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 P
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