the Czech Companies
accounted for 100% of the $9.5 million in revenue earned for the nine months
ended September 30, 1997. GTS-Hungary's revenue increased by $1.4 million to
$5.9 million for the nine months ended September 30, 1997, from the comparable
period in 1996, largely due to a 25.0% increase in the number of VSATs installed
since September 1996. Revenue of the Czech Companies, which provide a range of
international telephone, private data and internet access services, increased by
$2.4 million to $3.6 million, for the nine months ended September 30, 1997, from
the comparable period in 1996, primarily due to increased voice and internet
traffic and lease line services.
All of Western Europe's consolidated revenue of $2.3 million for the nine
months ended September 30, 1997 was derived from HER's initial Amsterdam to
Brussels route.
Gross Margin. GTS's consolidated gross margin was $1.9 million and $1.8
million, or 6.3% and 12.0% of total revenue, for the nine months ended September
30, 1997 and 1996, respectively. The decrease in consolidated gross margin as a
percentage of revenue was attributable to the consolidation of HER in fiscal
1997.
TeleRoss Operating Company had a gross margin of $1.0 million and $(1.0)
million for the nine months ended September 30, 1997 and 1996, respectively.
GTS-Hungary had gross margins of $2.7 million and $1.9 million for the nine
months ended September 30, 1997 and 1996, respectively (representing 45.8% and
42.2% of GTS-Hungary's revenue during these periods). The remaining consolidated
gross margin of $(1.8) million and $0.9 million for the nine months ended
September 30, 1997 and 1996, respectively, was primarily attributable to HER,
which generated a negative gross margin of $(3.2) million for the nine months
ended September 30, 1997, and to the Czech Companies, which generated gross
margin of $0.9 million and $0.2 million for the nine months ended September 30,
1997 and 1996, respectively.
Operating Expenses. Consolidated operating costs were $52.1 million and
$35.7 million for the nine months ended September 30, 1997 and 1996,
respectively. The increase in operating costs reflected the growth in
expenditures associated with building business infrastructure, the inclusion of
HER's operating expenses and increasing corporate staff.
Equity in (Losses)/Earnings of Ventures. GTS recognized losses from its
investments in non-consolidated ventures of $18.2 million and $7.0 million for
the nine months ended September 30, 1997 and 1996, respectively. Included in
these losses were $10.4 million and $5.1 million for the nine months ended
34
September 30, 1997 and 1996, respectively, that related to GTS's ownership share
of the losses incurred. The increase in the Company's losses from its ventures
was primarily the result of write-downs of investments and assets of
approximately $17.4 million and $2.4 million in the Asia and Central Europe
regions, respectively, for the nine months ended September 30, 1997. The Company
would have recognized earnings from its investments in non-consolidated ventures
of $1.6 million for the nine months ended September 30, 1997, had the Company
not recognized the write-downs of investments and assets of approximately $17.4
million and $2.4 million, respectively. The Asia region write-downs were the
result of management's periodic reassessment of the recoverability of its
long-lived assets, and accordingly, specific assets are now reflected at their
fair value as determined by their expected recovery as of September 30, 1997.
Their fair value was based on the estimated future cash flows to be generated by
the assets, discounted at a market rate of interest. The write-down of Central
Europe's investment in EuroHivo was a result of the Company's decision in the
third quarter to recognize the contingent liabilities associated with the
expected liquidation and discontinuation of EuroHivo's operations as of
September 30, 1997. In addition, the Company's results were negatively affected
by the recognition of Excess Losses of $5.5 million and $1.9 million for the
nine months ended September 30, 1997 and 1996, respectively. As of September 30,
1997, $9.7 million represents the net unrecovered Excess Losses for the
Company's equity method investments, respectively, that is expected to favorably
benefit future period results from operations upon the Company's existing equity
method business ventures becoming profitable. CIS' ventures, primarily Sovintel
and TCM (with combined earnings to the Company of $11.6 million and $8.3 million
for the nine months ended September 30, 1997 and 1996, respectively), generated
earnings for the Company of approximately $8.2 million and $5.0 million for the
nine months ended September 30, 1997 and 1996, respectively, which partially
offset losses generated by other ventures. See "-- Results of
Operations -- Non-Consolidated Ventures (Equity Investees)."
Interest, Net. GTS incurred interest expenses of $21.1 million and $7.3
million for the nine months ended September 30, 1997, and 1996, respectively.
Interest expense is comprised of interest accrued from debt maturing within one
year, long-term debt obligations, amortization of debt discount on the long-term
debt obligations and various other debt instruments. The increase in interest
expense was primarily related to the issuance of $144.8 million in Convertible
Bonds in July 1997 and $265.0 million in senior notes raised in August 1997 by
HER. See "-- Liquidity and Capital Resources."
GTS earned interest income of $5.3 million and $1.5 million for the nine
months ended September 30, 1997 and 1996, respectively, primarily as a result of
investing the proceeds from equity and debt offerings in various highly liquid
investments.
Provision for Income Taxes. The company's consolidated tax provision was
$1.8 million and $1.0 million for the nine months ended September 30, 1997 and
1996, respectively. The Company's income tax rates are significantly affected by
foreign taxes and the utilization of net operating losses. In addition, the
Company operates worldwide in numerous tax jurisdictions. As a result, losses
incurred in one jurisdiction may not be available to offset income in another.
Year Ended December 31, 1996 compared to Year Ended December 31, 1995 and
compared to Year Ended December 31, 1994
Revenue. The Company's consolidated revenue was $24.1 million, $8.4 million
and $2.5 million for the years ended December 31, 1996, 1995 and 1994,
respectively. The growth in revenue was attributable to the commencement in 1995
of commercial operations by TeleRoss Operating Company, as well as the continued
expansion of services and customer base in Central Europe.
TeleRoss Operating Company generated revenue of $9.2 million and $3.8
million, representing 38.3% and 44.9% of the Company's consolidated revenue for
the years ended December 31, 1996 and 1995, respectively. Service revenue
represented 64.1% and 21.1% of TeleRoss Operating Company's revenue for the
years ended December 31, 1996 and 1995, respectively, with the balance of its
revenue in such periods principally represented by equipment sales. The growth
in revenue was a result of increased traffic volume generated by the TeleRoss
Ventures as they expanded to seven new cities during the year ended December 31,
1996, added customers in existing cities and installed several VSATs at customer
locations outside of cities in which they have a presence.
35
GTS-Hungary and the Czech Companies accounted for $6.9 million and $2.3
million of the Company's consolidated revenue in 1996, respectively, compared to
$4.2 million and $0.3 million in 1995, respectively, and $1.3 million and none
in 1994, respectively. The growth in revenue of GTS-Hungary from 1994 to 1996
was due to the expansion of its customer base and the introduction of microwave
technology services. The Hungary state lottery accounted for 55.3%, 65.0% and
67.2% of GTS-Hungary's revenue in 1996, 1995 and 1994, respectively. The growth
in revenue of the Czech Companies was generated through increases in voice
traffic carried from sixteen buildings at December 31, 1996 as compared to eight
buildings at December 31, 1995.
Gross Margin. GTS's consolidated gross margin was $5.2 million, or 21.6% of
revenue, for the year ended December 31, 1996 and $0.02 million, or 0.0% of
revenue, for the years ended December 31, 1995 and 1994.
TeleRoss Operating Company incurred a negative gross margin of $1.0 million
for both the years ended December 31, 1996 and 1995 which was the result of the
high fixed cost component of its network hub in Moscow. GTS-Hungary had a gross
margin of $3.0 million, $1.7 million and $(0.3) million, representing 43.4%,
40.5% and (23.1)% of GTS-Hungary's revenue for the years ended December 31,
1996, 1995 and 1994, respectively. The favorable gross margin trend reflected
the increased utilization of GTS-Hungary's 1,000 VSAT capacity hub located in
Budapest. The remaining gross margin of $3.2 million for the year ended December
31, 1996 was attributable to the higher margin sales of equipment and consulting
services.
Operating Expenses. Consolidated operating costs were $52.9 million, $41.0
million and $12.9 million for the years ended December 31, 1996, 1995 and 1994,
respectively. The increase in operating costs reflected the growth in
expenditures associated with building business infrastructure for primarily the
TeleRoss Operating Company and GTS-Hungary and increasing corporate staff.
Equity in (Losses)/Earnings of Ventures. GTS recognized losses from its
investments in non-consolidated ventures of $10.2 million, $7.9 million and $0.1
million for the years ended December 31, 1996, 1995 and 1994, respectively.
Included in these losses were $5.7 million, $5.2 million and $0.1 million for
the years ended December 31, 1996, 1995 and 1994, respectively, that related to
GTS's ownership share of the losses. In addition, the Company's results were
negatively affected due to the recognition of Excess Losses of $4.5 million and
$2.7 million for the years ended December 31, 1996 and 1995, respectively. See
"--Overview." The Company would have recognized additional losses of $8.2
million and $3.3 million for the years ended December 31, 1996 and 1995,
respectively, had the Company been considered the financing partner of HER
during those time periods. The Company's losses from its ventures were primarily
the result of most of its ventures being in the early stages of operations.
Sovintel and TCM, however, generated combined earnings of $11.8 million and $3.8
million for the years ended December 31, 1996 and 1995, respectively, which
partially offset losses generated by other ventures.
Other Non-Operating Income. Favorably affecting the 1995 results was the
non-recurring $10.3 million gain the Company recognized as a result of its cash
settlement of certain claims with a third party in 1995.
Interest, Net. GTS incurred interest expense of $11.1 million, $0.7 million
and $0.1 million for the years ended December 31, 1996, 1995 and 1994,
respectively. The increase in interest expense was due to the $60.0 million
increase in debt during 1996. See "--Liquidity and Capital Resources."
GTS earned interest income of $3.6 million, $2.2 million and $1.2 million
for the years ended December 31, 1996, 1995 and 1994, respectively, primarily as
a result of investing the proceeds from private placements of common stock in
various highly liquid investments.
Provision for Income Taxes. The Company's consolidated tax provision was
$1.4 million and $2.6 million for the years ended December 31, 1996 and 1995,
respectively. These rates were significantly affected by foreign taxes and the
utilization of net operating losses. In addition, the Company operates
world-wide in numerous tax jurisdictions. As a result, losses incurred in one
jurisdiction may not be available to offset income in another. The Company had
no income tax expense for the year ended December 31, 1994.
36
RESULTS OF OPERATIONS -- NON-CONSOLIDATED VENTURES (EQUITY INVESTEES)
Nine Months Ended September 30, 1997 compared to Nine Months Ended September
30, 1996
RUSSIA -- CIS
Sovintel. Sovintel's revenue increased by 58.9% to $82.0 million for the
nine months ended September 30, 1997, from $51.6 million for the comparable
period in 1996. The increase in revenue was primarily the result of
telecommunications services revenue, which increased to $61.5 million for the
nine months ended September 30, 1997, from $34.9 million for the nine months
ended September 30, 1996, due to the Moscow customer base growth and traffic
from other GTS ventures that generated increased volume of outgoing
international and domestic minutes carried by Sovintel. Incoming international
revenue grew significantly by $6.3 million to $9.9 million for the nine months
ended September 30, 1997, from the comparable period in 1996. Included in
Sovintel's 1997 traffic revenue was $8.7 million for the nine months ended
September 30, 1997, that was related to customers using phone numbers provided
by TCM. This revenue was derived primarily from international/long distance
traffic and local traffic. Sovintel and TCM have an arrangement whereby Sovintel
reimburses TCM 50% of installation charges, monthly fees and local traffic
revenues and approximately 33% of the international/long distance billings from
TCM-supplied phone numbers.
Sovintel's non-traffic related revenue increased to $20.5 million for the
nine months ended September 30, 1997, from $16.7 million for the comparable
period in 1996. In March 1997, Sovintel's historically largest customer for port
sales revenue, MTS, received its own numbering plan. Accordingly, management
expects revenue from port sales to continue to decline.
Sovintel's gross margin percentage decreased to 37.8% for the nine months
ended September 30, 1997, as compared to 40.7% for the comparable period in
1996, in part due to a general price decrease implemented in April 1997.
Operating expenses were $12.4 million and $7.3 million, or 15.1% and 14.1%
of total revenue, for the nine months ended September 30, 1997 and 1996,
respectively. The increase in operating expenses for the nine months ended
September 30, 1997 was related to an increase in turnover taxes associated with
revenues, and also increased personnel, advertising and sales force costs
required to support Sovintel's growth.
Income tax expense was $4.7 million and $3.9 million for the nine months
ended September 30, 1997 and 1996, respectively.
TCM. TCM's revenue grew 64.9% to $20.7 million for the nine months ended
September 30, 1997, from the comparable period in 1996. TCM's gross margin was
$16.0 million and $10.3 million, or 77.3% and 81.7% of total revenue, for the
nine months ended September 30, 1997 and 1996, respectively. The decrease in
gross margin as a percentage of revenue was attributable to higher
infrastructure and settlement costs. Operating expenses were $2.0 million and
$1.2 million, or 9.7% and 9.5% of total revenue, for the nine months ended
September 30, 1997 and 1996, respectively.
Sovam. Sovam's revenue increased by 61.3% to $12.9 million for the nine
months ended September 30, 1997, from the comparable period in 1996. Sovam's
revenue was derived primarily from data services, network capabilities and
application revenues. The increase in revenue is primarily attributable to the
expansion of Sovam's network throughout Russia and the CIS and the improvement
in the quality of Internet services due to increased international bandwidth.
Sovam's gross margin was $5.0 million, or 39.5% of total revenue, for the
nine months ended September 30, 1997, up from $2.1 million, or 26.3%, for the
nine months ended September 30, 1996. Operating expenses were $4.6 million and
$4.2 million, or 35.7% and 52.5% of total revenue, for the nine months ended
September 30, 1997 and 1996, respectively.
TeleRoss Ventures. Revenue for the TeleRoss Ventures for the nine months
ended September 30, 1997 and 1996 was $5.1 million and $1.3 million,
respectively. The increase in revenues reflected growth in settlement fees
charged to the TeleRoss Operating Company. The settlement fees are based on
minutes of use by regional customers in the core switched voice services, as
well as installation work and equipment sales.
37
Gross margin was $3.7 million and $0.8 million, or 72.6% and 66.6% of total
revenue, for the nine months ended September 30, 1997 and 1996, respectively.
Operating expenses of $2.5 million and $1.5 million were incurred for the nine
months ended September 30, 1997 and 1996, respectively.
GTS Cellular. The Company operates three cellular networks through
differing ownership structures; Vostok Mobile, Prim Telefone and Bancomsvyaz.
Revenue for Vostok Mobile increased by 41.5% from $10.6 million to $15.0
million for the nine months ended September 30, 1997, from the comparable period
in 1996, as a result of increased subscribership to approximately 11,000 at
September 30, 1997. Vostok Mobile's gross margin was $7.6 million and $5.3
million, or 50.7% and 50.0% of total revenue, for the nine months ended
September 30, 1997 and 1996, respectively. Operating expenses were $4.8 million
and $5.4 million for the nine months ended September 30, 1997 and 1996,
respectively. The higher operating costs in 1996 was attributed to development
and start-up expenses related to new business ventures.
Revenue for PrimTelefone increased by 43.3% to $8.2 million for the nine
months ended September 30, 1997, from the comparable period in 1996, due to an
increase in subscribership to approximately 4,600 as of September 30, 1997.
PrimTelefone's gross margin was $4.7 million and $3.0 million, or 57.3% and
52.6% of total revenue, for the nine months ended September 30, 1997 and 1996,
respectively. Operating expenses were $2.7 million and $1.5 million, or 32.9%
and 26.3% of total revenue, for the nine months ended September 30, 1997 and
1996, respectively.
Revenues for Bancomsvyaz was $4.0 million for the nine months ended
September 30, 1997, with a gross margin of $1.5 million and operating expenses
of $3.4 million for the nine months ended September 30, 1997, respectively.
WESTERN EUROPE
GTS-Monaco Access. In 1997, GTS-Monaco Access revenue increased
significantly to $7.9 million for the nine months ended September 30, 1997, from
$2.2 million for the same period in 1996. The increase was the result of a
substantially larger traffic base and number of countries covered under the
network. Gross margin for the nine months ended September 30, 1997 and 1996 was
$0.4 million and $(0.3) million, respectively.
CENTRAL EUROPE
Eurohivo. Eurohivo's operating results were minimal for the nine months
ended September 30, 1997 and 1996. In September 1997, the Company recorded a
$2.4 million charge in the third quarter to recognize the contingent liabilities
associated with the planned liquidation and discontinuance of Eurohivo's
operations. See Footnote 2 in the Company's condensed consolidated financial
statements for additional disclosures related to Eurohivo.
ASIA
Most of the Company's ventures within the Asia region were in the start-up
phase and had not commenced operations in 1996. The non-consolidated ventures in
the Asia region had no revenue for the nine months ended September 30, 1997, and
had minimal revenue of $0.5 million for the nine months ended September 30,
1996. See Footnote 2 in the Company's condensed consolidated financial
statements for additional disclosures related to the Company's Asia operations.
Year Ended December 31, 1996 compared to Year Ended December 31, 1995 and
compared to Year Ended December 31, 1994
RUSSIA -- CIS
Sovintel. Sovintel's revenue for the years ended December 31, 1996, 1995
and 1994 was $75.0 million, $44.3 million, and $20.7 million, respectively.
Sovintel's revenue was derived from telecommunications
38
services, including international, domestic and local traffic, and other
non-traffic related revenue associated with port and equipment sales, leased
line installation and maintenance. Telecommunications services traffic revenue
was $50.8 million, $26.8 million and $19.5 million, representing 67.7%, 60.5%
and 94.2% of Sovintel's total revenue, for the years ended December 31, 1996,
1995 and 1994, respectively.
Revenue from outgoing international, domestic long distance and Moscow
local traffic was $44.0 million, $24.6 million and $18.0 million for the years
ended December 31, 1996, 1995 and 1994, respectively. This growth was due to
Sovintel's increased customers in Moscow and traffic from other GTS ventures.
Sovintel began providing Moscow local access services in 1995. Revenue from
incoming international minutes was $6.8 million, $2.2 million and $1.5 million
for the years ended December 31, 1996, 1995 and 1994, respectively. Included in
Sovintel's 1996 traffic revenue was $5.0 million from customers using phone
numbers provided by TCM.
Sovintel's non-traffic related revenue of $24.2 million, $17.5 million and
$1.2 million for the years ended December 31, 1996, 1995 and 1994, respectively,
was primarily attributable to non-recurring port sales revenues of $12.4 million
and $14.4 million for the years ended December 31, 1996 and 1995, respectively.
Included in 1996 non-traffic related revenue was $3.7 million from one-time
installation charges related to TCM-supplied phone numbers. There were no
significant port sales in 1994.
Sovintel's gross margin was $31.1 million, $18.0 million and $8.2 million,
or 41.5%, 40.6% and 39.6% of revenue, for the years ended December 31, 1996,
1995 and 1994, respectively. The gross margin percentage remained relatively
unchanged over the past three years as the decrease in average revenue per
minute for international and intercity calls was partially offset by the
decrease in average settlement cost per minute.
Operating expenses were $10.3 million, $7.1 million and $4.6 million, or
13.7%, 16.0% and 22.2% of total revenue, for the years ended December 31, 1996,
1995 and 1994, respectively. Turnover taxes and personnel related costs
comprised the majority of the increase in selling, general and administrative
costs. The increase in personnel related costs reflected the growth in sales and
general operations of Sovintel.
Income tax expense was $5.2 million and $2.6 million for the years ended
December 31, 1996 and 1995, respectively. The increase in income tax expense was
attributable to Sovintel's profitable operations. According to Russian
Federation tax holiday provisions, Sovintel was exempt from income taxes for a
two-year period beginning with the first year of taxable income, which was in
1993.
TCM. TCM's total revenue was $16.5 million for the year ended December 31,
1996 and had minimal activities in 1995. TCM had a gross margin of $13.2
million, or 80.0% of total revenue, and operating expenses of $1.9 million, or
11.5% of total revenue, for the year ended December 31, 1996.
Sovam. Sovam's revenue was $11.7 million, $4.4 million and $3.3 million for
the years ended December 31, 1996, 1995 and 1994, respectively. The increase in
revenues is primarily attributable to the wider variety of service offerings,
including the introduction of Russia On Line services.
Gross margin was $3.4 million, $1.5 million and $1.8 million, or 29.1%,
34.1% and 54.6% of total revenue for the years ended December 31 in 1996, 1995
and 1994, respectively. The decline in gross margin as a percentage of revenue
was reflective of the higher cost of sales component in Sovam's recently
introduced products. Operating expenses were $5.7 million, $3.3 million and $2.1
million, or 48.7%, 75.0% and 63.6% of total revenue, for the years ended
December 31, in 1996, 1995 and 1994, respectively.
TeleRoss Ventures. Revenues for TeleRoss Ventures for the years ended
December 31, 1996 and 1995 were $2.4 million and $0.1 million, respectively.
Revenues resulted from settlement fees charged to TeleRoss Operating Company.
The growth in total revenue was the result of steady growth in sales of core
switched voice services in the five cities serviced in 1995 as well as the
addition of seven new cities to the network in 1996.
Gross margin for the years ended December 31, 1996 and 1995 was $1.6
million and $0.1 million, respectively. Operating expenses of $2.3 million and
$0.2 million were incurred for the years ended December 31, 1996 and 1995,
respectively.
39
GTS Cellular. The Company operates three cellular networks through
differing ownership structures: Vostok Mobile, PrimTelefone and Bancomsvyaz.
Revenue for Vostok Mobile was $16.5 million and $2.0 million for the years
ended December 31, 1996 and 1995, respectively. Vostok Mobile's gross margin was
$9.3 million and $1.1 million, or 56.4% and 55.0% of total revenue, and
operating expenses were $9.2 million and $4.7 million for the year ended
December 31, 1996 and 1995, respectively.
Revenue for PrimTelefone was $8.4 million and $2.2 million for the years
ended December 31, 1996 and 1995, respectively. PrimTelefone's gross margin was
$4.7 million and $0.6 million, or 56.0% and 27.3% of total revenue, and
operating expenses were $3.7 million and $0.7 million for the years ended
December 31, 1996 and 1995, respectively.
Bancomsvyaz did not have significant operations until 1997.
WESTERN EUROPE
HER. HER represents substantially all of GTS's investment in the Western
Europe region. A small operational revenue stream was earned in 1996.
Operating expenses were $16.0 million, $6.7 million and $0.2 million for
the years ended December 31, 1996, 1995 and 1994, respectively. The increase in
selling, general and administrative expenses reflected HER's continued
transition from the start-up phase to the operational phase.
GTS-Monaco Access. Limited international traffic was carried from GTS
subsidiaries through GTS-Monaco Access for termination worldwide during 1995
which resulted in minimal revenues earned. Total revenue was $3.9 million and
gross margin was $(0.4) million for the year ended December 31, 1996.
CENTRAL EUROPE
EuroHivo. EuroHivo's revenue was $1.0 million and $0.5 million for the
years ended December 31, 1996 and 1995, respectively. Although revenue improved
significantly during 1996, EuroHivo continued to show negative gross margins of
$(0.2) million and $(0.5) million for the years ended December 31, 1996 and
1995, respectively. Furthermore, operating expenses decreased to $1.9 million
for the year ended December 31, 1996 from $2.4 million for the year ended
December 31, 1995 despite a 64.0% increase in personnel during 1996. This was
primarily attributable to management's decision to grow revenue through
alternative measures resulting in significant reductions to advertising
expenditures in 1996.
ASIA
Most of the Company's ventures within the Asia region were in the start-up
phase and had not commenced operations in 1996. The non-consolidated ventures in
the Asia region had revenue of $7.0 million and $0.0 million for the years ended
December 31, 1996 and 1995, respectively. The revenue in 1996 consisted
principally of equipment sales. The Company believes that future revenue will be
derived primarily from providing telecommunications engineering and consulting
services.
LIQUIDITY AND CAPITAL RESOURCES
The telecommunications business is capital intensive. The Company generally
is the primary source of funding for its ventures, both for working capital and
capital expenditures. Under a typical arrangement, GTS's venture partner
contributes the necessary licenses or permits under which the venture will
conduct its business, office space and other equipment. GTS's contribution is
generally cash and equipment, but may consist of other specific assets as
required by the joint venture agreement.
The Company has raised capital through the issuance of equity securities
and through various debt agreements. The issuance of equity securities has
raised $36.5 million, $107.7 million, $42.1 million and $62.1 million in 1997,
1996, 1995 and 1994, respectively, net of placement fees, for a total of $248.4
million. In addition, the Company and HER received $409.8 million, $60.0 million
and $23.3 million in 1997, 1996 and
40
1995, respectively, for a total of $493.1 million under various debt agreements.
Included within the debt proceeds identified above, the Company received $3.5
million, $60.0 million and $10.0 million in 1997, 1996 and 1995, respectively,
from lenders who are affiliated with, and are considered related parties to, the
Company as a result of their (or their affiliates) ownership of the Company's
Common Stock.
The Company had working capital of $353.4 million and $66.5 million as of
September 30, 1997 and 1996, respectively. Approximately $190.0 million of the
$353.4 million of working capital at September 30, 1997, is restricted, pursuant
to the terms and conditions of the senior notes issued by HER in August 1997,
for the buildout of the HER Network. The Company had an accumulated deficit of
$213.8 million as of September 30, 1997, including a net loss of approximately
$87.9 million and $48.5 million for the nine months ended September 30, 1997 and
1996, respectively. During 1997, the Company has incurred and expects to
continue to incur substantial expenditures to fund the working capital
requirements of its ventures, to provide capital equipment for certain of its
ventures, and to engage in new development and acquisitions.
GTS will require substantial capital investment to execute its business
plans and to fund expected operating losses. Management expects that GTS and its
ventures will incur over $515.0 million of capital expenditures during the next
three fiscal years, of which approximately $235.0 million will be incurred in
1998. The Company has obtained funds in 1997 through a variety of financing
arrangements, including (i) the issuance in September 1997 of $39.2 million of
Common Stock in a private placement of equity with a value of $15.67 per common
share, (ii) the issuance in August 1997 of $265.0 million in gross proceeds (of
which $56.5 million was placed into escrow to fund the first two years' interest
payments) of 11.5% Senior Notes by HER that may be redeemed upon the successful
completion of a complying equity offering or meeting other certain criteria, and
(iii) the issuance in July and August 1997 of $144.8 million in gross proceeds
of the Convertible Bonds by GTS, that are convertible into Common Stock upon the
Company's completion of a complying equity offering.
The Company believes that the net proceeds from the Offerings, together
with existing cash and cash flow from operations, if any, will be sufficient to
fund its expected capital needs until at least June 1999. The Company expects
that it may require additional capital to execute its current business plan and
to fund expected operating losses, as well as to consummate future acquisitions
and exploit opportunities to expand and develop its businesses. There can be no
assurances that the Company will be able to consummate additional financing on
favorable terms. As a result, the Company may be subject to additional or more
restrictive financial covenants, its interest obligations may increase
significantly and its existing shareholders may be adversely diluted. Failure to
generate sufficient funds in the future, whether from operations or by raising
additional debt or equity capital, may require the Company to delay or abandon
some or all of its anticipated expenditures, to sell assets, or both, either of
which could have a material adverse effect on the operations of the Company.
HER
Construction of the HER fiber optic network is one of the Company's most
significant business activities. The buildout of the network is expected to
require approximately $290.0 million of capital expenditures during fiscal year
1998 and thereafter, with approximately $35.0 million required for initial five
country network. As of September 30, 1997, approximately $27.6 million has been
spent on network capital expenditures. In August 1997, HER completed the
issuance of $265.0 million in gross proceeds of 11.5% Senior Notes due in August
2007. The Senior Notes are be general unsecured obligations of HER. HER
currently estimates that its capital resources will be sufficient to fund
operations and expected network development through December 1998, at which time
it may be required to obtain additional funds. Sources of capital to fund
network development after 1998 may include internally generated funds, bank debt
and vendor financing. HER is currently in discussion with a number of financial
institutions to obtain debt financing and to negotiate vendor financing with key
suppliers of network equipment. Any failure to obtain necessary financing may
require HER to delay or abandon its plans for the deploying the remainder of the
network and would jeopardize the viability of HER, or may require the Company to
make additional capital contributions to HER at the expense of the Company's
other operations, either of which could have a material adverse effect on the
41
operations of the Company. There can be no assurance that GTS or its partners in
HER would have sufficient capital to make contributions to HER, or that they
would be willing to do so.
Pursuant to the Recapitalization, HER offered to GTS-Hermes, HIT Rail and
the eleven individual members of the HIT Rail consortium the right to subscribe
to additional common stock of the Company. GTS-Hermes and two of the members of
HIT Rail exercised their rights, while HIT Rail and the nine remaining members
of HIT Rail declined to participate.
As a result of the finalization of the Recapitalization, total shareholder
loans of ECU 39.4 million (approximately $48.5 million) from, collectively,
GTS-Hermes, HIT Rail and two of the members of HIT Rail, were converted into
equity. Additionally, GTS-Hermes contributed ECU 46.0 million (approximately
$51.8 million) and one of the members of HIT Rail contributed a ten-year fiber
optic cable lease which was valued at ECU 1.8 million (approximately $2.0
million). The ownership of HER subsequent to the recapitalization was as
follows: GTS-Hermes, 79.08%; HIT Rail, 12.63%; and the two members of HIT Rail
combined, 8.29%. See "Business -- Western Europe -- HER -- HER
Recapitalization."
Liquidity Analysis
The Company had cash and cash equivalents of $366.8 million and $86.5
million as of September 30, 1997 and 1996, respectively. Approximately $190.0
million of the $366.8 million of cash and cash equivalents at September 30,
1997, is restricted for the build-out of the HER network. The Company had
restricted cash of $59.8 million and $3.9 million as of September 30, 1997 and
1996, respectively. Restricted cash included amounts held in escrow to pay the
first two years' interest payments on the Senior Notes of HER, amounts held for
equipment purchases under various debt agreements, and cash maintained in
foreign financial institutions that may not be readily convertible into dollars
or easily repatriated.
During the nine months ended September 30, 1997 and 1996, the Company used
$38.9 million and $31.8 million, respectively, of cash for operating activities.
Cash used for investing activities was $73.0 million and $48.0 million for the
nine months ended September 30, 1997 and 1996, respectively. The use of cash in
operations and for investing activities reflected primarily the development and
buildout of existing telecommunications networks and the funding of fully
operational ventures.
Substantially all of the Company's operations are in foreign countries and
therefore the Company's consolidated financial results are subject to
fluctuations in currency exchange rates. The Company's consolidated operations
transact their business in the following significant currencies: Russian Ruble,
Hungarian Forint, Belgian Franc and the European Currency Unit. For those
operating companies that transact their business in currencies that are not
readily convertible, the Company attempts to minimize its exposure by indexing
its invoices and collections to the applicable dollar/foreign currency exchange
rate to the extent its costs (including interest expense, capital expenditures
and equity) are incurred in U.S. dollars. Although the Company will continue to
attempt to match revenues, costs, borrowing and repayments in terms of their
respective currencies, the Company may experience economic loss and a negative
impact on earnings with respect to holdings solely as a result of foreign
currency exchange rate fluctuations, which include foreign currency devaluations
against the U.S. dollar. Furthermore, certain of the Company's operations have
notes payable and notes receivable which are denominated in a currency other
than their own functional currency or loans linked to the U.S. dollar. The
Company may also experience economic loss and a negative impact on earnings
related to these monetary assets and liabilities.
The Company is in the process of developing risk management policies that
will establish guidelines for managing foreign exchange risk. The Company
expects that these policies will be implemented in the first quarter of 1998,
and anticipates that these policies will allow management to use financial
hedging instruments to manage foreign exchange exposure. Currently, the Company
is considering alternatives to hedge foreign exchange exposure resulting from
the issuance of $265 million in senior notes by HER.
42
BUSINESS
INTRODUCTION
GTS is a provider of a broad range of telecommunications services to
businesses, other telecommunications service providers and consumers in Russia,
the CIS and Central Europe. Through HER, GTS is developing, and operating the
initial segments of, a pan-European high capacity fiber optic network that is
designed to interconnect a majority of the largest Western and Central European
cities and to transport international voice, data and multimedia/image traffic
for other carriers throughout Western and Central Europe. GTS's strategy to
develop its businesses generally has been to establish joint ventures with a
strong local partner or partners while maintaining a significant degree of
operational control. The Company's business activities consist of the ownership
and operation of (i) international long distance businesses, which operate
through international gateways that provide international switching services and
transmission capacity, (ii) local access networks, which provide local telephone
service, (iii) cellular networks, which provide wireless telecommunications
services, (iv) a domestic long distance business, (v) data networks and (vi)
carriers' carrier networks, which provide high volume transmission capacity to
other carriers.
In Russia and the CIS, GTS's objective is to become the premier alternative
telecommunications operator. To attain its objective, the Company has partnered
with regional telephone companies and with Rostelecom, the national long
distance carrier in Russia. The Company currently operates in 24 oblasts
(regions) and the city of Moscow in Russia, as well as in 11 additional cities
in the CIS, and believes it is well-positioned to become the leading independent
telecommunications service provider in Russia. These businesses include: (i)
Sovintel, which provides Moscow, and recently St. Petersburg, with international
long distance and local telephone services and access to the major domestic long
distance carriers; (ii) TCM, which provides local access services in Moscow;
(iii) TeleRoss, which provides domestic long distance services in fourteen
cities in Russia, including Moscow, as well as VSAT service to customers outside
its primary long distance satellite network; (iv) Sovam, which provides data
services, including high-speed data transmission, electronic mail, Internet
access services, as well as Russia On Line, the first Russian language Internet
service; and (v) GTS Cellular, which operates cellular networks in twelve
regions in Russia and also in Kiev, Ukraine, with licenses covering regions with
an aggregate population of approximately 25 million people at the end of 1996.
Whenever practical, GTS's businesses integrate and co-market their service
offerings in Russia and the CIS, utilizing TeleRoss as the domestic long
distance provider, Sovintel as the international gateway, TCM and GTS Cellular
for local access, and Sovam as the data communications and Internet access
network for business applications and on-line services. Together, GTS's Russian
and CIS ventures carried 202.5 million and 291.3 million minutes of traffic for
the year ended December 31, 1996 and the nine months ended September 30, 1997,
respectively, and had approximately 24,600 customers, including approximately
16,300 cellular subscribers, as of September 30, 1997. See "-- Russia and the
CIS."
In Western Europe, GTS seeks to position itself as the leading independent
carriers' carrier through the development of two ventures, HER and GTS-Monaco
Access. HER's objective is to become the leading pan-European carriers' carrier
by providing centrally managed cross-border telecommunications transmission
capacity to telecommunications companies including traditional PTOs and New
Entrants on an approximately 18,000 kilometer pan-European high capacity fiber
optic network designed to interconnect a majority of the largest Western and
Central European cities. HER is currently operating over an approximately 1,700-
kilometer portion of the network linking Brussels, Antwerp, Rotterdam,
Amsterdam, London and Paris. HER expects the initial five country network to be
placed in operation in the second quarter of 1998. This segment of the network
is expected to deliver managed transport services over approximately 2,900
kilometers of fiber optic cable linking the cities of London, Rotterdam,
Amsterdam, Antwerp, Brussels, Paris, Dusseldorf and Frankfurt. The full 18,000
kilometer network is expected to become fully operational during the year 2000.
HER also plans to lease capacity on a transatlantic cable linking the European
network to North America and is exploring various interconnectivity options to
Russia and Asia. Such intercontinental interconnectivity will help HER to
satisfy the needs of its European customers with respect to outgoing traffic and
to attract additional non-European customers with traffic terminating in Europe.
HER commenced commercial service over the Brussels-Amsterdam portion of the
network in late 1996, and the London-Paris portion in November 1997. GTS-Monaco
Access operates an international gateway in Monaco in partnership with, and
43
utilizing the existing gateway infrastructure of, the Principality of Monaco and
provides transit and routing of international calls to other telecommunications
operators. Through its HER and GTS-Monaco Access ventures, GTS is building a new
network for transporting voice, data and multimedia/image traffic for other
carriers throughout Western and Central Europe and for worldwide international
voice, data and multimedia/image traffic that either originates or terminates
in, or transits through, Western and Central Europe. See " -- Western Europe."
In Central Europe, GTS's objective is to become one of the leading
alternative telecommunications providers in the region. GTS currently provides
private data communications services to government and commercial customers in
Hungary and the Czech Republic. In the Czech Republic, the Company provides
outgoing voice services and operates an international gateway and a data
services network. In Hungary, GTS operates a VSAT network, which GTS believes is
the largest VSAT network in Central Europe as measured by number of VSAT sites.
The Company has also signed an agreement to provide international data services
in Poland, subject to the receipt of necessary governmental approvals. GTS's
strategy is to expand its service offerings as the regulatory environment
permits, leverage its existing VSAT and international gateway infrastructure
where possible and provide a broad range of services to its target markets. See
" -- Central Europe."
Although GTS does not currently own or operate significant
telecommunication assets in Asia, GTS's objective is to become an established
and diversified telecommunications provider in China and India. GTS seeks to
leverage its position in these countries to capitalize on opportunities as they
arise. See "-- Asia."
BUSINESS STRATEGY
GTS seeks to develop businesses to meet the rapidly expanding market demand
for telecommunications services. GTS's goal in emerging markets is to establish
itself as the leading alternative to the incumbent telecommunications service
providers and as a premier provider of value-added services. In addition, the
Company seeks to position itself as the leading independent carriers' carrier
within Western and Central Europe through the development of a pan-European
fiber optic network and an international gateway in Monaco.
GTS believes that it will be able to successfully operate its businesses
and develop business opportunities by pursuing the following strategies:
- Identify and Seize Early Market Opportunities. GTS's primary strategy is
to identify less developed markets in which the incumbent operator offers
inadequate service and where liberalization of telecommunications
regulations may be pending. The Company believes entering these less
developed markets quickly is a key competitive advantage in the global
telecommunications market. GTS leverages its management's knowledge of
the markets in which the Company operates to assess and react quickly
when attractive business opportunities arise.
- Establish Joint Ventures with Experienced Local Partners. GTS seeks to
establish and maintain strategic partnerships and relationships with key
telecommunications operators and service providers in the countries in
which it operates. The Company believes that these relationships increase
its ability to anticipate and respond to changes in the regulatory and
legal environment and assist with license renewal and expansion of its
operating companies.
- Retain Significant Operational Control. In general, GTS actively
participates in the management of its ventures by (i) providing most of
the funding for the ventures' operations, (ii) selecting key members of
the local management team, (iii) developing business plans and marketing
strategies together with local management, (iv) monitoring operating
functions, (v) maintaining close working relationships with local
partners and (vi) integrating its networks and businesses in a manner
which is consistent with the Company's overall strategic objectives.
- Build Infrastructure to Provide High Quality Services. GTS continues to
develop and expand its network infrastructure. The Company believes that
its networks offer service, quality and cost advantages over incumbent
providers as a result of the Company's customer support, network
monitoring, management systems and its ability to integrate and co-market
its service offerings.
44
- Leverage Management Depth and Experience. GTS's management has
significant experience in the development and operation of
telecommunications businesses outside the United States. The Company
believes that this experience, together with the Company's extensive
operations, has provided its management with the ability to identify,
evaluate and pursue international telecommunications business
opportunities. Additionally, GTS has assembled a management team
comprised of executives with extensive experience managing
telecommunications companies in the respective local markets. GTS
believes that its management team possesses a broad knowledge of relevant
political and regulatory structures, as well as the cultural awareness
and fluency with international and local business practices necessary to
implement the Company's objectives.
- Ability to Access Capital. In general, the Company's financing strategy
is to establish parent level funding to meet general corporate needs and
the costs of start-ups and acquisitions and, when it is possible and
cost-effective, to finance ongoing operations at the venture level. Since
1993, the Company has raised approximately $268 million in equity and
approximately $215 million of debt (of which approximately $74 million
was raised through shareholders). In addition, HER completed a $265
million private placement of senior notes (of which $56.5 million was
placed in escrow for the first two years' interest payments) in 1997. The
Company's principal investors include affiliates of George Soros and Alan
B. Slifka and certain of his affiliates.
In addition to its overall business strategy, GTS has developed specific
market strategies to achieve its goals in emerging markets and Western Europe.
Emerging Markets. The Company pursues its goals in emerging markets through
a three-stage approach of market entry, market expansion and market integration.
- Market Entry. GTS identifies a market as a suitable target for entry
based upon: (i) superior growth prospects for such market, demonstrated
by growing demand for high quality telecommunications services; (ii) the
provision of inadequate services by incumbent providers, typically
resulting from the incumbents' unwillingness to offer high quality
services with reliable customer support at attractive prices; and (iii)
attractive regulatory environments in which emerging alternative
telecommunications providers such as GTS have, or expect to have over a
clearly defined time horizon, the ability to compete on a substantially
equal basis with the incumbent providers in terms of certain services and
the cost of providing those services. Once GTS has identified a market as
suitable for entry, the Company seeks to establish its presence in that
market by establishing a venture with a strong local partner or partners.
In general, GTS maintains a significant degree of operational control in
such ventures. Through such ventures, the Company benefits from its
partners' ability to provide infrastructure, regulatory expertise and
personnel that will provide GTS with a competitive advantage in entering
that market. When entering a new market, GTS's strategy is to provide its
customers with higher quality service as compared to the services offered
by incumbent providers.
- Market Expansion. Having entered a market successfully and established a
limited service offering to its targeted customer base, GTS then seeks to
expand the range of services it offers to existing and potential
customers and to further develop its relationships with local partners.
By broadening its service offerings, GTS anticipates achieving increased
economies of scale through the common use of administrative and operating
functions already in place, increasing the Company's share of its
customers' telecommunications spending and expanding GTS's base of
potential customers through the provision of a bundled service offering.
The Company also seeks to expand its targeted geographic market by
forming new partnerships, installing infrastructure and offering services
in additional geographic regions, allowing the Company to further enhance
its operating leverage and ability to service its customers'
telecommunications needs.
- Market Integration. GTS ultimately intends to integrate and co-market its
service offerings in each of the markets in which it operates. The
Company believes such integration enables it to enhance its operating
efficiency by leveraging its distribution channels, infrastructure and
networks, and management information systems. As customers develop a need
for a broader variety of telecommunications services, the Company
believes GTS's integrated operations will represent an attractive service
45
alternative for customers seeking a single provider with the ability to
meet all their telecommunications needs.
Western Europe. The Company seeks to position itself as the leading
independent carriers' carrier within Western Europe through the development of
HER's pan-European fiber optic network and the operation of GTS-Monaco Access's
international gateway in partnership with, and utilizing the gateway
infrastructure of, the Principality of Monaco. The overall strategy of GTS in
Western Europe is to complement and enhance the services provided by PTOs and
New Entrants in a way that helps them to more successfully meet the needs of
their end-user customers. HER seeks to enter the market ahead of competition and
encourage a wide variety of carriers to use its network with service offerings
that meet their needs. To establish itself as the leading carriers' carrier for
international telecommunications within Europe, HER intends to provide its
customers with significantly higher quality transmission and advanced network
capabilities at a competitive price by utilizing advanced, uniform technology
across the region and providing redundant routing for higher levels of
reliability.
RUSSIA AND THE CIS
OVERVIEW
GTS is a leading provider of a broad range of telecommunications services
in Russia. GTS's services include international long distance services, domestic
long distance services, high speed data transmission and Internet access,
cellular services and local access services. GTS was among the first foreign
telecommunications operators in the CIS, where it began offering data links to
the United States in 1986, international long distance services in 1992, local
access to its networks in 1994 and cellular services in 1995. GTS has developed
these businesses into a leading provider of telecommunications service offerings
in Russia by building its own infrastructure, including a fully digital overlay
network and interconnections with its local Russian telecommunications partners.
The Company believes that evolving changes in government policy over the
last several years and the overall inadequacy of basic telecommunications
services throughout Russia have created a significant opportunity. Before 1990,
all international, domestic long distance and local telecommunications in the
Soviet Union were provided by a monopoly state telecommunications company
managed by the Ministry of Posts and Communications. In 1990, the Council of
Ministers established a joint-stock company called Sovtelecom and transferred to
it all of the telecommunications assets and operations of the Soviet Ministry of
Posts and Communications. Following the dissolution of the Soviet Union in 1991,
the name of the company was changed to Intertelecom. In 1992, the Russian
government decided to split Intertelecom into several components to foster
privatization, competition and investment. The international and long-distance
assets and operations were combined into Rostelecom, creating a monopolistic
service provider. The local telecommunications assets and operations were broken
up into 88 independent regional joint-stock companies, seven of which serve
cities, including the Moscow City Telephone Network and the Petersburg Telephone
Network. Most of the regional companies have a telecommunications trunk operator
and provide a domestic long distance service within their service region.
Domestic long distance calls to and from areas outside the companies' service
area, as well as international calls, are switched to and from Rostelecom, which
forwards the calls to and from another regional company or a foreign carrier for
international calls. Exceptions to this rule include the seven city operators.
In Moscow and St. Petersburg, the trunk operators have been isolated into
separate, long distance companies called Moscow MMT and St. Petersburg MMT. All
domestic long distance and international calls originating from or terminating
in Moscow and St. Petersburg are switched through the MMTs, which forward the
calls to and from Rostelecom.
Following the former Soviet Union's transformation from a centralized
economy to a more market-oriented economy, increased demand from emerging
private businesses and from individuals, together with the poor state of the
public telephone network, has led to rapid growth in the telecommunications
sector in Russia and the CIS. In 1991 the MOC was established as the Russian
successor to the Soviet Ministry of Posts and Communications to regulate and
improve the telecommunications industry and to be the government's
representative for its ownership share of the 88 regional operating companies,
the assets currently held by
46
Svyazinvest (then the monopoly international and domestic long distance service
provider) and national radio, television and satellite operating companies. This
enabled the MOC and operating organizations to begin the privatization process,
attract foreign investment and initiate joint ventures with foreign partners.
Although it remains subject to certain restrictions, significant progress
in privatization of the telecommunications industry in Russia and the CIS has
occurred. Under Russian law, state-owned enterprises within the
telecommunications sector were subject to privatization but only pursuant to a
decision of the Russian government in each individual case and with the state
retaining a certain percentage of the stock of the privatized entity for three
years, subject to extension for national security reasons. At present, virtually
all of the former state telecommunications enterprises have been privatized and,
subject to the above restrictions, shares of the newly formed joint stock
companies have been sold to the public. Also, a significant number of private
operators provide a wide variety of telecommunications services pursuant to
licenses from the MOC to a growing number of customers throughout Russia.
According to the MOC, more than 6,000 licenses have been granted to
telecommunications operators in Russia, a large portion of which is assumed to
represent licenses reissued to the same operators as a result of their
reorganization or obligation to hold such licenses on counterfeit-proof paper.
In October 1994, the President authorized the establishment of Svyazinvest
with the stated purpose of fostering greater efficiency and economies of scale
within the industry through competition. As a wholly government-owned company,
Svyazinvest was granted a controlling stake in approximately 85 regional
telecommunications companies in order to compete in these respective markets.
Svyazinvest was also given control of more than 20 million of the 25.5 million
telephone lines in Russia, except in Moscow and St. Petersburg.
In April 1997, President Yeltsin approved the transfer of the federal
government's 51% stake in Rostelecom, as well as similar stakes in Central
Telegraph (the national PTO), the Yekaterinberg City Telephone Network and
Giprosvyaz (a telecommunications research institute), to Svyazinvest. On July
30, 1997, Mustcom Ltd., a Cyprus-based company that represents the interests of
a consortium which includes ICFI Cyprus, Renaissance International Ltd.,
Deutsche Morgan Grenfell, Morgan Stanley, and an affiliate of George Soros,
purchased a 25% stake in Svyazinvest for $1.87 billion. The President has also
authorized the sale of another 24% of Svyazinvest at a future date. This sale is
scheduled to occur in the first half of 1998 and is currently reserved solely
for Russian investors. The Russian government has announced that it will retain
a controlling 51% interest in Svyazinvest.
The Russian government's interest in Svyazinvest is held by the MOC, which
was reclassified as the State Committee on Telecommunications and Informatics
during a recent government reorganization. The MOC remains the central body of
federal authority in the Russian Federation, having responsibility for state
management of the communications industry and supervisory responsibility for the
condition and development of all types of communications.
Despite the recent changes in the Russian telecommunications industry, the
level of telecommunications service generally available from most public
operators in Moscow remains significantly below that available in cities of
Western Europe and the United States, although in recent years, the Moscow local
telephone infrastructure has benefitted from significant capital investment. By
1995, there were approximately 16 lines per 100 persons in Russia and 45 lines
per 100 persons in Moscow. In comparison, there were 60 and 58 lines per 100
persons in the United States and Western Europe, respectively. In addition, the
quality of services, reflected as the percentage of digital switching in local
telephone networks, currently is approximately 12% in Russia compared to 65% and
66% in the United States and Western Europe, respectively.
Outside Moscow (and to a lesser extent St. Petersburg), most standard
Russian telecommunications equipment is obsolete. For example, many of the
telephone exchanges are electromechanical and most telephones still use pulse
dialing. The Russian population is over 145 million, of which approximately two-
thirds is concentrated in urban areas. The telecommunications market in Russia
currently includes a number of operators that compete in different service
offering segments -- local, inter-city, international, data and cellular
services. In large measure, the relative lack of economic development in the
regions accounts for the lack of improvement in local telecommunications
infrastructure. Although the regions still generally rely on an
47
outdated infrastructure inherited from the former Soviet Union, they are
starting to resort to sophisticated sources of finance, such as municipal bond
offerings, in order to upgrade it.
Growth in the Russian telecommunications industry has been principally
driven by businesses in Moscow requiring international and domestic long
distance voice and data services and by consumers using mobile telephony. This
growth has been most significant as multinational corporations have established
a presence in Moscow and Russian businesses have begun to expand. The service
sector, which includes operations in distribution, financial services and
professional services and tends to be the most telecommunications-intensive
service sector of the economy, is growing rapidly in Moscow. Since moving to a
more market-oriented economy, the economic conditions in the outlying regions in
Russia have also generally improved. The telecommunications industry in the
outlying regions has experienced recent growth, principally as a result of
growth in the industrial sector as well as the establishment of satellite
offices in the regions by multinational corporations and growing Russian
businesses. The extent of overall market growth will depend in part on the rate
at which the Russian economy expands, although recent revenue growth in the
sector has been significant (in spite of a declining economy in certain regions)
because of increasing traffic from pre-existing customers and the normalization
of tariffs for business services.
The Company believes it is well-positioned to take advantage of market
growth factors due to (i) its early market entry, (ii) its strong infrastructure
position in Moscow, by far the most important regional market, (iii) the local
market experience of its local partners, (iv) the extent of its existing
customer base and (v) its extensive range of international and domestic
telecommunications services. GTS believes it is the only operator in Russia
currently capable of providing a broad range of service offerings and marketing
them as a single end-to-end service offering for its customers.
STRATEGY
GTS's objective is to become the premier alternative carrier in Russia and
other key growth markets of the CIS. To attain this objective, the Company has
developed and implemented the following strategy:
- Develop Strong Local Partnerships. The Company has and continues to
develop its Russian and CIS business through alliances with experienced
local partners, which to date have been primarily regional telephone
companies and Rostelecom. These ventures combine the management,
financial and marketing expertise of GTS together with its partner's
ability to provide infrastructure and local regulatory experience. GTS
believes that these relationships lend it credibility and increase its
ability to anticipate and respond to the evolving regulatory and legal
environment. GTS maintains a significant degree of managerial and
operational control in its joint ventures through its foundation
documents, which enable GTS to develop them in a manner consistent with
its overall strategic objectives.
- Expand Customer Base. The Company continues to expand its customer base
through the provision of basic telephone and digital services in markets
where such services are not currently provided. Once they have
established a presence in a market, the Company's ventures seek for
opportunities to expand further into neighboring regions and cities.
- Increase Range of Digital Services. As its business customers expand
their operations throughout Russia and the CIS and as their
telecommunications needs become more sophisticated, the Company seeks to
increase its revenues by expanding the range of integrated digital
services offered to its customers.
- Offer High Quality Telecommunications Service and Customer Service. The
Company continues to invest in and build sophisticated high-speed digital
networks and other infrastructure through which customers can gain local
access to the Company's services. In addition to providing advanced, high
quality network infrastructure, the Company emphasizes and offers its
customers a level of customer service which the Company believes cannot
be found elsewhere in the market.
To date, GTS has made substantial progress employing this strategy. The
Company provides digital voice, data and local services in Moscow through its
Sovintel, Sovam and TCM ventures and provides these same services to thirteen
additional Russian cities through its TeleRoss long distance network.
48
OPERATIONS
GTS provides a broad range of telecommunications services in Russia,
including international long distance services, domestic long distance services,
cellular services, high speed data transmission, Internet access and local
access services. These services are supported by operator assistance, itemized
call reporting and billing, and other value-added capabilities that leverage
GTS's investment in advanced switching, data collection and processing
equipment. GTS also provides customized systems integration, including PABXs,
key systems, wiring and interconnectivity. GTS's own infrastructure is
supplemented with dedicated and leased capacity to allow GTS to bypass the
severely congested and poorly maintained local, domestic and long distance
circuits of the Russian carriers.
Whenever practical, GTS's business units integrate and co-market their
service offerings, utilizing TeleRoss as the long distance provider, Sovintel as
the international gateway, TCM and GTS Cellular for local access, and Sovam as
the data communications and Internet access network for business applications
and on-line services. Through this integrated marketing approach, GTS is able to
provide comprehensive telecommunications solutions to multinational corporations
operating throughout Russia and the CIS.
The following table sets forth certain operating data related to the
Company's operating ventures in Russia and the CIS.
AT AND FOR THE YEAR
ENDED DECEMBER 31, AT AND FOR THE NINE
------------------------ MONTHS ENDED
1994(1) 1995 1996 SEPTEMBER 30, 1997
------- ---- ----- --------------------
Cities In Service................................. 5 24 33 40
Total Voice Minutes (millions)(2)
Inter-city...................................... -- (3) 2.3 15.8 33.8
Local........................................... 0.0 22.1 133.0 174.9
International Outgoing.......................... 7.7(3) 10.5 20.5 31.7
Incoming........................................ 2.0 4.5 33.2 50.9
Total Data Customers (thousands).................. 1.9 2.9 6.2 8.3
Total Cellular Subscribers (thousands)............ 0.0 1.6 9.8 16.3
(1) In 1994, the Company's interest in ventures operating in Russia consisted of
a ten-percent interest in Baltic Communications Limited, a one-third
interest in Sovam, and Sovintel, in which the Company owned a 12.5% interest
through May 1994 and a 50% interest thereafter.
(2) Amounts include minutes between Company affiliates.
(3) International and inter-city long distance outgoing minutes not segregated
in 1994.
SOVINTEL
GTS owns 50% of Sovintel, a joint venture with Rostelecom, the national
long distance carrier. Sovintel was founded in 1990 by GTS, Rostelecom and GTE
Spacenet, with GTS acquiring GTE Spacenet's interest in 1994. Sovintel markets a
broad range of high quality telecommunications services by (i) directly
providing international direct dial access to over 170 countries and private
line dedicated voice channels and (ii) leveraging the infrastructure and
services of the other GTS ventures, including TeleRoss, TCM and Sovam. In
addition, Sovintel provides and installs for its customers equipment such as
PABXs, key systems and wiring and provides maintenance and other value-added
services. Sovintel customers, which primarily consist of businesses, hotels and
Moscow-based cellular operators, are able to access these telecommunications
services through Sovintel's fully-digital overlay network in Moscow. In
addition, Sovintel has recently commenced construction of a limited network in
St. Petersburg that is interconnected to Sovintel's Moscow network and is
intended to support Sovintel's Moscow clients which have a presence in St.
Petersburg. Sovintel serviced over 40,500 telephone numbers, or "ports," for
business customers and cellular providers and had over 240 employees as of
September 30, 1997.
49
Sovintel has constructed and operates a fully-digital overlay network in
and around Moscow which consists of (i) an approximately 600-kilometer fiber
optic ring, (ii) over 250 PABXs linked to the fiber optic ring, (iii) a
fully-digital microwave network, (iv) a wireless local loop and (v) an
international gateway connected to the fiber optic ring. In addition, Sovintel
leases dedicated international long distance channels. Customers are connected
to the Sovintel network via last mile connections to over 250 PABXs that provide
"points-of-presence" in and around Moscow. The PABXs are connected to the
network through a direct fiber connection or a digital microwave network. Some
of Sovintel's new customers are temporarily connected to the network through a
wireless local loop. The wireless local loop provides a significant competitive
advantage because it allows Sovintel to connect customers to its network more
quickly than alternative methods. As these customers are provided permanent
connections to Sovintel's network through direct connections to the PABXs,
additional customers are rolled onto the wireless local loop.
[GTS SOVINTEL MOSCOW NETWORK]
After a customer is connected to the Sovintel network, local telephone
services are provided through the Sovintel fiber optic ring's interconnection
with the switches of either TCM or MTU Inform. These switches provide access to
local telephone service in Moscow through interconnections with the Moscow city
telephone network ("MGTS") and the principal Moscow cellular providers. Sovintel
provides its customers access to domestic long distance service through the
TeleRoss long distance network, or through Rostelecom's network in cities not
currently served by TeleRoss. International service is provided primarily
through the Sovintel international gateway, which transmits international
traffic via dedicated international leased long distance channels. Sovintel's
customers also can receive high speed data services through Sovintel's
interconnection with the Sovam data network. Accordingly, from a customer's
perspective, Sovintel offers a broad range of telecommunication services.
50
The following table sets forth certain operating data related to Sovintel's
operations:
AT AND FOR THE
NINE MONTHS
AT AND FOR THE YEAR ENDED DECEMBER 31, ENDED
-------------------------------------- SEPTEMBER 30,
1994 1995 1996 1997
-------- --------- --------- ---------------
MINUTES OF USE(1)
International Minutes
Number of Minutes.................... 7,681(2) 10,516 20,839 30,628
Average Rate Per Minute.............. $ 2.35 $ 2.06 $ 1.55 $ 1.19
Domestic Long Distance Minutes
Number of Minutes.................... --(2) 2,047 10,098 16,946
Average Rate Per Minute.............. -- $ 0.86 $ 0.65 $ 0.55
Moscow (Local) Fixed Line Minutes
Number of Minutes.................... -- -- -- 2,302
Average Rate Per Minute.............. -- -- -- $ 0.06
Moscow (Local) Cellular Minutes
Number of Minutes.................... -- 21,478 83,673 82,333
Average Rate Per Minute.............. -- $ 0.06 $ 0.08 $ 0.08
Incoming Minutes
Number of Minutes.................... 1,967 3,839 24,306 34,571
Average Rate Per Minutes............. $ 0.76 $ 0.58 $ 0.28 $ 0.29
PORTS
Number of Ports (cumulative)............ -- 6,079 29,646 40,563
NUMBER OF PRIVATE LINE CHANNELS
International........................... 1 26 89 162
Inter- and Intra-City................... 1 26 103 184
APPROXIMATE EQUIPMENT SALES (THOUSANDS)... $1,100 $ 1,400 $ 2,200 $ 2,500
(1) Minutes in thousands. Amounts include minutes among affiliates.
(2) International and domestic long distance outgoing minutes not segregated in
1994.
Services. Sovintel markets a broad range of high quality telecommunications
services by (i) directly providing international direct dial access to over 170
countries and private line dedicated voice services and (ii) by leveraging the
infrastructure and services of the other GTS ventures. Sovintel's services
include:
- Switched International, Domestic Long Distance and Local
Services. Customers are provided switched international long distance
services directly through Sovintel's international gateway in Moscow and
its leased long distance channels. Domestic long distance services are
marketed by Sovintel and provided either through the TeleRoss long
distance network or, where the call destination is not served by
TeleRoss, through Rostelecom's network. Local call service is provided by
Sovintel indirectly as a result of its interconnection, through TCM or
MTU Inform, with the Moscow city telephone network. Based on its
familiarity with the market, the Company believes that Sovintel's
services are distinguished by a higher level of quality than those of its
competitors, particularly with respect to call completion rates for its
domestic long distance and local call services. In addition, the Company
trains its employees to provide customer service at a level which is
comparable to that provided by Western telecommunications companies. As a
result, the Company believes that customers choose Sovintel over its
competitors because it has earned a reputation for providing high quality
telecommunications services through an experienced and professional
customer service staff.
- Private Line Channels. Private line channels, which are provided over
dedicated leased lines, are principally utilized by customers with
high-volume data traffic needs, such as Sovam and large data providers.
Private line customers have access to intra-city service in Moscow
through Sovintel's fiber optic ring and to inter-city service between
Moscow and St. Petersburg via fiber leased by Sovintel, in
51
each case benefitting from Sovintel's high quality infrastructure.
Private line domestic long distance service is provided through TeleRoss
and, for cities not served by TeleRoss, through Rostelecom. International
private line service is provided through dedicated leased fiber channels
from Rostelecom.
- Equipment Sales, Installation Services and Project Planning and
Management Services. In providing the above services to its customers,
Sovintel installs and maintains equipment on its customers' premises,
including PABXs, key systems and wiring. Sovintel also provides project
planning and management services, including system design and management,
to its customers.
- World Access Service. Customers are able to access Sovintel's
international long distance services through the World Access Card, which
provides customers either direct or calling-card-based portable access to
domestic and international long distance service. The calling card can be
used in 15 Russian cities, including Moscow and St. Petersburg, and 23
countries.
Sovintel complements its service offerings by providing a wide range of
value-added services including operator assistance, maintenance and customer
support and itemized call reporting and billing.
Customers and Pricing. Sovintel's customers consist primarily of
high-volume business and professional customers, such as IBM, Credit Suisse
Group and Reuters, other multinational corporations and Russian enterprises, a
number of premium Moscow hotels and other telecommunications carriers. In
addition, Sovintel is one of the primary providers of domestic and international
long distance service for the major cellular service providers in Moscow,
including VimpelCom, MTS and Moscow Cellular. Sovintel's customers typically
demand a higher level of service than generally available in the market.
Sovintel further provides to its large corporate customers data services such as
frame relay and Internet access contracted from Sovam in order to offer
"one-stop shopping" telecommunications solution to these customers, who
increasingly require this type of service.
The pricing structure for international and domestic long distance calls is
based upon traffic volume and overall market rates, with Sovintel's rates
varying depending on the time and destination of the call. Local calls, other
than calls placed to cellular phones, are completed without charge. Sovintel
expects to continue its practice of not charging to complete local calls unless
and until the MGTS begins to charge for completion of such calls. Sovintel
prices its international long distance services slightly below those of its
principal competitors, and has recently reduced its rates in anticipation of
increased competitive pricing pressures. Sovintel's average revenue per minute
for outgoing international long distance calls has declined from approximately
$2.35 per minute for the year ended December 31, 1994 to approximately $1.19 per
minute for the nine months ended September 30, 1997. Sovintel expects increased
pricing pressure from competitors over time. Sovintel prices domestic long
distance services in line with those of its principal competitors. Prices for
domestic long distance services have increased significantly over the last
several years, although such prices stabilized in the second half of 1996.
Sovintel's private line services are priced competitively. Sovintel provides
private line channels by releasing lines it leases from Rostelecom. The lines
are leased by Sovintel from Rostelecom at wholesale rates and leased by Sovintel
to its customers at prices in line with Rostelecom's retail rate.
Customers are billed monthly with larger-volume customers receiving
discounts of up to 25%. Customers using international services, domestic long
distance or data services are billed in U.S. dollars. To the extent permitted by
law, payment is made either in U.S. dollars or in rubles at the ruble/dollar
exchange rate at the time of payment, plus a conversion charge in order to
minimize the impact of currency fluctuations. Sovintel currently bills on an
invoicing system that was internally developed. Currently, the system is
adequate for Sovintel's present customer base; however, the Company is
evaluating alternatives for upgrading the system in anticipation of future
growth.
Sales and Marketing. Sovintel's sales and marketing strategy targets large
multinational and Russian businesses both directly and through contacts with
real estate developers and business center managers in the greater Moscow area.
These developers and managers typically determine which telecommunications
service provider will service their respective properties. By identifying and
building relationships with these developers and managers at an early stage
(typically up to one year prior to the completion of a new building project),
52
Sovintel seeks to enhance the likelihood of winning the service contract. In
addition to its traditional target market, Sovintel has recently begun to market
its services to smaller businesses. Sovintel utilizes a departmentalized sales
force in order to focus its sale efforts on the different segments within its
target market. The sales force is comprised of 40 sales personnel, including 15
account managers, all of whom specialize in serving specific targeted
industries. Dedicated marketing and customer support personnel provide technical
support, customer service, training, market monitoring and promotional functions
for Sovintel. Sovintel's sales and marketing personnel are paid through a
combination of salary, commissions and incentive bonuses.
Ownership and Control. Sovintel is a joint venture between a wholly-owned
entity of GTS and Rostelecom with each having a 50% ownership interest. Under
Sovintel's charter, GTS and Rostelecom each have the right to appoint three of
the six members of Sovintel's managing board. Rostelecom has the right to
nominate the Director General (the highest ranking executive officer at
Sovintel), while GTS has the right to nominate the First Deputy Director General
(the next-highest ranking executive officer at Sovintel). In practice, the
Director General and the First Deputy Director General together perform the role
of a chief executive officer. Certain business decisions, including the adoption
of Sovintel's annual budget and business plan as well as the distribution of
profits and losses require the approval of both GTS and Rostelecom. Neither GTS
nor Rostelecom are obligated to fund Sovintel's operations or capital
expenditures. Losses and profits of Sovintel are allocated to the partners in
accordance with their ownership percentages, in consideration of funds at risk.
As of September 30, 1997, GTS and Rostelecom has each made equity contributions
of $1.0 million to Sovintel. In addition, Sovintel had outstanding loans of $9.0
million to GTS as of September 30, 1997. See "Management's Discussion and
Analysis -- Accounting Methodology -- Profit and Loss Accounting." The Sovintel
joint venture agreement does not have an expiration date. See "Risk
Factors -- Dependence on Certain Local Parties; Absence of Control."
TCM
GTS beneficially owns approximately 50% of TCM, a joint venture founded in
1994 that provides a licensed numbering plan and interconnection to the Moscow
city telephone network for carriers needing basic local access service in
Moscow. GTS's partners in TCM are MTU-Inform and a group of entrepreneurs with
extensive telecommunications experience. TCM is currently licensed to provide
100,000 numbers in Moscow, of which approximately 44,000 have been leased. TCM
has contracted with MGTS to construct up to an additional 100,000 numbers in
several stages over the next five years, and currently plans to construct 10,000
numbers in each of 2000, 2001 and 2002. Any such construction, however, is
subject to TCM obtaining a license covering the additional numbers and the
availability of such numbers in the portion of the MGTS numbering plan in which
TCM plans to construct such numbers. TCM's switching facilities are fully
integrated with the networks of Rostelecom, Sovintel, and MGTS, allowing it to
provide high quality digital service to its customers.
Services. TCM acts as a local gateway by providing numbers and ports to
carriers in Moscow, including Sovintel, VimpelCom, MTS and Moscow Cellular, and
thus providing interconnectivity to the Moscow city telephone network. Access to
the Moscow city telephone network provides customers with the higher quality and
broader range of services available in Moscow, such as the services provided by
Sovintel. Access from outlying regions is typically obtained through a domestic
long distance service provider such as TeleRoss. See "-- Sovintel" and
"-- TeleRoss."
Customers and Pricing. TCM provides its services on the wholesale level to
primary carriers. VimpelCom is TCM's primary customer and accounts for
substantially all of TCM's revenues, hence the loss of VimpelCom as a customer
would have a material adverse effect on the Company. TCM also provides ports to
Sovintel and to other network operators including MTS and Moscow Cellular. TCM's
ports are leased principally to carriers in Moscow. Although local access
services are priced upon the basis of supply and demand factors in the local
market, in general, for each port cellular operators pay an approximately $300
installation fee and a $16 flat monthly fee plus a per minute charge for traffic
while other carriers pay a larger initial fee of approximately $500 and a
monthly fee of approximately $25. Local access services are typically provided
pursuant to five-year contracts that may be renewed upon expiration for
additional one-year periods. TCM has entered into an agreement with Sovintel
pursuant to which billing and collecting functions
53
for TCM-Sovintel joint customers are performed by Sovintel, with Sovintel
remitting such amounts (less applicable settlement charges and administrative
costs) to TCM. The rapid growth of cellular services in markets like Moscow has
placed a premium on new numbers, which has translated into attractive prices for
these numbers. TCM, however, believes these prices will decline over time.
Ownership and Control. GTS's indirect interest in TCM is represented by its
approximately 52% interest in a holding company, which owns 95% of TCM. This
structure provides GTS with 50% beneficial ownership interest in TCM. Decisions
of the holding company regarding TCM require unanimous board approval and
neither GTS nor its partner in the holding company is obligated to fund
operations or capital expenditures of the holding company. In addition, neither
the holding company nor the TCM shareholders are obligated to fund operations or
capital expenditures of TCM. At both the holding company and TCM level, losses
and profits are allocated to the partners in accordance with their ownership
percentages, in consideration of funds at risk. GTS acquired its indirect, 50%
beneficial interest in TCM for approximately $700,000 and certain additional
consideration. As of September 30, 1997, GTS had no outstanding loans relating
to TCM. See "Management's Discussion and Analysis -- Accounting
Methodology -- Profit and Loss Accounting." None of the operative charters and
agreements relating to the holding company or TCM have expiration dates. See
"Risk Factors -- Dependence on Certain Local Parties; Absence of Control."
TELEROSS
TeleRoss, which began operations in 1995, consists of (i) two wholly-owned
holding companies and a 99% owned subsidiary of GTS that operates a domestic
long distance network (collectively, the "TeleRoss Operating Company") and (ii)
thirteen joint ventures that are 50% beneficially-owned by GTS that originate
traffic and provide local termination of calls (the "TeleRoss Ventures" and,
together with TeleRoss Operating Company, "TeleRoss"). The TeleRoss domestic
long distance network serves fourteen major Russian cities, including Moscow
and, through VSAT technology, 19 customers located outside these cities.
TeleRoss provides digital domestic long distance services and other value-added
services through its own infrastructure as well as access to Sovintel's
international gateway services and access to the Moscow city telephone network
through TCM's switching facilities. Sovam uses the TeleRoss digital channels to
provide regional data service and has co-located its access facilities with
TeleRoss. As of September 30, 1997, TeleRoss employed approximately 188 persons
of which approximately 90 people were based in Moscow and approximately 98
people were deployed in the regions in which TeleRoss operates.
54
TeleRoss's licenses cover the city of Moscow and a total of 39 regions
throughout Russia. Most of the thirteen cities in which TeleRoss primarily
operates are regional capitals, with an aggregate population of approximately
11.5 million. TeleRoss's licenses cover the entire oblast surrounding these
cities, with populations totalling approximately 38.1 million persons, and GTS
intends eventually to extend the reach of the TeleRoss network beyond the
regional capitals to the surrounding areas. The cities in which TeleRoss
currently offers its services are:
(1) This column reflects the population residing in cities. Source: GTS estimate
(2) This column reflects the urban population in oblast. Source: Rusline
(3) This column reflects the total population residing in the oblast, including
rural population. Source: Rusline
(4) TeleRoss plans to expand to the city of Samara in January, 1998. The 1995
city population, urban oblast population and total oblast population for
Samara was 1.2 million, 2.7 million and 3.3 million, respectively.
The TeleRoss network architecture involves local city switches connected to
remote earth stations which communicate via satellite to a Moscow-based hub.
This hub consists of the network control center, earth station equipment,
multiplexing equipment and a switch. The earth stations, hub and related
equipment are owned by TeleRoss, which gives TeleRoss the flexibility to
redeploy network assets to other locations as necessary. The hub interconnects
to Sovintel's network providing access to Sovam's data networks, TCM's switching
facilities and Sovintel's international gateway, which transports international
traffic via dedicated international leased satellites and fiber channels and
provides access to Rostelecom's long distance networks. Outside of Moscow,
TeleRoss's local joint venture partners provide interconnection to the local
public telephone networks in each of the cities it serves. In addition to
providing services through its network, TeleRoss currently serves 19 customers
in 18 additional cities through VSAT technology which links the customers via
satellite to the Moscow hub.
55
The following table sets forth certain operating data related to TeleRoss's
operations:
AT AND FOR
AT AND FOR THE NINE
THE YEAR MONTHS
ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
MINUTES OF USE(1)
Domestic Minutes (thousands).............................. 3,478 14,440
Average Rate Per Domestic Minute.......................... $ 0.99 $ 0.66
International Minutes (thousands)......................... 189 486
Average Rate Per International Minute..................... $ 2.76 $ 2.56
NUMBER OF CITIES SERVED..................................... 13 14
WORLD CONNECT DIAL/RUSSIA
Number of Connect Dial Ports.............................. 472 961
Average Revenue Per Port Per Month........................ $ 767 $ 378
MOSCOW CONNECT
Number of Ports........................................... 49 56
Average Revenue Per Port Per Month........................ $1,165 $ 1,513
DEDICATED CIRCUITS
Number of Dedicated Channels.............................. 33 43
Average Price Per Channel................................. $4,553 $ 4,264
WORLD ACCESS SERVICE
Number of World Access Card Users......................... 3,929 4,360
Average Revenue Per Card Per Month........................ $ 52 $ 45
VSAT SERVICES
Number of VSATs........................................... 12 20
(1) Includes minutes among affiliates.
Services. Through its network and VSAT offerings, TeleRoss offers the
following services:
- Carriers' Carrier Services. TeleRoss provides services as a "carriers'
carrier," providing domestic long distance carrier services to cellular
operators, Sovintel, the TeleRoss Ventures' regional partners and
competitive bypass operators from the cities in which the TeleRoss
Ventures operate, and to customers in remote cities using VSAT stations.
These services are provided to and from Moscow, and are provided by
TeleRoss at wholesale rates competitive with those offered by Rostelecom.
TeleRoss also provides private line channels to Sovam in cities where the
TeleRoss Ventures operate. In addition, TeleRoss has recently received a
license to provide international private line service.
- World Connect Dial/Russia Connect Dial. Customers in TeleRoss's cities
are provided dedicated local access to the regional TeleRoss switch
through lines leased from the TeleRoss Venture's regional joint venture
partner. These customers then have access to the domestic long distance
service provided by TeleRoss, international long distance service
provided by Sovintel and are fully integrated into the local phone
networks operated by the applicable TeleRoss Venture's partner and to the
Moscow city telephone network through TCM.
- Moscow Connect. Customers are provided with dedicated last mile
connection over lines leased from the regional joint venture partner
which lines are connected to a local TeleRoss switch. The TeleRoss
network and its interconnection to TCM provide customers with a Moscow
dial tone which allows users in remote locations better access to
Moscow's advanced telecommunications infrastructure. In addition, Moscow
Connect service provides better call quality at lower rates for domestic
and international long distance. Moscow Connect also facilitates
communications between users and their
56
Moscow-based associates as calls can be made to and from Moscow without
the use of prefixes and without long distance charges accruing to the
Moscow-based parties.
- Dedicated Circuits. Customers are provided with point-to-point clear
channel circuits within Russia and internationally through the TeleRoss
backbone and its interconnection with Sovintel's international gateway in
Moscow. Dedicated circuits are generally used by news services, banks and
other commercial customers who require high capacity and high quality
service. This service can be used for voice or data, depending on the
user's needs. In providing dedicated circuits, TeleRoss competes against
other alternative communications providers, however, TeleRoss believes
that it has a distinct price advantage over its competitors because of
the use of its own infrastructure and the bulk purchase of satellite
capacity.
- World Access Service. TeleRoss and Sovintel co-market World Access
Service to their customers in each of the cities they serve through two
products: World Access Direct and World Access Card. Through World Access
Direct, TeleRoss customers can access domestic long distance and
international service anywhere within the customer's city through the
local telephone network. The World Access Card is a calling card which
allows TeleRoss customers portable access to domestic long distance and
international service from 15 Russian cities, including Moscow and St.
Petersburg, and 23 countries. This service is provided through Sovintel's
infrastructure.
- VSAT Services. For customers that are located outside the cities serviced
by TeleRoss or that cannot be physically linked to TeleRoss's regional
switches, TeleRoss offers VSAT service which connects these customers
directly to TeleRoss's Moscow-based hub through a VSAT antenna installed
at the customer's location. Both dedicated and switched services are
provided through these VSAT arrangements.
In addition to continuing the development of its core domestic long
distance business, TeleRoss's strategy includes the development of local access
networks to capitalize on demand for local phone service and to capture
additional customers for its long distance and value-added service offerings.
Outside Moscow, TeleRoss has primarily pursued a strategy whereby it develops
its own intra-city trunking network with copper based or fiber optic facilities
leased from the regional joint venture partners. As of September 30, 1997,
TeleRoss, in conjunction with regional joint venture partners, has installed
approximately 25 kilometers of fiber optic cable in 3 cities and plans to
install an aggregate of approximately 100 kilometers of additional fiber optic
cable in up to an additional 6 cities over the next 24 to 30 months. Customers
who obtain local phone numbers from TeleRoss's venture partners are directly
interconnected to the local telephone company and to the Company's long distance
network and Sovintel's international gateway and may obtain a broad range of
value-added services offered by the Company.
Customers and Pricing. TeleRoss's customers include businesses and other
telecommunications service providers such as carriers, PTOs, cellular operators,
Sovintel and Sovam. TeleRoss's business customers consist of large multinational
and Russian businesses in each of the regions it services, as well as medium and
small-sized businesses. Between 1993 and mid-1996, consumer prices in TeleRoss's
industry increased significantly as a result of Rostelecom raising its prices in
an effort to raise capital for investment and development of its network
infrastructure, although prices have stabilized over the past six months. In the
first nine months of 1997, TeleRoss increased sales to carriers, which sales
were made at wholesale rates, resulting in a decrease in the average rate per
minute for TeleRoss. TeleRoss strategically prices its domestic long distance
services at a slight premium over similar services offered by Rostelecom to
account for a higher quality of service, but in line with the prices offered by
regional competitors.
Sales and Marketing. TeleRoss markets its services to carriers and
businesses through direct sales channels. As of September 30, 1997, TeleRoss
employed 27 sales and marketing personnel, approximately half of which are based
in Moscow with the other half deployed regionally to identify and contact
prospective customers. The Moscow-based sales and marketing personnel are
organized into industry groups in order to better identify and serve customer
needs. Each region is typically served by one or two sales representatives.
TeleRoss's sales efforts are supported by market research and promotional
activities carried out at the joint venture level and tailored to the specific
market base of each region. TeleRoss's marketing strategy is to attract
57
carrier customers by focusing on those carriers with high volume minutes
operating in regions where TeleRoss has a competitive advantage. Through
cross-marketing agreements with Sovintel and Sovam, TeleRoss markets many of the
other service offerings of GTS's Russian businesses to customers throughout its
service regions. Billing functions and the monitoring of quality control and
technical issues are performed centrally through the Moscow-based hub.
Ownership and Control. TeleRoss consists of the TeleRoss Operating Company,
and the 50% beneficially-owned TeleRoss Ventures. GTS controls TeleRoss
Operating Company (which holds the network license) and co-manages the TeleRoss
Ventures under the terms of the applicable TeleRoss Ventures' foundation
agreements and charters. Under some of these charters, GTS generally has the
right to designate the Chairman of the board of directors, and GTS's local
partner has the right to designate the Deputy Chairman, for the first two-year
term (and thereafter GTS and the local partner nominate the Chairman and Deputy
Chairman for approval by the entire board on a rotating basis). The foundation
agreements and charters do not have expiration dates. While GTS has significant
influence within these ventures, decisions, including the decision to declare
and pay dividends, are generally subject to GTS's partner's approval. See "Risk
Factors -- Dependence on Certain Local Parties; Absence of Control." Neither GTS
nor its respective joint venture partners are obligated to fund operations or
capital expenditures of the TeleRoss Ventures. Losses and profits are allocated
to the partners in accordance with their ownership percentages, in consideration
of funds at risk. As of September 30, 1997, GTS and its partners had each made
equity contributions aggregating $1.7 million to the various TeleRoss Ventures.
Contributions made by the partners include contributions of cash and intangible
assets, such as licenses. In addition, the various TeleRoss Ventures had
outstanding loans of $3.3 million to GTS as of September 30, 1997. See
"Management's Discussion and Analysis -- Accounting Methodology -- Profit and
Loss Accounting."
SOVAM
Sovam is a venture owned 66.7% by GTS and 33.3% by the Institute for
Automated Systems ("IAS"). Sovam was founded in 1990 as a venture equally owned
by GTS and IAS. In 1992, Cable & Wireless acquired a 33% ownership interest in
Sovam, which interest was subsequently acquired by GTS in 1994, bringing GTS's
ownership interest to its current 66.7%. GTS has reached an agreement in
principle to purchase IAS's interest in Sovam and expects to consummate the
transaction in January 1998, thereby making Sovam a wholly owned subsidiary of
GTS. Sovam provides high-speed data communications services, electronic mail and
database access over a high-speed packet/frame relay network in 30 major Russian
and CIS cities. Sovam also offers Russia On Line, the first Russian language
Internet service, which provides direct access to the Internet as well as access
to a wide range of local and international information services and databases.
As of September 30, 1997, Sovam had approximately 1,667 data service customers
and approximately 3,272 Russia On Line customers. Sovam employed over 100
persons in Moscow and other regions of the CIS as of September 30, 1997. Sovam
provides equipment and maintains marketing and technical support personnel at
each location either through its own infrastructure or through the
infrastructure of TeleRoss.
In addition to serving the Moscow and St. Petersburg markets, Sovam
co-locates its operations with the TeleRoss Ventures, offering its services in
all TeleRoss cities, and also serves 15 additional cities in Russia and the CIS.
Sovam operates under its own license within Russia while services elsewhere in
the CIS are provided through applicable joint venture or local partner licenses.
The local partners of the TeleRoss Ventures provide facilities, assist in the
provision of leased lines to Sovam customers that allow them to connect with
Sovam's local data switches and also provide technical support. Sovam utilizes
Sovintel's international capabilities and, in TeleRoss-served locations,
TeleRoss's satellite overlay network, to take data through its local data
switches and over the leased lines to its customers. Customers may obtain
virtual private data networks without investing in, acquiring, installing and
maintaining their own network nodes and switches.
58
The following table sets forth certain operating data related to Sovam's
operations:
AT AND FOR THE
AT AND FOR THE YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
--------------------------- SEPTEMBER 30,
1994 1995 1996 1997
------- ------- ------- ----------------
BASIC DATA SERVICE
Percentage of Total Sovam Revenue..... 96% 91% 79% 80%
Number of Customers................... 1,335 1,587 1,726 1,667
Average Revenue Per Month Per
Customer........................... $ 180 $ 201 $ 446 $ 675
Number of Cities in Service........... 2 11 25 30
EQUIPMENT AND HARDWARE SALES
Percentage of Total Sovam Revenue..... 4% 8% 14% 10%
RUSSIA ON LINE SERVICE
Percentage of Total Sovam Revenue..... -- 1% 7% 10%
Number of Subscribers(1).............. -- 407 1,854 2,606
Average Revenue Per Month Per
Subscriber......................... -- $ 49 $ 52 $ 67
(1) In addition to the subscribers included above, Sovam frequently connects
potential Russia On Line subscribers on a complimentary one-month trial
basis. As of September 30, 1997, there were approximately 600 such potential
subscribers.
Services. Sovam's service offerings are comprised of data services,
equipment and hardware sales and its Russia On Line services.
- Data Services. Sovam provided high speed connectivity, electronic mail,
database access and fax services to approximately 1,667 customers as of
September 30, 1997, in Russia and the CIS. Sovam customers can use
electronic mail systems to send and receive messages and data and to
access public and private data networks (including the Internet)
worldwide. Customers may obtain virtual private data networks without
investing in, acquiring, installing and maintaining their own network
nodes and switches. In addition, Sovam offers its customers value-added
data services. For example, Sovam offers "one-stop shopping" for
hardware, software, installation and maintenance support and products
such as "SovamMail," an e-mail service which allows customers to use
Sovam's data network to send telex or facsimile messages to overseas
recipients worldwide. Data services are currently available in 30 cities
throughout Russia and the CIS, including Moscow, St. Petersburg, each of
the cities served by TeleRoss and some cities outside of the TeleRoss
network.
- Equipment and Hardware Sales. Sovam sells communications equipment and
hardware, and provides related installation, maintenance and support
functions, to its customers. Sovam's primary customers in the equipment
and hardware market are banking clients who use the equipment to
interface with Sovam's network.
- Russia On Line. Russia On Line is the first Russian language, as well as
the first dual language, graphical user interface online service for
accessing domestic and international information sources designed to
appeal to a wide commercial audience. This service, which is distributed
via GTS's domestic long distance infrastructure, provides customers with
access to international databases (including the Internet), as well as an
array of proprietary Russian and English language information services,
such as news stories and market updates. Sovam had 2,606 Russia On Line
subscribers as of September 30, 1997. Sovam has developed a modified
version of Netscape's Internet browser, which utilizes the Cyrillic
alphabet, as part of its Russia On Line package. Sovam's enhanced Russian
version of Netscape's browser is provided by Sovam to its customers under
a distribution agreement with Netscape. In addition, Sovam has signed a
letter of intent with Microsoft whereby Microsoft has agreed to include
software access to Russia On Line in its Russian version of Windows 97,
which had not been released as of September 1997. Sovam has also entered
into agreements with equipment
59
manufacturers, including Dell, Hewlett-Packard and U.S. Robotics, to
include Russia On Line software with their products.
Customers and Pricing. Sovam's data communications customers consist
primarily of banking and financial services organizations and large
multinational companies, while Sovam's Russia On Line customers consist of a
wide variety of commercial enterprises. Sovam charges customers an installation
fee when service is commenced and a charge for any equipment which is installed.
Thereafter, customers are billed on a monthly basis for leased line fees, port
access charges and charges for data and Russia On Line services rendered during
the month. Data services are priced on a two-tier structure with high volume
users generally negotiating a flat-rate fee and lower volume uses paying a
volume-based fee which on average was $446 and $675 per subscriber in 1996 and
for the nine months ended September 30, 1997, respectively. Russia On Line
customers pay a fixed monthly access charge plus an additional volume-based fee.
Customers are billed in dollars and payment is remitted in rubles and, to the
extent permitted by law, in dollars, with a 5% conversion fee added to
ruble-denominated payments.
Sales and Marketing. Sovam employs a dedicated sales and marketing force
comprised of 23 Russian nationals, 18 of which are based in Moscow with the
remainder deployed in the other Russian and CIS regions. Salespersons are paid a
fixed salary supplemented by sales commissions and performance-based bonuses.
Sovam's sale efforts are focused primarily on the banking and financial
communities and large multinational companies, although small and medium sized
entities are also emerging as potential Sovam customers. Bundled service
packages, which include Sovam's data and Internet service, Sovintel's
international service and TeleRoss's long distance service, are frequently
marketed together in order to offer customers a comprehensive telecommunications
solution. In addition to data communications services, Sovam offers its
customers hardware, installation and maintenance service and is a distributor of
Northern Telecom equipment.
Ownership and Control. GTS owns 66.7% of Sovam and IAS owns the remaining
33.3%. GTS has reached an agreement in principle to purchase IAS's interest in
Sovam and expects to consummate the transaction in January 1998, thereby making
Sovam a wholly owned subsidiary of GTS. The Sovam managing board is comprised of
three GTS representatives and two IAS representatives. Decisions of the managing
board are adopted by a majority vote. Changes to the charter and certain
business decisions, including decisions on distribution of profits and losses,
obtaining loans and approving major transactions, require unanimous approval.
See "Risk Factors -- Dependence on Certain Local Parties; Absence of Control."
The Sovam charter does not have an expiration date. Neither GTS nor IAS are
obligated to fund Sovam's operations or capital expenditures. Losses and profits
of Sovam are allocated to the partners in accordance with their ownership
percentages, in consideration of funds at risk. As of September 30, 1997, GTS
and its partner had made equity contributions of $1.3 million and $0.7 million,
respectively, to Sovam. In addition, Sovam had outstanding loans of $10.4
million to GTS as of September 30, 1997. See "Management's Discussion and
Analysis -- Accounting Methodology -- Profit and Loss Accounting."
GTS CELLULAR
GTS Cellular operates three cellular businesses in Russia and Ukraine. In
Russia, GTS has a wholly owned subsidiary Vostok Mobile, which operates eleven
AMPS cellular companies in Russian regions west of the Urals under the trade
name Unicel. Vostok Mobile owns between 50% and 70% of these cellular joint
ventures (the "Unicel Ventures") in Russia. In addition, GTS intends to enter
into the cellular markets of additional Russian regions through its Vostok
Mobile venture. GTS also participates in PrimTelefone, a 50% owned joint venture
that operates an NMT-450 network in Vladivostok and four other cities in the
Primorsky region of Russia. In Ukraine, GTS has an approximately 25% beneficial
interest in Bancomsvyaz which operates a DCS-1800 cellular network in Kiev, and
an international overlay network in Ukraine. GTS Cellular entities possess
licenses covering major Russian and Ukrainian markets (excluding Moscow and St.
Petersburg) with an aggregate 1995 population of approximately 25 million
people.
60
GTS currently offers cellular services in the following regions as of
September 30, 1997:
(4) Prior to September 26, 1997, GTS owned 62% of Vostok Mobile. On September
26, 1997, GTS acquired the minority interest in Vostok Mobile, making Vostok
Mobile a wholly owned subsidiary of GTS. Vostok Mobile owns between 50% and
70% of a series of 11 cellular joint ventures in various regions in Russia.
In addition, Vostok Mobile has acquired a 50% interest in a cellular joint
venture in the city of Barnaul, which became operational in December 1997.
GTS intends to enter into the cellular markets of additional Russian regions
through its Vostok Mobile venture.
(5) Includes Vladivostok and four other cities in the Primorsky region.
61
The following table sets forth certain operating data related to GTS
Cellular's operations:
AT AND FOR THE AT AND FOR THE
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
----------------- SEPTEMBER 30,
1995 1996 1997
------ ------- ----------------
Vostok Mobile
Total Subscribers................................... 850 6,884 10,991
Average Revenue Per Subscriber Per Month............ -- $ 128 $ 138
Minutes of Use(1)(thousands)........................ -- 10,561 18,800
Population Covered by Licenses (thousands).......... 18,400 18,400 18,400
Population Covered by Networks (thousands).......... 4,000 6,500 6,500
Subscriber Penetration of Population Covered by
Networks.......................................... -- 0.11% 0.17%
PrimTelefone
Total Subscribers................................... 792 2,822 4,581
Average Revenue Per Subscriber Per Month............ $ 282 $ 236 $ 230
Minutes of Use(1)(thousands)........................ 725 6,919 10,592
Population Covered by Licenses (thousands).......... 2,200 2,200 2,200
Population Covered by Networks (thousands).......... 500 1,175 1,175
Subscriber Penetration of Population Covered by
Networks.......................................... 0.16% 0.24% 0.39%
Bancomsvyaz
Cellular Network
Total Subscribers................................... -- 121 1,438
Average Revenue Per Subscriber Per Month............ -- $ 62 $ 185
Minutes of Use(1)(thousands)........................ -- 9 2,261
Population Covered by Licenses (thousands).......... -- 4,500 4,500
Population Covered by Networks (thousands).......... -- 1,669 1,669
Subscriber Penetration of Population Covered by
Networks.......................................... -- 0.01% 0.09%
Overlay Network
Minutes of Use(1)(thousands)........................ -- -- 2,232
Number of Ports..................................... -- -- 555
Average Revenue Per Minute.......................... -- -- $ 0.36
(1) Includes minutes among affiliates.
Vostok Mobile. Through Vostok Mobile, GTS participates in eleven cellular
joint ventures in Russia. Vostok Mobile owns between 50% and 70% interests in
each of the eleven Unicel Ventures with regional telephone companies and, in one
instance, a private Russian company, owning the remaining ownership interest.
The Unicel Ventures each operate an AMPS-based cellular network, which was
chosen principally because of the lower licensing fees and equipment costs
associated with AMPS operations. The Company believes that the Unicel Ventures'
AMPS-based networks can be upgraded to digital AMPS ("D-AMPS") for an
incremental capital investment. Cellular networks which utilize digital
technology, such as D-AMPS, DCS and GSM offer several advantages over analog
technology including improved overall signal and sound quality, improved call
security, potentially lower incremental infrastructure costs for additional
subscribers and the ability to provide enhanced data transmission services, such
as facsimile and e-mail. Digital technology also provides increased system
capacity. The ventures intend to convert to D-AMPS at such time as there exists
sufficient competitive pressures and/or market demand for digital services to
merit the additional investment.
AMPS technology is widely used by other cellular networks throughout
Russia, making roaming commercially feasible. The Unicel Ventures have entered
into roaming agreements with other AMPS-based cellular providers, which allow
their subscribers to manually roam throughout Russia. Manual roaming, as opposed
to automated roaming, requires subscribers to notify their local cellular
providers of their travel plans
62
in order to receive roaming capability. Vostok Mobile is currently working with
VimpelCom to develop automated roaming standards which will provide subscribers
with automated roaming capability.
The Unicel Ventures, collectively, are licensed to provide cellular service
to regions with an aggregate population of approximately 18.4 million people and
the cellular networks of these ventures cover populations of approximately 6.5
million people. Over the next five years, Vostok Mobile plans to expand the
coverage of the cellular networks to approximately 9.8 million people.
The Unicel Ventures are the only cellular operators in many of their
respective regions. Each region, however, has the potential for three licensed
operators, including one operator for each of the AMPS, NMT and GSM cellular
standards, and the Company expects competition to increase in the future as the
Russian economy develops and telephony demands increase. Each of the Unicel
Ventures operates independently within uniform guidelines established by Vostok
Mobile. The Unicel Ventures employ local engineering and marketing personnel,
which helps the ventures maximize their presence in their respective markets and
maintain quality control. Vostok Mobile and its ventures employed over 279
persons as of September 30, 1997, with over 240 persons employed regionally.
PrimTelefone. GTS's cellular operations in Vladivostok are conducted
through PrimTelefone, a 50% owned GTS subsidiary, with the local electrosviaz
owning the remaining 50%. PrimTelefone began operations in 1995 and operates an
NMT-450 network in Vladivostok and four other cities in the Primorsky region.
PrimTelefone entered and penetrated the Vladivostok market by leveraging its
network design and full interconnection with the city telephone network. As a
result, PrimTelefone's subscriber base has grown to 3,907 as of September 30,
1997 and PrimTelefone has been able to capture approximately half of the
Vladivostok cellular market. PrimTelefone has also updated its billing system,
which allows it to offer automated roaming. Although PrimTelefone has
experienced significant growth, it does face competition. PrimTelefone's only
current competitor has recently upgraded its network for more complete coverage
and has been fully interconnected to the city telephone network and may prove to
be more competitive in the future. PrimTelefone employs approximately 60 persons
which include dedicated sales, marketing and customer service personnel.
PrimTelefone holds a license to provide cellular service to a region having
a population of approximately 2.2 million people and, as of September 30, 1997,
its cellular network covered an area with a population of approximately 1.2
million people. PrimTelefone plans to expand its network's coverage to
approximately 1.7 million people over the next five years.
Bancomsvyaz. GTS operates in Ukraine through a 60% owned intermediate
holding company which holds an approximately 49% interest in Bancomsvyaz, giving
GTS an indirect approximately 25% economic interest in Bancomsvyaz. The
remaining approximately 51% interest in Bancomsvyaz is owned by Bancomservice, a
private company whose principals include telecommunications industry
participants in Ukraine, and a Ukranian national. Bancomsvyaz is co-managed by
GTS and Bancomservice, with Bancomservice appointing the General Director and
GTS appointing the Chief Operating Officer, Chief Financial Officer and two
Business Line directors. The current General Director has been active in the
development of the telecommunications industry in Ukraine. Through Bancomsvyaz,
GTS participates in the operation of a cellular network and an international
overlay network. With over 96 employees, Bancomsvyaz markets its services and
closely monitors technical and quality-related issues.
Cellular network. Bancomsvyaz operates a cellular network in Kiev utilizing
DCS-1800 cellular technology, and operates under a cellular license that covers
the Kiev oblast. Bancomsvyaz began cellular operations in 1996 by covering the
city center of Kiev and expanded its coverage to include the entire city in
1997. Bamcomsvyaz currently provides automated roaming capability in the U.K.
and has entered into a clearinghouse agreement with a European PTO which
provides Bancomsvyaz customers with automated roaming capability with all GSM
signatories with a roaming agreement with this PTO.
Bancomsvyaz holds a license to provide cellular service to a region having
a population of approximately 4.5 million people and, as of September 30, 1997,
its cellular network covered an area with approximately 1.7 million people.
Bancomsvyaz plans to expand its network's coverage to approximately 3.2 million
people over the next five years.
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Overlay network. Bancomsvyaz provides switched traffic service through its
overlay network in Kiev. Bancomsvyaz owns and operates a partitioned mobile
switch for both its overlay and cellular businesses. Bancomsvyaz has seven
central offices in the city and also provides last mile connections (which are
primarily copper) from the central offices to customers. Local traffic is routed
to the local telephone network through the mobile switch. International traffic
is routed through a government-owned satellite dish to the GTS-Monaco Access
international gateway. Bancomsvyaz emphasizes its high quality service and
markets primarily to multinational companies, real estate developers and hotels.
Bancomsvyaz is also negotiating with Sovintel to provide a link to Moscow and
plans to offer VSAT-based connections to its network in the future.
Sales and Marketing. The GTS Cellular entities have entered into agreements
with local distributors to more effectively reach their target markets.
Particular emphasis is placed on product branding. Vostok Mobile's sales and
marketing efforts are focused on the branding of its trade name, Unicel, which
is marketed and promoted at the local level by each of the Unicel Ventures. By
promoting the Unicel trade name, local ventures can emphasize their
relationships with Vostok Mobile and the other Unicel Ventures, allowing
customers to view the Unicel Ventures as integrated parts of a large cellular
organization rather than as lone, independent operators. Bancomsvyaz operates
under the trade name Golden Telecom.
Customers and Pricing. GTS Cellular's customers are primarily large,
mid-sized and start-up businesses and wealthy individuals. Increases in the
number of customers for GTS Cellular's ventures is typically linked to the
economic health of the region in which such venture operates. Cellular service
is generally a premium service in the cities in which GTS Cellular operates and
is priced as such. Each venture begins with two tariff plans, a "standard"
tariff plan and a "premium" tariff plan, which includes a fixed amount of
airtime at a discounted per-minute rate. Each plan prices late night and weekend
calls at off-peak rates. The Company expects that prices will decrease as
competition increases. Connection fees are minimized in order to reduce license
fees in AMPS regions (which are partially calculated by reference to connection
fees), as well as to keep market entry costs low. GTS Cellular has benefited
from high margins generated by the sale of handsets, which are marked up in line
with other cellular operators in Russia and the CIS. Value-added services, such
as call forwarding and conference calling, when available, are priced nominally
and discounted when sold in packages. Cellular accounts are recorded in dollars
and customers remit payment in rubles at the exchange rate on the date of the
bill and, in instances permitted by law, in dollars. Ruble accounts generally
are charged a two percent conversion fee and payments in rubles are applied at
the rate of exchange on the date of payment. In order to lessen risks to its
receivables, the Company and its cellular ventures require advance payment from
all customers with prepayments averaging approximately $250 per customer for six
to eight weeks of service.
Ownership and Control. GTS Cellular's Russian operations (except for the
Vladivostok operations) are conducted through ventures that are owned between
50% and 70% by Vostok Mobile, a wholly owned subsidiary of GTS. GTS Cellular's
Vladivostok and Ukrainian operations are conducted through ventures which
require partner approval for most decisions. The applicable foundation
agreements and charters do not have expiration dates. See "Risk
Factors -- Dependence on Certain Local Parties; Absence of Control." Neither GTS
nor any of its respective partners in its Vladivostok or Ukrainian operations
are obligated to fund operations or capital expenditures. Losses and profits of
all such ventures are allocated to the partners in accordance with their
ownership percentages, in consideration of funds at risk. As of September 30,
1997, GTS and its partners had made equity contributions aggregating $15.8
million and $15.3 million, respectively, to the various GTS Cellular Ventures.
Contributions made by the partners include contributions of cash and intangible
assets, such as licenses. In addition, the various GTS Cellular Ventures had
outstanding loans of $28.0 million to GTS as of September 30, 1997. See
"Management's Discussion and Analysis -- Accounting Methodology -- Profit and
Loss Accounting."
LICENSES AND REGULATORY ISSUES
Telecommunications operators in Russia are nominally subject to the
regulations of the Regional Communications Committee (the "RCC"). As a practical
matter, national telecommunications authorities of the individual CIS countries
and certain regional and local authorities generally regulate telecommunications
operators in their markets through their power to issue licenses and permits.
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The Communications Law sets out a comprehensive legal and regulatory
framework for the sector. It also sets forth general principles for the right to
carry on telecommunications activities, describes government involvement in
telecommunications regulation and operation, establishes the institutional
framework involved in regulation and administration of telecommunications, and
deals with various operational matters, such as ownership of networks,
protection of fair competition, interconnection, privacy and liability. This
institutional framework is implemented by separate legislation.
Licenses to provide telecommunications services are issued by the MOC on
the basis of a decision by the Licensing Commission at the MOC. No new licensing
regulations have been issued since the enactment of the Communications Law and
in practice the MOC continues to issue licenses based on the Licensing
Regulations. Under the Licensing Regulations, licenses for rendering
telecommunications services may be issued and renewed for periods ranging from 3
to 10 years and several different licenses may be issued to one person. Once the
licenses are received, the licensee is required to register its right to hold
and operate under the license with Gossvyaznadzor, the national authority
responsible for monitoring compliance with regulatory and technical norms.
Renewals may be obtained upon application to the MOC and verification by
appropriate government authorities that the licensee has conducted its
activities in accordance with the licenses. Officials of the MOC have fairly
broad discretion with respect to both the issuance and renewal procedures. Both
the Communications Law and the Licensing Regulations provide that a license may
not be transferred. However, regional authorities are sometimes in a practical
position to limit these national authorities. In August 1995, the Russian
government created Svyazinvest, a holding company, to hold the federal
government's interests in the majority of Russian local telecommunications
operators. Such entities at the oblast and krai levels (administrative regions
within Russia) and two cities -- Moscow and St. Petersburg -- exercise
significant control over their respective local telephone networks.
License procedures for the Company's cellular services include frequency
licensing from the MOC through a two step process. A license must first be
obtained from the MOC for permission to operate mobile cellular services on a
commercial basis in a specific standard and frequency bandwidth. Thereafter, an
approval to use specific frequencies within the band must be received from the
State Radio Frequencies Commission. Once the licenses are received,
Gossvyaznadzor confirms the rights of an operator to offer radio frequency
transmissions on specific frequencies, administers type acceptance procedures
for radio communications equipment and monitors compliance with licensing
constraints. In each instance, the Company is required to obtain additional
licenses and permits with respect to the use of equipment and the provision of
services.
Telecommunications laws and regulations in Ukraine are similar in many
respects to those of Russia but are subject to greater risks and uncertainties.
Regulations currently prohibit foreign entities from owning more than 49% of any
telecommunications operating company. GTS's Ukrainian joint venture agreements
provide it with the option of purchasing an additional one percent of the
cellular network if these rules are liberalized. The Ukrainian government has
proposed substantial frequency permit fees in connection with providing GSM
service in Ukraine. Although the government has not imposed additional fees on
Bancomsvyaz's existing DCS-1800 service, there can be no assurance that such
fees will not be imposed in the future.
GTS's subsidiaries and ventures hold the following licenses in Russia and
Ukraine:
Switched Services. In Russia, the Company holds two licenses. The first
license was reissued to Sovintel in November 1996 and authorizes Sovintel to
operate as an international overlay network with the ability to interconnect
with the Moscow region and St. Petersburg public switched telecommunications
network ("PSTN"). This license ultimately requires Sovintel to provide service
to at least 50,000 subscribers and expires in May 2000. It was amended in
February 1997 to cover the Leningrad region. The second license was reissued to
SFIT, Ltd., a wholly-owned subsidiary of GTS in February 1997, for provision of
intercity services in 39 regions and in Moscow with ability to interconnect with
the PSTN. In Kiev, Ukraine, the company holds a license for provision of overlay
network services, including international services, in the name of its
affiliate, Bancomsvyaz. In addition, Sovintel is an ITU recognized private
operating agency ("RPOA"), which enables it to maintain a separate dialing code
(7-501) that can be directly dialed from over 170 countries. Sovintel's status
as an RPOA also enables it to terminate calls directly with other operators.
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Leased Circuits. In September 1996 the MOC issued to Sovintel a five-year
license to lease local, intercity and international circuits in the territory of
Moscow, Moscow region and St. Petersburg, valid until September 2001. The total
amount of circuits leased is approximately 300 and may be increased up to a
total authorized capacity of 2,500.
Data Services. In August 1996, the MOC reissued to Sovam a 2 1/2-year
license, effective July 1996, to provide data transmission services via a
dedicated network to a number of oblasts and other regions covering a large
portion of Russia. The license permits a network capacity of not less than 5,000
customers, allows it to interconnect with other data transfer networks in
Russia, and expires January 1, 1999.
Local Access Services. In January 1997, the MOC has licensed TCM to provide
local telephone service in Moscow to not less than 100,000 subscriber local
access lines. The license expires in May 2006. TCM has an agreement with MGTS to
provide up to 200,000 lines, which would require an extension to its license,
when its current capacity is reached.
Cellular Services. In connection with cellular operations, Russian law
apportions the responsibility for regulating and licensing cellular businesses
between national and regional regulators. National telecommunications regulators
have been assigned the responsibility of regulating and licensing cellular
businesses utilizing the GSM and NMT-450 cellular standards prevalent in Europe.
These regulators have auctioned licenses to provide these services to a number
of ventures that have included large, well capitalized western
telecommunications providers such as U S WEST and Nokia during the last four
years. Regional telecommunications authorities have been given the rights to
supervise the observance of licenses by cellular businesses utilizing AMPS
cellular standard service, which is prevalent in the United States. However,
AMPS licenses are issued by the MOC. GTS believes that, in many instances,
cellular operators obtaining AMPS standard licenses, particularly those in
second tier cities, pay license fees that are lower than those paid for the GSM
and NMT-450 "national standards". Licenses for cellular providers have a term of
approximately 10 years.
The Company's twelve Russian cellular companies have licenses which expire
between 2005 and 2007. One of the companies initially received an operating
license in 1994, six companies initially received an operating license in 1995
and five companies initially received an operating license in 1996.
Bancomsvyaz holds a license for provision of DCS-1800 mobile services in
the Kiev oblast.
COMPETITION
Overview. GTS faces significant competition in virtually all of its
existing telecommunications businesses in the CIS. Many of the Company's
competitors and potential competitors, which include large multinational
telecommunications companies, have substantially greater financial and technical
resources than the Company and have the ability to operate independently or with
global or local partners and to obtain a dominant position in these markets. The
Company believes that it has a competitive advantage in each of these markets
because of its operating history, its ability to bundle a broad range of
telecommunications services in the region and its ability to make rapid
decisions in pursuing new business opportunities and addressing customer service
needs. The Company also believes that its local partnerships and reliance on
nationals in the management of its businesses and joint ventures provide it with
better knowledge of local political and regulatory structures, cultural
awareness and access to customers.
International Services. Sovintel faces significant competition from more
than ten other existing service providers in Moscow, including Rostelecom and
joint ventures between local parties and multinational telecommunications
providers. Large competitors include the "Combelga" joint venture, an RPOA
operator in which Alcatel and the Belgian PTO participate as foreign investors,
"Comstar", a joint venture between GPT Plessey and MGTS, providing services
similar to those provided by the Company, TelMos, a joint venture between AT&T,
MGTS, Global One, through its Moscow based ventures, and Peterstar, in
Petersburg, which is part of the PLD Telekom group. Several smaller companies,
such as DirectNet, and Aerocom provide high-volume and carrier's carrier
services in Moscow. Bancomsvyaz competes in the switched international traffic
market with the Kiev electrosviaz and UTel, a joint venture that includes
Western partners with substantial capital and technical resources who together
hold a dominant share of the
66
Kiev market. The Company expects that market consolidation will take place among
the competitive field in international services.
Domestic Long Distance Services. The Company believes its major competitors
in the Russian domestic long distance market consist of Rostelecom, the
electrosviazs, including those which are partners in the Company's TeleRoss
Ventures, and a variety of ventures that include foreign partners with
substantial financial resources. The most significant of such competitors
include: Global One, through its regional operations; Rustel, a venture that
includes Rostelecom, other Russian partners and International Business
Communication Systems, a Massachusetts telecommunications firm; Belcom, a
private company in which Comsat has a majority interest and which provides VSAT
services primarily to the energy sector; Satcom, a Russian joint venture
licensed to provide local, long distance and international service over private
and public switched networks; Teleport TP, a satellite overlay company jointly
owned by Rostelecom and Petersburg Long Distance that provides satellite
teleports in cities throughout Russia; and Comincom, a Russian private venture.
In the Russian far east, TeleRoss competes with Vostok Telecom, which is owned
by the Japanese companies KDD and NIC and certain Russian partners; and Nakhodka
Telecom, which is owned by Cable & Wireless and certain Russian partners.
GTS both cooperates and competes with Rostelecom. Rostelecom provides only
international and long distance services to international carriers and regional
electrosviazs, and does not provide end-to-end customer services. GTS provides
last mile, account management, and transit services for Rostelecom in Moscow,
and uses Rostelecom channels and switches for both international and long
distance services. GTS provides long distance and international services on an
end-to-end basis, using service elements of Rostelecom, the electrosviazs and
its own resources. However, Rostelecom does compete with Teleross, in that
Teleross provides intercity services to customers, using satellite channels
provided by other state agencies (Intersputnik), and provides transit services
to various electrosviazs, on a traffic overflow basis.
GTS believes that it enjoys a number of competitive advantages in the
Russian domestic long distance market, the most important being the maturity of
its international and data service businesses in Russia. This provides GTS with
access to the services, customers, products, licenses and facilities of its
other businesses. The Company also believes that it has more experienced
management, a more comprehensive strategy to build out a nationwide long
distance network and stronger relationships with many regional telephone
companies and with satellite capacity providers, such as Intersputnik, than most
of its competitors. In addition, the Company believes that it does not have any
significant competitor in the regional inter-city market (i.e., calls between
Russian cities other than Moscow or St. Petersburg).
Data Services. Sovam has several primary competitors in the market for data
services: Global One, which began packet-switched service in Moscow and St.
Petersburg in June 1992, under the Sprint Networks venture; Demos, an Internet
service provider; and Relcom, a cooperative affiliation of computer users that
relies on an older generation of technology that supplies slower and lower-cost
messaging facilities to customers (primarily domestic commodities traders) that
do not require higher levels of service. In addition MCI and Rostelecom have
recently announced their agreement to create a national Internet access network
utilizing Rostelecom's domestic network and MCI's international infrastructure.
Rostelecom has also announced the formation of a new Internet services company
called RTK Internet, with Relcom as its partner. Although Sovam's business has
grown quickly, the Company believes that Global One is the market leader. GTS
believes that other potential competitors, including foreign PSTNs, Infotel,
Infocom and Glasnet, are also active in this market.
Although the Company faces significant competition in this market, it
believes that it enjoys certain competitive advantages, including the ability to
reach a wide area throughout Russia through TeleRoss, innovative service
offerings such as Russia On Line, the maturity of its business in the key
banking services segment, high levels of customer service and support, and high
speed digital channels through TeleRoss.
Local Access Services. The Company believes that its major competition in
the Moscow local access market consists of a number of ventures with Western
partners, including Telmos (which includes AT&T), Comstar (which includes GPT
Plessey), and Combelga. However, since TCM has obtained an allocation of
67
up to 100,000 numbers, the Company believes that TCM will account for a
substantial proportion of the new capacity to come onto the market within the
next five years.
Cellular Services. Most Russian cellular markets have the potential for
three licensed operators, including one operator for each of the GSM and NMT-450
cellular standards, which Russia has adopted as national standards, and one
operator using the AMPS cellular standard, which has been set as a regional
standard. Many large Western telecommunications operators, including U S WEST,
Deutsche Telekom, STET, Midcom and Millicom, have participated in auctions for
licenses to provide GSM and NMT-450 cellular service to certain significant
Russian urban centers. In addition, a CDMA auction is likely to occur in the
future which could result in one or more CDMA operators entering the market. In
Ukraine, Bancomsvyaz competes primarily with an NMT operator and a GSM operator
in Kiev. Additional GSM licenses were auctioned off in early 1997 and other GSM
operators may enter other markets in 1998.
68
WESTERN EUROPE
OVERVIEW
GTS seeks to position itself as the leading independent carriers' carrier
within Western Europe through the development of two ventures, HER and
GTS-Monaco Access. HER's objective is to become the leading pan-European
carriers' carrier by providing centrally managed cross-border telecommunications
transmission capacity to telecommunications companies including traditional PTOs
and New Entrants on an approximately 18,000 kilometer high capacity fiber optic
network designed to interconnect a majority of the largest Western and Central
European cities. HER is currently operating over an approximately
1,700-kilometer portion of the network linking Brussels, Antwerp, Rotterdam,
Amsterdam, London and Paris. HER expects the initial five country network to be
placed in operation in the second quarter of 1998. This segment of the network
is expected to deliver managed transport services over approximately 2,900
kilometers of fiber optic cable linking the cities of London, Rotterdam,
Amsterdam, Antwerp, Brussels, Paris, Dusseldorf and Frankfurt. The full 18,000
kilometer network is expected to become fully operational during the year 2000.
HER also plans to lease capacity on a transatlantic cable linking the European
network with North America and is exploring various interconnectivity options to
Russia and Asia. Such intercontinental interconnectivity will help HER satisfy
the needs of its European customers with respect to outgoing traffic and attract
additional non-European customers with traffic terminating in Europe. HER
commenced commercial service over the Brussels-Amsterdam portion of the network
in late 1996, and the London-Paris portion in November 1997. GTS-Monaco Access
operates an international gateway in Monaco in partnership with, and utilizing
the existing gateway infrastructure of, the Principality of Monaco and provides
transit and routing of international calls to other telecommunications
operators. Through its HER and GTS-Monaco Access ventures, GTS is building a new
network for transporting voice, data and multimedia/image traffic for other
carriers throughout Western and Central Europe and for worldwide international
voice, data and multimedia/image traffic that either originates or terminates
in, or transits through, Western and Central Europe.
The Company believes that the international segment of the Western and
Central European telecommunications market will be an attractive market for new
telecommunications entrants because of its large size, the high operating costs
and low productivity of current providers, and the barriers to entry created by
the need to control a network and its rights-of-way.
The European telecommunications market has historically been dominated by
monopoly PTOs. This system has ensured the development of broad access to
telecommunications services in Europe, but it has also restricted the growth of
high quality and competitively priced pan-European voice and data services. The
current liberalization occurring in Europe is intended to address these
structural deficiencies by breaking down PTO monopolies, allowing new
telecommunications operators to enter the market and increasing the competition
within the European telecommunications market. In March 1996, the European
Commission adopted a directive (the "Full Competition Directive") requiring the
full liberalization of all telecommunications services in most EU member states
by January 1, 1998. The Company expects that full liberalization in these
European countries will lead to the emergence of New Entrants with new and
competitive service offerings. HER expects this increase in competition will
result in lower prices and a substantial increase in the volume of traffic and
range of telecommunication services provided. HER believes that as a result of
the increased call volume and growth in value added services, participants in
these markets will require significant amounts of new cross-border
telecommunications transport capacity to provide their services.
The Hermes network will offer PTOs and New Entrants an attractive
alternative for the transport of cross-border European telecommunications
traffic. In the traditional system, PTOs own and control circuits only within
their national borders, and as a result, cross-border traffic must be passed
from one PTO to another PTO at the national boundary. No single PTO therefore
owns or controls end-to-end circuits for cross-border calls. The alternative for
carriers of this traffic will be to build their own transport capacity or use
International Private Leased Circuits ("IPLCs") which are provisioned by
combining half-circuits on the networks of two or more PTOs. The Company
believes that there are a number of problems with these options that result in
HER being well-positioned to become the leading independent carriers' carrier in
Western and Central Europe. In particular, building their own transport capacity
is unlikely to be an attractive option for most
69
carriers because of the high traffic volumes required to justify the expense,
the need to focus resources on marketing and customer service, the time
commitment and the regulatory and administrative complexities involved,
particularly in obtaining the rights of way across national borders. Likewise,
IPLCs provided by the PTOs also have a number of disadvantages, including high
prices, lack of end-to-end quality control, lack of redundancy, low quality due
to diversity of network systems and equipment, limited availability of bandwidth
and long lead times for provisioning.
HER
HER's objective is to become the leading pan-European carriers' carrier by
providing centrally managed cross-border telecommunications transmission
capacity to telecommunications companies including PTOs and New Entrants. HER
intends to offer these target customers a better transport system than is
currently available in Europe with a higher and more consistent level of
transmission quality, redundancy, network functionality and service across
Europe at lower prices. Development of the HER network is dependent upon, among
other things, HER's continuing ability to obtain the necessary financing,
rights-of-way, licenses and other regulatory approvals in a timely and
cost-effective manner. See "Risk Factors -- HER Network Roll-out."
HER is developing an approximately 18,000 kilometer, pan-European high
capacity fiber optic network designed to interconnect a majority of the largest
Western and Central European cities. Each access point of the network will be
placed in operation as it is linked to the network. HER intends to build the
network using the most accessible and cost-efficient infrastructure base in each
of the regions served, including using rights-of-way and existing infrastructure
of railways, motorways, pipeline companies, waterways and power companies. HER
plans a flexible approach to the network build-out plan and intends to fine-tune
the scope, route and design of the network based upon the evaluation of customer
demand.
HER began initial trials of the Brussels-Amsterdam portion of the network
in the third quarter of 1996 and commenced commercial service in November 1996.
Commercial service connecting Paris to Amsterdam, Brussels and London started in
November 1997.
HER expects to continue to roll-out full telecommunications transport
service on the initial network in the first five countries linking the
additional cities of Dusseldorf and Frankfurt in the second quarter of 1998.
This initial network in the first five countries is expected to consist of 2,900
kilometers of fiber optic cable covering countries which, in 1995, originated
over 60% of all outgoing calls and terminated over 60% of all incoming calls in
the countries to be served by the full network. Network coverage is planned to
be expanded to include Munich, Berlin, Geneva, Zurich, Stockholm, Copenhagen,
and Milan in the third quarter of 1998. By the year 2000, the 18,000 kilometer
HER network is expected to have points of presence in at least 32 cities in 15
European countries, including Southern and Central Europe. HER also plans to
lease capacity on a transatlantic cable linking the European network with North
America and is exploring various interconnectivity options to Russia and Asia.
HER has entered into agreements for the construction and/or lease of fiber
optic routes for the initial network in the first five countries. Contracts have
been concluded with respect to the portion of the network connecting Germany
with each of France, the Netherlands and Switzerland and HER continues to
negotiate rights-of-way and other infrastructure arrangements in five other
Western European countries representing the remainder of the Western European
portion of the rollout. HER will need to negotiate similar agreements to
complete the network in four Central European countries. Buildout of the HER
network is subject to numerous risks and uncertainties that could delay
deployment or increase the costs of the network, or make the network
commercially unfeasible. See "Risk Factors -- HER Network Roll-out."
HER was formed on July 6, 1993 by HIT Rail. HIT Rail was incorporated in
1990 by eleven national railways to carry out telecommunications engineering
activities in order to construct and exploit a data communications network for
railway traffic. GTS-Hermes purchased a 34.4% interest in HER in 1994 and has
increased its interest to 50% in 1995 and to 79% in 1997. GTS-Hermes is a wholly
owned subsidiary of GTS.
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Business and Marketing Strategy
The overall strategy of HER is to offer PTOs and New Entrants pan-European
cross-border telecommunications transport services to help them, in turn, more
successfully meet the needs of their end-user customers. The HER network also
provides a vehicle through which a carrier can compete in markets where it does
not own infrastructure. HER expects to enter the market ahead of similar
competition and encourage a wide variety of carriers to use its network with
service offerings that meet their needs. HER's primary service offerings are
large-capacity circuits for "wholesale" customers such as PTOs and New Entrants.
HER's focus on carriers is designed to complement and not compete with carriers'
own business objectives in providing services to end-users.
To establish HER as the leading carriers' carrier for international
telecommunications within Europe, HER intends to offer its customers
significantly higher quality transmission and extended/advanced network
capabilities at a competitive price by focusing on the following:
High Capacity International Network Facilities. The HER network is
designed to offer its customers access to high capacity network facilities
outside their domestic markets, providing cross-border capabilities without
requiring customers to invest in network infrastructure or being
constrained by a narrow range of capacity offerings. With STM-64 technology
and Wavelength Division Multiplexing ("WDM") upgrades, HER's fiber
deployment plan provides for the equivalent of 128 fiber pairs of capacity
across Europe.
Uniform Network Architecture. The HER network is designed to offer
managed transport services from country to country and across multiple
countries utilizing a single uniform network, in contrast to services
currently available that use multiple providers over several networks with
varying technologies and each under the control of separate, not
necessarily compatible, network control systems. The HER network's uniform
technology enhances service by providing quality and reliability as well as
uniformity of features throughout the network.
Diverse Routing. The HER network architecture includes diverse,
redundant routes that are designed to provide high levels of reliability.
The network is designed to provide availability of over 99.98% for most
routes and to provide customers with a wide range of telecommunications
transmission capacity. To achieve this level of reliability without the use
of a network similar to the HER network, HER believes that carrier
customers would need to purchase additional dedicated circuits to provide
for redundancy.
Rapid Provisioning. HER services provide access to the network, such
that additional capacity can be provided to customers on the HER network on
a rapid basis. This access provides a level of capabilities that HER
believes is unavailable in Europe today. This ability to rapidly provide
service is largely due to HER's development of capacity substantially in
excess of HER's forecasted requirements.
- Flexibility. HER services are focused on providing customers flexibility
across the network through which the customer may minimize risk by
enabling network rerouting, eventually even under customer direct
control.
- Advanced Technology. HER is deploying SDH technology which, by using WDM
techniques and hardware, is upgradeable and will permit significant
expansion of transmission capacity without increasing the number of fiber
pairs in the network. This technology also provides the basis for
structuring advanced operating features, such as virtual private network
service and ATM-based services. Additionally, the SDH technology deployed
by HER may be upgraded.
- Innovative Pricing. Currently the price of E1 equivalent circuits on
transborder European routes is artificially high and not necessarily
related to the cost of such circuits. HER intends to offer competitive
pricing. HER will also offer highly tailored contract terms and volume
discounts, which allow carrier customers to plan more efficiently the
fixed costs of their service portfolio. Customers can select varying
capacity, access, guaranteed availability and contract terms at
competitive prices. Customers sourcing from PTOs are generally limited to
order from a very narrow set of capabilities offered under inflexible
pricing plans.
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Although HER and GTS have relationships with certain PTOs or other access
providers for specific projects, they do not have wide-ranging alliances with
any of the major consortia or large Western telecommunications companies.
Additionally, HER's strategy calls for it to focus on carriers' carrier
services, so that it will limit overlap of target markets with its carrier
customers in end user markets. HER believes that this independence will make it
an attractive service provider for carriers who may otherwise be reluctant to
obtain services from other providers of intra-European transport that also may
be their competitors in the retail market.
SERVICES
HER's primary service is large capacity cross-border European circuits
provided to carriers and service providers over an integrated, managed
pan-European network structure thus providing a service for wholesale customers
such as PTOs and New Entrants. The HER network will be based on SDH technology,
which provides for digital transmission capability upon which a broad range of
advanced functionality may be built and which offers network availability,
flexibility, bandwidth speeds and error performance not otherwise available to
carriers for transport of telecommunications traffic across national borders in
Western and Central Europe. The network is designed to provide customers with a
wide variety of bandwidth speeds, ranging from VC12/E1 Standard (equivalent to
2.048 Mbps) to STM-1/E4 Standard (equivalent to 155 Mbps) and beyond.
HER will provide high quality cross-border transmission services for
licensed or otherwise authorized telecommunications providers. Services are
based on the principle of adding greater value than currently available in the
market while retaining competitive prices.
Point-to-Point Transport Service. The current market for cross-border
transport is served by IPLCs provided by PTOs. IPLCs are formed by combining
half-circuits from two PTOs between customer locations, often with additional
PTOs providing transit segments. Under the IPLC service, overall service quality
guarantees generally are not provided and only a limited range of bandwidth is
available, usually only E1 and in certain instances, E3. The Company believes
that HER's Point-to-Point Transport Service will be a major improvement to the
PTO-based approach because it provides a greater range of bandwidths (from 2
Mbps (E1 or VC-12) to 140/155 Mbps (E4 or VC-4)) and allows customers to choose
a service level agreement with guarantees appropriate for their applications,
including guarantees for on-time service delivery and service availability.
Point-to-Point Transport Service consists of two services, "Integrated" and
"Node-to-Node." The HER "Integrated" service provides an end-to-end service
between customer-specified locations where the customer can request for HER to
arrange for "last mile" services from the HER node location to the customer's
location. The HER "Node-to-Node" service can be selected when the customer
prefers to provides its own services to reach the local HER node location. In
Node-to-Node Service, HER guarantees service only on its portion of the network
between HER nodes. Both services are competitively priced relative to current
service offerings. A premium is charged for the highest guaranteed level of
service which incorporates an end-to-end, fully diverse, protected, "Integrated"
service. The customer can choose flexible contract terms from one to five or
more years' duration, with volume discount schemes designed to ensure that HER
remains a cost-effective solution.
Virtual Infrastructure Service. Carriers and operators that plan to expand
their operations to become pan-European service providers as the European
marketplace is liberalized require a flexible and cost-effective means of
telecommunications transport. To date such service providers obtain
international transport service by leasing IPLCs. Leasing IPLCs requires a
carrier to lease channels on a segment-by-segment basis from multiple PTOs,
linking the target cities under arrangements having fixed capacity and pricing
structure for each segment of the carrier's network. Leasing IPLCs has several
disadvantages, including (i) difficulty in obtaining discount/volume pricing
schemes since there is no single provider of pan-European coverage, (ii) delays
in implementation due to numerous contractual negotiations and having to
interconnect numerous IPLCs, (iii) limited availability of pan-European leased
capacity at high bandwidth and (iv) variability of quality due to multiple
operators and the absence of a single uniform network. Operators could also
construct
72
their own network, which is expensive, time-consuming and complex and which may
not be justified by such operators' traffic volume.
HER's Virtual Infrastructure Service will offer a new solution and an
attractive alternative to leasing IPLCs or building infrastructure. This service
will enable HER's customers to obtain a uniform pan-European or cross-border
network under one service agreement by allowing the customer to select any
number of cities along the HER network at a pricing structure based on the
overall amount of leased capacity for the customer's entire network. The key
feature behind Virtual Infrastructure Service is that it gives the customer the
ability to add or reconfigure capacity in 24 hours between locations connected
in the Virtual Infrastructure Service, thereby enabling the customers to respond
almost immediately to changes in traffic. By being able to transfer capacity
among the network routes, HER's customers are able to avoid over- and
under-utilization of leased channels. This service offering provides a customer
with the benefits of ownership (rapid provisioning, freedom to rearrange and
control) with a "pay-as-you-go" managed service offering, without the burdens of
up-front investment and costs required to build a network, and without having to
manage the on-going maintenance and operation of the network.
The service would be delivered through pre-installed physical facilities at
each of the customer locations. These facilities are designed to ensure that
most growth or changes in customer requirements can be addressed purely by
remote logical reconfiguration from the HER Network Operations Center. This
remote network management ability is inherent in SDH technology and allows rapid
provisioning and high quality of service.
Ring Service. Most medium to large carriers and operators purchase network
capacity in excess of actual requirements, and prefer to have physical
configuration control over their networks. The HER Ring Service connects
multiple customer locations with multiple VC-4 paths in a ring configuration.
The customer has direct control over the configuration of the VC-3 and VC-12
paths within the ring, and has exclusive control over the routing. Additional
ring capacity can be added with no service interruption and additional customer
locations may be added to the ring with minimal service interruption. Because
HER is not required to configure 'idle' bandwidth or to manage the 'SDH subnet'
this service can be provided at a very competitive rate vis-a-vis other
point-to-point services.
Sales and marketing of HER's services are conducted through its sales and
marketing department, which includes a director and senior sales managers
responsible for various regions and customer segments. Additionally, HER expects
that its railway shareholders that develop domestic telecommunications
businesses, or other local network access providers, can provide an effective
distribution channel to smaller carrier customers.
PRICING
Currently the price of cross-border pan-European calls are often
significantly higher than the underlying cost of transport and terminating such
calls and higher than the price of intra-country calls or transborder calls to
and from liberalized markets. The low cost of operating the network enables HER
to attractively and competitively price services in the face of declining
overall tariffs for telecommunication services. HER's low-cost basis is due to,
among other things, its use of up-to-date technology without the burden of
legacy networks, which requires fewer employees to operate.
The term of a typical customer agreement currently ranges from 1 to 3
years. The customer agrees to purchase, and HER agrees to provide, cross-border
transmission services. In general the customer agrees to pay certain
non-recurring charges and recurring charges on an annual basis, payable in
twelve monthly installments. If the customer terminates the service order prior
to the end of the contract term, it is generally required to pay HER a
cancellation charge equal to three months service for each of the twelve months
remaining in the contract term. HER guarantees transmission services to a
certain service level. If such levels are not met or HER fails to deliver
service by the committed delivery date, the customer is eligible for a credit
against charges otherwise payable in respect of the relevant link.
73
CUSTOMERS
HER's high capacity, SDH-based fiber optic network is designed to enable
PTOs and New Entrants to integrate high quality, cross-border capacity into
their end user offerings. As of November 30, 1997, fifteen customers were under
contract for service on the HER network, including PTOs, a global consortium of
PTOs, Internet service providers, an international carrier, VANs and resellers.
HER provided capacity of approximately 110 E1 equivalent circuits as of November
30, 1997. The type and quality of HER's customers validates the concept of the
HER network, and illustrates the type of customers who will be attracted to the
full network. The success of this limited network also demonstrates the demand
for cross-border transport services. In total, HER is targeting seven major
market segments or customer groups which can be characterized as follows:
- Existing PTOs. This customer segment consists of the traditional
European PTOs that generally participate in the standard bilateral
agreements for cross-border connectivity. Hermes provides a vehicle
for PTOs to compete in non-domestic markets both before and after
January 1, 1998. As of January 1, 1998, both reserved and
non-reserved traffic can be transported by alternative infrastructure
providers, thus vastly expanding the available PTO market for HER.
- Global Consortia of Telecommunications Operators. Many of the
largest PTOs and international carriers have pooled resources and
formed consortia in order to compete more effectively in important
telecommunications markets such as those in Western Europe
particularly outside their home markets. Prior to liberalization of
the provision of switched voice services in Western European markets,
one of the primary objectives of these consortia is to provide
non-reserved pan-European services to multinational business
customers, including X.25/frame relay (high speed data network)
service and closed-user group voice services. Under the current
regulatory framework, consortia would otherwise be required to
purchase leased lines at negotiated retail rates, even within their
home countries. HER believes that it provides an attractive
alternative at better pricing in those environments where such a
consortium does not already own its infrastructure. Furthermore, HER
believes that it is well positioned to provide cross-border
connectivity between different domestic infrastructures of these
alliances.
- International Carriers. This customer segment consists of
non-European carriers with traffic between European and other
international gateways. Such carriers include Teleglobe, GTS-Monaco
Access and eventually the U.S. Regional Bell Operating Companies. HER
can provide these customers a pan-European distribution network to
gather and deliver traffic to and from their own and other hubs.
- Alternative Carriers. This segment consists of second carriers,
cable TV and mobile carriers and competitive access providers. These
new carriers have chosen to compete with the incumbent PTOs in their
respective countries, and the Company believes that they would look
favorably to an alternative such as HER. HER believes that this
segment will sustain the largest growth as competition emerges in
Europe. HER also believes that non-PTO competitors in Europe will
prefer to use a non-PTO alternative like HER to meet their
cross-border telecommunication transport needs.
- Internet Backbone Networks. Internet backbone networks are a fast
emerging segment and are expected to generate significant
requirements for the services HER offers. These require large
capacity international connectivity services between Internet nodes
(point of interconnection between local Internet service providers)
in all local European markets. The Internet segment is experiencing
significant growth in demand for transmission capacity.
- Resellers. Resellers are carriers that do not own transmission
facilities, but obtain communications services from another carrier
for resale to the public. Resellers are also a growing segment of the
market and are expected to increase in conjunction with the
liberalization of the European telecommunications market. In the
U.S., for example, resellers were a significant factor in the
expansion of competition.
74
- Value Added Networks ("VANs") and other Service Providers. VANs are
data communications systems in which special service features enhance
the basic data transmission facilities offered to customers. Many of
these networks are targeted to the data transfer requirements of
specific international customer segments such as airlines and
financial institutions. VANs' basic network transmission requirement
is to connect data switches or processors. VANs currently purchase
their own international circuits and build additional resiliency into
their network infrastructure. HER will allow them to meet these needs
cost-effectively, and to extend their services to new markets or
customers without substantial capital investment.
HER expects that additional demand for alternative service providers will
come from increased usage of dedicated circuits for Internet access, private
lines for the deployment of wide-area networks by large corporations, "single
source" local and long distance services by small and medium-sized businesses
and emerging broad band applications such as cable TV programming distribution
(other than broadcast) to the end user.
CURRENT OPERATIONS
HER currently operates an approximately 1,700 kilometer network connecting
the cities of Brussels, Antwerp, Rotterdam, Amsterdam, London and Paris. HER
began initial trials of a 244 kilometer portion of the network between Brussels
and Amsterdam in the third quarter of 1996 and commenced commercial service in
November 1996. Commercial service connecting Paris to Amsterdam, Brussels and
London started in November 1997. HER's Network Operations Center located in
Brussels, Belgium and its backup center located in Antwerp, Belgium are fully
operational and house network management and customer support services which
operate 24 hours a day, seven days a week. Billing and customer service
functions are also operational.
NETWORK DESIGN
Network Architecture. The network architecture is based on a highly meshed
flat topology which covers a wide geographical area with large distances between
individual network nodes. This architecture allows rerouting of traffic at
electronic speeds in the event of a network failure. This approach also lowers
network cost by allowing each node to be sized to match anticipated traffic
volumes rather than to a standard capacity. Individual nodes can be configured
to connect any trunk to any other in the nodes, thus allowing efficient
transmission of traffic. Each node will be connected to at least two other nodes
allowing rerouting of traffic in the event of a network failure. HER believes
that its network will be the first cross border pan-European network with such
redundancy.
The HER network has been designed to be controlled by a single network
management center and supported by advanced operational support systems. A
centralized network center can pinpoint overloaded pathways or malfunctioning
circuitry and reroute traffic much more quickly than networks controlled by
separate network centers operated by PTOs in different countries. HER primarily
uses Alcatel for the supply of transmission equipment and network management
systems. HER's advanced operational support systems allow it to correct network
failures and isolate equipment faults with greater speed and at a lower cost
than is the case with heterogeneous multi-operator networks. Critical elements
of the network, including network maintenance and control systems, are designed
with redundancy in order to ensure a high quality of service. The network design
has several important resilience features including: multiple paths to each
node, built-in hardware redundancy and redundant power supplies. For all network
routings, there will be at least two paths. Should service failure occur on one
route, the network is designed to automatically re-route traffic to another
route. HER believes that these techniques will result in performance of 99.98
percent or better for premium service customers for most routes.
HER expects to operate the entire network and to own substantially all of
the network equipment as well as some segments of the fiber optic cable. A
substantial part of the fiber is leased on a long-term basis. Long-term leases
for fiber are advantageous to HER because they reduce the capital expense burden
of building large quantities of capacity before they can be used. Where HER
leases dark fiber, the infrastructure provider
75
will generally be responsible for maintaining such fiber optic cable. HER will
enter into agreements with Alcatel and infrastructure providers and other third
parties to supply and/or maintain the equipment for the HER network. See "Risk
Factors -- HER Network Roll-out."
Network Capacity. The network will consist of Synchronous Digital
Hierarchy ("SDH") STM-16 links managed by equipment and operating centers owned
by HER and running on dark fiber leased from infrastructure providers or built
by HER on leased rights of way. Each line system and multiplexer works initially
at the 2.5 Gbps (STM-16) level. The most important types of equipment used or to
be used in this network are Add-Drop Multiplexors ("ADMs") and regulators and a
variety of optical amplifiers for boosting optical signals. The STM-16 links are
expected, where needed, to be upgraded to STM-64. Furthermore, fibers will be
multiplexed using WDM, also as required. Additional capacity can be achieved by
adding new fiber accesses to a given city over alternative routes, thereby
achieving more meshing and the resulting improved network availability.
Network Agreements. HER has entered into agreements and letters of intent
with various infrastructure providers for construction and/or dark fiber lease
of portions of the HER network. HER's agreements for leases of portions of the
network typically required the infrastructure provider to provide a certain
number of pairs of dark fiber and node and/or regenerator sites along the
network route commencing on certain dates provided by HER. The term of a lease
agreement typically ranges from 10 to 18 years. An agreement typically contains
optical specification standards for the fiber and methods of testing. HER is
allowed to use the cable for the transmission of messages and in other ways,
including increasing capacity. The infrastructure provider also provides space
for the location of equipment and spare parts and guarantees the provision of
power and other utilities together with environmental controls and security to
ensure the proper functioning of the equipment. The infrastructure provider is
typically responsible for maintenance of the cable and the provision of first
line maintenance to equipment and permits HER access to such facilities. Access
arrangements to the nodes are also provided so that connection may be made to
HER customers or to the rest of the network. An agreement also provides for an
annual price for the provision of fiber and for the facilities and maintenance.
The agreements typically provide for termination by the parties only for
material breach, with a 90 day minimum cure period. The agreements typically
contain a transition period after termination of the agreement to allow HER to
continue to serve its customers until it can reach agreement with an alternative
infrastructure provider.
Local Access. Access to the HER network will be provided to clients
through SDH access lines including at the STM-1 or STM-4 level. However,
customers who continue to use the older PDH technology may also access the HER
network. In each city, as a HER point of presence is deployed, HER may contract
with a local access network supplier for "last mile" services to customer
locations. HER will not invest in building local access infrastructure but such
connectivity can be supplied on a case-by-case basis via preferred local access
partner arrangements. Currently Telfort in the Netherlands and Belgacom in
Belgium are providing local access to the operating Amsterdam-Brussels route. In
London and Paris, HER has contracted with local access providers to connect the
HER network to intra-city networks in those cities. Pursuant to this agreement,
HER can offer its carrier customers local connectivity in those cities. Various
Local Access Network Suppliers may also be interested in HER for the purpose of
linking the business centers in which they are active. Therefore, the
76
Company believes that the relationships between HER and local access network
suppliers can benefit both parties. Set forth below is an illustration of the
connection between the HER network and local access providers.
[SDH/WDM NETWORK CHART]
Network Routes. The table below sets forth the current planning dates of
the development of routes in the initial network in the first five countries.
ESTIMATED
COMMERCIAL
SERVICE TOTAL ROUTE
AVAILABILITY KILOMETERS OF
FROM TO DATE FIBER
------------ ---------- ------------ --------------
Amsterdam Brussels Operational 244
Amsterdam London Operational 458
Brussels London Operational 474
Paris Brussels Operational 514
Dusseldorf Amsterdam April 1998 246
Paris Frankfurt June 1998 716
Frankfurt Dusseldorf June 1998 236
HER is currently operating on an approximately 1,700 kilometer portion of
the network. Under HER's current plan, HER expects to have an aggregate of
approximately 3,200 kilometers completed in the first half of 1998,
approximately 10,200 kilometers completed at the end of 1998 and the entire
18,000 kilometer network completed by the year 2000. Hermes also plans to lease
capacity on a transatlantic cable linking the European network with North
America in 1999.
The Dusseldorf-Amsterdam, Frankfurt-Dusseldorf and Paris-Frankfurt fiber
optic routes are currently under construction. "Under construction" means that
with respect to each of the segments that make up each of these routes, one of
the following is occurring: (i) HER has contracted to build or is contracting to
build the
77
fiber optic cable segment, and (ii) HER has leased or will lease such segment of
dark fiber optic cable from a third party who has built or is currently building
such segment. The dates set forth above may be subject to delays due to a
variety of factors, many of which are beyond the control of the Company. See
"Risk Factors -- HER Network Roll-Out."
HER is deploying the network along the rights-of-way of several
shareholders as well as the rights-of-way of a variety of alternative sources,
including motorways, waterways, pipelines and utilities. The rights-of-way of
HER-built portions of the network will be provided pursuant to long-term leases
or other arrangements entered into with railroads, highway commissions, pipeline
owners, utilities or others. HER generally prefers to use the infrastructure of
its rail-based shareholders when such infrastructure is available on a timely
and commercially reasonable basis. In certain cases, however, HER has not been
able to reach agreement with such shareholders for the provision of
rights-of-way along their railways, which has resulted in significant delays to
the network buildout. In all cases, it is the policy of HER to evaluate multiple
alternative infrastructure suppliers in order to maximize flexibility. As a
result of its network development activities to date, HER has gained access to
infrastructure for its network routes which, in certain cases, HER believes will
be difficult for its competitors to duplicate.
Competition
The European and international telecommunications industries are
competitive. HER's success depends upon its ability to compete with a variety of
other telecommunications providers offering or seeking to offer cross-border
services, including (i) the respective PTO in each country in which HER operates
and (ii) global alliances among some of the world's largest telecommunications
carriers. HER expects that some of these potential competitors may also become
its customers. HER believes that the ongoing liberalization of the European
telecommunications market will attract New Entrants to the market and increase
the intensity of competition. Competitors in the market compete primarily on the
basis of price and quality. HER intends to focus on these factors and on service
innovation as well. HER business plan anticipates substantial head-to-head
competition as well as indirect competition.
WorldCom recently announced plans to construct a pan-European fiber
network, the first phase of which is expected to connect London, Amsterdam,
Frankfurt, Brussels and Paris by early 1998. Although the Company believes that
the proposed WorldCom pan-European network is primarily intended to carry
WorldCom traffic, WorldCom has stated that any excess capacity on such network
will be used to provide a competitive carrier's carrier service.
HER also competes with respect to its "point-to-point" transborder service
offering against circuits currently provided by PTOs through International
Private Leased Circuits. In addition, the liberalization of the European
telecommunications market is likely to attract additional entrants to both the
"point-to-point" and other telecommunications markets.
If HER's competitors, many of whom possess greater technical, financial and
other resources than HER, devote significant resources to the provision of
pan-European, cross-border telecommunications transport services to carriers,
such action could have a material adverse effect on HER's business, financial
condition and results of operations. There can be no assurance that HER will be
able to compete successfully against such new or existing competitors. See "Risk
Factors -- Competition."
HER RECAPITALIZATION
HER has completed a recapitalization (the "HER Recapitalization"), wherein
HER extended rights to subscribe to additional shares of HER to GTS-Hermes, HIT
Rail and the eleven railways comprising the HIT Rail consortium. Pursuant
thereto, GTS-Hermes and two of the eleven railways that comprise the HIT Rail
consortium have exercised their subscription rights, while HIT Rail and the
other nine railways have declined to exercise their subscription rights. HER has
issued (i) 150,592 shares to GTS-Hermes in exchange for the conversion of loans
and additional consideration, (ii) 24,007 shares to HIT Rail in exchange for the
conversion of loans, (iii) 11,424 shares to Societe Nationale des Chemins de Fer
Belges S.A. de Droit Public/Nationale Maatschappij der Belgische Spoorwegen N.V.
Van Publiek Recht (the Belgian national railway)
78
("SNCB/NMBS") and (iv) 4,365 shares to AB Swed Carrier (a wholly owned
subsidiary of SJ, the Swedish national railway). As a result, GTS-Hermes owns
79.08%, HIT Rail owns approximately 12.63%, SNCB/NMBS owns 6% and AB Swed
Carrier owns 2.29% of the issued HER shares. Pursuant to the HER
Recapitalization, HER, GTS-Hermes, HIT Rail, SNCB/NMBS and AB Swed Carrier have
executed a new Shareholders Agreement, the principal terms of which are set
forth below.
Under the new Shareholders Agreement, actions to be taken by shareholders
will be adopted by a simple majority vote with the exception of certain actions
which will require at least 85% of the votes cast: (i) purchase by HER of its
own shares and any redemption thereof, (ii) exclusion of preemptive rights in
the case of the issuance of new shares and the transfer of shares held by HER,
except in the event of a public listing of the shares or of new shares or of an
offering of shares or options on new shares (warrants) to professional investors
in order to obtain further funding, (iii) winding up or dissolution of HER, (iv)
any amendment to the articles of association other than those pertaining to
increases in the authorized capital of HER or to convert HER into an N.V.
("Naamloze Vennootschap") to enable a public listing of shares or new shares,
(v) any amendment to the scope of HER's business, (vi) the declaration of
dividends and (vii) the admission of new shareholders to the Shareholders
Agreement. In addition, the Shareholders Agreement provides that (a) if
GTS-Hermes is the owner of at least 50% of the issued shares, then it will have
the right to make a binding nomination for the appointment of half of the
members of the Board of Supervisory Directors or (b) if GTS-Hermes is the owner
of at least two-thirds of the issued shares, then it will have the right to make
a binding nomination for the appointment of half of the members of the Board of
Supervisory Directors plus one member more, appointed pursuant to nominations by
all other shareholders. As long as HIT Rail is the owner of at least one share,
HIT Rail will be entitled to make a binding nomination for the appointment of at
least one member of the Supervisory Board. The Shareholders Agreement also
provides that shareholders who participated in the capital restructuring other
than GTS-Hermes and HIT Rail with a shareholding of at least 6.8% subject to
adjustment in the discretion of the other shareholders will be entitled to make
a binding nomination for the appointment of one member of the Board of
Supervisory Directors. Shareholders who participated in the capital
restructuring other than GTS-Hermes and HIT Rail who hold fewer than 6.8% of the
issued share capital of HER will be entitled on a rotating basis to make one
binding nomination for the appointment of a member of the Board of Supervisory
Directors for two-year periods.
Articles of Association and Shareholders Agreement
Under the Articles of Association and the Shareholders Agreement, both
GTS-Hermes and HIT Rail have preemptive rights in connection with issuances of
ordinary shares and options on shares to be issued in proportion to the total
nominal value of the shares held by each of them. Preemptive rights can be
exercised for four weeks after the date the notice of the offer is received by
the shareholders.
The Shareholders Agreement provides that HER or its designated vendor will
provide fiber capacity in its network for use by the shareholders of HER on fair
commercial terms, use, quantity and price to be negotiated on a bilateral basis.
In the Shareholders Agreement, HIT Rail has covenanted to (i) use its best
efforts to establish such commercial agreements between individual HIT Rail
shareholders and HER, to obtain rights of way from individual HIT Rail
shareholders and to cooperate in obtaining such licenses as may advance the
business of HER, (ii) use its best efforts to ensure that the HIT Rail
shareholders cooperate in obtaining such license in accordance with the business
plan of HER and as may be necessary or advisable in furtherance of HER's
business, (iii) will not, so long as both HIT Rail and GTS-Hermes are
shareholders of HER and for one year after HIT Rail ceases to be a shareholder,
agree with any entity other than GTS-Hermes or HER to assist or cooperate in the
development of any pan-European telecommunications operator and (iv) use its
best efforts to obtain on HER's behalf such materials as may be required and
arrange inspection visits of selected rights of way for the purpose of making
initial cost estimates.
The foregoing summary of the Shareholders Agreement does not purport to be
complete and is qualified in its entirety by reference to the Shareholders
Agreement.
79
LICENSES AND REGULATORY ISSUES
A summary discussion of the regulatory framework in the countries of the
network in the first five countries and the next five countries into which HER
expects to develop the network is set forth below. This discussion is intended
to provide a general outline, rather than a comprehensive discussion, of the
more relevant regulations and current regulatory posture of the various
jurisdictions.
National authorities in individual member states of the EU are responsible
for regulating the operation (and in some cases the construction) of
telecommunications infrastructure. HER believes that the adoption of the Full
Competition Directive and the various related Directives adopted by the European
Parliament and the Council of the EU have resulted in the removal of most
regulatory barriers to the operation of telecommunications infrastructure in the
countries of the initial network in the first five countries.
HER requires licenses, authorizations or registrations in all countries to
operate the network. There can be no assurance that HER will be able to obtain
such licenses, authorizations or registrations or that HER's operations will not
become subject to other regulatory, authorization or registration requirements
in the countries in which it plans to operate. Licenses, authorizations or
registrations have been obtained in the United Kingdom, the Netherlands,
Belgium, France and Germany and a trial concession has been granted in
Switzerland. HER intends to file applications in other countries in anticipation
of service launch in accordance with the network roll-out plan.
On June 28, 1990, the European Commission, in an effort to promote
competition and efficiency in the European Union, issued a directive (the "1990
Directive") requiring EU member states to immediately liberalize all
telecommunication services with the exception of voice telephony to the general
public (basic voice services provided over the public switched voice network).
This step liberalized value added services and voice services over corporate
networks and/or "closed user groups," although the exact definitions of the
terms used in the 1990 Directive were not altogether clear.
On July 22, 1993, the Council of EU agreed that all voice telephony
services in EU member states should be liberalized by January 1, 1998 subject to
additional transitional periods of up to five years to allow member states with
less developed networks to achieve the necessary adjustments. It was agreed that
such exemptions would be granted to Spain, Ireland, Greece and Portugal, subject
to formal application and satisfaction of certain requirements. Luxembourg,
because of the small size of its market, would be eligible for a special
transitional period of up to two years.
In April 1995, a communication from the European Commission sought to
clarify the types of services that were liberalized by the 1990 Directive,
stating that the burden of proof as to why a service should be considered
"reserved" and therefore not open to competition should be upon the PTOs and the
regulatory authorities of member states. Along with this statement came the
threat of formal procedures under the Treaty of Rome against member states that
do not implement the 1990 Directive "within a reasonable time." Procedures have
been brought so far against Italy, Greece, Germany and Spain for failing to
apply the requirements of the 1990 Directive.
On March 13, 1996, the European Commission adopted the Full Competition
Directive extending the 1990 Directive to all services, requiring that licensing
procedures for these services be transparent and non-discriminatory, requiring
member states to fully liberalize alternative infrastructure to allow a
competitive market for "non-reserved" services such as data, value added
services and non-public (closed-user group) switched voice services by July 1,
1996 and mandating open competition in all public telecommunications services,
including voice telephony to the general public, by January 1, 1998 (except for
countries to which grace periods were granted in accordance with the 1993
Council Resolution).
On April 10, 1997, the European Parliament and the Council of Ministers
adopted a Directive on a common framework for general authorizations and
individual licenses in the field of telecommunications services, including
networks. Licenses must be awarded through open, non-discriminatory and
transparent procedures and applications will be required to be dealt with in a
timely fashion. The number of licenses may only be restricted to the extent
required to ensure the efficient use of radio frequencies or for the time
necessary to make available sufficient numbers in accordance with EC law.
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HER believes that many European countries have revised telecommunications
regulations to comply with the 1990 Directive and the Full Competition Directive
and that such changes will enhance HER's ability to obtain other necessary
regulatory approvals for its operations.
As a multinational telecommunications company, HER is subject to varying
degrees of regulation in each of the jurisdictions in which it provides its
services. Local laws and regulations and the interpretation of such laws and
regulations, differ significantly among the jurisdictions in which HER operates.
There can be no assurance that future regulatory, judicial and legislative
changes will not have a material adverse effect on HER, that domestic or
international regulators or third parties will not raise material issues with
regard to HER's compliance or noncompliance with applicable regulations or that
regulatory activities will not have a material adverse effect on HER. See "Risk
Factors -- Government Regulation." The regulatory framework in certain
jurisdictions in which HER provides its services is briefly described below.
United Kingdom
Since the elimination in 1991 of the United Kingdom telecommunications
duopoly consisting of British Telecommunications and Mercury, it has been the
stated goal of Oftel, the United Kingdom telecommunications regulatory
authority, to create a competitive marketplace from which detailed regulation
could eventually be withdrawn. The United Kingdom has already liberalized its
market beyond the requirements of the Full Competition Directive, and most
restrictions on competition have been removed in practice as well as in law. HER
has received a license from the Secretary of State for Trade and Industry which
grants it the right to run a telecommunications system or systems in the United
Kingdom connected to an overseas telecommunications system and to provide
international services over such systems. Like the licenses granted to other
providers of international facilities-based services, the license granted to HER
on December 18, 1996 was for an initial six months' duration and thereafter is
subject to revocation on one month's notice in writing. The short duration of
these initial licenses was adopted for administrative convenience on the
opening-up of the United Kingdom market for international facilities-based
services. The Department of Trade and Industry ("DTI") has confirmed that it
intends to replace the initial licenses with new licenses and that it would not
normally expect to revoke an initial license without replacing it with another
license giving an equivalent authorization. The DTI is currently discussing with
license holders the arrangements to put these new licenses into effect and
although the DTI has indicated that the new licenses are expected to be of 25
years duration, there can be no certainty that this will be the case or that the
new licenses will not contain terms or conditions unfavorable to HER.
The Netherlands
On July 1, 1997 the Dutch government abolished the prohibition on the use
of fixed infrastructure for the provision of public voice telephony, thereby
complying with the requirements of the Full Competition Directive six months
ahead of schedule. On August 1, 1996, HER was granted a license for the
installation, maintenance and use of a fixed telecommunications infrastructure.
An entirely new Telecommunications Bill was introduced to the Second
Chamber (the House of Representatives) of the Parliament on September 15, 1997.
The new Telecommunications Act is intended to confirm the full liberalization of
the telecommunications market according to European Community standards. It is
not expected that the new Telecommunications Act will detrimentally affect the
conduct of business by HER.
Belgium
Belgium has implemented the "alternative infrastructure" provider provision
of the Full Competition Directive. Full liberalization of competition, including
the provision of voice telephony, requires further legislation which is expected
to be introduced to the legislature in the near future. HER has obtained,
through a wholly-owned subsidiary, a license from the Belgian regulatory
authority to provide liberalized services using alternative infrastructure and
is currently operating under its license in Belgium on the Brussels-Amsterdam
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route. HER also has authorization to build infrastructure between major Belgian
population centers and the relevant border crossings.
Germany
Germany has approved legislation to implement the Full Competition
Directive and remove all remaining restrictions on competition from January
1998. HER was granted a license by the German regulatory authorities on July 18,
1997. The license permits HER to operate the portions of the network in Germany
connecting Dusseldorf, Frankfurt and Stuttgart; Dusseldorf to the Dutch border;
and Stuttgart to the French and Swiss borders. HER expects to extend its license
in Germany as appropriate in order to enable it to operate the remaining
portions of the network in Germany.
France
A new regulatory agency, the Autorite de Regulation des Telecommunications
("ART"), was established in France effective January 1, 1997. In 1996, France
approved legislation to implement the Full Competition Directive and to remove
all remaining restrictions on competition from January 1998. HER applied for an
authorization to operate its network in specific regions of France, which was
approved on October 22, 1997.
Switzerland
The Swiss Parliament has recently passed a new Telecommunications Law which
will enter into force on January 1, 1998. Although Switzerland is not a Member
State of the EU, the effect of the law is largely to mirror the EC
telecommunications liberalization Directives and therefore from that date
existing voice telephony monopoly will be abolished and such services will be
fully liberalized. An independent national regulatory authority has previously
been established. HER obtained a trial concession on October 30, 1997, in order
to roll out its network and to provide its services in advance of the full
liberalization coming into effect on January 1, 1998.
Italy
Although in the past Italy has been dilatory in implementing EC
liberalization measures, Italy enacted legislation on July 31, 1997 which
substantially completes the liberalization of services in accordance with the
Full Competition Directive. The Parliament has also approved the creation of an
independent national regulatory authority for the telecommunications and
audiovisual sectors. The most recent EC liberalization Directives relating to
licensing and interconnection remain to be implemented. HER intends to apply for
a license to provide its services in due course.
Spain
Under the Full Competition Directive Spain was granted the right to request
a delay of up to five years in liberalizing fully its telecommunications market.
However, the Spanish government and the European Commission have agreed that
full liberalization should take place on December 1, 1998. In order to ensure
effective liberalization from that date, the Commission Decision granting the
eleven month extension sets out a timetable of interim measures leading up to
full liberalization. These measures include the passing of legislation
authorizing regional cable operators to provide telecommunications services and
the adoption of a new General Telecommunications Bill effectively transposing EC
Directives into Spanish law. Further RETEVISION, S.A. has been granted a second
national operator's license to compete with the national PTO and Spain has
agreed to grant a third national operator license in early 1998. HER intends to
apply for a license to provide its services in due course.
Sweden
Full liberalization of the Swedish telecommunications market occurred in
1993. A new Telecommunications Act was passed this year to reinforce the powers
of the national regulatory authority, to ensure
82
conformity with EC Directives and to supplement the pre-existing licensing
regime with a general authorization regime for services other than telephony
services, mobile services and leased lines. HER intends to register to provide
its services in due course.
Denmark
With the liberalization of infrastructure from July 1, 1997 Denmark has
fully liberalized its telecommunications markets in accordance with the
requirements of the relevant EC Directives. An independent national regulatory
authority has been established. According to the Danish rules, HER will not
require any regulatory approval in order to install or operate the network in
Denmark.
GTS-MONACO ACCESS
GTS owns a 50% interest in and manages GTS-Monaco Access, a joint venture
with the Principality of Monaco created to develop Monaco's existing
international telecommunications infrastructure into a leading international
gateway hub for transport of international traffic to European and overseas
destinations. The Principality has constructed and operates a sophisticated
international gateway infrastructure that includes an international digital
switching center and a satellite earth station to support significant amounts of
carriers' carrier traffic. Through Monaco's network, GTS-Monaco Access is linked
to approximately 170 countries worldwide. GTS believes that this partnership
provides it with the opportunity to build a strong international gateway
operator in lucrative Western European markets.
GTS-Monaco Access offers competitively priced international switching and
transit services, primarily to the "wholesale" international gateway and
carrier-to-carrier portion of the international calling market, as distinguished
from "retail" services offered to end users. Basic service offerings include (i)
international switched traffic; (ii) international private lines; (iii)
facilities management, including billing, customer management and fault
reduction systems; (iv) resale distribution for Internet service providers; and
(v) prepaid calling card platform services.
With the cooperation of Monaco Telecom ("MT"), GTS-Monaco Access is
entitled to exercise the privileges of signatories to international treaties
such as the ITU, and to international satellite agreements, such as Intelsat,
Inmarsat and Eutelsat. Other signatories are generally PTOs and other
quasi-governmental telecommunications entities. GTS-Monaco Access purchases
capacity on international fiber routes at rates available only to recognized
operators which are substantially below the rates charged to other service
providers. These fiber-based facilities are an important element for GTS-Monaco
Access's core network and provide it with capacity that may be leased or resold
to customers. Monaco inaugurated its independent country code, 377, on June 21,
1996, which made it eligible for certain privileges, including special terms
(generally reserved for PTOs) in connection with transmission agreements,
transit agreements, settlements and low-cost accounting rates with select
carriers.
GTS's partner in GTS-Monaco Access is an investment fund designated by the
Principality of Monaco to represent its interests. GTS-Monaco Access functions
in cooperation with MT under a commercial agreement governing, among other
things, the terms of use of existing facilities, access to and acquisition of
new international infrastructure, and sales and marketing. GTS exercises
operational control of the joint venture, and provides managerial and financial
support, international telecommunications expertise and strategic planning.
Neither GTS nor its partner is obligated to fund operations or capital
expenditures of GTS-Monaco Access. Losses and profits of GTS-Monaco Access are
allocated to the partners in accordance with their ownership percentages, in
consideration of funds at risk. As of September 30, 1997, GTS and its partner
had each made equity contributions of $1.7 million to GTS-Monaco Access. In
addition, GTS-Monaco Access had outstanding loans of $2.9 million to GTS as of
September 30, 1997. See "Management's Discussion and Analysis -- Accounting
Methodology -- Profit and Loss Accounting." The agreement between GTS-Monaco
Access and MT, by its terms, continues in operation until 2020.
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BUSINESS AND MARKETING STRATEGY
GTS's objective is to develop GTS-Monaco Access into a leading
international gateway hub. The Company's strategy to achieve this objective
includes the following:
- Develop Advanced Carrier Services Offerings. GTS-Monaco Access intends to
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 has
begun to develop relationships to broaden its service offerings.
GTS-Monaco Access has entered into agreements with UUNET, one of its
gateway customers, to provide wholesale Internet access to GTS-Monaco
Access's carrier customers in a number of Western European countries. The
agreement allows these services to be "cobranded" with GTS's affiliates.
- Pricing. Price is a critical factor in the market for international
switching as competition increases due to expanding international
capacity, advances in technology and falling regulatory barriers. GTS-
Monaco Access intends to price its services competitively with the
prevailing price for comparable inter-PTO transit and gateway services.
GTS-Monaco Access is not bound by legacy systems, infrastructure and
personnel levels and can, therefore, manage lower cost operations.
- Leverage Non-Aligned Position. Because GTS's Western European activities
are not allied with any of the major consortia or large Western European
telecommunications companies, and generally focus on carriers' carrier
services, GTS-Monaco Access will not compete with its carrier customers
in retail markets. This independence should make GTS-Monaco Access an
attractive service provider for Western European carriers who may
otherwise be reluctant to obtain services from the larger operators of
international gateways that are often their competitors in the retail
market.
- Exploit GTS Synergies. GTS intends to support GTS-Monaco Access by
allying it with other GTS companies in Europe and the CIS. GTS-Monaco
Access is expected to realize significant reductions in its cost
structure through access to low-cost pan-European transmission capacity
through alternative infrastructure providers such as HER, Sovintel and
C-Datacom International, Inc., GTS's Indian venture, already route
international traffic through GTS-Monaco Access's gateway.
- Local Points of Presence. Beginning in the first quarter of 1998,
GTS-Monaco Access intends to establish points of presence in the United
Kingdom, France and Germany in order to take advantage of the HER network
rollout and negotiate arrangements with local customers and suppliers for
the pick up and delivery of international traffic.
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 can 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, will 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 Internet service providers will be in
direct competition with PTO-owned services in large European markets.
- Second Carriers/Resellers. GTS believes that many second carriers will
seek to enter new markets quickly without investing in international
switching capacity.
84
- Established ("Aligned") PTOs. This customer segment will be a niche
market for GTS-Monaco Access. As markets are deregulated and carriers
become increasingly competitive, traditional friendly correspondent
relations may become strained, and opportunities may emerge to leverage
GTS's non-aligned status to route traffic between rivals or to displace
incumbents for transit relationships.
- Other GTS Companies. GTS-Monaco Access currently provides gateway
services to Sovintel, CDI and other GTS companies that aggregate traffic
or provide international long distance services. It may also provide
these services to HER.
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. Beginning in the first quarter of 1998,
GTS-Monaco Access intends to establish points of presence in Europe by
co-locating in certain cities served by HER, which will allow GTS-Monaco Access
to terminate traffic through HER and reduce GTS-Monaco Access's transmission
costs.
LICENSES AND REGULATORY ISSUES
Because it operates in coordination with MT, the licensed operator of the
Monaco public network, and in indirect partnership with the government,
GTS-Monaco Access's telecommunications activities in Monaco require no
telecommunications license.
Because the Principality of Monaco is not an EU member state, GTS-Monaco
Access's telecommunications activities in the Principality are not subject to
European law. However, GTS-Monaco Access will have to comply with EU regulation
to the extent it does business in EU member states. The regulatory requirements
established by the EU create general guidelines under which the national
agencies of EU member states regulate. Accordingly, local laws and regulations
may differ significantly among these jurisdictions, and the interpretation and
enforcement of such laws and regulations may vary. Local rules are sometimes
based on the informal views of the local ministries which, in some cases, are
subject to influence by the local PTOs. In certain of the Company's existing and
target markets, there are laws and regulations which affect the number and types
of customers which the Company can address. For instance, certain countries may
and do require licenses for communication companies to interconnect to the
public network to originate traffic.
In addition, one of the services provided by GTS-Monaco Access is a form of
transit service, known in the industry as "re-filing." Re-filing is the practice
of routing traffic through a third country in order to take advantage of
disparities in settlement rates between different countries, allowing traffic to
a potential country to be treated as if it originated in the third country that
enjoys lower settlement rates with the destination country, thereby resulting in
lower overall costs on an end-to-end basis. Re-filing is prevalent in the
industry even though the practice is technically in contravention of ITU
regulations. In practice, because of the widespread non-observance of these
regulations, such a contravention normally does not give rise to specific legal
problems. However, their enforceability essentially depends on the status given
to ITU obligations by 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
85
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.
GTS expects 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.
CENTRAL EUROPE
In Central Europe, GTS's objective is to become one of the leading
alternative telecommunications providers in the region. GTS currently provides
private data communications services to government and commercial customers in
Hungary and the Czech Republic. In the Czech Republic, the Company provides
outgoing voice services and operates an international gateway and a data
services network. In Hungary, GTS operates a VSAT network which GTS believes is
the largest VSAT network in Central Europe as measured by number of VSAT sites.
The Company has also signed an agreement to provide international data services
in Poland, subject to receipt of necessary governmental approvals. GTS's
strategy is to expand its service offerings as the regulatory environment
permits, leveraging its existing VSAT and international gateway infrastructure
where possible and providing a broad range of services to its target markets.
Hungary
GTS-Hungary. GTS-Hungary, a 99% owned subsidiary of GTS, is a leading
provider of customized data services offering high quality, reliable virtual
private network services to customers throughout Hungary and, through other GTS
affiliates, other countries in Central Europe. GTS-Hungary provides these
services through VSATs installed at customer sites throughout the country and a
microwave-based high speed overlay network for points in the Budapest
metropolitan area. Along with these data transmission services, GTS-Hungary
provides high quality customer service including (i) significant system
integration support in the initial implementation of the customers' networks and
in on-going expansion and improvements and (ii) a unique maintenance and
technical support service, which include "rapid response" service calls and
24-hour hub service operations support, which can be backed by financial
guarantees when required.
As of September 30, 1997, GTS-Hungary's VSAT network consisted of
approximately 935 owned and operated VSAT sites which the Company believes makes
it the largest VSAT-based network in Central Europe. GTS believes that its
choice of VSAT technology as a way of quickly deploying a full range of business
services nationwide will allow it to capture key customers and market segments.
Such positioning, the Company believes, will enable GTS-Hungary to expand its
service offerings as the Central European market matures and as regulatory
authorities further privatize and deregulate the telecommunications industry.
GTS-Hungary is undertaking a nationwide expansion of its microwave-based
Budapest overlay network. The expansion will increase GTS-Hungary's revenue base
in the region and provide opportunities to leverage further its other service
offerings. There can be no assurance, however, that the expansion will be
completed on a timely and commercially feasible basis.
The Hungarian state lottery is GTS-Hungary's largest customer, accounting
for more than 54% of GTS-Hungary's VSAT revenue for the nine months ended
September 30, 1997. GTS-Hungary has also targeted its VSAT network services to
business customers in the domestic service industry and other government
organizations. Although GTS-Hungary continues to diversify its revenue and
customer base, the loss of the Hungarian state lottery as a customer would have
a material adverse effect on GTS-Hungary's business.
GTS-Hungary generally charges its data services customers a flat monthly
fee for a fixed amount of usage and usage-based fees for use above the
contractual amount. Customers are billed in Hungarian forints (indexed to US
dollars) on a monthly basis. Pricing is generally determined for an individual
client based
86
upon the size of traffic requirements. In general, GTS-Hungary's strategy is to
minimize the initial customer investment in order to lower the barriers to
purchase, while committing customers to long-term contracts.
GTS-Hungary's major competitors include BankNet, Hungaro-DigiTel and MATAV,
the Hungarian PTO, each of which operates a network with at least 200 VSAT
sites. MATAV offers a broad range of services and has recently targeted the
business sector that GTS serves. GTS believes that, while some of its
competitors have stronger financial resources, GTS-Hungary remains the leading
VSAT service provider in Hungary in terms of number of VSAT sites, the size and
quality of its infrastructure and the quality of its service. GTS also believes
it has distinguished itself from its competition by its superior customer
service.
Currently, all VSAT licenses in Hungary have been granted under temporary
telecommunications regulations. The temporary licenses prohibit connection to
public telecommunications networks or other international or domestic
data-transmitting systems. In December 1993, GTS received a temporary service
permit to provide data-transfer services utilizing a VSAT-based wireless
communications system throughout Hungary. In March 1997 the government issued
new telecommunications regulations which require all operations with temporary
licenses to apply for permanent licenses by the end of April 1997. GTS-Hungary
has submitted applications for the conversion of its temporary licenses to
permanent ones. While no assurances can be given, GTS expects permanent licenses
to be issued in due course. The failure to receive such licenses would have a
material adverse effect on the business of GTS-Hungary.
Neither GTS nor its partner in GTS-Hungary are obligated to fund operations
or capital expenditures of GTS-Hungary. Losses and profits of GTS-Hungary are
allocated to the partners in accordance with their ownership percentages, in
consideration of funds at risk. As of September 30, 1997, GTS had made equity
contributions of $9.5 million to GTS-Hungary, GTS' partner has not made any
equity contributions as of September 30, 1997. In addition, GTS-Hungary had
outstanding loans of $3.4 million to GTS as of September 30, 1997. See
"Management's Discussion and Analysis -- Accounting Methodology -- Profit and
Loss Accounting." Further, the joint venture does not have an expiration date.
EuroHivo. In addition to its network and data services, GTS also provides
nationwide paging services primarily to the retail consumer market through its
70% owned joint venture, EuroHivo. GTS has concluded that EuroHivo is not a core
business and is currently assessing offers to sell its interests in EuroHivo. In
connection with this anticipated divestiture, the Company wrote-off its
investment in EuroHivo in the third quarter of 1997. See "Management's
Discussion and Analysis -- Results of Operations -- Consolidated Ventures."
Czech Republic
The Czech Companies. The Czech Companies, which consist of two wholly owned
subsidiaries of GTS, offer the only alternative international telephony service
in the Czech Republic, as well as a full range of private data services,
delivered through a combination of a fully digital microwave overlay network and
an international satellite gateway in Prague and GTS-Hungary's VSAT network.
Through an intercompany arrangement with GTS-Hungary, the Czech Companies
provide all of the same VSAT services offered by GTS-Hungary. In addition, the
Czech Companies offer high-speed Internet access service and are among the
leading Internet access providers in the Czech Republic. The Czech Companies
seek to become the second carrier in the Czech Republic and are also targeting
opportunities in Slovakia, based upon the historic relationship between the
Czech and Slovak markets.
The Czech Companies network consist of an earth station linked to
GTS-Monaco Access and to British Telecom, a series of point-to-point and
point-to-multipoint microwave connections providing dedicated access to the
buildings served by the Czech Companies and individual VSATs based on, and
controlled by, GTS-Hungary's hub in Budapest.
The Czech Companies target customers include real estate developers, hotels
and multinational companies which require international voice or data services
or Internet connectivity, where both GTS's own services and the services of GTS
partners are sold. The Czech Companies provide outgoing international voice
services and high-speed Internet access to large commercial buildings in Prague.
As of September 30, 1997,
87
the Czech Companies had concluded agreements with building owners to convert
PABXs in 23 buildings in Prague. International voice services are offered at
prices similar to those of the Czech PTO. The Czech market for VSAT services is
extremely competitive, with prices at approximately 50% of those in Hungary for
basic services. The Czech Companies plan to pursue customers who require
value-added services which may be offered at higher prices and better margins.
The Czech Companies are licensed to provide international satellite and
domestic private voice and data services. They received their operating licenses
in 1994 and 1995 and began offering services in 1995. The licenses grant
permission to install and operate up to 150 earth stations and, upon
application, an additional 150 earth stations. The licenses currently prohibit
the provision of switched voice services and the interconnection to public
voice, telex and data networks and telecommunications networks of other
providers.
The Czech Companies are the only alternative international telephony
provider licensed in the Czech Republic. As such, their only competitor is SPT
Telecom, the Czech PTO. Should SPT decide to compete aggressively with the Czech
Companies, it has the ability to discount prices below those which could be
easily sustained by the Czech Companies. In data services, Telenor, GITY and
Nextel (a subsidiary of SPT Telecom) are the Czech Companies' three major
competitors for data services in the Czech Republic. GTS believes that its
experience in establishing VSAT services in the region and its emphasis on
integrated voice and data services provides the Czech Companies with a
competitive advantage. Additionally, GTS's transmission facilities and
infrastructure in Hungary and Monaco provide them with a relatively low cost
infrastructure and, as a consequence, greater pricing flexibility than their
competitors. With respect to Internet services, GTS believes that, although this
market consists of a large number of small providers and that SPT Telecom will
seek to enter this market, the dedicated, high-speed infrastructure that the
Czech Companies are installing will provide superior services to its customers.
ASIA
Chinese law generally prohibits foreign investment or participation in the
operation of telecommunications services, while Indian law requires foreign
telecommunications operators to conduct certain telecommunications businesses,
including basic switched telephony and cellular services, through joint ventures
that are at least 51% owned by Indian partners. GTS believes that these
restrictive regulations will eventually be liberalized and that its early entry
into these markets and its strong relationships with influential commercial
firms and with local, regional and national-level government entities will
provide it with a strong competitive advantage over competitors that await more
explicit regulatory regimes authorizing direct telecommunications investments.
China
GTS participates in the nationwide tourist industry VSAT network through
GTS China Investments LLC, a company in which GTS holds a 75% interest and an
affiliate of the Soros Foundations owns a 25% interest. See "Certain Related
Party Transactions." GTS China Investments LLC holds an indirect 63% interest in
Beijing Tianmu Satellite Communications Technology Co. Ltd. ("Beijing Tianmu"),
which provides technical, operational and financial support for the VSAT
network. In addition, through Shanghai V-Tech Telecommunications Systems Co.,
Ltd. ("V-Tech"), a venture in which GTS holds a 75% interest, the Company
provides financing, operational consulting, technical and engineering services
to a Shanghai-based VSAT network operator.
With respect to V-Tech, in addition to the Company's initial equity
contribution of $3.75 million, GTS committed to fund up to an additional $3.0
million (all of which has been funded as of September 30, 1997). The joint
venture expires in April 2015, and profits and losses are allocated according to
ownership interests in consideration of funds at risk. See "Management's
Discussion and Analysis -- Accounting Methodology -- Profit and Loss
Accounting."
With respect to Beijing Tianmu, in addition to the Company's initial equity
contribution of $8.75 million, GTS is responsible for arranging additional
financing of up to $14.4 million, subject to the approval of the venture's Board
of Directors, the majority of members of which are elected by GTS. The joint
venture expires
88
in March 2021, and profits and losses are allocated according to ownership
interests, in consideration of funds at risk. See "Management's Discussion and
Analysis -- Accounting Methodology -- Profit and Loss Accounting."
India
In India, GTS is following the strategy it implemented in Moscow and is
currently pursuing in Central Europe, in which it initially penetrates the
telecommunications market by developing satellite-based international gateway
networks to provide telecommunications services to targeted business customers.
GTS's operations in India are conducted through C-Datacom International, Inc.
("CDI"), a wholly owned subsidiary which provides digital international private
line communications to and from India for multiple applications, including data
and voice. While not permitted to provide telephony services, CDI is currently
in the process of installing an international gateway switch adjacent to
GTS-Monaco Access's international gateway for the purpose of handling
international traffic.
EMPLOYEES
On September 30, 1997, GTS employed a total of 166 persons. On September
30, 1997, the joint ventures in which GTS participates employed approximately
1,400 persons. The Company believes its future success will depend on its
continued ability to attract and retain highly skilled and qualified employees.
The Company believes that its relations with its employees are good.
Although GTS's employees are not unionized, unions represent employees of
the Company's railroad partners in HER. Under the agreements contemplated
between HER and its railroad partners, some of these employees will be required
to construct and maintain certain portions of the HER network. There can be no
assurances that unionized employees of HER's partners will not experience labor
unrest.
PROPERTIES
The Company's physical properties include owned and leased space for
offices, storage and equipment rooms and collocation sites. Additional equipment
rooms will be leased as networks are expanded. GTS maintains regional
headquarters offices in Moscow and Budapest, as well as facilities in McLean,
Virginia and London. Hermes is headquartered just outside of Brussels, Belgium.
LITIGATION
In addition to routine legal proceedings incidental to the conduct of its
business, the Company, GTS-Hungaro and GTS-Hungary are named as defendants in an
action captioned USH Ventures and USH Telecom, L.L.C. v. Global TeleSystems
Group, Inc. and GTS-Hungaro, Inc., Civil Action No. 97C-08-86, commenced in
August 1997, which is currently pending in the Superior Court of the State of
Delaware in and for New Castle County. The complaint alleges breach of contract
and interference with a business relationship. While it is not possible at this
time to make a meaningful assessment of the outcome of this litigation, based
upon information currently available and upon consultation with counsel, the
Company does not believe that the outcome of this litigation will have a
material adverse effect upon the financial condition of the Company.
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MANAGEMENT
The directors, executive officers and key employees of the Company, their
positions and their ages are as follows:
Name Age Positions
---- --- ---------
Alan B. Slifka(1)(3)(4)................. 68 Chairman of the Board of Directors
Gerald W. Thames(1)..................... 50 President, Chief Executive Officer and Director
Bruno d'Avanzo.......................... 56 Executive Vice President and Chief Operating
Officer
William H. Seippel...................... 41 Executive Vice President of Finance and Chief
Financial Officer
Jan Loeber.............................. 53 Senior Vice President -- HER
Raymond I. Marks........................ 51 Senior Vice President -- Asia
Stewart P. Reich........................ 53 Senior Vice President -- Russia
Louis T. Toth........................... 55 Senior Vice President -- Central Europe
Grier C. Raclin......................... 45 Senior Vice President, General Counsel and
Secretary
N.S. Molberger.......................... 42 Senior Vice President -- Law and Development
Eileen K. Sweeney....................... 46 Senior Vice President -- Human Resources
Kevin Power............................. 44 Managing Director -- GTS-Monaco Access
Gary Gladstein(2)....................... 52 Director
Michael A. Greeley(4)................... 34 Director
Bernard McFadden(3)..................... 64 Director
Stewart J. Paperin(2)(3)................ 49 Director
W. James Peet(1)(4)..................... 42 Director
Jean Salmona(3)......................... 61 Director
Morris A. Sandler(2)(4)................. 51 Director
Joel Schatz(2).......................... 60 Director
Adam Solomon(2)(4)...................... 44 Director
(1) Member of Executive Committee
(2) Member of Audit Committee
(3) Member of Compensation Committee
(4) Member of Finance Committee
Biographical information on each of the foregoing officers follows:
Alan B. Slifka, Chairman of the Board of Directors. Mr. Slifka has served
as a director of GTS since 1990. Mr. Slifka is a New York investment banker and
the Managing Principal of Halcyon/Alan B. Slifka and Company LLC, an equity
asset management firm specializing in nontraditional investments, specifically
corporate event investing. Previously, Mr. Slifka was a partner of L.F.
Rothschild, Unterberg, Towbin from 1961 to 1982. He is a director of Pall
Corporation and is active in other business, civic and philanthropic affairs as
founder, director or officer of numerous for-profit and not-for-profit
corporations and foundations. Mr. Slifka served as acting Chief Executive
Officer of GTS during most of 1993.
Gerald W. Thames, President, Chief Executive Officer and Director. Mr.
Thames joined GTS as Chief Executive Officer in February 1994, and has served as
a director of GTS since February 1994. From 1990 to 1994, Mr. Thames was
President and Chief Executive Officer for British Telecom North America and
Syncordia, a joint venture company focused on the international outsourcing
market. Mr. Thames has spent over 18 years in senior positions with
telecommunications companies, where he was responsible for developing start-up
telecommunications companies, including 15 years with AT&T, where he rose to the
position of General Manager of Network Services for the Northeast Region of AT&T
Communications.
Bruno d'Avanzo, Executive Vice President and Chief Operating Officer. Mr.
d'Avanzo joined GTS as Executive Vice President and Chief Operating Officer in
August 1996. From 1994 to 1996, Mr. d'Avanzo was
90
Executive Vice President and Chief Operating Officer of Intelsat, the largest
telecommunications satellite operator in the world. From 1992 to 1994, Mr.
d'Avanzo was a senior executive with Olivetti Corporation, serving as Vice
President and General Manager -- Europe and as Vice President -- U.S., Canada
and South America. Mr. d'Avanzo also spent 15 years with Digital Equipment
Corporation, a diversified computer manufacturer where his last position was
Vice President -- European Sales and Marketing.
William H. Seippel, Executive Vice President of Finance and Chief Financial
Officer. Mr. Seippel joined GTS as Executive Vice President of Finance and Chief
Financial Officer in October 1996. From July 1992 to October 1996, Mr. Seippel
was Vice President -- Finance and Chief Financial Officer of Landmark Graphics
Corporation. From August 1990 to July 1992, Mr. Seippel was Director of Finance
for Covia, Inc., an affiliate of United Airlines. From April 1984 to August
1990, Mr. Seippel held the positions of Group Business Controller (1989 to
1990), Group Controller Sales/Marketing (1986 to 1989), and Product Line
Controller (1984 to 1986) with Digital Equipment Corporation, a diversified
computer manufacturer.
Jan Loeber, Senior Vice President -- HER. Mr. Loeber joined GTS in January
1995. From October 1992 to December 1994, Mr. Loeber was a Managing Director of
BT Securities Corporation. From April 1990 to September 1992, Mr. Loeber held
positions as Managing Director of Unitel Ltd. (now One 2 One) in the United
Kingdom, Group President of Nokia North America Inc., Vice President of ITT
Corporation, and Marketing and Product Management Director of ITT Europe. Mr.
Loeber also spent almost 10 years with AT&T, where his last position was
Executive Director, Bell Laboratories. Mr. Loeber has over 22 years of
experience in the telecommunications industry and an additional 9 years of
experience in information technology with the Pentagon, IBM and Chemical Bank of
New York.
Raymond I. Marks, Senior Vice President -- Asia. Mr. Marks joined GTS as
Senior Vice President -- Asia in July 1994. From October 1986 to June 1994, Mr.
Marks served as Vice President and General Manager of GTE Spacenet Corporation,
where he had overall responsibility for strategic planning, domestic and
international business development, creation of joint ventures and international
alliances, as well as the worldwide management of the marketing, sales and
technical support organizations. Mr. Marks has also served as Vice President for
the Digital Information Group for MCI Communications Corporation. Mr. Marks has
28 years of experience in the telecommunications and computer industries.
Stewart P. Reich, Senior Vice President -- Russia. Mr. Reich joined GTS as
President -- GTS Russia in September 1997. From September 1992 to August 1997,
Mr. Reich was President of UTEL, a joint venture of AT&T, Deutsche Telekom, PTT
Telecom (Netherlands), and Ukrtelecom (a Ukrainian telecommunications company)
which provides international and interregional telecommunications services in
Ukraine. From 1982 to 1992, Mr. Reich held various positions at AT&T where his
last position was Financial Manager, AT&T International Communications Switched
Services. Mr. Reich was also employed for 20 years with Western Electric Company
from 1961 to 1981.
Louis T. Toth, Senior Vice President -- Central Europe. Mr. Toth joined GTS
as Senior Vice President -- Central Europe in July 1993. From February 1987 to
July 1991, Mr. Toth served as President of Dynaforce Inc. and as Partner and
General Manager for the pan-European expansion of Andlinger & Company. Mr. Toth,
who is currently based in London, has 23 years of telecommunications experience
with ITT Corporation in Europe, Latin America and Asia.
Grier C. Raclin, Senior Vice President and General Counsel. Mr. Raclin
joined GTS as its Senior Vice President and General Counsel in September, 1997,
and was elected Secretary of the Company in December 1997. Prior to joining GTS,
Mr. Raclin served as Vice-Chairman and a Managing Partner of the Washington,
D.C. office of Gardner, Carton & Douglas, a 250-attorney, corporate law firm
based in Chicago, Illinois, where his practice was concentrated in the area of
international telecommunications. Mr. Raclin received his undergraduate and law
degrees from Northwestern University and attended the University of Chicago
School of Business Executive Program.
N.S. Molberger, Senior Vice President -- Law and Development. Mr. Molberger
joined GTS as General Counsel in July 1993 and served as Vice President and
General Counsel from April 1994 to January 1997. Prior to that, Mr. Molberger
was in private law practice.
91
Eileen K. Sweeney, Senior Vice President -- Human Resources. Ms. Sweeney
joined GTS as Senior Vice President -- Human Resources in November, 1997. Prior
to joining GTS, Ms. Sweeney was President of Global Resource Associates, a
consulting company specializing in international human resource issues. Prior to
that time, Ms. Sweeney spent 10 years with ITT Corporation in a variety of human
resource management positions, including eight years based in Europe and in the
Middle East. Ms. Sweeney holds a Master's Degree in Business Administration from
Simmons Graduate School of Management in Boston.
Kevin Power, Managing Director -- GTS Monaco Access. Prior to joining GTS
Monaco Access in October 1995, Mr. Power was Vice President, Carrier Relations
for the Company beginning in November 1994, where he was responsible for
assisting and coordinating the carrier activities of the GTS group of companies.
In 1988, Mr. Power was one of a group of five people who started the commercial
operations of Orion Network Systems and he stayed with the company until the
launch of its first satellite in 1994. His last position there was Vice
President of Carrier Services. Prior to that, he held positions with INTELSAT,
National Economic Research Associates (NERA) and the U.S. Department of
Commerce.
Biographical data on each of the directors, other than Mr. Thames, are as
follows:
Gary Gladstein, Director. Mr. Gladstein has served as a director of GTS
since December 1990. Mr. Gladstein is a Managing Director of Soros Fund
Management, an investment advisory firm with which he has been associated since
1985. Mr. Gladstein is also a director of Crystal Oil, Jos. A. Bank Clothier,
Inversiones y Representaciones S.A., Cresud S.A., Emerging Dolphin Fund and
Argentina High Yield and Capital Appreciation Fund Ltd.
Michael A. Greeley, Director. Mr. Greeley has served as a director of GTS
since September 1996. Mr. Greeley is the Senior Vice President of GCC
Investments, Inc., the investment group of GC Companies, Inc. From June 1989 to
July 1994, Mr. Greeley was a Vice President at Wasserstein Perella & Co., Inc.,
an international investment bank, specializing in mergers and acquisitions and
corporate finance transactions. Mr. Greeley is also a director of Teletrac,
Inc., Crescent Communications and American Capital Access Holdings, LLC. By
contractual arrangement, GCC Investments, Inc. has the right to designate one
person for nomination to the Board of Directors as long as it holds not less
than two and one-half percent of the issued and outstanding shares of the Common
Stock on a fully diluted basis. Mr. Greeley is the designee of GCC Investments,
Inc. to the Board of Directors.
Bernard McFadden, Director. Mr. McFadden has served as a director of GTS
since February 1994. Mr. McFadden currently serves as an independent consultant
for GTS and is a GTS representative on the supervisory board of HER. Mr.
McFadden's career in international telecommunications includes 32 years with ITT
Corporation, where he served as President and Chief Executive Officer of ITT's
Telecom International Group, and a four and one-half year assignment as
President and Chief Operating Officer of Alcatel Trade International, S.A.
Stewart J. Paperin, Director. Mr. Paperin has served as a director of GTS
since March 1997. Mr. Paperin serves as Executive Vice President of The Open
Society Institute, a charitable foundation associated with George Soros. In
addition, he has served as the President of Capital Resource East since October
1993. Prior to that, Mr. Paperin was President of Brooke Group International,
from 1990 to 1993 where he was responsible for investments in the former Soviet
Union. Mr. Paperin also served as Chief Financial Officer of Western Union
Corporation from 1989 to 1990. Mr. Paperin serves as a director of the Board of
Penn Octane Corporation.
W. James Peet, Director. Mr. Peet has served as a director of GTS since
January 1996. Mr. Peet has been affiliated with The Chatterjee Group, an
investment firm, since 1991. Mr. Peet is a director of three public companies:
Viatel Global Communications, Phoenix Information Systems, and Primus
Telecommunications, Inc. and several private companies. Immediately prior to
joining The Chatterjee Group, Mr. Peet spent six years with McKinsey & Company.
By contractual arrangement, The Chatterjee Group has the right to designate one
person for nomination to the Board of Directors to serve a term of five years.
Mr. Peet is the designee of The Chatterjee Group to the Board of Directors.
92
Jean Salmona, Director. Mr. Salmona has served as a director of GTS since
March 1996. Since 1989, Mr. Salmona has been Chairman and Chief Executive
Officer of CESIA Consulting Group ("CESIA"), a consulting concern based in
France that specializes in information and communications systems and
technologies. Mr. Salmona is also Chairman and Director General, Data for
Development International Association, a nongovernmental organization with
consultative status to the United Nations Economic and Social Council; and a
member of the board of directors of CESYS, a joint venture between CESIA and
COGEMA, the French State company which processes nuclear waste.
Morris A. Sandler, Director. Mr. Sandler has served as a director of GTS
since 1990. Mr. Sandler has been a consultant to GTS since November 1995. Prior
to that, Mr. Sandler was Executive Vice President of GTS from February 1994 to
November 1995, and acting Chief Operating Officer from April 1993 to February
1994. From August 1990 to April, 1993, Mr. Sandler was an employee of Alan B.
Slifka and Company. Since November 1995, Mr. Sandler has been a principal of
Pennwood Capital Corporation, a venture capital investment and management firm.
He has served as director of Baltic International USA, Inc. since 1995.
Joel Schatz, Director. Mr. Schatz has served as a director of GTS since the
inception of the Company. Mr. Schatz was a founder of the Company and served as
its President from 1985 to 1991. Mr. Schatz is presently the Chairman and Chief
Executive Officer of Datafusion, Inc., a company developing software to
accelerate knowledge synthesis.
Adam Solomon, Director. Mr. Solomon has served as a director of the Company
since June 1995. Mr. Solomon is also Chairman of Shaker Investments, Inc., a
growth equity investment firm and Chairman of Signature International, L.P., a
venture/development firm whose initial focus is redeveloping existing
residential/golf communities, and a member of the board of directors of MetaSolv
Software, Inc. Prior to that, Mr. Solomon spent eleven years with E.M. Warburg,
Pincus & Co., Inc., where he was Managing Director from 1988 to 1992. While at
E.M. Warburg, Pincus & Co., Inc., Mr. Solomon served as a member of the board of
directors of LCI International, Inc., a regional long-distance carrier.
EXECUTIVE COMPENSATION AND OTHER INFORMATION
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
Prior to the completion of the Offerings, each director of GTS received an
annual director's fee of $10,000. In addition, each director of GTS who attended
any meetings of the Board of Directors was entitled to receive a director's fee
of $1,000 for each such meeting, and each director of GTS who attended a
committee meeting was entitled to a directors' fee of $750 for each such
committee meeting.
Upon completion of the Offerings, each director of GTS will receive an
annual directors' fee of $15,000. In addition, the fee for attending any meeting
of the Board of Directors will increase to $1,500 per meeting, except for
telephonic Board of Directors meetings of two hours or less, where the fee will
be decreased to $750 for each such meeting. Similarly, upon the completion of
the Offerings, each director who attends a committee meeting will be entitled to
a directors' fee of $1,000 per meeting, except for telephonic committee meetings
of a duration of two hours or less, for which a fee of $500 will be paid.
For the year ended December 31, 1996, the aggregate compensation paid by
the Company to its directors and executive officers for services in all
capacities was approximately $3.1 million.
GTS maintains the Global TeleSystems Group, Inc. Non-Employee Directors'
Stock Option Plan that permits directors to share in the growth of the value of
GTS through the grant and exercise of nonqualified stock options. See "-- Global
TeleSystems Group, Inc. Non-Employee Directors' Stock Option Plan."
93
GLOBAL TELESYSTEMS GROUP, INC. NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
The purpose of the Global TeleSystems Group, Inc. Non-Employee Directors'
Stock Option Plan (the "Directors' Plan") is to permit eligible non-employee
directors of GTS (each a "Non-Employee Director") to share in the growth of the
value of GTS through the grant and exercise of nonqualified stock options.
The total number of shares of Common Stock presently reserved and available
for delivery under the Directors' Plan is 375,000, subject to adjustment upon
certain changes in capitalization. Upon completion of the Offerings, an
additional 900,000 shares of Common Stock, totalling 1,275,000 shares, will be
reserved and available under the Directors' Plan. The Directors' Plan is
administered by the compensation committee of the Board of Directors (the
"Committee"). Only directors of GTS who are not employees of GTS or any
subsidiary of GTS on the date on which an option is to be granted are eligible
to participate in the Directors' Plan on such date.
An option (a "Directors' Option") to purchase shares of Common Stock was
granted to each Non-Employee Director on the effective date of the Directors'
Plan and a Director's Option is granted to each new Non-Employee Director when
he or she is first elected or appointed to serve as a director of GTS. One-half
of the Directors' Options vests six months after the date of grant. An
additional one quarter become exercisable on the date six months following the
first annual meeting of GTS's shareholders to occur after such date of grant,
and the remaining one quarter shares become exercisable on the date six months
following the second annual meeting of GTS's shareholders to occur after such
date of grant. Prior to the completion of the Offerings, initial Directors'
Options represented 18,000 shares of Common Stock. After the completion of the
Offerings, an initial Directors' Option will represent 22,250 shares of Common
Stock. On the date of the third annual meeting of GTS's shareholders following
the grant of the initial Directors' Options to any Non-Employee Director,
provided that such Non-Employee Director remains an incumbent on such date, an
additional Directors' Option to purchase 13,500 shares of Common Stock is
granted to such Non-Employee Director. The second Directors' Options become
exercisable with respect to 4,500 shares on the date six months after the date
of grant, with respect to an additional 4,500 shares on the date six months
following the first annual meeting of GTS's shareholders to occur after such
date of grant, and with respect to the final 4,500 shares on the date six months
following the second annual meeting of GTS's shareholders to occur after such
date of grant. After the completion of the Offerings, on the date of each annual
meeting of GTS's shareholders, an additional Directors' Option to purchase 9,000
shares will be granted each year on the date of the Company's annual meeting to
the individuals who will serve as elected Non-employee Directors of the Company
during the next year.
Directors' Options are nonqualified stock options which are subject to
certain terms and conditions including those summarized below. The exercise
price per share of Common Stock purchasable under a Directors' Option will be
equal to 100% of the fair market value of Common Stock on the date of grant.
Each Directors' Option will expire upon the earliest of (a) the tenth
anniversary of the date of grant, (b) one year after the Non-Employee Director
ceases to serve as a director of GTS due to death or disability, (except that,
in the case of disability, if the Non-Employee Director dies within that
one-year period, the Directors' Option is exercisable for a period of one year
from the date of death), (c) three months after the Non-Employee Director ceases
to serve as a director of GTS for any reason other than death or disability,
(except that, if the Non-Employee Director dies within that three-month period,
his or her Directors' Options are exercisable for a period of one year from the
date of such death), and (d) three months after the Non-Employee Director ceases
to be employed by GTS if such Non-Employee Director had become an employee of
GTS (except that, if the Non-Employee Director dies within that three-month
period, his or her Directors' Options are exercisable for a period of one year
from the date of such death). Each Directors' Option may be exercised in whole
or in part by giving written notice of exercise to GTS specifying the Directors'
Option to be exercised and the number of shares to be purchased. Such notice
must be accompanied by payment in full of the exercise price in cash or by
surrender of shares of Common Stock or a combination thereof. Directors' Options
granted under the Directors' Plan may not be sold, pledged, assigned or
otherwise disposed of in any manner other than by will or by the laws of descent
and distribution.
94
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.
95
EXECUTIVE COMPENSATION
The following table sets forth each component of compensation paid or
awarded to, or earned by, the chief executive officer and the four most highly
compensated executive officers other than the chief executive officer serving as
of December 31, 1996 (collectively, the "Named Executive Officers") for the year
ended December 31, 1996.
SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION
-----------------------
ANNUAL COMPENSATION AWARDS
----------------------- -----------------------
RESTRICTED SECURITIES
PAID OTHER ANNUAL STOCK UNDERLYING ALL OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION AWARD(S) OPTIONS COMPENSATION
POSITION ($) ($) ($) ($) (#) ($)(7)
------------------ -------- -------- ------------ ---------- ---------- ------------
Gerald W. Thames,.......... $325,000 $113,750 (1) -0- 37,500(5) 9,954
President and Chief
Executive Officer
Jan Loeber,................ 235,000 78,608 74,642(4) 20,000(5) 3.5(6) 12,986
Senior Vice President --
HER
Raymond I. Marks,.......... 230,091 46,200 (1) -0- 55,500(5) 13,788
Senior Vice President --
Asia
Henry A. Radzikowski,...... 208,750 42,000 226,060(2) -0- 55,500(5) 12,986
Senior Vice President and
Chief Executive
Officer -- CIS Operations
Louis T. Toth,............. 203,937 40,950 33,602(3) -0- 43,500(5) 13,004
Senior Vice President --
Central Europe
(1) Perquisites and other personal benefits paid to the Named Executive Officer
during fiscal year 1996 were less than the lesser of $50,000 and 10 percent
of the total of annual salary and bonus reported for the Named Executive
Officer.
(2) Mr. Radzikowski received a cost of living allowance totalling $96,000 during
fiscal year 1996. In addition, GTS paid approximately $122,376 in housing
expenses on behalf of Mr. Radzikowski. Mr. Radzikowski's successor as Chief
Executive Officer -- CIS and Eastern Europe Operations was Mr. Reich. Mr.
Radzikowski resigned in the second quarter of 1997.
(3) These amounts represent a cost of living allowance of $27,500 and paid home
leave of $6,102 paid to Mr. Toth during fiscal year 1996.
(4) Mr. Loeber received a cost of living allowance and paid home leave during
fiscal year 1996. HER provided Mr. Loeber with a tax equalization that
compensates him for the higher taxes he pays because he resides in Belgium
instead of the United States. Furthermore, HER provided Mr. Loeber with a
housing allowance equal to $31,836 per year (converted from Belgian Francs
to U.S. Dollars at an exchange rate of BF32.0392 = $1.00). In addition, HER
provides Mr. Loeber with the use of a company car.
(5) Stock options awarded under the 1992 Stock Option Plan.
(6) Stock options awarded under the GTS-Hermes Plan.
(7) Amounts hereunder represent premiums paid by GTS for $1,000,000 in term life
insurance for each Named Executive Officer and contributions by GTS under
the 401(k) Plan to each Named Executive Officer's account.
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THE GTS 401(k) PLAN
The GTS 401(k) Plan (the "401(k) Plan") is a defined contribution
retirement benefit plan that is qualified for favorable tax treatment under
Section 401 of the Code. All employees of GTS, including the Named Executive
Officers, who are at least 21 years of age and have completed the minimum
service requirement are eligible to participate in the 401(k) Plan. The 401(k)
Plan participants may defer pre-tax income by contributing to the plan up to the
maximum amount permitted by law. After-tax contributions are also permitted
under the 401(k) Plan. GTS matches 50% of each participant's pre-tax
contribution to the 401(k) Plan up to 5% of the participant's total
compensation. In addition, GTS may, in its sole discretion and in a
nondiscriminatory manner, contribute additional amounts as profit sharing to
each participant's account. The amounts that are deposited into each
participant's account are invested among various investment options according to
the direction of the participant. Each participant's pre-tax and after-tax
contributions are immediately vested and nonforfeitable. GTS's matching
contribution and profit sharing allocations to each participant's account do not
vest until the participant has completed three years of service with GTS, at
which time the matching contribution and profit sharing allocations become 100%
vested. Each participant is eligible to begin receiving benefits under the
401(k) Plan on the first day of the month coincident with or following the
attainment of normal retirement age. There is no provision for early retirement
benefits under the 401(k) Plan.
THE SFMT, INC. EQUITY COMPENSATION PLAN
The purpose of the SFMT, Inc. Equity Compensation Plan (the "Equity
Compensation Plan") is to attract, retain and motivate key employees, officers
and eligible independent contractors of GTS and to enable such individuals to
own Common Stock and to have a mutuality of interest with other shareholders of
GTS through the grant of restricted stock and other equity-based awards.
The total number of shares of Common Stock that may be issued or
transferred under the Equity Compensation Plan is four percent of the total
number of shares of Common Stock outstanding at the beginning of the calendar
year, subject to certain adjustments, which are described below. This threshold
number may be increased by the number of shares (a) that were issued under the
Equity Compensation Plan with respect to which no dividends were paid and (b)
that were subsequently forfeited, in accordance with the terms of the Equity
Compensation Plan.
The Equity Compensation Plan is administered by the Committee. The chief
executive officer of GTS has the authority to recommend the individuals to whom
awards will be granted, subject to approval by the Committee. The Committee has
full and binding authority to determine the fair market value of the Common
Stock and the number of shares included in any awards, to establish terms and
conditions of any award, to interpret the Equity Compensation Plan, to prescribe
rules relating to the Equity Compensation Plan and to make all other
determinations necessary to administer the Equity Compensation Plan. The
Committee may condition the vesting of restricted stock upon the attainment of
specified performance goals or such other factors as the Committee may determine
in its sole discretion. In the event that the Committee determines, in its sole
discretion, that an award of restricted stock would not be appropriate with
respect to any individual who has been recommended for an award by the chief
executive officer, the Committee has the authority to grant to any such
individual any other variety of equity-based compensation award, including, but
not limited to, phantom stock, phantom units, stock appreciation rights,
performance shares and performance units. The Committee does not, however, have
the authority to grant stock options pursuant to the Equity Compensation Plan.
Grants under the Equity Compensation Plan are determined by the Committee
in its sole discretion. For this reason, it is not possible to determine the
benefits or amounts that will be received by any individual employee or group of
employees in the future. The Equity Compensation Plan will remain effective
until November 14, 2004, unless earlier terminated by GTS. No restricted stock
may be granted under the Equity Compensation Plan on or after November 14, 2000.
During a specified period set by the Committee commencing with the date of
any restricted stock award, the participant is not permitted to sell, transfer,
pledge or otherwise encumber shares of restricted stock.
97
Within these limits, the Committee, in its sole discretion, may provide for the
lapse of such restrictions or may accelerate or waive such restrictions in whole
or in part, based on service, performance and such other factors. Unless the
Committee specifically determines otherwise, a restricted stock award granted
under the Equity Compensation Plan vests one-third on the second anniversary of
the date of grant, one-third on the third anniversary of the date of grant and
one-third on the fourth anniversary of the date of grant.
The Committee may impose such other restrictions on shares of Common Stock
issued under the Equity Compensation Plan, including a right of first refusal by
GTS that requires the participant to offer GTS any shares that the participant
wishes to sell.
The Equity Compensation Plan provides that, in the event of a change to the
Common Stock (whether by reason of merger, consolidation, reorganization,
recapitalization, stock dividend, stock split, combination or exchange of
shares, or other change in the capital structure made without receipt of
consideration), the Board of Directors will preserve the value of outstanding
awards by making certain equitable adjustments in its discretion.
The Board of Directors may amend, alter, suspend, discontinue or terminate
the Equity Compensation Plan at any time, except that any such action will be
subject to the approval of GTS shareholders at the first annual meeting
following such action if such shareholder approval is required by any federal or
state law or regulation or the rules of any stock exchange or automated
quotation system on which Common Stock may then be listed or quoted, or if the
Board of Directors determines in its discretion to seek such shareholder
approval.
THE AMENDED AND RESTATED 1992 STOCK OPTION PLAN OF GLOBAL TELESYSTEMS GROUP,
INC.
In 1992, the Board of Directors approved the adoption of the 1992 Stock
Option Plan of Global TeleSystems Group, Inc. (the "1992 Option Plan") for key
employees of GTS. The purpose of the 1992 Option Plan is to enable GTS to
attract and retain the best personnel for positions of substantial
responsibility, to provide additional incentives to employees of GTS and its
subsidiaries and to promote the success of the business of GTS and its
subsidiaries by providing certain employees with an ownership interest in the
Company.
The total number of shares of Common Stock that may be subject to options
granted under the 1992 Option Plan (the "1992 Options") is generally 18.5% of
the total number of shares of Common Stock outstanding at the beginning of the
calendar year.
The 1992 Option Plan is administered by the Committee, which must be
composed of not less than two members of the Board of Directors who are
"non-employee directors" within the meaning of Rule 16b-3 of the Exchange Act.
The Committee has full and binding authority to determine the fair market value
of the Common Stock, the exercise price of options to be granted, the persons to
whom and the times at which options will be granted and the number of shares to
be represented by each option. The Committee also has full and binding authority
to interpret the 1992 Option Plan, to prescribe rules relating to the 1992
Option Plan, to establish terms and conditions of each 1992 Option and to make
all other determinations necessary to administer the 1992 Option Plan.
The 1992 Option Plan will remain effective until November 14, 2004, unless
earlier terminated by GTS. Grants under the 1992 Option Plan are determined by
the Committee in its sole discretion. For this reason, it is not possible to
determine the benefits or amounts that will be received by any individual
employee or group of employees in the future.
The 1992 Option Plan authorizes the grant of both nonqualified options,
which are not qualified for special tax treatment, and incentive stock options
("ISOs"), which qualify for special federal income tax treatment under Section
422 of the Code. The exercise price per share of Common Stock issuable pursuant
to an ISO may not be less than 100% of the fair market value of Common Stock on
the date of grant. Unless otherwise specified in any respective option
agreement, a nonqualified 1992 Option will expire ten years and one day after
the date of grant and an ISO will expire ten years from the date of grant. Each
person granted 1992 Options shall be provided with an option agreement setting
forth the terms of each grant pursuant to the
98
1992 Option Plan. Unless the Committee specifically determines otherwise, each
1992 Option vests one-third on each of the first three anniversaries of the date
of grant. The full purchase price of the shares must be paid, either in cash, by
delivery of previously owned shares, or by withholding of shares having a fair
market value equal to the 1992 Option exercise price or by such other method
approved by the Committee. Each 1992 Option expires (a) 30 days after the option
holder ceases to be an employee of GTS for any reason other than death,
disability or retirement, (b) one year from the date of death or disability of
an employee, or (c) 90 days following retirement of the employee. 1992 Options
may not be sold, pledged, assigned or otherwise disposed of in any manner other
than by will or by the laws of descent and distribution.
The Committee may impose such other restrictions on shares of Common Stock
issued under the 1992 Option Plan, including a right of first refusal by GTS. In
addition, if the amount of any payment under the 1992 Option Plan, either
separately or in combination with any other payment by GTS, would constitute an
excess parachute payment within the meaning of Section 280G of the Code, the
total payments payable under the 1992 Option Plan will be reduced in order to
maximize the amount received by the participant under the 1992 Option Plan in
combination with other payments by GTS.
The 1992 Option Plan provides that, in the event of a change to the Common
Stock (whether by reason of merger, consolidation, reorganization,
recapitalization, stock dividend, stock split, combination of shares or exchange
of shares, or other change in the capital structure made without receipt of
consideration), the Board of Directors will, in its discretion, preserve the
value of outstanding 1992 Option Plan awards by making certain equitable
adjustments.
The Board of Directors may amend, alter, suspend, discontinue, or terminate
the 1992 Option Plan at any time, except that any such action will be subject to
the approval of GTS shareholders at the first annual meeting following such
Board of Directors action if such shareholder approval is required by any
federal or state law or regulation or the rules of any stock exchange or
automated quotation system on which Common Stock may then be listed or quoted,
or if the Board of Directors determines in its discretion to seek such
shareholder approval.
THE GTS 1996 TOP TALENT RETENTION PROGRAM
GTS implemented the GTS 1996 Top Talent Retention Program (the "Program")
which, for 1996 only, alters the terms offered to certain employees under the
1992 Option Plan. Employees who are offered participation in the Program must
sign a "retention agreement," the terms of which are described below, in order
to receive any 1992 Options during 1996. The Program has been offered to
approximately 28 employees, and it provides that any 1992 Options granted to
such participants will vest as follows: (i) one-half of any 1992 Option granted
under the Program will vest at a rate of 25% per year beginning on the first
anniversary of the initial date of grant and (ii) the remaining portion of any
1992 Option granted under the Program will vest one-quarter according to the
achievement of performance revenue levels, and one-quarter according to the
achievement of price levels of Common Stock, provided that all options will vest
on the fifth anniversary of the date of grant regardless of whether such
performance revenue and pricing levels are attained.
99
OPTION GRANTS IN THE LAST FISCAL YEAR -- 1992 STOCK OPTION PLAN
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($)
---- ---------- ------------ ------------ ---------- ----------
Gerald W. Thames........................ 112,500(1) 7.3 $10.27 3-30-06 $1,155,000
Henry A. Radzikowski.................... 55,500(1) 3.6 10.27 3-30-06 569,800
Louis T. Toth........................... 43,500(1) 2.8 10.27 3-30-06 446,400
Raymond I. Marks........................ 55,500(1) 3.6 10.27 3-30-06 569,800
Jan Loeber.............................. -- -- -- -- --
(1) Stock options were awarded under the 1992 Stock Option Plan. Each option
vests one-third on each of the first three anniversaries of the date of
grant.
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES -- 1992 STOCK OPTION PLAN
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FY-END(#)(1) AT FY-END($)(2)
----------------------- ---------------------
EXERCISABLE/ EXERCISABLE/
NAME UNEXERCISABLE UNEXERCISABLE
---- ------------- -------------
Gerald W. Thames........................ 575,000/287,501 $5,538,540/$1,103,336
Henry A. Radzikowski.................... 89,801/310,100 857,883/ 2,679,717
Louis T. Toth........................... 186,549/122,601 1,883,386/ 788,677
Raymond I. Marks........................ 144,996/195,504 1,301,667/ 1,186,033
Jan Loeber.............................. -- --
(1) No options were exercised during the year ended December 31, 1996.
(2) Based on $13.33 per share value of Common Stock as of December 31, 1996 less
the exercise price.
GTS-HERMES, INC. 1994 STOCK OPTION PLAN
The GTS-Hermes, Inc. 1994 Stock Option Plan (the "GTS Hermes Plan") was
adopted by the board of directors of GTS-Hermes, Inc. ("GTS-Hermes") in 1994 to
enable employees of GTS-Hermes and its subsidiaries, including HER, and
affiliates to participate in ownership of GTS-Hermes and to attract and retain
key employees of particular merit. The GTS-Hermes Plan provides for the award of
incentive stock options, nonqualified stock options and stock appreciation
rights. All employees of GTS-Hermes and its subsidiaries, including HER, and
affiliates are eligible to participate in the GTS-Hermes Plan.
The maximum number of shares authorized with respect to grants of awards
under the GTS-Hermes Plan in each calendar year is 6.5% of the shares of common
stock, par value $0.01 per share, of GTS-Hermes issued and outstanding, and the
aggregate number of shares of stock subject to the GTS-Hermes Plan is 13% of the
total shares of stock issued and outstanding. The GTS-Hermes Plan is
administered by a committee appointed by the board of directors of GTS-Hermes,
which has broad discretion to determine who shall receive awards under the
GTS-Hermes Plan and the characteristics of any award thereunder, including the
price, term and vesting of such award, and to interpret the terms of the
GTS-Hermes Plan and awards granted under the GTS-Hermes Plan. Stock appreciation
rights may not be awarded alone and may only be awarded in tandem with an option
grant.
The GTS-Hermes Plan provides that in the event of a change in control, as
defined under the GTS-Hermes Plan, any stock appreciation rights outstanding for
at least six months and any stock options awarded under the GTS-Hermes Plan not
previously exercisable and vested which have been held for at least six months
from the date of grant will become fully vested and exercisable at an adjusted
price to be determined
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according to the highest sales price per share paid in any transaction reported
or offer made at any time during the preceding 60 days as determined by the
committee.
The board of directors of GTS-Hermes may amend, alter or discontinue the
GTS-Hermes Plan at any time, provided that the rights of participants are not
impaired, except that shareholder approval is necessary for certain material
modifications.
HER intends to establish a stock option plan to replace the GTS-Hermes Plan
for the purpose of incentivizing HER key employees, in substantially similar
form to the GTS-Hermes Plan. The aggregate number of shares of HER stock subject
to the proposed plan would be approximately 13% of the total shares of HER stock
issued and outstanding including options. Grants under the GTS-Hermes Plan would
be converted into grants under the proposed HER plan. Upon establishment of such
plan, the GTS-Hermes Plan would be terminated.
OPTION GRANTS IN THE LAST FISCAL YEAR -- GTS-HERMES PLAN(1)
POTENTIAL
REALIZABLE VALUE AT
ASSUMED ANNUAL
NUMBER OF % OF TOTAL RATES OF STOCK
SECURITIES OPTIONS PRICE APPRECIATION
UNDERLYING GRANTED IN EXERCISE OR FOR OPTION TERM(2)
OPTIONS EMPLOYEES IN BASE EXPIRATION -------------------
NAME GRANTED(#) FISCAL YEAR PRICE($/SH.) DATE 5% ($) 10% ($)
---- ---------- ------------ ------------ ---------- ------ -------
Jan Loeber(3)........................... 3.5 53.8 $57,142.86 2007 N/A N/A
(1) Stock options are for GTS-Hermes stock pursuant to the GTS-Hermes Plan. Each
stock option vests one-third on each of the first three anniversaries of the
date of grant. HER intends to establish a new stock option plan to replace
the GTS-Hermes Plan during the fourth quarter of 1997. The new plan, the Key
Employee Stock Option Plan of Hermes Europe Railtel B.V. (the "New Plan"),
and the stock option agreements that will be issued pursuant thereto have
been drafted and are pending final approval and execution. The options
outstanding under the GTS-Hermes Plan will be converted into options under
the New Plan as soon as practicable after such plan becomes effective.
(2) Due to the high exercise price of the options granted under the GTS-Hermes
Plan and the relatively low value of GTS-Hermes shares, GTS and GTS-Hermes
have agreed that it is reasonable to set the potential realizable value of
the options at zero with respect to the assumed annual rates of stock price
appreciation of 5% and 10% for the term of the options.
(3) In 1995, Jan Loeber was granted 3.5 shares.
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND
FISCAL YEAR-ENDED OPTION VALUES -- GTS-HERMES PLAN
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FY-END(#) AT FY-END($)(1)
------------------------- -------------------------
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ------------------------- -------------------------
Jan Loeber.............................. 1.167/5.833 N/A
(1) Due to the high exercise price of the options granted under the GTS-Hermes
Plan and the relatively low value of GTS-Hermes shares, GTS and GTS-Hermes
have agreed that it is reasonable to set the potential realizable value of
the options at zero with respect to the assumed annual rates of stock price
appreciation of 5% and 10% for the term of the options.
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EMPLOYMENT AGREEMENTS
GTS has executed employment agreements (together, the "Employment
Agreements") with all the Named Executive Officers. The agreements with Messrs.
Thames, Radzikowski and Marks include a three-year term of employment commencing
on April 1, 1996. Mr. Radzikowski resigned from the Company in the second
quarter of 1997. The agreements with Mr. Toth and Mr. Loeber include a two-year
term of employment commencing on April 1, 1996 and January 3, 1995,
respectively. All the Employment Agreements provide for the automatic renewal of
the term for additional one-year periods after the initial term unless written
notice of intent to terminate is provided by either party within a stated period
of between 120 days and six months prior to the renewal date. The salary of each
Named Executive Officer is reviewed yearly and may be increased at the sole
discretion of the Board of Directors. In addition to salary, each Named
Executive Officer is eligible for a performance-based annual bonus, to
participate in the GTS 1992 Stock Option Plan (with the exception of Mr. Loeber
whose employment agreement provides him with an option grant under the
GTS-Hermes Plan), to receive standard health and insurance benefits that are
provided to executives of GTS, to receive certain other fringe benefits and to
be reimbursed for all reasonable expenditures incurred in the execution of each
Named Executive Officer's respective duties. In addition, Mr. Loeber's
employment agreement provides him with 20,000 shares of restricted stock that
vest in an amount of one-third each year for three years beginning on January 2,
1997.
The performance-related bonuses are discretionary annual bonuses. Mr.
Loeber's bonus is based on a comparison of the projected to the actual
performance of HER during any given fiscal year. The maximum amount of Mr.
Loeber's bonus is a percentage of his salary that is determined by the Board of
Directors in its sole discretion. The bonus awards for Messrs. Thames, Marks and
Toth are based on the achievement of performance goals by a combination of both
GTS and the pertinent named Executive Officer and are determined each year by
the compensation committee. The amount of the performance-based bonuses awarded
to Messrs. Marks and Toth may equal up to 30% of the executive's salary for the
year. Mr. Thames may receive a performance-based bonus of up to 100% of his
salary for the year.
Each Employment Agreement may be terminated by GTS by giving notice of
intent to not extend the term of employment, for cause or as a result of the
Named Executive Officer's permanent disability. In the event that the employment
relationship is terminated due to the employee's disability or death or if GTS
provides notice of its intent not to renew the term of employment, GTS shall pay
to the Named Executive Officer or to the Named Executive Officer's estate, as
the case may be, the salary and bonus for the remaining portion of the fiscal
year in which the termination of employment occurs. In addition, if the Company
provides notice of its intent not to extend the term of employment, each Named
Executive Officer will receive assurances in an amount equal to his salary for
the greater of (a) the number of months or days in the notice period and (b) the
period during which the Named Executive Officer remains subject to the
restrictive covenants described below. If the Named Executive Officer is
terminated for cause or if he quits other than for the reasons stated above, he
shall not be entitled to any salary bonus or severance (other than accrued
salary).
Each Employment Agreement includes noncompetition and nonsolicitation
clauses that are effective during the term of employment and for a period of
from four months to one year thereafter. In addition, the Employment Agreements
include an unlimited covenant of confidentiality and nondisclosure. Any dispute
arising under an employment agreement must be resolved through arbitration,
except that each agreement also provides for specific performance and for a
court injunction in the event of a breach by the Named Executive Officer.
102
CERTAIN RELATED PARTY TRANSACTIONS
Alan B. Slifka, the Chairman of the Board of Directors, owns an interest in
an office building in New York in which GTS leased office space until the
corporate headquarters were moved to McLean, Virginia on March 1, 1995. GTS
retains a small office space in New York City that is leased from Mr. Slifka on
a monthly basis, and the annual expense for 1996 was $40,600. Mr. Slifka also
has a consulting agreement with GTS pursuant to which he is paid consulting fees
of $100,000 per year.
Bernard McFadden, Director, has a consulting agreement with GTS pursuant to
which he is paid $100,000 in consulting fees each year.
In August and September 1997, affiliates of George Soros and Mr. Slifka
purchased 319,149 and 57,015 shares of Common Stock, respectively, at a price of
$15.67 per share in the Company's private stock offering. In addition,
affiliates of Mr. Slifka purchased $2.9 million of Convertible Bonds in
September 1997. Pursuant to the terms of the indenture related to the
Convertible Bonds, the Convertible Bonds will be convertible into such shares of
Common Stock as is equal to the principal amount of such Convertible Bonds
divided by the applicable conversion price, which conversion price shall be
equal to the public offering price of the Common Stock in the Offerings. See
"Description of Certain Indebtedness."
Affiliates of Soros Fund Management purchased $40 million of notes from GTS
in 1996, which notes bear interest at 10% per annum, in partial consideration of
which (i) W. James Peet was appointed to the Board of Directors and (ii) the
affiliates received warrants to purchase 4,444,443 shares of Common Stock.
Together with their prior equity interests in GTS, these affiliates currently
hold, on a fully diluted basis (excluding shares underlying stock options), in
excess of 26.6% of the Company's Common Stock. In accordance with the terms of
the warrant agreement, the exercise price of the warrants was reduced from
$10.27 per share to $9.33 per share as the outstanding debt had not been repaid
prior to December 31, 1996. In addition, these affiliates collect a monitoring
fee of $40,000 per month, which they will continue to collect until the
consummation of the Offerings, at which point it will be reduced to $25,000.
Under certain agreements, these affiliates have the right to co-invest with GTS
in all of its new ventures throughout Asia, excluding countries in the former
Soviet Union, and pursuant to this right, one of these affiliates holds a 25%
interest in GTS China Investments LLC. See "Business -- Asia."
Affiliates of Capital Research International purchased $30 million of notes
from GTS in 1996, which notes bear interest at 10% per annum, in partial
consideration of which it received warrants to purchase 3,333,333 shares of
Common Stock. In accordance with the terms of the warrant agreement, the
exercise price of the warrants was reduced from $10.27 per share to $9.33 per
share as the outstanding debt had not been repaid prior to December 31, 1996.
Jean Salmona, a director of GTS, is the Chairman and Chief Executive
Officer of CESIA. CESIA also provides consultancy services for CDI and for HER.
The Company paid $123,685 in 1996 and $0 in both 1995 and 1994 to CESIA for
consulting services related to CDI. In addition, HER paid $84,270 in 1996 and $0
in both 1995 and 1994 to CESIA for consulting services. Further, the Company
paid $2,314 and $5,443 to CESIA in 1996 and 1997, respectively, pursuant to the
purchase agreement with CESIA related to the CDI business.
Pursuant to a 1995 purchase agreement, the Company received its interest in
GTS-Vox Limited, the intermediate holding company of TCM, in exchange for a note
in the principal amount of $693,380 issued to the sellers and certain additional
consideration to its partners payable in the form of either cash or Common Stock
based upon its financial performance. The Company paid the note in 1996. On
January 17, 1997, the agreement was amended such that the consideration would
only be in the form of the issuance of Common Stock and as such, GTS is
obligated under these arrangements to issue up to a maximum of 1,121,640 shares
of Common Stock. In the first quarter of 1997, pursuant to this agreement the
Company issued 504,600 common shares, which was valued at the Company's current
fair market value of $13.33 per share. 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
103
obligations are at the following prices: (i) if shares of Common Stock are then
being publicly traded, at the average trading price of such shares for the 10
trading days preceding such repurchase or (ii) if shares of Common Stock are not
then publicly traded, at the price shares of Common Stock were most recently
offered to individual investors in a private placement, or, if no such private
placement has occurred within the three months preceding the repurchase of such
shares, at a price determined by an independent financial institution to be
agreed upon by GTS and the seller. As a result of their receipt of shares of
Common Stock in 1997, the sellers became shareholders of GTS.
GTS purchased its interest in PrimTelefone, the Company's cellular
operations in the Primorsky region of Russia, from Commstruct International,
B.V. ("CIBV") for $500,000 cash and 400,000 shares of Common Stock of the
Company, as a result of which CIBV became a stockholder of the Company. Pursuant
to the asset purchase agreement relating to the purchase by GTS of its interest
in PrimTelefone, CIBV has the right to have some or all of its shares of Common
Stock repurchased, which right will terminate on the date when the Company first
sells shares of Common Stock to the public pursuant to an effective registration
statement under the Securities Act, by GTS over a five-year period at the
current fair market value of such shares at the time of such repurchase.
Affiliates of Baring International Investment Management Limited
("Barings"), which affiliates consist primarily of investment funds and trusts,
are shareholders of the Company and Barings may designate a non-voting observer
to attend meetings of the Board of Directors of the Company. Barings' observer
status terminates upon the consummation of an initial public offering of the
Company's Common Stock. In April 1996, GTS entered into an agreement with First
NIS Regional Fund SICAF, an affiliate of Barings, to organize GTS Ukrainian
TeleSystems, L.L.C. (the "LLC"), a Delaware limited liability company 60% owned
by GTS, which in turn entered into a stock purchase agreement to acquire 49% of
all the ownership interests in Bancomsvyaz, a Ukrainian limited liability
company. See "Business -- Russia and the CIS." Such acquisition closed in May
1996. By contractual arrangement, Barings designates one member of the board of
directors of Bancomsvyaz. Barings funded $4.5 million to be applied towards the
LLC's purchase of the interest in Bancomsvyaz and for the LLC's $1.5 million
contribution to the registered capital of Bancomsvyaz. Prior to March 1, 1999,
Barings may put its initial investment to GTS for $4.5 million, plus accrued
interest at 13.5% per annum, or, if GTS has consummated an initial public
offering of its Common Stock, may exercise an option to convert such investment
into 438,311 shares of Common Stock at an exercise price of $10.27. In June 1997
the agreement was amended, such that Barings funded an additional $4.1 million
to be applied toward Bancomsvyaz's capital expenditure and operating capital
requirements. On September 30, 2000, Barings may put that portion of its LLC
interest represented by the additional Barings investment to GTS for $4.1
million, or if GTS has consummated an initial public offering of its Common
Stock, may exercise an option to convert such additional investment into 275,000
Shares of Common Stock at an exercise price of $15.00.
104
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding ownership of
the Common Stock and rights to acquire Common Stock by (i) stockholders that
manage or own, either beneficially or of record, five percent or more of the
Common Stock of the Company, (ii) each of the Company's directors, (iii) each of
the Named Officers and (iv) all directors and executive officers of the Company
as a group as of September 30, 1997.
September 30, 1997
----------------------------
Number of
Shares Percentage
Beneficially Beneficially
Name of Beneficial Owner Owned(1)(2) Owned(1)
------------------------ ------------ ------------
George Soros affiliates..................................... 10,837,791(3) 25.8%
Alan B. Slifka and affiliates............................... 5,248,325(4) 14.0%
Capital Research International.............................. 5,347,620(5) 13.1%
Emerging Markets Management................................. 2,842,046(6) 7.6%
Morgan Stanley Asset Management............................. 2,243,316(7) 6.0%
Gary Gladstein.............................................. 22,500(8) *
Bernard McFadden............................................ 22,500 *
Michael A. Greeley.......................................... 9,000(9) *
Stewart J. Paperin.......................................... 9,000(8) *
W. James Peet............................................... 13,500(8) *
Jean Salmona................................................ 13,500 *
Morris A. Sandler........................................... 13,500 *
Joel Schatz................................................. 22,500 *
Adam Solomon................................................ 22,500 *
Gerald W. Thames............................................ 676,562 1.5%
Jan Loeber.................................................. 10,000 *
Raymond I. Marks............................................ 231,941 *
Henry A. Radzikowski........................................ 186,539 *
Louis T. Toth............................................... 256,538 *
All Directors and Executive Officers as a group (21
persons)............................................... 1,815,757 4.0%
Total of above.............................................. 28,334,855
Total shares on a fully diluted basis:...................... 45,384,590
* Less than 1%
(1) The percentage of ownership is based upon 45,384,590 shares, comprised of
37,606,814 shares of Common Stock issued and outstanding, and warrants to
purchase 7,777,776 of Common Stock. Excluded from the calculation are:
195,528 treasury shares; 5,556,282 shares of Common Stock issued to
employees under the Company's 1992 Option Plan, of which 2,594,906 are
vested at September 30, 1997; 772,500 options to purchase shares of Common
Stock issued to employees prior to the adoption of the Company's 1992 Option
Plan and options issued pursuant to the Directors' Plan and Equity
Compensation Plan; and an option to convert a debt put right to 713,311
shares of Common Stock.
(2) Includes shares of Common Stock issuable upon the exercise of stock options
and stock warrants within 60 days of September 30, 1997.
(3) Comprised of 3,074,199 shares of Common Stock held by the Soros
Foundation-Hungary; 1,125,000 shares of Common Stock held by the Soros
Charitable Foundation; 1,125,000 shares and warrants to purchase 3,333,333
shares of Common Stock held by The Open Society Institute; 500,000 and
250,000 shares of Common Stock held by Winston Partners II LDC and Winston
Partners II LLC, respectively; warrants to purchase 370,371, 185,184 and
555,555 shares of Common Stock held by Winston Partners II LDC, Winston
Partners II LLC and Chatterjee Fund Management, respectively, all of which
are affiliates of George Soros. The George Soros affiliates disclaim
ownership of the 22,500, 9,000 and 13,500 shares of Common Stock held by
Gary Gladstein, Stewart J. Paperin and W. James Peet, respectively.
105
(4) Included 2,563,784 shares of Common Stock owned by Mr. Slifka and shares of
Common Stock held in trust for a minor child; 2,513,041 shares of Common
Stock owned by various Halcyon Partnerships which are managed by
Halcyon/Alan B. Slifka Management Company LLC, of which Mr. Slifka is the
Managing Principal and over which Mr. Slifka disclaims beneficial ownership;
67,500 shares of Common Stock held by GTS 1995 Partners, LP; 4,500 shares of
Common Stock held by Kevah Konner; and 49,500 shares of Common Stock owned
by Randolf Slifka, Mr. Slifka's son and a principal of Halcyon/ Alan B.
Slifka Management Company LLC, over which Mr. Slifka disclaims beneficial
ownership.
(5) Includes 2,014,287 shares of Common Stock and warrants to purchase 3,333,333
shares of Common Stock held by funds managed by affiliates of Capital
Research International.
(6) Shares of Common Stock held by funds managed by Emerging Markets Management.
(7) Shares of Common Stock held by funds managed by Morgan Stanley Asset
Management.
(8) Gary Gladstein, Stewart J. Paperin and W. James Peet disclaim ownership of
shares of Common Stock held by the George Soros affiliates.
(9) Michael A. Greeley disclaims ownership of the 769,149 shares of Common Stock
owned by Chestnut Hill Telecom Inc., an affiliate of Mr. Greeley.
DESCRIPTION OF CERTAIN INDEBTEDNESS
CHATTERJEE NOTES AND CAPITAL RESEARCH NOTES
In 1996, the Company issued $40 million of notes (the "Chatterjee Notes")
to the Chatterjee Group, an affiliate of George Soros. In connection with the
issuance of the Chatterjee Notes, the Chatterjee Group received warrants (the
"Chatterjee Warrants") to purchase 4,444,443 shares of Common Stock. The
Chatterjee Warrants were initially issued with an exercise price of $10.27 per
share, which exercise price was subsequently reduced to $9.33 per share in
accordance with the terms of the warrant agreement. In addition, The Chatterjee
Group was granted the right to appoint, and has appointed, one member to the
Board of Directors and collects a monitoring fee of $40,000 per month, which it
will continue to collect until the Company completes the Offering. The
Chatterjee Group also has the right to co-invest with GTS in all of its new
ventures throughout Asia, excluding countries in the former Soviet Union, and
pursuant to this right has invested and holds a 25% interest in GTS China
Investments LLC. See "Business -- Asia -- Operations." The Chatterjee Notes bear
interest at 10% per annum and the principal is payable in 12 quarterly
installments commencing April 1, 1998.
In 1996, the Company also issued $30 million of notes (the "Capital
Research Notes") to affiliates of Capital Research International. In connection
with the issuance of the Capital Research Notes, Capital Research International
received warrants (the "Capital Research Warrants") to purchase 3,333,333 shares
of Common Stock. The Capital Research Warrants were initially issued with an
exercise price of $10.27 per share, which exercise price was subsequently
reduced to $9.33 per share in accordance with of the warrant agreement. The
Capital Research Notes bear interest at 10% per annum and the principal is
payable in 12 quarterly installments commencing April 1, 1998.
Both the Chatterjee Notes and the Capital Research Notes impose significant
covenants on the Company which covenants, among other things, limit the ability
of the Company and its subsidiaries to incur debt and pay dividends and require
the Company to maintain certain financial ratios.
The Company intends to use a portion of the net proceeds of the Offerings
to repay the Chatterjee Notes and the Capital Research Notes.
CONVERTIBLE BONDS
The Company sold approximately $144.8 million bonds ("Convertible Bonds")
in the Convertible Bond Offering. The Convertible Bonds have a three year
maturity and are unsecured, senior subordinated obligations of the Company. The
Convertible Bonds are issued pursuant to an indenture containing certain
covenants for the benefit of the holders of the Convertible Bonds, including,
among other things, covenants
106
limiting the incurrence of indebtedness, restricted payments, liens, payment
restrictions affecting certain subsidiaries and joint ventures, transactions
with affiliates, asset sales and mergers and combinations. In the event of a
change of control of the Company, holders of the Convertible Bonds have the
right to require GTS to purchase such holder's Convertible Bonds at prices
ranging from 106.5 percent of the principal amount if the date of redemption
occurs on or before June 30, 1998 to 121.0 percent of the principal amount if
the date of redemption occurs after June 30, 1999. The Convertible Bonds bear
interest at the rate of 8.75% per annum until maturity on June 30, 2000. The
Company has granted to the holders of the Convertible Bonds certain rights with
respect to the registration of the shares of Common Stock issuable upon
conversion of the Convertible Bonds.
Each Convertible Bond is convertible into such number of shares of Common
Stock as is equal to the principal amount of such Convertible Bond divided by
the applicable Conversion Price. The applicable Conversion Prices shall be
determined as follows: (i) where a Complying Public Equity Offering (as defined
herein) has not been preceded since the issuance of the Convertible Bonds by a
Non-Complying Equity Offering (as defined herein), the Conversion Price shall
equal the per share price to the public in the Complying Public Equity Offering,
provided, however, that a 7% or 15% discount will be given to Convertible Bond
holders from the per share price to the public if the Complying Public Equity
Offering occurs during the second or third year, respectively, from the date of
issuance of the Bonds; (ii) where a Complying Public Equity Offering has been
preceded by one or more Non-Complying Equity Offerings since the issuance of the
Convertible Bonds, the Conversion Price shall equal the lower of (a) the
dollar-weighted average conversion price for all of such Non-Complying Equity
Offerings and the Complying Public Equity Offering (as calculated for each such
offering at the gross per share offering price for the applicable offering,
provided, however, that a 7% or 15% discount will be included in the calculation
if the closing dates of such offerings occur during the second or third year,
respectively from the date of issuance of the Convertible Bonds) and (b) the
conversion price for the Complying Public Equity Offering (as calculated in (i)
above); (iii) where a Non-Complying Public Equity Offering of at least $50
million, which is not a Complying Public Equity Offering solely by reason of the
offering's failure to satisfy the $100,000,000 offering size condition for a
Complying Public Equity Offering, has not been preceded by a Complying Public
Equity Offering since the issuance of the Bonds and has been preceded by one or
more Non-Complying Equity Offerings, the Conversion Price shall equal the lower
of (a) the dollar-weighted average conversion price for all of such Non-
Complying Equity Offerings and the Non-Complying Public Equity Offering (as
calculated for each Non-Complying Public Equity Offering at the per share
offering price for the applicable offering, provided, however, that a 7% or 15%
discount will be included in the calculation if the closing dates of such
offerings occur during the second or third year, respectively from the date of
issuance of the Convertible Bonds) and (b) the conversion price for the
Non-Complying Public Equity Offering alone or (iv) in the case of any other
Non-Complying Equity Offering not provided for in clause (iii) above, where no
Complying Public Equity Offering has occurred since the issuance of the
Convertible Bonds, the Conversion Price shall equal the lowest conversion price
calculated for each Non-Complying Equity Offering (as calculated for each such
offering at the gross per share offering price provided, however, that a 7% or
15% discount will be included in the calculation if the closing dates of such
offerings occur during the second or third year from the date of issuance of the
Convertible Bonds).
There shall be excluded from the calculation of the applicable Conversion
Price any private equity offerings of Common Stock (made pursuant to an
exemption from registration under the Securities Act) aggregating no more than
$100 million in gross proceeds if such offering or offerings are consummated on
or prior to December 31, 1997 and certain private sales of the Common Stock to a
strategic purchaser so long as there has occurred a Complying Public Equity
Offering or a Non-Complying Equity Offering.
Outstanding Convertible Bonds are, subject to certain conditions,
redeemable at the option of the Company on or after the second anniversary of a
Complying Public Equity Offering, at the principal amount thereof plus accrued
interest, if any. At maturity the Convertible Bonds will be redeemed at their
principal amount plus accrued interest; however, in the event that a Complying
Public Equity Offering has not occurred, outstanding Convertible Bonds will be
redeemed at 121% of their principal amount, plus accrued interest, if any.
107
A "Complying Public Equity Offering" means a public offering of Common
Stock where, immediately following completion thereof, (a) the following
conditions are met: (i) the Company has made public offerings of Common Stock
with a cumulative public offering price of at least $100,000,000 to an aggregate
of not less than 50 purchasers; (ii) the Common Stock has been listed or shall
be listed in connection with the offering on either the New York Stock Exchange,
the London Stock Exchange, the American Stock Exchange or the Nasdaq National
Market; and (iii) the Company shall have registered additional shares of Common
Stock from private offerings of Common Stock (made pursuant to an exemption from
registration under the Securities Act) with a market value of at least
$100,000,000 calculated using the offering price in the Complying Public Equity
Offering and (b) the aggregate number of shares of Common Stock sold thereby,
together with any Common Stock sold in any prior public offerings plus the
number of shares of Common Stock into which the Convertible Bonds may be
converted (calculated as if such conversion were to be effected on the date of
determination) does not exceed 50 percent of the total number of shares of
Common Stock outstanding on a fully diluted basis. A "Non-Complying Public
Equity Offering" means a public equity offering of Common Stock which satisfies
all of the conditions specified in (a) above, except that the cumulative public
offering price is less than $100,000,000. A "Non-Complying Equity Offering"
means (i) a private offering of Common Stock or (ii) a public offering of Common
Stock that is not a Complying Public Equity Offering.
HER NOTES
HER sold $265 million aggregate principal amount of 11 1/2% Senior Notes
due 2007 ("HER Notes") in August, 1997. The HER Notes have a ten year maturity
and are unsecured, senior obligations of HER. HER placed approximately $56.5
million of the net proceeds in escrow for the first two years' interest payments
on the HER Notes. The HER Notes were issued pursuant to an indenture containing
certain covenants for the benefit of the holders of HER Notes, including, among
other things, covenants limiting the incurrence of indebtedness, restricted
payments, liens, payment restrictions affecting certain subsidiaries and joint
ventures, transactions with affiliates, assets sales and mergers. The HER Notes
are redeemable in whole or part, at the option of HER at any time on or after
August 15, 2002 at a price ranging from 105.75 percent to 100.0 percent of the
principal amount.
A portion of the HER Notes are also redeemable at any time or from time to
time prior to August 15, 2000 at a redemption price equal to 111.5% of the
principal amount of the HER Notes so redeemed, plus accrued and unpaid interest
thereon, if any, to the date of redemption with the net cash proceeds of one or
more public equity offerings or strategic equity investments resulting in
aggregate gross cash proceeds to HER of at least $75 million. In the event of a
change of control of HER, holders of the HER Notes have the right to require HER
to purchase such holder's HER Notes at a price equal to 101% of the aggregate
principal amount.
108
DESCRIPTION OF THE NOTES
The Notes will be issued under an Indenture (the "Indenture") to be dated
as of , 1998 between the Company and The Bank of New York, as trustee
(the "Trustee"). The following summary of certain provisions of the Indenture
and the Escrow Agreement does not purport to be complete and is subject to, and
is qualified in its entirety by reference to, the Trust Indenture Act of 1939,
as amended (the "Trust Indenture Act"), and to all of the provisions of the
Indenture and the Escrow Agreement, including the definitions of certain terms
therein and those terms made a part of the Indenture by reference to the Trust
Indenture Act. A copy of each of the Indenture and the Escrow Agreement has been
filed as an exhibit to the Registration Statement of which this Prospectus is a
part. The definitions of certain terms used in the following summary are set
forth under "-- Certain Definitions" below. References in this "Description of
the Notes" section to "the Company" mean only Global TeleSystems Group, Inc. and
not any of its Subsidiaries.
GENERAL
The Notes will be issued only in registered form, without coupons, in
denominations of $1,000 and integral multiples of $1,000. The Company will
initially appoint the Trustee to serve as registrar and principal paying agent
under the Indenture at its offices at 101 Barclay Street, New York, New York
10286. The registrar, paying agents, and transfer agents (the "Registrar,"
"Paying Agents" and "Transfer Agents," respectively) are appointed in accordance
with the Indenture and initially are as set forth on the inside back cover page
hereof. No service charge will be made for any registration of transfer or
exchange of the Notes, except for any tax or other governmental charge that may
be imposed in connection therewith.
RANKING
The Notes will be general unsecured obligations of the Company and will
rank senior in right of payment to all Indebtedness of the Company that is, by
its terms or by the terms of the agreement or instrument governing such
Indebtedness, expressly subordinated in right of payment to the Notes (including
the Company's outstanding Senior Subordinated Convertible Bonds due 2000) and
pari passu in right of payment with all existing and future unsecured
liabilities of the Company that are not so subordinated.
The Notes will not be entitled to any security, except as described under
"-- Escrow Account" and will not be entitled to the benefit of any guarantees,
except under the circumstances described under "-- Certain
Covenants -- Limitation on Issuances of Guarantees by Restricted Group Members."
MATURITY, INTEREST AND PRINCIPAL OF THE NOTES
The Notes will be limited to $100.0 million aggregate principal amount and
will mature on , 2005. Cash interest will accrue on the Notes at the rate
per annum set forth on the cover page of this Prospectus and will be payable
semi-annually in arrears on each and , commencing , 1998, to the
holders of record of Notes (the "Holders") at the close of business on and
, respectively, immediately preceding such interest payment date. Cash
interest will accrue from the most recent interest payment date to which
interest has been paid or, if no interest has been paid, from the Issue Date.
Interest will be computed on the basis of a 360-day year of twelve 30-day
months.
Principal of, and interest on, the Notes will be payable, and the transfer
of Notes will be registrable, at the office of the Trustee, and at the offices
of the Paying Agents and Transfer Agents, respectively. Payments of such
principal and premium, if any, will be made against surrender of Certificated
Notes at the corporate trust office of the Paying Agent in New York City or,
subject to any applicable laws and regulations, at the offices of the Paying
Agent in by United States dollar check drawn on, or wire transfer to a
United States dollar account maintained by the Holder with, a bank located in
New York City. Payments of any installment of interest on Notes will be made by
a United States dollar check drawn on a bank in New York City mailed to the
Holder at such Holder's registered address or (if arrangements satisfactory to
the Company and the Paying Agents are made) by wire transfer to a United States
dollar account maintained by the Holder with a bank in New York City.
109
If a payment date is not a Business Day at a place of payment, payment may
be made at that place on the next succeeding Business Day and no interest shall
accrue for the intervening period.
The Company may at any time deliver Notes to the Trustee for cancellation.
Subject to the terms of the Indenture, the Company may not issue new Notes to
replace Notes that it has paid or delivered to the Trustee for cancellation.
ESCROW ACCOUNT
Concurrently with the consummation of the Offering, pursuant to the
Indenture, the Company shall place approximately $ million of the net
proceeds of the Offering, representing funds that together with the proceeds
from the investment thereof will be sufficient to pay the first four scheduled
interest payments on the Notes, in an Escrow Account (the "Escrow Account") held
by the Trustee for the benefit of the Holders in accordance with an Escrow
Agreement to be entered into between the Company and the Trustee (the "Escrow
Agreement"). The Escrow Agreement will provide, among other things, that funds
may be disbursed from the Escrow Account for interest payments the Company makes
on the Notes. The Trustee will be instructed to cause all funds in the Escrow
Account to be invested, pending disbursement, in Cash Equivalents. Interest
earned on these Cash Equivalents will be added to the Escrow Account.
Under the Escrow Agreement, the Company will grant to the Trustee, for the
benefit of the Holders, a first priority and exclusive security interest in the
Escrow Account and the proceeds thereof (the "Escrow Collateral"). The Escrow
Agreement will provide that the Trustee may foreclose on the Escrow Collateral
upon acceleration of the maturity of the Notes. Under the terms of the
Indenture, the proceeds of the Escrow Collateral will be applied, first, to
amounts owing to the Trustee in respect of fees and expenses of the Trustee, and
second, to the Obligations of the Company to the Holders under the Notes and the
Indenture. The ability of Holders to realize upon the Escrow Collateral may be
subject to certain bankruptcy law limitations in the event of the bankruptcy of
the Company.
Upon payment in full of the first four scheduled interest payments, if no
Default or Event of Default has occurred and is continuing, the Escrow
Collateral will be released to the Company.
OPTIONAL REDEMPTION
Except as set forth below, the Notes are not redeemable prior to ,
2002. The Notes will be redeemable at the option of the Company, in whole or in
part, at any time or from time to time on or after , 2002, upon not less
than 30 nor more than 60 days' prior notice mailed by first class mail to each
Holder's registered address, at the redemption prices (expressed as a percentage
of principal amount) set forth below, plus accrued and unpaid interest thereon,
if any, to the date of redemption, if redeemed during the 12-month period
beginning on of the years indicated below:
REDEMPTION
YEAR PRICE
---- ----------
2002...................................................... %
2003...................................................... %
2004 and thereafter....................................... 100.000%
In addition, at any time or from time to time prior to , 2001, upon
not less than 30 nor more than 60 days' prior notice mailed by first class mail
to each Holder's registered address, the Company may redeem up to 33 1/3% of the
original aggregate principal amount of the Notes at a redemption price equal to
% of the principal amount of the Notes (determined at the redemption date),
plus accrued and unpaid interest thereon, if any, to the date of redemption with
the net cash proceeds of one or more additional Public Equity Offerings or
Strategic Equity Investments resulting in aggregate gross proceeds to the
Company of at least $ million; provided, however, that at least 66 2/3% of
the original aggregate principal amount of Notes remains outstanding immediately
after giving effect to any such redemption (excluding any Notes owned by the
Company or any of its Affiliates). Notice of any such redemption must be given
within 60 days after the date of a Public Equity Offering or Strategic Equity
Investment resulting in gross cash proceeds to the Company,
110
when aggregated with all prior Public Equity Offerings or Strategic Equity
Investments, of at least $ million.
SELECTION AND NOTICE OF REDEMPTION
In the event that less than all of the Notes are to be redeemed at any time
pursuant to an optional redemption, selection of such Notes for redemption will
be made by the Trustee in compliance with the requirements of the principal
national securities exchange, if any, on which the Notes are listed or, if the
Notes are not then listed on a national securities exchange, on a pro rata
basis, by lot or by such method as the Trustee shall deem fair and appropriate;
provided, however, that (1) no Notes of a principal amount of $1,000 or less
shall be redeemed in part, and (2) if a partial redemption is made pursuant to
the provisions described under "-- Optional Redemption" above selection of the
Notes or portions thereof for redemption shall be made by the Trustee only on a
pro rata basis or on as nearly a pro rata basis as is practicable (subject to
the procedures of The Depository Trust Company), unless such method is otherwise
prohibited. Notice of redemption shall be mailed by first-class mail at least 30
but not more than 60 days before the date of redemption to each Holder of Notes
to be redeemed at its registered address. If any Note is to be redeemed in part
only, the notice of redemption that relates to such Note shall state the portion
of the principal amount thereof to be redeemed. A new Note in a principal amount
equal to the unredeemed portion thereof will be issued in the name of the Holder
thereof upon cancellation of the original Note. On and after the date of
redemption, interest will cease to accrue on Notes or portions thereof called
for redemption as long as the Company has deposited with the Paying Agents for
the Notes in New York funds in satisfaction of the redemption price pursuant to
the Indenture.
CHANGE OF CONTROL
Following the occurrence of a Change of Control (the date of such
occurrence being the "Change of Control Date"), the Company shall notify the
Holders of such occurrence in the manner prescribed by the Indenture and shall,
within 30 days after the Change of Control Date, make an Offer to Purchase all
Notes then outstanding at a purchase price in cash equal to 101% of the
principal amount thereof, plus accrued and unpaid interest thereon, if any, to
the date of purchase. The Company will cause a copy of such notice to be
published in a daily newspaper with general circulation in (which is
expected to be the ). The Company's obligations may be satisfied if a
third party makes the Offer to Purchase in the manner, at the times and
otherwise in compliance with the requirements of the Indenture applicable to an
Offer to Purchase made by the Company and purchases all Notes validly tendered
and not withdrawn under such Offer to Purchase.
If an Offer to Purchase is made, there can be no assurance that the Company
will have available funds sufficient to pay for all of the Notes that might be
tendered by Holders seeking to accept the Offer to Purchase. If the Company
fails to purchase all of the Notes tendered for purchase upon the occurrence of
a Change of Control, such failure will constitute an Event of Default. See
"-- Events of Default" below and "Risk Factors -- Ability to Service Debt,
Ability to Repurchase Notes Upon a Change of Control."
If the Company makes an Offer to Purchase, the Company will comply with all
applicable tender offer laws and regulations, including, to the extent
applicable, Section 14(e) and Rule 14e-1 under the Exchange Act, and any other
applicable Federal or state securities laws and regulations and any applicable
requirements of any securities exchange on which the Notes are listed, and any
violation of the provisions of the Indenture relating to such Offer to Purchase
occurring as a result of such compliance shall not be deemed a Default.
CERTAIN COVENANTS
Limitation on Restricted Payments. The Company shall not, and shall not
cause or permit any Restricted Group Member to, directly or indirectly.
(i) declare or pay any dividend or any other distribution on any
Equity Interests of the Company or any Restricted Group Member or make any
payment or distribution to the direct or indirect holders of Equity
Interests of the Company or any Restricted Group Member, other than (a)
dividends,
111
distributions and payments made to the Company or any Restricted Group
Member, (b) dividends or distributions payable to any Person solely in
Qualified Equity Interests or in options, warrants or other rights to
purchase Qualified Equity Interests and (c) pro rata dividends or
distributions on Equity Interests of Restricted Group Members held by
Persons other than the Company or other Restricted Group Members; provided,
however, that the Company or any other Restricted Group Members holding
shares of Equity Interests of such dividend or distribution-paying
Restricted Group Member shall receive such pro rata dividends or
distributions as may be due to such other Restricted Group Members or the
Company at or prior to the payment of such pro rata dividends or
distributions to such Persons other than the Company or any Restricted
Group Member;
(ii) purchase, redeem or otherwise acquire or retire for value any
Equity Interests of the Company or any Restricted Group Member, other than
any such Equity Interests owned by the Company or any Restricted Group
Member;
(iii) purchase, redeem, defease or retire for value, or make any
principal payment on, prior to any scheduled maturity, scheduled repayment
or scheduled sinking fund payment, any Subordinated Indebtedness, other
than any (a) Subordinated Indebtedness held by any Restricted Group Member
and (b) the purchase, repurchase or the acquisition of Indebtedness in
anticipation of satisfying a sinking fund obligation, principal installment
or final maturity, in any case due within one year of the date of
acquisition; or
(iv) make any Investment (other than Permitted Investments)
(any of the foregoing (other than any exception to any of the foregoing), a
"Restricted Payment"), unless
(a) no Default or Event of Default shall have occurred and be
continuing at the time of, or after giving effect to, such Restricted
Payment;
(b) immediately after giving effect to such Restricted Payment, the
Company would be able to Incur $1.00 of additional Indebtedness under the
first paragraph of " -- Limitation on Incurrence of Indebtedness" below;
and
(c) immediately after giving effect to such Restricted Payment, the
aggregate amount of all Restricted Payments (including the Fair Market
Value of any non-cash Restricted Payment) declared or made on or after the
Issue Date (excluding any Restricted Payment described in clause (ii),
(iii) or (iv) of the next paragraph) does not exceed an amount equal to the
sum of the following (the "Basket"):
(1) (x) the Cumulative Operating Cash Flow determined at the time
of such Restricted Payment less (y) % of cumulative Consolidated
Interest Expense determined for the period (treated as one accounting
period) commencing on the Issue Date and ending on the last day of the
most recent fiscal quarter immediately preceding the date of such
Restricted Payment for which consolidated financial information of the
Company is required to be available, plus
(2) the aggregate net cash proceeds received by the Company either
(x) as capital contributions to the Company after the Issue Date or (y)
from the issue and sale (other than to any Restricted Group Member) of
Qualified Equity Interests after the Issue Date (other than any issuance
and sale of Qualified Equity Interests financed, directly or indirectly,
using funds (I) borrowed from the Company or any Restricted Group Member
until and to the extent such borrowing is repaid or (II) contributed,
extended, guaranteed or advanced by the Company or any Restricted Group
Member (including, without limitation, in respect of any employee stock
ownership or benefit plan)), plus
(3) the aggregate amount by which Indebtedness (other than any
Subordinated Indebtedness, including without limitation the Company's
outstanding Senior Subordinated Convertible Bonds due 2000) of the
Company or any Restricted Subsidiary is reduced on the Company's balance
sheet upon the conversion or exchange (other than by a Subsidiary of the
Company) subsequent to the Issue Date into Qualified Equity Interests
(less the amount of any cash, or the fair value of property, distributed
by the Company or any Restricted Subsidiary upon such conversion or
exchange), plus
112
(4) in the case of the disposition or repayment of any Investment
that was treated as a Restricted Payment made after the Issue Date, an
amount (to the extent not included in the computation of Cumulative
Operating Cash Flow) equal to the lesser of: (x) the return of capital
with respect to such Investment and (y) the amount of such Investment
that was treated as a Restricted Payment, in either case, less the cost
of the disposition of such Investment and net of taxes, plus
(5) so long as the Designation thereof was treated as a Restricted
Payment made after the Issue Date, with respect to any Unrestricted
Group Member that has been redesignated as a Restricted Group Member
after the Issue Date in accordance with " -- Designation of Unrestricted
Group Members" below, the Company's proportionate interest in an amount
equal to the excess of (x) the total assets of such Restricted Group
Member, valued on an aggregate basis at the lesser of book value and
Fair Market Value, over (y) the total liabilities (other than
liabilities to the Company or any Restricted Group Member) of such
Restricted Group Member, determined in accordance with GAAP (and
provided that such amount shall not in any case exceed the Designation
Amount with respect to such Restricted Group Member when it was
originally designated as an Unrestricted Group Member), minus
(6) with respect to each Restricted Group Member which has been
designated as an Unrestricted Group Member after the Issue Date in
accordance with " -- Designation of Unrestricted Group Members" below,
the greater of (x) $0 and (y) the Designation Amount thereof (measured
as of the date of Designation).
The foregoing provisions will not prevent (i) the payment of any dividend
or distribution on, or redemption of, Equity Interests within 60 days after the
date of declaration of such dividend or distribution or the giving of formal
notice of such redemption, if at the date of such declaration or giving of
formal notice such payment or redemption would comply with the provisions of the
Indenture; (ii) the purchase, redemption, retirement or other acquisition of any
Equity Interests of the Company in exchange for, or out of the net cash proceeds
of the substantially concurrent (A) common equity capital contribution to the
Company from any Person (other than a Restricted Group Member) or (B) issue and
sale (other than to a Restricted Group Member) of Qualified Equity Interests;
(iii) any Investment to the extent that the consideration therefor consists of
the net proceeds of the substantially concurrent issue and sale (other than to a
Restricted Group Member) of Qualified Equity Interests; (iv) the purchase,
redemption, retirement, defeasance or other acquisition of Subordinated
Indebtedness made in exchange for, or out of the net cash proceeds of, a
substantially concurrent issue and sale (other than to a Restricted Group
Member) of (x) Qualified Equity Interests or (y) other Subordinated Indebtedness
issued in a Permitted Refinancing; (v) any Investment in any Person principally
engaged in a Telecommunications Business so long as the aggregate amount of
Investments pursuant to this clause (v) shall not exceed $ million; or
(vi) Investments in a Person which has ceased to be a Restricted Affiliate or
ceases to observe any of the provisions of the covenants applicable to it as a
result of an Involuntary Event; provided, however, (a) such Investment is made
with the proceeds of a substantially concurrent capital contribution to the
Company from any Person (other than a Restricted Group Member), or sale (other
than to any Restricted Group Member) of Qualified Equity Interests of the
Company, and (b) after such Investment such Involuntary Event shall no longer
continue and such Person shall be a Restricted Affiliate; provided, however,
that in the case of each of clauses (ii), (iii), (iv), (v) and (vi), no Default
or Event of Default shall have occurred and be continuing or would arise
therefrom (except, with respect to clause (vi), a Default or Event of Default
that will cease to exist substantially contemporaneously with such Investment).
For purposes of clause (iv) of the first paragraph of this covenant,
"Investment" in any Person shall include the Fair Market Value of the Equity
Interests (or any other Investment), held by the Company or any Restricted Group
Member, of (or in) any Person that has ceased to be a Restricted Group Member,
including without limitation, by reason of any transaction permitted by clause
(iii) of " -- Limitation on the Issuance and Sale of Equity Interests of
Restricted Group Members" below or an Investment ceasing to be a Permitted
Investment pursuant to clause (l)(II) of the definition of "Permitted
Investment"; provided, however, that the Fair Market Value of the Investment
remaining in any Person that has ceased to be a Restricted Group
113
Member shall not exceed (a) the value of the aggregate amount of Investments
previously made in such Person valued at the time such Investments were made
less (b) the net reduction of such Investments.
Limitation on Incurrence of Indebtedness. (a) The Company shall not, and
shall not cause or permit any Restricted Group Member to, directly or
indirectly, Incur any Indebtedness (including Acquired Indebtedness); provided,
however, that the Company and any Restricted Group Member may Incur Indebtedness
if, at the time of and after giving effect to such Incurrence, the Company's
Debt to Annualized Operating Cash Flow Ratio would be less than or equal to
to 1.0.
(b) The foregoing limitations of paragraph (a) of this covenant will not
apply to any of the following, each of which shall be given independent effect:
(i) the Notes and Permitted Refinancings thereof;
(ii) Indebtedness of the Company or any Restricted Group Member to the
extent outstanding on the date of the Indenture, and Permitted Refinancings
thereof;
(iii) Indebtedness of the Company or any Restricted Group Member, in
each case, to the extent that the proceeds of or credit support provided by
such Indebtedness is used to (x) finance the cost (including the cost of
design, development, construction, installation or integration) of network
assets, equipment or inventory acquired by the Company or a Restricted
Group Member after the Issue Date or (y) to finance or support working
capital, operations or capital expenditures for a Telecommunications
Business, and Permitted Refinancings thereof;
(iv) (1) Indebtedness of the Company or any Restricted Group Member,
in each case, to the extent that the proceeds of or credit support provided
by such Indebtedness is used to finance a Telecommunications Acquisition,
or working capital for, or to finance the construction of, the business or
network acquired and (2) Acquired Indebtedness, and, in each case,
Permitted Refinancings thereof, but in each case only to the extent that
(x) the aggregate amount of Indebtedness outstanding of the Company and the
Restricted Group Members after giving effect to the Incurrence of such
Indebtedness and the application of the proceeds therefrom does not exceed
the product of 2.0 and the Share Capital of the Company at the date of
Incurrence of such Indebtedness or (y) the aggregate amount of such
Indebtedness or Acquired Indebtedness, together with all Indebtedness of
the Person, if any, that is to become a Restricted Group Member or be
merged or consolidated with or into the Company or any Restricted Group
Member in the contemplated transaction outstanding at the time of such
transaction (whether or not Incurred in connection with, or in
contemplation of, such transaction), does not exceed the net sum of the
plant, property and equipment set forth on the Latest Balance Sheet of such
Person;
(v) (1) Indebtedness of any Restricted Group Member and (2)
Indebtedness of the Company owed to and held by any Restricted Group Member
which is unsecured and subordinated in right of payment to the payment and
performance of the Company's obligations under the Notes; provided,
however, that an Incurrence of Indebtedness that is not permitted by this
clause (v) shall be deemed to have occurred upon (x) any sale or other
disposition of any Indebtedness of the Company or any Restricted Group
Member referred to in this clause (v) to any Person other than the Company
or any Restricted Group Member or (y) any Restricted Group Member that
holds Indebtedness of the Company or another Restricted Group Member
ceasing to be a Restricted Group Member;
(vi) Interest Rate Protection Obligations of the Company or any
Restricted Group Member relating to Indebtedness of the Company or such
Restricted Group Member, as the case may be (which Indebtedness is
otherwise permitted to be Incurred under this covenant); provided, however,
that the notional principal amount of such Interest Rate Protection
Obligations does not exceed the principal amount of the Indebtedness to
which such Interest Rate Protection Obligations relate;
(vii) Indebtedness of the Company or any Restricted Group Member under
Currency Agreements to the extent relating to (x) Indebtedness of the
Company or such Restricted Group Member, as the case may be, and/or (y)
obligations to purchase assets, properties or services incurred in the
ordinary course of business of the Company or such Restricted Group Member,
as the case may be; provided, however, that
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such Currency Agreements do not increase the Indebtedness or other
obligations of the Company and the Restricted Group Members outstanding
other than as a result of fluctuations in foreign currency exchange rates
or by reason of fees, indemnities or compensation payable thereunder;
(viii) Indebtedness of the Company and/or any Restricted Group Member
in respect of performance bonds of the Company or any Restricted Group
Member or surety bonds provided by the Company or any Restricted Group
Member incurred in the ordinary course of business and on ordinary business
terms in connection with the construction or operation of a
Telecommunications Business;
(ix) Indebtedness arising from agreements providing for
indemnification, adjustment of purchase price or similar obligations, or
from guarantees or letters of credit, surety bonds or performance bonds
securing any obligations of the Company or any Restricted Group Member
pursuant to such agreements, in any case Incurred in connection with the
disposition of any business, assets or Restricted Group Member (other than
guarantees of Indebtedness Incurred by any Person acquiring all or any
portion of such business, assets or Restricted Group Member for the purpose
of financing such acquisition), in a principal amount not to exceed the
gross proceeds actually received by the Company or any Restricted Group
Member in connection with such disposition; and
(x) in addition to the items referred to in clauses (i) through (ix)
above, Indebtedness of the Company or any Restricted Group Member in an
aggregate amount not to exceed $15.0 million at any time outstanding.
(c) For purposes of determining any particular amount of Indebtedness under
this covenant, guarantees, Liens or obligations with respect to letters of
credit supporting Indebtedness otherwise included in the determination of such
particular amount shall not be included; provided, however, that the foregoing
shall not in any way be deemed to limit the provisions of " -- Limitation on
Issuances of Guarantees by Restricted Group Members" below.
(d) For purposes of determining compliance with this covenant, in the event
that an item of Indebtedness may be Incurred through the first paragraph of this
covenant or by meeting the criteria of one or more of the types of Indebtedness
described in the second paragraph of this covenant (or the definitions of the
terms used therein), the Company, in its sole discretion, may, at the time of
such Incurrence, (i) classify such item of Indebtedness under and comply with
either of such paragraphs (or any of such definitions), as applicable, (ii)
classify and divide such item of Indebtedness into more than one of such
paragraphs (or definitions), as applicable, and (iii) elect to comply with such
paragraphs (or definitions), as applicable, in any order.
(e) Notwithstanding any other provision of this covenant, the maximum
amount of Indebtedness that the Company or a Restricted Group Member may incur
pursuant to this covenant shall not be deemed to be exceeded, with respect to
any outstanding Indebtedness, due solely to the result of fluctuations in the
exchange rates of currencies.
Limitation on Restrictions Affecting Restricted Group Members. The Company
shall not, and shall not cause or permit any Restricted Group Member to,
directly or indirectly, create or otherwise cause or suffer to exist or become
effective any encumbrance or restriction on the ability of any Restricted Group
Member to (x) pay dividends or make any other distributions to the Company or
any other Restricted Group Member on its Equity Interests or with respect to any
other interest or participation in, or measured by, its profits, or pay any
Indebtedness owed to the Company or any other Restricted Group Member, (y) make
loans or advances to, or guarantee any Indebtedness or other obligations of, the
Company or any other Restricted Subsidiary or (z) transfer any of its properties
or assets to the Company or any other Restricted Group Member.
The foregoing shall not prohibit (a) any encumbrance or restriction
existing under or by reason of any agreement in effect on the Issue Date, as any
such agreement is in effect on such date or as thereafter amended or
supplemented but only if such encumbrance or restriction is no more restrictive
than in the agreement being amended; (b) customary provisions contained in an
agreement that has been entered into for the sale or disposition of all or
substantially all of the Capital Stock or assets of a Restricted Group Member;
provided, however, that (x) such encumbrance or restriction is applicable only
to such Restricted Group
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Member (or the applicable assets to be sold) and (y) such sale or disposition is
made in accordance with " -- Limitation on Asset Sales" below; (c) any
encumbrance or restriction existing under or by reason of applicable law; (d)
customary provisions restricting subletting or assignment of any lease governing
any leasehold interest of any Restricted Group Member; (e) covenants in purchase
money obligations for property acquired in the ordinary course of business
restricting transfer of such property; (f) covenants in security agreements
securing Indebtedness of a Restricted Group Member (to the extent that such
Liens were otherwise incurred in accordance with "-- Limitation on Liens" below)
that restrict the transfer of property subject to such agreements; (g) any
agreement or other instrument of a Person acquired by the Company or any
Restricted Group Member in existence at the time of such acquisition, which
encumbrance or restriction (x) is not applicable to any Person, or the
properties or assets of any Person, other than the Person, or the properties or
assets of the Person so acquired, and (y) is not incurred in connection with or
in contemplation of such acquisition; (h) any encumbrance or restriction
contained in any agreement entered into after the Issue Date, so long as such
encumbrance or restriction is not materially more disadvantageous to the Holders
than the encumbrances and restrictions in existence at the Issue Date; or (i)
contained in any stockholders, joint venture or similar agreement, so long as
such encumbrance or restriction is not materially more disadvantageous to the
Holders than the encumbrances and restrictions contained in comparable
agreements entered into by the Company or a Restricted Group Member.
Nothing contained in this covenant shall prevent the Company or any
Restricted Group Member from (i) creating, incurring, assuming or suffering to
exist any Liens not prohibited by the "-- Limitation on Liens" covenant
described below; or (ii) restricting the sale or other disposition of property
or assets of the Company or any Restricted Group Member that secure Indebtedness
of the Company or any Restricted Group Member.
Designation of Unrestricted Group Members. (a) The Company may designate
any Restricted Group Member as an "Unrestricted Group Member" under the
Indenture (a "Designation") only if:
(i) no Default or Event of Default shall have occurred and be
continuing at the time of or after giving effect to such Designation;
(ii) at the time of and after giving effect to such Designation, the
Company could Incur $1.00 of additional Indebtedness under the first
paragraph of " -- Limitation on Incurrence of Indebtedness" above;
(iii) the Company would be permitted to make an Investment (other than
a Permitted Investment) at the time of such Designation (assuming the
effectiveness of such Designation) pursuant to the first paragraph of
"-- Limitation on Restricted Payments"above in an amount (the "Designation
Amount") equal to the Fair Market Value of the Equity Interests of such
Restricted Group Member owned directly or indirectly by the Company on such
date; and
(iv) if such Restricted Group Member is a Subsidiary of Hermes Europe,
simultaneously with such Designation, Hermes Europe shall make a similar
designation of such Subsidiary in accordance with the terms of the Hermes
Europe Senior Notes Indenture.
All Subsidiaries of Unrestricted Subsidiaries shall be Unrestricted Group
Members. On the Issue Date, the Company shall effect Designations of each
Subsidiary of Hermes Europe that Hermes Europe has previously designated as an
Unrestricted Subsidiary in accordance with terms of the Hermes Europe Senior
Notes Indenture.
The Company shall not, and shall not cause or permit any Restricted Group
Member to, directly or indirectly, at any time (x) provide credit support for,
subject any of its properties or assets (other than the Equity Interests of any
Unrestricted Group Member) to the satisfaction of, or guarantee, any
Indebtedness of any Unrestricted Group Member (including any undertaking,
agreement or instrument evidencing such Indebtedness), (y) be liable for any
Indebtedness of any Unrestricted Group Member or (z) be liable for any
Indebtedness which provides that the holder thereof may (upon notice, lapse of
time or both) declare a default thereon or cause the payment thereof to be
accelerated or payable prior to its final scheduled maturity upon the occurrence
of a default with respect to any Indebtedness of any Unrestricted Group Member.
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(b) The Company may revoke any Designation of a Subsidiary or Affiliate as
an Unrestricted Group Member (a "Revocation") only if:
(i) no Default or Event of Default shall have occurred and be
continuing at the time of and after giving effect to such Revocation;
(ii) all Liens and Indebtedness of such Unrestricted Group Member
outstanding immediately following such Revocation would, if Incurred at
such time, have been permitted to be Incurred for all purposes of the
Indenture;
(iii) any transaction (or series of related transactions) between such
Subsidiary or Affiliate and any of its Affiliates that occurred while such
Subsidiary or Affiliate was an Unrestricted Group Member would be permitted
by " -- Limitation on Transactions with Affiliates" below as if such
transaction (or series of related transactions) had occurred at the time of
such Revocation (after giving effect to any modification to such
transaction (or series of related transactions) effective at such time);
and
(iv) if such Subsidiary is a Subsidiary of Hermes Europe,
simultaneously with such Revocation, Hermes Europe shall make a similar
revocation with respect to such Subsidiary in accordance with the terms of
the Hermes Europe Senior Notes Indenture.
All Designations and Revocations must be evidenced by resolutions of the
Board of Directors of the Company, delivered to the Trustee certifying
compliance with the foregoing provisions.
Limitation on Liens. The Company shall not, and shall not cause or permit
any Restricted Group Member to, directly or indirectly, incur or suffer to exist
any Lien (other than any Permitted Lien) of any kind against or upon any of
their respective properties or assets now owned or hereafter acquired, or any
proceeds, income or profits therefrom, unless contemporaneously therewith or
prior thereto, (i) in the case of any Lien securing an obligation that ranks
pari passu with the Notes, effective provision is made to secure the Notes
equally and ratably with or prior to such obligation with a Lien on the same
collateral and (ii) in the case of any Lien securing an obligation that is
subordinated in right of payment to the Notes, effective provision is made to
secure the Notes with a Lien on the same collateral that is prior to the Lien
securing such subordinated obligation, in each case, for so long as such
obligation is secured by such Lien.
Limitation on Asset Sales. The Company shall not, and shall not cause or
permit any Restricted Group Member to, directly or indirectly, make any Asset
Sale, unless (x) the Company or such Restricted Group Member, as the case may
be, receives consideration at the time of such Asset Sale at least equal to the
Fair Market Value of the assets sold or otherwise disposed of and (y) at least
75% of such consideration consists of (i) cash or Cash Equivalents, (ii)
Replacement Assets, (iii) publicly traded Equity Interests of a Person who is
engaged primarily in a Telecommunications Business; provided, however, that the
Company or such Restricted Group Member shall sell (a "Monetization Sale"), for
cash or Cash Equivalents, such Equity Interests to a third Person (other than to
the Company or a Restricted Group Member) at a price not less than the Fair
Market Value thereof within 425 days of the consummation of such Asset Sale, or
(iv) any combination of the foregoing clauses (i) through (iii). The amount of
any (x) Indebtedness (other than any Subordinated Indebtedness) of the Company
or any Restricted Group Member that is actually assumed by the transferee in
such Asset Sale and from which the Company and the Restricted Group Members are
fully released shall be deemed to be cash for purposes of determining the
percentage of cash consideration received by the Company or such Restricted
Group Member and (y) notes or other similar obligations received by the Company
or any Restricted Group Member from such transferee that are converted, sold or
exchanged within 30 days of the related Asset Sale by the Company or any
Restricted Group Member into cash shall be deemed to be cash, in an amount equal
to the net cash proceeds realized upon such conversion, sale or exchange for
purposes of determining the percentage of cash consideration received by the
Company or such Restricted Group Member. Any Net Cash Proceeds from any Asset
Sale or any Monetization Sale that are not invested in Replacement Assets or
used to repay and permanently reduce the commitments under Indebtedness of any
Restricted Group Member within 425 days of the consummation of such Asset Sale
or Monetization Sale shall constitute "Excess Proceeds" subject to disposition
as provided below.
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Within 40 days after the aggregate amount of Excess Proceeds equals or
exceeds $10.0 million, the Company shall make an Offer to Purchase, from all
Holders, that aggregate principal amount of Notes as can be purchased with the
Note Portion of Excess Proceeds at a price in cash equal to 100% of the
outstanding principal amount thereof, plus accrued and unpaid interest, if any,
to any purchase date. To the extent that the aggregate of the principal and
accrued interest of Notes validly tendered and not withdrawn pursuant to an
Offer to Purchase is less than the Excess Proceeds, the Company may use such
surplus for general corporate purposes. If the aggregate of the principal and
accrued interest of Notes validly tendered and not withdrawn by Holders thereof
exceeds the amount of Notes that can be purchased with the Note Portion of
Excess Proceeds, Notes to be purchased will be selected pro rata based on the
aggregate principal amount of Notes tendered by each Holder. Upon completion of
an Offer to Purchase, the amount of Excess Proceeds shall be reset to zero.
In the event that any other Indebtedness of the Company that ranks pari
passu with the Notes (the "Other Debt") requires an offer to purchase to be made
to repurchase such Other Debt upon the consummation of an Asset Sale, the
Company may apply the Excess Proceeds otherwise required to be applied to an
Offer to Purchase to offer to purchase such Other Debt and to an Offer to
Purchase so long as the amount of such Excess Proceeds applied to purchase the
Notes is not less than the Note Portion of Excess Proceeds. With respect to any
Excess Proceeds, the Company shall make the Offer to Purchase in respect thereof
at the same time as the analogous offer to purchase is made pursuant to any
Other Debt and the Purchase Date in respect thereof shall be the same as the
purchase date in respect thereof pursuant to any Other Debt.
For purposes of this covenant, "Note Portion of Excess Proceeds" means (1)
if no Other Debt is being offered to be purchased, the amount of the Excess
Proceeds and (2) if Other Debt is being offered to be purchased, the amount of
the Excess Proceeds equal to the product of (x) the Excess Proceeds and (y) a
fraction the numerator of which is the aggregate amount of all Notes tendered
pursuant to the Offer to Purchase related to such Excess Proceeds (the "Note
Amount") and the denominator of which is the sum of the Note Amount and the
aggregate amount as of the relevant purchase date of all Other Debt tendered and
purchased pursuant to a concurrent offer to purchase such Other Debt made at the
time of such Offer to Purchase.
If and to the extent that the Excess Proceeds from any Asset Sale of any
Restricted Group Member cannot at such time be paid as a dividend to the Company
by virtue of the Hermes Europe Senior Note Indenture as in effect on the issue
date, such Excess Proceeds shall not be deemed to constitute Excess Proceeds
until such time as and to the extent that such Excess Proceeds are permitted to
be paid as a dividend thereunder.
Notwithstanding the foregoing, to the extent that any or all of the Net
Cash Proceeds of any Asset Sale of assets based outside the United States are
prohibited or delayed by applicable local law from being repatriated to the
United States and such Net Cash Proceeds are not actually applied in accordance
with the foregoing paragraphs, the Company shall not be required to apply the
portion of such Net Cash Proceeds so affected but may permit the applicable
Restricted Group Members to retain such portion of the Net Cash Proceeds so long
but only so long as the applicable local law will not permit repatriation to the
United States (the Company hereby agreeing to cause the applicable Restricted
Group Member to promptly take all actions required by the applicable local law
to permit such repatriation) and once such repatriation of any such affected New
Cash Proceeds is permitted under the applicable local law, such repatriation
will be immediately effected and such repatriated Net Cash Proceeds will be
applied in the manner set forth in this covenant as if the Asset Sale had
occurred on such date; provided, however, that to the extent that the Company
has determined in good faith that repatriation of any or all of the Net Cash
Proceeds of such Asset Sale would have a material adverse tax cost consequence,
the Net Cash Proceeds so affected may be retained by the applicable Restricted
Group Member for so long as such material adverse tax cost event would continue.
In the event that the Company makes an Offer to Purchase the Notes, the
Company shall comply with any applicable securities laws and regulations,
including any applicable requirements of Section 14(e) of, and
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Rule 14e-l under, the Exchange Act, and any violation of the provisions of the
Indenture relating to such Offer to Purchase occurring as a result of such
compliance shall not be deemed a Default or an Event of Default.
Limitation on Transactions with Affiliates. The Company shall not, and
shall not cause or permit any Restricted Group Member to, directly or
indirectly, conduct any business or enter into any transaction or series of
related transactions with or for the benefit of any Affiliate, any holder of 5%
or more of any class of Equity Interests or any officer, director or employee of
the Company or any Restricted Subsidiary (each, an "Affiliate Transaction"),
unless such Affiliate Transaction is on terms that are no less favorable to the
Company or such Restricted Group Member, as the case may be, than could
reasonably be obtained at such time in a comparable transaction with an
unaffiliated third party. For any such transaction that involves value in excess
of $5.0 million, the Company shall deliver to the Trustee an officers'
certificate stating that a majority of the Disinterested Directors has
determined that the transaction satisfies the above criteria and shall evidence
such a determination by a Board Resolution delivered to the Trustee. For any
such transaction that involves value in excess of $12.5 million, the Company
shall also obtain a written opinion from an Independent Financial Advisor to the
effect that such transaction is fair, from a financial point of view, to the
Company or such Restricted Group Member, as the case may be.
Notwithstanding the foregoing, the restrictions set forth in this covenant
shall not apply to (i) transactions between or among the Company and one or more
Restricted Group Members or between or among Restricted Group Members; (ii)
customary directors' fees, indemnification and similar arrangements, employee
salaries, bonuses or employment agreements, compensation or employee benefit
arrangements and incentive arrangements with any officer, director or employee
of the Company or any Restricted Group Member entered into in the ordinary
course of business (including customary benefits thereunder); (iii) transactions
pursuant to agreements in effect on the Issue Date, as such agreements are in
effect on the Issue Date or as thereafter amended or supplemented in a manner
not adverse to the Holders; (iv) loans and advances to officers, directors and
employees of the Company or any Restricted Group Member for travel,
entertainment, moving and other relocation expenses, in each case made in the
ordinary course of business and consistent with past business practices; (v) any
transaction between the Company or any Restricted Group Member, on the one hand,
and any Affiliate of the Company engaged primarily in a Telecommunications
Business, on the other hand, (x) in the ordinary course of business and
consistent with commercially reasonable practices or (y) approved by a majority
of the Disinterested Directors; and (vi) payment of dividends in respect of
Equity Interests of the Company or any Restricted Group Member permitted under
"-- Limitation on Restricted Payments" above.
Limitation on Issuances of Guarantees by Restricted Group Members. The
Company shall not cause or permit any Restricted Group Member, directly or
indirectly, to guarantee any Indebtedness of the Company ("Guaranteed
Indebtedness"), unless (i) such Restricted Group Member simultaneously executes
and delivers a supplemental indenture to the Indenture pursuant to which such
Restricted Group Member guarantees (a "Guarantee") all of the Company's
obligations under the Notes and the Indenture and (ii) such Restricted Group
Member waives, and will not in any manner whatsoever claim or take the benefit
or advantage of, any rights of reimbursement, indemnity or subrogation or any
other rights against the Company or any other Restricted Group Member as a
result of any payment by such Restricted Group Member under its Guarantee. If
the Guaranteed Indebtedness is (A) pari passu with the Notes, then the guarantee
of such Guaranteed Indebtedness shall be pari passu with, or subordinated to,
the Guarantee or (B) subordinated to the Notes, then the guarantee of such
Guaranteed Indebtedness shall be subordinated to the Guarantee at least to the
extent that the Guaranteed Indebtedness is subordinated to the Notes.
Any Guarantee by a Restricted Group Member shall provide by its terms that
it shall be automatically and unconditionally released and discharged upon (i)
any sale, exchange or transfer, to any Person not an Affiliate of the Company,
of all of the Equity Interests of the Company or any Restricted Group Member in,
or all or substantially all the assets of, such Restricted Group Member (which
sale, exchange or transfer is made in accordance with the Indenture) or (ii) the
release or discharge of the guarantee which resulted in the creation of such
Guarantee, except a discharge or release by or as a result of payment under such
guarantee.
119
Limitation on the Issuance and Sale of Equity Interests of Restricted Group
Members. The Company shall not sell, and shall not cause or permit any
Restricted Group Member, directly or indirectly, to issue or sell, any Equity
Interests of any Restricted Group Member, except (i) to the Company or a Wholly
Owned Restricted Subsidiary; (ii) issuances of director's qualifying shares or
sales to foreign nationals of shares of Equity Interests of a foreign Restricted
Group Member, to the extent required by applicable law; (iii) if, immediately
after giving effect to such issuance or sale, such Restricted Group Member would
no longer constitute a Restricted Group Member; provided, however, any
investment in such Person remaining after giving effect to such issuance or sale
would have been permitted to be made under "-- Limitation on Restricted
Payments" above, if made on the date of such issuance or sale; (iv) issuances or
other sales of common stock (including options, warrants or other rights to
purchase common stock) of a Restricted Group Member; provided, however, the Net
Cash Proceeds, if any, of such sale are applied in accordance with "--Limitation
on Asset Sales" above; (v) issuances of common stock for cash (including
options, warrants or other rights to purchase common stock) of a Restricted
Group Member; provided, however, that the per share price to the investor of
each share of common stock sold in such issuance shall not be less than the book
value per share of such Restricted Group Member's common stock prior to such
issuance (after adjusting for the effect of such issuance); and (vi) issuances
of Equity Interests by any Restricted Group Member in a transaction in which the
Company acquires at the same time sufficient Equity Interests of such Restricted
Group Member to at least maintain the same percentage ownership interest it had
prior to such transaction.
Limitations on Lines of Business. The indenture will provide that the
Company will not, and will not permit any Restricted Subsidiary to, directly or
indirectly engage to any substantial extent in any line or lines of business
other than a Related Business.
Merger, Sale of Assets, etc. The Company shall not consolidate with or
merge with or into (whether or not the Company is the Surviving Person) any
other Person and the Company shall not, and shall not cause or permit any
Restricted Subsidiary to, sell, convey, assign, transfer, lease or otherwise
dispose of all or substantially all of the property and assets of the Company
and the Restricted Group Members, taken as a whole, to any Person or Persons
(other than any Wholly Owned Restricted Subsidiary), in each case, in a single
transaction or series of related transactions, unless: (i) either (x) the
Company shall be the Surviving Person or (y) the Surviving Person (if other than
the Company) shall be a corporation organized and validly existing under the
laws of the United States of America or any State thereof or the District of
Columbia, and shall, in any such case, expressly assume by a supplemental
indenture, the due and punctual payment of the principal of and interest on the
Notes and the performance and observance of every covenant of the Indenture and
the Escrow Agreement to be performed or observed on the part of the Company;
(ii) immediately after giving effect to such transaction, no Default or Event of
Default shall have occurred and be continuing; and (iii) immediately after
giving effect to such transaction, the Surviving Person (as the Company) could
Incur at least $1.00 of additional Indebtedness under the first paragraph of
"-- Limitation on Incurrence of Indebtedness" above.
For purposes of the foregoing, the transfer (by lease, assignment, sale or
otherwise, in a single transaction or series of transactions) of all or
substantially all the properties and assets of one or more Restricted Group
Members the Equity Interests of which constitutes all or substantially all the
properties and assets of the Company shall be deemed to be the transfer of all
or substantially all the properties and assets of the Company.
In the event of any transaction (other than a lease) described in and
complying with the conditions listed in the first paragraph of this covenant in
which the Company is not the Surviving Person and the Surviving Person is to
assume all the Obligations of the Company under the Notes, the Indenture and the
Escrow Agreement pursuant to a supplemental indenture, such Surviving Person
shall succeed to, and be substituted
120
for, and may exercise every right and power of, the Company, and the Company
shall be discharged from its Obligations under the Notes, the Indenture and the
Escrow Agreement.
Provision of Financial Information. Whether or not the Company is subject
to Section 13(a) or 15(d) of the Exchange Act, or any successor provision
thereto, the Company shall file with the SEC (if permitted by SEC practice and
applicable law and regulations) the annual reports, quarterly reports and other
documents which the Company would have been required to file with the SEC
pursuant to such Section 13(a) or 15(d) or any successor provision thereto if
the Company were so required, such documents to be filed with the SEC on or
prior to the respective dates (the "Required Filing Dates") by which the Company
would have been required so to file such documents if the Company were so
required; provided, however, that until the Company is subject to Section 13(a)
or Section 15(d) of the Exchange Act or any successor provisions thereto, the
Required Filing Dates for such quarterly reports shall be 75 days following the
end of the applicable fiscal quarter. The Company shall also in any event (a)
within 15 days of each Required Filing Date (whether or not permitted or
required to be filed with the SEC but subject to the proviso in the previous
sentence) (i) transmit (or cause to be transmitted) by mail to all Holders, as
their names and addresses appear in the Note register, without cost to such
Holders, and (ii) file with the Trustee, copies of the annual reports, quarterly
reports and other documents which the Company is required to file with the SEC
pursuant to the preceding sentence, or, if such filing is not so permitted,
information and data of a similar nature, and (b) if, notwithstanding the
preceding sentence, filing such documents by the Company with the SEC is not
permitted by SEC practice or applicable law or regulations, promptly upon
written request supply copies of such documents to any Holder.
EVENTS OF DEFAULT
The occurrence of any of the following will be defined as an "Event of
Default" under the Indenture: (a) failure to pay principal of any Note when due;
(b) failure to pay any interest on any Note when due, continued for 30 days or
more; (c) failure to pay on the Purchase Date the Purchase Price for any Note
validly tendered pursuant to any Offer to Purchase; (d) failure to perform or
comply with any of the provisions described under "-- Certain
Covenants -- Merger, Sale of Assets, etc." above; (e) failure to perform any
other covenant, warranty or agreement of the Company under the Indenture or the
Escrow Agreement or in the Notes continued for 30 days or more after written
notice to the Company by the Trustee or Holders of at least 25% in aggregate
principal amount of the outstanding Notes; provided, however, that a default or
breach of a covenant or agreement arising from a Restricted Affiliate ceasing to
observe any covenant applicable to it resulting from an Involuntary Event shall
not constitute an Event of Default unless such Involuntary Event continues for
90 days; (f) there shall be, with respect to any issue or issues of Indebtedness
of the Company or any Restricted Group Member having an outstanding principal
amount of $10.0 million or more in the aggregate for all such issues of all such
Persons, whether such Indebtedness now exists or shall hereafter be created, (x)
an event of default that has caused the holders thereof (or their
representative) (I) to declare such Indebtedness to be due and payable prior to
its scheduled maturity and such Indebtedness has not been discharged in full or
such acceleration has not been rescinded or annulled within 45 days following
such acceleration and/or (II) to commence judicial proceeding to foreclose upon,
or to exercise remedies under applicable law or applicable security documents to
take ownership of, the property or assets securing such Indebtedness and/or (y)
the failure to make a principal payment at the final fixed maturity and such
defaulted payment shall not have been made, waived or extended within 45 days of
such payment default; (g) the rendering of a final judgment or judgments against
the Company or any Restricted Group Member in an amount of $10.0 million or more
which remains undischarged or unstayed for a period of 60 consecutive days; (h)
certain events of bankruptcy, insolvency or reorganization affecting the Company
or any Significant Restricted Group Member; or (i) the Company shall challenge
the Lien on the Escrow Collateral under the Escrow Agreement prior to such time
as the Escrow Collateral is to be released to the Company, or the Escrow
Collateral shall become subject to any Lien other than the Lien under the Escrow
Agreement.
If an Event of Default with respect to the Notes (other than an Event of
Default with respect to the Company described in clause (h) of the preceding
paragraph) occurs and is continuing, the Trustee or the Holders of at least 25%
in aggregate principal amount at maturity of the outstanding Notes by notice in
writing
121
to the Company may declare the unpaid principal of (and premium, if any) and
accrued interest to the date of acceleration on all the outstanding Notes to be
due and payable immediately and, upon any such declaration, such principal
amount (and premium, if any) and accrued interest, notwithstanding anything
contained in the Indenture or the Notes to the contrary, will become immediately
due and payable; provided, however, that after such acceleration, but before a
judgment or decree based on acceleration, the Holders of a majority in aggregate
principal amount of outstanding Notes may, under certain circumstances, rescind
and annul such acceleration if all Events of Default, other than the nonpayment
of accelerated principal, have been cured or waived as provided in the
Indenture. If an Event or Default specified in clause (h) of the preceding
paragraph with respect to the Company occurs under the Indenture, the Notes will
ipso facto become immediately due and payable without any declaration or other
act on the part of the Trustee or any Holder.
The Indenture provides that the Trustee shall, within 30 days after the
occurrence of any Default or Event of Default with respect to the Notes, give
the Holders notice of all uncured Defaults thereunder known to it; provided,
however, that, except in the case of an Event of Default in payment with respect
to the Notes or a Default or Event of Default in complying with "-- Certain
Covenants -- Merger, Sale of Assets, etc." above, the Trustee shall be protected
in withholding such notice if and so long as a committee of its trust officers
in good faith determines that the withholding of such notice is in the interest
of the Holders.
No Holder will have any right to institute any proceeding with respect to
the Indenture or for any remedy thereunder, unless the Trustee (i) shall have
failed to act for a period of 60 days after receiving written notice of a
continuing Event of Default by such Holder and a request to act by Holders of at
least 25% in aggregate principal amount at maturity of Notes outstanding, (ii)
shall have been offered indemnity reasonably satisfactory to it and (iii) shall
not have received from the Holders of a majority in aggregate principal amount
at maturity of the outstanding Notes a direction inconsistent with such request.
However, such limitations do not apply to a suit instituted by a Holder of any
Note for enforcement of payment of the principal of or interest on such Note on
or after the due date therefor (after giving effect to the grace period
specified in clause (b) of the first paragraph of this "-- Events of Default"
section).
The Company will be required to furnish to the Trustee after the end of
each fiscal year a statement as to the performance by it of certain of its
obligations under the Indenture and as to any default in such performance.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES, INCORPORATOR AND
STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the Company
or any of its Affiliates, as such, shall have any liability for any obligations
of the Company or any of its Affiliates under the Notes or the Indenture or for
any claim based on, in respect of or by reason of, such obligations or their
creation. Each Holder by accepting a Note waives and releases all such
liability. The waiver and release are part of the consideration for issuance of
the Notes.
SATISFACTION AND DISCHARGE OF INDENTURE; DEFEASANCE
The Company may terminate its substantive obligations in respect of the
Notes by delivering all outstanding Notes to the Trustee for cancellation and
paying all sums payable by it on account of principal of, premium, if any, and
interest on all Notes or otherwise. In addition to the foregoing, the Company
may terminate the applicability of the covenants under "-- Certain Covenants"
and "-- Change of Control" above or any Event of Default under clause (e) of
"-- Events of Default" above by (i) depositing with the Trustee, under the terms
of an irrevocable trust agreement, money or U.S. Government Obligations
sufficient (without reinvestment) to pay all remaining indebtedness on such
Notes at maturity or upon earlier redemption; (ii) delivering to the Trustee
either an opinion of counsel or a ruling directed to the Trustee from the
Internal Revenue Service to the effect that the Holders of the Notes will not
recognize income, gain or loss for federal income tax purposes as a result of
such deposit and termination of obligations; (iii) delivering to the Trustee an
opinion of counsel to the effect that the Company's exercise of its option under
this paragraph will not result in any of the Company, the Trustee or the trust
created by the Company's deposit of funds pursuant to this provision becoming or
being deemed to be an "investment company" under the United States Investment
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Company Act of 1940, as amended (the "Investment Act"); and (iv) complying with
certain other requirements set forth in the Indenture. In addition, the Company
may, provided that no Default or Event of Default has occurred and is continuing
or would arise therefrom (or, with respect to a Default specified in clause (h)
of "-- Events of Default" above occurs at any time on or prior to the 91st
calendar day after the date of the deposit (it being understood that this
condition shall not be deemed satisfied until after such 91st day)) under the
Indenture, terminate all of its substantive obligations in respect of the Notes
(including its obligations to pay the principal of and interest on such Notes)
by (1) depositing with the Trustee, under the terms of an irrevocable trust
agreement, money or U.S. Government Obligations sufficient (without
reinvestment) to pay all remaining Indebtedness on such Notes at maturity or
upon earlier redemption; (2) delivering to the Trustee either a ruling directed
to the Trustee from the Internal Revenue Service to the effect that the Holders
of such Notes will not recognize income, gain or loss for federal income tax
purposes as a result of such deposit and termination of obligations or an
opinion of counsel addressed to the Trustee based upon such a ruling or based on
a change in the applicable federal tax law since the date of the Indenture, to
such effect; (3) delivering to the Trustee an opinion of counsel to the effect
that the Company's exercise of its option under this paragraph will not result
in any of the Company, such Trustee or the relevant trust created by the
Company's deposit of funds pursuant to this provision becoming or being deemed
to be an "investment company" under the Investment Act; and (4) complying with
certain other requirements set forth in the Indenture.
MODIFICATION AND WAIVER
Modifications and amendments of the Indenture may be made by the Company
and the Trustee with the consent of the Holders of a majority in aggregate
principal amount of the Notes (including consents obtained in connection with a
tender offer or exchange offer for such Notes); provided, however, that no such
modification or amendment to the Indenture may, without the consent of the
Holder of each Note affected thereby, (a) change the maturity of the principal
of any such Note; (b) alter the optional redemption or repurchase provisions of
any such Note or the Indenture in a manner adverse to the Holders of such Notes;
(c) reduce the principal amount (or premium) of any such Note; (d) reduce the
rate of or extend the time for payment of interest on any such Note; (e) change
the place or currency of payment of principal of (or premium) or interest on any
such Note; (f) modify any provisions of the Indenture relating to the waiver of
past defaults (other than to add sections of the Indenture or the Notes subject
thereto) or the right of the Holders of Notes to institute suit for the
enforcement of any payment on or with respect to any such Note in respect
thereof or the modification and amendment provisions of the Indenture and such
Notes (other than to add sections of the Indenture or such Notes which may not
be amended, supplemented or waived without the consent of each Holder therein
affected); (g) reduce the percentage of the principal amount of outstanding
Notes necessary for amendment to or waiver of compliance with any provision of
the Indenture or the Notes or for waiver of any Default in respect thereof; (h)
waive a default in the payment of principal of, interest on, or redemption
payment with respect to, such Note (except a rescission of acceleration of the
relevant Notes by the Holders thereof as provided in the Indenture and a waiver
of the payment default that resulted from such acceleration); (i) modify the
ranking or priority of any such Note; (j) modify the provisions of any covenant
(or the related definitions) in the Indenture requiring the Company to make an
Offer to Purchase in a manner materially adverse to the Holders of Notes
affected thereby; or (k) modify the provisions of the Escrow Agreement or the
Indenture relating to the Escrow Collateral in any manner adverse to the Holders
or release any of the Escrow Collateral from the Lien under the Escrow Agreement
or permit any other obligation to be secured by the Escrow Collateral.
The Holders of a majority in aggregate principal amount of the outstanding
Notes, on behalf of all Holders, may waive compliance by the Company with
certain restrictive provisions of the Indenture. Subject to certain rights of
the Trustee as provided in the Indenture, the Holders of a majority in aggregate
principal amount of the Notes, on behalf of all Holders, may waive any past
default under the Indenture (including any such waiver obtained in connection
with a tender offer or exchange offer for such Notes), except a default in the
payment of principal, premium or interest or a default arising from failure to
purchase any Notes tendered pursuant to an Offer to Purchase pursuant thereto,
or a default in respect of a provision that under the Indenture cannot be
modified or amended without the consent of the Holder of each Note that is
affected.
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GOVERNING LAW
The Indenture and the Notes will be governed by the laws of the State of
New York without regard to principles of conflicts of laws.
THE TRUSTEE
Except during the continuance of a Default, the Trustee will perform only
such duties as are specifically set forth in the Indenture. During the existence
of a Default under the Indenture, the Trustee will exercise such rights and
powers vested in it under the Indenture and use the same degree of care and
skill in its exercise as a prudent person would exercise under the circumstances
in the conduct of such person's own affairs.
The Indenture and provisions of the Trust Indenture Act incorporated by
reference therein contain limitations on the rights of the Trustee, should it
become a creditor of the Company or any other obligor upon the Notes, to obtain
payment of claims in certain cases or to realize on certain property received by
it in respect of any such claim as the Notes or otherwise. The Trustee is
permitted to engage in other transactions with the Company or an Affiliate of
the Company; provided, however, that if it acquires any conflicting interest (as
defined in the Indenture or in the Trust Indenture Act), it must eliminate such
conflict or resign.
CERTAIN DEFINITIONS
Set forth below are certain defined terms used in the Indenture. Reference
is made to the Indenture for a full disclosure of all such terms, as well as any
other capitalized terms used herein for which no definition is provided.
"Acquired Indebtedness" means Indebtedness of a Person (a) assumed in
connection with an Acquisition from such Person or (b) existing at the time such
Person becomes a Restricted Group Member or is merged or consolidated with or
into the Company or any Restricted Group Member; provided, however, that (i)
such Indebtedness was not Incurred in connection with, or in contemplation of,
such Acquisition, such Person becoming a Restricted Group Member or such merger
or consolidation and (ii) Indebtedness of such Person which is redeemed,
defeased, retired or otherwise repaid at the time of or immediately upon
consummation of the transactions by which such Person becomes a Restricted Group
Member or such Asset Acquisition shall not be Acquired Indebtedness.
"Acquired Person" means, with respect to any specified Person, any other
Person which merges with or into or becomes a Subsidiary of such specified
Person.
"Acquisition" means (i) any capital contribution (by means of transfers of
cash or other property to others or payments for property or services for the
account or use of others, or otherwise) by the Company or any Restricted Group
Member to any other Person, or any acquisition or purchase of Equity Interests
of any other Person by the Company or any Restricted Group Member, in either
case pursuant to which such Person shall become a Restricted Group Member or
shall be consolidated, merged with or into the Company or any Restricted Group
Member or (ii) any acquisition by the Company or any Restricted Group Member of
the assets of any Person which constitute substantially all of an operating unit
or line of business of such Person or which is otherwise outside of the ordinary
course of business.
"Affiliate" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified person. For purposes of this definition,
"control"(including, with correlative meanings, the terms "controlling,"
"controlled by" and "under common control with"), as used with respect to any
Person, shall mean the possession, directly or indirectly, of the power to
direct or cause the direction of the management or policies of such Person
whether through the ownership of voting securities, by agreement or otherwise.
"Asset Sale" means any direct or indirect sale, conveyance, transfer, lease
(that has the effect of a disposition), or other disposition (including. without
limitation, any merger, consolidation or sale-leaseback transaction) to any
Person other than the Company or a Restricted Group Member, in one transaction
or a series of related transactions, of (i) any Equity Interest of any
Restricted Group Member; (ii) any material
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license, franchise or other authorization of the Company or any Restricted Group
Member; (iii) any assets of the Company or any Restricted Group Member which
constitute substantially all of an operating unit or line of business of the
Company or any Restricted Group Member; or (iv) any other property or asset of
the Company or any Restricted Group Member outside of the ordinary course of
business (including the receipt of proceeds paid on account of the loss of or
damage to any property or asset and awards of compensation for any asset taken
by condemnation, eminent domain or similar proceedings). For the purposes of
this definition, the term "Asset Sale" shall not include (a) any transaction
consummated in compliance with "-- Certain Covenants -- Merger, Sale of Assets,
etc." above and the creation of any Lien not prohibited by "-- Certain
Covenants -- Limitation on Liens" above; provided, however, that any transaction
consummated in compliance with "-- Certain Covenants -- Merger, Sale of Assets,
etc." above involving a sale, conveyance, assignment, transfer, lease or other
disposal of less than all of the properties or assets of the Company and the
Restricted Group Members shall be deemed to be an Asset Sale with respect to the
properties or assets of the Company and Restricted Group Members that are not so
sold, conveyed, assigned, transferred, leased or otherwise disposed of in such
transaction; (b) sales of property or equipment that has become worn out,
obsolete or damaged or otherwise unsuitable for use in connection with the
business of the Company or any Restricted Group Member, as the case may be; and
(c) any transaction consummated in compliance with "-- Certain
Covenants -- Limitation on Restricted Payments" above. In addition, solely for
purposes of "-- Certain Covenants -- Limitation on Asset Sales" above, any sale,
conveyance, transfer, lease or other disposition of any property or asset,
whether in one transaction or a series of related transactions, with a Fair
Market Value not in excess of $1.0 million in any fiscal year shall be deemed
not to be an Asset Sale.
"Basket" see "-- Certain Covenants -- Limitation on Restricted Payments"
above.
"Board of Directors" means, with respect to any Person, the Board of
Directors of such Person (or comparable governing body), or any authorized
committee of that Board (it being understood that the Board of Directors of the
Company shall be its Board of Supervisory Directors).
"Business Day" means a day (other than a Saturday or Sunday) on which the
Depository and banks in New York are open for business.
"Capital Lease Obligation" means, at the time any determination thereof is
to be made, the amount of the liability in respect of a capital lease that would
at such time be so required to be capitalized on the balance sheet in accordance
with GAAP.
"Cash Equivalents" means: (a) U.S. dollars; (b) securities issued or
directly and fully guaranteed or insured by the U.S. government or any agency or
instrumentality thereof having maturities of not more than six months from the
date of acquisition; provided, however, that securities deposited in the Escrow
Account may have longer maturities; (c) certificates of deposit and eurodollar
time deposits with maturities of six months or less from the date of
acquisition, bankers' acceptances with maturities not exceeding six months and
overnight bank deposits, in each case with any commercial bank having capital
and surplus in excess of $500 million; provided, however, that securities
deposited in the Escrow Account may have longer maturities; (d) repurchase
obligations with a term of not more than seven days for underlying securities of
the types described in clauses (b) and (c) entered into with any financial
institution meeting the qualifications specified in clause (c) above; and (e)
commercial paper rated P-1, A-1 or the equivalent thereof by Moody's Investors
Service, Inc. or Standard & Poor's Ratings Group, respectively, and in each case
maturing within six months after the date of acquisition.
"Change of Control" means the occurrence of any of the following events
(whether or not approved by the Board of Directors of the Company): (a) any
Person or group, excluding Permitted Holders, is or becomes the beneficial
owner, directly or indirectly, of Voting Equity Interests representing 35% or
more of the total voting power of the Voting Equity Interests of the Company at
a time when the Permitted Holders together (x) own Voting Equity Interests
representing a lesser percentage of the total voting power of the Voting Equity
Interests of the Company, than such Person or group (for purposes of determining
the percentage of the Voting Equity Interests of such Person or group, the
holdings of the Permitted Holders who are part of such Person or group shall not
be counted in the Voting Equity Interests of such Person or group)
125
or (y) do not hold the power to elect a majority of the members of the Board of
Directors of the Company; (b) any Person or group is or becomes the beneficial
owner directly or indirectly, of Voting Equity Interests representing 50% or
more of the total voting power of the Voting Equity Interests of the Company or
has the power, directly or indirectly, to elect a majority of the members of the
Board of Directors of the Company; (c) the Company consolidates with, or merges
with or into, another Person or the Company or one or more Restricted
Subsidiaries sell, assign, convey, transfer, lease or otherwise dispose of all
or substantially all of the assets of the Company and the Restricted
Subsidiaries, taken as a whole, to any Person (other than a Wholly Owned
Restricted Subsidiary), or any Person consolidates with, or merges with or into,
the Company, in any such event other than pursuant to a transaction in which the
Person or Persons that "beneficially owned," directly or indirectly, a majority
of the total voting power of the Voting Equity Interests of the Company
immediately prior to such transaction, "beneficially own," directly or
indirectly, Voting Equity Interests representing a majority of the total voting
power of the Voting Equity Interests of the surviving or transferee Person; (d)
during any consecutive two year period, individuals who at the beginning of such
period constituted the Board of Directors of the Company (together with any new
directors whose election by the Board of Directors of the Company or whose
nomination for election by the stockholders of the Company was approved by a
vote of a majority of the directors then still in office who were either
directors at the beginning of such period or whose election or nomination for
election was previously so approved) cease for any reason (other than by action
of the Permitted Holders) to constitute a majority of the Board of Directors of
the Company, then in office; (e) there shall occur the liquidation or
dissolution of the Company. For purposes of this definition, (i) "group" has the
meaning under Section 13(d) and 14(d) of the Exchange Act or any successor
provision to either of the foregoing, including any group acting for the purpose
of acquiring, holding or disposing of securities within the meaning of Rule
13d-5(b)(1) under the Exchange Act, and (ii) "beneficial ownership" has the
meaning set forth in Rules 13d-3 and 13d-5 under the Exchange Act, except that a
Person shall be deemed to have "beneficial ownership" of all securities that
such Person has the right to acquire, whether such right is exercisable
immediately or only after the passage of time, upon the happening of an event or
otherwise.
"Change of Control Date" see "-- Change of Control" above.
"Consolidated Income Tax Expense" means, with respect to any period, the
provision for federal, state, local and foreign income taxes payable by the
Company and the Restricted Group Members for such period as determined on a
consolidated basis in accordance with GAAP.
"Consolidated Interest Expense" means, with respect to any period, without
duplication, the sum of (i) the interest expense of the Company and the
Restricted Group Members for such period as determined on a consolidated basis
in accordance with GAAP, including, without limitation, (a) any amortization of
debt discount, (b) the net cost under Interest Rate Protection Obligations
(including any amortization of discounts), (c) the interest portion of any
deferred payment obligation, (d) all commissions, discounts and other fees and
charges owed with respect to letters of credit and bankers' acceptance financing
and (e) all capitalized interest and all accrued interest, (ii) the interest
component of Capital Lease Obligations paid, accrued and/or scheduled to be paid
or accrued by the Company and the Restricted Subsidiaries during such period as
determined on a consolidated basis in accordance with GAAP and (iii) dividends
and distributions in respect of Disqualified Equity Interests actually paid in
cash by the Company or any Restricted Group Member (other than to the Company or
another Restricted Group Member) during such period as determined on a
consolidated basis in accordance with GAAP.
"Consolidated Net Income" means, with respect to any period, the net
income of the Company and the Restricted Group Members for such period
determined on a consolidated basis in accordance with GAAP, adjusted, to the
extent included in calculating such net income, by excluding, without
duplication, (a) other than for purposes of calculating the Basket, all
extraordinary gains or losses for such period, (b) other than for purposes of
calculating the Basket, all gains or losses from the sales or other dispositions
of assets out of the ordinary course of business (net of taxes, fees and
expenses relating to the transaction giving rise thereto) for such period; (c)
that portion of such net income derived from or in respect of investments in
Persons other than Restricted Group Members, except to the extent actually
received in cash by the Company or any Restricted Group Member (subject, in the
case of any Restricted Group Member, to the provisions of
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clause (f) of this definition); (d) the portion of such net income (or loss)
allocable to minority interests in any Person (other than a Restricted Group
Member) for such period, except to the extent the Company's allocable portion of
such Person's net income for such period is actually received in cash by the
Company or any Restricted Group Member (subject, in the case of any Restricted
Group Member, to the provisions of clause (f) of this definition); (e) the net
income (or loss) of any other Person combined with the Company or any Restricted
Group Member on a "pooling of interests" basis attributable to any period prior
to the date of combination; (f) the net income of any Restricted Group Member to
the extent that the declaration or payment of dividends or similar distributions
by that Restricted Group Member of that income is not at the time (regardless of
any waiver) permitted, directly or indirectly, by operation of the terms of its
charter or any agreement, instrument, judgment, decree, order, statute, rule or
governmental regulations applicable to that Restricted Group Member or its
Equity Interest holders; provided, however, that with respect to any restriction
on the declaration or payment of dividends or similar distribution in place on
the Issue Date pursuant to any agreement in effect on the Issue Date (or any
amendment or modification thereto no more restrictive than that in effect on the
Issue Date), so long as such restriction on the declaration or payment of
dividends or similar distributions is no less favorable to the Holders than the
restrictions contained in the Hermes Europe Senior Notes Indenture as in effect
on the Issue Date, this clause (f) shall apply solely for purposes of
determining Cumulative Operating Cash Flow in connection with a Restricted
Payment described in clauses (i), (ii) and (iii) of "-- Certain
Covenants -- Limitation on Restricted Payments" above; and (g) to the extent not
otherwise excluded in accordance with GAAP, the net income (or loss) of any
Restricted Group Member in an amount that corresponds to the percentage
ownership interest in the income of such Restricted Group Member not owned on
the last day of such period, directly or indirectly, by the Company.
"Consolidated Operating Cash Flow" means, with respect to any period,
Consolidated Net Income for such period increased (without duplication), to the
extent deducted in calculating such Consolidated Net Income, by (a) Consolidated
Income Tax Expense for such period; (b) Consolidated Interest Expense for such
period; and (c) depreciation, amortization and any other non-cash items for such
period (other than any non-cash item which requires the accrual of, or a reserve
for, cash charges for any future period) of the Company and the Restricted Group
Members, including, without limitation, amortization of capitalized debt
issuance costs for such period, all of the foregoing determined on a
consolidated basis in accordance with GAAP minus non-cash items to the extent
they increase Consolidated Net Income (including the partial or entire reversal
of reserves taken in prior periods) for such period.
"Cumulative Operating Cash Flow" means, as at any date of determination,
the positive cumulative Consolidated Operating Cash Flow realized during the
period commencing on the Issue Date and ending on the last day of the most
recent fiscal quarter immediately preceding the date of determination for which
consolidated financial information of the Company is available or, if such
cumulative Consolidated Operating Cash Flow for such period is negative, the
negative amount by which cumulative Consolidated Operating Cash Flow is less
than zero.
"Currency Agreement" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement, which may include the use
of derivatives, designed to protect the Company or any Restricted Subsidiary
against fluctuations in currency values.
"Debt to Annualized Operating Cash Flow Ratio" means the ratio of (a) the
Total Consolidated Indebtedness as of the date of calculation (the
"Determination Date") to (b) two times the Consolidated Operating Cash Flow for
the latest two fiscal quarters for which financial information is available
immediately preceding such Determination Date (the "Measurement Period"). For
purposes of calculating Consolidated Operating Cash Flow for the Measurement
Period immediately prior to the relevant Determination Date, (I) any Person that
is a Restricted Group Member on the Determination Date (or would become a
Restricted Group Member on such Determination Date in connection with the
transaction that requires the determination of such Consolidated Operating Cash
Flow) will be deemed to have been a Restricted Group Member at all times during
such Measurement Period, (II) any Person that is not a Restricted Group Member
on such Determination Date (or would cease to be a Restricted Group Member on
such Determination Date in connection with the transaction that requires the
determination of such Consolidated Operating Cash Flow)
127
will be deemed not to have been a Restricted Group Member at any time during
such Measurement Period, and (III) if the Company or any Restricted Group Member
shall have in any manner (x) acquired (through an Acquisition or the
commencement of activities constituting such operating business) or (y) disposed
of (by way of an Asset Sale or the termination or discontinuance of activities
constituting such operating business) any operating business during such
Measurement Period or after the end of such period and on or prior to such
Determination Date, such calculation will be made on a pro forma basis in
accordance with GAAP as if, in the case of an Acquisition or the commencement of
activities constituting such operating business, all such transactions had been
consummated on the first day of such Measurement Period and, in the case of an
Asset Sale or termination or discontinuance of activities constituting such
operating business, all such transactions had been consummated prior to the
first day of such Measurement Period (it being understood that in calculating
Consolidated Operating Cash Flow the exclusions set forth in clauses (a) through
(f) of the definition of Consolidated Net Income shall apply to an Acquired
Person as if it were a Restricted Group Member).
"Default" means any event that is, or with the passage of time or the
giving of notice or both would be, an Event of Default.
"Designation" See "-- Certain Covenants -- Designation of Unrestricted
Group Members" above.
"Designation Amount" See "-- Certain Covenants -- Designation of
Unrestricted Group Members" above.
"Disinterested Director" means a member of the Board of Directors of the
Company who does not have any material direct or indirect financial interest in
or with respect to the transaction being considered.
"Disposition" means, with respect to any Person, any merger, consolidation
or other business combination involving such Person (whether or not such Person
is the Surviving Person) or the sale, assignment, transfer, lease, conveyance or
other disposition of all or substantially all of such Person's assets.
"Disqualified Equity Interest" means any Equity Interest which, by its
terms (or by the terms of any security into which it is convertible or for which
it is exchangeable at the option of the holder thereof), or upon the happening
of any event, matures or is mandatorily redeemable, pursuant to a sinking fund
obligation or otherwise, or redeemable, at the option of the holder thereof, in
whole or in part, on or prior to the Maturity Date; provided, however, that any
Equity Interests that would not constitute Disqualified Equity Interests but for
provisions thereof giving holders thereof the right to require the Company to
repurchase or redeem such Equity Interests upon the occurrence of a change in
control occurring prior to the Maturity Date shall not constitute Disqualified
Equity Interests if the change in control provisions applicable to such Equity
Interests are no more favorable to the holders of such Equity Interests than the
provisions described under "-- Change of Control" above and such Equity
Interests specifically provide that the Company will not repurchase or redeem
any such Equity Interests pursuant to such provisions prior to the Company's
repurchase of Notes as are required to be repurchased pursuant to the provisions
described under "-- Change of Control" above.
"Dollar Equivalent" means, with respect to a monetary amount in a currency
other than U.S. dollars, at any time for the determination thereof, the amount
of U.S. dollars obtained by converting such other currency involved in such
computation into U.S. dollars at the rate for the purchase of U.S. dollars with
the applicable currency as set forth in the Key Currency Cross Rates table of
The Wall Street Journal (or a successor table) on the date that is two Business
Days prior to such determination.
"Equity Interest" in any Person means any and all shares, interests, rights
to purchase, warrants, options, participations or other equivalents of or
interests in (however designated) corporate stock or other equity
participations, including partnership interests, whether general or limited, in
such Person, including any Preferred Equity Interests.
"Exchange Act" means the Securities Exchange Act of 1934, as amended, and
the rules and regulations promulgated by the SEC thereunder.
128
"Existing Joint Venture" means each of PrymTelefon, Bancomsvyaz,
TeleCommunications of Moscow, LvNet-Telport, GTS Monaco Access S.A.M., Sovam
Teleport Kiev Division L.L.C., EDN Sovintel, all the entities in which
SFMT-Rusnet, Inc. currently has an interest, all the entities in which Vostok
Mobile b.v. currently has an interest and their respective successors.
"Expiration Date" see the definition of "Offer to Purchase" above.
"Fair Market Value" means, with respect to any asset, the price (after
taking into account any liabilities relating to such assets) which could be
negotiated in an arm's-length free market transaction, for cash, between a
willing seller and a willing and able buyer, neither of which is under any
compulsion to complete the transaction; provided, however, that the Fair Market
Value of any such asset or assets shall be determined conclusively by the Board
of Directors of the Company acting in good faith, which determination shall be
evidenced by a resolution of such Board delivered to the Trustee.
"GAAP" means, at any date of determination, generally accepted accounting
principles in effect in the United States which are applicable at the date of
determination and which are consistently applied for all applicable periods.
"guarantee" means, as applied to any obligation, (i) a guarantee (other
than by endorsement of negotiable instruments for collection in the ordinary
course of business), direct or indirect, in any manner, of any part or all of
such obligation and (ii) an agreement, direct or indirect, contingent or
otherwise, the practical effect of which is to assure in any way the payment or
performance (or payment of damages in the event of non-performance) of all or
any part of such obligation, including, without limiting the foregoing, the
payment of amounts drawn down by letters of credit. A guarantee shall include,
without limitation, any agreement to maintain or preserve any other person's
financial condition or to cause any other Person to achieve certain levels of
operating results.
"Hermes Europe" means Hermes Europe Railtel B.V., a company organized in
the Netherlands.
"Hermes Europe Senior Notes Indenture" means the indenture governing the
11 1/2% Senior Notes due 2007 of Hermes Europe.
"Incur" means, with respect to any Indebtedness or other obligation of any
Person, to create, issue, incur (including by conversion, exchange or
otherwise), assume, guarantee or otherwise become liable in respect of such
Indebtedness or other obligation or the recording, as required pursuant to GAAP
or otherwise, of any such Indebtedness or other obligation on the balance sheet
of such Person (and "Incurrence," "Incurred" and "Incurring" shall have meanings
correlative to the foregoing). Indebtedness of a Person existing at the time
such Person becomes a Restricted Group Member or is merged or consolidated with
or into the Company or any Restricted Group Member shall be deemed to be
Incurred at such time.
"Indebtedness" means (without duplication), with respect to any Person,
whether recourse is to all or a portion of the assets of such Person and whether
or not contingent, (a) every obligation of such Person for money borrowed; (b)
every obligation of such Person evidenced by bonds, debentures, notes or other
similar instruments, including obligations incurred in connection with the
acquisition of property, assets or businesses; (c) every reimbursement
obligation of such Person with respect to letters of credit, bankers'
acceptances or similar facilities issued for the account of such Person; (d)
every obligation of such Person issued or assumed as the deferred purchase price
of property or services (but excluding trade accounts payable incurred in the
ordinary course of business and payable in accordance with industry practices,
or other accrued liabilities arising in the ordinary course of business which
are not overdue or which are being contested in good faith); (e) every Capital
Lease Obligation of such Person; (f) every net obligation under interest rate
swap or similar agreements or foreign currency hedge, exchange or similar
agreements of such Person; (g) every obligation of the type referred to in
clauses (a) through (f) of another Person and all dividends of another Person
the payment of which, in either case, such Person has guaranteed or is
responsible or liable for, directly or indirectly, as obligor, guarantor or
otherwise; and (h) any and all Refinancing of, or amendments, modifications or
supplements to, any liability of the kind described in any of the preceding
clauses (a) through (g) above. Indebtedness (i) shall never be calculated taking
into account any cash and cash equivalents held by such Person; (ii) shall not
include obligations of any Person (x) arising from the honoring by a bank or
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other financial institution of a check, draft or similar instrument
inadvertently drawn against insufficient funds in the ordinary course of
business, provided that such obligations are extinguished within two Business
Days of their incurrence unless covered by an overdraft line, (y) resulting from
the endorsement of negotiable instruments for collection in the ordinary course
of business and consistent with past business practices and (z) under stand-by
letters of credit to the extent collateralized by cash or Cash Equivalents;
(iii) which provides that an amount less than the principal amount thereof shall
be due upon any declaration of acceleration thereof shall be deemed to be
Incurred or outstanding in an amount equal to the accreted value thereof at the
date of determination determined in accordance with GAAP; and (iv) shall include
the liquidation preference and any mandatory redemption payment obligations in
respect of any Disqualified Equity Interests of the Company or any Preferred
Equity Interests of any Restricted Group Member.
"Independent Financial Advisor" means a recognized, accounting, appraisal,
investment banking firm or consultant with experience in a Telecommunications
Business (i) which does not, and whose directors, officers and employees or
Affiliates do not, have a material direct or indirect financial interest in the
Company and (ii) which, in the judgment of the Board of Directors of the
Company, is otherwise independent and qualified to perform the task for which it
is to be engaged.
"interest" means, with respect to the Notes, the sum of any cash interest
on the Notes.
"Interest Rate Protection Obligations" means, with respect to any Person,
the Obligations of such Person under (i) interest rate swap agreements, interest
rate cap agreements and interest rate collar agreements, and (ii) other
agreements or arrangements designed to protect such Person against fluctuations
in interest rates.
"Investment" means, with respect to any Person, any direct or indirect
loan, advance, guarantee or other extension of credit or capital contribution to
(by means of transfers of cash or other property or assets to others or payments
for property or services for the account or use of others, or otherwise), or
purchase or acquisition of capital stock, bonds, notes, debentures or other
securities or evidences of Indebtedness issued by, any other Person. The amount
of any Investment shall be the original cost of such Investment, plus the cost
of all additions thereto, and minus the amount of any portion of such Investment
repaid to such Person in cash as a repayment of principal or a return of
capital, as the case may be, but without any other adjustments for increases or
decreases in value, or write-ups, write-downs or write-offs with respect to such
Investment. In determining the amount of any investment involving a transfer of
any property or asset other than cash, such property shall be valued at its Fair
Market Value at the time of such transfer. "Investments" shall exclude
extensions of trade credit in the ordinary course of business in accordance with
normal trade practices.
"Involuntary Event" see the definition of "Permitted Investments" below.
"Issue Date" means the original issue date of the Notes.
"Latest Balance Sheet" means, of any Person, the latest consolidated
balance sheet of such Person reported on by a recognized firm of independent
accountants without qualification as to scope.
"Lien" means any lien, mortgage, charge, security interest, hypothecation,
assignment for security or encumbrance of any kind (including any conditional
sale or capital lease or other title retention agreement, any lease in the
nature thereof, and any agreement to give any security interest).
"Maturity Date" means the date, which is set forth on the face of the
Notes, on which the Notes will mature.
"Net Cash Proceeds" means the aggregate proceeds in the form of cash or
Cash Equivalents received by the Company or any Restricted Subsidiary in respect
of any Asset Sale, including all cash or Cash Equivalents received upon any
sale, liquidation or other exchange of proceeds of Asset Sales received in a
form other than cash or Cash Equivalents, net of (a) the direct costs relating
to such Asset Sale (including, without limitation, legal, accounting and
investment banking fees, and sales commissions) and any relocation expenses
incurred as a result thereof; (b) taxes paid or payable as a result thereof
(after taking into account any available tax credits or deductions and any tax
sharing arrangements); (c) amounts required to be applied to the repayment of
Indebtedness secured by a Lien on the asset or assets that were the subject of
such Asset Sale; (d) amounts deemed, in good faith, appropriate by the Board or
Directors of the Company to be provided as a reserve, in
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accordance with GAAP, against any liabilities associated with such assets which
are the subject of such Asset Sale (provided that the amount of any such
reserves shall be deemed to constitute Net Cash Proceeds at the time such
reserves shall have been released or are not otherwise required to be retained
as a reserve); and (e) with respect to Asset Sales by any Restricted Group
Member, the portion of such cash payments attributable to Persons holding a
minority interest in such Restricted Group Member.
"Non-Subsidiary Affiliate," of any specified Person, means any other Person
in which an Investment in the Equity Interests of such Person has been made by
such specified Person other than a direct or indirect Subsidiary of such
specified Person.
"Obligations" means any principal, interest (including, without limitation,
post-petition interest), penalties, fees, indemnifications, reimbursement
obligations, damages and other liabilities payable under the documentation
governing any Indebtedness.
"Offer" see the definition of "Offer to Purchase" above.
"Offer to Purchase" means a written offer (the "Offer") sent by or on
behalf of the Company by first-class mail, postage prepaid, to each Holder at
his address appearing in the register for the Notes on the date of the Offer
offering to purchase up to the principal amount of Notes specified in such Offer
at the purchase price specified in such Offer (as determined pursuant to the
Indenture). Unless otherwise required by applicable law, the Offer shall specify
an expiration date (the "Expiration Date") of the Offer to Purchase, which shall
be not less than 20 Business Days nor more than 90 days after the date of such
Offer, and a settlement date (the "Purchase Date") for purchase of Notes to
occur no later than five Business Days after the Expiration Date. The Company
shall notify the Trustee at least 15 Business Days (or such shorter period as is
acceptable to the Trustee) prior to the mailing of the Offer of the Company's
obligation to make an Offer to Purchase, and the Offer shall be mailed by the
Company or, at the Company's request, by the Trustee in the name and at the
expense of the Company. The Offer shall contain all the information required by
applicable law to be included therein. The Offer shall contain all instructions
and materials necessary to enable such Holders to tender Notes pursuant to the
Offer to Purchase. The Offer shall also state:
(1) the Section of the Indenture pursuant to which the Offer to
Purchase is being made;
(2) the Expiration Date and the Purchase Date;
(3) the aggregate principal amount of the outstanding Notes offered to
be purchased by the Company pursuant to the Offer to Purchase (including,
if less than 100%, the manner by which such amount has been determined
pursuant to the Section of the Indenture requiring the Offer to Purchase)
(the "Purchase Amount");
(4) the purchase price to be paid by the Company for each $1,000
aggregate principal amount of Notes accepted for payment (as specified
pursuant to the Indenture) (the "Purchase Price");
(5) that the Holder may tender all or any portion of the Notes
registered in the name of such Holder and that any portion of a Note
tendered must be tendered in an integral multiple of $1,000 principal
amount at maturity;
(6) the place or places where Notes are to be surrendered for tender
pursuant to the Offer to Purchase;
(7) that interest on any Note not tendered or tendered but not
purchased by the Company pursuant to the Offer to Purchase will continue to
accrue;
(8) that on the Purchase Date the Purchase Price will become due and
payable upon each Note being accepted for payment pursuant to the Offer to
Purchase and that interest thereon shall cease to accrue on and after the
Purchase Date:
(9) that each Holder electing to tender all or any portion of a Note
pursuant to the Offer to Purchase will be required to surrender such Note
at the place or places specified in the Offer to Purchase prior to the
close of business on the Expiration Date (such Note being, if the Company
or the Trustee so
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requires, duly endorsed by, or accompanied by a written instrument of
transfer in form satisfactory to the Company and the Trustee duly executed
by, the Holder thereof or his attorney duly authorized in writing);
(10) that Holders will be entitled to withdraw all or any portion of
Notes tendered if the Company (or Paying Agent) receives, not later than
the close of business on the fifth Business Day next preceding the
Expiration Date, a telegram, telex, facsimile transmission or letter
setting forth the name of the Holder, the principal amount of the Note the
Holder tendered, the certificate number of the Note the Holder tendered and
a statement that such Holder is withdrawing all or a portion of his or her
tender;
(11) that (a) if Notes in an aggregate principal amount less than or
equal to the Purchase Amount are duly tendered and not withdrawn pursuant
to the Offer to Purchase, the Company shall purchase all such Notes and (b)
if Notes in an aggregate principal amount in excess of the Purchase Amount
are tendered and not withdrawn pursuant to the Offer to Purchase, the
Company shall purchase Notes having an aggregate principal amount equal to
the Purchase Amount on a pro rata basis (with such adjustments as may be
deemed appropriate so that only Notes in denominations of $1,000 principal
amount at maturity or integral multiples thereof shall be purchased); and
(12) that in the case of any Holder whose Note is purchased only in
part, the Company shall execute and the Trustee shall authenticate and
deliver to the Holder of such Note without service charge, a new Note or
Notes, of any authorized denomination as requested by such Holder, in an
aggregate principal amount equal to and in exchange for the unpurchased
portion of the Note so tendered.
An Offer to Purchase shall be governed by and effected in accordance with
the provisions above pertaining to any Offer.
"Permitted Holders" means (a) Alan B. Slifka and any entity controlled by
him, (b) one or more of George Soros, Soros Fund Management LLC, Purnendu
Chatterjee or Chatterjee Management Company or Affiliates of any of the
foregoing, and any person or entity for which any such person or entity acts as
investment advisor or investment manager and (c) any Person that acquires the
Equity Interests of the Company in a Strategic Equity Investment.
"Permitted Investments" means (a) Cash Equivalents; (b) Investments in
prepaid expenses, negotiable instruments held for collection and lease, utility
and workers' compensation, performance and other similar deposits; (c) loans and
advances to employees made in the ordinary course of business not to exceed $3.0
million in the aggregate at any one time outstanding; (d) Interest Rate
Protection Obligations and Currency Agreements permitted under "-- Certain
Covenants -- Limitation on Incurrence of Indebtedness" above; (e) bonds, notes,
debentures or other securities received as a result of Asset Sales permitted
under "-- Certain Covenants -- Limitation on Asset Sales" above; (f)
transactions with officers, directors and employees of the Company or any
Restricted Group Member entered into in the ordinary course of business
(including compensation or employee benefit arrangements with any such director
or employee) and consistent with past business practices; (g) Investments made
in the ordinary course of business and on ordinary business terms as partial
payment for constructing a network relating principally to a Telecommunications
Business; (h) Investments in any Restricted Group Member; (i) intercompany
Indebtedness to the extent permitted under paragraph (b)(v) of "-- Certain
Covenants -- Limitation on Incurrence of Indebtedness" above; (j) Investments by
the Company or any Restricted Group Member in another Person, if as a result of
such Investment (x) such other Person becomes a Restricted Group Member or (y)
such other Person is merged or consolidated with or into, or transfers or
conveys all or substantially all of its assets to, the Company or a Restricted
Group Member; (k) Investments in evidences of Indebtedness, securities or other
property received from another Person by the Company or any Restricted Group
Member in connection with any bankruptcy proceeding or by reason of a
composition or readjustment of debt or a reorganization of such Person or as a
result of foreclosure, perfection or enforcement of any Lien in exchange for
evidences of Indebtedness, securities or other property of such Person held by
the Company or any Restricted Group Member, or for other liabilities or
obligations of such other Person to the Company or any Restricted Group Member
that were created in accordance with the terms of the Indenture; and (l) an
Investment by the Company or a Restricted Group Member in a Restricted Affiliate
or a Person which will, upon the making of
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such Investment, become a Restricted Affiliate or be merged or consolidated with
or into or transfer or convey all or substantially all its assets to, a
Restricted Affiliate; provided, however, that (I) such Person's primary business
is related, ancillary or complementary to the businesses of the Company and its
Restricted Group Members on the date of such Investment, and (II) any such
Investment shall cease to be a Permitted Investment in the event such Restricted
Affiliate shall cease to be a Restricted Affiliate or shall cease to observe any
of the provisions of the covenants that are applicable to such Restricted
Affiliate; provided, however, that in the event such Restricted Affiliate ceases
to be a Restricted Affiliate or such Restricted Affiliate ceases to observe any
of the provisions of the covenants applicable to it solely as a result of
circumstances, developments or conditions beyond the control of the Company
(such failure to be a Restricted Affiliate or failure to observe a covenant as a
result of any such circumstance, development or condition, being an "Involuntary
Event") any such Investment previously made in such Restricted Affiliate will
not cease to be a Permitted Investment unless such Involuntary Event continues
for 90 days.
"Permitted Liens" means (a) Liens on property of a Person existing at the
time such Person is merged into or consolidated with the Company or any
Restricted Group Member; provided, however, that such Liens were in existence
prior to the contemplation of such merger or consolidation and do not secure any
property or assets of the Company or any Restricted Group Member other than the
property or assets subject to the Liens prior to such merger or consolidation;
(b) Liens existing on the Issue Date; (c) Liens securing Indebtedness consisting
of Capitalized Lease Obligations, mortgage financings, industrial revenue bonds
or other monetary obligations, in each case incurred solely for the purpose of
financing all or any part of the purchase price or cost of construction or
installation of assets used in the business of the Company or any Restricted
Group Member, or repairs, additions or improvements to such assets; provided,
however, that (I) such Liens secure Indebtedness in an amount not in excess of
the original purchase price or the original cost of any such assets or repair,
addition or improvement thereto (plus an amount equal to the reasonable fees and
expenses in connection with the Incurrence of such Indebtedness), (II) such
Liens do not extend to any other assets of the Company or any Restricted Group
Member (and, in the case of repair, addition or improvements to any such assets,
such Lien extends only to the assets (and improvements thereto or thereon)
repaired, added to or improved), (III) the Incurrence of such Indebtedness is
permitted by "-- Certain Covenants -- Limitation on Incurrence of Indebtedness"
above and (IV) such Liens attach within 90 days of such purchase, construction,
installation, repair, addition or improvement; (d) Liens to secure any
Refinancings, in whole or in part, of any Indebtedness secured by Liens referred
to in the clauses above so long as such Lien does not extend to any other
property (other than improvements thereto); (e) Liens securing letters of credit
entered into in the ordinary course of business and consistent with past
business practice; (f) Liens on and pledges of the capital stock of any
Unrestricted Group Member securing any Indebtedness of such Unrestricted Group
Member; (g) Liens on any property or assets of a Restricted Group Member granted
in favor of and held by the Company or any Restricted Group Member; (h) Liens on
any property or assets of the Company or any Restricted Group Member securing on
a pari passu basis all of the Notes; (i) statutory Liens of landlords and
carriers, warehousemen, mechanics, suppliers, materialmen, repairmen or other
like Liens arising in the ordinary course of business of the Company or any
Restricted Group Member and with respect to amounts not yet delinquent or being
contested in good faith by appropriate proceedings; (j) Liens for taxes,
assessments, government charges or claims that are being contested in good faith
by appropriate proceedings promptly instituted and diligently conducted;
provided, however, that any reserve or other appropriate provision as shall be
required in conformity with GAAP shall have been made therefor; (k) Liens
incurred or deposits made to secure the performance of tenders, bids, leases,
statutory obligations, surety and appeal bonds, government contracts,
performance bonds and other obligations of a like nature incurred in the
ordinary course of business (other than contracts for the payment of money); (1)
easements, rights-of-way, restrictions and other similar charges or encumbrances
not interfering in any material respect with the business of the Company or any
Restricted Group Member and incurred in the ordinary course of business; (m)
Liens arising by reason of judgment, decree or order of any court so long as
such Lien is adequately bonded and any appropriate legal proceedings that may
have been duly initiated for the review of such judgment, decree or order shall
not have been finally terminated or the period within which such proceedings may
be initiated shall not have expired; (n) Liens on properties or assets of any
Restricted Group Member securing Indebtedness of any Restricted Group Member
(other than any guarantee of Indebtedness of the Company) to the extent
permitted to be
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Incurred under "-- Certain Covenants -- Limitation on Incurrence of
Indebtedness" above, (o) Liens securing Indebtedness under Interest Rate
Protection Obligations or Indebtedness under Currency Agreements to the extent
permitted to be Incurred under "-- Certain Covenants -- Limitation on Incurrence
of Indebtedness" above; (p) Liens incurred or deposits made in the ordinary
course of business in connection with workers' compensation, unemployment
insurance and other types of social security; and (q) Liens arising under the
Escrow Agreement.
"Permitted Refinancing" means, with respect to any Indebtedness,
Indebtedness to the extent representing a Refinancing of such Indebtedness;
provided, however, that (1) the Refinancing Indebtedness shall not exceed the
sum of the amount of the Indebtedness being Refinanced, plus the amount of
accrued interest or dividends thereon, the amount of any reasonably determined
prepayment premium necessary to accomplish such Refinancing and reasonable fees
and expenses incurred in connection therewith; (2) the Refinancing Indebtedness
shall have a Weighted Average Life to Maturity equal to or greater than the
Weighted Average Life to Maturity of the Indebtedness being Refinanced and shall
not permit redemption or other retirement (including pursuant to any required
offer to purchase to be made by the Company or any Restricted Group Member) of
such Indebtedness at the option of the Holder thereof prior to the final stated
maturity of the Indebtedness being Refinanced, other than a redemption or other
retirement at the option of the Holder of such Indebtedness (including pursuant
to a required offer to purchase made by the Company or a Restricted Group
Member) upon a change of control of the Company pursuant to provisions
substantially similar to those contained in the Indenture described under
"-- Change of Control" above; (3) Indebtedness that ranks pari passu with the
Notes may be Refinanced only with Indebtedness that is made pari passu with or
subordinate in right of payment to the Notes, and Indebtedness that is
subordinate in right of payment to the Notes may be Refinanced only with
Indebtedness that is subordinate in right of payment to the Notes on terms no
less favorable to the Holders than those contained in the Indebtedness being
Refinanced; and (4) the Refinancing Indebtedness shall be Incurred by the
obligor on the Indebtedness being Refinanced or by the Company.
"Person" means any individual, corporation, partnership, joint venture,
association, joint-stock company, limited liability company, limited liability
partnership, limited partnership, trust, unincorporated organization or
government or any agency or political subdivision thereof.
"Preferred Equity Interest," in any Person, means an Equity Interest of any
class or classes (however designated) which is preferred as to the payment of
dividends or distributions, or as to the distribution of assets upon any
voluntary or involuntary liquidation or dissolution of such Person, over Equity
Interests of any other class in such Person.
"principal" of a debt security means the principal of the security, plus,
when appropriate, the premium, if any, on the security.
"Public Equity Offering" means an underwritten public offering of common
Equity Interests of the Company pursuant to an effective registration statement
filed under the Securities Act (excluding registration statements filed on Form
S-8).
"Purchase Amount" see the definition of "Offer to Purchase" above.
"Purchase Date" see the definition of "Offer to Purchase" above.
"Purchase Price" see the definition of "Offer to Purchase" above.
"Qualified Equity Interest" means any Equity Interest of the Company other
than any Disqualified Equity Interest.
"Refinance" means refinance, renew, extend, replace, defease or refund; and
"Refinancing" and "Refinanced" have correlative meanings.
"Related Business" means any business in which the Company or its
Restricted Group Members are engaged, directly or indirectly, that consists
primarily of, or is related to, operating, acquiring, developing and
constructing any telecommunications services and related businesses.
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"Replacement Assets" means (x) properties and assets (other than cash or
any Equity Interests or other security) that will be used in a
Telecommunications Business of the Company and the Restricted Group Members or
(y) Equity Interests of any Person engaged primarily in a Telecommunications
Business, which Person will become on the date of acquisition thereof a
Restricted Group Member as a result of the Company's or any other Restricted
Group Member's acquisition of such Equity Interests.
"Restricted Affiliate" means any direct or indirect Non-Subsidiary
Affiliate of the Company or a Restricted Subsidiary of the Company that has been
designated by the Board of Directors of the Company as a Restricted Affiliate
based on a determination by the Board of Directors that the Company has,
directly or indirectly, the requisite control over such Non-Subsidiary Affiliate
to prevent it from Incurring Indebtedness, or taking any other action at any
time, in contravention of any of the provisions of the Indenture that are
applicable to Restricted Affiliates; provided, however, that immediately after
giving effect to such designation (i) the Liens and Indebtedness of such
Non-Subsidiary Affiliate outstanding immediately after such designation would,
if Incurred at such time, have been permitted to be Incurred for all purposes of
the Indenture; and (ii) no Default or Event of Default shall have occurred and
be continuing. The Company will be required to deliver an Officers' Certificate
to the Trustee upon designating any Non-Subsidiary Affiliate as a Restricted
Affiliate. As of the Issue Date, every Existing Joint Venture or a Restricted
Subsidiary of the Company is a Restricted Affiliate.
"Restricted Group Members" means collectively, each Restricted Subsidiary
of the Company, each Restricted Affiliate and each Restricted Subsidiary of a
Restricted Affiliate.
"Restricted Subsidiary" means any Subsidiary of the Company that has not
been designated by the Board of Directors of the Company, by a resolution of the
Board of Directors of the Company delivered to the Trustee, as an Unrestricted
Subsidiary pursuant to "-- Certain Covenants -- Designation of Unrestricted
Group Members" above. Any such designation may be revoked by a resolution of the
Board of Directors of the Company delivered to the Trustee, subject to the
provisions of such covenant.
"SEC" means the Securities and Exchange Commission.
"Share Capital" means, at any time of determination, the stated capital of
the Equity Interests (other than Disqualified Stock) and additional paid-in
capital of the Company at such time, all as determined in accordance with GAAP.
"Significant Restricted Group Member" means, at any date of determination,
(a) any Restricted Group Member that, together with its Subsidiaries that
constitute Restricted Group Members (i) for the most recent fiscal year of the
Company accounted for more than 10.0% of the consolidated revenues of the
Company and the Restricted Group Members or (ii) as of the end of such fiscal
year, owned more than 10.0% of the consolidated assets of the Company and the
Restricted Group Members, all as set forth on the consolidated financial
statements of the Company and the Restricted Group Members for such year
prepared in conformity with GAAP, and (b) any Restricted Group Member which,
when aggregated with all other Restricted Group Members that are not otherwise
Significant Restricted Group Members and as to which any event described in
clause (h) of "-- Events of Default" above has occurred and is continuing, would
constitute a Significant Restricted Group Member under clause (a) of this
definition.
"Stated Maturity" when used with respect to any Note or any installment of
interest thereon, means the date specified in such Note as the fixed date on
which the principal of such Note or such installment of interest is due and
payable.
"Strategic Equity Investments" means the issuance and sale of Qualified
Equity Interests to a Person that has an equity market capitalization, a net
asset value or annual revenues of at least $1.5 billion and owns and operates
business primarily in a Telecommunications Business.
"Subordinated Indebtedness" means any Indebtedness of the Company which is
expressly subordinated in right of payment to the Notes.
"Subsidiary" means, with respect to any Person, (a) any corporation of
which the outstanding Voting Equity Interests having at least a majority of the
votes entitled to be cast in the election of directors shall at
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the time be owned, directly or indirectly, by such Person, or (b) any other
Person of which at least a majority of Voting Equity Interests are at the time,
directly or indirectly, owned by such first named Person.
"Surviving Person" means, with respect to any Person involved in or that
makes any Disposition, the Person formed by or surviving such Disposition or the
Person to which such Disposition is made.
"Telecommunications Acquisition" means an Acquisition of properties or
assets to be used in a Telecommunications Business of the Equity Interests of
any Person that becomes a Restricted Subsidiary; provided, however, that such
Person's properties and assets shall consist principally of properties or assets
that will be used in a Telecommunications Business.
"Telecommunications Business" means any business owning, constructing,
financing and operating a telephone and/or communications system located
entirely in countries located in Russia, India and Western and Central Europe,
or any business reasonably related thereto, including, without limitation, any
business conducted by the Company or any Restricted Subsidiary on the Issue
Date.
"Total Consolidated Indebtedness" means, as at any date of determination,
an amount equal to the aggregate amount of all Indebtedness of the Company and
the Restricted Subsidiaries, on a consolidated basis, outstanding as of such
date of determination, after giving effect to any Incurrence of Indebtedness and
the application of the proceeds therefrom giving rise to such determination.
"Unrestricted Affiliate" means any Non-Subsidiary Affiliate of the Company
other than a Restricted Affiliate. The Board of Directors of the Company may
designate any Restricted Affiliate to be an Unrestricted Affiliate unless such
Non-Subsidiary Affiliate owns any Equity Interests of, or owns or holds any Lien
on any property of, the Company or any Restricted Group Member; provided,
however, that (i) any Guarantee by the Company or any Restricted Group Member of
any Indebtedness of the Non-Subsidiary Affiliate being so designated shall be
deemed an "Incurrence" of such Indebtedness and an "Investment" by the Company
or such Restricted Group Member (or both, if applicable) at the time of such
designation; and (ii) if applicable, the Incurrence of Indebtedness and the
Investment referred to in clause (i) of this proviso would be permitted under
"-- Certain Covenants -- Limitation on Incurrence of Indebtedness"and
"-- Certain Covenants -- Limitation on Restricted Payments" above. Any such
designation by the Board of Directors of the Company shall be evidenced to the
Trustee by promptly filing with the Trustee a copy of the board resolution
giving effect to such designation and an Officers' Certificate certifying that
such designation complied with the foregoing provisions.
"Unrestricted Group Member" means, collectively, each Unrestricted
Subsidiary of the Company and each Unrestricted Affiliate.
"Unrestricted Subsidiary" means any Subsidiary of the Company designated as
such pursuant to "-- Certain Covenants -- Designation of Unrestricted Group
Members" above. Any such designation may be revoked by a resolution of the Board
of Directors of the Company delivered to the Trustee, subject to the provisions
of such covenant.
"U.S. Government Obligations" means direct non-callable obligations of, or
obligations guaranteed by, the United States of America for the payment of which
guarantee or obligations the full faith and credit of the United States is
pledged.
"Voting Equity Interests" means Equity Interests in a corporation or other
Person with voting power under ordinary circumstances entitling the holders
thereof to elect the Board of Directors or other governing body of such
corporation or Person.
"Weighted Average Life to Maturity" means, when applied to any Indebtedness
at any date, the number of years obtained by dividing (a) the sum of the
products obtained by multiplying (i) the amount of each then remaining
installment, sinking fund, serial maturity or other required scheduled payment
of principal, including payment of final maturity, in respect thereof, by (ii)
the number of years (calculated to the nearest one-twelfth) that will elapse
between such date and the making of such payment, by (b) the then outstanding
aggregate principal amount of such Indebtedness.
"Wholly Owned Restricted Subsidiary" means any Restricted Subsidiary all of
the outstanding Voting Equity Interests (other than directors' qualifying
shares) of which are owned, directly or indirectly, by the Company.
136
CERTAIN UNITED STATES FEDERAL TAX CONSEQUENCES
The following is a summary of the principal United States federal income
tax considerations regarding the purchase, ownership and disposition of the
Notes. This summary is based on the Internal Revenue Code of 1986, as amended
(the "Code"), existing and proposed Treasury regulations promulgated thereunder
and administrative and judicial interpretations thereof (all as of the date
hereof and all of which are subject to change, possibly with retroactive
effect). Except as specifically set forth herein, this summary deals only with
Notes purchased on original issuance at their issue price and held as capital
assets within the meaning of section 1221 of the Code. It does not discuss all
of the tax consequences that may be relevant to holders in light of their
particular circumstances or to holders subject to special rules, such as banks,
insurance companies, tax-exempt organizations, dealers in securities or foreign
currencies, persons holding the Notes as part of a hedging transaction,
"straddle," conversion transaction, or other integrated transaction, or U.S.
Holders whose functional currency (as defined in section 985 of the Code) is not
the U.S. dollar. Persons considering the purchase of the Notes are urged to
consult with their own tax advisors with regard to the Notes in view of the
application of the United States federal income tax laws to their particular
situations as well as any tax consequences arising under the laws of any state,
local or foreign jurisdiction.
As used herein, the term "U.S. Holder" means a beneficial owner of a Note
that for United States federal income tax purposes is (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 of any
political subdivision thereof, (iii) an estate, the income of which is subject
to United States federal income taxation regardless of its source, or (iv) a
trust, if both: (A) a United States court 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. The term "Non-U.S. Holder" means an individual or entity other than a
U.S. Holder.
U.S. HOLDERS
Interest paid on a Note generally will be taxable to a U.S. Holder as
ordinary interest income at the time it accrues or is received, in accordance
with the U.S. Holder's method of accounting for federal income tax purposes. If
the Company qualifies as an "80/20 company" (as described below) for a
particular year, such interest income for such year will constitute income for
foreign sources.
Upon the sale, exchange or retirement of a Note, a U.S. Holder generally
will recognize taxable gain or loss equal to the difference between the amount
realized on the sale, exchange or retirement (reduced by any amounts
attributable to accrued but unpaid interest, which will be taxable as such) and
such holder's adjusted tax basis in the Note. The adjusted tax basis of a Note
generally will equal its cost. Gain or loss on the sale, exchange or retirement
of a Note generally will be capital gain or loss. Under newly enacted
legislation, the net amount of such gain recognized by an individual U.S. Holder
generally will be subject to tax at a maximum rate of (i) 28%, if the Note is
held for more than 12 months but not more than 18 months and (ii) 20%, if the
Note is held for more than 18 months.
Certain "backup" withholding and information reporting requirements may
apply to payments on, and to proceeds of the sale before maturity of, the Notes.
The Company, its agent, a broker, the relevant Trustee or any paying agent, as
the case may be, may withhold tax at a rate of 31% from any such payments to a
U.S. Holder that fails to furnish its taxpayer identification number (social
security number or employer identification number), to certify that such holder
is not subject to backup withholding, or to otherwise comply with the applicable
requirements of the backup withholding rules. Certain holders (including, among
others, corporations) generally are not subject to the backup withholding and
information reporting requirements.
Any amounts withheld under the backup withholding rules from a payment to a
U.S. Holder would be allowed as a refund or a credit against such holder's
United States federal income tax provided that the required information is
timely furnished to the Internal Revenue Service.
137
NON-U.S. HOLDERS
Under present United States federal law, and subject to the discussion
below concerning backup withholding:
(a) payments of principal, interest and premium, if any, on the Notes by
the Company or any paying agent to any Non-U.S. Holder will not be subject to
United States withholding tax, provided that, in the case of interest, either
(i) the Company is an "80/20 company," as described below, or, if the Company is
not an 80/20 company, (ii) the requirements for the "Portfolio Interest
Exemption" are satisfied; and
(b) a Non-U.S. Holder of a Note will not be subject to United States
federal income tax on gain realized on the sale, exchange or other disposition
of such Note, unless (i) such Holder is an individual who is present in the
United States for 183 days or more in the taxable year of disposition and
certain other conditions are met, or (ii) such gain is effectively connected
with the conduct by such Holder of a trade or business in the United States.
United States withholding tax will not be imposed on interest paid by a
domestic corporation if at least 80% of the gross income derived by such
corporation (either directly or through its subsidiaries) during the applicable
testing period is "active foreign business income," as defined in section 861 of
the Code (an "80/20 company"). At present, the Company believes that it
qualifies as an 80/20 company. However, the 80% test for active foreign business
income is applied on a periodic basis, and operations and business plans of the
Company may change in subsequent taxable years. Therefore, while at present it
appears that this exception from withholding is available, no assurances can be
made regarding its future availability.
If the Company is not an 80/20 Company, a Non-U.S. Holder will be exempt
from United States withholding tax under the Portfolio Interest Exemption,
provided that (A) such Holder does not own, actually or constructively, 10
percent or more of the total combined voting power of all classes of stock of
the Company entitled to vote, is not a controlled foreign corporation related,
directly or indirectly, to the Company through stock ownership, and is not a
bank receiving interest described in section 881(c)(3)(A) of the Code and (B)
the statement requirement set forth in section 871(h) or section 881(c) of the
Code has been fulfilled with respect to the beneficial owner. Sections 871(h)
and 881(c) of the Code require that either the beneficial owner of the Note, or
a securities clearing organization, bank or other financial institution that
holds customers' securities in the ordinary course of its trade or business (a
"Financial Institution") and that is holding the Note on behalf of such
beneficial owner, file a statement with the withholding agent to the effect that
the beneficial owner of the Note is not a U.S. Holder. Under temporary Treasury
regulations that generally apply to stated interest paid on a Note on or before
December 31,1998 and to payments on or before such date of proceeds from a sale
or exchange of a Note, such requirement will be fulfilled if (i) the beneficial
owner of a Note certifies on Internal Revenue Service ("IRS") Form W-8, under
penalties of perjury, that it is not a U.S. Holder and provides its name and
address, and (ii) any Financial Institution holding the Note on behalf of the
beneficial owner files a statement with the withholding agent to the effect that
it has received such a statement from the Holder (and furnishes the withholding
agent with a copy thereof). Recently finalized Treasury regulations (the "Final
Regulations"), which apply to interest paid on a Note after December 31, 1998
and to payments made after such date of proceeds from a sale or exchange of a
Note, also provide that the requirement of section 871(h) and 881(c) will be
fulfilled if the two conditions set forth in the preceding sentence are met.
Certain pass-thru entities may be required to comply with additional
certification requirements.
If a Non-U.S. Holder of a Note is engaged in a trade or business in the
United States, and if interest on the Note is effectively connected with the
conduct of such trade or business, the Non-U.S. Holder, although exempt from the
withholding tax discussed in the preceding paragraph, will generally be subject
to regular United States federal income tax on interest and on any gain realized
on the sale, exchange or other disposition of a Note in the same manner as if it
were a U.S. Holder. See "U.S. Holders" above. In lieu of the certificate
described in the preceding paragraph, such a Holder will be required to provide
to the Company a properly executed IRS Form 4224 in order to claim an exemption
from withholding tax on stated interest paid on the Notes on or before December
31, 1998 and payments made on or before such date of proceeds from a sale or
exchange of a Note. Under the Final Regulations, such a Non-U.S. Holder will be
required to provide
138
a Form W-8 to the withholding agent on which such Holder provides its name,
address and TIN and states, under penalty of perjury, that the interest paid on
a Note and the gain on the sale or exchange of a Note is effectively connected
with such Holder's United States trade or business in order to obtain an
exemption from withholding tax on payments made after December 31, 1998. In
addition, if such Non-U.S. Holder is a foreign corporation, it may be subject to
a branch profits tax equal to 30% (or such lower rate provided by an applicable
treaty) of its effectively connected earnings and profits for the taxable year,
subject to certain adjustments. For purposes of the branch profits tax, interest
on and any gain recognized on the sale, exchange or other disposition of a Note
will be included in the effectively connected earnings and profits of such Non-
U.S. Holder if such interest or gain, as the case may be, is effectively
connected with the conduct by the Non-U.S. Holder of a trade or business in the
United States.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Under current United States federal income tax law, backup withholding tax
of 31% will not apply to payments by the Company on a Note to certain
corporations and other "exempt recipients" and will not apply to other Non-U.S.
Holders if the certifications required by sections 871(h) and 881(c), discussed
above, are received, provided in each case that the Company or such paying
agent, as the case may be, does not have actual knowledge that the payee is a
United States person.
Under current Treasury regulations, payments on the sale, exchange or other
disposition of Note made to or through a foreign office of a broker generally
will not be subject to backup withholding. However, if such broker is a United
States person, a controlled foreign corporation for United States tax purposes
or a foreign person 50 percent or more of whose gross income is effectively
connected with a United States trade or business for a specified three-year
period or, in the case of payments made after December 31, 1998, a foreign
partnership (i) at least 50 percent of the capital or profit interests in which
are owned by United States persons or (ii) that has a United States trade or
business, information reporting will be required unless the broker has in its
records documentary evidence that the beneficial owner is not a United States
person and certain other conditions are met or the beneficial owner otherwise
establishes an exemption. Under the Final Regulations, backup withholding may
apply to any payment made after December 31, 1998 which such broker is required
to report if such broker has actual knowledge that the payee is a United States
person. Payments to or through the United States office of a broker will be
subject to backup withholding and information reporting unless the Holder
certifies, under penalties of perjury, that it is not a United States person or
otherwise establishes an exemption.
Non-U.S. Holders of Notes should consult their tax advisers regarding the
application of information reporting and backup withholding in their particular
situations, the availability of an exemption therefrom, and the procedure for
obtaining such an exemption, if available. Any amounts withheld from a payment
to a Non-U.S. Holder under the backup withholding rules will be allowed as a
credit against such Holder's United States federal income tax liability and may
entitle such Holder to a refund, provided that the required information is
furnished to the IRS.
THE FEDERAL INCOME TAX DISCUSSION SET FORTH ABOVE IS INCLUDED FOR GENERAL
INFORMATION ONLY AND MAY NOT BE APPLICABLE DEPENDING UPON A HOLDER'S PARTICULAR
SITUATION. HOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THE TAX
CONSEQUENCES TO THEM OF THE OWNERSHIP AND DISPOSITION OF THE NOTES, INCLUDING
THE TAX CONSEQUENCES UNDER STATE, LOCAL, FOREIGN AND OTHER TAX LAWS AND THE
POSSIBLE EFFECTS OF CHANGES IN FEDERAL OR OTHER TAX LAWS.
139
BOOK ENTRY; DELIVERY AND FORM
The Notes will be issued in the form of fully registered global securities
(the "Registered Global Notes") and deposited with DTC or a nominee thereof.
Unless and until it is exchanged in whole or in part for Notes in definitive
registered form, Registered Global Notes may not be transferred except as a
whole by DTC to its nominee or by a nominee of DTC to DTC or another nominee of
DTC or by DTC or any such nominee to a successor of DTC or a nominee of such
successor. DTC currently accepts only securities that are denominated in U.S.
dollars.
Ownership of beneficial interests in the Registered Global Notes will be
limited to persons that have accounts with DTC for such Registered Global Notes
("participants") or persons that may hold interests through participants. Upon
the issuance of the Registered Global Notes, DTC will credit, on its book-entry
registration and transfer system, the participants' accounts with the respective
principal amounts of the Notes represented by such Registered Global Notes
beneficially owned by such participants. The accounts to be credited will be
designated by any dealers, underwriters or agents participating in the
distribution of such Notes. Ownership of beneficial interests in such Registered
Global Notes will be shown on, and the transfer of such ownership interests will
be effected only through, records maintained by DTC (with respect to interests
of participants) and on the records of participants (with respect to interests
of persons holding through participants). The laws of some states may require
that certain purchasers of securities take physical delivery of such securities
in definitive form. Such limits and such laws may impair the ability to own,
transfer or pledge beneficial interests in Registered Global Notes.
So long as DTC or its nominees is the owner of record of the Registered
Global Notes, DTC or such nominee, as the case may be, will be considered the
sole owner or holder of the Notes represented by such Registered Global Notes
for all purposes under the Indenture. Except as set forth below, owners of
beneficial interests in the Registered Global Notes will not be entitled to have
the Notes represented by such Registered Global Notes registered in their names,
and will not receive or be entitled to receive physical delivery of such Notes
in definitive form and will not be considered the owners or holders thereof
under the Indenture. Accordingly, each person owning a beneficial interest in a
Registered Global Note must rely on the procedures of DTC for such Registered
Global Note and, if such person is not a participant, on the procedures of the
participant through which such person owns its interest, to exercise any rights
of a holder of record under the Indenture. The Company understands that under
existing industry practices, if the Company requests any action of holders or if
any owner of a beneficial interest in a Registered Global Note desires to give
or take any action which a holder is entitled to give or take under the
Indenture, DTC would authorize the participants holding the relevant beneficial
interests to give or take such action, and such participants would authorize
beneficial owners owning through such participants to give or take such action
or would otherwise act upon the instruction of beneficial owners holding through
them.
Payments of principal of, premium, if any, and interest on Notes
represented by Registered Global Notes registered in the name of DTC or its
nominee will be made to DTC or its nominee, as the case may be, as the
registered owner of such Registered Global Notes. None of the Company, the
Trustee or any other agent of the Company or agent of the Trustee will have any
responsibility or liability for any aspect of the records relating to or
payments made on account of beneficial ownership interests in such Registered
Global Notes or for maintaining, supervising or reviewing any records relating
to such beneficial ownership interests.
The Company expects that DTC, upon receipt of any payment of principal,
premium, if any, or interest in respect of a Registered Global Note, will
immediately credit participants' accounts with payments in amounts proportionate
to their respective beneficial interests in such Registered Global Note as shown
on the records of DTC. The Company also expects that payments to owners of
beneficial interests in such Registered Global Note held through such
participants will be governed by standing customer instructions and customary
practices, as is now the case with securities held for the accounts of customers
in bearer form or registered in "street name," and will be the responsibility of
such participants.
If DTC notifies the Company that it is at any time unwilling or unable to
continue as depositary for Notes represented by Registered Global Notes or
ceases to be eligible under applicable law, and a successor depositary eligible
under applicable law is not appointed by the Company within 90 days, the Company
will
140
issue such Notes in definitive form in exchange for such Registered Global
Notes. In addition, the Company may at any time and in its sole discretion
determine not to have any of the Notes represented by Registered Global Notes
and, in such event, will issue Notes in definitive form in exchange for all of
the Registered Global Notes. Any Notes issued in definitive form in exchange for
a Registered Global Note will be registered in such name or names as DTC shall
instruct the Trustee. It is expected that such instructions will be based upon
directions received by DTC from participants with respect to ownership of
beneficial interests in such Registered Global Notes.
SAME-DAY SETTLEMENT IN RESPECT OF GLOBAL NOTES
So long as any Notes are represented by Registered Global Notes registered
in the name of DTC or its nominee, such Notes will trade in DTC's Same-Day Funds
Settlement System, and secondary market trading activity in such Notes will
therefore be required by DTC to settle in immediately available funds. No
assurance can be given as to the effect, if any, of settlement in immediately
available funds on trading activity in the Notes.
141
UNDERWRITING
Subject to the terms and conditions of an Underwriting Agreement, dated
, 1998 (the "Underwriting Agreement"), the Underwriters named below
(the "Underwriters") have severally agreed to purchase from the Company the
respective principal amount of Notes set forth opposite their names below.
PRINCIPAL AMOUNT
UNDERWRITERS OF NOTES
------------ ----------------
Donaldson, Lufkin & Jenrette Securities Corporation......... $
Merrill Lynch, Pierce, Fenner & Smith
Incorporated...................................
UBS Securities LLC..........................................
----------------
Total............................................. $
================
The Underwriting Agreement provides that the obligations of the several
Underwriters to purchase and accept delivery of the Notes offered hereby are
subject to approval by their counsel of certain legal matters and to certain
other conditions. The Underwriters are obligated to purchase and accept delivery
of all Notes offered hereby if any are purchased.
The Underwriters initially propose to offer the Notes in part directly to
the public at the initial public offering price set forth on the cover page of
this Prospectus and in part to certain dealers at such price less a concession
not in excess of % of the principal amount of the Notes. The Underwriters
may allow, and such dealers may reallow, to certain other dealers a concession
not in excess of % of the principal amount of the Notes. After the initial
public offering of the Notes, the public offering price and other selling terms
may be changed by the Underwriters at any time without notice. The Underwriters
do not intend to confirm sales to any accounts over which they exercise
discretionary authority.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act, or to contribute to
payments that the Underwriters may be required to make in respect thereof.
The Notes are a new issue of securities with no established trading market.
The Company does not intend to apply for listing of the Notes on any securities
exchange or the Nasdaq National Market. The Company has been advised by the
Underwriters that the Underwriters intend to make a market in the Notes;
however, they are not obligated to do so, and they may discontinue any such
market making at any time without notice. Therefore, no assurance can be given
as to the liquidity of the trading market for the Notes.
Other than in the United States, no action has been taken by the Company or
the Underwriters that would permit a public offering of the Notes in any
jurisdiction where action for that purpose is required. The Notes offered hereby
may not be offered or sold, directly or indirectly, nor may this Prospectus or
any other offering material or advertisements in connection with the offer and
sale of the Notes be distributed or published in any jurisdiction, except under
circumstances that will result in compliance with the applicable rules and
regulations of such jurisdiction. Persons into whose possession this Prospectus
comes are advised to inform themselves about and to observe any restrictions
relating to the Notes Offering and the distribution of this Prospectus. This
Prospectus does not constitute an offer to sell or a solicitation of an offer to
buy any of the Notes offered hereby in any jurisdiction in which such an offer
or a solicitation is unlawful.
In connection with the Notes Offering, the Underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
Notes. Specifically, the Underwriters may overallot the Notes Offering, creating
a syndicate short position. The Underwriters may bid for and purchase Notes in
the open market to cover such syndicate short position or to stabilize the price
of the Notes. These activities may stabilize or maintain the market price of the
Notes above independent market levels. The Underwriters are not required to
engage in these activities, and may end either of these activities at any time.
142
LEGAL MATTERS
Certain legal matters relating to the offering in this Prospectus have been
passed upon by Shearman & Sterling, New York, New York, counsel for the Company.
Certain legal matters will be passed upon for the Underwriters by Cahill Gordon
& Reindel (a partnership including a professional corporation), New York, New
York. The validity of the Notes offered hereby will be passed upon by Shearman &
Sterling, counsel for the Company.
EXPERTS
The consolidated financial statements of Global TeleSystems Group, Inc. as
of December 31, 1996 and 1995, and for each of the three years in the period
ended December 31, 1996, included in this Prospectus 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 consolidated financial statements of EDN Sovintel as of December 31,
1996 and 1995, and for each of the three years in the period ended December 31,
1996, included in this Prospectus appearing in this Prospectus and Registration
Statement, have been audited by Ernst & Young (CIS) Ltd., independent auditors
as set forth in their report appearing elsewhere herein and are included in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
The consolidated financial statements of Hermes Europe Railtel B.V. as of
December 31, 1996 and 1995, and for each of the two years in the period ended
December 31, 1996, included in this Prospectus appearing in this Prospectus and
Registration Statement, have been audited by Ernst & Young Reviseurs
d'Entreprises S.C.C., independent auditors, as set forth in their report
appearing elsewhere herein and are included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.
143
INDEX TO FINANCIAL STATEMENTS
GLOBAL TELESYSTEMS GROUP, INC.
YEAR END FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors........... F-3
Consolidated Balance Sheets as of December 31, 1995 and
1996...................................................... F-4
Consolidated Statements of Operations for the years ended
December 31, 1994, 1995, and 1996......................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1994, 1995, and 1996......................... F-6
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1994, 1995, and 1996............. F-7
Notes to Consolidated Financial Statements.................. F-8
THIRD QUARTER FINANCIAL STATEMENTS
Condensed, Consolidated Balance Sheets as of December 31,
1996 and September 30, 1997............................... F-25
Condensed, Consolidated Statements of Operations for the
nine months ended September 30, 1996 and 1997............. F-26
Condensed, Consolidated Statements of Cash Flows for the
nine months ended September 30, 1996 and 1997............. F-27
Notes to Condensed, Consolidated Financial Statements....... F-28
EDN SOVINTEL
YEAR END FINANCIAL STATEMENTS
Report of Ernst & Young (CIS) Limited, Independent
Auditors.................................................. F-33
Balance Sheets as of December 31, 1996 and 1995............. F-34
Statements of Income and Retained Earnings for the years
ended December 31, 1996, 1995, and 1994................... F-35
Statements of Cash Flows for the years ended December 31,
1996, 1995, and 1994...................................... F-36
Notes to Financial Statements............................... F-37
THIRD QUARTER FINANCIAL STATEMENTS
Condensed Balance Sheets as of December 31, 1996 and
September 30, 1997........................................ F-46
Condensed Statements of Operations for the nine months ended
September 30, 1996 and 1997............................... F-47
Condensed Statements of Cash Flows for the nine months ended
September 30, 1996 and 1997............................... F-48
Notes to Condensed Financial Statements..................... F-49
F-1
HERMES EUROPE RAILTEL B.V.
YEAR END FINANCIAL STATEMENTS
Report of Ernst & Young Reviseurs d'Entreprises S.C.C.,
Independent Auditors...................................... F-52
Consolidated Balance Sheets as of December 31, 1995 and
1996...................................................... F-53
Consolidated Statements of Operations for the years ended
December 31, 1994, 1995 and 1996 and from inception (July
6, 1993) to December 31, 1996............................. F-54
Consolidated Statements of Cash Flows for the years ended
December 31, 1994, 1995 and 1996 and from inception (July
6, 1993) to December 31, 1996............................. F-55
Consolidated Statements of Shareholders' Equity from
inception (July 6, 1993) to December 31, 1993 and for the
years ended December 31, 1994, 1995 and 1996.............. F-56
Notes to Consolidated Financial Statements.................. F-57
THIRD QUARTER FINANCIAL STATEMENTS
Condensed, Consolidated Balance Sheets as of December 31,
1996 and September 30, 1997............................... F-66
Condensed, Consolidated Statements of Operations for the
nine months ended September 30, 1996 and 1997............. F-67
Condensed, Consolidated Statements of Cash Flows for the
nine months ended September 30, 1996 and 1997............. F-68
Notes to the Condensed Consolidated Financial Statements.... F-69
F-2
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors
Global TeleSystems Group, Inc.
We have audited the accompanying consolidated balance sheets of Global
TeleSystems Group, Inc. as of December 31, 1995 and 1996, and the related
consolidated statements of operations, cash flows, and shareholders' equity for
each of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Global
TeleSystems Group, Inc. at December 31, 1995 and 1996, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1996, in conformity with generally accepted accounting
principles.
/s/ ERNST & YOUNG LLP
Washington, D.C.
March 31, 1997
F-3
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
---------------------
1995 1996
-------- ---------
(IN THOUSANDS,
EXCEPT SHARE DATA)
Current assets
Cash and cash equivalents................................. $ 9,044 $ 57,874
Accounts receivable, less allowance for doubtful accounts
of $30 and $782 at December 31, 1995 and 1996.......... 2,972 8,920
Restricted cash........................................... -- 13,627
Prepaid expenses.......................................... 1,932 2,537
Other assets.............................................. 4,189 2,187
-------- ---------
Total current assets.............................. 18,137 85,145
Notes receivable............................................ 84 209
Property and equipment, net................................. 29,523 35,463
Investments in and advances to ventures..................... 56,153 104,459
Goodwill and intangible assets, net of accumulated
amortization of $1,983 and $3,916 at December 31, 1995 and
1996...................................................... 8,681 9,548
Restricted cash............................................. 3,043 2,554
-------- ---------
TOTAL ASSETS...................................... $115,621 $ 237,378
======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 8,705 $ 6,761
Accrued compensation...................................... 2,339 3,151
Other accrued expenses.................................... 6,029 5,299
Debt maturing within one year............................. 14,580 27,437
Other current liabilities................................. 957 2,040
-------- ---------
Total current liabilities......................... 32,610 44,688
Long-term debt, less current portion (principally related
party debt)............................................... 12,874 58,110
Taxes and other non-current liabilities..................... 9,542 14,664
-------- ---------
TOTAL LIABILITIES................................. 55,026 117,462
Commitments and contingencies
Minority interest........................................... 1,936 1,915
Common stock, subject to repurchase (216,667 shares
outstanding).............................................. 3,337 4,333
SHAREHOLDERS' EQUITY
Preferred stock, $0.0001 par value (10,000,000 shares
authorized; none issued and outstanding).................. -- --
Common stock, $0.0001 par value (40,000,000 and 60,000,000
shares authorized; 17,469,839 and 23,059,404 shares issued
and outstanding, net of 50,000 and 77,759 shares of
treasury stock at December 31, 1995 and 1996)............. 2 2
Additional paid-in capital.................................. 114,762 241,725
Cumulative translation adjustment........................... (1,535) (2,161)
Accumulated deficit......................................... (57,907) (125,898)
-------- ---------
TOTAL SHAREHOLDERS' EQUITY........................ 55,322 113,668
-------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $115,621 $ 237,378
======== =========
The accompanying notes are an integral part of these financial statements.
F-4
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
--------------------------------
1994 1995 1996
-------- -------- --------
(IN THOUSANDS)
Revenues, net:
Telecommunication and other services..................... $ 1,295 $ 5,979 $ 19,210
Equipment sales.......................................... 1,173 2,433 4,907
-------- -------- --------
2,468 8,412 24,117
-------- -------- --------
Operating costs and expenses:
Cost of revenues:
Telecommunication and other services.................. 1,474 8,150 14,741
Equipment sales....................................... 971 246 4,200
Selling, general and administrative...................... 12,863 41,014 52,928
Equity in losses of ventures............................. 135 7,871 10,150
-------- -------- --------
15,443 57,281 82,019
-------- -------- --------
Loss from operations....................................... (12,975) (48,869) (57,902)
Other income/(expense):
Other non-operating income............................... -- 10,270 --
Interest income.......................................... 1,189 2,177 3,569
Interest expense......................................... (100) (728) (11,122)
Foreign currency losses.................................. (99) (685) (1,176)
-------- -------- --------
990 11,034 (8,729)
-------- -------- --------
Net loss before income taxes............................... (11,985) (37,835) (66,631)
Income taxes............................................... -- 2,565 1,360
-------- -------- --------
Net loss................................................... $(11,985) $(40,400) $(67,991)
======== ======== ========
The accompanying notes are an integral part of these financial statements.
F-5
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
--------------------------------
1994 1995 1996
-------- -------- --------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net loss................................................... $(11,985) $(40,400) $(67,991)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................ 576 3,721 7,444
Amortization of discount on note payable................. -- -- 3,598
Equity in losses of ventures, net of dividends
received.............................................. 135 7,871 11,123
Other non-operating income............................... -- (10,270) --
Deferred interest........................................ -- -- 6,583
Other.................................................... 8 1,960 729
Changes in assets and liabilities, excluding effects of
acquisitions and ventures:
Accounts receivable................................... (15) (1,396) (6,698)
Prepaid expenses...................................... -- (438) (605)
Accounts payable and accrued expenses................. 4,184 12,647 (1,862)
Other changes in assets and liabilities............... (7,615) 19,744 8,207
-------- -------- --------
Net cash used in operating activities...................... (14,712) (6,561) (39,472)
INVESTING ACTIVITIES
Investments in and advances to ventures.................. (14,213) (45,102) (54,932)
Purchases of property and equipment...................... (6,375) (23,084) (10,987)
Restricted cash.......................................... (500) (2,543) (13,138)
Acquisitions, net of cash acquired....................... -- (1,871) --
Goodwill and other intangibles........................... -- (6,960) (3,264)
Other investing activities............................... -- 2,069 (125)
-------- -------- --------
Net cash used in investing activities...................... (21,088) (77,491) (82,446)
FINANCING ACTIVITIES
Proceeds from debt....................................... -- 23,325 63,599
Net proceeds from issuance of common stock............... 62,108 42,175 107,775
Other financing activities............................... (190) (750) --
-------- -------- --------
Net cash provided by financing activities.................. 61,918 64,750 171,374
Effect of exchange rate changes on cash and cash
equivalents.............................................. (124) (1,289) (626)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents....... 25,994 (20,591) 48,830
Cash and cash equivalents at beginning of year............. 3,641 29,635 9,044
-------- -------- --------
Cash and cash equivalents at end of year................... $ 29,635 $ 9,044 $ 57,874
======== ======== ========
The accompanying notes are an integral part of these financial statements.
F-6
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
COMMON STOCK ADDITIONAL CUMULATIVE TOTAL
--------------- PAID-IN TRANSLATION ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT CAPITAL ADJUSTMENT DEFICIT EQUITY
------ ------ ---------- ----------- ----------- -------------
(IN THOUSANDS)
Balance at December 31, 1993.......... 6,153 $ 1 $ 10,328 $ (122) $ (5,522) $ 4,685
Proceeds from the sale of common
stock, net of expense of
$3,649........................... 7,667 -- 62,082 -- -- 62,082
Other............................... 34 -- 26 -- -- 26
Translation adjustment.............. -- -- -- (124) -- (124)
Net loss............................ -- -- -- -- (11,985) (11,985)
------ ---- -------- ------- --------- --------
Balance at December 31, 1994.......... 13,854 1 72,436 (246) (17,507) 54,684
Proceeds from the sale of common
stock, net of expenses of
$3,680........................... 3,394 1 42,137 -- -- 42,138
Issuance of 370 warrants in
connection with debt financing... -- -- 564 -- -- 564
Issuance of common stock, subject to
repurchase....................... 267 -- -- -- -- --
Accretion of common stock, subject
to repurchase.................... -- -- (412) -- -- (412)
Other............................... (45) -- 37 -- -- 37
Translation adjustment.............. -- -- -- (1,289) -- (1,289)
Net loss............................ -- -- -- -- (40,400) (40,400)
------ ---- -------- ------- --------- --------
Balance at December 31, 1995.......... 17,470 2 114,762 (1,535) (57,907) 55,322
Proceeds from the sale of common
stock, net of expenses of
$3,567........................... 5,566 -- 107,744 -- -- 107,744
Net issuance of 4,815 warrants in
connection with debt financing... -- -- 20,184 -- -- 20,184
Accretion of common stock, subject
to repurchase.................... -- -- (996) -- -- (996)
Other............................... 23 -- 31 -- -- 31
Translation adjustment.............. -- -- -- (626) -- (626)
Net loss............................ -- -- -- -- (67,991) (67,991)
------ ---- -------- ------- --------- --------
Balance at December 31, 1996.......... 23,059 $ 2 $241,725 $(2,161) $(125,898) $113,668
====== ==== ======== ======= ========= ========
The accompanying notes are an integral part of these financial statements.
F-7
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
13, "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 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.
The Company had a working deficit of approximately $14.5 million and
working capital of approximately $40.5 million as of December 31, 1995 and 1996,
respectively. The Company has an accumulated deficit of $125.9 million as of
December 31, 1996, including a net loss of approximately $68.0 million for the
year then ended. During 1997, the Company expects to incur substantial
expenditures to fund the working capital requirements of its ventures, to
provide for capital equipment for certain of its ventures, and to engage in new
development and acquisitions. The Company's working capital at December 31,
1996, plus its anticipated cash flows from operations for 1997, will not be
sufficient to meet such objectives as presently planned.
Management recognizes that the Company must generate additional capital
resources in order to continue its operations and meet its new development
initiatives. The Company is pursuing other equity and debt financing sources and
has entered into substantive negotiations with various financial institutions in
order to obtain further debt and/or equity financing. The Company has also
retained independent consultants to assist it in identifying other entities
interested in entering into strategic partnerships relative to its
telecommunications properties and new development initiatives. If the Company is
not successful in closing debt or equity financing, the Company will be required
to curtail new development initiatives, sell certain assets or a combination of
these actions.
The financial statements have been prepared on the basis of accounting
principles applicable to a going concern which assumes that the Company will
continue operations in the foreseeable future and will be able to realize its
assets and discharge its liabilities in the normal course of operations. If the
going concern assumptions were not appropriate for these financial statements,
then adjustments would have been necessary in the carrying value of assets and
liabilities and the reported revenues and expenses.
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
F-8
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
not exercise unilateral operating and financial control are accounted for by the
equity method. The Company has certain majority-owned ventures that are
accounted for by the equity method as a result of super majority voting
conditions or other governmentally imposed uncertainties so severe that they
prevent the Company from obtaining unilateral control of the venture. If the
Company has little ability to exercise significant influence over a venture, the
venture is accounted for by the cost method. All significant intercompany
accounts and transactions are eliminated upon consolidation.
The Company recognizes profits and losses in accordance with its underlying
ownership percentage or allocation percentage as specified in the agreements
with its partners; however, the Company recognizes 100% of the losses in
ventures where the Company bears all of the financial risk. When such ventures
become profitable, the Company recognizes 100% of the profits until such time as
the excess losses previously recognized have been recovered.
Reclassifications
Certain reclassifications have been made to the 1994 and 1995 consolidated
financial statements in order to conform to the 1996 presentation.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less at the time of purchase to be cash equivalents. The Company
had $3.0 million and $16.2 million of restricted cash at December 31, 1995 and
1996, respectively. The restricted cash is primarily related to required
collateral on debt obligations for equipment purchases (see Note 5, "Debt
Obligations").
Property and Equipment
Property and equipment is stated at cost. Depreciation is calculated on a
straight-line basis over the estimated lives ranging from five to seven years
for telecommunications equipment and three to five years for furniture, fixtures
and equipment and other property. Construction in process reflects amounts
incurred for the configuration and build-out of telecommunications equipment and
telecommunications equipment not yet placed into service. Maintenance and
repairs are charged to expense as incurred.
Goodwill and Intangible Assets
Goodwill represents the excess of acquisition costs over the fair market
value of the net assets of acquired businesses and is being amortized on a
straight-line basis over their estimated useful lives ranging from three to ten
years. Intangible assets, principally telecommunications service contracts,
licenses and deferred financing costs, are amortized on a straight-line basis
over the lesser of their estimated useful lives, generally three to fifteen
years or their contractual term. In accordance with APB 17, "Intangible Assets,"
the Company continues to evaluate the amortization period to determine whether
events or circumstances warrant revised amortization periods. Additionally, the
Company considers whether the carrying value of such assets should be reduced
based on the future benefits of its intangible assets.
Long-Lived Assets
Effective January 1, 1995, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." In accordance
with SFAS No. 121, long-lived assets to be held and used by the Company are
reviewed to determine whether any events or changes in circumstances indicate
that the carrying amount of the asset may not be recoverable. For long-lived
assets to be held and used, the Company bases its evaluation
F-9
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
on such impairment indicators as the nature of the assets, the future economic
benefit of the assets, any historical or future profitability measurements, as
well as other external market conditions or factors that may be present. If such
impairment indicators are present or other factors exist that indicate that the
carrying amount of the asset may not be recoverable, the Company determines
whether an impairment has occurred through the use of an undiscounted cash flows
analysis of assets at the lowest level for which identifiable cash flows exist.
If an impairment has occurred, the Company recognizes a loss for the difference
between the carrying amount and the estimated value of the asset. The fair value
of the asset is measured using quoted market prices or, in the absence of quoted
market prices, fair value is based on an estimate of discounted cash flow
analysis. During the years ended December 31, 1995 and 1996, the Company's
analyses indicated that there was not an impairment of its long-lived assets.
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 which will be neither billed nor collected.
Revenue from service or consulting contracts is accounted for when the services
are provided. Equipment sales and installation revenue is generally recognized
upon shipment and the installation of the equipment. Billings received in
advance of service being performed are deferred and recognized as revenue as the
service is performed.
Fair Value of Financial Instruments
The Company believes that the carrying amount of its assets and liabilities
reported in the balance sheets approximates their fair value.
F-10
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Off Balance Sheet Risk and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash and cash equivalents and accounts and
notes receivable. The Company maintains most of its cash and cash equivalents in
one high-quality U.S. financial institution. The Company extends credit to
various customers and establishes an allowance for doubtful accounts for
specific customers that it determines to have significant credit risk. The
Company provides allowances for potential credit losses when necessary.
The Company does not now hedge against foreign currency fluctuations,
although the Company may implement such practices in the future. Under current
practices, the Company's results from operations could be adversely affected by
fluctuations in foreign currency exchange rates.
Stock Based Compensation
SFAS No. 123, "Accounting for Stock-Based Compensation," 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 25. The Company will continue accounting for its stock-based compensation in
accordance with the provisions of APB 25 and will present pro forma disclosures
of net loss as if the fair value method has 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.
NOTE 3: INVESTMENTS IN AND ADVANCES TO VENTURES
The Company has various investments in ventures that are accounted for by
the equity method (see Note 2, "Summary of Significant Accounting Policies").
The Company's ownership percentages in its equity method investments range from
49% to 80%. The Company has no investments in ventures that are accounted for by
the cost method.
The components of the Company's investments in and advances to ventures are
as follows:
DECEMBER 31,
-------------------
1995 1996
------- --------
(IN THOUSANDS)
Equity in net assets acquired............................... $18,664 $ 41,105
Excess of investment cost over equity in net assets
acquired, net of amortization on $1.7 million and $4.3
million at December 31, 1995 and 1996, respectively....... 8,577 11,288
Accumulated losses recognized............................... (6,267) (13,840)
Dividends................................................... -- (973)
Cash advances and other..................................... 35,179 66,879
------- --------
Total investments in and advances to ventures..... $56,153 $104,459
======= ========
F-11
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3: INVESTMENTS IN AND ADVANCES TO VENTURES (CONTINUED)
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 periodically evaluates the recoverability of their equity investments
and if a circumstance arises where a loss in value is considered to be other
than temporary, the Company will record a write-down of excess investment cost.
In addition, 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 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.
Further, the Company's share of the venture's foreign currency translation
adjustments is reflected in the investment accounts.
Changes in the investments in and advances to ventures are as follows:
DECEMBER 31,
-------------------
1995 1996
------- --------
(IN THOUSANDS)
Balance, at beginning of year............................... $13,841 $ 56,153
------- --------
Equity in net assets acquired............................... 13,888 22,441
Excess of investment cost over equity in net assets
acquired.................................................. 5,646 5,288
Dividends................................................... (973)
Cash advances and other..................................... 30,649 31,700
------- --------
50,183 58,456
Equity ownership in losses.................................. (4,224) (3,122)
Excess losses recognized over amount attributable to
ownership interest........................................ (2,709) (4,451)
Amortization of excess of investment cost over equity in net
assets acquired........................................... (938) (2,577)
------- --------
(7,871) (10,150)
------- --------
Balance, at end of year..................................... $56,153 $104,459
======= ========
Investments accounted for under the equity method and the percentage
interest owned consist of the following:
OWNERSHIP
EQUITY OWNED SUBSIDIARIES %
------------------------- ---------
EDN Sovintel................................................ 50%
Sovam Teleport.............................................. 67%
Bancomsvyaz................................................. 49%
GTS Ukrainian TeleSystems, L.L.C............................ 50%
GTS Vox Limited............................................. 52.64%
TeleRoss Ventures -- 13 joint ventures in various regions in
the CIS................................................... 50%
Vostok Ventures -- 11 joint ventures in various regions in
the CIS................................................... 31-43%
PrymTelefon................................................. 50%
Hermes Europe Railtel B.V................................... 50%
GTS Monaco Access S.A.M..................................... 50%
Eurohivo.................................................... 70%
Sitel-VSAT s.r.o............................................ 49%
Shanghai V-Tech Telecommunications Systems Co., Ltd......... 75%
Beijing Global Tong Da Telecommunications Co................ 55%
GTS China Investments, L.L.C................................ 75%
Beijing Tianmu Satellite Communications Tech................ 47%
Shanghai Global Intelligent TeleSystems Co., Ltd............ 80%
F-12
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3: INVESTMENTS IN AND ADVANCES TO VENTURES (CONTINUED)
Associated with the Company's investment in new business ventures during
1995, the Company is obligated to pay additional consideration, a maximum of
$6.0 million in either cash or in the Company's common stock, if the venture
achieves specific financial performance objectives subsequent to 1995. The
Company will recognize any additional consideration paid under this agreement as
goodwill, as the amount would represent incremental excess of investment cost
over equity in net assets of the underlying investment venture. As of December
31, 1996, the maximum amount of the Company's common stock that would be issued
pursuant to this agreement is 149,920 shares. This agreement was amended
subsequent to year end (see Note 5, "Debt Obligations," and Note 14, "Subsequent
Events").
Additionally, one of the venture agreements that the Company entered into
during 1995 provided that the Company's partner had a put right with regard to
its ownership interest in the investment venture. The put right becomes
effective in 1997 and stipulates a fair value amount that is determined
utilizing a formula based on the financial performance of the venture.
The following tables present condensed financial information of the
Company's ventures that are accounted for by the equity method of accounting as
of December 31, 1995 and 1996. See further financial information of the
Company's business operations within Note 13, "Segment Information and Certain
Geographical Data."
YEAR ENDED DECEMBER 31, 1995
----------------------------------------------------------
MAJORITY OWNED 50% OR LESS OWNED TOTAL EQUITY METHOD
EQUITY METHOD ENTITIES VENTURES VENTURES VENTURES
---------------------- -------------- ----------------- -------------------
(IN THOUSANDS)
Revenue.......................... $ 4,966 $49,085 $54,051
Gross margin..................... 1,096 19,944 21,040
Net loss......................... (5,156) (1,224) (6,380)
Equity in net losses............. (5,136) (1,797) (6,933)
Current assets................... 5,188 27,074 32,262
Total assets..................... 17,343 79,486 96,829
Current liabilities.............. 9,214 38,411 47,625
Total liabilities................ 14,395 54,734 69,129
Net assets....................... 2,948 24,752 27,700
Ownership interest in equity in
net assets..................... 2,595 12,511 15,106
YEAR ENDED DECEMBER 31, 1996
----------------------------------------------------------
MAJORITY OWNED 50% OR LESS OWNED TOTAL EQUITY METHOD
EQUITY METHOD ENTITIES VENTURES VENTURES VENTURES
---------------------- -------------- ----------------- -------------------
(IN THOUSANDS)
Revenue............................ $36,202 $107,270 $143,472
Gross margin....................... 17,109 45,937 63,046
Net loss........................... (1,178) (8,460) (9,638)
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
F-13
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4: SUPPLEMENTAL BALANCE SHEET INFORMATION
DECEMBER 31,
------------------
1995 1996
------- -------
(IN THOUSANDS)
Accounts receivable consists of:
Trade accounts receivable................................. $ 1,026 $ 6,769
Value added taxes receivable.............................. 1,082 1,971
Other receivables......................................... 894 962
------- -------
3,002 9,702
Less: allowance for doubtful accounts..................... 30 782
------- -------
Total accounts receivable, net.................... $ 2,972 $ 8,920
======= =======
Property and equipment, net consists of:
Telecommunications equipment.............................. $ 9,296 $28,302
Furniture, fixtures and equipment......................... 4,111 5,877
Other property............................................ 658 837
Construction in process................................... 17,555 7,009
------- -------
31,620 42,025
Less: accumulated depreciation............................ 2,097 6,562
------- -------
Total property and equipment, net................. $29,523 $35,463
======= =======
NOTE 5: DEBT OBLIGATIONS
Company debt consists of:
DECEMBER 31,
------------------
1995 1996
------- -------
(IN THOUSANDS)
Debt obligations, with principal payments beginning April 1,
1998 and maturing on March 31, 2001 at 10% interest, net
of unamortized discount for 5,185 warrants issued......... $ -- $59,079
Promissory notes, due on demand at 10% interest............. 9,941 7,887
Interim financing, due June 6, 1996 at 10% interest, net of
unamortized discount for 370 warrants issued.............. 9,481 --
Notes payable, acquisition.................................. 2,406 5,201
Other financing agreements (interest at 7% to 13.5% as of
December 31, 1996)........................................ 5,626 13,380
------- -------
27,454 85,547
Less: debt maturing within one year....................... 14,580 27,437
------- -------
Total long-term debt.............................. $12,874 $58,110
======= =======
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," for further discussion). 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 discretion of the Company, the interest payments can be
deferred until the time the Company is obligated to begin making the principal
payments. Further, in connection with the Debt Obligations, the Company issued
5,185,184
F-14
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5: DEBT OBLIGATIONS (CONTINUED)
warrants, valued at $20.7 million, to purchase the Company's common stock. In
accordance with the terms of the warrant agreement, the exercise price of the
warrants was reduced from $15.40 per share to $14.00 per share, as the
outstanding debt had not been repaid prior to December 31, 1996. The warrants
may be exercised up to six years after the date of the relevant agreements. Upon
the consummation of these Debt Obligations, the Company repaid in full the
outstanding $9.5 million interim financing ("Interim Financing") balance
outstanding at December 31, 1995, and the 370,370 warrants associated with the
interim financing were canceled. The Company entered into the $10.0 million
Interim Financing in December 1995 in order to provide the Company sufficient
working capital to meet its contractual obligations, until a larger dollar
amount and longer-term maturity debt could be finalized between the Company and
the Lenders. The Company is subject to certain restrictive covenants pursuant to
these Debt Obligations, including restrictions on the payment of dividends and
indebtedness to affiliated ventures.
In contemplation of securing more permanent financing, the Company entered
into a series of short-term promissory notes, totaling $9.9 million as of
December 31, 1995, with a network equipment provider. In 1996, a wholly-owned
subsidiary of the Company entered into a credit agreement ("Credit Agreement")
totaling $30.7 million with a bank which will provide loans to eleven cellular
ventures within the CIS region for the purchase of certain equipment and
services. Funding under this facility is currently awaiting the finalization of
certain conditions precedent. As a result of the delays in funding under the
Credit Agreement, the Company was required to pay down $2.0 million of the $9.9
million indebtedness. In addition, the Company issued a Letter of Credit for
$12.2 million as collateral for the existing indebtedness and for future
procurements of equipment from the network equipment provider. This letter of
credit was utilized for drawdown purposes upon expiration at March 31, 1997, due
to the continued delays in finalizing the conditions precedent.
In connection with a purchase of a venture during 1995, the Company is
required to pay additional consideration through 1998, either in cash or shares
of the Company's common stock, based upon the actual earnings of the venture. As
of December 31, 1996, the Company determined that additional purchase payments
of $4.5 million would be payable in 1997 as a result of the venture's operating
results for the year ended December 31, 1996. Consequently, the total amount
outstanding is $5.2 million based on the venture's 1995 and 1996 operating
results. The purchase agreement related to acquiring this venture was amended
subsequent to year end, resulting in the note payable being replaced with shares
of the Company's common stock (see Note 14, "Subsequent Events," for further
discussion).
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.
During 1996, the Company entered into a financing agreement with a
shareholder of the Company for $4.5 million. The outstanding amount accrues
interest at a rate of 13.5% per annum and is payable upon demand. The
outstanding amount may be converted into 292,207 shares of the Company's common
stock upon completion of an initial public offering of the Company's common
stock. The outstanding amount has been included in "Other financing agreements."
Aggregate maturities of long-term debt, as of December 31, 1996, are as
follows: 1997 -- $27.4 million, 1998 -- $19.3 million, 1999 -- $25.0 million,
2000 -- $24.6 million and $6.4 million thereafter.
The Company paid interest of $0.1 million, $0.7 million and $0.2 million in
1994, 1995 and 1996, respectively.
The Company is pursuing other equity and debt financing sources to
refinance all or a portion of its indebtedness and expansion through sales of
additional debt or equity securities of the Company.
The Company's non-cash financing activities for the year ended December 31,
1996, included the following: $6.2 million of accrued interest rolled into a
note payable with principal payments beginning April 1,
F-15
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5: DEBT OBLIGATIONS (CONTINUED)
1998 and maturing on March 31, 2001 and $3.6 million of amortization on the
discount of a note payable with principal payments beginning April 1, 1998 and
maturing on March 31, 2001. No significant non-cash financing activities were
incurred for the years ended December 31, 1994 and 1995.
NOTE 6: SHAREHOLDERS' EQUITY
Common Stock
The following table summarizes the Company's equity private placements:
YEAR ENDED DECEMBER 31,
--------------------------------------------
SHARES ISSUED SHARE PRICE NET PROCEEDS
------------- ----------- ------------
(IN THOUSANDS, EXCEPT SHARE DATA)
1994......................................... 7,666,579 $7.00-10.00 $ 62,082
1995......................................... 3,393,917 13.50 42,138
1996......................................... 5,565,688 20.00 107,744
During 1995, the Company issued 266,667 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 50,000 shares at $15.00 per share and the
repurchased shares became treasury stock. Additionally, the Company has accreted
the value of the outstanding common stock subject to repurchase (216,667 shares
on December 31, 1995 and 1996), to the fair value of the Company's common stock
as of December 31, 1995 and 1996 ($15.40 and $20.00 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 5,185,184 warrants to purchase common stock at $15.40 per share. The
exercise price of the warrants was automatically reduced to $14.00 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 9,049,632 shares of common stock for issuance upon
conversion of the exercise of outstanding and future stock options, warrants and
common stock put rights.
Preferred Stock
As of December 31, 1995 and 1996, there were 10,000,000 shares of $0.0001
par value preferred stock authorized, with rights and preferences to be
determined by the Board of Directors. As of December 31, 1995 and 1996, no
shares of preferred stock had been issued.
NOTE 7: STOCK OPTION PLANS
Employee Stock Options
The Company applies the provisions of APB 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
F-16
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7: STOCK OPTION PLANS (CONTINUED)
No. 123, the Company's net loss in 1995 and 1996 would have been approximately
$40.9 million and $69.4 million, respectively. The fair value of options granted
during 1995 and 1996 are estimated as $3.28 and $4.39 per share, respectively,
on the date of grant using the minimum value option pricing model with the
following assumptions: dividend yield 0%, risk free interest rate of 5.50% for
1995 and 6.13% for 1996, and an expected life of five years.
The Company maintains the 1992 Stock Option Plan and the Non-Employee
Directors Stock Option Plan ("the Option Plans"). As of December 31, 1996, the
maximum number of shares of common stock available for grant under the Option
Plans were 4,515,990. All options granted under the Option Plans are at exercise
prices that are at least equal to the fair market value of common stock at the
date of grant. Generally, all options granted under the Option Plans vest over a
three year period from the date of grant and expire ten years from the date of
grant.
Additional information with respect to Stock Option activity is summarized
as follows:
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------
1994 1995 1996
--------------------- --------------------- ---------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- --------- --------- --------- --------- ---------
Outstanding at beginning
of year................. 278,000 $3.37 1,621,200 $ 5.47 2,261,600 $ 6.38
Options granted........... 1,343,200 5.91 787,200 13.63 1,070,308 16.60
Options exercised......... (18,667) 6.69 (37,665) 10.04
Options canceled or
expired................. (128,133) 5.36 (73,002) 13.09
--------- --------- ---------
Outstanding at end of
year.................... 1,621,200 5.47 2,261,600 6.38 3,221,241 10.94
========= ========= =========
Options exercisable at
year-end................ 269,684 $3.60 656,962 $ 5.02 1,292,155 $ 6.77
========= ========= =========
The following table summarizes information about stock options outstanding
at December 31, 1996:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE
REMAINING WEIGHTED WEIGHTED
CONTRACTUAL AVERAGE AVERAGE
NUMBER LIFE EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICE OUTSTANDING (IN YEARS) PRICE EXERCISABLE PRICE
----------------------- ----------- ----------- -------- ----------- --------
$2.125 to $4.125.................... 1,085,667 7 $ 4.02 822,331 $ 3.99
$7.00 to $13.50..................... 892,966 8 11.77 412,431 11.14
$15.00 to $20.00.................... 1,242,608 9 16.39 57,393 15.07
--------- ---------
3,221,241 8 $10.94 1,292,155 $ 6.77
========= =========
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 781,500 shares of the Company's common stock at an exercise price of
$0.80 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, 402,000 of the options
were canceled and in 1994, 33,500 options were exercised, leaving 346,000 fully
vested options outstanding at December 31, 1995 and 1996.
F-17
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7: STOCK OPTION PLANS (CONTINUED)
During 1996, the Company issued 5,000 options to an individual that is
neither an employee nor a director, outside of the Option Plans. The options
were granted at an exercise price equal to the fair value of the underlying
common stock at the date of grant, $15.40 per share. The options are fully
vested, and as such, can be exercised at any time subject to a four-year
expiration from the grant date.
Certain of the Company's ventures have stock option plans, or similar
agreements, in place or in the process of being implemented for key officers and
employees. No significant amounts of compensation expense have been recognized
or are contemplated under these plans, nor is the ownership dilution caused by
such plans expected to be significant.
Equity Compensation Plan
In November 1994, the GTS Equity Compensation Plan ("Equity Compensation
Plan") was approved by the Board of Directors to award officers, key employees
and eligible independent contractors of the Company, grants of restricted stock
or other equity based awards. Under the Equity Compensation Plan, up to 4.0% of
the total number of shares of the Company's common stock outstanding at the
beginning of the year are available for granting purposes. As of January 1,
1997, 698,794 represents the maximum number of Company common shares that are
available for grant under the Equity Compensation plan. A committee selected by
the Board of Directors shall establish, within the provisions of the Equity
Compensation Plan, the number of shares to be awarded, the terms and conditions
of the restricted stock, and the purchase price for the restricted stock. As of
December 31, 1996, there were options outstanding to purchase 20,000 shares of
restricted stock at $10.00 per share.
NOTE 8: EMPLOYEE BENEFIT PLAN
The Company has a 401(k) retirement savings plan (the "Savings Plan")
covering all U.S. citizen employees. The Savings Plan qualifies under section
401(k) of the Internal Revenue Code and as such, participants may defer pretax
income in accordance with federal income tax limitations. The Company provides a
50.0% matching contribution on the first 5.0% contributed by the employee. The
Company may also, at its discretion, make non-matching contributions. Both
matching and non-matching contributions by the Company vest 100% after three
years of service. The Company's expense under the Savings Plan was less than
$0.1 million, $0.1 million, and $0.2 million for the years ended December 31,
1994, 1995 and 1996, respectively. The Company made no discretionary
(non-matching) contributions in 1994, 1995 or 1996.
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:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10: INCOME TAXES (CONTINUED)
In 1995 and 1996, the Company recorded $2.6 million and $1.4 million,
respectively, in income tax expense that related exclusively to its current
provision for foreign taxes. The Company did not have income tax expense for
1994.
The reconciliation of the U.S. statutory federal tax rate of 34.0% to the
Company's effective tax rate is as follows:
YEAR ENDED DECEMBER 31,
----------------------------------------
1995 1996
------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- -------
(IN THOUSANDS)
Taxes at U.S. statutory rates................. $(12,865) 34.0% $(22,655) 34.0%
Foreign operating losses generating no tax
benefit..................................... 6,550 (17.3) 8,526 (12.8)
Domestic operating losses generating no tax
benefit..................................... 6,315 (16.7) 14,129 (21.2)
Other -- net.................................. 2,565 (6.8) 1,360 (2.1)
-------- ----- -------- -----
$ 2,565 (6.8)% $ 1,360 (2.1)%
======== ===== ======== =====
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:
DECEMBER 31,
-------------------
1995 1996
------- --------
(IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards.......................... $10,106 $ 20,720
Other deferred tax assets................................. 245 1,326
------- --------
Total deferred tax asset.......................... 10,351 22,046
------- --------
Deferred tax liabilities:
Depreciation.............................................. 34 358
Other deferred tax liabilities............................ 690 803
------- --------
Total deferred tax liability...................... 724 1,161
------- --------
Net deferred tax asset...................................... 9,627 20,885
Less: valuation allowance................................. (9,627) (20,885)
------- --------
Total............................................. $ -- $ --
======= ========
As of December 31, 1996, the Company had net operating loss carryforwards
for U.S. federal income tax purposes of approximately $60.9 million expiring in
fiscal years 2003 through 2011. Because of the "change in ownership" provisions
of the Tax Reform Act of 1986, the utilization of the Company's net operating
loss carryforwards will be subject to an annual limitation.
The Company's investment in EDN Sovintel is treated for U.S. tax purposes
as a partnership and, therefore, the Company's share of EDN Sovintel's income or
loss flows through to the Company's consolidated federal income tax return on a
current basis. Undistributed earnings of the Company's other foreign investments
are considered to be indefinitely reinvested and, accordingly, no provision for
U.S. federal and state income taxes, or foreign withholding taxes has been made.
Upon distribution of those earnings, the Company would be subject to foreign
withholding taxes and U.S. income taxes (subject to reduction for foreign tax
credits).
F-19
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10: INCOME TAXES (CONTINUED)
Certain ventures in the CIS and Hungary are operating under tax holidays
granted by the local governments. Tax holidays are for periods ranging from up
to five years to several years after achieving profitability under local tax
regulations. In addition to these tax holidays, certain of the Company's foreign
ventures have foreign tax loss carryforwards in excess of $25.0 million. The
Company's financial statements do not reflect any provision for benefits that
might be associated with such loss carryforwards.
NOTE 11: COMMITMENTS AND CONTINGENCIES
Operating Leases
Operating lease commitments are primarily for office space and equipment.
Rental expense aggregated $0.7 million, $2.0 million and $2.2 million for the
years ended December 31, 1994, 1995 and 1996, respectively.
Future minimum lease payments under these non-cancelable operating leases
with terms of one year or more, as of December 31, 1996, are as follows:
1997 -- $2.0 million, 1998 -- $1.4 million, 1999 -- $1.3 million, 2000 -- $0.3
million and $1.1 million thereafter.
Other Commitments and Contingencies
The Company has made commitments to certain of its ventures for future
contract obligations amounting to $8.8 million.
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, 1996 was
approximately $3.0 million. In addition, certain ventures are currently
negotiating other financing instruments in which the Company will guarantee upon
perfection of the obligations.
See Note 5, "Debt Obligations," for additional disclosures associated with
the Company's 1996 transactions with its financing activities.
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 1994.
Tax Matters
The taxation system in Russia ("Russian Taxes") is evolving as the central
government transforms itself from a command to a market oriented economy. The
Russian Federation has introduced and continues to introduce new tax and royalty
laws and related regulations. These laws and regulations are not always clearly
written and their interpretation is subject to the opinions of the local tax
inspectors, Central Bank officials and the Ministry of Finance. Instances of
inconsistent opinions between local, regional and federal tax authorities and
between the Central Bank and Ministry of Finance are not unusual.
The Company's policy is to accrue for contingencies in the accounting
period in which a liability is deemed probable and the amount is reasonably
determinable. In this regard, because of the uncertainties associated with the
Russian Taxes, the Company's Russian Taxes may be in excess of the estimated
amount expensed to date and accrued at December 31, 1995 and 1996. 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
F-20
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11: COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 an
Interim Financing agreement and Debt Obligations during 1995 and 1996,
respectively, with the Lenders. The Lenders are shareholders of the Company. As
part of these transactions, the Company provided one of the Lenders with the
opportunity, at its discretion, to co-invest with the Company in all of the
Company's new ventures within the Asia region.
The Company has entered into certain consulting agreements with directors
of the Company and paid $0.1 million, $0.2 million and $0.2 million in 1994,
1995 and 1996, respectively, pursuant to those agreements.
The Company had notes receivable due from employees aggregating $0.2
million and $0.1 million in 1995 and 1996, 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 in 1996. There
was no significant revenue earned from affiliate sales in 1995 and 1994.
F-21
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13: 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 financial information by geographic area for
1994, 1995 and 1996. Transfers between geographic areas were not considered
material for disclosure purposes.
YEAR ENDED DECEMBER 31, 1994
------------------------------------------------------------------
CORPORATE
WESTERN CENTRAL OFFICE &
EUROPE CIS EUROPE ASIA ELIMINATIONS TOTAL
-------- -------- -------- ------- ------------ --------
(IN THOUSANDS)
Total revenue..................... $ -- $ -- $ 1,295 $ -- $ 1,173 $ 2,468
Gross margin...................... -- -- (179) -- 202 23
Operating loss.................... (546) (1,802) (1,122) -- (9,505) (12,975)
Net loss.......................... (423) (939) (1,661) -- (8,962) (11,985)
Identifiable assets............... 2,173 15,423 9,297 -- 35,064 61,957
Liabilities....................... -- 3,921 6,501 -- (3,157) 7,265
Net assets........................ 2,173 11,502 2,796 -- 38,221 54,692
YEAR ENDED DECEMBER 31, 1995
------------------------------------------------------------------
CORPORATE
WESTERN CENTRAL OFFICE &
EUROPE CIS EUROPE ASIA ELIMINATIONS TOTAL
-------- -------- -------- ------- ------------ --------
(IN THOUSANDS)
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) (15,576) (48,869)
Net loss........................ (5,452) (19,415) (7,091) (4,771) (3,671) (40,400)
Identifiable assets............. 5,898 73,816 15,639 9,167 11,101 115,621
Liabilities..................... 11,766 78,440 26,834 13,936 (75,950) 55,026
Net (liabilities)/assets........ (5,868) (4,624) (11,195) (4,769) 87,051 60,595
YEAR ENDED DECEMBER 31, 1996
------------------------------------------------------------------
CORPORATE
WESTERN CENTRAL OFFICE &
EUROPE CIS EUROPE ASIA ELIMINATIONS TOTAL
-------- -------- -------- ------- ------------ --------
(IN THOUSANDS)
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) (22,907) (57,902)
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
F-22
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14: SUBSEQUENT EVENTS
Equity Transactions
As previously discussed in Note 5, "Debt Obligations," in connection with a
purchase of a venture during 1995, the Company may be required to pay additional
consideration through 1998, either in cash or shares of the Company's common
stock, based on the actual earnings of the venture. On January 17, 1997, the
purchase agreement related to acquiring this venture was amended. As a result,
the consideration associated with the 1996 performance was modified and the
notes payable of $5.2 million was replaced and additional consideration was paid
by the issuance of 336,400 shares of the Company's common stock valued at $20.00
per share.
As previously discussed in Note 6, "Shareholders' Equity," the Company
issued, as additional consideration, 266,667 shares of the Company's common
stock to an independent third party as a result of the Company's investment in a
venture within the CIS region. On March 13, 1997, the Company repurchased 21,667
shares at $20.00 per share and these repurchased shares became treasury shares.
The Company will be required to repurchase the remaining shares on an equal
basis over the next three years which requirement will terminate on the date
when the Company first sells shares of Common Stock to the public pursuant to an
effective registration statement under the Securities Act.
As a result of a share offering of one of the Company's equity method
business ventures in early 1997, the Company's investment in the business
venture may increase from 50.0% to between 52.0% and 77.0%, depending on the
equity subscribed for by the other investors. The share offering is expected to
be completed in the second quarter of 1997. In addition, effective January 1,
1997, the Company will recognize 100% of the losses of this venture due to the
Company's becoming the financing partner. The Company would have recognized
additional losses of $3.3 million and $8.2 million in 1995 and 1996,
respectively, had the Company been considered the financing partner. There would
not have been significant additional losses in 1994.
F-23
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THIRD QUARTER OF 1997
(UNAUDITED)
DECEMBER 31, SEPTEMBER 30,
1996 1997
-------------- ---------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Current assets
Cash and cash equivalents................................. $ 57,874 $ 366,841
Accounts receivable, less allowance for doubtful accounts
of $782 and $2,588 at December 31, 1996 and September
30, 1997............................................... 8,920 13,498
Restricted cash........................................... 13,627 30,404
Prepaid expenses and deposits............................. 2,537 9,741
Finished goods, net....................................... 949 4,671
Other assets.............................................. 1,238 1,447
--------- ---------
Total current assets.............................. 85,145 426,602
Notes receivable............................................ 209 238
Property and equipment, net of accumulated depreciation of
$6,562 and $13,051 at December 31, 1996 and September 30,
1997...................................................... 35,463 60,728
Investments in and advances to ventures..................... 104,459 84,068
Goodwill and intangible assets, net of accumulated
amortization of $3,916 and $7,755 at December 31, 1996 and
September 30, 1997........................................ 9,548 46,770
Restricted cash............................................. 2,554 29,382
--------- ---------
TOTAL ASSETS...................................... $ 237,378 $ 647,788
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 6,761 $ 10,883
Accrued expenses.......................................... 8,450 23,627
Related party debt maturing within one year............... 4,947 11,760
Debt maturing within one year............................. 16,261 14,815
Other current liabilities................................. 2,040 5,731
--------- ---------
Total current liabilities......................... 38,459 66,816
Related party debt, less current portion.................... 59,079 64,715
Long-term debt, less current portion........................ 5,260 411,192
Taxes and other non-current liabilities..................... 14,664 14,898
--------- ---------
TOTAL LIABILITIES................................. 117,462 557,621
Minority interest........................................... 1,915 20,275
Common stock, subject to repurchase (325,000 and 797,100
shares outstanding at December 31, 1996 and September 30,
1997)..................................................... 4,333 12,489
SHAREHOLDERS' EQUITY
Preferred stock, $1.00 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 issued and
outstanding, net of 116,639 and 195,528 shares of treasury
stock at December 31, 1996 and September 30, 1997)........ 3,459 3,761
Additional paid-in capital.................................. 238,268 274,433
Cumulative translation adjustment........................... (2,161) (7,021)
Accumulated deficit......................................... (125,898) (213,770)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY........................ 113,668 57,403
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $ 237,378 $ 647,788
========= =========
The accompanying notes are an integral part of these condensed, consolidated
financial statements.
F-25
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED
SEPTEMBER 30, 1997
--------------------
1996 1997
-------- --------
(IN THOUSANDS)
Revenues, net:
Telecommunication and other services...................... $ 12,474 $ 26,547
Equipment sales........................................... 2,165 3,669
-------- --------
14,639 30,216
Cost of revenues:
Telecommunication and other services...................... 11,231 25,169
Equipment sales........................................... 1,650 3,183
-------- --------
Total cost of revenues............................ 12,881 28,352
-------- --------
Gross margin................................................ 1,758 1,864
Operating expenses:
Selling, general and administrative....................... 29,555 46,203
Depreciation and amortization............................. 5,109 4,404
Non-income taxes.......................................... 1,061 1,452
-------- --------
Total operating expenses.......................... 35,725 52,059
Write-off of impaired assets................................ -- 1,673
Equity in losses of ventures................................ 6,999 18,234
-------- --------
Loss from operations........................................ (40,966) (70,102)
Other income/(expense):
Interest income........................................... 1,546 5,278
Interest expense.......................................... (7,262) (21,086)
Foreign currency losses................................... (819) (1,094)
-------- --------
(6,535) (16,902)
-------- --------
Net loss before taxes and minority interest................. (47,501) (87,004)
Income taxes................................................ 977 1,838
-------- --------
Net loss before minority interest........................... (48,478) (88,842)
Minority interest........................................... 5 970
-------- --------
Net loss.................................................... $(48,473) $(87,872)
======== ========
The accompanying notes are an integral part of these condensed, consolidated
financial statements.
F-26
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1996 1997
-------- --------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net loss.................................................... $(48,473) $(87,872)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 6,094 9,173
Amortization of discount on note payable.................. 2,502 3,665
Equity in losses of ventures.............................. 6,999 18,234
Deferred interest......................................... 4,386 8,142
Write-off impaired assets................................. -- 1,673
Noncash compensation...................................... -- 1,465
Other..................................................... 1,047 1,355
Changes in assets and liabilities:
Accounts receivable.................................... (3,965) (5,723)
Prepaid expenses....................................... (960) (2,030)
Accounts payable and accrued expenses.................. (2,062) 9,311
Other changes in assets and liabilities................ 2,608 (2,743)
-------- --------
Net cash used in operating activities....................... (31,824) (45,350)
INVESTING ACTIVITIES
Investments in and advances to ventures................... (34,187) (2,158)
Purchases of property and equipment....................... (10,088) (7,444)
Restricted cash........................................... (853) (55,813)
Cash acquired............................................. -- 1,050
Goodwill and other intangibles............................ (1,807) (2,196)
Other investing activities................................ (1,104) (29)
-------- --------
Net cash used in investing activities....................... (48,039) (66,590)
FINANCING ACTIVITIES
Proceeds from debt........................................ 62,360 415,986
Payment of debt issue costs............................... (582) (24,178)
Net proceeds from issuance of common stock................ 95,002 36,526
Other financing activities................................ 118 (556)
-------- --------
Net cash provided by financing activities................... 156,898 427,778
Effect of exchange rate changes on cash and cash
equivalents............................................... 425 (6,871)
-------- --------
Net increase in cash and cash equivalents................... 77,460 308,967
Cash and cash equivalents at beginning of period............ 9,044 57,874
-------- --------
Cash and cash equivalents at end of period.................. $ 86,504 $366,841
======== ========
The accompanying notes are an integral part of these condensed, consolidated
financial statements.
F-27
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
1. FINANCIAL PRESENTATION AND DISCLOSURES
In the opinion of management, the accompanying unaudited condensed,
consolidated financial statements of Global TeleSystems Group, Inc. (the
"Company") contain all adjustments (consisting only of normal recurring
accruals) necessary to present fairly the Company's financial position as of
December 31, 1996 and September 30, 1997 and the results of operations and cash
flows for the periods indicated.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. Material intercompany affiliate account
transactions have been eliminated; however, other adjustments may have been
required had an audit been performed. It is suggested that these financial
statements be read in conjunction with the Company's 1996 audited consolidated
financial statements and the notes related thereto. The results of operations
for the nine months ended September 30, 1997, may not be indicative of the
operating results for the full year.
The Company'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 ventures that
are accounted for by the equity method as a result of super-majority voting
conditions or other governmentally imposed uncertainties so severe that they
prevent the Company from obtaining unilateral control of the venture. If the
Company has little ability to exercise significant influence over the ventures,
those ventures are accounted for by the cost method.
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. As a result of this
policy, the Company recognized excess losses of $3.0 million and $10.9 million
in its results of operations for the nine months ended September 30, 1996 and
1997, respectively. In addition, effective January 1, 1997, and through August
31, 1997, the Company recognized 100% of the losses of Hermes Europe Railtel,
B.V. ("HER") that historically has been accounted for by the equity method, due
to the Company being the financing partner for that period. As a result, the
Company recognized $5.3 million in additional losses for the nine months ended
September 30, 1997. The Company would have recognized additional losses of $5.6
million for the nine months ended September 30, 1996 had the Company been
considered the financing partner at that time. During the third quarter of 1997,
HER completed its recapitalization (the "Recapitalization"), which resulted in
the Company owning 79.1% of HER's common stock. An amended shareholders'
agreement was signed on July 16, 1997, which provided the Company with
unilateral control of the venture. As a result of the Company's ownership
interest increasing to 79.1% and the amended shareholders agreement, HER was
consolidated into the Company's financial statements as of July 16, 1997 (see
Note 5, "HER Recapitalization and Other Acquisitions").
2. IMPAIRMENT OF ASSETS AND INVESTMENTS IN AND ADVANCES TO CERTAIN VENTURES
As of September 30, 1997, the Company determined that certain assets and
investments in certain business ventures within the Asia and Central Europe
regions were impaired. This resulted in a $1.7 million write-down of impaired
assets to their fair values and a permanent write-down of the Company's impaired
investments by $5.4 million, which is included in the equity in losses of
ventures on the income statement. Also included in the equity in losses of
ventures is the recognition of losses of $14.4 million, which represents the
Company's share of the write-downs of specifically identified impaired assets to
their respective fair values that were recognized by certain equity-method
ventures within the Asia region. Their fair value was based on
F-28
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the estimated future cash flows to be generated by the assets, discounted at a
market rate of interest. The write down of Central Europe's investment in
Eurohivo was a result of the Company's decision in the third quarter to
discontinue funding Eurohivo's operations and to recognize the contingent
liabilities associated with the expected liquidation and discontinuance of
Eurohivo's operations.
3. DEBT OBLIGATIONS
In July 1997, the Company issued aggregate principal amount $144.8 million
of senior subordinated convertible bonds (the "Bonds") due June 30, 2000. The
Bonds constitute direct, unsecured senior subordinated obligations of the
Company and rank senior in right of payment to all subordinated indebtedness
after existing debt of $84.1 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 common stock as is equal to the principal amount of such Bonds
divided by the applicable conversion price, which conversion price will be equal
to the public offering price of the Company's common stock in the Offering. The
Bonds bear interest payable semiannually at a 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 percent of
their principal amount.
On August 15, 1997, HER issued aggregate principal amount $265.0 million of
senior notes due August 15, 2007 (the "Senior Notes"). The Senior Notes are
general unsecured obligations of HER, 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 are being held in escrow for the first four semiannual
interest payments commencing on February 15, 1998. HER may redeem the Senior
Notes, in whole or in part, any time on or after August 15, 2002 at specific
redemption prices. HER may also redeem the Senior Notes at a price equal to
111.5% of the principal amount prior to August 15, 2000 with net cash proceeds
of a public equity offering by HER with gross proceeds of at least $75.0 million
or in certain other circumstances specified in the indenture for the Senior
Notes, provided, however, that at least two-thirds of the principal amount of
the Senior Notes originally issued remains outstanding after each such
redemption. Pursuant to the covenants in the offering, HER has filed an S-4
registration statement with the Securities Exchange Commission to exchange
registered senior notes, with the same terms and conditions as the Senior Notes,
for the Senior Notes.
During 1996, the Company entered into an arrangement with one of its
shareholders for the joint investment in a business venture within the Ukraine.
Pursuant to the Company's arrangement with its shareholder, the Company is
obligated to buy out the shareholder's interest in the joint venture, if so
required by such shareholder. The initial capital infusion by the Company and
its shareholder in 1996 was for $4.5 million each. In June 1997, an additional
$4.1 million was contributed by each partner, and the Company is obligated to
buy out the other partner's additional $4.1 million contribution by September
30, 2000. Included in the buyout agreement, the outstanding obligation of $8.6
million may be converted, at the partner's election, into 713,310 shares of the
Company's Common Stock upon completion of an initial public offering of the
Company's common stock.
In connection with a purchase of a venture during 1995, the Company is
required to pay additional consideration through 1998, either in cash or shares
of the Company's common stock, based upon the actual earnings of the venture.
During the first quarter of 1997, the purchase agreement related to acquiring
this venture was amended and notes payable of $5.2 million were replaced and
additional consideration was paid by the issuance of 504,600 shares of the
Company's common stock valued at $13.33 per share. Further, the
F-29
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
agreement was modified such that the remaining consideration would only be in
the form of the issuance of the Company's common stock. The Company's maximum
obligation pursuant to this agreement is to issue 1,121,640 shares. Pursuant to
the purchase agreement, as amended, 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.
4. EQUITY TRANSACTIONS
At December 31, 1996, the Company had 325,000 shares of common stock
subject to repurchase, valued at $13.33 per common share. These shares were
originally issued in 1995 by the Company in connection with the acquisition of
an interest in a venture. In March 1997, the Company repurchased 32,500 shares
at $13.33 per share, and these shares became treasury stock. The Company will be
required to repurchase the remaining shares on an equal basis over the next
three years at the prevailing fair value of the Company's common stock on the
date of repurchase. At September 30, 1997, the remaining 292,500 shares of
common stock subject to repurchase were valued at $15.67 per common share,
reflecting the accretion in the Company's stock value since December 31, 1996.
The Company completed a private placement offering in September 1997 and
issued approximately 2,502,000 shares of the Company's common stock at
approximately $15.67 per share, for aggregate gross proceeds of $39.3 million.
5. HER RECAPITALIZATION AND OTHER ACQUISITIONS
In an effort to generate sufficient capital resources to continue its
buildout of the network and sustain working capital requirements, HER undertook
the Recapitalization during the first quarter of 1997, which was completed in
the third quarter. Prior to the Recapitalization, HER was 50% owned by HIT Rail
B.V. ("HIT Rail"), a consortium of eleven European railway companies, and 50%
owned by a wholly-owned subsidiary of the Company.
Pursuant to the Recapitalization, HER offered to the Company, HIT Rail and
the eleven individual members of the HIT Rail consortium the right to subscribe
to additional common stock of HER. The Company and two of the members of HIT
Rail exercised their rights, while HIT Rail and the nine remaining members of
HIT Rail declined to participate.
As a result of the finalization of the Recapitalization, total shareholder
loans outstanding of ECU 39.4 million (approximately $48.5 million) from,
collectively, the Company (approximately $28.4 million), HIT Rail (approximately
$14.0 million) and the two participating railways (collectively, approximately
$6.1 million) were converted into equity. Additionally, the Company contributed
ECU 46.0 million (approximately $51.8 million) and one of the participating
railways contributed a ten-year fiber optic cable lease which was valued at ECU
1.8 million (approximately $2.0 million).
As a result of the Recapitalization, the Company owns 79.1% of HER and the
two exercising railways (collectively) and HIT Rail own 8.3% and 12.6% of HER,
respectively.
Accordingly, HER was consolidated into the Company's financial statements
as of July 16, 1997. The Company's statement of operations includes HER's
results for the nine months ended September 30, 1997, and due to the Company's
policy of recognizing 100% of the losses of HER through August 31, 1997, the
minority partner's share of losses through July 16, 1997 of approximately $5.0
million has not been reflected on the statement of operations as preacquisition
losses.
As of September 30, 1997, the Company purchased the remaining interest in
one of its subsidiaries within the CIS region for $5.2 million, which was paid
in October 1997. Furthermore, the Company is required to pay additional
consideration, of a minimum of $2.4 million, if certain revenue levels are met,
certain other 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
F-30
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
6. SUBSEQUENT EVENTS
In 1996, a wholly-owned subsidiary of the Company entered into a credit
agreement with a bank which will provide loans totaling up to $30.7 million to
certain cellular ventures within the CIS region for the purchase of certain
equipment and services. Subsequent to September 30, 1997, certain conditions
precedent were finalized which allowed funding under the facility. Initial loans
of $7.5 million were incurred at a floating interest rate based on the
Eurodollar rate, with principal and interest payments due semiannually beginning
June 15, 1998 through December 15, 2002. The initial interest rate was 6.04%,
which rate is reset semiannually.
Subsequent to September 30, 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 $98.0
million. The commitments have expected lease terms of three to twenty years with
options for renewal rights of five additional years. As of September 30, 1997,
HER made deposits of approximately $6.8 million related to the above leases.
On November 10, 1997, the board of directors approved (subject to
shareholder approval) 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 preferred and common shares from $0.0001 to $1.00 and
$0.10, respectively, on a post-split basis. Accordingly, the Company has
presented share and per share data on a restated basis to give effect to the
increase in authorized common shares, the stock split and the increase in par
value for its capital stock.
F-31
EDN SOVINTEL
FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
F-32
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Owners
EDN Sovintel
We have audited the accompanying balance sheets of EDN Sovintel as of
December 31, 1996 and 1995, and the related statements of income and retained
earnings, and cash flows for each of the three years in the period ended
December 31, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of EDN Sovintel at December 31,
1996 and 1995, and the results of its operations and its cash flows for each of
the three years in period ended December 31, 1996, in conformity with accounting
principles generally accepted in the United States of America.
We have also audited the financial statements of the Company at December
31, 1996, 1995 and 1994 and for each of the three years ended December 31, 1996,
not presented herewith, prepared in compliance with the regulations for
bookkeeping and accounting for income tax and statutory reporting purposes in
the Russian Federation on which we expect to report separately for the 1996
audited financial statements and have reported separately for the 1995 and 1994
financial statements. The significant differences between the accounting
principles applied for preparing the statutory financial statements and
accounting principles generally accepted in the United States of America are
summarized in Note 2, "Basis of Presentation."
Ernst & Young (CIS) Ltd.
Moscow, Russia
February 21, 1997
F-33
EDN SOVINTEL
BALANCE SHEETS
ASSETS
DECEMBER 31,
------------------
1996 1995
------- -------
(IN THOUSANDS OF
US DOLLARS)
Current assets:
Cash and cash equivalents................................. $ 3,606 $ 3,094
Cash deposit with related party........................... 476
Accounts receivable, net of allowances.................... 15,329 7,400
Due from affiliates....................................... 1,879 1,196
Inventories............................................... 1,749 938
Prepaid expenses and other assets......................... 2,328 1,540
------- -------
Total current assets.............................. 25,367 14,168
Property and equipment, net................................. 27,709 21,349
Deferred expenses........................................... 1,080 1,215
------- -------
Total assets...................................... $54,156 $36,732
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note due shareholder...................................... $ 5,700 $ 5,500
Trade payables............................................ 8,382 8,761
Accrued liabilities and other payables.................... 1,130 701
Taxes accrued or payable.................................. 1,086 1,019
Amounts due to shareholder and affiliates................. 5,703 2,664
Current portion of amount due to partner in commercial
venture................................................ 1,350
Current portion of long-term debt......................... 694
------- -------
Total current liabilities......................... 23,351 19,339
Amount due to partner in commercial venture................. 1,350
Commitments and contingencies
Shareholders' equity:
Capital contributions..................................... 2,000 2,000
Retained earnings......................................... 28,805 14,043
------- -------
Total shareholders' equity........................ 30,805 16,043
------- -------
Total liabilities and shareholders' equity........ $54,156 $36,732
======= =======
See accompanying notes.
F-34
EDN SOVINTEL
STATEMENTS OF INCOME AND RETAINED EARNINGS
YEAR ENDED DECEMBER 31,
-----------------------------
1996 1995 1994
------- ------- -------
(IN THOUSANDS OF US DOLLARS)
Revenues, net:
Service revenues.......................................... $63,488 $29,920 $19,674
Installation revenues..................................... 9,312 12,981 0
Product sales............................................. 2,240 1,391 1,054
------- ------- -------
75,040 44,292 20,728
------- ------- -------
Cost of revenues:
Service costs............................................. 37,884 18,545 11,814
Cost of installation...................................... 4,656 6,491 0
Cost of products.......................................... 1,370 1,211 705
------- ------- -------
43,910 26,247 12,519
------- ------- -------
Gross profit................................................ 31,130 18,045 8,209
Selling, general and administrative expenses................ 10,291 7,145 4,644
Interest expense............................................ 638 703 612
Interest income............................................. (87) (59) (24)
Other loss (income)......................................... 120 (98) (113)
Foreign exchange loss on net monetary items................. 252 112 467
------- ------- -------
Income before taxes......................................... 19,916 10,242 2,623
Income taxes................................................ 5,154 2,594
------- ------- -------
Net income.................................................. 14,762 7,648 2,623
Retained earnings, beginning of year........................ 14,043 6,395 3,772
------- ------- -------
Retained earnings, end of year.............................. $28,805 $14,043 $ 6,395
======= ======= =======
See accompanying notes.
F-35
EDN SOVINTEL
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
------------------------------
1996 1995 1994
-------- ------- -------
(IN THOUSANDS OF US DOLLARS)
Operating activities
Net income................................................ $ 14,762 $ 7,648 $ 2,623
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 3,638 2,448 1,929
Provision for doubtful accounts........................ 678 132 303
Write-off of accounts receivable....................... (147) (492)
Write-down of network equipment and inventories........ 100 196 170
Foreign exchange loss.................................. 252 112 467
Changes in operating assets and liabilities:
Accounts receivable, net of allowances................. (8,460) (2,759) (358)
Due from affiliates.................................... (683) (1,011) (172)
Inventories............................................ (911) (309) 77
Advances to related party.............................. (376)
Prepaid expenses and other assets...................... (1,054) (307) (712)
Trade payables......................................... (193) 2,983 2,176
Accrued liabilities and other payables................. 429 586 (591)
Taxes accrued or payable............................... 207 876
Amounts due to shareholder and affiliates.............. 3,039 2,165 499
Other.................................................. (132)
-------- ------- -------
Net cash provided by operating activities......... 11,657 12,268 5,903
Investing activities -- Purchases of and advances for
property and equipment.................................... (9,863) (9,259) (5,729)
Financing activities
Borrowings from shareholder............................... 11,300 11,888 2,883
Repayments to shareholder................................. (11,100) (9,271)
Repayments of long-term debt.............................. (694) (3,979) (3,979)
Increase in cash deposited with related party............. (476)
-------- ------- -------
Net cash used in financing activities............. (970) (1,362) (1,096)
Effect of exchange rate changes on cash and cash
equivalents............................................... (312) (220)
-------- ------- -------
Net increase (decrease) in cash and cash equivalents........ 512 1,647 (1,142)
Cash and cash equivalents at beginning of year.............. 3,094 1,447 2,589
-------- ------- -------
Cash and cash equivalents at end of year.................... $ 3,606 $ 3,094 $ 1,447
======== ======= =======
See accompanying notes.
F-36
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS
(US DOLLAR AMOUNTS IN TABLES EXPRESSED IN THOUSANDS)
1. DESCRIPTION OF BUSINESS
EDN Sovintel (the "Company") was created in August 1990 to design,
construct, and operate a telecommunications network in Moscow. This network
provides worldwide communications services, principally to major hotels,
business offices and mobile communication companies. Telecommunications services
are subject to local licensing. The Company's license for international,
intercity and local calls was most recently renewed on November 4, 1996 and is
valid until January 5, 2000. The Company received a license for leased lines on
September 20, 1996 valid for 5 years. The Company began operating in December
1991, providing services under long-term contracts payable in US dollars.
The Company initially registered as a limited liability Russian-American
joint venture. The venture re-registered as a limited liability Russian company
in October 1992. The Company is fifty-percent owned by Open Joint Stock Company
"Rostelecom", an intercity and long-distance carrier which is 51% owned by the
Russian Government, and fifty-percent owned by Sovinet, a US general
partnership, owned by two wholly-owned Global TeleSystems Group, Inc. ("GTS")
subsidiaries.
2. BASIS OF PRESENTATION
The Company maintains its records and prepares its financial statements in
Russian roubles in accordance with the requirements of Russian accounting and
tax legislation. The accompanying financial statements differ from the financial
statements used for statutory purposes in Russia in that they reflect certain
adjustments, not recorded on the Company's books, which are appropriate to
present the financial position, results of operations and cash flows in
accordance with generally accepted accounting principles in the United States of
America ("US GAAP"). The principal adjustments are related to foreign currency
translation, and depreciation and valuation of property and equipment.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements, in conformity with US GAAP,
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
Foreign Currency Translation
The Company's functional currency is the US dollar because the majority of
its revenues, costs, property and equipment purchased, and debt and trade
liabilities are either priced, incurred, payable or otherwise measured in US
dollars. Accordingly, transactions and balances not already measured in US
dollars (primarily Russian roubles) have been remeasured into US dollars in
accordance with the relevant provisions of US Financial Accounting Standard
("FAS") No. 52, "Foreign Currency Translation".
Under FAS No. 52, revenues, costs, capital and non-monetary assets and
liabilities are translated at historical exchange rates prevailing on the
transaction dates. Monetary assets and liabilities are translated at exchange
rates prevailing on the balance sheet date. Exchange gains and losses arising
from remeasurement of monetary assets and liabilities that are not denominated
in US dollars are credited or charged to operations.
The rouble is not a convertible currency outside the territory of Russia.
Within Russia its official exchange rates were determined principally through
trading on Moscow Interbank Currency Exchange ("MICEX") until May 17, 1996.
Although MICEX rates did occasionally diverge from market rates, they were
generally considered to be a reasonable approximation. Beginning May 17, 1996,
official exchange rates
F-37
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
were determined daily by the Central Bank of Russia ("CBR") and are generally
considered to be a reasonable approximation of market rates. The translation of
rouble denominated assets and liabilities into US dollars for the purpose of
these financial statements does not indicate that the Company could realize or
settle in US dollars the reported values of the assets and liabilities.
Likewise, it does not indicate that the Company could return or distribute the
reported US dollar values of capital and retained earnings to its shareholders.
The exchange rate used for translation purposes is the CBR rate as of
December 31, 1996 and the MICEX rate as of December 31, 1995 and 1994. The rates
at December 31, 1996, 1995 and 1994 for one US dollar were RUR 5,560, RUR 4,640
and RUR 3,550, respectively. At February 21, 1997, the CBR rate had changed to
RUR 5,665. The effect of this devaluation of the rouble on monetary assets and
liabilities has not been determined.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand and in the bank.
Accounts Receivable
Accounts receivable are shown at their net realizable value which
approximates their fair value. Accounts receivable are shown in the balance
sheet net of an allowance for uncollectible accounts of $900,000 and $369,000 at
December 31, 1996 and 1995, respectively.
Inventories
Inventories consist of telecommunications equipment held for resale and are
stated at the lower of cost or market. Cost is computed on a weighted average
basis.
Property and Equipment
Property and equipment are recorded at their historical cost. Depreciation
and amortization are provided on the straight-line method over the following
estimated useful lives:
Network equipment....................................... 10 years
Other property and equipment............................ 3-5 years
There is no depreciation charge for construction-in-progress. Depreciation
commences upon completion of the related project.
Deferred Expenses
Deferred expenses represent the Company's interest in the historical cost
of network equipment owned by MTU Inform, a partner in a commercial venture
(Note 8). These expenses are amortized over the equipment's useful life of 10
years.
Revenue Recognition and Taxes on Revenue
Service revenues from telecommunication traffic and periodic fixed fees are
recognized in the period in which the traffic occurs or the fixed fee earned.
Installation revenues represent connection fees and are recognized in the period
of installation. Product sales are recognized in the period in which the
products are sold. Revenues are stated net of any value-added taxes ("VAT")
charged to customers. Certain other taxes on revenues were charged at rates
ranging from 1.5% to 4.0% over the three year period ending December 31, 1996
and amounted to $2,792,000, $1,166,000 and $336,000 in 1996, 1995 and 1994,
respectively, and are charged to selling, general and administrative expenses.
F-38
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Advertising
The Company expenses the cost of advertising as incurred. Advertising
expenses for the years ended December 31, 1996, 1995 and 1994 were $512,000,
$395,000 and $270,000, respectively, and are included in selling, general and
administrative expenses.
Investment Incentive Deductions
Russian legislation allows for certain additional tax deductions related to
new asset investments. These deductions are accounted for as a reduction to
current income taxes in the year in which they arise.
Income Taxes
The Company computes and records income taxes in accordance with FAS No.
109, "Accounting for Income Taxes".
Government Pension Funds
The Company contributes to the Russian Federation state pension fund,
social fund, medical insurance fund, unemployment charters and transport fund on
behalf of all its Russian employees. Contributions were 40.5%, 41.0% and 40.0%
for 1996, 1995 and 1994, respectively.
Fair Value of Financial Instruments
The fair value of financial instruments included in current assets and
liabilities is considered to be the carrying value.
Comparative figures
Certain of the 1995 comparative figures have been reclassified to conform
to the presentation adopted in the current year.
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31:
1996 1995
------- -------
Network equipment........................................... $31,251 $20,875
Other property and equipment................................ 3,108 2,740
------- -------
34,359 23,615
Accumulated depreciation and amortization................... (9,380) (5,877)
Construction-in-progress.................................... 1,796 1,539
Network equipment and advances for network equipment not yet
in service................................................ 934 2,072
------- -------
Net book value.............................................. $27,709 $21,349
======= =======
Total depreciation and amortization expense on property and equipment for
1996, 1995 and 1994 was $3,503,000, $2,253,000 and $1,720,000, respectively.
F-39
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. INCOME TAXES
The Russian Federation was the only tax jurisdiction in which the Company's
income was taxed. The income tax expense reported in the accompanying statements
of operations for the years ended December 31, 1996, 1995 and 1994 represents
the provision for taxes currently payable.
The following is a reconciliation of the tax basis and book basis of the
taxable income reported in the Russian statutory financial statements to the
income before taxes reported in the accompanying financial statements presented
in accordance with US GAAP for the years ended December 31:
1996 1995 1994
------- ------- ------
Taxable income (loss) reported for
Russian tax purposes.................. $14,726 $ 7,411 $
Investment incentive deductions....... 9,030 7,220
Tax loss carry-forwards utilized...... 113
Net permanent difference related to
revenues and expenses incurred in
the ordinary course of business
which are not assessable or
deductible for Russian tax
purposes........................... (1,174) (2,595) (948)
------- ------- ------
Russian income (loss) before taxes...... 22,695 12,036 (948)
Adjustments to present financial
statements in accordance with US GAAP:
Reversal of excess depreciation due to
statutory revaluations............. (1,497) (293) (285)
Depreciation rate differences......... (424) (236) (98)
Allowances for uncollectible
accounts........................... 369 (132) (129)
Inventory allowance................... (100) (249) (29)
Accrual of deductible expenses........ (2,437) (1,339) (659)
Accrual of revenue.................... 1,093 19
Foreign exchange differences.......... 280 1,425 5,665
Other non-deductible accruals......... (63) (989) (894)
------- ------- ------
Income before taxes under US GAAP....... $19,916 $10,242 $2,623
======= ======= ======
The Company operated under a two-year income tax holiday in 1994 and 1993.
As such, no Russian tax calculations or tax filings were made or reported.
A reconciliation between the statutory rate and the effective income tax
rate is as follows for the years ended December 31:
1996 1995 1994
------- ------- -------
Income tax expense computed on financial
income taxes at statutory tax rate of
35% for 1996 and 1995 and 38% for
1994.................................. $ 6,970 $ 3,585 $ 997
Tax effect of permanent differences:
Investment incentive deductions....... (3,161) (2,594)
Tax loss carryforwards utilized....... (40)
Other permanent differences........... 411 805 360
Adjustments made to compute income
before taxes for US GAAP financial
reporting.......................... 813 555 (1,548)
Temporary differences not recognised as
measured by the change in the
valuation allowance................... 161 243 191
------- ------- -------
Income tax expense reported in the
financial statements.................. $ 5,154 $ 2,594 $
======= ======= =======
F-40
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. INCOME TAXES -- (CONTINUED)
The deferred tax balances are calculated by applying the statutory tax
rates in effect at the respective balance sheet dates to the temporary
differences between the tax basis of assets and liabilities and the amount
reported in the accompanying financial statements, and consist of the following
at December 31:
For financial reporting purposes, a valuation allowance has been recognised
to reflect management's estimate of the deferred tax assets that are less likely
than not to be realized. Management's estimate of the recoverability of the
deferred tax assets is based on the Company's limited history of profitable
operations as well as the uncertainties surrounding the tax and legal systems in
Russia (see Note 11).
Unexpired tax loss carryforwards at December 31, 1996 amount to $113,000
and is available in and expires in 1997.
The Company paid Russian profits tax of $5,849,000 and $2,660,000 in 1996
and 1995, respectively, and no taxes in 1994.
6. NOTE DUE TO SHAREHOLDER AND LONG-TERM DEBT
In October 1995, the Company entered into a $5,000,000 credit facility with
Sovinet, one of the Company's shareholders. It was subsequently increased to
$7,000,000. In January of 1997, this facility was repaid and on January 16,
1997, a new six-month facility was established with GTS Finance, Inc. for
$7,000,000. The loan bears interest at a rate equal to the then current six
month LIBOR rate (5.6% as of December 31, 1996) plus 5.0 percent per annum. As
of December 31, 1996 and 1995, the outstanding borrowings under this agreement
were $5,700,000 and $5,500,000, respectively.
In April 1991, the Company entered into a $5,300,000 credit facility with
Barclays Bank PLC and International Moscow Bank. This loan was fully repaid
during 1996.
The Company believes that the carrying value of the above loans approximate
their fair values.
The Company paid interest of $403,000, $576,000 and $472,000 in 1996, 1995
and 1994, respectively.
F-41
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. SHAREHOLDERS' EQUITY
The Company's capital structure as specified in its charter capital
document as of December 31 is as follows:
1996 1995
---------- ----------
Registered capital in Russian roubles:
Rostelecom............................ 600,000 600,000
Sovinet............................... 600,000 600,000
---------- ----------
1,200,000 1,200,000
========== ==========
Historical value of the Company's
capital in US dollars................. $ 2,000 $ 2,000
========== ==========
As a Russian limited liability company, the Company has no capital stock;
rather, it has only contributed and locally registered capital in accordance
with its charter. As such, no earnings per share data are presented in these
financial statements.
Retained earnings available for distribution at December 31, 1996 amounted
to 84 billion roubles or approximately $15,108,000 at applicable year-end
exchange rates.
8. RELATED PARTY TRANSACTIONS
Transactions and balances with Rostelecom (one of the Company's
shareholders) and its affiliates were, as of and for the years ending December
31, as follows:
1996 1995 1994
------ ------ ----
Sales................................... $1,525 $ 62
Telecommunication lease and traffic
costs................................. 4,586 1,506 $410
Amounts due to shareholder and
affiliates............................ 656 460
Cash deposit with related party......... 476
At the request of Rostelecom, a shareholder, the Company placed a deposit
of 2.65 billion roubles in August 1996 with a Russian bank related to this
shareholder. The bank deposit agreement states a deposit term of one year. The
deposit earns interest quarterly at a rate of 15% per annum plus any devaluation
losses against the US dollar up to a maximum of 4.8% per quarter. Management is
aware that the deposited amount collateralizes certain obligations of the
shareholder.
Transactions and balances with Sovinet (one of the Company's shareholders),
GTS and affiliates were, as of and for the years ending December 31, as follows:
1996 1995 1994
------ ------ ------
Sales................................... $3,115 $1,041 $ 172
Management service fees and
reimbursements of expenses of
expatriate staff...................... 927 2,062 499
Balances due under credit facility...... 5,700 5,500 2,883
Interest expense........................ 626 461 65
Amounts due from affiliates............. 1,879 1,196 185
Amounts due to shareholder and
affiliates............................ 5,047 2,204 499
F-42
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. RELATED PARTY TRANSACTIONS -- (CONTINUED)
Transactions and balances with MTU Inform, an entity with which the Company
entered into a commercial agreement to co-develop and operate a "258" phone
exchange were, as of and for the years ending December 31, as follows:
1996 1995 1994
------- ------- ----
Telecommunication settlement and rent
expense............................... $15,889 $10,491
Balances in trade payables.............. 1,237 2,184
Balance of amount due to partner in
commercial venture.................... 1,350 1,350
Balances in prepaid expenses and other
assets................................ $376
The Company also has an interest in the cost of the related network
equipment owned by MTU Inform, which is reflected in the balance sheet as
deferred expenses.
9. CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of temporary cash deposits and trade accounts
receivables. The Company deposits its available cash with several Russian
financial institutions. The Company's sales and accounts receivable are made to
and due from a variety of international and Russian business customers. As of
December 31, 1996, two customers accounted for 17% and 16% of revenues and 25%
and 10% of accounts receivable, respectively. As of December 31, 1995, these
same two customers accounted for 1% and 14% of revenues and 10% and 11% of
accounts receivable, respectively. The Company did not have significant
activities with these customers during 1994. However, during 1994, a different
customer accounted for 14% of revenues. The Company has no other significant
concentrations of credit risk.
10. COMMITMENTS
The Company has several cancelable operating leases for office and
warehouse space and telecommunications lines with terms ranging from one to five
years.
Total rent expense for 1996, 1995 and 1994 was $2,123,000, $1,068,000 and
$1,058,000, respectively.
11. CONTINGENCIES
The tax and legal systems in Russia are evolving as Russia and its central
government transform from a command to a market oriented economy. The Russian
Federation has and continues to introduce laws, decrees and related regulations.
These laws, decrees and regulations are not always clearly written and are, at
times, conflicting. In addition, their interpretation is subject to the opinions
of a variety of local, regional and federal tax inspectors, Central Bank
officials and the Ministry of Finance. Instances of inconsistent opinions among
and between these authorities are not unusual.
The Company's policy is to accrue contingencies in the accounting period in
which a loss is deemed probable and the amount is reasonably determinable. In
this regard, because of the uncertainties associated with the Russian tax and
legal systems, the ultimate taxes as well as penalties and interest, if any,
assessed may be in excess of the amount expensed to date and accrued at December
31, 1996. It is the opinion of management, that the ultimate resolution of the
Company's Russian tax liability and potential loss contingencies, to the extent
not previously provided for, will not have a material effect on the financial
condition of the Company. However, depending on the amount and timing of an
unfavorable resolution of this contingency, it is possible that the Company's
future results of operations or cash flows could be materially affected in a
particular period.
F-43
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
11. CONTINGENCIES -- (CONTINUED)
The Company's operations and financial position will continue to be
affected by Russian political developments including the application of existing
and future legislation, tax regulations, cancellations or non-renewal of license
rights, and expropriation of property. The Company does not believe that these
contingencies, as related to its operations, are any more significant than those
of similar enterprises in Russia.
F-44
EDN SOVINTEL
CONDENSED FINANCIAL STATEMENTS
FOR THE THIRD QUARTER OF 1997
(UNAUDITED)
F-45
EDN SOVINTEL
CONDENSED BALANCE SHEETS
(UNAUDITED)
ASSETS
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(IN THOUSANDS)
Current assets
Cash and cash equivalents................................. $ 3,606 $ 6,041
Accounts receivable, less allowance for doubtful accounts
of $900 and $1,477 at December 31, 1996 and September
30, 1997............................................... 15,329 14,779
Restricted cash........................................... 476 492
Due from affiliated companies............................. 1,879 2,267
Inventory................................................. 1,749 2,836
Deferred tax asset........................................ -- 665
Prepaid expenses and other assets......................... 2,328 4,544
------- -------
Total current assets.............................. 25,367 31,624
Property and equipment, net of accumulated depreciation of
$9,380 and $13,197 at December 31, 1996 and September 30,
1997...................................................... 27,709 35,344
Deferred expenses........................................... 1,080 958
------- -------
TOTAL ASSETS...................................... $54,156 $67,926
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 8,382 $ 8,492
Accrued expenses.......................................... 2,216 4,043
Due to affiliated companies............................... 5,703 5,572
Note payable to shareholder............................... 5,700 3,449
Taxes and other liabilities............................... 1,350 1,350
------- -------
TOTAL LIABILITIES................................. 23,351 22,906
Commitments and contingencies
SHAREHOLDERS' EQUITY
Contributed capital......................................... 2,000 2,000
Retained earnings........................................... 28,805 43,020
------- -------
TOTAL SHAREHOLDERS' EQUITY........................ 30,805 45,020
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $54,156 $67,926
======= =======
The accompanying notes are an integral part of these financial statements.
F-46
EDN SOVINTEL
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
1996 1997
------- -------
(IN THOUSANDS)
Revenues, net:.............................................. 51,977 82,029
Cost of revenues:........................................... 30,613 51,048
------- -------
Gross margin.............................................. 21,364 30,981
Operating expenses:
Selling, general and administrative....................... 4,619 8,175
Depreciation and amortization............................. 320 452
Non-income taxes.......................................... 2,372 3,697
------- -------
Total operating expenses.......................... 7,311 12,324
Income from operations...................................... 14,053 18,657
Other (expense) income:
Interest income........................................... 36 176
Interest expense.......................................... (481) (447)
Foreign currency losses................................... (170) (87)
------- -------
(615) (358)
Net income before taxes..................................... 13,438 18,299
Income taxes................................................ 3,916 4,084
------- -------
Net income.................................................. $ 9,522 $14,215
======= =======
The accompanying notes are an integral part of these financial statements.
F-47
EDN SOVINTEL
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1996 1997
------- --------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net income.................................................. $ 9,522 $ 14,215
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 2,397 3,817
Provision for doubtful accounts........................... (550) (577)
Income tax benefit........................................ -- (665)
Changes in assets and liabilities:
Accounts receivable.................................... (5,991) 1,126
Inventory.............................................. (507) (1,087)
Prepaid expenses and other assets...................... (1,352) (2,216)
Accounts payable and accrued expenses.................. 3,620 1,937
------- --------
Net cash provided by operating activities................... 7,139 16,550
INVESTING ACTIVITIES
Purchases of property and equipment....................... (6,938) (11,329)
Restricted cash........................................... (40) (16)
------- --------
Net cash used in investing activities....................... (6,978) (11,345)
FINANCING ACTIVITIES
Borrowing on (repayment of) shareholder note, net......... 278 (2,251)
Repayment of debt......................................... (694) --
Due to affiliated companies, net.......................... 832 (519)
------- --------
Net cash provided by (used in) financing activities......... 416 (2,770)
------- --------
Net increase in cash and cash equivalents................... 577 2,435
Cash and cash equivalents at beginning of period............ 3,094 3,606
------- --------
Cash and cash equivalents at end of period.................. $ 3,671 $ 6,041
======= ========
The accompanying notes are an integral part of these financial statements.
F-48
EDN SOVINTEL
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED
1. FINANCIAL PRESENTATION AND DISCLOSURES
In the opinion of management, the accompanying unaudited condensed
financial statements of EDN Sovintel (the "Company") contain all adjustments
(consisting only of normal recurring accruals) necessary to present fairly the
Company's financial position as of December 31, 1996 and September 30, 1997, and
the results of operations and cash flows for the periods indicated.
The Company was established in August 1990 to design, construct and operate
a telecommunications network in Moscow. This network provides worldwide
communications services, principally to major hotels, business offices and
mobile communication companies. Telecommunications services are subject to local
licensing. The Company's license for international, intercity and local calls
was most recently renewed on November 4, 1996 and is valid until January 5,
2000. The Company began operating in December 1991, providing services under
long-term contracts payable in U.S. dollars.
The Company initially registered as a limited liability Russian-American
joint venture. The venture re-registered as a limited liability Russian company
in October 1992. The Company is 50.0% owned by Sovinet, a U.S. general
partnership that is owned by two wholly-owned subsidiaries of Global TeleSystems
Group, Inc. ("GTS"); and the Company is 50.0% owned by Open Joint Stock Company
"Rostelecom," an intercity and long-distance carrier that is 51.0% owned by the
Russian Government.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. Material accruals have been recorded; however,
other adjustments may have been required had an audit been performed. It is
suggested that these financial statements be read in conjunction with the
Company's 1996 audited financial statements and the notes related thereto. The
results of operations for the nine months ended September 30, 1997 may not be
indicative of the operating results for the full year.
The Company maintains its records and prepares its financial statements in
Russian roubles in accordance with the requirements of Russian accounting and
tax legislation. The accompanying financial statements differ from the financial
statements used for statutory purposes in Russia in that they reflect certain
adjustments, not recorded on the Company's books, which are appropriate to
present the financial position, results of operations and cash flows in
accordance with generally accepted accounting principles in the United States of
America. The principal adjustments are related to foreign currency translation,
and depreciation and valuation of property and equipment.
2. DEBT OBLIGATIONS
In October 1995, the Company entered into a $5.0 million credit facility
with Sovinet, one of the Company's shareholders. It was subsequently increased
to $7.0 million. In January 1997, this facility was repaid, and on January 16,
1997 a new six-month facility was established with GTS Finance, Inc., a wholly-
owned subsidiary of GTS, for $5.9 million. The new facility was subsequently
repaid in June 1997, and on June 23, 1997, a new six-month facility was
established with GTS Finance, Inc. for $5.0 million, with a remaining balance of
$3.5 million at September 30, 1997. The loan bears interest at a rate equal to
the then current six-month LIBOR rate, approximately 5.6%, plus 5.0% per annum.
3. CONTINGENCIES
The tax and legal system in Russia are evolving as Russia and its central
government transform from a command to a market-oriented economy. The Russian
Federation has and continues to introduce laws, decrees and related regulations.
These laws, decrees and regulations are not always clearly written and are, at
times, conflicting. In addition, their interpretation is subject to the opinions
of a variety of local, regional and
F-49
EDN SOVINTEL
NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
federal tax inspectors, Central Bank officials and the Ministry of Finance.
Instances of inconsistent opinions among and between these authorities are not
unusual.
The Company's policy is to accrue contingencies in the accounting period in
which a loss is deemed probable and the amount is reasonably determinable. In
this regard, because of the uncertainties associated with the Russian tax and
legal systems, the ultimate taxes as well as penalties and interest, if any,
assessed may be in excess of the amount expensed to date and accrued at
September 30, 1997. It is the opinion of management that the ultimate resolution
of the Company's Russian tax liability and potential loss contingencies, to the
extent not previously provided for, will not have a material effect on the
financial condition of the Company. However, depending on the amount and timing
of an unfavorable resolution of this contingency, it is possible that the
Company's future results of operations or cash flows could be materially
affected in a particular period.
The Company's operations and financial position will continue to be
affected by Russian political developments, including the application of
existing and future legislation, tax regulations, cancellations or non-renewal
of license rights, and expropriation of property. The Company does not believe
that these contingencies, as related to its operations, are any more significant
than those of similar enterprises in Russia.
F-50
HERMES EUROPE RAILTEL B.V.
FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995
F-51
REPORT OF ERNST & YOUNG, INDEPENDENT AUDITORS
To the Board of Directors and
the Shareholders of
Hermes Europe Railtel B.V.
We have audited the accompanying consolidated balance sheets of Hermes
Europe Railtel B.V. (a development stage company) as of December 31, 1995 and
1996, and the related consolidated statements of operations, cash flows, and
shareholders' equity for the years ended December 31, 1995 and 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Hermes Europe
Railtel B.V. at December 31, 1995 and 1996, and the consolidated results of its
operations and its cash flows for the years then ended in conformity with United
States generally accepted accounting principles.
Ernst & Young Reviseurs
d'Entreprises S.C.C.
Represented by
L. SWOLFS
Partner
Brussels, Belgium
June 11, 1997 except for Note 9, which
is as of July 15, 1997
F-52
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS
PRO FORMA AT
DECEMBER 31,
DECEMBER 31, DECEMBER 31, 1996
1995 1996 (UNAUDITED)
------------ ------------ ------------
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Current assets
Cash and cash equivalents............................... $ 5,784 $ 2,013 $ 1,125
Restricted cash......................................... -- 3,840 3,840
Accounts receivable..................................... -- 84 84
Due from affiliated companies........................... 67 491 491
Other assets............................................ 579 1,100 1,100
------- -------- --------
Total current assets............................ 6,430 7,528 6,640
Property and equipment, net............................... 4,671 20,303 20,303
------- -------- --------
Total Assets.................................... $11,101 $ 27,831 $ 26,943
======= ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses................... $ 4,659 $ 8,476 $ 8,476
Due to affiliated companies............................. 2,117 3,344 3,344
Debt maturing within one year........................... 9 63 63
Other current liabilities............................... -- 24 24
------- -------- --------
Total current liabilities....................... 6,785 11,907 11,907
Long-term debt, less current portion...................... 10 499 499
Pension obligation........................................ -- 8 8
------- -------- --------
Total Liabilities............................... 6,795 12,414 12,414
Commitments and contingencies
Shareholders' loans....................................... 8,353 34,863 --
SHAREHOLDERS' EQUITY
Common stock, 1,000 Dutch guilders par value (305 shares
authorized and 80 shares issued and outstanding at
December 31, 1995 and 1996; 297,000 shares authorized
and 174,679 shares issued and outstanding on a pro
forma basis at December 31, 1996).................... 45 45 88,829
Additional paid-in capital.............................. 2,884 2,884 6,612
Shareholder receivable.................................. -- -- (58,537)
Cumulative translation adjustment....................... (254) 316 316
Deficit accumulated during the development stage........ (6,722) (22,691) (22,691)
------- -------- --------
Total Shareholders' Equity...................... (4,047) (19,446) 14,529
------- -------- --------
Total Liabilities and Shareholders' Equity...... $11,101 $ 27,831 $ 26,943
======= ======== ========
The accompanying notes are an integral part of these financial statements.
F-53
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
ACTIVITY FROM
YEAR ENDED INCEPTION
------------------------------------------ (JULY 6,
DECEMBER 31, 1993) TO
1994 DECEMBER 31, DECEMBER 31, DECEMBER 31,
(UNAUDITED) 1995 1996 1996
------------ ------------ ------------ -------------
(IN THOUSANDS)
Revenues...................................... $ -- $ -- $ 48 $ 48
Operating costs and expenses:
Cost of revenues............................ -- -- 4,694 4,694
Selling, general and administrative......... 183 6,637 10,552 17,372
----- -------- -------- --------
183 6,637 15,246 22,066
----- -------- -------- --------
Loss from operations.......................... (183) (6,637) (15,198) (22,018)
Other income/(expense):
Interest income............................. 18 125 508 651
Interest expense............................ -- (9) (153) (162)
Foreign currency (losses) gains............. (55) 19 (1,126) (1,162)
----- -------- -------- --------
(37) 135 (771) (673)
----- -------- -------- --------
Loss before income taxes...................... (220) $ (6,502) $(15,969) $(22,691)
Income taxes.................................. -- -- -- --
----- -------- -------- --------
Net Loss...................................... $(220) $ (6,502) $(15,969) $(22,691)
===== ======== ======== ========
The accompanying notes are an integral part of these financial statements.
F-54
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED ACTIVITY FROM
------------------------------------------ INCEPTION
DECEMBER 31, (JULY 6, 1993) TO
1994 DECEMBER 31, DECEMBER 31, DECEMBER 31,
(UNAUDITED) 1995 1996 1996
------------ ------------ ------------ -----------------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net loss................................. $ (220) $ (6,502) $(15,969) $(22,691)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization......... 5 11 658 674
Deferred interest..................... -- -- 125 125
Changes in assets and liabilities:
Accounts receivable................. -- -- (84) (84)
Deposits............................ -- (17) (589) (606)
Accounts payable and accrued
expenses......................... 89 4,570 3,817 8,476
Other changes in assets and
liabilities...................... (41) (521) 100 (462)
------- -------- -------- --------
Net cash used in operating
activities..................... (167) (2,459) (11,942) (14,568)
INVESTING ACTIVITIES
Purchases of property and equipment...... (52) (4,635) (16,290) (20,977)
Restricted cash.......................... -- -- (3,840) (3,840)
------- -------- -------- --------
Net cash used in investing
activities..................... (52) (4,635) (20,130) (24,817)
FINANCING ACTIVITIES
Proceeds from debt....................... -- 19 543 562
Net proceeds from issuance of common
stock................................. 1,028 1,901 -- 2,929
Proceeds from shareholders' loans........ -- 8,353 26,385 34,738
Due to affiliated companies, net......... -- 2,050 803 2,853
------- -------- -------- --------
Net cash provided by financing
activities..................... 1,028 12,323 27,731 41,082
Effect of exchange rate changes on cash and
cash equivalents......................... 58 (312) 570 316
------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents.............................. 867 4,917 (3,771) 2,013
Cash and cash equivalents at beginning of
period................................... -- 867 5,784 --
------- -------- -------- --------
Cash and cash equivalents at end of
period................................... $ 867 $ 5,784 $ 2,013 $ 2,013
======= ======== ======== ========
The accompanying notes are an integral part of these financial statements.
F-55
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the period from July 6, 1993 (date of inception) to December 31, 1993
and the years ended December 31, 1994, 1995 and 1996:
DEFICIT
ACCUMULATED
COMMON STOCK ADDITIONAL CUMULATIVE DURING THE TOTAL
--------------- PAID-IN TRANSLATION DEVELOPMENT SHAREHOLDERS'
SHARES AMOUNT CAPITAL ADJUSTMENT STAGE EQUITY
------ ------ ---------- ----------- ------------ -------------
(IN THOUSANDS EXCEPT SHARE DATA)
Issuance of shares on July 6, 1993 (date of
inception)................................... 40 $21 $ -- $ -- $ -- $ 21
-- --- ------ ------ -------- --------
BALANCE AT DECEMBER 31, 1993................... 40 21 -- -- -- 21
Proceeds from the sale of common stock......... 21 11 996 -- -- 1,007
Translation adjustment......................... -- -- -- 58 -- 58
Net loss....................................... -- -- -- -- (220) (220)
-- --- ------ ------ -------- --------
BALANCE AT DECEMBER 31, 1994................... 61 32 996 58 (220) 866
Proceeds from the sale of common stock......... 19 13 1,888 -- -- 1,901
Translation adjustment......................... -- -- -- (312) -- (312)
Net loss....................................... -- -- -- -- (6,502) (6,502)
-- --- ------ ------ -------- --------
BALANCE AT DECEMBER 31, 1995................... 80 45 2,884 (254) (6,722) (4,047)
Translation adjustment......................... -- -- -- 570 -- 570
Net loss....................................... -- -- -- -- (15,969) (15,969)
-- --- ------ ------ -------- --------
BALANCE AT DECEMBER 31, 1996................... 80 $45 $2,884 $ 316 $(22,691) $(19,446)
== === ====== ====== ======== ========
The accompanying notes are an integral part of these financial statements.
F-56
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: NATURE OF BUSINESS OPERATIONS
Hermes Europe Railtel B.V. (the "Company") intends to become the leading
pan-European carriers' carrier by constructing and operating a managed,
seamless, fiber optic, pan-European network, and providing high-quality
trans-border transmission services to telecommunications carriers across Europe.
The Company is 50% owned by HIT Rail B.V.("HIT Rail"), a consortium of
eleven European railway companies and 50% owned by GTS-Hermes,
Inc.("GTS-Hermes"), a U.S. holding company that is a wholly-owned subsidiary of
Global TeleSystems Group, Inc., a provider of a broad range of
telecommunications services to businesses, other telecommunications service
providers and consumers through its operations of voice and data networks,
international gateways, local access and cellular networks and the provision of
various value added services in markets outside of the United States.
The Company is still a development stage enterprise, as currently the
telecommunications network is being configured. The buildout of the network
started in 1996; full commercial services are anticipated to commence in the
first half of 1998.
The Company had working deficits of approximately $4.4 million and $0.4
million as of December 31, 1996 and 1995, respectively. The Company had an
accumulated deficit of $22.7 million as of December 31, 1996, including a net
loss of approximately $16.0 million for the year then ended. During 1997, the
Company expects to incur substantial expenditures for working capital and
capital expenditure requirements. The Company's working capital at December 31,
1996, plus its anticipated cash flows from operations for 1997, will not be
sufficient to meet such objectives as presently planned.
Management recognizes that the Company must generate additional capital
resources in order to continue its buildout of the network. The Company is
pursuing other equity and debt financing sources and has entered into
substantive negotiations with various financial institutions in order to obtain
further debt financing and is expecting to complete a recapitalization (the
"Recapitalization") by the end of August, 1997 (see Note 9, "Subsequent Events
and Pro Forma Adjustments").
The financial statements have been prepared on the basis of accounting
principles applicable to a going concern, which assumes that the Company will
continue in the foreseeable future and will be able to realize its assets and
discharge its liabilities in the normal course of business. If the going concern
assumptions were not appropriate for these financial statements, then
adjustments would have been necessary in the carrying value of assets and
liabilities and the reported revenues and expenses.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The financial statements include the accounts of Hermes Europe Railtel
B.V., its Belgian branch and of Hermes Europe Railtel N.V. All significant
intercompany accounts and transactions are eliminated upon consolidation.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1995 consolidated financial
statements in order to conform to the 1996 presentation.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of
three months or less at the time of purchase to be cash equivalents. The Company
had $3.8 million of restricted cash at December 31, 1996.
F-57
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The restricted cash is primarily related to cash held in escrow in compliance
with an agreement with a major vendor.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is calculated on a
straight-line basis over the estimated lives ranging from five to seven years
for telecommunications equipment and three to ten years for furniture, fixtures
and equipment and other property. A substantial part of the costs includes
construction in process, which is currently related to the configuration and
build-out of the network, and these costs primarily consist of labor. These
costs are transferred to telecommunications equipment in service as construction
is completed and/or equipment is placed into service. Depreciation is recorded
commencing with the first full month that the assets are in service. Maintenance
and repairs are charged to expense as incurred.
The Company intends to capitalize material interest costs associated with
the construction of telecommunications equipment; however, no interest costs
have been capitalized as of December 31, 1996.
LONG-LIVED ASSETS
Effective January 1, 1995, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." In accordance
with SFAS No. 121, long-lived assets to be held and used by the Company are
reviewed to determine whether any events or changes in circumstances indicate
that the carrying amount of the asset may not be recoverable. For long-lived
assets to be held and used, the Company bases its evaluation on such impairment
indicators as the nature of the assets, the future economic benefit of the
assets, any historical or future profitability measurements, as well as other
external market conditions or factors that may be present. If such impairment
indicators are present or other factors exist that indicate that the carrying
amount of the asset may not be recoverable, the Company determines whether an
impairment has occurred through the use of an undiscounted cash flow analysis of
assets at the lowest level for which identifiable cash flows exist. If an
impairment has occurred, the Company recognizes a loss for the difference
between the carrying amount and the estimated value of the asset. The fair value
of the asset is measured using quoted market prices or, in the absence of quoted
market prices, fair value is based on an estimate of discounted cash flow
analysis. During the years ended December 31, 1995 and 1996, the Company's
analyses indicated that there was not an impairment of its long-lived assets.
INCOME TAXES
The Company uses the liability method of accounting for income taxes.
Deferred income taxes result from temporary differences between the tax basis of
assets and liabilities and the basis as reported in the consolidated financial
statements.
FOREIGN CURRENCY TRANSLATION
The accounting records of the Dutch B.V. company are maintained in Dutch
guilders. The accounting records of the Belgian branch and the Belgian N.V.
company are maintained in Belgian francs. The functional currency for the
Company has been determined to be the Belgian franc. Therefore, the Dutch
guilder statements have been remeasured into Belgian franc equivalents,
consolidated with the Belgian branch and Belgian N.V. statements and then
translated into U.S. dollar equivalents for the purpose of preparing the
accompanying financial statements, in accordance with accounting principles
generally accepted in the United States.
F-58
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company follows a translation policy in accordance with SFAS No. 52,
"Foreign Currency Translation." Assets and liabilities are translated at the
rates of exchange at the balance sheet date. Income and expense accounts are
translated at average monthly rates of exchange. The resultant translation
adjustments are included in the cumulative translation adjustment, a separate
component of shareholders' equity. Gains and losses from foreign currency
transactions are included in the operations.
REVENUE RECOGNITION
The Company's revenue is associated with its customers right to use the
network and is recognized on a straight-line basis over the terms of the
customer contracts.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company believes that the carrying amount of its assets and liabilities
reported in the balance sheets approximates their fair value.
OFF BALANCE SHEET RISK AND CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash and cash equivalents and accounts
receivable. The Company maintains most of its cash and cash equivalents in high
quality European financial institutions.
The Company does not now hedge against foreign currency fluctuations,
although the Company may implement such practices in the future. Under current
practices, the Company's results from operations could be adversely affected by
fluctuations in foreign currency exchange rates.
USES OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of these consolidated financial statements, in conformity
with generally accepted accounting principles, requires management to make
estimates and assumptions that affect amounts in the financial statements and
accompanying notes and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
NOTE 3: SUPPLEMENTAL BALANCE SHEET INFORMATION
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
(IN THOUSANDS)
Other assets consist of:
Deposits.................................................. $ 17 $ 606
VAT receivable............................................ 272 402
Other assets.............................................. 290 92
------ -------
Total other assets................................ $ 579 $ 1,100
====== =======
F-59
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3: SUPPLEMENTAL BALANCE SHEET INFORMATION (CONTINUED)
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
(IN THOUSANDS)
Property and equipment, net consists of:
Construction in process................................... $3,879 $12,981
Telecommunications equipment in service................... -- 4,947
Furniture, fixtures and equipment......................... 807 2,507
Leasehold improvements.................................... 2 543
------ -------
4,688 20,978
Less: accumulated depreciation......................... 17 675
------ -------
Total property and equipment, net................. $4,671 $20,303
====== =======
Accounts payable and accrued expenses consist of:
Trade accounts payable.................................... 2,225 5,445
Accrued salaries and bonuses.............................. 668 1,924
Accrued vacation expense.................................. 110 774
Accrued legal expenses.................................... 522 147
Accrued expense........................................... 1,134 186
------ -------
$4,659 $ 8,476
====== =======
NOTE 4: DEBT OBLIGATIONS
Company debt consists of:
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
(IN THOUSANDS)
Debt obligation, vendor financing agreement with quarterly
principal payments and maturing on October 1, 2004 at 6.8%
interest.................................................. $-- $562
Other financing agreements with interest at 10.2%........... 19 --
--- ----
Less: debt maturing within one year......................... 9 63
--- ----
Total long-term debt........................................ $10 $499
=== ====
Aggregate maturities of long-term debt, as of December 31, 1996, are as
follows: 1997 -- $0.06 million, 1998 -- $0.06 million, 1999 -- $0.06 million,
2000 -- $0.07 million, 2001 -- $0.07 million and $0.2 million thereafter.
The Company paid interest of $0.02 million and $0.01 million in 1996 and
1995, respectively. The Company did not pay interest in 1994.
NOTE 5: DEFINED BENEFIT PLAN
The Company established a defined benefit pension plan in 1995 that covers
substantially all of its employees upon twenty-five years of age and at least
one year of service. The benefits are based on years of service and the
employee's compensation. The Company has entered into an arrangement with an
insurance company for the provision of a group insurance policy (the "Policy").
Under the Policy, the insurance provider has undertaken a legal obligation to
provide specified benefits to participants in return for a fixed premium;
accordingly, the Company no longer bears significant financial risk. Premium
payments for the
F-60
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5: DEFINED BENEFIT PLAN (CONTINUED)
Policy are partly paid by the employee; based on specified terms that consider
the employees annual salary, with the remaining premium paid by the employer.
Premiums are intended to provide not only for benefits attributed to service to
date but also for those expected to be earned in the future.
The Company's expense under the plan was $0.05 million in 1995. No
actuarial calculation was performed due to the immateriality to the financial
statements.
The following table sets forth the plan's funded status and amounts
recognized at December 31, 1996:
(IN THOUSANDS)
Actuarial present value of benefit obligations:
Accumulated benefit obligation............................ $(136)
-----
Projected benefit obligation for service rendered to
date................................................... $(388)
Plan assets at fair value, primarily Belgian bonds........ 338
-----
Projected benefit obligations in excess of plan assets.... (50)
Unrecognized net obligation............................... 42
-----
Pension obligation........................................ $ 8
=====
Net pension cost for 1996 included the following components:
Service cost -- benefits earned during the period......... $ 365
Interest cost on projected benefit obligation............. 3
Actual return on plan assets.............................. (9)
Net amortization.......................................... 2
-----
Net periodic pension cost......................... $ 361
=====
The discount rate and rate of increase in future compensation levels used
in determining the actuarial present value of the projected benefit obligation
was 4.5%. The expected long-term rate of return on assets was 7.0%
NOTE 6: INCOME TAXES
The components of loss before income taxes were as follows:
No current income taxes are due as the Company incurred losses due to the
start-up activities in the Belgian branch and the Company.
F-61
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6: INCOME TAXES (CONTINUED)
A deferred tax asset is 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 asset:
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
(IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards.......................... $ 3,919 $ 11,729
------- --------
Net deferred tax assets..................................... 3,919 11,729
Less: valuation allowance................................... (3,919) (11,729)
------- --------
Total............................................. $ -- $ --
======= ========
As of December 31, 1996, the Company had net operating loss carryforwards
for Belgian and Dutch income tax purposes of approximately $29.3 million, which
are recoverable from profits for an unlimited period of time.
NOTE 7: COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
Operating lease commitments are primarily for office space and car rental.
The office lease has a term of nine years, expiring on June 30, 2005, with an
option to cancel January 1, 2002 with a penalty of six months, rental payment as
well as the remaining principal due on the debt obligation (see Note 4, "Debt
Obligations"). In addition, the Company received a reduction in annual expense
during the first three years of the lease. This reduction is being amortized
over the first six years of the lease, using a straight-line method.
Rental expense aggregated approximately $0.5 million and $0.7 million, net
of sublease income of $0.01 million and $0.08 million for the years ended
December 31, 1996 and 1995, respectively. The Company did not have rent expense
in 1994.
Future minimum lease payments under these non-cancelable operating leases
with terms of one year or more, as of December 31, 1996, are as follows:
1997 -- $1.1 million, 1998 -- $1.1 million, 1999 -- $1.2 million, 2000 -- $1.2
million, 2001 -- $1.2 million and $0.6 million thereafter.
OTHER MATTERS
In the ordinary course of business, the Company may be party to various
legal and tax proceedings, and subject to claims, certain of which relate to the
regulatory environments in which the Company currently or intends to operate. In
the opinion of management, the Company's liability, if any, in all pending
litigation, or other legal proceeding or other matter other than what is
discussed above, will not have a material effect upon the financial condition,
results of operations or liquidity of the Company.
F-62
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8: RELATED PARTY TRANSACTIONS
The Company received financing through shareholders' loan transactions
provided by HIT Rail and GTS-Hermes. The components of the Company's shareholder
loans are as follows:
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
(IN THOUSANDS)
HIT Rail.................................................... $6,425 $13,999
GTS-Hermes.................................................. 1,928 20,864
------ -------
Total shareholders' loans......................... $8,353 $34,863
====== =======
The amount due from GTS-Hermes includes $0.1 million of accrued interest at
December 31, 1996. The loans will be converted into shares of the Company's
common stock as part of the Recapitalization which is expected to be completed
by the end of August, 1997 (see Note 9, "Subsequent Events and Pro Forma
Adjustments").
NOTE 9: SUBSEQUENT EVENTS AND PRO FORMA ADJUSTMENTS
Subsequent to December 31, 1996, Hermes Europe Railtel N.V. began
negotiating a new lease on a second office building, which is currently being
constructed. The terms of the lease are expected to be finalized by the fourth
quarter of 1997, the expected completion date of the construction. The lease
period will be for eight years and will have an annual expense of $0.4 million
to be paid in quarterly installments.
In January and February 1997, additional loans of ECU 6.4 million
(approximately $7.5 million) were advanced to the Company by GTS-Hermes. These
loans were converted into shares of the Company's common stock ("Common Stock")
as part of the Recapitalization. In addition, loans of ECU 5.4 million
(approximately $6.1 million) were advanced to the Company in February and April
1997 by individual members of HIT Rail. These loans are expected to be converted
into Common Stock as part of the Recapitalization discussed below.
To increase the equity of the Company by means of the contribution of fiber
optic cable leases and/or cash by its current partners and individual
shareholders of HIT Rail, the Company expects to complete the Recapitalization
by the end of August, 1997.
Pursuant to the Recapitalization, the Company extended rights to subscribe
to additional Common Stock to GTS-Hermes, HIT Rail and the eleven individual
members of the HIT Rail consortium. HIT Rail and eight of the members of HIT
Rail have declined to exercise their rights, while GTS-Hermes and three of the
members of HIT Rail have indicated that they intend to exercise their rights.
The first phase of the Recapitalization was completed on July 7, 1997. As a
result, all shareholders' loans from GTS-Hermes and HIT Rail were converted into
Common Stock. In addition, GTS-Hermes exercised its right to subscribe to
additional Common Stock, resulting in a contribution of ECU 46.0 million
(approximately $51.1 million), which will be paid to the Company by September
30, 1997. The first phase of the Recapitalization resulted in the following
ownership of the Company:
SHARES CONVERSION OF EXERCISE SHARES
DECEMBER 31, 1996 SHAREHOLDERS' LOANS OF RIGHTS JULY 7, 1997
----------------- ------------------- --------- ------------
GTS-Hermes...................... 40 50,197 100,395 150,632
HITRail......................... 40 24,007 -- 24,047
-- ------- ------- -------
80 74,204 100,395 174,679
== ======= ======= =======
F-63
HERMES EUROPE RAILTEL B.V.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9: SUBSEQUENT EVENTS AND PRO FORMA ADJUSTMENTS (CONTINUED)
Under Dutch law, the Company is required to pay a 1% capital duty tax on
all issuances of common stock, which will result in the Company paying a capital
duty tax of approximately $0.9 million. The pro forma balance sheet at December
31, 1996 gives effect to the first phase of the Recapitalization as discussed
above.
Additional phases of the Recapitalization are expected to include the
conversion of loans of ECU 5.4 million (approximately $6.1 million) advanced to
the Company by two of the individual members of HIT Rail, as well as the
contribution of fiber optic cable leases. If all three individual members of HIT
Rail participate in the Recapitalization as anticipated, it will result in the
following ownership of the Company:
SHARES ADDITIONAL SHARES AT COMPLETION
JULY 7, 1997 SHARES OF RECAPITALIZATION
------------ ---------- --------------------
GTS-Hermes................................... 150,632 150,632
HIT Rail..................................... 24,047 24,047
Individual members of the HIT Rail
consortium................................. -- 21,385 21,385
------- ------ -------
174,679 21,385 196,064
======= ====== =======
F-64
HERMES EUROPE RAILTEL B.V.
CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THIRD QUARTER OF 1997
(UNAUDITED)
F-65
HERMES EUROPE RAILTEL B.V.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------- --------------
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Current assets
Cash and cash equivalents................................. $ 2,013 $237,541
Restricted cash........................................... 3,840 29,155
Accounts receivable....................................... 84 479
Due from affiliated companies............................. 491 672
Other assets.............................................. 1,100 8,260
-------- --------
Total current assets.............................. 7,528 276,107
Property and equipment, net................................. 20,303 28,270
Restricted cash............................................. -- 27,877
Intangible assets, net...................................... -- 14,748
-------- --------
Total assets...................................... $ 27,831 $347,002
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses..................... $ 8,476 $ 15,138
Due to affiliated companies............................... 3,344 1,251
Deferred income........................................... 24 1,577
Other current liabilities................................. -- 591
Debt maturing within one year............................. 63 52
-------- --------
Total current liabilities......................... 11,907 18,609
Long-term debt, less current portion........................ 499 265,401
Pension obligation.......................................... 8 8
-------- --------
Total liabilities................................. 12,414 284,018
Commitments and contingencies
Shareholders' loans......................................... 34,863 --
SHAREHOLDERS' EQUITY
Common stock, 1000 guilders par value (305 shares
authorized and 80 shares issued and outstanding at
December 31, 1996; 297,000 shares authorized and
190,468 shares issued and outstanding at September 30,
1997).................................................. 45 96,757
Additional paid-in capital................................ 2,884 8,949
Cumulative translation adjustment......................... 316 (2,920)
Accumulated deficit....................................... (22,691) (39,802)
-------- --------
Total shareholders' equity........................ (19,446) 62,984
-------- --------
Total liabilities and shareholders' equity........ $ 27,831 $347,002
======== ========
The accompanying notes are an integral part of these condensed, consolidated
financial statements.
F-66
HERMES EUROPE RAILTEL B.V.
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1996 1997
-------- --------
(IN THOUSANDS)
Revenues.................................................... $ -- $ 2,262
-------- --------
Operating costs and expenses:
Cost of revenues.......................................... 3,442 5,989
Selling, general and administrative....................... 7,329 11,613
-------- --------
10,771 17,602
-------- --------
Loss from operations........................................ (10,771) (15,340)
Other income/(expense):
Interest income/(expense), net............................ 423 (1,864)
Foreign currency (losses)/gains........................... (774) 93
-------- --------
(351) (1,771)
-------- --------
Loss before income taxes.................................... (11,122) (17,111)
Income taxes................................................ -- --
-------- --------
Net loss.................................................... $(11,122) $(17,111)
======== ========
The accompanying notes are an integral part of these condensed, consolidated
financial statements.
F-67
HERMES EUROPE RAILTEL B.V.
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1996 1997
-------- --------
(IN THOUSANDS)
-------------------
OPERATING ACTIVITIES
Net loss.................................................. $(11,122) $(17,111)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.......................... 387 1,862
Non-cash compensation.................................. -- 1,468
Changes in assets and liabilities:
Accounts receivable.................................. -- (414)
Deposits............................................. (628) (6,240)
Accounts payable and accrued expenses................ 4,625 7,871
Other changes in assets and liabilities.............. (1,705) 234
-------- --------
Net cash used in operating activities............. (8,443) (12,330)
INVESTING ACTIVITIES
Purchases of property and equipment....................... (12,834) (12,757)
Restricted cash........................................... (6,883) (54,860)
-------- --------
Net cash used in investing activities............. (19,717) (67,617)
FINANCING ACTIVITIES
Proceeds from debt........................................ 583 270,849
Payment of debt issue costs............................... -- (13,238)
Net proceeds from issuance of common stock................ -- 52,015
Proceeds from shareholders' loans......................... 25,305 13,311
Due to affiliated companies, net.......................... 351 (1,964)
-------- --------
Net cash provided by financing activities......... 26,239 320,973
Effect of exchange rate changes on cash and cash
equivalents............................................... (404) (5,498)
-------- --------
Net (decrease) increase in cash and cash equivalents........ (2,325) 235,528
Cash and cash equivalents at beginning of period............ 5,784 2,013
-------- --------
Cash and cash equivalents at end of period.................. $ 3,459 $237,541
======== ========
The accompanying notes are an integral part of these condensed, consolidated
financial statements.
F-68
HERMES EUROPE RAILTEL B.V.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. FINANCIAL PRESENTATION AND DISCLOSURES
In the opinion of management, the accompanying unaudited condensed,
consolidated financial statements of Hermes Europe Railtel B.V. (the "Company")
contain all adjustments (consisting only of normal recurring accruals) necessary
to present fairly the Company's financial position as of December 31, 1996 and
September 30, 1997, and the results of operations and cash flows for the periods
indicated.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. Material intercompany affiliate account
transactions have been eliminated; however, other adjustments may have been
required had an audit been performed. It is suggested that these financial
statements be read in conjunction with the Company's 1996 audited consolidated
financial statements and the notes related thereto. The results of operations
for the nine months ended September 30, 1997 may not be indicative of the
operating results for the full year.
The Company intends to become the leading pan-European carriers' carrier by
constructing and operating a managed, seamless, fiber optic, pan-European
network, and providing high quality trans-border transmission services to
telecommunications carriers across Europe.
In an effort to generate sufficient capital resources to continue its
buildout of the network and sustain working capital requirements, the Company
undertook a recapitalization (the "Recapitalization") during the first quarter
of 1997, which was completed in September 1997. Prior to the recapitalization,
the Company was 50% owned by HIT Rail B.V. ("HIT Rail"), a consortium of eleven
European railway companies, and 50% owned by GTS-Hermes, Inc. ("GTS-Hermes"), a
U.S. holding company that is a wholly-owned subsidiary of Global TeleSystems
Group, Inc. ("GTS"), 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 value-added services, in markets
outside the United States.
Pursuant to the Recapitalization, the Company offered to GTS-Hermes, HIT
Rail and the eleven individual members of the HIT Rail consortium the right to
subscribe to additional common stock of the Company. GTS-Hermes and two of the
members of HIT Rail, Societe Nationale des Chemins de Fer Belges S.A. de Droit
Public/Nationale Maatschappij der Belgische Spoorwegen N.V. ("NMBS") and AB Swed
Carrier ("Swed Carrier"), exercised their rights, while HIT Rail and the nine
remaining members of HIT Rail declined to participate.
As a result of the finalization of the Recapitalization, total shareholder
loans of ECU 39.4 million (approximately $48.5 million) from, collectively,
GTS-Hermes, HIT Rail, NMBS and Swed Carrier were converted into equity.
Additionally, GTS-Hermes contributed ECU 46.0 million (approximately $51.8
million) and NMBS contributed a ten-year fiber optic cable lease which was
valued at ECU 1.8 million (approximately $2.0 million).
In addition, under Dutch law, the Company is required to pay a 1% capital
duty tax on issuances of common stock, resulting in a tax of approximately $1.0
million, of which $0.6 million remains to be paid at September 30, 1997.
F-69
HERMES EUROPE RAILTEL B.V.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. FINANCIAL PRESENTATION AND DISCLOSURES -- (CONTINUED)
The ownership of the Company as a result of the Recapitalization is as
follows:
In an additional effort to obtain capital resources, the Company completed
a debt offering in August 1997 that raised $265.0 million (see Note 2, "Debt
Obligations").
The Company was a development stage enterprise through December 31, 1996.
NOTE 2. DEBT OBLIGATIONS
On August 15, 1997, the Company issued aggregate principal amount $265.0
million of senior notes due August 15, 2007 (the "Senior Notes"). The Senior
Notes are general unsecured obligations of the Company, with interest payable
semiannually at a rate of 11.5%. Approximately $56.6 million of the net proceeds
of the offering of the Senior Notes is being held in escrow for the first four
semiannual interest payments commencing on February 15, 1998. The Company may
redeem the Senior Notes, in whole or in part, any time on or after August 15,
2002 at specific redemption prices. The Company may also redeem the Senior Notes
at a price equal to 111.5% of the principal amount prior to August 15, 2000 with
net cash proceeds of a public equity offering with gross proceeds of at least
$75.0 million or in certain other circumstances specified in the indenture for
the Senior Notes, provided, however, that at least two-thirds of the principal
amount of the Senior Notes originally issued remains outstanding after each such
redemption. Pursuant to the covenants in the offering, the Company has filed an
S-4 registration statement with the Securities Exchange Commission to exchange
registered senior notes, with the same terms and conditions as the Senior Notes,
for the Senior Notes.
NOTE 3. RELATED PARTY TRANSACTIONS
During 1997, additional shareholder loans of $7.5 million, $3.9 million and
$2.2 million were received from GTS-Hermes, NMBS and Swed Carrier, respectively.
All shareholder loans outstanding were converted into equity prior to September
30, 1997 (See Note 1, "Financial Presentation and Disclosures").
NOTE 4. SUBSEQUENT EVENTS
Subsequent to September 30, 1997, the Company entered into contractual
commitments to lease fiber pairs, including facilities and maintenance and
utilizing the partial routes for laying fiber optic cable. Based on the contract
provisions, these commitments are currently estimated to aggregate approximately
$98.0 million. The commitments have expected lease terms of three to twenty
years with options for renewal rights of five additional years. As of September
30, 1997, the Company made deposits of approximately $6.8 million related to the
above leases.
F-70
EXHIBIT A
GLOSSARY OF TELECOMMUNICATIONS INDUSTRY TERMS
Accounting Rate Mechanism (ARM) -- The current system of bilateral
settlement agreements between PTOs under which tariffs for cross-border
pan-European-switched voice traffic are determined.
Add-drop multiplexer (ADM) -- A multiplexer which controls cross connect
between individual circuits by software, permitting dynamic cross connect of
individual 64 kbps circuits within an E-1 line.
AMPS -- Advanced Mobile Phone System; the cellular mobile telephone system
based on analog technology that is now used in U.S. systems. Each AMPS cell can
handle 832 simultaneous conversations.
Asynchronous Transfer Mode (ATM) -- A switching and transmission technology
that is one of general class of packet technologies that relay traffic by way of
an address contained within the first five bits of a switching and transmission
of mixed voice, data, and video at varying rates. The ATM format can be used by
many different information systems, including LANs.
Bps -- Bits per second; the basic measuring unit of speed in a digital
transmission system; the number of bits that a transmission facility can convey
between a sending location and a receiving location in one second.
Backbone -- The through-portions of a transmission network, as opposed to
spurs which branch off the through-portions.
Bandwidth -- The information-carrying capability of a transmission medium
is measured by its bandwidth, which is the relative range of frequencies that
can be passed without distortion by such medium. Bandwidth is measured in Hertz,
but may also be expressed as the number of bits that can be transmitted per
second.
Capacity -- Refers to transmission.
Carrier -- A provider of communications transmission services by fiber,
wire, or radio.
CCIT -- International Telegraph and Telephone Consultative Committee.
Closed User Group -- A group of customers with some affiliation with one
another and which are treated for regulatory purposes as not being the public.
Competitive Local Telecommunications Provider -- A company that provides
its customers with an alternative to the local telephone company for local
transport of private line, special access and transport of switched access
telecommunications services. Competitive Local Telecommunications Providers are
also referred to in the industry as alternative local telecommunications service
providers (ALTS), Competitive Access Providers (CAPs) and Competitive Local
Exchange Carriers (CLECs).
Dark Fiber -- Fiber that lacks the requisite electronic and optronic
equipment necessary to use the fiber for transmission.
Dedicated -- Refers to telecommunications lines dedicated to or reserved
for use by particular customers along predetermined routs (in contract to
telecommunications lines within the local telephone company's public switched
network).
Digital -- Describes a method of storing, processing and transmitting
information through the use of distinct electronic or optical pulses that
represent the binary digits 0 and 1. Digital transmission/switching technologies
employ a sequence of discrete, distinct pulses to represent information, as
opposed to the continuously variable analog signal.
E1 -- Data transmission rate of approximately 2 Mbps.
E3 -- Data transmission rate of approximately 34 Mbps.
Electrosviaz -- regional telephone company.
A-1
Enhanced Network Services -- Telecommunications services providing digital
connectivity, primarily for data applications, via frame relay, ATM, or digital
interexchange private line facilities. Enhanced network services also include
applications on such networks, including Internet access and other Internet
services.
ERMES -- A standard for a pan-European radio message system sponsored by
the EC.
Eutelsat -- European Telecommunications Satellite Organization; an
international satellite organization in which members of the European Union hold
an 88% combined investment.
Frame Relay -- A wide area transport technology that organizes data into
units called frames instead of providing fixed bandwidth as with private lines.
A high-speed, data-packet switching service used to transmit data between
computers. Frame Relay supports data units of variable lengths at access speeds
ranging from 56 kilobits per second to 1.5 megabits per second. This service is
well-suited for connecting local area networks, but is not presently well-suited
for voice and video applications due to the variable delays which can occur.
Frame Relay was designed to operate at high speeds on modern fiber optic
networks.
Gbps -- Gigabits per second, which is a measurement of speed for digital
signal transmission expressed in billions of bits per second.
Gateway -- A network element interconnecting two otherwise incompatible
networks, network nodes, subnetworks or devices; performs a protocol conversion
operation across a wide spectrum of communications functions.
GSM -- Global System for Mobile Communications, formerly known as Groupe
Speciale Mobile. GSM began as a pan-European standard for digital cellular
systems. The name was changed to reflect the fact that the standard has been
adopted by several countries in Asia.
Hertz -- The unit for measuring the frequency with which an electromagnetic
signal cycles through the zero-value state between lowest and highest states.
One Hz (Hertz) equals one cycle per second. kHz (kilohertz) stands for thousands
of Hertz; MHz (megahertz) stands for millions of Hertz.
Inmarsat -- The International Maritime Satellite service, which provides
mobile communications to ships at sea, aircraft in flight and vehicles on the
road.
Intelsat -- International Telecommunications Satellite Organization; a
worldwide consortium of national satellite communications organizations.
Interconnect -- Connection of a telecommunications device of service to the
PSTN.
Interconnection -- Connection of a piece of telephone equipment to the
telephone network, or a data terminal to a data communications network. Also
refers to the connection of one communications network to another so that users
of one network can communicate with users of another network.
International Simple Resale -- Refers to the wholesale purchase of IPLCs
from facilities-based carriers and the reselling of such capacity to customers
for switched telephone service.
IPLC -- International Private Leased Circuits.
ISDN (Integrated Services Digital Network) -- ISDN is an internationally
agreed standard which, through special equipment, allows two-way, simultaneous
voice and data transmission in digital formats over the same transmission line.
ISDN permits video conferencing over a single line, for example, and also
supports a multitude of value-added switched service applications. ISDN's
combined voice and data networking capabilities reduce costs for end users and
result in more efficient use of available facilities. ISDN combines standards
for highly flexible customer to network signaling with both voice and data
within a common facility.
ITU -- International Telecommunications Union; a United Nations treaty
organization whose purpose is to accredit international telecommunications
standards. ITU signatories can turn ITU-approved standards into law through
international treaties such as the treaties governing use of the radio spectrum
for international satellite telecommunications and broadcasting.
A-2
Kbps -- Kilobits per second, which is a measurement of speed for digital
signal transmission expressed in thousands of bits per second.
Local Area Network (LAN) -- The interconnection of computers for the
purpose of sharing files, programs and peripheral devices such as printers and
high-speed modems. LANs may include dedicated computers or file servers that
provide a centralized source of shared files and programs. LANs are generally
confined to a single customer's premises and may be extended or interconnected
to other locations through the use of bridges and routes.
Local Loop -- The local loop is that portion of the local telephone network
that connects the customer's premises to the local exchange provider's central
office or switching center. This includes all the facilities starting from the
customer premise interface which connects to the inside wiring and equipment at
the customer premise to a terminating point within the switching wire center.
Mbps -- Megabits per second, which is a measurement of speed for digital
signal transmission expressed in millions of bits per second.
MGTS -- Moscow city telephone network.
Multiplexing -- The use of some means to inter-leave narrow-band or
slow-speed data from multiple sources in order to make use of a wide-band or
high-speed channel.
NMT -- Acronym for Nordic Mobile Telephone System, a cellular standard
widely used in Northern Europe.
Nodes -- Locations within the network housing electronic equipment and/or
switches which serve as intermediate connection points to send and receive
transmission signals.
PBX/PABX (private branch exchange/private automatic branch exchange) -- A
customer operated switch on customer premises, typically used by large
businesses with multiple telephone lines.
Plesiochronous Digital Hierarchy (PDH) -- A method of controlling the
timing between transmission and switching systems that is not synchronized but
rather relies on highly accurate clocks to minimize the slip rates between
switching nodes.
POCSAG (Postal Office Code Standard Advisory Group) -- A lower-cost paging
technology which can be transmitted on ERMES frequency.
Points of Presence (POPs) -- Locations where a carrier has installed
transmission equipment in a service area that serves as, or relays calls to, a
network switching center of that carrier.
PSTN -- Public switched telecommunications network.
PTT/PTO -- Postal, Telegraph and Telephone agency/Public Telephony
Operators; a government authority or agency that operates the public
telecommunications network, and sets standards and policies. PTTs/PTOs are
agencies in charge of telecommunications services in many countries, under
direct supervision of the national government.
Public Telecommunications Operator (PTO) -- A licensed telecommunications
common carrier.
Redundant Electronics -- Describes a telecommunications facility using two
separate electronic devices to transmit the telecommunications signal so that if
one device malfunctions, the signal may continue without interruption.
Regeneration/amplifier -- Devices which automatically re-transmit or boost
signals on an out-bound circuit.
Route Kilometers -- The number of kilometers along which fiber optic cables
are installed.
Route Mile -- The number of miles along which fiber optic cables are
installed.
A-3
STM-1 -- Data transmission rate of approximately 155 Mbps.
STM-4 -- Data transmission rate of approximately 622 Mbps.
STM-16 -- Data transmission of approximately 2,488 Mbps.
STM-64 -- Data transmission rate of approximately 9,952 Mbps.
Switch -- A mechanical or electronic device that opens or closes circuits
or selects the paths or circuits to be used for the transmission of information.
Switching is a process of linking different circuits to create a temporary
transmission path between users.
Synchronous Digital Hierarchy (SDH) -- SDH is a set of standards for
optical communications transmission systems that define optical rates and
formats, signal characteristics, performance, management and maintenance
information to be embedded within the signals and the multiplexing techniques to
be employed in optical communications transmission systems. SDH facilitates the
interoperability of dissimilar vendors' equipment and benefits customers by
minimizing the equipment necessary for telecommunications applications. SDH also
improves the reliability of the local loop connecting customers' premises to the
local exchange provider, historically one of the weakest links in the service
delivery.
TCP/IP -- Transmission Control Protocol/Internet Protocol; an "open"
standard operating and interface protocol for federal government local area
networks that use devices from multiple vendors. TCP/IP, first developed by the
U.S. Defense Department, has been adopted by some academic and business
institutions who deal regularly with the federal government.
Trunk -- A telephone circuit with a switch at both ends. A trunk may
connect two central office switches, or two PBXs, or a PBX and a central office
switch.
VSAT -- Very Small Aperture Terminal; a satellite communications technology
that employs frequencies in the Ku band or C band and very small receiving
dishes. VSAT systems employ satellite transponders; the receiving dishes may be
leased or owned by the VSAT user.
Wavelength Division Multiplexing (WDM) -- A multiplexing technique allowing
multiple different signals to be carried simultaneously on a fiber by allocating
resources according to frequency on non-overlapping frequency bands.
X.25 -- A CCITT standard governing the interface between data terminals and
data circuit termination equipment for terminals on packet-switched data
networks.
A-4
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 UNDER-WRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN
OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITY OTHER THAN THE
SECURITIES OFFERED HEREBY, NOR DOES IT CONSTITUTE AN OFFER TO SELL, OR A
SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY, TO ANY
PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER OR SOLICITATION WOULD BE
UNLAWFUL. 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
PAGE
Prospectus Summary..................... 1
Risk Factors........................... 12
Use of Proceeds........................ 27
Capitalization......................... 28
Selected Historical Consolidated
Financial Data....................... 29
Supplemental Information -- Selected
Historical Financial Data............ 30
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 31
Business............................... 43
Management............................. 90
Executive Compensation and Other
Information.......................... 93
Certain Related Party Transactions..... 103
Principal Stockholders................. 105
Description of Certain Indebtedness.... 106
Description of the Notes............... 109
Certain United States Federal Tax
Consequences......................... 137
Book Entry; Delivery and Form.......... 140
Underwriting........................... 142
Legal Matters.......................... 143
Experts................................ 143
Index to Financial Statements.......... F-1
Exhibit A -- Glossary of
Telecommunications Industry Terms.... A-1
UNTIL , 1998 (90 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY
REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
$100,000,000
[GLOBAL TELESYSTEMS GROUP, INC. LOGO]
GLOBAL TELESYSTEMS GROUP, INC.
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the estimated expenses, other than
underwriting discounts and commissions, to be borne by the Company in connection
with the offering of the securities being hereby registered.
ITEM
----
SEC Registration Fee........................................ $ 29,500
NASD Filing Fee............................................. 10,500
Blue Sky Fees and Expenses.................................. 10,000
Accounting Fees and Expenses................................ 200,000
Legal Fees and Expenses..................................... 200,000
Printing and Mailing Expenses............................... 250,000
Miscellaneous............................................... 100,000
--------
TOTAL............................................. $800,000
========
* To be provided by amendment
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.
II-1
The Company's Certificate of Incorporation (the "Certificate") provides
that the Company's Directors shall not be liable to the Company or its
stockholders for monetary damages for breach of fiduciary duty as a director
provided, however, that such exculpation from liabilities is not permitted with
respect to liability arising from items described in clauses (i) through (iv) in
the preceding paragraph. The Certificate and the Company's By-Laws further
provide that the Company shall indemnify its directors and officers to the
fullest extent permitted by the DGCL.
The directors and officers of the Company are covered under directors' and
officers' liability insurance policies maintained by the Company.
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 affiliates of
George Soros 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 affiliates of George Soros, 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.
II-2
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 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
$39.3 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 $2.9 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.
ITEM 16. EXHIBITS
(a) Exhibits:
The following is a list of exhibits filed as a part of this registration
statement.
1.1*** -- Form of Purchase Agreement
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
4.1*** -- Form of Indenture
4.1(a) -- Form of Note (included in Exhibit 4.1)
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)
II-3
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.
5.1*** -- Form of Opinion of Shearman & Sterling respecting the Common
Stock 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
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
II-4
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+ -- Global TeleSystems Group, Inc. Non-Employee Directors' Stock
Option Plan
10.15+ -- GTS-Hermes, Inc. 1994 Stock Option Plan
10.16+ -- Restricted Stock Grant letter, dated as of January 1, 1995
10.17+ -- Employment Agreement dated as of January 1995 between SFMT,
Inc. and Jan Loeber
10.18+ -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Louis Toth
10.19+ -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Gerald W. Thames
10.20+ -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Raymond J. Marks
10.21+ -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Henry Radzikowski
10.22+ -- SFMT, Inc. Equity Compensation Plan
10.23+ -- Form of Non-Statutory Stock Option Agreement
10.24+ -- Amended and Restated 1992 Stock Option Plan of Global
TeleSystems Group Inc. dated as of January 16, 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
II-5
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** -- 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)
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
11.1*** -- Statement regarding computation of per share earnings
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, Ernst & Young (CIS) Ltd., and
Ernst & Young Reviseurs d'Entreprises S.C.C.
24.1*+ -- Powers of Attorney (included on signature page to this
registration statement)
27.1+ -- Financial Data Schedule extracted from 12/31/96 audited
financial statements
27.2+ -- Financial Data Schedule extracted from 9/30/97 unaudited
financial statements
* Filed herewith.
** Previously filed.
*** To be filed by amendment.
+ 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.
II-6
(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 our Prospectus, 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 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.
II-7
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant certifies that it has duly caused this Amendment to the Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of McLean, Commonwealth of Virginia, on this 23rd day of
December, 1997.
GLOBAL TELESYSTEMS GROUP, INC.
By: /s/ GRIER C. RACLIN
----------------------------------
Name: Grier C. Raclin
Title: Senior Vice President and
General Counsel
We, the undersigned officers and directors of Global TeleSystems Group,
Inc. hereby severally constitute and appoint Gerald W. Thames, William H.
Seippel, and Alan Krenck, 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 23rd day of December, 1997.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ GERALD W. THAMES President, Chief December 23, 1997
----------------------------------------------------- Executive Officer and
Gerald W. Thames Director (principal
executive officer)
/s/ WILLIAM H. SEIPPEL Executive Vice President December 23, 1997
----------------------------------------------------- of Finance and Chief
William H. Seippel Financial Officer
(principal financial
and accounting officer)
/s/ ALAN B. SLIFKA Chairman of the Board of December 23, 1997
----------------------------------------------------- Directors
Alan B. Slifka
/s/ GARY GLADSTEIN Director December 23, 1997
-----------------------------------------------------
Gary Gladstein
II-8
SIGNATURE TITLE DATE
--------- ----- ----
/s/ MICHAEL GREELEY Director December 23, 1997
-----------------------------------------------------
Michael Greeley
/s/ BERNARD MCFADDEN Director December 23, 1997
-----------------------------------------------------
Bernard McFadden
/s/ STEWART J. PAPERIN Director December 23, 1997
-----------------------------------------------------
Stewart J. Paperin
/s/ W. JAMES PEET Director December 23, 1997
-----------------------------------------------------
W. James Peet
/s/ JEAN SALMONA Director December 23, 1997
-----------------------------------------------------
Jean Salmona
/s/ MORRIS A. SANDLER Director December 23, 1997
-----------------------------------------------------
Morris A. Sandler
/s/ JOEL SCHATZ Director December 23, 1997
-----------------------------------------------------
Joel Schatz
/s/ ADAM SOLOMON Director December 23, 1997
-----------------------------------------------------
Adam Solomon
II-9
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
========================================================================================================
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
--------------------------------------------------------------------------------------------------------
Allowance for doubtful accounts at
12/31/94.............................. 0 0
Allowance for doubtful accounts at
12/31/95.............................. 0 30 30
Allowance for doubtful accounts at
12/31/96.............................. 30 752 782
S-1
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
1.1*** -- Form of Purchase Agreement..................................
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......................
4.1*** -- Form of Indenture...........................................
4.1(a) -- Form of Note (included in Exhibit 4.1)......................
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. ......................................
5.1*** -- Form of Opinion of Shearman & Sterling respecting the Common
Stock 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.........................................
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.1(f)+ -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 29, 1997.........................................
10.1(g)+ -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated September 29, 1997....................................
10.2+ -- Registration Rights Letter Agreement, dated as of January
19, 1996, among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P. .....
10.3+ -- Warrant Agreement, dated as of January 19, 1996, among
Global TeleSystems Group, Inc., The Open Society Institute
and Chatterjee Fund Management, L.P. .......................
10.4+ -- Joint Venture Letter Agreement, dated January 19, 1996,
among Global TeleSystems Group, Inc., The Open Society
Institute and Chatterjee Fund Management, L.P. .............
10.5 -- Intentionally Omitted
10.6+ -- Registration Rights Letter Agreement, dated June 6, 1996,
among the Company, The Open Society Institute, Winston
Partners II LDC and Winston Partners II LLC.................
10.7+ -- Warrant Agreement, dated as of June 6, 1996, between Global
TeleSystems Group, Inc., The Open Society Institute, Winston
Partners II LDC and Winston Partners II LLC.................
10.8+ -- Senior Note Purchase Agreement, dated as of February 2,
1996, between Global TeleSystems Group, Inc. and Emerging
Markets Growth Fund, Inc. ..................................
10.8(a)+ -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated June 6, 1996 (see
Exhibit No. 10.1(b))........................................
10.8(b)+ -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated June 6, 1996......
10.8(c)+ -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated July 25, 1996.....
10.8(d)+ -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated September 10,
1996........................................................
10.8(e)+ -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated September 16,
1996........................................................
10.8(f)+ -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated December 30,
1996........................................................
10.8(g)+ -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated May 13, 1997......
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...
EXHIBIT
NUMBER DESCRIPTION
------- -----------
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+ -- Global TeleSystems Group, Inc. Non-Employee Directors' Stock
Option Plan.................................................
10.15+ -- GTS-Hermes, Inc. 1994 Stock Option Plan.....................
10.16+ -- Restricted Stock Grant letter, dated as of January 1,
1995........................................................
10.17+ -- Employment Agreement dated as of January 1995 between SFMT,
Inc. and Jan Loeber.........................................
10.18+ -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Louis Toth..................................
10.19+ -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Gerald W. Thames............................
10.20+ -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Raymond J. Marks............................
10.21+ -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Henry Radzikowski...........................
10.22+ -- SFMT, Inc. Equity Compensation Plan.........................
10.23+ -- Form of Non-Statutory Stock Option Agreement................
10.24+ -- Amended and Restated 1992 Stock Option Plan of Global
TeleSystems Group Inc. dated as of January 16, 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** -- Shareholders' Agreement among the Hermes Europe Railtel,
B.V., GTS-Hermes Inc., HIT Rail B.V., SNCB/NMBS and AB Swed
Carrier (incorporated by reference to Exhibit 10.1 to the
Hermes Europe Railtel B.V.'s Registration Statement on Form
S-4 (File No. 333-37719) filed on December 11, 1997)
(supersedes the Amended and Restated Shareholders' Agreement
filed as Exhibit 10.31 to this Registration Statement)......
10.32+ -- Company Agreement between The Societe National de
Financement, GTS S.A.M. and The Principality of Monaco,
dated September 27, 1995....................................
10.33+ -- Joint Venture Agreement between SFMT-Hungaro Inc. and
Montana Holding Vagyonkezelo Kft., dated December 23,
1993........................................................
10.34+ -- Joint Venture and Shareholders' Agreement among Gerard
Aircraft Sales and Leasing Company, SFMT-Hungaro Inc., and
Microsystem Telecom Rt., dated August 5, 1994...............
10.35+ -- Agreement on the Establishment of Limited Liability Company
between SFMT-Czech, Inc. and B&H s.r.o., dated July 12,
1994........................................................
EXHIBIT
NUMBER DESCRIPTION
------- -----------
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...........................
11.1+ -- Statement regarding computation of per share earnings.......
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, Ernst & Young (CIS) Ltd., and
Ernst & Young Reviseurs d'Entreprises S.C.C. ...............
24.1+ -- Powers of Attorney (included on signature page to this
registration statement).....................................
27.1+ -- Financial Data Schedule extracted from 12/31/96 audited
financial statements........................................
27.2+ -- Financial Data Schedule extracted from 9/30/97 unaudited
financial statements........................................
* Filed herewith.
** Previously filed.
*** To be filed by amendment.
+ Incorporated by reference to the corresponding exhibit to the Company's
Registration Statement on Form S-1 (File No. 333-36555) filed on September
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