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Securities and Exchange Commission
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the fiscal year ended December 31, 1997
OR
[ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 1-11484
HUNGARIAN TELEPHONE AND CABLE CORP.
(Exact Name of Registrant as specified in its charter)
Delaware 13-3652685
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 First Stamford Place, Stamford, CT 06902
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (203) 348-9069
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
Common Stock, American Stock Exchange
par value $.001 per share
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirement for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of March 27, 1998, 5,291,770 shares of the Registrant's Common Stock
were outstanding, of which 5,237,920 were held by non-affiliates of the
Registrant. The aggregate market value of the Registrant's Common Stock held by
non-affiliates, computed by reference to the closing price of the Common Stock
on the American Stock Exchange as of March 26, 1998, was $45,831,800. (The
exclusion of shares owned by any person from such amount shall not be deemed an
admission by the Registrant that such person is an affiliate of the Registrant.)
Documents Incorporated by Reference
Part III - Portions of the Registrant's proxy statement for the Annual
Meeting of Stockholders for the fiscal year ended December 31, 1997.
Cautionary Statement Regarding Forward-Looking Statements
Certain statements contained herein which express "belief,"
"anticipation," "expectation," or "intention" or any other projection, insofar
as they may apply prospectively and are not historical facts, are
"forward-looking" statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Because such
statements include risks and uncertainties, actual results may differ materially
from those expressed or implied by such forward-looking statements. Factors that
could cause actual results to differ materially from those expressed or implied
by such forward-looking statements include, but are not limited to, the factors
set forth in "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations." See also Item 14 "Exhibits, Financial
Statement Schedules and Reports on Form 8-K, Exhibit 99.1."
PART I
In this Part I of Form 10-K, all references to "$" or "U.S. Dollars"
are to United States Dollars and all references to "HUF" or `Forints" are to
Hungarian Forints. Certain amounts stated in Forints herein also have been
stated in U.S. Dollars solely for the informational purposes of the reader, and
should not be construed as a representation that such Forint amounts actually
represent such U.S. Dollar amounts or could be, or could have been, converted
into U.S. Dollars at the rate indicated or at any other rate. Unless otherwise
stated or the context otherwise requires, such amounts have been stated at
December 31, 1997 exchange rates. The Forint/U.S. Dollar middle exchange rate as
of December 31, 1997 was approximately 203.92 Forints per U.S. Dollar.
Item 1. Business
Company Overview
Hungarian Telephone and Cable Corp. ("HTCC" or the "Registrant" and,
together with its consolidated subsidiaries, the "Company") provides basic
telephone services in five defined regions within the Republic of Hungary (each,
an "Operating Area" and together, the "Operating Areas") pursuant to 25-year
telecommunications concessions granted by the Hungarian government. HTCC,
through its four majority-owned operating subsidiaries (each, an Operating
Company and together, the "Operating Companies"), owns and operates virtually
all existing public telephone exchanges and local loop telecommunications
network facilities in its Operating Areas and is the exclusive provider through
November 1, 2002 of non-cellular local voice telephone services in such areas.
The Company has recently completed its significant network modernization and
construction program in all of its Operating Areas which substantially met its
demand backlog, increased the number of basic telephone access lines in service
and modernized existing facilities. The Company's networks now have the
capacity, with some additional capital expenditures, to provide basic telephone
services to virtually all of the estimated 266,600 homes and 38,900 business and
other institutional subscribers (including government institutions) within its
Operating Areas.
-2-
The Company acquired its concession rights from the Hungarian Ministry
of Transportation, Telecommunications and Water Management (the "Ministry") for
$11.5 million (at historical exchange rates) and purchased the existing
telecommunications infrastructure in the Operating Areas, including
approximately 61,400 access lines, from Magyar Tavkozlesi Rt. ("MATAV"), the
formerly State-controlled monopoly telephone company, for $23.2 million (at
historical exchange rates). Kelet-Nograd Com Rt. ("KNC") and Raba Com. Rt.
("Raba-Com"), two of the Operating Companies, acquired the existing
telecommunications assets in their respective Operating Areas in the first
quarter of 1995, while Papa es Tersege Telefon Koncesszios Rt. ("Papatel") and
Hungarotel Tavkozlesi Rt. ("Hungarotel"), the other two Operating Companies,
acquired the existing telecommunications assets in their respective Operating
Areas on January 1, 1996. Since the acquisition of such existing networks, the
Operating Companies have incurred capital expenditures through December 31, 1997
of $155 million (at historical exchange rates) to expand and upgrade their
network facilities which has resulted in the completion of a modern
communications network in each of the Operating Areas, which networks include
new digital switches and increased network capacity, utilizing the latest in
communications transmission technology. The completion of the Company's network
construction program has resulted in the addition of approximately 113,700 new
access lines in service (including pay phones) as of December 31, 1997 to the
61,400 access lines acquired from MATAV and the replacement of all of the 10,810
manual exchange lines acquired from MATAV.
The Company completed its network modernization and construction
program in each of its Operating Areas primarily through turnkey construction
contracts with Siemens Telefongyar Kft., Ericsson Technika and Fazis
Telecommunication System Design and Construction Corporation. The contracts were
primarily funded with the Company's $170 million 10-year credit facility with
Postabank es Takarekpenztar (the "Postabank Credit Facility"), a Hungarian
commercial bank ("Postabank"), and a $47.5 million contractor financing
facility.
As of December 31, 1997, the Company's telecommunications networks had
approximately 175,100 access lines in service (including pay phones) and the
necessary wired switching capacity to service, with some additional capital
expenditures, 190,000 households, businesses and other institutions and the
backbone fiber network capacity to service 326,000 households, businesses and
other institutions.
The following table sets forth certain information as of December 31,
1997 with respect to each of the Operating Companies.
Raba-Com KNC Papatel Hungarotel Total
Population............................... 67,600 152,200 67,700 421,100 708,600
Residences.............................. 23,700 61,800 24,100 157,000 266,600
Businesses and other(1)............... 4,300 6,800 3,200 24,600 38,900
Access lines in operation:
Residential........................ 18,500 30,400 15,200 88,900 153,000
Business and other(2)........... 2,100 5,100 1,800 13,100 22,100
-------- -------- -------- --------- --------
Total...................... 20,600 35,500 17,000 102,000 175,100
Pay phones............................. 145 485 171 1,152 1,953
Population Penetration rate(3)..... 30.5 23.3 25.1 24.2 24.7
Residential Penetration rate (4)... 78.1 49.2 63.1 56.6 57.4
Waiting List........................... 600 2,000 1,000 6,500 10,100
- --------
(1) Represents Company estimates of business and other institutional subscribers
or potential subscribers (including government institutions).
(2) Represents Company estimates of subscribers which are businesses and other
institutional subscribers (including government institutions), leased lines
and pay phones.
(3) Population Penetration rate is defined as the number of access lines per 100
inhabitants.
(4) Residential Penetration rate is defined as the number of residential access
lines per 100 residences.
-3-
The following table sets forth the number of access lines served by each of
the Operating Companies at takeover from MATAV and at the end of 1995, 1996 and
1997.
Takeover 1995 1996 1997
-------- ---- ---- ----
Raba-Com 2,500(1) 5,100 14,000 20,600
KNC 13,000(1) 14,200 20,500 35,500
Papatel 3,800(2) 3,800 11,100 17,000
Hungarotel 42,100(2) 42,100 47,800 102,000
-------- -------- -------- -------
Total 61,400 65,200 93,400 175,100
(1) 1st Quarter 1995
(2) Year-End 1995
History
Overview of Hungarian Telecommunications Industry
The Company believes that Hungary is an attractive market for
telecommunications services, especially since the Hungarian telecommunications
market was historically significantly underdeveloped by MATAV, which, in past
years, did not make the investments in the Hungarian telecommunications
infrastructure necessary to achieve a comparable level of teledensity to that of
Western Europe. As of December 31, 1995, Hungary had a basic telephone
penetration rate of approximately 21 telephone access lines per 100 inhabitants
compared to an European Union average of approximately 48 access lines per 100
inhabitants and a United States average of approximately 60 access lines per 100
inhabitants. Of such access lines in Hungary, approximately 40% were located in
Budapest (in which approximately 20% of Hungary's population resides). In the
Company's Operating Areas, access line penetration was approximately nine access
lines per 100 inhabitants as of December 31, 1995. By comparison, basic
telephone penetration rates in other Eastern European countries such as the
Czech Republic, Poland, Slovakia and Bulgaria, as of December 31, 1995, were 23,
15, 21 and 28 access lines per 100 inhabitants, respectively. However, MATAV has
invested approximately HUF 171 billion ($839 million) in its fixed
telecommunications network from 1994 to 1996 which resulted in the addition of
over one million access lines to MATAV's networks. In addition, due to the
completion of the Company's network modernization and construction program,
access line penetration has increased to 25 access lines per 100 inhabitants as
of December 31, 1997. Given that the Company's, MATAV's, and the other LTOs' (as
defined below) investments in the Hungarian telecommunications market over the
last several years produced a significant increase in the overall penetration
rate in Hungary (29% as of September 30, 1997), the Company expects to benefit
from a continued increase in the use of its telecommunications services by its
customer base.
In addition, since 1989 Hungary has been the most successful country in
Central Europe in attracting foreign investment, due to its early start in, and
ongoing commitment to, economic reform. According to the Hungarian Ministry of
Industry, Trade and Tourism, total foreign direct investment in Hungary was
valued at $18 billion at the end of 1997. Hungary's gross domestic product rose
4% in 1997, up from a 1% increase in 1996. GDP growth of approximately 4% is
expected to continue in 1998. Hungary's exports increased 21% in 1997 from the
1996 level to $19 billion while imports totaled $21 billion, an increase of 16%
from 1996.
-4-
Historically, the exclusive provider of telecommunications services in
Hungary was MATAV, once a part of the Hungarian Post Office. Beginning in 1992,
the Hungarian government began the process of privatizing Hungary's
telecommunications industry by selling an initial 30% stake in MATAV (raised to
67% in 1995) to a consortium called MagyarCom, a company wholly owned by
Deutsche Telekom, a consortium of the German public telephone operator, and
Ameritech, a U.S. regional bell operating company. In addition, the Ministry
divided the country into 54 primary telecommunications service areas in order to
take some of such primary telecommunications service areas out of MATAV's
national network with respect to the provision of local basic telephone service
while allowing MATAV to continue its monopoly in the provision of domestic and
international long distance services. In 1993, the Ministry solicited bids for
concessions to build, own and operate telecommunications networks in the 25
service areas which had been chosen to exit the MATAV system. As of December 31,
1997, 23 of the 25 concessions for which the Ministry solicited bids had been
awarded. Winning bidders (each a Local Telephone Operator, "LTO", and together
the "LTOs") included: the Company (presently 5 areas); UTI, a consortium formed
by Alcatel Austria AG and US Telecom East, Inc. (4 areas); affiliates of
Compagnie Generale des Eaux (4 areas) and the Swiss and Dutch PTTs (1 area); a
bidding group including United International Holdings (1 area); a consortium
comprised of Bezeq, the Israeli PTO, and MATAV (3 areas); and MATAV (5 areas).
MATAV also retained the rights to service 2 areas for which there were no
successful bidders. In addition to the fees paid to the government which
aggregated approximately $80.0 million (at historical exchange rates), each of
the non-MATAV LTOs negotiated a separate asset purchase agreement with MATAV
for each concession area's existing basic telephone plant and equipment, which
led to the transfer of approximately 260,000 access lines from a total of 1.2
million access lines in the MATAV system. MATAV's concession areas presently
cover approximately 75% of Hungary's population and approximately 70% of its
geographic area.
In addition to the liberalization of basic telephone services, the
Ministry also selected two consortia to provide nationwide cellular telephone
services. A consortium comprised of MATAV and U.S. West ("Westel") was granted
two licenses to provide both analog (NMT-450) and digital (GSM-900) services
while Pannon GSM Tavkozlesi, a consortium formed by various Scandinavian PTOs
(including Tele Danmark A/S) and the Dutch PTT ("Pannon"), was granted a license
to provide only digital cellular services. The Company believes that there are
currently approximately 650,000 cellular subscribers in Hungary.
-5-
Hungary and the Ministry continue to pursue industry liberalization
efforts. In the fourth quarter of 1997, MATAV completed its initial public
offering pursuant to which MagyarCom's stake in MATAV was reduced to
approximately 60% and the Hungarian State's stake was reduced to approximately
6.6%. The Hungarian State retained certain shareholder rights by retaining one
"golden share." In 2002, MATAV's right to provide exclusive domestic and
international long distance voice transmission is expected to end as are the
exclusive rights of MATAV and the other LTOs, including the Operating Companies,
to provide non-cellular local voice telephone services. During the fourth
quarter of 1997, the Ministry entered into a preliminary agreement with MKM-Tel,
a newly formed Hungarian company ("MKM"), which preliminary agreement is
intended to establish a company which will build a telecommunications network
throughout Hungary which could provide such services as data transmission, voice
mail and other services which are not subject to exclusive concessions when
MKM's network is functional. If the current regulatory framework remains
unchanged, the Ministry may invite tenders for concessions to provide local,
long distance and international basic telephone services when the monopolies of
the Operating Companies, the other LTOs and MATAV expire. MKM would be entitled
to submit a bid as will any other telephone operator. The current shareholders
of MKM include MAV (the Hungarian railway company), MOL (the Hungarian oil
company), KFKI (a Hungarian information technology research firm) and Unisource
(a Netherlands-based telecommunications alliance whose members include
Koninklijke PTT Nederland NV, Sweden's Telia AB and Swiss Telecom). The
Hungarian broadcaster Antenna Hungaria also has an option to acquire a stake in
MKM. In addition, in July 1997 the European Union Commission recommended that
Hungary be invited to enter into negotiations for membership in the European
Union (the "EU"). The EU has adopted numerous directives providing for an open
telecommunications market among its member nations. The Company believes that if
Hungary joins the EU prior to the expiration of the Company's exclusivity
rights, Hungary may enter into certain transitional arrangements to preserve
these exclusivity rights. Furthermore, Hungary, as a member of the World Trade
Organization ("WTO"), ratified the WTO's Telecommunications Agreement, which
agreement began liberalizing the market for telecommunications services
effective January 1, 1998. Hungary's ratification postponed Hungary's
liberalization of its telecommunications market until 2002. See also
"Competition."
HTCC and its Operating Companies
In 1994, the Ministry awarded KNC and Raba-Com concession rights to
construct local telephone exchanges and provide non-cellular local voice
telephone services for a period of 25 years, with exclusivity for the first
eight years. The Company subsequently acquired two other Operating Companies,
Hungarotel and Papatel, that had been awarded substantially identical concession
rights by the Ministry. MATAV continues to be the sole provider of domestic and
international long distance non-cellular voice telephone services through 2002.
HTCC conducts its operations through the Operating Companies. Set forth
below is an organizational chart of the Company and its principal stockholders
and affiliates as of March 27, 1998. Share ownership percentages of HTCC are
based on shares of HTCC's common stock (the "Common Stock") owned as of March
26, 1998, without giving effect to outstanding options or warrants.
-6-
Additionally, ownership percentages for the Operating Companies do not give
effect to future Hungarian equity ownership requirements. See "-Regulation -
Hungarian Equity Ownership Requirements."
Citizens Public HTCC Tele
17.1% 63.1% Management Danmark
1.0% 18.8%
HTCC
Papatel Raba-Com KNC Hungarotel
79.2% 90.7% 94.8% 99.0%
Other Other Other Other
Stockholders: Stockholders: Stockholders: Stockholders:
IFC 20.0% Municipalities 9.3% Municipalities 5.0% Private
Municipalities 0.8% Antenna Hungaria 0.2% Hungarian
Investor 1.0%
HTCC was organized under the laws of the State of Delaware on March 23,
1992. The Common Stock is traded on the American Stock Exchange under the symbol
"HTC." The Company's United States office is located at 100 First Stamford
Place, Stamford, Connecticut 06902; telephone (203) 348-9069. The Company's
principal office in Hungary is located at Kiralyhago u.2, H-1126, Budapest;
telephone (361) 457-6300.
Certain Stockholders
The Company has benefited from the extensive telecommunications
experience and capabilities of certain of its stockholders. Set forth below is a
brief description of such stockholders.
Citizens Utilities Company
Citizens Utilities Company (together with its subsidiaries, "Citizens")
is a New York Stock Exchange listed diversified growth company which provides
communications services, competitive local exchange carrier ("CLEC") services
and public services including electric transmission and distribution, natural
gas transmission and distribution, water distribution and wastewater treatment
-7-
services to approximately 1.72 million customers in 21 states throughout the
United States. Citizens is an independent telecommunications company in the
United States and holds a significant investment interest in Centennial Cellular
Corp., a cellular telephone company serving markets with a population of
approximately 10 million. Citizens also owns Electric Lightwave Inc., a CLEC
operating in five western states in the United States. Through a joint venture
with Century Communications Corp., Citizens provides cable television services
to approximately 69,500 subscribers. At December 31, 1997, Citizens had $4.9
billion in assets and $1.9 billion in equity. For the twelve months ended
December 31, 1997, Citizens had net income of $94.1 million and $1.4 billion of
revenues before a second quarter charge to earnings and a fourth quarter gain on
sale of subsidiary stock. Telecommunications services accounted for 62% of total
revenues.
In May 1995, Citizens purchased 300,000 shares of Common Stock from a
former executive of the Company and has since acquired an additional 502,908
shares pursuant to certain agreements entered into with HTCC (as amended and
restated in certain cases to date, the "Citizens Agreements") and 103,000 shares
pursuant to certain open market purchases bringing its ownership of the
outstanding Common Stock as of March 27, 1998, to 17.1%. In addition, as a
result of the Citizens Agreements, Citizens has received options and a warrant,
with per share exercise prices ranging from $12.75 to $18.00 (together, the
"Citizens Options"). The Citizens Agreements provide Citizens with certain
preemptive rights to purchase, upon the issuance of Common Stock in certain
circumstances to third parties, shares of Common Stock at $13.00 per share with
respect to third party issuances prior to September 12, 1997 and at the same
price per share as any such third party would pay per share for issuances to any
such third party after September 12, 1997. The Company and Citizens presently
have a disagreement regarding certain issues with respect to 1.9 million shares
of Common Stock subject to Citizens' preemptive rights to date. The Company is
currently in discussions with Citizens in an attempt to resolve these issues.
Assuming the exercise of all of its outstanding rights, options and warrants to
purchase Common Stock as of March 27, 1998 (including the Citizens Options and
the 1.9 million shares of Common Stock subject to Citizens' preemptive rights at
issue), Citizens would own 58.9% of the Common Stock on a fully-diluted basis.
See Notes 1(a), 9(f) and 14 of Notes to Consolidated Financial Statements.
Concurrently with its initial investment in HTCC, Citizens entered into
an agreement with HTCC pursuant to which Citizens provides HTCC and the
Operating Companies with certain administrative, financial, technical,
construction, marketing and operational services (the "Management Services
Agreement") for a fee. As of December 31, 1997, the Company has accrued, but not
paid, $7.2 million pursuant to the Management Services Agreement. The Company
and Citizens presently have a disagreement regarding certain issues with respect
to the Management Services Agreement. The Company is currently in discussions
with Citizens in an attempt to resolve these issues. Until such time as these
issues are resolved, the Company currently intends to withhold any payments to
Citizens with respect to the Management Services Agreement. See Notes 1(a), 9(f)
and 14 of Notes to Consolidated Financial Statements. For a more detailed
description of some of the Citizens Agreements, see Item 13 "Certain
Relationships and Related Party Transactions." See also Item 12 "Security
Ownership of Certain Beneficial Owners and Management".
-8-
Tele Danmark A/S
Tele Danmark A/S (together with its affiliates, "Tele Danmark") is a Danish
public telephone company. Tele Danmark's stock trades on the Copenhagen Stock
Exchange and the New York Stock Exchange. Through various wholly-owned
subsidiaries, Tele Danmark provides a variety of telecommunications services to
customers in Denmark, including regional, mobile, maritime and other telephone
services. In addition, Tele Danmark provides teledata, electronic mail, telex,
distribution of radio and television programs to local cable distributors,
leased lines, pay phones and other services. In Hungary, Tele Danmark also has
an 23.2% interest in Pannon (defined above), one of the two Hungarian digital
cellular operators. At December 31, 1997, Tele Danmark had total assets of
Danish Kroner 51.557 billion (approximately $7.3 billion at current exchange
rates) and shareholders' equity of Danish Kroner 28.338 billion (approximately
$4.0 billion at current exchange rates). During 1997, Tele Danmark had net
income of Danish Kroner 1.539 billion (approximately $219 million at current
exchange rates) on net revenues of Danish Kroner 28.996 billion (approximately
$4.1 billion at current exchange rates).
Tele Danmark previously owned 20% of the outstanding capital stock of
each of KNC and Raba-Com and had loans outstanding in the amount of $5.5 million
in the aggregate to KNC and Raba-Com. On July 1, 1997, Tele Danmark transferred
its 20% interest in each of KNC and Raba-Com to HTCC in exchange for 420,908
shares of HTCC common stock. On September 30, 1997, Tele Danmark transferred its
interest in its loans to KNC and Raba-Com and a 4.8% interest in the outstanding
capital stock of KNC and Raba-Com, which Tele Danmark had acquired from The
Investment Fund for Central and Eastern Europe, to HTCC in exchange for 548,250
shares of HTCC common stock. See Note 7 of Notes to Consolidated Financial
Statements.
In October 1997, Ameritech, Tele Danmark and the Danish government
announced that they had reached an agreement pursuant to which Ameritech would
acquire 42% of Tele Danmark and have the right to nominate one half of Tele
Danmark's Board of Directors, including the Chairman. The acquisition was
consummated in January 1998. Tele Danmark has announced that it intends to sell
its interest in Pannon in 1998 to avoid any conflicts of interest with respect
to Ameritech's interest (through MATAV) in Westel.
International Finance Corporation
The International Finance Corporation (the "IFC") is the private-sector
financing organization of the World Bank, a global cooperative which provides
financial and other aid to developing countries. The IFC owns 20.0% of the
capital stock of Papatel.
Recent Developments
Management Changes
On February 4, 1998, the Company announced that James G. Morrison, a
Director, President and Chief Executive Officer of the Company would retire
effective May 1, 1998. Mr. Morrison was instrumental in planning and overseeing
the Company's network construction program. The Board of Directors of the
Company also announced that it had elected David A. Finley, a Director of the
Company, as the Company's Non-Executive Chairman of the Board. In such role, Mr.
Finley is leading an Executive Search Committee of the Board to hire a
replacement for Mr. Morrison. The Company has also appointed Francis J. Busacca,
Jr. as its Executive Vice President and Chief Financial Officer. Mr. Busacca
assumed his duties on March 2, 1998.
-9-
Lucent
In October 1997, the Company entered into an agreement with Lucent
Technologies to become the exclusive distributor of Lucent PBX and Key System
products in Hungary. As part of the agreement, the Company purchased fixed
assets and inventory valued at $470,000 and agreed to purchase commitments
starting at $6 million for each of the next three years. The agreement provided
for the imposition of penalties of up to $500,000 annually for failure to meet
the purchase requirements. The Company also assumed 36 employees. The Company
recently entered into an agreement in principle with Lucent pursuant to which
the Company and Lucent will amend the original agreement. Effective April 1,
1998, the Company will be the exclusive supplier of PBX and Key System products
in its Operating Areas while retaining the non-exclusive rights to service other
Hungarian customers outside of the Operating Areas. In addition, the Company
will be entitled to sell large call centers on a commission basis. The Company's
minimum purchase requirements have been reduced to $2 million annually with
potential penalties reduced to a maximum of $200,000 annually for failure to
meet the purchase requirements. As part of the renegotiated relationship, the
Company agreed to transfer back $400,000 of assets to Lucent and pay Lucent
$150,000. The Company will transfer 28 of its 36 assumed employees back to
Lucent or to a subcontractor.
Year 2000 Issue
The Company recently formed a committee to begin, possibly with the
assistance of outside consultants, an evaluation of its network and computer
systems for Year 2000 compliance. The Year 2000 problem is the result of
computer programs being written using two digits rather than four to define the
applicable year. Any of the Company's programs that have time-sensitive software
may recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a major system failure or miscalculations causing disruption of
operations.
Following the Company's evaluation of its network and computer systems
for Year 2000 compliance, the Company expects to adopt a plan to mitigate the
Year 2000 Issue. While the extent and total cost of the Year 2000 modifications
and conversions has not yet been determined, the Company presently believes
that, with modifications to existing software and converting to new software,
the Year 2000 problem will not pose significant operational problems for the
Company's networks and systems as so modified and converted. However, if such
modifications and conversions are not completed timely, the Year 2000 problem
may have a material impact on the operations of the Company.
Strategy
With the completion of the construction program in all of the Operating
Areas in 1997, the Company has met its primary 1997 objective. In 1998, the
primary focus of the Company is to increase call revenues and reduce operating
costs while continuing to add residential and business customers to its
networks. In an effort to accomplish this goal, the Company intends to increase
its marketing efforts, improve operational efficiencies and increase customer
satisfaction by providing superior services at reasonable costs to the entire
customer base. In short, the Company intends to transform itself from a
construction driven organization to a marketing driven operationally efficient
organization in 1998. The Company has implemented the following operational
strategies in order to further its business objectives.
-10-
Revenue Growth
The Company plans to continue its revenue growth by increasing the
penetration levels in the business and residential sectors. In addition, the
Company intends to increase call revenues by using a detailed marketing plan for
each customer segment. The Company has placed emphasis on increasing the
installation and usage levels of the Company's business customers, who currently
generate approximately 45% of the Company's total call revenues. The Company is
also focusing on the marketing and sales of deregulated services in 1998,
including managed lease lines, PBX sales and services, ISDN, Internet, Digifon
and Centrex Services.
Operational Efficiency
The Company is increasing its productivity and operational efficiency
by achieving certain economies of scale with respect to network management,
administration, customer service, billing, accounts receivable, payroll
processing, purchasing and network maintenance. For example, the Company is in
the process of implementing its own centralized operating and accounting system
in all of its Operating Areas which will be completed by the end of the second
quarter 1998. A significant increase in operational efficiency will result from
the implementation of this system specifically in the areas of customer billing
and financial accountability. In addition, some of the Company's Operating Areas
are contiguous, which is expected to facilitate the realization of certain
economies of scale. For example, by using fiber optic technology between
contiguous Operating Areas, the Company realizes certain operational
efficiencies by centralizing certain functions.
As of February 28, 1998, the Operating Companies had a total of 290
access lines per employee, which represents an increase of more than 100 access
lines per employee over the same date in 1997.
Marketing
The Company is in the process of consolidating its sales and marketing
efforts, as it moves from being a construction-driven organization to a
marketing driven operationally efficient company. The Company is training and
educating its marketing and sales force in the latest telephony technologies and
educating customers and potential customers on the benefits available from the
Company's products and services. The Company is also targeting its marketing
efforts towards its business customers by offering "turn-key" business
communications solutions and educating these business customers on the potential
revenue gains that can be achieved with advanced telecommunications technology.
Strategic Acquisitions and Alliances
The Company intends to selectively explore opportunities, which may
include the acquisition of other concessions or the creation of strategic joint
ventures, in order to expand its telecommunications services and the geographic
areas in Hungary in which it provides such services. In this regard, the Company
has engaged in discussions with certain existing and potential
telecommunications providers in the Hungarian market regarding such possible
acquisitions or alliances, although, to date, none of these discussions has
resulted in any definitive plans.
-11-
Operations
Services
The Company provides non-cellular local voice telephone service in the
Operating Areas which allows subscribers to have facsimile, and modem
transmission capabilities and makes available to its subscribers, through
interconnection with MATAV, domestic and international long distance services.
In addition to these standard services, the Company currently offers its
subscribers data transmission and other value-added services, including
Internet, voice mail, call waiting, call forwarding, and three-way calling. The
Company intends to provide ISDN, Centrex, caller ID and audio text services in
all of its Operating Areas in 1998.
The Company's revenues are derived from the provision of local and
domestic and international long distance telephone services which consist of (i)
charges for measured telephone service, which vary depending on the day, the
time of day, distance and duration of the call, (ii) connection and subscription
fees, and (iii) other operating revenues consisting principally of charges and
fees from leased lines, public phones, detailed billing and other customer
services, including revenues from the sale and lease of telephone equipment.
Measured Service. Charges for local and domestic and international long
distance measured service vary with the number of pulses generated by a call.
The number of pulses generated for a particular call depends upon the day, the
time of day, the distance covered and the duration of the call. Currently, the
Company charges HUF 10.4 ($.05) per pulse. The Ministry adjusts such fees
annually based on a Hungarian price index. For all local calls within an
Operating Area, the Company retains all of the revenues associated with the
call. For domestic long distance calls outside of an Operating Area (including
those between Operating Areas, including adjacent Operating Areas) and all
international calls, the Company has a revenue sharing arrangement with MATAV
the terms of which are governed by a decree of the Ministry. Mobile telephone
calls to customers in the Operating Areas and calls from customers in the
Operating Areas to mobile phones are included in long-distance service revenues
shared with MATAV. Through December 31, 1997, such revenue sharing arrangement
was intended to result in each Operating Company receiving 67% of the total
measured service revenue (including all the revenues attributable to local,
domestic long distance and international long distance calls) and subscription
fees within an Operating Area, with MATAV receiving the remaining 33%. As a
result of negotiations between the Company and the other non-MATAV LTOs with
the Ministry and MATAV regarding new revenue sharing arrangements, the Ministry
issued a decree in 1998 which regulates the amount of revenue the Company and
the other LTOs will receive in 1998 for domestic long distance and international
calls. The Company believes that the new regulation will result in an overall
increase in the Company's revenue per call in 1998 for domestic long distance
and international calls over the amount received in 1997. See "- Regulation Rate
Setting and Revenue Sharing."
Subscription and Connection Fees. The Company collects a monthly
subscription fee from its customers. Such fees vary depending on such factors as
whether the services are provided to a residential or business or other customer
(including government institutions), and whether the customer is linked to a
digital or analog exchange. The Company charges a monthly subscription fee to
digital and single-party exchange customers of HUF 1,104 ($5.41) for residential
customers and HUF 1,425 ($6.99) for business and other institutional subscribers
(including government institutions). See "- Regulation - Rate Setting and
Revenue Sharing."
-12-
Connection fees are earned when a customer is added to the network. The
Company may collect the full connection fee provided the customer is connected
within 30 days; otherwise, the Company may collect only one-third of the
connection fee and must connect the subscriber within one year. The connection
fee is not recognized as income until the customer receives a telephone and the
connection is made. Currently, connection fees are HUF 30,000 ($147) (plus VAT)
for residential customers and HUF 90,000 ($441) (plus VAT) for business and
other institutional subscribers (including government institutions), which are
the maximum allowable fees, pursuant to a decree of the Ministry. Customers
requesting additional access lines are charged an additional connection fee per
line.
Other Operating Revenue. The Company supplies private line service
(point-to-point and point-to-multi-point) primarily to businesses. As of
December 31, 1997, approximately 1,151 leased lines were in service. In
addition, as of December 31, 1997, the Company had 1,953 public pay phones in
the Operating Areas in accordance with the terms of the Concession Contracts (as
defined under "- Network Design, Construction and Performance - Milestones").
The Company generates additional revenues from the provision of value-added
services, including voice mail, call waiting, call forwarding, and three-way
calling, as well as through the sale and leasing of telephone equipment.
Pricing
Maximum pricing levels are set by the Ministry and historically rate
increases have tracked inflation, as measured by the Hungarian Producer Price
Index ("PPI"). The Ministry, pursuant to a decree, has set forth a new
regulatory framework for regulating annual increases in the fees for (a) local
calls, (b) domestic long distance and international calls and (c) subscription
fees based on the Hungarian Consumer Price Index ("CPI"). In addition to
separate price caps for such categories of services, the Ministry has enacted a
rebalancing formula which provides for greater increases in charges for
subscription fees and local calls than in domestic long distance and
international calls. See also "- Regulation - Rate Setting and Revenue Sharing."
The Company's customers are on a one-month billing cycle. For domestic long
distance and international calls, the Company is required to charge the same
tariffs as MATAV. For local calls, the Company may choose to increase its rates
up to the permitted amount; however, price increases in the past generally have
conformed to the price increases promulgated by MATAV. Measured service rate
increases are effected by the Ministry by either increasing charges per pulse or
reducing the time interval between pulses, depending on the time of day and
other factors. In addition, the Company charges additional fees for services
such as data transmission, voice mail, call waiting and call transfer in all of
its Operating Areas. The fees charged for these services are not subject to
regulation by the Ministry.
The Company has been allowing its subscribers to pay connection fees on
various installment basis plans and encourages customers to lease their
telephones. The Company believes that to date the various installment plans have
resulted in an increase in the number of subscribers in the Operating Areas.
The Company currently purchases telephone sets in bulk from a variety
of manufactures at an average price of HUF 2.700 ($13.24). Customers can choose
to buy the phone and pay HUF 3,240 ($15.89) or lease the phone and pay a monthly
fee of HUF 160 ($0.78). Although there is no Ministry or other governmental
regulation relating to lease rates, the Company adjusts such rates annually
according to the Hungarian PPI. Each phone set has an expected life of 10 years.
Approximately 58% of the Company's subscribers as of December 31, 1997 leased
their phones from the Company.
-13-
Marketing Strategy
As the exclusive provider of basic telephone services in the Operating
Areas, the Company's primary marketing objective is to increase the usage of its
telephone services by its existing residential and business customers. In
addition, the Company intends to attract new subscribers by targeting the needs
of various market segments, while maintaining superior customer service and
reliability based on current "state of the art" telecommunications technology.
The Company's targeted market segments are: (i) residential customers; (ii)
small businesses and professionals; (iii) medium and large businesses; and (iv)
government institutions. During the construction phase of the Company's
operations in 1997, the Company connected substantially all of the homes and
businesses on the Company's waiting lists and targeted its marketing efforts at
homes surrounding wait-listed subscribers and on the business and professional
sectors which are characterized by low price sensitivity, high usage and
substantial demand for value added services. This enabled the Company to take
advantage of its construction schedule by targeting those areas where
construction was in progress. The Company's marketing efforts included
advertising on radio and television, door-to-door marketing surveys, newspaper
advertising, participation in local trade shows, direct mail, community meetings
and billboard advertising.
With the completion of the construction program in all of the Operating
Areas, the Company is now capable of connecting the majority of any new
customers in a relatively short period of time. In most cases connections can be
made within 30 days of the customer order. The Company anticipates lowering the
target to seven days by the end of 1998. During 1998, the Company intends to
target the residences and businesses that do not yet have telephone service
through direct marketing. However, the Company's primary marketing efforts in
1998 will be on educating both business and residential customers on the
availability and use of several "value added services" including the premium
rate services, voice mail and all of the Digifon services (e.g. call forwarding,
call waiting, call barring, caller ID). The Company will also emphasize ISDN and
CCS-7 (high speed data transfer) services which should be available by the end
of the second quarter of 1998. The Company believes that this effort will result
in a greater understanding by its business customers of the potential revenue
gains that can be achieved with advanced telecommunications technology.
Customer Service; Customer Base
The Company believes that providing a high level of customer service is
important to achieving its objective of attracting additional customers and
increasing the usage of existing services by its current customer base. Prior to
completion of the construction program, some customers waited for over 20 years
for telephone service. Today, most residences and businesses can be connected to
one of the Company's networks within 30 days. The Company also operates full
time operator service centers in each of the Operating Areas which are staffed
by operators capable of providing, among other things, call completion
assistance, directory assistance and trouble reporting. In addition, the Company
operates customer service centers in each of the Operating Areas which offer
facsimile, Internet, photocopying and telephone bill payment services. These
offices also sell communications equipment, process telephone service
applications and handle billing inquiries.
Most of the Company's subscriber base consists of residential
customers. As of December 31, 1997, 89% of subscribers were residential
customers and 11% were business and other institutional subscribers (including
government institutions).
-14-
Network Design, Construction and Performance
The Company has constructed a versatile modern communications network
which substantially replaced the antiquated system purchased from MATAV. This
new system provides many of the technologically advanced services currently
available in the United States and Western Europe. The Company's networks
maintain the North American standard, or "P01", grade of service. The P01
standard means that one call out of 100 will be blocked in the busiest hour of
the busiest season. The Company believes that its ability to meet the
telecommunications requirements of its customers through a combination of
conventional fiber optic and wireless local loop technology affords it
significant flexibility with respect to network development and network capital
expenditures. The Company has replaced all manually operated local battery and
common battery cord type switchboards purchased from MATAV while retaining
certain analog switching systems. The Company upgraded such analog switching
systems allowing such systems to mimic many of the features available in modern
digital switching systems with a minimal investment.
Conventional Network Design
In developing its networks, the Company has implemented service quality
and redundancy objectives on par with Western European and North American
digital network standards. Certain of the networks constructed are based on
digital hosts and remotes with fiber optic rings and copper feeder and
distribution. Such a distribution system is the conventional system used in the
United States and Western Europe. Telecommunications services are transmitted to
the home through twisted pair copper wire telephone cable. The diagram below
shows the general design of the Company's conventional network.
The Company's conventional networks have been designed to employ an
open architecture, generally using Synchronous Digital Hierarchy ("SDH")
technology for system resilience. The Company's networks are designed to provide
voice and high speed data services. The Company believes that the flexible
design of the conventional networks it has constructed allows it to readily
implement new technologies and provide enhanced or new services. The Company's
switches in its conventional networks allow it to connect to networks operated
by other LTOs or by MATAV in order to route voice and data transmissions between
subscribers.
Wireless Network Design
In certain portions of the Operating Areas, the Company is deploying
wireless network technology based upon the Digital Enhanced Cordless
Telecommunications ("DECT") system which interfaces radio technology to
fiber-optic, digital microwave or fixed copper networks. The principal advantage
in deploying a wireless network lies in the significant reduction in capital
expenditure requirements as compared to a conventional copper network build-out.
In addition, use of DECT technology generally reduces the time and expense of
installation and securing rights of way. In a conventional network build,
significant investment must be made in order to offer service to a large
proportion of potential customers whether or not they become actual customers.
By contrast, the use of the DECT system in a network build-out provides for
capital investment proportional to the number of customers actually connected
because the radio links and other required equipment are installed only for
those households choosing to take the service and are installed only at the time
service is requested.
-15-
In many areas in which the Company is utilizing a wireless network
design, the Company is deploying a fiber optic cable to the node in the same
fashion as in a conventional network build-out. At each newly constructed node,
the Company has constructed a radio base station ("RBS"), rather than switching
to twisted pair copper wire distribution to the home. Each RBS has the capacity
to provide service to between 200 and 600 customers. As additional customers are
brought onto the network, the Company will install a transceiver unit at the
subscriber's premises. Such transceiver's operating software is digitally
encrypted so that it will operate only with its supporting RBS. A conventional
telephone jack is then installed in the subscriber's household near an
electrical outlet which is used to power the transceiver unit. The subscriber
then uses a conventional phone to make outgoing and receive incoming calls. The
Company also utilizes a 900 MHz analog radio solution in certain portions of the
Operating Areas. Such systems differ from a DECT-based solution only in that the
transceiver is an analog rather than a digital unit and operates on a different
frequency.
The DECT-based wireless local loop system provides the same grade of
service as a conventional telephone network. In addition, a DECT-based network
is able to provide many of the same services as a conventional copper network
including voice mail, call forwarding and call barring.
The diagram below shows the general design of the Company's network
utilizing the DECT-based wireless local loop system.
[DIAGRAM]
-16-
Milestones
The Operating Companies' rights to provide non-cellular local voice
telephone services in the Operating Areas are governed by concession contracts
with the Ministry (the "Concession Contracts"). All of the Operating Companies
entered into Concession Contracts with the Ministry in 1994. Each Concession
Contract prescribes certain build obligations ("milestones") that require each
Operating Company to install a specified number of access lines within
prescribed time periods. Hungarotel and Papatel entered into amended Concession
Contracts with the Ministry in June 1996 as a result of the Ministry's approval
of the Company's acquisition of Hungarotel and Papatel. For 1997, Hungarotel,
Papatel and Raba-Com were in full compliance with their build-out requirements.
KNC was in substantial compliance but the Company does not anticipate any
material fines. For 1998, the Company expects to be in full compliance with the
milestones in each of its Operating Areas. See "Regulation - Concession
Contracts - Fines".
Network Administration
The Company actively monitors the switching centers and all critical
network operational parameters in each Operating Area. As digital features are
introduced into their respective networks, the network technicians have the
ability to monitor the networks and evaluate and respond accordingly. The
Company will also be able to analyze the performance data generated by these
systems in order to make the operating adjustments or capital expenditures
necessary to enhance individual network operations.
The Operating Companies
The following is a brief description of each of the Operating
Companies:
Hungarotel
The Company owns a 99.0% interest in Hungarotel while a private
Hungarian investor owns the remaining 1.0%. The Hungarotel Operating Area
encompasses the southern portion of Bekes County, which borders Romania. The
Hungarotel Operating Area is comprised of 75 municipalities and has a population
of approximately 421,100 with an estimated 157,000 residences and 24,600
business and other potential subscribers (including government institutions).
Bekes is the most intensively cultivated agrarian region in Hungary and produces
a substantial portion of Hungary's total wheat production. Industry, generally
related to food processing, glass and textile production, is also a strong
employer in the region. Foreign investors in the Operating Area include Owens
Illinois of the United States and a number of European manufacturers. The region
is also a center for natural gas exploration and production. As of December 31,
1997, Hungarotel had 102,000 access lines connected to its network. The
Hungarotel network utilizes a combination of a conventional build, fiber optic
and wireless local loop technology.
-17-
KNC
The Company holds a 94.8% interest in KNC. The KNC Operating Area
municipalities own 5.0% and Antenna Hungaria owns the remaining 0.2%. The KNC
Operating Area is comprised of 74 municipalities in the eastern portion of
Nograd County, which borders Slovakia. The KNC Operating Area has a population
of approximately 152,200, with an estimated 61,800 residences and 6,800 business
and other potential subscribers (including government institutions). The
principal economic activities in the KNC Operating Area include light
manufacturing, tourism, some coal mining and agriculture. Foreign investors in
the region include the Irish dairy producer, Avonmore, and the Japanese company,
Paramount Glass. The Operating Area's proximity to Budapest, 1-1/2 hours by car,
and its many cultural attractions makes it a desirable weekend and tourist
destination. As of December 31, 1997, KNC had 35,500 access lines connected to
its network. The KNC network utilizes a combination of a conventional build,
fiber optic and wireless local loop technology.
Papatel
The Company holds a 79.2% interest in Papatel. The IFC owns a 20.0%
interest and Papa, the principal city in the Papatel Operating Area, owns the
remainder. The Operating Area is composed of 51 municipalities located in the
northern portion of Veszprem County and is contiguous with the Raba-Com
Operating Area. The population of the Papatel Operating Area is approximately
67,700 with an estimated 24,100 residences and 3,200 business and other
potential subscribers (including government institutions). The region is
relatively underdeveloped economically with the principal economic activities
centering around light industry, appliance manufacturing, agriculture and forest
products. Significant foreign investors in the Operating Area include ATAG, the
Dutch appliance maker, and Electricite de France. As of December 31, 1997,
Papatel had 17,000 access lines connected to its network. The Papatel network
utilizes a combination of a conventional build, fiber optic and wireless local
loop technology.
Raba-Com
The Company holds a 90.7% interest in Raba-Com. Municipalities in the
Raba-Com Operating Area own the remaining 9.3%. The Raba-Com Operating Area is
comprised of 63 municipalities in Vas County, which borders Austria and
Slovenia. The Raba-Com Operating Area has a population of approximately 67,600,
with an estimated 23,700 residences and 4,300 business and other institutional
subscribers (including government institutions). The principal economic
activities in the Raba-Com Operating Area include heavy manufacturing,
agriculture and tourism. Significant employers include: Linde (the Hungarian
central natural gas distributor): Phillips (a Dutch-owned electronics
manufacturer); EcoPlast (a plastics producer); and Saga (a British-owned poultry
processor). As of December 31, 1997, Raba-Com had 20,600 access lines connected
to its network. The Raba-Com network utilizes a combination of a conventional
build and fiber optic infrastructure.
Regulation
In November 1992, the Hungarian Parliament enacted the Hungarian
Telecommunications Act of 1992 (the "Telecom Act") which took effect in 1993.
The Hungarian Telecom Act provided for, among other things, the establishment of
the conditions under which individuals and companies (including MATAV, foreign
persons and foreign owned companies) could bid for concessions to build, own and
operate local telecommunications networks in designated service areas. The
Hungarian Telecom Act also gave the Ministry the authority to regulate the
industry, including the setting of local, domestic long distance and
international rates, the sharing of revenues between the LTOs and MATAV, the
accrediting of equipment vendors and the setting of standards in respect of
network development and services offered. In order to meet these obligations,
the Hungarian Telecom Act created a professional supervisory body, the
Telecommunications Chief Inspectorate (the "Inspectorate") which is supervised
by the Ministry. Its tasks include supervising the progress of the LTOs with
respect to build-out scheduling, equipment purchases and the quality of network
construction.
-18-
Concession Contracts
Pursuant to the Hungarian Telecom Act and in accordance with the
Concession Act of 1991, in connection with the award of a concession, each of
the LTOs entered into a Concession Contract with the Ministry governing the
rights and obligations of the LTO with respect to each concession. Topics
addressed by individual concession contracts include the royalties to be paid to
the Ministry, guidelines concerning LTO capital structure, build-out milestones,
employment guidelines and the level of required contributions to meet social and
educational requirements. For example, the Concession Contracts stipulate that
an LTO may not change its capital structure by more than 10% without the express
written consent of the Ministry and that former MATAV employees generally must
be retained for the first five to eight years of operation. The Company may,
however, enter into termination agreements with its employees.
Corporate Governance. The amended Concession Contracts for Hungarotel
and Papatel provide that two out of every five members of their Boards of
Directors and one-half of the members of their Supervisory Boards be Hungarian
citizens.
Exclusivity. The Concession Contracts provide that each Operating
Company has the exclusive right to provide non-cellular local voice telephone
services for eight years. Commencing in 2002, the Ministry will have the right
to grant additional concessions for non-cellular local voice telephone services.
Milestones/Network Construction. Each of the Concession Contracts
prescribe certain build-out obligations ("milestones") that require each
Operating Company to install a specified number of access lines within
prescribed time periods. For 1997, Hungarotel, Papatel and Raba-Com were in full
compliance with their build-out requirements. KNC was in substantial compliance
in 1997 but the Company does not anticipate any material fines. For 1998, the
Company expects to be in full compliance with the milestones in each of the
Operating Areas. See "- Fines."
Presently, only three vendors have been accredited to provide
telecommunications switching equipment to LTOs, namely, Siemens, Ericsson and a
Hungarian subsidiary of Northern Telecom. Although only these three vendors have
been accredited, the Operating Companies have not encountered any equipment
supply shortfalls.
Royalties. Each of the LTOs is required by the terms of its individual
concession contract to pay annual royalties to the Ministry equal to a
percentage of net revenue from basic telephone services. Net revenue for this
purpose are generally defined as gross revenue from basic telephone services
less interconnect fees paid to MATAV. The royalty percentage may also differ by
region. For example, the Operating Companies must pay royalties in the following
percentage amounts: KNC 0.1%; Raba-Com 1.5%; Hungarotel (Bekescsaba) 2.3%;
Hungarotel (Oroshaza) 0.3%; and Papatel 2.3%. These amounts are paid annually,
in arrears.
-19-
Social and Educational Contributions. In addition to the royalties
described above, Concession Contracts may also call for social and educational
contributions based on revenues of the Operating Company, excluding VAT. The
Concession Contracts for KNC and Raba-Com require them to contribute 1.5% and
1.0% of such revenues, respectively, to support social and educational projects
in their Operating Areas. The Concession Contracts for Hungarotel require it to
pay an amount equal to 10 times the local occupational excise tax, which amount
could, if levied under current restrictions, amount to as much as approximately
1.0% of net revenues. As this tax is currently not levied, it is not possible to
predict the effect, if any, such provision will have on the Company.
Renewal. Each Concession Contract provides for a 25-year term with the
right to submit a proposal, within 18 months prior to the expiration of the
Concession Contract to apply for an additional 12-1/2 years which the Ministry
may grant if it approves the Operating Company's proposal, subject to
consultation with local authorities and professional and consumer protection
bodies. Such extension would involve the payment of an additional concession fee
to be set by the Ministry prior to the submission of the proposal. In the event
the proposal is rejected or is not timely filed, the concession would be
auctioned by the Ministry, although the existing Operating Company would have
priority in the event the Operating Company's proposal provides for the same
terms and conditions as that of another bidder.
Fines. The failure to meet required construction milestones may result
in the levying of fines by the Ministry. Such fines are computed based on a
contractual formula and may be substantial. For 1997, Hungarotel, Papatel and
Raba-Com were in full compliance with their build-out requirements. KNC was in
substantial compliance in 1997 but the Company does not anticipate any material
fines. For 1998, the Company expects to be in full compliance with the
milestones in each of the Operating Areas.
Termination upon Lack of Performance. If an LTO is unable to comply
with its Concession Contracts, the Ministry has the right to abrogate the
Concession Contract. In such an instance, the Ministry has authority to
determine alternative provisions for such service, which may include the sale of
the LTO's telecommunications assets to another provider. In such case, the LTO
would be obligated to sell its assets under the terms of a contract to the
provider to whom the concession is transferred. The Company believes that it has
demonstrated substantial performance to date under its Concession Contracts and
that its relations with the Ministry are good and, therefore, the chance of any
termination of any Concession Contract are remote.
Dispute Resolution. Any disputes arising with respect to the
interpretation of a Concession Contract will be adjudicated by a Hungarian
court.
Hungarian Equity Ownership Requirements.
The Ministry has stipulated in the Concession Contracts for Hungarotel
and Papatel, as amended in June 1996, that each of the Operating Companies must
meet certain Hungarian ownership requirements so that by the end of the seventh
year of their Concession Contracts Hungarian ownership must consist of 25% plus
one share of the relevant Operating Company. For the first three months after
assuming operations of an Operating Area from MATAV, no Hungarian ownership was
required. For the seven-year period following the date or amendment of a
Concession Contract, as the case may be, Hungarian ownership must be at least
10%, except that during such period, such ownership may be reduced to as low as
1% for a period of up to two years. During such seven-year period, while the
Hungarian ownership block is required to be at least 10%, such block must have
voting power of at least 25% plus one share, thus providing Hungarian owners the
right to block certain transactions which, under Hungarian corporate law,
require a supermajority (75%) of stockholders voting on the matter, such as
mergers and consolidations, increases in share capital and winding-up.
-20-
For these purposes, Hungarian ownership of shares means shares owned by
Hungarian citizens. Shares owned by a corporation are considered Hungarian owned
only in proportion to the Hungarian ownership of such corporation. The LTOs can
also fulfill the 25% plus one share Hungarian ownership requirement by listing
such shares on the Budapest Stock Exchange.
The equity ownership requirements and exceptions described above are
contained in the June 1996 amended Concession Contracts for Hungarotel and
Papatel. KNC and Raba-Com may not presently be in compliance with the equity
ownership requirements expressly set forth in their Concession Contracts which
call for a shorter compliance period. However, the Ministry has stated, pursuant
to a letter dated September 18, 1996, that it intends that all of the Operating
Companies be treated equally with respect to such ownership requirements which
requirements KNC and Raba-Com are currently in compliance.
Each of the Operating Companies, other than Papatel, is currently in
compliance with the 1% ownership requirement. Papatel's Concession Contract
permits an initial Hungarian ownership level of its current 0.8%. If the
Hungarian ownership does not meet the required levels, the LTO is required to
give notice to the Ministry, which may then require the LTO to rectify the
situation within three months, or a shorter period if the Ministry considers
that there has been a delay in the required notification. The Ministry has
publicly stated that it is currently reviewing the Hungarian equity ownership
requirements. In the case of one other LTO, the Ministry has granted a waiver on
the 10% ownership issue. The Company believes that it is reasonably likely that
the Ministry will either change the Hungarian equity ownership requirements by
the time the Operating Companies must meet the 10% Hungarian equity ownership
requirement in June 1998 or that the Ministry will grant the Operating Companies
a waiver. In any event, the Company will formulate plans to meet the Hungarian
equity ownership requirements. Failure to do so, or failure to comply with the
greater than 25% Hungarian ownership requirement at the end of the seven-year
period will be considered a serious breach of a Concession Contract, giving the
Ministry the right, among other things, to terminate the Concession Contract.
There can be no assurance that the Company will be able to increase the
Hungarian ownership in the Operating Companies in a manner sufficient to comply
with such requirements in the future.
The Hungarian ownership requirements effectively give minority
Hungarian stockholders in the Operating Companies the ability to block certain
corporate transactions requiring the approval of 75% of stockholders voting on
the matter, including mergers and consolidations, increases in share capital and
winding-up. In addition, unless the Hungarian ownership requirements are
changed, compliance would result in a reduction in the Company's ownership in
the Operating Companies, and, consequently, the Company's share of income, if
any, or loss of the Operating Companies will be reduced proportionately.
-21-
Rate-Setting and Revenue Sharing
Pursuant to the Hungarian Act LXXXVII of 1990 on Pricing (the "Pricing
Act") and the Telecom Act, the Ministry, issues, in agreement with the Hungarian
Ministry of Finance, decrees regulating the tariffs for telecommunications
services provided by the Company, MATAV and the other LTOs. Through December 31,
1997 the Ministry regulated, pursuant to Decree No. 30/1993 (XL.23) KHVM, as
amended, on the Rates Charged for Public Telephone Services (the "1993 Tariff
Decree"), the revenue sharing arrangements between the Company and MATAV
applicable to long distance and international calls and the fees the Company
could charge its customers for services. The Ministry regulates the subscriber
connection fees pursuant to Decree 11/1995 (VII.12) KHVM, as amended, on the
One-Time Access Fee Payable for Establishment of Public Telephone Service Access
Points (the "Connection Fee Decree").
Through December 31, 1997, the 1993 Tariff Decree regulated the prices
that the Company could charge its customers for: (a) subscription fees, (b)
local calls, and (c) long distance and international calls. The 1993 Tariff
Decree provided for an aggregate price cap and separate price caps for each
separate service. The 1993 Tariff Decree permitted annual increases in these
categories of services according to a formula tied to the PPI. The Operating
Companies were required to charge the same tariffs as MATAV for long distance
and international calls. The Company increased its tariffs 28.3% and 23.3% for
1996 and 1997, respectively. In December 1997 the Ministry adopted Decree No.
31/1997 of the KHVM on Interconnection Fees Related to Telecommunication
Services Subject to Concession, On Fees of Leased Line Services Utilized for the
Provision of Telecommunication Services Subject to Concession and On Settlement
of Fees("1997 Tariff Decree") which regulates the Operating Companies' tariffs
for services effective January 1, 1998. The 1997 Tariff Decree sets separate
price caps for each category of service through 2000, which price caps provide
for annual rate increases based on the CPI for the prior year. Based on the 1997
Tariff Decree, the Operating Companies' tariffs in 1998 can be increased by up
to 18.0% from the Operating Companies' 1997 rates. The 1997 Decree also provides
for a rebalancing formula which allows for greater increases in the charges for
subscription fees and local calls than in domestic long distance or
international calls.
Pursuant to the 1993 Tariff Decree, the Ministry set the revenue
sharing arrangements between the Operating Companies and MATAV with respect to
long distance and international calls through December 31, 1997. The revenue
sharing arrangements provided for the Operating Companies to retain an
interconnection fee from the fees collected from the Operating Companies'
customers for long distance and international calls. The interconnection fees
were fixed based on a complex formula which was intended to result in the LTOs
(including MATAV, in its role as an LTO, and the Operating Companies) receiving
67% of the telecommunications revenue and MATAV, in its role as the long
distance and international provider, receiving 33% of such revenue. For 1997,
the weighted average interconnection fee was fixed at HUF 12.82/minute for long
distance and international calls, depending on the tariff period. An LTO
received 60% of the interconnection fee for a domestic long distance or
international call initiated by such LTO's customer and an LTO received 40% of
the interconnection fee for domestic long distance or international calls
terminating with one of such LTO's customers. In January 1998 the Ministry
adopted Decree 1/1998 of the KHVM on Distribution of Revenues Related to
Telecommunication Services Subject to Concession, on Fees of Leased Line
Services Utilized for Provision of Telecommunication Services Subject to
Concession and on Settlement of Fees ("the 1998 Interconnection Decree") which
regulates the interconnection fees for 1998 and provides for each LTO to receive
an average interconnection fee of HUF 8.14/minute for either the initiation or
termination of a domestic long distance or international call. For 1999 and
future years, the Ministry has announced that it intends to start regulating the
interconnection fees based on internationally accepted benchmarks with the goal
of creating a cost-based interconnection fee regime. To that end, the Ministry
has requested MATAV and each of the LTOs to create a cost based system for
measuring what the actual costs are for interconnection services so that the
Ministry could factor this data into its future regulation of interconnection
fees. There is however no legal obligation at the present time for the Ministry
to introduce a cost-based interconnection fee regime, which is already a
requirement for EU members. See " Competition."
-22-
The Connection Fee Decree provides for maximum subscriber connection
fees at HUF 90,000 ($441) for business customers and HUF 30,000 ($147) for
residential customers. See "- Operations - Services - Subscription and
Connection Fees."
Wireless Networks
The use of radio frequencies for wireless communications technology is
licensed and regulated by the Ministry and the Inspectorate, which have the
authority to grant such licenses after a formal review process, including
licenses for use of the DECT system frequency band of 1880 MHz to 1900 MHz. In
Hungary, the service provider having the concession, after acquiring the
necessary permits and licenses, will have the authority to: (i) establish
subscriber radio lines with fixed service or with DECT mobility; (ii) establish
a radio telecommunication system to be accessed by a building or group of
buildings, with fixed service or with DECT mobility; and (iii) provide PBX
service with fixed service or with DECT mobility.
Hungarian Taxation
Corporate Income Tax. The operations of the Company's Hungarian
subsidiaries, including the Operating Companies, are subject to Hungarian
corporate income tax. Generally, Hungarian corporations are subject to tax at an
annual rate of 18.0% of all undistributed profits and a further 20% of
distributed profits. Companies which fulfilled certain criteria became entitled
to a 100.0% reduction in income taxes for the five year period ending December
31, 1998 and a 60.0% reduction in income taxes for the subsequent five year
period ending December 31, 2003, provided certain criteria continue to be met.
See Note 1(j) of Notes to Consolidated Financial Statements.
The Operating Companies are currently eligible for such tax treatment. However,
the corporate income tax is reviewed, and subject to change, annually. Any tax
increase or change in the tax exempt status of the Operating Companies could
have a material adverse effect on the Company.
Value Added Tax ("VAT"). The Hungarian VAT system is virtually
identical to the one used in most European countries. VAT is a consumption tax
which is fully borne by the final consumer of a product or service. The current
rates of VAT in Hungary vary between 0.0% and 25.0%, depending on the type of
product or service.
Social Insurance Contributions. The level of contributions for social
insurance in Hungary is one of the highest in Europe. Employers are required to
pay the state 42% (39% for 1998) of an employee's gross salary as a social
security contribution and 4.5% of an employee's gross salary as the employer's
contribution to the unemployment fund. The Company's share of pension,
unemployment, social security and health insurance payments are reflected in
operating and maintenance expenses.
-23-
Competition
The Concession Contracts provide for an eight-year period of
exclusivity in the provision of non-cellular local voice telephone services,
which ends in 2002, while the initial 25-year terms of the Concession Contracts
are scheduled to expire in 2019. Other telecommunications service providers
presently are permitted to apply for licenses to provide non-exclusive services
(e.g., data transmission and voice mail) throughout Hungary, including the
Operating Areas. In addition, beginning in 2002, other competitors may choose to
enter the non-cellular local voice telephone services market, but the terms and
conditions upon which such market entry will be effected are today unclear.
During the fourth quarter of 1997, the Ministry entered into a preliminary
agreement with MKM-Tel, a newly formed Hungarian company ("MKM"), which
preliminary agreement is intended to establish a company which will build a
telecommunications network throughout Hungary which could provide such services
as data transmission, voice mail and other services which are not subject to
exclusive concessions when MKM's network is functional. If the current
regulatory framework remains unchanged, the Ministry may invite tenders for
concessions to provide local, long distance and international basic telephone
services when the monopolies of the Operating Companies, the other LTOs and
MATAV expire. MKM-Tel would be entitled to submit a bid as will any other
telephone operator. The current shareholders of MKM include MAV (the Hungarian
railway company), MOL (the Hungarian oil company), KFKI (a Hungarian information
technology research firm) and Unisource (a Netherlands-based telecommunications
alliance whose members include Koninklijke PTT Nederland NV, Sweden's Telia AB
and Swiss Telecom). The Hungarian broadcaster Antenna Hungaria also has an
option to acquire a stake in MKM. In addition, in July 1997 the European Union
Commission recommended that Hungary be invited to enter into negotiations for
membership in the European Union (the "EU"). The EU has adopted numerous
directives providing for an open telecommunications market among its member
nations. The Company believes that if Hungary joins the EU prior to the
expiration of the Company's exclusivity rights, Hungary may enter into certain
transitional arrangements to preserve these exclusivity rights. Furthermore,
Hungary, as a member of the World Trade Organization ("WTO"), ratified the WTO's
Telecommunications Agreement, which agreement began liberalizing the market for
telecommunications services effective January 1, 1998. Hungary's ratification
postponed Hungary's liberalization of its telecommunications market until 2002.
In the event MKM or any other competitor builds a telecommunications
infrastructure with the capacity to provide non-exclusive services prior to 2002
and non-cellular local voice telephone services beginning in 2002 in an
Operating Area, such competitor could, assuming it obtains the proper
authorizations, directly compete with the Company in the Operating Areas with
respect to such services. Prior to 2002, the Company may consider adopting plans
to compete in other local telecommunications concession areas in Hungary or in
the long distance and international telecommunications markets in Hungary, which
may include joint ventures with Hungarian or international entities.
The Company also faces competition from the three Hungarian cellular
providers-Westel 900 GSM Mobil Tavkozlesi ("Westel 900"), Westel Radiotelefon
Kft. ("Westel") and Pannon, which are able to provide consumers with mobile
telephones rather than fixed telephones (including the telephones which the
Company has installed as a result of its decision to use wireless local loop
technology in certain parts of its Operating Areas). Westel 900 and Westel, both
joint ventures between US West and MATAV have the national licenses to provide
both digital and analog cellular services, while Pannon, a consortium comprised
of the Scandinavian PTOs (including Tele Danmark) and the Dutch PTT, may only
provide digital cellular services. The airtime and monthly fees charged by the
cellular operators are more than the fees for comparable services charged by the
Company.
-24-
Employees
The Company had a total of approximately 686 employees, including 17
expatriates, at December 31, 1997. The Company hired approximately 700 persons
in connection with the assets acquired from MATAV for its five Operating Areas.
The Company completed the collective bargaining agreements with its former MATAV
employees in 1997 which are effective through 1998. The Company has recently
entered into wage negotiations with its unions. The Company considers its
relations with its employees to be satisfactory.
Item 2. Properties
The Company leases 1,157 square feet of office space at 100 First
Stamford Place, Stamford, CT at a monthly rental of $2,508. The lease expires
March 31, 2000. The Company owns 365 square meters of office space in Budapest
at Kiralyhago u.2. The Company believes that its leased and owned office space
is adequate for its present and anticipated needs for the foreseeable future.
In addition, each Operating Company owns or leases the following office
or customer service space in its respective Operating Area: KNC owns or leases
57,000 square feet of total space; Raba-Com owns or leases 15,000 square feet of
total space; Hungarotel owns or leases 119,594 square feet of total space; and
Papatel owns or leases 18,000 square feet of total space. The aggregate monthly
rent for the leased space is $10,900.
Item 3. Legal Proceedings
Hungarotel is a defendant in a lawsuit filed by Dialcont Kft.
("Dialcont") on March 28, 1996 in Hungary alleging a breach of contract for
services allegedly provided by Dialcont during 1994 and 1995. The Company
believes that Dialcont's claim is without merit. Dialcont is seeking HUF 270
million ($1.3 million).
Raba-Com is a defendant in a lawsuit filed by an individual residential
customer in Hungary on December 4, 1997. The plaintiff sought a refund of a
minimal amount alleging that his home was connected to Raba-Com's network in an
untimely fashion. Raba-Com prevailed on the merits. The plaintiff has not filed
an appeal. Should, however, the Plaintiff file an appeal and prevail on such
appeal, the Company could be subject to additional claims for refunds. The
Company believes its meritorious defense to this claim and any others that may
be filed regarding this matter.
The Company and its subsidiaries are involved in various other legal
actions arising in the ordinary course of business. The Company is contesting
these legal actions in addition to the suits noted above; however, the outcome
of individual matters is not predictable with assurance. Although the ultimate
resolution of these actions (including the actions discussed above) is not
presently determinable, the Company believes that any liability resulting from
the current pending legal actions involving the Company, in excess of amounts
provided therefor, will not have a material adverse effect on the Company's
consolidated financial position, results of operations or liquidity.
-25-
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the Company's security holders
during the quarter ended December 31, 1997.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Information
The Company's Common Stock is traded on the American Stock Exchange
(the "Amex") under the symbol "HTCC." Trading of the Common Stock on the Amex
commenced on December 20, 1995. From December 8, 1994 through December 19, 1995,
the Common Stock was quoted on the Nasdaq National Market and from December 28,
1992 through December 7, 1994 the Common Stock was quoted on the Nasdaq
Small-Cap Market.
The following table sets forth the high and low sale prices for the
Common Stock as reported by the Amex for each quarter in 1996 and 1997.
High Low
Quarter Ended:
1996
March 31, 1996 . . . . . . . . . . . $16-1/4 $10-5/8
June 30, 1996. . . . . . . . . . . . . 16 11-3/4
September 30, 1996 . . . . . . . . . 13-7/8 9-3/8
December 31, 1996. . . . . . . . . . 13 8-1/2
1997
March 31, 1997 . . . . . . . . . . . $11-3/8 $ 9-1/4
June 30, 1997. . . . . . . . . . . . . 10-5/8 8-1/4
September 30, 1997 . . . . . . . . . 12-7/8 8-3/8
December 31, 1997. . . . . . . . . . 13-3/4 9-3/8
On March 26, 1998, the closing sale price for the Common Stock on the
Amex was $8-3/4.
Stockholders
As of March 27, 1998, the Company had 5,291,770 shares of Common Stock
outstanding held by 103 holders of record. The Company believes that it has
approximately 1,900 beneficial owners who hold their shares in street names.
The Company will furnish, without charge, on the written request of any
stockholder, a copy of the Company's Annual Report on Form 10-K for the year
ended December 31, 1997, including financial statements filed therewith.
Stockholders wishing a copy may send their request to the Company at 100 First
Stamford Place, Suite 204, Stamford, CT 06902.
-26-
Dividend Policy
It is the present policy of the Company to retain earnings, if any, to
finance the development and growth of its businesses. Accordingly, the Board of
Directors does not anticipate that cash dividends will be paid until earnings of
the Company warrant such dividends, and there can be no assurance that the
Company can achieve such earnings or any earnings.
At present, HTCC's only source of revenues is payments, including
repayment of any intercompany loans, payments under its management service
agreements and dividends, if any, from the Operating Companies. The Operating
Companies' ability to pay dividends or make other capital distributions to the
Company is governed by Hungarian law, and is significantly restricted by certain
obligations of the Operating Companies.
Item 6. Selected Financial Data
HUNGARIAN TELEPHONE AND CABLE CORP.
AND SUBSIDIARIES
Selected Financial and Operating Data
(Dollars in Thousands, Except Per Share Amounts)
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
For the Year
Operating revenues $ 37,891 $20,910 $ 4,070 $ --- $ ---
Operating income (loss) $ (1,263) $(20,553) $(17,829) $ (5,272) $ (1,400)
Net loss $ (36,236) $(54,769) $(20,024) $ (4,597) $ (1,400)
Net loss per common share $ (7.97) $ (13.14) $ (6.30) $ (2.13) $ (.80)
At Year-End
Total assets $ 186,485 $156,615 $110,387 $ 27,577 $ 6,894
Long-term debt, excluding
current installments $ 194,537 $148,472 $ 23,467 $ 2,299 $ ---
Total stockholders' (deficit) $ (41,837) $(23,790) $ 15,739 $ 12,563 $ 3,958
equity
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Introduction
HTCC was organized on March 23, 1992 and was a development stage
enterprise through March 31, 1995. The Company is now engaged primarily in the
provision of telecommunications services through its majority-owned
subsidiaries, Raba-Com, KNC, Papatel and Hungarotel. During 1996 and 1997, the
Company embarked on a significant network development program designed to meet
its substantial demand backlog, increase the number of basic telephone access
lines in service and modernize existing facilities. Since commencing operations,
the Company's network upgrade and expansion program has resulted in the
modernization of facilities acquired from MATAV and the addition of
approximately 113,700 access lines through December 31, 1997 to the 61,400
access lines purchased from MATAV. As a result, the Company had 175,100 access
lines in operation at year end 1997.
-27-
From 1994 to 1996, the Company devoted a substantial portion of its
efforts to obtaining concession rights, negotiating acquisitions, raising debt
and equity financing, assembling a management team and commencing operations. As
a result, the Company recognized no revenue until 1995 and incurred aggregate
net losses of approximately $117.2 million through December 31, 1997.
Since the quarter ended March 31, 1995, the Company has provided
telecommunications services in the Raba-Com and KNC Operating Areas. As of
January 1, 1996, the Company commenced providing telecommunications services in
the Papatel and Hungarotel Operating Areas. The development and installation of
the network in each of the Company's Operating Areas has required significant
capital expenditures. These expenditures, together with associated operating
expenses, have resulted in substantial cash requirements until a customer base
large enough to provide sufficient revenues and operating cash flow is
established. The ability of the Company to generate sufficient revenues to
satisfy cash requirements and become profitable will depend upon a number of
factors, including the Company's ability to attract additional customers,
revenues per customer and construction costs. These factors are expected to be
primarily influenced by the success of the Company's operating and marketing
strategies as well as market acceptance of telecommunications services in the
Company's Operating Areas. In addition, the Company's profitability may be
affected by changes in the Company's regulatory environment and other factors
that are beyond the Company's control.
The success of the Company's strategy is dependent upon its ability to
increase revenues through the addition of new subscribers while limiting churn.
Since March 31, 1995, the Company's network construction and expansion program
has added 113,700 access lines through December 31, 1997 to the 61,400 access
lines acquired directly from MATAV. During this same period, churn has been
negligible, primarily due to the Company's exclusivity rights and the demand for
services evidenced by the number of wait-listed subscribers.
Comparison of Year Ended December 31, 1997 to Year Ended December 31, 1996
Net Revenues
Year ended
(dollars in millions) 1997 1996
Measured service revenues $ 26.2 $ 20.5
Subscription revenues 7.2 3.8
Net interconnect charges (10.2) (8.9)
------ ------
Net measured service and subscription revenues 23.2 15.4
Connection fees 12.9 4.1
Other operating revenues, net 1.8 1.4
------ ------
Telephone Service Revenues, Net $ 37.9 $ 20.9
====== =======
The Company recorded an 81.3% increase in net telephone service
revenues to $37.9 million for the year ended December 31, 1997 from $20.9
million for the year ended December 31, 1996.
-28-
Net measured service and subscription revenues increased 50.7% to $23.2
million for the year ended December 31, 1997 from $15.4 million for the year
ended December 31, 1996. Measured service revenues increased 27.8% to $26.2
million in 1997 from $20.5 million in 1996 while subscription revenues increased
89.5% to $7.2 million in 1997 from $3.8 million in 1996. These increases in call
and subscription fee revenues are the result of a 74% increase in average access
lines in service from approximately 76,000 lines for the year ended December 31,
1996 to approximately 132,000 lines for the year ended December 31, 1997. The
growth in access lines is not fully reflected in increased measured service
revenues as newer customers require a period of maturity before producing
revenues similar to established telephone customers. In addition, approximately
28,000 lines, representing 35% of the total increase in access lines in 1997,
were placed in service during the fourth quarter of 1997.
These revenues have been offset by net interconnect charges which
totalled $10.2 million for the year ended December 31, 1997 as compared to $8.9
million for the year ended December 31, 1996. As a percentage of call and
subscription revenues, net interconnect charges have declined from 37% for the
year ended December 31, 1996 to 31% for the year ended December 31, 1997, due to
a higher proportion of local traffic as additional access lines are placed in
service.
Connection fees for the year ended December 31, 1997 totaled $12.9
million as compared to $4.1 million for the year ended December 31, 1996. This
increase reflects the Company's ongoing network construction which resulted in
the connection of 81,700 access lines during the year ended December 31, 1997 as
compared to the connection of 28,200 access lines during the year ended December
31, 1996. As the majority of wait-listed customers have been provided with
access lines, connection fees will decline substantially. This reduction in
connection fee revenues is expected to be partially offset by increases in net
measured service and subscription revenues resulting from 1997 access line
connections.
Other operating revenues increased 28.6% to $1.8 million during the
year ended December 31, 1997 compared to $1.4 million during the year ended
December 31, 1996 due to higher revenues from the provision of direct lines,
telephone leasing, PBX and telephone sales.
Operating and Maintenance Expenses
Operating and maintenance expenses for the year ended December 31, 1997
increased to $25.0 million compared to $22.0 million for the year ended December
31, 1996. On a per line basis, operating and maintenance expenses decreased to
approximately $190 per average access line for the year ended December 31, 1997
from $285 for the year ended December 31, 1996 as the Company achieved
productivity improvements, including the decreased use of labor intensive manual
switchboards and the increased use of modern switching technology.
Depreciation and Amortization
Depreciation and amortization charges increased to $8.3 million for the
year ended December 31, 1997 from $4.3 million for the year ended December 31,
1996. This increase was due to the substantial increase in property, plant and
equipment placed in service in 1997 as a result of the network construction
program.
-29-
Management Fees
Management fees pursuant to management service agreements decreased to
$5.8 million for the year ended December 31, 1997 from $6.9 million for the year
ended December 31, 1996. This decrease was due primarily to the termination of
certain management agreements with Tele Danmark in August 1996. See "- Liquidity
and Capital Resources," and Notes 1(a), 9(f) and 14 of Notes to Consolidated
Financial Statements.
Asset Write-downs
During the year ended December 31, 1996, the Company recorded asset
write-downs totaling $2.0 million, which represented the decommissioning and
write-off of redundant assets as a result of the network construction in 1996.
Cost of Termination of Former Officers and Directors
During the year ended December 31, 1996, the Company recorded a charge
totaling $6.3 million representing the present value of payments due and options
granted to former executive officers and directors under separate termination
and release agreements, consulting agreements and noncompetition agreements.
Loss from Operations
Loss from operations decreased to $1.3 million for the year ended
December 31, 1997 from a loss from operations of $20.6 million for the year
ended December 31, 1996. Adjusted for asset write-downs and the cost of
termination of former officers and directors, the loss from operations totaled
$12.3 million for the year ended December 31, 1996. The decreasing operating
loss in 1997 was principally due to the additional revenue generated by the
network development program, offset by increases in operating and maintenance
and depreciation expenses.
Foreign Exchange Loss
Foreign exchange losses decreased to $0.5 million for the year ended
December 31, 1997 from $6.3 million for the year ended December 31, 1996. Such
foreign exchange losses resulted from the devaluation of the Hungarian Forint
against the U.S. Dollar and the German Mark. The decrease in the foreign
exchange loss is due to a significant reduction in debt and other obligations
denominated in U.S. Dollars and German Marks.
Interest Expense
Interest expense increased to $35.2 million for the year ended December
31, 1997 from $23.2 million for the year ended December 31, 1996. This increase
was attributable to higher average debt levels during the year ended December
31, 1997 as compared to the year ended December 31, 1996 as the Company incurred
additional indebtedness in order to continue the construction of its
telecommunications networks. Interest capitalized and included in the cost of
construction of certain long term assets amounted to approximately $4.5 million
during 1997 and $2.1 million in 1996.
Included in interest expense in 1996 is $4.9 million, the value of
consideration provided to Citizens for assistance in fulfilling the Company's
obligations under the Citicorp Credit Facility (as defined herein). See Notes 5
and 14 of Notes to Consolidated Financial Statements.
-30-
Interest Income
Interest income decreased to $0.7 million for the year ended December
31, 1997 from $1.5 million for the year ended December 31, 1996. This decrease
is due to decreased average cash balances outstanding during 1997.
Abandonment of Financing
During the year ended 1996, the Company cancelled a planned bond
offering in favor of a Hungarian Bank Credit Facility. The costs of abandonment
of financing were $3.0 million and included $2.0 million in settlement of fees
and costs of the underwriter and $1.0 million for professional fees and various
out of pocket expenses.
Other, net
Other, net income decreased to $13,000 for the year ended December 31,
1997 from $1.1 million for the year ended December 31, 1996 principally due to a
decrease in non-operating income and ancillary services.
Loss Before Extraordinary Items
As a result of the factors discussed above, the Company recorded a loss
before extraordinary items of $36.2 million for the year ended December 31, 1997
compared to a loss before extraordinary items of $47.5 million for the year
ended December 31, 1996.
Extraordinary Item
The Company did not record any extraordinary items in 1997 as compared
to the year ended December 31, 1996, during which the Company recorded an
extraordinary item of $7.3 million comprised of a non-cash charge of $8.2
million related to the write-off of the remaining unamortized deferred financing
costs pertaining to the Citizens Loan Agreements, offset by extraordinary income
of $0.9 million relating to a gain on early retirement of a vendor credit
facility. See Notes 5 and 14 of Notes to Consolidated Financial Statements.
Net Loss
As a result of the factors discussed above, the Company recorded a net
loss of $36.2 million for the year ended December 31, 1997 as compared to a net
loss of $54.8 million for the year ended December 31, 1996.
-31-
Comparison of Year Ended December 31, 1996 to Year Ended December 31, 1995
Net Revenues
Year ended
(dollars in millions) 1996 1995
Measured service revenues $ 20.5 $ 3.8
Subscription revenues 3.8 0.7
Net interconnect charges (8.9) (1.7)
-------- -------
Net measured service and subscription revenues 15.4 2.8
Connection fees 4.1 1.0
Other operating revenues 1.4 0.3
------- -------
Telephone Service Revenues, Net $ 20.9 $ 4.1
======= =======
The Company recorded an increase in net telephone service revenues to
$20.9 million for the year ended December 31, 1996 from $4.1 million for the
year ended December 31, 1995.
Net measured service and subscription revenues increased to $15.4
million for the year ended December 31, 1996 from $2.8 million for the year
ended December 31, 1995. Measured service revenues increased to $20.5 million in
1996 from $3.8 million in 1995 while subscription revenues increased to $3.8
million in 1996 from $0.7 million in 1995. These increases in call and
subscription fee revenues were the result of an increase in average access lines
in service from approximately 14,000 lines for the year ended December 31, 1995
to approximately 76,000 lines for the year ended December 31, 1996. The
principal reason for this significant increase in lines was the addition of
approximately 44,000 lines in the Hungarotel and Papatel areas which were
acquired from MATAV on December 31, 1995.
These revenues were offset by net interconnect charges which totaled
$8.9 million for the year ended December 31, 1996 as compared to $1.7 million
for the year ended December 31, 1995. As a percentage of call and subscription
revenues, net interconnect charges declined slightly from 38% for the year ended
December 31, 1995 to 37% for the year ended December 31, 1996.
Connection fees for the year ended December 31, 1996 totaled $4.1
million as compared to $1.0 million for the year ended December 31, 1996. This
increase reflects the Company's network construction program which resulted in
the connection of 28,200 access lines during the year ended December 31, 1996 as
compared to the connection of 3,800 subscribers during the year ended December
31, 1995.
The Company recorded other operating revenues of $1.4 million for the
year ended December 31, 1996 as compared to other operating revenues of $0.3
million for the year ended December 31, 1995. This increase reflects additional
revenues from the provision of direct lines, telephone leasing and telephone
sales.
-32-
Operating and Maintenance Expenses
Operating and maintenance expenses for the year ended December 31, 1996
increased $7.1 million to $22.0 million as compared to $14.9 million for the
year ended December 31, 1995. The $14.9 million of operating expenses incurred
in the year ended December 31, 1995 included non-cash charges totalling $6.4
million relating to deferred stock compensation. Included in operating and
maintenance expenses for the year ended December 31, 1996 was deferred stock
compensation of $0.4. Operating and maintenance expenses adjusted to remove the
effect of the deferred stock compensation totalled $21.6 million and $8.5
million for the years ended December 31, 1996 and 1995, respectively, an
increase of $13.1 million, or 154%. The increase in adjusted operating and
maintenance expenses resulted primarily from the inclusion of operating and
maintenance expenses of Hungarotel and Papatel. On a per line basis, adjusted
operating and maintenance expenses decreased to approximately $285 per average
access line for the year ended December 31, 1996 from $620 for the year ended
December 31, 1995 as the Company achieved productivity improvements, including
the decreased use of labor intensive manual switchboards and the increased use
of modern switching technology.
Depreciation and Amortization
Depreciation and amortization charges increased to $4.3 million for the
year ended December 31, 1996 from $2.2 million for the year ended December 31,
1995. This increase was due to the increase in plant and access lines in
operation during the year ended December 31, 1996.
Management Fees
Management fees pursuant to management service agreements increased to
$6.9 million for the year ended December 31, 1996 from $4.2 million for the year
ended December 31, 1995. The increase is primarily due to a full year of monthly
management fees due to Citizens which commenced July 1, 1995, offset by the
expiration in the third quarter of 1996 of the management services agreement
between the Company and Tele Danmark. See Notes 13(c) and 14 of Notes to
Consolidated Financial Statements, "- Liquidity and Capital Resources," and
Notes 1(a), 9(f) and 14 of Notes to Consolidated Financial Statements.
Asset Write-downs
Asset write-downs increased to $2.0 million for the year ended December
31, 1996 from $0.6 million for the year ended December 31, 1995. This was due to
the decommissioning and write-off of redundant assets as a result of the network
construction in 1996.
Cost of Termination of Former Officers and Directors
For the year ended December 31, 1996, the Company recorded a charge of
$6.3 million representing the present value of payments due and options granted
to former officers and directors under separate termination and release
agreements, consulting agreements and noncompetition agreements. See Note 13(a)
of Notes to Consolidated Financial Statement.
Loss from Operations
Loss from operations increased to $20.6 million for the year ended
December 31, 1996 from $17.8 million for the year ended December 31, 1995. The
operating loss for the year ended December 31, 1996 was principally due to the
costs of termination of certain former officers and directors as noted above and
to the additional expenses incurred by the Company to expand management project
oversight, engineering design and systems needed to achieve rapid line growth
and revenue increases, and provide for the introduction and control of new
services.
-33-
Foreign Exchange Losses
Foreign exchange losses increased to $6.3 million for the year ended
December 31, 1996 from $4.1 million for the year ended December 31, 1995. Such
foreign exchange losses resulted from the devaluation of the Hungarian Forint
against the U.S. Dollar and the German Mark. The Company incurred debt and other
obligations which were denominated in U.S. Dollars and German Marks in order to
commence the construction of its telecommunication networks. During the year
ended December 31, 1996, the Hungarian Forint devalued against the U.S. Dollar
and the German Mark by 18.4% and 9.0%, respectively, as compared to 26.0% and
36.3% during the year ended December 31, 1995. The increase in foreign exchange
loss was primarily attributable to the repayment in 1996 of U.S. Dollar and
German Mark denominated intercompany loans resulting in a realized foreign
exchange loss in the operating subsidiaries. The loss was offset by a reduced
devaluation of the Hungarian Forint during 1996 as well as the repayment of the
German Mark denominated vendor credit facility. Since the substantial portion of
the liabilities within the operating companies are now denominated in the
Hungarian Forint, the Company's foreign currency losses have decreased
significantly.
Interest Expense
Interest expense increased to $23.2 million for the year ended December
31, 1996 from $1.7 million for the year ended December 31, 1995. This increase
was attributable to higher average debt levels in the year ended December 31,
1996 as compared to the year ended December 31, 1995 as the Company incurred
indebtedness in order to continue the construction of its telecommunications
networks. These interest expenses were offset by capitalized interest of $2.1
million in 1996 and $0.5 million in 1995.
Included in interest expense is $4.9 million, the value of consideration
provided to Citizens for assistance in fulfilling the Company's obligations
under the Citicorp Credit Facility (as defined herein). See Notes 5 and 14 of
Notes to Consolidated Financial Statement.
Interest Income
Interest income increased $0.5 million to $1.5 million for the year
ended December 31, 1996 from $1.0 million for the year ended December 31, 1995
primarily due to higher available cash reserves for short term investment.
Abandonment of Financing
During 1996 the Company cancelled a planned bond offering in favor of a
Hungarian Bank Credit Facility. The costs of abandonment of financing were $3.0
million and included $2.0 million in settlement of fees and costs of the
underwriter and $1.0 million for professional fees and various out of pocket
expenses.
Other, net
Other, net increased from net charges of $0.3 million for the year
ended December 31, 1995 to net income of $1.1 million for the year ended
December 31, 1996 principally due to non-operating income and ancillary
services.
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Loss Before Extraordinary Items
As a result of the factors discussed above, for the year ended December
31, 1996, the Company recorded a loss before extraordinary items of $47.5
million compared to a loss of $20.0 million for the year ended December 31,
1995.
Extraordinary Item
For the year ended December 31, 1996, the Company recorded an
extraordinary item of $7.3 million comprised of a non-cash charge of $8.2
million related to the write-off of the remaining unamortized deferred financing
costs pertaining to the Citizens Loan Agreements, offset in part by
extraordinary income of $0.9 million relating to a gain on early retirement of a
vendor credit facility. See Notes 5 and 14 of Notes to Consolidated Financial
Statement.
Net Loss
As a result of the factors discussed above the Company recorded a net
loss of $54.8 million for the year ended December 31, 1996 as compared to a net
loss of $20.0 million for the year ended December 31, 1995.
Liquidity and Capital Resources
The Company was considered a development stage company through March
31, 1995. It has historically funded its capital requirements primarily through
a combination of debt, equity and vendor financing. The ongoing development and
installation of the network in each of the Company's Operating Areas requires
significant capital expenditures. These expenditures, together with associated
operating expenses, will continue to result in substantial cash requirements at
least until a customer base large enough to provide sufficient revenues and
operating cash flow is established.
In 1995 the Company entered into a financing agreement with Citizens
pursuant to which Citizens guaranteed a $33.2 million loan from Chemical Bank in
November 1995. During February and March 1996, the Company borrowed $18.2
million under a second financing agreement with Citizens.
On March 29, 1996, the Company entered into a $75.0 million Secured
Term Loan Credit Facility (the "Citicorp Credit Facility") and, together with
HTCC Consulting, a related Pledge and Security Agreement with Citicorp North
America, Inc. ("Citicorp"). On April 3, 1996, the Company used $50.8 million
from the Citicorp Credit Facility to repay all the funds advanced or guaranteed
by Citizens and Chemical Bank. As of such date, all loan agreements with
Citizens and Chemical Bank were terminated. Accordingly, in April 1996, the
Company incurred a non-cash charge of approximately $8.2 million representing
the remaining unamortized deferred financing costs pertaining to the loan
agreements with Citizens.
In order to meet contractual commitments pursuant to construction
contracts in addition to ongoing operating expenses, the Company used an
additional $24.0 million from the Citicorp Credit Facility.
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On October 15, 1996, the Company entered into a $170 million 10-year
Multi-Currency Credit Facility with Postabank. Proceeds from the Postabank
Credit Facility may be drawn entirely in Hungarian Forints and up to 20% of the
principal may be drawn in U.S. Dollars through March 31, 1999. Drawdowns in
Hungarian Forints bear interest at a rate of 2.5% above the average of the yield
on six- and twelve-month discounted Hungarian treasury bills while drawdowns in
U.S. Dollars bear interest at 2.5% above LIBOR. Interest for the first two years
has been deferred at the Company's option. Amounts outstanding in Hungarian
Forints, including any deferred interest, are payable in 32 equal quarterly
installments beginning on March 31, 1999. Amounts outstanding in U.S. Dollars
are payable in equal quarterly installments through December 31, 2002.
In October 1996, the Company borrowed the equivalent of $82.3 million
in Hungarian Forints under the Postabank Credit Facility. Approximately $75.2
million of this amount was used to repay Citicorp all funds advanced pursuant to
the Citicorp Credit Facility, as amended, and $2.0 million in fees and costs
representing settlement in connection with the cancellation of the Company's
proposed private placement of debt securities. The remaining $5.1 million was
used to pay management fees and reimbursable costs owed to Citizens pursuant to
the Management Services Agreement with Citizens. An additional $5.6 million of
the facility was used to pay loan origination fees and costs to Postabank under
the terms of the loan agreement, $2 million of which are being reimbursed to the
Company in equal quarterly installments over a two year period, and which will
be amortized over the life of the loan facility. The remainder of the proceeds
have been and will be used to complete construction of the Company's
telecommunication networks, provide additional working capital, and refinance or
repay other existing debt obligations. As of December 31, 1997, the Company had
borrowed a total of $154 million under the Postabank Credit Facility.
In 1996, the Company's subsidiary Hungarotel entered into a $47.5
million construction contract for the construction of a telephone network with a
capacity of 40,000 lines in its Bekescsaba service area. Financing has been
provided by the contractor for the full contract amount. The financing agreement
requires repayment in 20 quarterly installments commencing on March 31, 1998,
with final payment due December 31, 2002. Interest is charged at a variable rate
computed as the weighted average of the six and 12 month Hungarian National
Treasury Bill interest rate for each quarter plus 2.5%. The Company may elect,
and has elected, to defer repayment of 20% of the total debt repayments due in
1998 and 1999.
In 1995, the Company applied for network construction subsidies from
the Hungarian government. In December 1995, certain of the Company's
applications were approved, subject to certain conditions, resulting in the
Company being awarded subsidies aggregating $0.9 million. The Company received
such subsidies in installments in the fourth quarter of 1996 and the first
quarter of 1997. One-half of such funds will be received in the form of a grant
and one-half in the form of a non-interest bearing loan repayable over a three
year period.
Net cash provided by operating activities totaled $4.9 million for the
year ended December 31, 1997 compared to net cash used by operating activities
of $35.8 million for the year ended December 31, 1996. For the year ended
December 31, 1997, the Company used $73.3 million in investing activities, which
was primarily used to fund the construction of the Company's telecommunications
networks, compared to $56.4 million in investing activities for the year ended
December 31, 1996. Financing activities provided net cash of $58.4 million and
$89.2 million for the years ended December 31, 1997 and 1996, respectively.
-36-
To date, the Company's activities have involved the acquisition of the
concessions and telecommunications networks from MATAV and the subsequent
design, development and construction of the modern telecommunications
infrastructure that the Company now has in service. The Company has suffered
from recurring losses from operations and has a working capital deficiency and a
net capital deficiency. The Company is dependent on its ability to generate cash
from operations, raise capital in the form of debt or equity, or refinance or
otherwise resolve its existing obligations, including those related to the
Management Services Agreement with Citizens. The ability of the Company to
generate sufficient revenues to satisfy cash requirements and become profitable
will depend upon a number of factors, including the Company's ability to attract
additional customers and revenues per customer. These factors are expected to be
primarily influenced by the success of the Company's operating and marketing
strategies as well as market acceptance of the Company's services.
Through December 31, 1997, the Company was in the construction phase of
its development. The Company paid the Ministry $11.5 million (at historical
exchange rates) for its concessions, spent approximately $23.2 million (at
historical exchange rates) to acquire the existing telecommunications assets in
its Operating Areas from MATAV, and spent $155 million (at historical exchange
rates) to complete its network modernization and construction program. The
Company anticipates that with the construction phase of its network complete, it
will spend approximately $16 million in 1998 and $7 million after 1998 to
complete the network expansion so that the Company will be able to provide basic
telephone services to all of the estimated 266,600 homes and 38,900 business and
other institutional subscribers (including government institutions) within its
Operating Areas.
With the construction phase of its development complete, the Company
intends to transform itself from a construction driven organization to a
marketing driven operationally efficient organization in 1998. To that end, the
Company recently hired Francis J. Busacca, Jr. as its Chief Financial Officer.
In addition, James G. Morrison, HTCC's President and Chief Executive Officer,
who was instrumental in overseeing the Company's network construction program is
retiring effective May 1, 1998. David A. Finley, the Chairman of the Company is
leading an Executive Search Committee of the Board in its search for a new
President and Chief Executive Officer.
The Company and Citizens presently have a disagreement regarding
certain issues with respect to the Management Services Agreement with Citizens.
As of December 31, 1997, the Company has accrued as a current liability, but not
paid, $7.2 million pursuant to the Management Services Agreement. The Company
currently intends to withhold any payments to Citizens with respect to the
Management Services Agreement until such time as these issues are resolved. The
Company is currently in discussions with Citizens in an attempt to resolve these
issues. The Company and Citizens also have a disagreement regarding certain
issues with respect to 1.9 million shares of Common Stock subject to Citizens'
preemptive rights to date. The Company is also currently in discussions with
Citizens in an attempt to resolve these issues.
-37-
The Company believes it will be able to meet its obligations as they
become due during 1998, provided it is not required to settle the accrued
liability to Citizens in cash, however, there can be no assurance that this will
be the case. Additionally, funding for the Company's future capital requirements
to repay existing debt obligations after 1998 may require the sale of equity
and/or debt of the Company or one or more of the Operating Companies. There can
be no assurance that such financing will be available to the Company when
needed, on commercially reasonable terms, or at all. The Company is, however,
reviewing its options with respect to refinancing its existing credit and/or
vendor facilities. The Company is also reviewing various other financing
alternatives with its financial advisors.
These factors raise substantial doubt about the Company's ability to
continue as a going concern. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
The Company has granted various warrants and options to purchase the
Company's Common Stock, including those previously granted to Citizens, and has
provided certain preemptive rights to Citizens. For the term of these warrants
and options, the holders will have the opportunity to exercise and dilute the
interests of other security holders or, in the case of Citizens, acquire a
controlling interest in the Company. As long as these warrants and options
remain unexercised, and dependent upon the outcome of the Company's
disagreements with Citizens, the Company's ability to obtain additional equity
capital may be adversely affected.
Inflation and Foreign Currency
For the year ended December 31, 1997, inflation in Hungary was
approximately 18.6% on an annualized basis. It is the stated policy goal of the
Hungarian government to keep inflation from exceeding approximately 15% in 1998.
The Company's Hungarian operations generate revenues in Hungarian
Forints and incur operating and other expenses, including capital expenditures,
in Hungarian Forints, U.S. Dollars and German Deutsche Marks. The Company's
resulting foreign currency exposure cannot be practically hedged due to the
significant costs involved and the lack of a market for such hedging. In
addition, certain of the Company's balance sheet accounts are expressed in
foreign currencies other than the Hungarian Forint, the Company's functional
currency. Accordingly, when such accounts are converted into Hungarian Forints,
the Company is subject to foreign exchange gains and losses which are reflected
as a component of net income or loss. When the Company and its subsidiaries'
Forint-denominated accounts are translated into U.S. Dollars for financial
reporting purposes, the Company is subject to translation adjustments, the
effect of which is reflected in a component of stockholders' deficit.
While the Company has the ability to increase the prices it charges for
its services commensurate with increases in the Hungarian Consumer Price Index
("CPI") pursuant to its licenses from the Hungarian government, it may choose
not to implement the full amount of the increase permitted due to competitive
and other concerns. In addition, the rate of increase in the Hungarian CPI may
be less than the rate at which the Hungarian Forint devalues. As a result, the
Company may be unable to generate cash flows to the degree necessary to meet its
obligation in currencies other than the Hungarian Forint.
Year 2000
The Company recently formed a committee to begin, possibly with the
assistance of outside consultants, an evaluation of its network and computer
systems for Year 2000 compliance. The Year 2000 problem is the result of
computer programs being written using two digits rather than four to define the
applicable year. Any of the Company's programs that have time-sensitive software
may recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a major system failure or miscalculations causing disruption of
operations.
-38-
Following the Company's evaluation of its network and computer systems
for Year 2000 compliance, the Company expects to adopt a plan to mitigate the
Year 2000 Issue. While the extent and total cost of the Year 2000 modifications
and conversions has not yet been determined, the Company presently believes
that, with modifications to existing software and converting to new software,
the Year 2000 problem will not pose significant operational problems for the
Company's networks and systems as so modified and converted. However, if such
modifications and conversions are not completed timely, the Year 2000 problem
may have a material impact on the operations of the Company.
Prospective Accounting Pronouncements
Statement of Financial Accounting Standards No. 130 ("SFAS 130"),
"Reporting Comprehensive Income," and Statement of Financial Accounting
Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and
Related Information," were issued in June 1997. SFAS 130 establishes standards
for reporting and display of comprehensive income and its components in a full
set of general purpose financial statements. This statement requires that all
items that are required to be recognized under accounting standards as
components of comprehensive income, such as foreign currency fluctuations
currently reported in stockholder's equity, be reported in a financial statement
that is displayed with the same prominence as other financial statements. SFAS
131 establishes standards for the way public companies report information about
operating segments in annual financial statements and requires that these
companies report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. The Company is required to adopt both new standards in the first
quarter of 1998.
Item 8. Financial Statements and Supplementary Data
Reference is made to the Consolidated Financial Statements of the
Company, beginning with the index thereto on page F-1.
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
During the three fiscal years ended December 31, 1997, the Company was
not involved in any disagreement with its independent certified public
accountants on accounting principles or practices or on financial statement
disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant
There is incorporated in this Item 10 by reference the information
appearing under the captions "Election of Directors - Nominees for Director,"
"Executive Officers Who Are Not Directors" and "- Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's definitive proxy statement for
the 1998 Annual Meeting of Stockholders, a copy of which will be filed not later
than 120 days after the close of the fiscal year.
-39-
Item 11. Executive Compensation
There is incorporated in this Item 11 by reference the information
appearing under the caption "Election of Directors" in the Company's definitive
proxy statement for the 1998 Annual Meeting of Stockholders, a copy of which
will be filed not later than 120 days after the close of the fiscal year.
Item 12. Security Ownership of Certain Beneficial Owners and Management
There is incorporated in this Item 12 by reference the information
appearing under the captions "Introduction - Stock Ownership of Certain
Beneficial Owners," "- Stock Ownership of Management," and "- Potential Change
in Control," and "Election of Directors - Nominees for Director" in the
Company's definitive proxy statement for the 1998 Annual Meeting of
Stockholders, a copy of which will be filed not later than 120 days after the
close of the fiscal year.
Item 13. Certain Relationships And Related Transactions
There is incorporated in this Item 13 by reference the information
appearing under the caption "Election of Directors - Certain Relationships and
Related Party Transactions," and "- Indebtedness of Management" in the Company's
definitive proxy statement for the 1998 Annual Meeting of Stockholders, a copy
of which will be filed not later than 120 days after the close of the fiscal
year.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) List of Financial Statements
Reference is made to the index on page F-1 for a list of all
financial statements filed as part of this Form 10-K.
(a)(2) List of Financial Statement Schedules
Reference is made to the index on page F-1 for a list of all
financial statement schedules filed as part of this Form 10-K.
-40-
(a)(3) List of Exhibits
Exhibit
Number Description
2 Plan of acquisition, reorganization, arrangement, liquidation or succession
(None)
3(i) Certificate of Incorporation of the Registrant, as amended, filed as
Exhibit 4.1 to the Registrant's Registration Statement on Form S-8 filed on
June 24, 1997 and incorporated herein by reference
3(ii) By-laws of the Registrant, as amended, filed as Exhibit 4.2 to the
Registrant's Registration Statement on Form S-8 filed on June 24, 1997 and
incorporated herein by reference
4 Instruments defining the rights of security holders, including indentures
(None)
9 Voting trust agreement (None) 10 Material contracts: 10.1 Concession
Agreement dated May 10, 1994 between the Ministry of Transportation,
Telecommunications and Water Management of the Republic of Hungary and
Raba-Com Rt., filed as Exhibit 10(y)(y) to the Registrant's Current Report
on Form 8-K for February 28, 1994 and incorporated herein by reference 10.2
Concession Agreement dated May 10, 1994 between the Ministry of
Transportation, Telecommunications and Water Management of the Republic of
Hungary and Kelet-Nograd Com Rt., filed as Exhibit 10(z)(z) to the
Registrant's Current Report on Form 8-K for February 28, 1994 and
incorporated herein by reference 10.3 English translation of Amended and
Restated Concession Contract between Papa es Tersege Telefon Koncesszios
Rt. and the Hungarian Ministry for Transportation, Telecommunications and
Water Management dated as of June 3, 1996, filed as Exhibit 10.78 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30,
1996 and incorporated herein by reference
10.4 English translation of Amended and Restated Concession Contract between
Hungarotel Tavkozlesi Rt. and the Hungarian Ministry for Transportation,
Telecommunications and Water Management dated as of June 3, 1996
(Oroshaza), filed as Exhibit 10.79 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1996 and incorporated herein by
reference
10.5 English translation of Amended and Restated Concession Contract between
Hungarotel Tavkozlesi Rt. and the Hungarian Ministry for Transportation,
Telecommunications and Water Management dated as of June 3, 1996
(Bekescsaba), filed as Exhibit 10.80 to the Registrant's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1996 and incorporated herein by
reference
10.6 Basic Contract for Takeover of Public Telephone Service in the Bekescsaba
and Oroshaza Primary Regions dated December 30, 1995 between Hungarotel and
MATAV, filed as Exhibit 10(c)(c)(c) to the Registrant's Current Report on
Form 8-K for December 30, 1995 and incorporated herein by reference
-41-
Exhibit
Number Description
10.7 Transfer Agreement for the Transfer of Assets relating to the Local Public
Telephone Service in the Bekescsaba and Oroshaza Primary Regions dated
December 30, 1995 between Hungarotel and MATAV, filed as Exhibit
10(d)(d)(d) to the Registrant's Current Report on Form 8-K for December 30,
1995 and incorporated herein by reference
10.8 Agreement on the Continuous Employment of MATAV Employees providing public
telephone service in the Bekescsaba and Oroshaza Primary Regions dated
December 30, 1995 between Hungarotel and MATAV, filed as Exhibit
10(e)(e)(e) to the Registrant's Current Report on Form 8-K for December 30,
1995 and incorporated herein by reference
10.9 Agreement on the Taking Over of Public Telecommunication Service in the
Bekescsaba and Oroshaza Primary Regions dated December 30, 1995 between
Hungarotel and MATAV, filed as Exhibit 10(f)(f)(f) to the Registrant's
Current Report on Form 8-K for December 30, 1995 and incorporated herein by
reference
10.10 Agreement on the Regulation of Rights and Obligations from Pending
Contracts concerning the Public Telephone Service in the Bekescsaba and
Oroshaza Primary Regions dated December 30, 1995 between Hungarotel and
MATAV, filed as Exhibit 10(g)(g)(g) to the Registrant's Current Report on
Form 8-K for December 30, 1995 and incorporated herein by reference
10.11 Network Agreement dated December 30, 1995 between Hungarotel and MATAV,
filed as Exhibit 10(h)(h)(h) to the Registrant's Current Report on Form 8-K
for December 30, 1995 and incorporated herein by reference
10.12 Basic Contract for Taking Over of Public Telephone Service in the Papa
Primary Region dated December 30, 1995 between Papatel and MATAV, filed as
Exhibit 10(l)(l)(l) to the Registrant's Current Report on Form 8-K for
December 30, 1995 and incorporated herein by reference
10.13 Transfer Agreement for the Transfer of Assets relating to the Local Public
Telephone Services in the Papa Primary Region dated December 30, 1995
between Papatel and MATAV, filed as Exhibit 10(m)(m)(m) to the Registrant's
Current Report on Form 8-K for December 30, 1995 and incorporated herein by
reference
10.14 Agreement on the Continuous Employment of MATAV Employees providing public
telephone service in the Papa Primary Region dated December 30, 1995
between Papatel and MATAV, filed as Exhibit 10(n)(n)(n) to the Registrant's
Current Report on Form 8-K for December 30, 1995 and incorporated herein by
reference
10.15 Agreement on the Taking Over of Public Telecommunication Services in the
Papa Primary Region dated December 30, 1995 between Papatel and MATAV,
filed as Exhibit 10(o)(o)(o) to the Registrant's Current Report on Form 8-K
for December 30, 1995 and incorporated herein by reference
-42-
Exhibit
Number Description
10.16 Agreement on the Regulation of Rights and Obligations from Pending
Contracts concerning the Public Telephone Service in the Papa Primary
Region dated December 30, 1995 between Papatel and MATAV, filed as Exhibit
10(p)(p)(p) to the Registrant's Current Report on Form 8-K for December 30,
1995 and incorporated herein by reference
10.17 Network Agreement dated December 30, 1995 between Papatel and MATAV, filed
as Exhibit 10(q)(q)(q) to the Registrant's Current Report on Form 8-K for
December 30, 1995 and incorporated herein by reference
10.18 English translation of Construction Contract between Papa es Tersege
Telefon Koncesszios Rt. and Fazis Telecommunications System Design and
Construction Corporation dated May 10, 1996, filed as Exhibit 10.74 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30,
1996 and incorporated herein by reference
10.19 English translation of Construction Contract between Hungarotel Tavkozlesi
Rt. and Ericsson Kft. dated May 17, 1996. (as amended), filed as Exhibit
10.75 to the Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1996 and incorporated herein by reference
10.20 English translation of Construction Contract between Papa es Tersege
Telefon Koncesszios Rt. and Ericsson Kft. dated May 31, 1996, filed as
Exhibit 10.76 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1996 and incorporated herein by reference
10.21 English translation of Construction Contract between Hungarotel Tavkozlesi
Rt. and Fazis Telecommunications System Design and Construction Corporation
dated June 28, 1996, filed as Exhibit 10.77 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1996 and incorporated
herein by reference
10.22 Non-Employee Director Stock Option Plan dated as of February 6, 1997,
filed as Exhibit 10.91 to the Registrant's Form 10-K for the fiscal year
ending December 31, 1996 and incorporated herein by reference
10.23 1992 Incentive Stock Option Plan of the Registrant, as amended, filed as
Exhibit 4.3 to the Registrant's Registration Statement on Form S-8 filed on
June 24, 1997 and incorporated herein by reference
10.24 Stock Option Agreement between the Registrant and James G. Morrison dated
as of March 13, 1997, filed as Exhibit 10.93 to the Registrant's Form 10-K
for the fiscal year ending December 31, 1996 and incorporated herein by
reference
10.25 Stock Option Agreement between the Registrant and Andrew E. Nicholson
dated as of March 13, 1997, filed as Exhibit 10.94 to the Registrant's Form
10-K for the fiscal year ending December 31, 1996 and incorporated herein
by reference
10.26 Stock Option Agreement between the Registrant and Daniel R. Vaughn dated
as of March 13, 1997, filed as Exhibit 10.95 to Registrant's Form 10-K for
the fiscal year ending December 31, 1996 and incorporated herein by
reference
-43-
Exhibit
Number Description
10.27 Employment Agreement dated September 12, 1995 between the Registrant and
Robert Genova, filed as Exhibit 4.5 to the Registrant's Registration
Statement on Form S-8 filed on June 24, 1997 and incorporated herein by
reference
10.28 Employment Agreement dated September 12, 1995 between the Registrant and
Frank R. Cohen, filed as Exhibit 4.6 to the Registrant's Registration
Statement on Form S-8 filed on June 24, 1997 and incorporated herein by
reference
10.29 Termination and Release Agreement dated as of July 26, 1996 between the
Registrant and Robert Genova, filed as Exhibit 10.62 to the Registrant's
Current Report on Form 8-K for July 26, 1996 and incorporated herein by
reference
10.30 Consulting Agreement dated as of July 26, 1996 between the Registrant and
Robert Genova, filed as Exhibit 10.63 to the Registrant's Current Report on
Form 8-K for July 26, 1996 and incorporated herein by reference
10.31 Noncompetition Agreement dated as of July 26, 1996 between the Registrant
and Robert Genova, filed as Exhibit 10.64 to the Registrant's Current
Report on Form 8-K for July 26, 1996 and incorporated herein by reference
10.32 Irrevocable Proxy dated July 26, 1996 executed by Robert Genova appointing
Hungarian Telephone and Cable Corp. as his proxy, filed as Exhibit 10.65 to
the Registrant's Current Report on Form 8-K for July 26, 1996 and
incorporated herein by reference
10.33 Termination and Release Agreement dated as of July 26, 1996 between the
Registrant and Frank R. Cohen, filed as Exhibit 10.66 to the Registrant's
Current Report on Form 8-K for July 26, 1996 and incorporated herein by
reference
10.34 Consulting Agreement dated as of July 26, 1996 between the Registrant and
Frank R. Cohen, filed as Exhibit 10.67 to the Registrant's Current Report
on Form 8-K for July 26, 1996 and incorporated herein by reference
10.35 Noncompetition Agreement dated as of July 26, 1996 between the Registrant
and Frank R. Cohen, filed as Exhibit 10.68 to the Registrant's Current
Report on Form 8-K for July 26, 1996 and incorporated herein by reference
10.36 Irrevocable Proxy dated July 26, 1996 executed by Frank R. Cohen
appointing Hungarian Telephone and Cable Corp. as his proxy, filed as
Exhibit 10.69 to the Registrant's Current Report on Form 8-K for July 26,
1996 and incorporated herein by reference
10.37 Termination and Release Agreement dated as of July 26, 1996 between the
Registrant and Donald K. Roberton, filed as Exhibit 10.70 to the
Registrant's Current Report on Form 8-K for July 26, 1996 and incorporated
herein by reference
10.38 Consulting Agreement dated as of July 26, 1996 between the Registrant and
Donald K. Roberton, filed as Exhibit 10.71 to the Registrant's Current
Report on Form 8-K for July 26, 1996 and incorporated herein by reference
-44-
Exhibit
Number Description
10.39 Noncompetition Agreement dated as of July 26, 1996 between the Registrant
and Donald K. Roberton, filed as Exhibit 10.72 to the Registrant's Current
Report on Form 8-K for July 26, 1996 and incorporated herein by reference
10.40 Irrevocable Proxy dated July 26, 1996 executed by Donald K. Roberton
appointing Hungarian Telephone and Cable Corp. as his proxy, filed as
Exhibit 10.73 to the Registrant's Current Report on Form 8-K for July 26,
1996 and incorporated herein by reference
10.41 Amended and Restated Employment Agreement dated as of October 17, 1996
between the Registrant and James G. Morrison, filed as Exhibit 10.81 to the
Registrant's Registration Statement on Form S-8 filed on October 18, 1996
and incorporated herein by reference
10.42 Amended and Restated Employment Agreement dated as of October 17, 1996
between the Registrant and Andrew E. Nicholson, filed as Exhibit 10.82 to
the Registrant's Registration Statement on Form S-8 filed on October 18,
1996 and incorporated herein by reference
10.43 Amended and Restated Employment Agreement dated as of October 17, 1996
between the Registrant and Daniel R. Vaughn, filed as Exhibit 10.83 to the
Registrant's Registration Statement on Form S-8 filed on October 18, 1996
and incorporated herein by reference
10.44 Amended and Restated Employment Agreement Between the Registrant and
Richard P. Halka dated as of January 9, 1997, filed as Exhibit 10.92 to the
Registrant's Form 10-K for the fiscal year ending December 31, 1996 and
incorporated herein by reference
10.45 Stock Purchase Agreement, dated as of August 31, 1995, between the
Registrant, Alcatel Austria AG, US Telecom East, Inc., and Central Euro
Telekom, Inc., filed as Exhibit 10(o)(o) to the Registrant's Current Report
on Form 8-K for August 31, 1995 and incorporated herein by reference
10.46 Stock Purchase Agreement dated as of July 1, 1997 between the Registrant
and Tele Danmark A/S, filed as Exhibit 10.96 to the Registrant's Current
Report on Form 8-K for July 1, 1997 and incorporated herein by reference
10.47 Stock Purchase Agreement dated as of September 30, 1997 between the
Registrant and Tele Danmark A/S filed as Exhibit 10.97 to the Registrant's
Current Report on Form 8-K for September 30, 1997 and incorporated herein
by reference
10.48 Exchange Agreement dated as of September 30, 1997 between the Registrant
and Tele Danmark A/S, filed as Exhibit 10.98 to the Registrant's Current
Report on Form 8-K for September 30, 1997 and incorporated herein by
reference
10.49 Secured Term Loan Credit Facility between the Registrant and Citicorp
North America, Inc. et al. dated as of March 29, 1996, filed as Exhibit
10.60 to the Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1996 and incorporated herein by reference
-45-
Exhibit
Number Description
10.50 Pledge and Security Agreement dated as of March 29, 1996 between the
Registrant, HTCC Consulting Rt., and Citicorp North America, Inc. et al
dated as of March 29, 1996, filed as Exhibit 10.61 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1996 and
incorporated herein by reference
10.51 Multi-Currency Credit Facility among Postabank Rt., as Lender, the
Registrant, as Guarantor, HTCC Consulting Rt., Hungarotel Tavkozlesi Rt.,
Kelet-Nograd Com Rt. and Papa es Tersege Telefon Koncesszios Rt. and Raba
Com Rt., as Borrowers entered into as of October 15, 1996, filed as Exhibit
10.84 to the Registrant's Current Report on Form 8-K for October 15, 1996
and incorporated herein by reference
10.52 Form of Loan Agreement entered into as of October 15, 1996 among Postabank
Rt., as Lender, the Registrant, as Guarantor, and each of certain
subsidiaries, as Borrowers, filed as Exhibit 10.85 to the Registrant's
Current Report on Form 8-K for October 15, 1996 and incorporated herein by
reference
10.53 Form of Mortgage and Pledge Agreement Securing Bank Loan entered into as
of October 15, 1996 between Postabank Rt. and each of certain subsidiaries,
filed as Exhibit 10.86 to the Registrant's Current Report on Form 8-K for
October 15, 1996 and incorporated herein by reference
10.54 Form of Security Agreement entered into as of October 15, 1996 among
Postabank Rt., as the secured party, ABN AMRO Rt., as the Escrow Agent, and
the Registrant and HTCC Consulting Rt., as the pledgors, filed as Exhibit
10.87 to the Registrant's Current Report on Form 8-K for October 15, 1996
and incorporated herein by reference
10.55 Master Agreement, dated May 31, 1995, between the Registrant and CU
CapitalCorp., filed as Exhibit 10(a)(a) to the Registrant's Current Report
on Form 8-K for May 31, 1995 and incorporated herein by reference
10.56 Agreement to Amend and Restate, dated September 28, 1995, between the
Registrant and CU CapitalCorp., filed as Exhibit 10(p)(p) to the
Registrant's Current Report on Form 8-K for September 28, 1995 and
incorporated herein by reference
10.57 Second Agreement to Amend and Restate, dated October 30, 1995, between the
Registrant and CU CapitalCorp., filed as Exhibit 10(t)(t) to the
Registrant's Current Report on Form 8-K for October 30, 1995 and
incorporated herein by reference
10.58 Third Agreement to Amend and Restate, dated February 26, 1996, between the
Registrant and CU CapitalCorp., filed as Exhibit 10(t)(t)(t) to the
Registrant's Current Report on Form 8-K for February 26, 1996 and
incorporated herein by reference
10.59 Management Services Agreement, dated May 31, 1995, between the Registrant
and Citizens International Management Services Company, filed as Exhibit
10(g)(g) to the Registrant's Current Report on Form 8-K for May 31, 1995
and incorporated herein by reference
10.60 First Amendment to Management Services Agreement, dated September 28,
1995, between the Registrant and Citizens International Management Services
Company, filed as Exhibit 10(s)(s) to the Registrant's Current Report on
Form 8-K for September 28, 1995 and incorporated herein by reference
-46-
Exhibit
Number Description
10.61 Second Amendment to the Management Services Agreement, dated February 26,
1996, between the Registrant and Citizens International Management Services
Company, filed as Exhibit 10(x)(x)(x) to the Registrant's Current Report on
Form 8-K for February 26, 1996 and incorporated herein by reference
10.62 Stock Option Agreement, dated May 31, 1995, between the Registrant and CU
CapitalCorp., filed as Exhibit 10(e)(e) to the Registrant's Current Report
on Form 8-K for May 31, 1995 and incorporated herein by reference
10.63 First Amendment to Stock Option Agreement between the Registrant and CU
CapitalCorp. dated as of October 18, 1996, filed as Exhibit 10.89 to the
Registrant's Current Report on Form 8-K for October 15, 1996 and
incorporated herein by reference
10.64 Second Stock Option Agreement, dated September 28, 1995, between the
Registrant and CU CapitalCorp., filed as Exhibit 10(r)(r) to the
Registrant's Current Report on Form 8-K for September 28, 1995 and
incorporated herein by reference
10.65 Third Stock Option between the Registrant and CU CapitalCorp dated as of
October 18, 1996, filed as Exhibit 10.90 to the Registrant's Current Report
on Form 8-K for October 15, 1996 and incorporated herein by reference
10.66 Warrant, dated May 31, 1995, granted by the Registrant to CU CapitalCorp.,
filed as Exhibit 10(c)(c) to the Registrant's Current Report on Form 8-K
for May 31, 1995 and incorporated herein by reference
10.67 First Amendment to Warrant between the Registrant and CU CapitalCorp.
dated as of October 18,1996, filed as Exhibit 10.88 to the Registrant's
Current Report on Form 8-K for October 15, 1996 and incorporated herein by
reference
10.68 Registration Agreement, dated May 31, 1995, between the Registrant and CU
CapitalCorp., filed as Exhibit 10(f)(f) to the Registrant's Current Report
on Form 8-K for May 31, 1995 and incorporated herein by reference
11 Statement re computation of per share earnings (not required)
12 Statement re computation of ratios (not required)
13 Annual report to security holders (not required)
16 Letter re change in certifying accountant, filed as Exhibit 1 to the
Registrant's Current Report on Form 8-K for June 16, 1995 and incorporated
herein by reference
18 Letter re change in accounting principles (None)
21 Subsidiaries of the Registrant
22 Published report regarding matters submitted to vote of security holders
(not required)
-47-
Exhibit
Number Description
23 Consents of experts and counsel (not required)
24 Power of Attorney (not required)
27.1 Financial Data Schedule
99.1 Cautionary Statements Regarding "Safe Harbor" Provisions of the Private
Securities Litigation Reform Act of 1995, filed as Exhibit 99.6 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31,
1997 and incorporated herein by reference.
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 26, 1998.
HUNGARIAN TELEPHONE AND CABLE CORP.
(Registrant)
By /s/Francis J. Busacca, Jr.
Francis J. Busacca, Jr.
Chief Financial Officer/Principal Accounting Officer
Pursuant to the requirements of the Securities Exchange of 1934, this
Report has been signed below by the following persons and on behalf of the
Registrant and in the capacities indicated as of March 26, 1998.
Signature/Name Title
/s/James G. Morrison President and Chief Executive Officer
James G. Morrison Director (Principal Executive Officer)
/s/Francis J. Busacca, Jr. Executive Vice President - Chief Financial Officer
Francis J. Busacca, Jr. (Principal Financial Officer)
-48-
/s/Ole Bertram Director
Ole Bertram
/s/David A. Finley Director, Chairman of the Board
David A. Finley
/s/John B. Ryan Director
John B. Ryan
/s/Finn Schkolnik Director
Finn Schkolnik
/s/James H. Season Director
James H. Season
Director
Ronald E. Spears
/s/William E. Starkey Director
William E. Starkey
Director
Leonard Tow
-49-
HUNGARIAN TELEPHONE AND CABLE CORP.
Index to Consolidated Financial Statements
The following information is included on the pages indicated:
Consolidated Financial Statements:
Page
Independent Auditor's Report F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Stockholders' (Deficit) Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7 to F-31
Financial Statement Schedules:
All financial statement schedules are omitted as the required information
is not applicable or the information is presented in the consolidated financial
statements or related notes.
F-1
Independent Auditors' Report
The Board of Directors and Stockholders
Hungarian Telephone and Cable Corp.
We have audited the accompanying consolidated balance sheets of Hungarian
Telephone and Cable Corp. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of operations, stockholders' deficit and
cash flows for each of the years in the three-year period ended December 31,
1997. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hungarian Telephone
and Cable Corp. and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997, in conformity with generally accepted
accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in note 1 to the
consolidated financial statements, the Company has suffered recurring losses
from operations, has a net capital deficiency and a working capital deficiency,
and may not be able to satisfy its current obligations as they come due unless
restructured. These factors raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are also described in note 1. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
KPMG PEAT MARWICK LLP
New York, New York
March 26, 1998
F-2
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1997 and 1996
(In thousands, except share data)
Assets 1997 1996
Current assets:
Cash $ 4,031 15,876
Restricted cash 536 6,092
Accounts receivable, net of allowance
of $540 in 1997 and $123 in 1996 9,437 4,575
VAT receivable, net 2,641 5,377
Inventories 1,231 682
Prepayments and other current assets 2,146 1,346
----- -----
Total current assets 20,022 33,948
Property, plant and equipment, net 138,885 82,012
Goodwill, net of accumulated amortization
of $1,011 in 1997 and $631 in 1996 11,299 9,245
Other intangibles, net of accumulated amortization
of $670 in 1997 and $547 in 1996 6,168 8,129
Other assets 9,533 11,497
Construction deposits 578 11,784
------ ------
Total assets $ 186,485 156,615
=========== =======
Liabilities and Stockholders' Deficit
Current liabilities:
Current installments of long-term debt $ 7,489 120
Accounts payable 7,996 17,777
Advance subscriber payments 351 3,202
Due to related parties 7,932 2,934
Accruals 4,364 1,748
Other current liabilities 689 1,952
--- -----
Total current liabilities 28,821 27,733
Long-term debt, excluding current installments 194,537 148,472
Due to related parties 3,476 4,200
Deferred revenue 1,488
----- -----
Total liabilities 228,322 180,405
======= =======
Stockholders' deficit:
Common stock, $.001 par value. Authorized
25,000,000 shares; issued 5,235,370 shares
in 1997 and 4,179,626 in 1996 5 4
Additional paid-in capital 70,772 59,327
Accumulated deficit (117,197) (80,961)
Foreign currency translation adjustment 4,964 (1,494)
Deferred compensation (381) (666)
---- ----
Total stockholders' deficit (41,837) (23,790)
------- -------
Total liabilities and stockholders' deficit $ 186,485 156,615
=========== =======
See accompanying notes to consolidated financial statements. The Company ceased
to be a development stage company on April 1, 1995.
F-3
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1997, 1996 and 1995
(In thousands, except share and per share data)
1997 1996 1995
TELEPHONE SERVICES REVENUES, NET $ 37,891 20,910 4,070
------------ ------ -----
Operating expenses:
Operating and maintenance expenses 25,044 22,011 14,948
Depreciation and amortization 8,349 4,270 2,211
Management fees 5,761 6,917 4,178
Asset write-downs 2,005 562
Termination of former officers and directors 6,260
------ ------ ------
Total Operating Expenses 39,154 41,463 21,899
------ ------ ------
LOSS FROM OPERATIONS (1,263) (20,553) (17,829)
Other income (expenses):
Foreign exchange losses (517) (6,278) (4,090)
Interest expense (35,159) (23,240) (1,672)
Interest income 690 1,488 981
Cost of abandoned financing (2,985)
Other, net 13 1,123 (252)
----- ----- ----
LOSS BEFORE MINORITY INTEREST (36,236) (50,445) (22,862)
MINORITY INTEREST 2,994 2,838
------ ------ -----
LOSS BEFORE EXTRAORDINARY ITEM (36,236) (47,451) (20,024)
EXTRAORDINARY ITEM, NET (7,318)
------ ------ ------
NET LOSS $ (36,236) (54,769) (20,024)
============ ======= =======
NET LOSS PER COMMON SHARE - BASIC:
BEFORE EXTRAORDINARY ITEM $ (7.97) (11.38) (6.30)
EXTRAORDINARY ITEM $ (1.76)
------ ------ ------
NET LOSS $ (7.97) (13.14) (6.30)
=========== ====== =====
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING 4,546,163 4,169,532 3,177,801
See accompanying notes to consolidated financial statements. The Company ceased
to be a development stage company on April 1, 1995.
F-4
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' (Deficit) Equity Years
ended December 31, 1997, 1996 and 1995
(In thousands, except share data)
Foreign
Additional Currency Total
Common Paid-in Accumulated Translation Deferred Stockholders
Shares Stock Capital Deficit Adjustment Compensation Equity
- --------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1994 2,704,683 $ 3 20,600 (6,168) 0 (1,872) $ 12,563
Exercise of warrants 55,025 284 284
Private placement costs (37) (37)
Common stock issuances 252,908 3,476 3,476
Options issued as consideration
for financial support 3,481 3,481
Exercise of options 328,494 2,012 2,012
Compensation related to stock options 4,493 1,872 6,365
Common stock granted to employees 102,500 1,050 (1,050) 0
Common stock issued for acquisitions 571,429 1 9,999 10,000
Foreign currency translation adjustment (2,381) (2,381)
Net loss (20,024) (20,024)
- --------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1995 4,015,039 $ 4 45,358 (26,192) (2,381) (1,050) $ 15,739
Common stock issuance 250,000 3,219 3,219
Exercise of options and warrants 8,016 81 81
Cancellation of shares (101,429) (1,775) (1,775)
Options granted in connection
with termination agreement 1,125 1,125
Options issued and extended as
consideration for financial support 11,218 11,218
Shares issued as compensation 8,000 101 101
Earned compensation 384 384
Foreign currency translation adjustment 887 887
Net loss (54,769) (54,769)
- --------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 4,179,626 $ 4 59,327 (80,961) (1,494) (666) $(23,790)
Exercise of options and warrants 81,586 635 635
Shares issued as compensation 5,000 52 52
Options issued to officers 70 70
Shares issued to Tele Danmark A/S 969,158 1 10,688 10,689
Earned compensation 285 285
Foreign currency translation adjustment 6,458 6,458
Net loss (36,236) (36,236)
- --------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 5,235,370 $ 5 70,772 (117,197) 4,964 (381) $(41,837)
See accompanying notes to consolidated financial statements. The Company ceased
to be a development stage company on April 1, 1995.
F-5
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1997, 1996 and 1995
(In thousands)
1997 1996 1995
Net cash provided by (used in) operating activities $ 4,937 (35,841) (466)
------------ ------- ----
Cash flows from investing activities:
Acquisition and construction of
telecommunications networks (83,055) (49,086) (41,921)
Decrease (increase) in construction deposits 9,780 (7,466) (4,313)
Acquisition of concession rights (7,119)
Cash received from sale of subsidiaries stock 1,464
Acquisition of interests in subsidiaries (330) (1,293)
Proceeds from sale of assets 336
Sale (acquisition) of interests in affiliates 130
------- ------ ------
Net cash used in investing activities (73,275) (56,416) (53,182)
------- ------- -------
Cash flows from financing activities:
Borrowings under long-term debt 72,064 132,307 31,694
Proceeds from short-term loans 108,729 31,956
Proceeds from exercise of options and warrants 635 81 2,296
Repayment of long-term debt (14,326) (9,026) (1,582)
Repayment of short-term loans (142,607)
Other (300) (37)
------ ------ ------
Net cash provided by financing activities 58,373 89,184 64,327
------ ------ ------
Effect of foreign exchange rate changes on cash (1,880) 2,757 (1,453)
------ ----- ------
Net (decrease) increase in cash (11,845) (316) 9,226
Cash at beginning of year 15,876 16,192 6,966
------ ------ -----
Cash at end of year $ 4,031 15,876 16,192
============ ====== ======
See accompanying notes to consolidated financial statements. The Company ceased
to be a development stage company on April 1, 1995.
F-6
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1997, 1996 and 1995
(1) Description of Business and Summary of Significant Accounting Policies
(a) Description of Business and Liquidity
Hungarian Telephone and Cable Corp. ("HTCC") was organized on
March 23, 1992 to own and manage telecommunications companies in
Hungary. Four subsidiaries of the Company are presently engaged in
the ownership, construction and operation of public switched
telephone service. HTCC and its subsidiaries (together, the
"Company") was in the development stage through March 31, 1995.
The Company, through two of its subsidiaries, commenced operations
in two concession regions in 1995 and through two other
subsidiaries, commenced operations in three additional concession
areas effective January 1, 1996. Accordingly, the Company devoted
substantially all of its efforts through 1994 and a considerable
portion of 1995 to obtaining concession rights, negotiating
acquisitions, raising capital in the form of debt and equity,
attracting and creating its management team and preparing to
commence operations. As a result, the Company recognized no
revenues until 1995.
The Company and Citizens (as hereinafter defined) presently have a
disagreement regarding certain issues with respect to the
Management Services Agreement with Citizens. As of December 31,
1997, the Company has accrued as a current liability, but not
paid, $7.2 million pursuant to the Management Services Agreement.
The Company currently intends to withhold any payments to Citizens
with respect to the Management Services Agreement until such time
as these issues are resolved. The Company is currently in
discussions with Citizens in an attempt to resolve these issues.
The Company and Citizens also have a disagreement regarding
certain issues with respect to 1.9 million shares of Common Stock
subject to Citizens' preemptive rights to date. The Company is
also currently in discussions with Citizens in an attempt to
resolve these issues.
To date, the Company's activities have involved the acquisition of
the concessions and telecommunications networks from MATAV and the
subsequent design, development and construction of the modern
telecommunications infrastructure that the Company now has in
service. The Company has suffered from recurring losses from
operations and has a working capital deficiency and a net capital
deficiency. The Company is dependent on its ability to generate
cash from operations, raise capital in the form of debt or equity,
or refinance or otherwise resolve its existing obligations,
including those related to the Management Services Agreement with
Citizens. The ability of the Company to generate sufficient
revenues to satisfy cash requirements and become profitable will
depend upon a number of factors, including the Company's ability
to attract additional customers and revenues per customer. These
factors are expected to be primarily influenced by the success of
the Company's operating and marketing strategies as well as market
acceptance of the Company's services.
Through December 31, 1997, the Company was in the construction
phase of its development. The Company paid the Ministry $11.5
million (at historical exchange rates) for its concessions, spent
approximately $23.2 million (at historical exchange rates) to
acquire the existing telecommunications assets in its Operating
Areas from MATAV, and spent $155 million (at historical exchange
rates) to complete its network modernization and construction
program.
F-7
With the construction phase of its development complete, the
Company intends to transform itself from a construction driven
organization to a marketing driven operationally efficient
organization in 1998.
The Company believes it will be able to meet its obligations as
they become due during 1998, provided it is not required to settle
the accrued liability to Citizens in cash, however, there can be
no assurance that this will be the case. Additionally, funding for
the Company's future capital requirements to repay existing debt
obligations after 1998 may require the sale of equity and/or debt
of the Company or one or more of the Operating Companies. There
can be no assurance that such financing will be available to the
Company when needed, on commercially reasonable terms, or at all.
The Company is, however, reviewing its options with respect to
refinancing its existing credit and/or vendor facilities. The
Company is also reviewing various other financing alternatives
with its financial advisors.
These factors raise substantial doubt about the Company's ability
to continue as a going concern. The consolidated financial
statements do not include any adjustments that might result from
the outcome of this uncertainty.
(b) Principles of Consolidation and the Use of Estimates
The consolidated financial statements include the financial
statements of the Company and its majority owned subsidiaries;
Kelet-Nograd Com Rt. ("KNC"), Raba-Com Rt. ("Raba-Com"),
Hungarotel Tavkozlesi Rt. ("Hungarotel"), Papa es Tersege Telefon
Koncesszios Rt. ("Papatel"), HTCC Consulting Rt. ("HTCC
Consulting"), Pilistav Rt. ("Pilistav"), and Telebud (CI) Ltd.
(KNC, Raba-Com, Hungarotel and Papatel are each individually
referred to as an "Operating Company", and together, the
"Operating Companies"). All material intercompany balances and
transactions have been eliminated. Investments in affiliates
representing less than 50% ownership, and in which the Company
exercises significant influence, are accounted for using the
equity method.
The consolidated financial statements are prepared in accordance
with U.S. generally accepted accounting principles (U.S. GAAP). In
preparing financial statements in conformity with U.S. GAAP,
management is required to make estimates and assumptions that
affect reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the
financial statements and revenue and expenses during the reporting
period. Actual results could differ from those estimates.
(c) Foreign Currency Translation
The statutory accounts of the Company's consolidated subsidiaries
and affiliates are maintained in accordance with local accounting
regulations and are stated in local currencies. Local statements
are adjusted to U.S. GAAP and then translated into U.S. dollars in
accordance with Statement of Financial Accounting Standards No.
52, "Accounting for Foreign Currency Translation" ("SFAS 52").
F-8
Since commencement of revenue generating activities, the Company
has used the Hungarian Forint ("HUF") as the functional currency
for its majority owned Hungarian subsidiaries. Accordingly,
foreign currency assets and liabilities are translated using the
exchange rates in effect at the balance sheet date. Results of
operations are generally translated using the average exchange
rates prevailing throughout the year. The effects of exchange rate
fluctuations on translating foreign currency assets and
liabilities into U.S. dollars are accumulated as part of the
foreign currency translation adjustment in stockholders' equity.
Foreign exchange fluctuations related to intercompany balances are
included in equity if such balances are intended to be long-term
in nature. At the time the Company settles such balances, the
resulting gain or loss is reflected in the consolidated statement
of operations. Gains and losses from foreign currency transactions
are included in net loss in the period in which they occur.
(d) Cash Equivalents
For the purposes of the consolidated statements of cash flows, the
Company considers all highly liquid debt instruments purchased
with a maturity of three months or less to be cash equivalents.
(e) Inventories
Inventories consist primarily of telephones and spare parts and
are stated at the lower of cost or market.
(f) Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is
computed using the straight-line method over the estimated useful
lives of the respective assets.
(g) Intangible Assets
Intangible assets are comprised of concession fees paid and the
excess of cost over net assets acquired. The concession fees are
being amortized over the 25-year concession period using the
straight-line method. Excess of cost over net assets acquired is
also amortized over 25 years using the straight-line method.
(h) Revenue Recognition
Telephone service revenues are recognized when earned and are
primarily derived from usage of the Company's local exchange
networks and facilities or under revenue sharing agreements with
the former state controlled monopoly telephone company, Magyar
Tavkozlesi Rt. ("MATAV"), the international and national long
distance interconnect service provider.
Advance subscriber payments represent advance connection fees
received from telephone subscribers and are recognized as income
when the subscriber is connected to the telephone network. Advance
fees received are required to be repaid with interest if the
subscriber is not connected to the local telephone network.
F-9
(i) Stock Based Compensation
Prior to January 1, 1996, the Company accounted for its stock
option plan in accordance with the provisions of Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees", and related interpretations. As such,
compensation expense would be recorded on the date of grant only
if the current market price of the underlying stock exceeded the
exercise price. On January 1, 1996, the Company adopted SFAS No.
123, "Accounting for Stock-Based Compensation", which permits
entities to recognize as expense over the vesting period the fair
value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to
apply the provisions of APB Opinion No. 25 and provide pro forma
net income and pro forma earnings per share disclosures for
employee stock option grants made in 1995 and future years as if
the fair-value-based method defined in SFAS No. 123 had been
applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma
disclosure provisions of SFAS No. 123.
Deferred compensation represents the value of Common Stock granted
to employees and is being amortized over the vesting periods of
the related awards.
(j) Income Taxes
Deferred tax assets and liabilities, net of appropriate valuation
allowances, are recognized for the future tax consequences
attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit
carry-forwards. Deferred tax assets and liabilities, if any, are
measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
The Company's Hungarian operating subsidiaries are 100% exempt
from Hungarian income tax for a period of five years beginning
from January 1, 1994 and 60% exempt for the subsequent five years
as long as (1) capitalization stays above 50,000,000 HUF
(approximately $245,000 at December 31, 1997 exchange rates), (2)
foreign ownership exceeds 30% of the registered capital, and (3)
more than 50% of the revenue earned arises from telecommunication
services.
(k) Net Loss Per Share
The Company adopted the provisions of Statement of Financial
Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"),
for year-end 1997. SFAS 128, which supersedes APB Opinion No. 15,
"Earnings Per Share" was issued in February 1997. SFAS 128
requires dual presentation of basic and diluted earnings per share
("EPS") for complex capital structures on the face of the
statement of operations. Basic EPS is computed by dividing income
or loss by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential
dilution from the exercise or conversion of securities into common
stock. Per share amounts for 1996 and 1995 have been retroactively
restated to give effect to SFAS 128 and were not different from
EPS measured under APB No. 15.
Net loss and weighted average shares outstanding used for
computing diluted loss per common share were the same as that used
for computing basic loss per common share for each of the years
ended December 31, 1997, 1996 and 1995.
F-10
The Company had potentially dilutive common stock equivalents of
7,200,859, 5,627,775 and 4,516,597 for the years ended December
31, 1997, 1996 and 1995, respectively, which were not included in
the computation of diluted net loss per common share because they
were antidilutive for the periods presented.
(l) Impairment of Long-Lived Assets and Long-Lived Assets to Be
Disposed Of
The Company adopted the provisions of SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of" on January 1, 1996. This Statement requires
that long-lived assets and certain identifiable intangibles be
reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used
is measured by a comparison of the carrying amount of an asset to
undiscounted future cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which
the carrying amount of the assets exceed the fair value of the
assets. Assets to be disposed of are reported at the lower of the
carrying amount or fair value less anticipated selling costs.
Adoption of this statement has not had a material impact on the
Company's financial position, results of operations, or
liquidity.
(2) Acquisitions
On January 1, 1995, subject to Concession Agreements (see note 9(a)), the
Company acquired certain operating plant and equipment from MATAV related
to the concession area to which Raba-Com has the rights. The purchase
price for the Raba-Com concession area assets was approximately HUF
75,131,000 (approximately $665,000 at January 1, 1995 exchange rates).
On February 28, 1995, subject to the Concession Agreements, the Company
acquired certain operating plant and equipment from MATAV related to the
concession area to which KNC has the rights. The purchase price for the
KNC concession area assets was HUF 548,450,000 (approximately $4.6
million at February 28, 1995 exchange rates).
On August 31, 1995, the Company acquired 45.12% of the outstanding Common
Stock and voting rights to an additional 6% of the outstanding Common
Stock of Papatel and 65% of the outstanding Common Stock and the right to
acquire a further 20% of Hungarotel from Alcatel Austria AG, US Telecom
East, Inc. and Central Euro TeleKom, Inc. ("CET") for 571,429 shares of
its Common Stock (subject to reduction based upon certain post-closing
purchase price adjustments). The value of the Common Stock issued in the
exchange was $10,000,000, however, pending resolution of the potential
post-closing adjustments, the Common Stock was not delivered. In
September 1995, the Company entered into agreements with MATAV to acquire
25.01% of the outstanding Common Stock of Papatel for $925,000, and
Microsystem Telecom Rt. and V.P. Consulting Kft. to acquire 9.19% of the
Common Stock and dividend rights to another 6% of the Common Stock of
Papatel for a purchase price of $300,000. These acquisitions resulted in
a total purchase price of $11,225,000 for 79.24% of Papatel and 65% of
Hungarotel.
On March 13, 1996, the Company acquired the remaining 35% of Hungarotel
for $330,000 in cash. As a result, the Company has adjusted the minority
interest and intangible assets acquired.
F-11
On May 21, 1996, the Company and CET entered into a Settlement Agreement
whereby the number of shares to be issued to CET in connection with the
acquisition of Hungarotel and Papatel was reduced based upon certain
post-closing purchase price adjustments. Pursuant to the Settlement
Agreement, the number of shares was reduced by 101,429. The reduction in
purchase price of approximately $1.8 million was reflected as a reduction
of goodwill and a reduction of Common Stock and additional paid-in
capital. Additionally, in May 1996, Papatel entered into a settlement
agreement with a contractor for pre-acquisition claims for approximately
$0.7 million more than the amount recorded at acquisition. The Company
recorded this excess as an increase in goodwill.
Contingent consideration for the acquisition of Hungarotel and Papatel in
the form of Common Stock is payable in the event that the average trading
price for the Company's Common Stock during the twenty (20) trading days
preceding August 31, 1998 is less than $17.50 per share. The maximum
number of additional shares issuable is currently 18,469.
The acquisition of the Common Stock of Hungarotel and Papatel has been
accounted for using the purchase method of accounting, and, accordingly,
the adjusted purchase price has been allocated to the assets purchased
and the liabilities assumed based upon the fair values at the date of
acquisition.
The net purchase price for the acquisitions of Hungarotel and Papatel, as
adjusted, was allocated as follows:
(in thousands)
Property, plant and equipment $ 5,046
Other assets 2,766
Intangible assets 7,260
Liabilities (3,807)
Minority interests (754)
----
Purchase price $ 10,511
============
On December 31, 1995, the Company acquired certain operating plant and
equipment from MATAV related to the concession areas to which Hungarotel
and Papatel have the rights. The purchase price for the Hungarotel and
Papatel concession area assets was HUF 2.5 billion (approximately $17.9
million at December 31, 1995 exchange rates). At the date of acquisition,
pending final allocation, the total purchase price was reflected as
property, plant and equipment.
During the fourth quarter of 1996, the Company finalized the network
design and construction schedule for the Hungarotel Operating Area and
completed its assessment of the fair value of assets acquired from MATAV
on December 31, 1995. The final allocation of the purchase price resulted
in a decrease in property, plant and equipment and an increase in
goodwill associated with the purchase of HUF 642.7 million (approximately
$3.9 million at December 31, 1996 exchange rates).
(3) Cash and Restricted Cash
(a) Concentration
At December 31, 1997, cash of $3,848,000 ($379,000 denominated in
U.S. dollars and the equivalent of $3,469,000 denominated in
Hungarian Forints) was on deposit with banks in Hungary. In
addition, cash of $183,000 denominated in U.S. dollars was on
deposit with two major money center banks in the United States.
F-12
(b) Restriction
At December 31, 1997, $490,000 of cash denominated in Hungarian
Forints was restricted under concession contract fulfillment
guarantees with restrictions to be removed upon the successful
attainment of certain operational requirements as prescribed in
the concession agreements. The Company intends to satisfy the
operational requirements within one year and therefore the amount
is shown as a current asset.
In addition, at December 31, 1997, $23,000 of cash denominated in
U.S. dollars was deposited in escrow accounts under terms of
construction contracts and $23,000 was restricted pursuant to
certain arrangements with other parties.
(4) Property, Plant and Equipment
The components of property, plant and equipment at December 31, 1997 and
1996 are as follows:
1997 1996 Estimated Useful Lives
(in thousands)
Land and Buildings $ 5,629 4,835 25 to 50 years
Telecommunications equipment 133,183 63,990 7 to 25 years
Other equipment 3,237 2,390 5 years
Construction in progress 6,241 14,467
----- ------
148,290 85,682
Less: accumulated depreciation (9,405) (3,670)
------ ------
$ 138,885 82,012
======= ======
During the fourth quarter of 1996, the Company wrote off network assets
with a net book value of approximately $1.3 million which were taken out
of service as a result of changes to the network design and configuration
in certain operating areas.
Interest capitalized and included in the cost of construction of certain
long-term assets amounted to approximately $4,504,000 in 1997 and
$2,076,000 in 1996.
(5) Short-Term Loans
There were no short-term loans outstanding at December 31, 1997 and 1996.
In 1995, the Company entered into financing agreements (the "1995
Citizens Loan Agreement") (see note 14) pursuant to which an affiliate of
Citizens Utilities Company (Citizens Utilities Company and its affiliates
are hereinafter referred to as "Citizens") provided a guaranty to
Chemical Bank that permitted the Company to borrow up to $33.2 million at
the bank's prime rate of interest + 2% through July 25, 1997. At December
31, 1995, the Company had borrowed $30.7 million under the facility.
During February and March of 1996, the Company borrowed from Citizens an
additional $18.2 million under a second financial agreement with Citizens
(the "1996 Citizens Loan Agreement" together with the 1995 Citizens Loan
Agreement, the "Citizens Loan Agreements") (see note 14).
At December 31, 1995, the Company had a short-term loan payable to
ABN-AMRO for DM 2,250,000 (approximately $1,603,000 at December 31, 1995
exchange rates) which bore interest at DM LIBOR + .625%. This loan was
repaid in March 1996.
F-13
At December 31, 1995, the Company had short-term loans payable to Tele
Danmark A/S which bore interest at DM and U.S. dollar LIBOR + 3%. The
loans were repaid in January 1996.
On March 29, 1996, the Company entered into a $75.0 million Secured Term
Loan Credit Facility ("Citicorp Credit Facility") and, together with HTCC
Consulting, a related Pledge and Security Agreement with Citicorp North
America, Inc. ("Citicorp"). This facility permitted the Company to borrow
funds through December 31, 1996 at interest rates ranging from 3.5% to
6.5% above LIBOR or Citicorp's announced based rate, at the Company's
option. In April, 1996, the Company used the Citicorp Credit Facility to
repay all the funds advanced or guaranteed by Citizens and Chemical Bank
and to meet contractual commitments pursuant to construction contracts
and operating expenses and recorded an extraordinary loss on the early
extinguishment of the debt of approximately $8.2 million representing a
non-cash charge relating to the write off of the remaining unamortized
deferred financing costs included in other assets pertaining to the
Citizens Loan Agreements.
In October 1996, utilizing funds provided by the Postabank Credit
Facility (see note 6), the Company paid Citicorp all funds owed pursuant
to the Citicorp Credit Facility, as amended, plus $2.0 million in fees
and costs representing settlement in connection with the cancellation of
the Company's proposed bond offering for which Citicorp was to act as
underwriter.
F-14
(6) Long-term Debt
Long-term debt at December 31, 1997 and 1996 consists of the following: 1997 1996
(in thousands)
Loan payable, maximum HUF equivalent of $170 million USD, interest at the
National Bank of Hungary weighted average Treasury Bill Rate + 2.5%
(22% and 26% at December 31, 1997 and 1996, respectively), payable in
32 quarterly installments beginning March 31, 1999 with final payment
due December 21, 2006; HUF 31,736,164,000 and HUF 19,136,275,000
outstanding at December 31, 1997 and 1996, respectively. 155,630 116,104
Construction loan, maximum HUF equivalent of $47.5 million, interest at
the National Bank of Hungary average Treasury Bill Rate + 2.5% (22%
and 26% at December 31, 1997 and 1996, respectively) payable in 20
quarterly installments beginning March 31, 1998 with final payment
due December 31, 2002; HUF 9,421,554,000 and HUF 1,565,450,000
outstanding at
December 31, 1997 and 1996, respectively. 46,202 9,498
Payable to MATAV, interest at the National Bank of Hungary 90 day
Treasury Bill rate + 2% (24% at December 31, 1996); HUF 1,492,357,000
outstanding at December 31, 1996; repaid in full in 1997. 9,054
Loan payable, imputed interest at LIBOR + 2.5%; $2,388,000 and DM 7,774,000
outstanding at December 31, 1996; repaid in full in 1997. 7,387
Loan payable, imputed interest at LIBOR + 2%; $1,499,000 and DM 5,429,000
outstanding at December 31, 1996; repaid in full in 1997
in exchange for shares of Common Stock (see Note 7). 4,986
Payable to MATAV, interest at the National Bank of Hungary 90 day
Treasury Bill rate + 2% (24% at December 31, 1996); HUF 198,212,000
outstanding at December 31, 1996; repaid in full in 1997. 1,203
Loan payable, without interest due in equal annual installments
over three years 194 360
------ ------
Total long-term debt $ 202,026 148,592
Less current installments 7,489 120
------ ------
Long-term debt, excluding current installments $ 194,537 148,472
======= =======
The aggregate maturities of long-term debt based on U.S. dollar
equivalents at December 31, 1997 exchange rates for each of the
subsequent five years are as follows: 1998, $7,489,000; 1999,
$33,545,000; 2000, $34,064,000; 2001, $34,064,000; and 2002, $34,064,000.
The carrying value of long-term debt approximates its fair value at
December 31, 1997.
F-15
On October 15, 1996, the Company entered into a $170 million 10-year
Multi-Currency Credit Facility with Postabank es Takarekpenztar
("Postabank"), a Hungarian commercial bank (the "Postabank Credit
Facility"). Proceeds from the loan may be drawn entirely in Hungarian
Forints or up to 20% of the principal may be drawn in U.S. dollars
through March 31, 1999. Concurrently upon entering into the loan
agreement with Postabank, the Company terminated its planned bond
offering and recorded a charge of $2,985,000 representing all related
costs.
Under the terms of the Postabank Credit Facility, drawdowns in Hungarian
Forints bear interest at a rate of 2.5% above the weighted average of the
yield on six- and twelve-month discounted Hungarian treasury bills while
drawdowns in U.S. dollars bear interest at 2.5% above LIBOR. Interest
payments for the first two years may be deferred at the Company's option.
Amounts outstanding in Hungarian Forints, including any deferred
interest, will be payable in 32 equal quarterly installments beginning on
March 31, 1999. Any amounts outstanding in U.S. dollars will be payable
in 16 equal quarterly installments beginning on March 31, 1999.
Concurrently with the Postabank Credit Facility, each subsidiary entered
into a Mortgage and Pledge Agreement pursuant to which each subsidiary
granted a security interest to Postabank in all assets acquired or to be
acquired with the funds provided by the loan. In addition, HTCC and HTCC
Consulting entered into a Security Agreement whereby each pledged,
subject to certain consents, their respective ownership interests in each
subsidiary as collateral.
In October 1996, pursuant to the Postabank Credit Facility, the Company
borrowed the equivalent of $82.3 million in Hungarian Forints.
Approximately $75.2 million of this amount was used to repay Citicorp all
funds advanced pursuant to the Citicorp Credit Facility, as amended, and
$2.0 million was paid to Citicorp for fees representing settlement in
connection with the cancellation of the Company's proposed bond offering.
The remaining $5.1 million was used to pay management fees and
reimbursable costs owed to Citizens pursuant to the Management Services
Agreement (see note 14). An additional $5.6 million of the facility was
used to pay loan origination fees and costs to Postabank under the terms
of the loan agreement, $2 million of which is being reimbursed to the
Company in equal quarterly installments over a two year period, and which
are being amortized over the life of the loan facility. At December 31,
1997, the remaining unamortized deferred financing costs have been
included in other assets. Additionally, certain costs were incurred as a
result of Citizens' financial support (see note 14).
In 1997, proceeds from the loan were used to continue construction of the
Company's telecommunications networks, provide additional working
capital, and refinance or repay other existing debt. The remaining
proceeds will be used in 1998 to complete the expansion of the Company's
telecommunications networks and repay other existing debt.
At December 31, 1996, current installments due under existing agreements
for certain long-term obligations were classified as long-term since the
Company had the ability and intent to refinance these obligations on a
long-term basis. In the first quarter of 1997, the Company repaid amounts
payable to MATAV and the Danish Fund under long-term agreements with
proceeds of the Postabank Credit Facility.
F-16
In 1996, Hungarotel entered into a $47.5 million construction contract
for the construction of a telephone network in one of its concession
areas. Financing for the full amount is being provided by the contractor.
The financing agreement requires repayment of principal and interest in
20 quarterly installments commencing March 31, 1998, with final payment
due December 31, 2002. Interest is charged at a variable rate computed as
the weighted average of the six and 12 month Hungarian National Treasury
Bill interest rate for each quarter plus 2.5%. According to the loan
agreement, the Company may elect to, and has elected to, defer repayment
of 20% of the total debt repayments due in 1998 and 1999. Security
pursuant to the loan represents all assets acquired with the funds
provided by the loan.
In 1995, the Company was awarded subsidies from the Ministry aggregating
HUF 118,720,000 (approximately $850,000 at December 31, 1995 exchange
rates). The required conditions were satisfied in 1996 and the funds were
received one-half in the form of a grant and one-half in the form of a
non-interest bearing loan repayable over a three year period.
(7) Transactions with Tele Danmark A/S
On July 1, 1997, the Company entered into an agreement with Tele Danmark
A/S ("TD") pursuant to which TD agreed to exchange its 20% interest in
each of two of HTCC's Operating Companies for 420,908 shares of the
Company's common stock. The value of shares on the date of issue totalled
$3,630,000. Under the agreement, TD was granted the preemptive right to
maintain its equity ownership percentage in addition to giving TD the
right, if TD acquired the 4.8% stake in each of the operating
subsidiaries owned by the Danish Fund for Central and Eastern Europe
("Danish Fund"), to sell such shares to the Company on similar terms.
On September 30, 1997, TD exercised its right and agreed to exchange the
4.8% interest in each of two of HTCC's Operating Companies that TD
purchased from the Danish Fund for 101,018 shares of the Company's common
stock. The value of shares on the date of issue totalled $1,301,000.
The total value of shares issued relating to these two transactions has
been recorded as an increase to goodwill and to Common Stock and
additional paid-in capital.
On September 30, 1997, the Company and TD entered into an agreement
whereby TD agreed to exchange loans and accrued interest totalling
$5,534,000 to two of HTCC's Operating Companies for 447,232 shares of the
Company's common stock.
As a result of these transactions, TD has increased its share ownership
in the Company to 18.8% of shares presently outstanding.
(8) Income Taxes
The statutory U.S. Federal tax rate for the years ended December 31,
1997, 1996 and 1995 was 35%. For Hungarian income tax purposes, the
concession companies are entitled to a 100% reduction in income taxes for
the five year period ending December 31, 1998 and a 60% reduction in
income taxes for the subsequent five year period ending December 31,
2003. The effective tax rate was zero for the years ended December 31,
1997 and 1996 due to the Company incurring net operating losses for which
no tax benefit was recorded.
F-17
For U.S. Federal income tax purposes, the Company has unused net
operating loss carryforwards at December 31, 1997 of approximately
$16,275,000 which expire in 2007, $142,000; 2008, $422,000; 2009,
$950,000; 2010, $6,507,000; 2011, $6,328,000; and 2012, $1,926,000. The
availability of loss carryforwards to offset income in future years may
also be restricted as a result of an ownership change which may occur, or
may have occurred, as a result of past and future sales of the Company's
Common Stock and other events.
For Hungarian corporate income tax purposes, the Hungarian subsidiaries
have unused net operating loss carryforwards at December 31, 1997 at
current exchange rates of approximately $54,113,000. Of this amount,
$30,673,000 may be carried forward indefinitely while $7,080,000 may be
carried forward until 2001 and $16,360,000 until 2002.
The tax effect of temporary differences that give rise to significant
portions of deferred tax assets are as follows:
December 31
1997 1996
($ thousand)
Net operating loss carryforwards $ 5,696 5,022
Write down of assets 418 418
Stock compensation 1,310 1,323
Citizen's options 1,991 1,777
Termination benefits 1,592 2,015
Management fees 2,361 369
Interest expense 620 421
Other 966 745
------- -------
Total gross deferred tax assets 14,954 12,090
Less valuation allowance (14,954) (12,090)
------- -------
Net deferred tax assets $ 0 0
========= ========
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management considers projected future taxable income and tax
planning in making these assessments. During 1997 and 1996, the valuation
allowance increased by $2,864,000 and $7,130,000, respectively.
(9) Commitments and Contingencies
(a) Concession Agreements
The Operating Companies have been awarded concession rights by the
Hungarian Ministry of Transportation, Telecommunications and Water
Management ("the Ministry") to own and operate local public
telephone networks in five regions of Hungary. Each of the
concession agreements are for a term of 25 years and provide for
an eight-year exclusivity period.
F-18
Agreements providing concession rights in two regions to
Hungarotel and one region to Papatel were entered into prior to
their acquisition by the Company and were renegotiated by the
Company. The renegotiated concession agreements provided for an
initial payment to the Ministry of HUF 938,250,000 (approximately
$6.7 at December 31, 1995 exchange rates) which was paid in
November 1995, and for annual concession fees based upon 2.3% and
0.3% of net telephone service revenues for the regions operated by
Hungarotel and 2.3% of net telephone service revenues for the
region operated by Papatel.
In 1994, the Ministry awarded concession rights to own and operate
local public telephone networks to KNC and Raba-Com under
agreements which provide for annual concession fees based upon
0.1% and 1.5% of net telephone service revenues for regions
operated by KNC and Raba-Com, respectively.
The concession agreements provide for, among other things, the
subsidiaries to provide telephone service to specific numbers of
customers by specified dates or be subject to possible monetary
penalties and possibly reduction in the period of exclusivity. As
of December 31, 1997, the Company believes it has fulfilled these
service requirements in their concession areas in all material
respects, and has not provided for any potential liability.
The activities of the subsidiaries which own concession rights are
regulated by the Ministry and by the terms of their respective
concession agreements. The Ministry regulates the construction,
operation and sale of local telephone exchanges and has been given
the authority to regulate the industry. This authority includes
approving local, long distance and international rates, the
sharing of revenues between concession companies and MATAV, the
equipment that can be used in the public switched telephone
network and requiring local companies to meet specified standards
as to growth and services.
The concession agreements require that each concession company
meet specified Hungarian ownership requirements so that by the
seventh year Hungarian ownership in each concession company must
consist of 25% plus one share. During the seven year period,
Hungarian ownership must be at least 10%, except that during such
period, such ownership may be reduced to as low as 1% for a period
of up to two years. During the seven year period in which the
Hungarian ownership block is required to be at least 10%, such
block must have voting power of at least 25% plus one share, thus
providing Hungarian owners the right to block certain transactions
such as mergers and consolidations, increases in share capital and
winding-up. At present, each of the concession companies is in
compliance with stipulated ownership requirements.
The Ministry has publicly stated that it is currently reviewing
the Hungarian ownership equity ownership requirements. In the case
of one other unrelated concession company, the Ministry has
granted a waiver on the 10% ownership issue. The Company believes
that it is reasonably likely that the Ministry will either change
the Hungarian equity ownership requirements by the time the
Operating Companies must meet the 10% requirement in June 1998 or
that the Ministry will grant the Operating Companies a waiver. In
any event, the Company will formulate plans to meet the Hungarian
ownership requirements. Failure to do so, or failure to comply
with the greater than 25% Hungarian ownership requirement at the
end of the seven year period will be considered a serious breach
of a Concession Contract, giving the Ministry the right, among
other things, to terminate the Concession Contract. There can be
no assurance that the Company will be able to increase the
Hungarian ownership in the Operating Companies in a manner
sufficient to comply with such requirements in the future.
F-19
(b) Construction Commitments
KNC has entered into contracts which provide for the continued
construction of a local telephone network and the addition of new
subscribers in its service area. These contracts total
approximately $18.5 million, $9.4 million of which remains to be
spent.
Hungarotel has entered into contracts totaling approximately $27.3
million which provide for the continued construction of a local
telephone network and the addition of new subscribers in its two
service areas. Of this total, approximately $8.0 million remains
to be spent.
(c) Settlement of Claim
In connection with the settlement of a claim relating to the
termination of a management agreement with an unrelated
corporation to operate certain concessions, the Company issued a
promissory note for $300,000 which was repaid in 1996 and 25,000
five-year assignable warrants with an estimated market value of
$100,000, entitling the holder to purchase 25,000 shares of the
Company's Common Stock at $20 per share. These warrants expire in
September 1999. The corporation also has a "put option" to require
the Company to purchase the warrants from the proceeds of any
public offering of the Company's securities at an aggregate price
of $300,000.
(d) Leases
The Company leases office facilities in Stamford, Connecticut,
which require minimum annual rentals of approximately $30,000.
During a portion of 1996 and all of 1995, the Company also leased
offices in Budapest, Hungary from Hungarian Teleconstruct Corp.
("Teleconstruct"), a company whose officers and directors consist
of certain former officers and directors of the Company (see note
13(b)). Certain Operating Companies also rent office space and
other facilities. Rent expense for the years ended December 31,
1997, 1996 and 1995, including rental amounts paid to
Teleconstruct, was $160,000, $221,000, $30,100, respectively.
Lease obligations for the subsequent five years are as follows:
1998, $30,000; 1999, $30,000; and 2000, $7,500.
(e) Legal Proceedings
Hungarotel is a defendant in a lawsuit filed by Dialcont Kft.
("Dialcont") on March 28, 1996 in Hungary alleging a breach of
contract for services allegedly provided by Dialcont during 1994
and 1995. The Company believes that Dialcont's claim is without
merit. Dialcont is seeking HUF 270 million ($1.3 million).
Raba-Com is a defendant in a lawsuit filed by an individual
residential customer in Hungary on December 4, 1997. The
plaintiff sought a refund of a minimal amount alleging that his
home was connected to Raba-Com's network in an untimely fashion.
Raba-Com prevailed on the merits. The plaintiff has not filed an
appeal. Should, however, the Plaintiff file an appeal and prevail
on such appeal, the Company could be subject to additional claims
for refunds. The Company believes its meritorious defense to this
claim and any others that may be filed regarding this matter.
The Company and its subsidiaries are involved in various other
claims and legal actions arising in the ordinary course of
business. In the opinion of management, the ultimate disposition
of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations
or liquidity.
F-20
(f) Issues With Citizens Utilities Company
As of December 31, 1997, the Company has accrued, but not paid,
$7.2 million pursuant to the Management Services Agreement with
Citizens. The Company and Citizens presently have a disagreement
regarding certain issues with respect to the Management Services
Agreement. The Company is currently in discussions with Citizens
in an attempt to resolve these issues. Until such time as these
issues are resolved, the Company currently intends to withhold
any payments to Citizens with respect to the Management Services
Agreement. The Company and Citizens also have a disagreement
regarding certain issues with respect to 1.9 million shares of
Common Stock subject to Citizens' preemptive rights to date. The
Company is currently in discussions with Citizens in an attempt
to resolve these issues.
(g) Agreements with Lucent Technologies
In October 1997, the Company entered into an agreement with
Lucent Technologies to become the exclusive distributor of Lucent
PBX and Key System products in Hungary. As part of the agreement,
the Company purchased fixed assets and inventory valued at
$470,000 and agreed to purchase commitments starting at $6
million for each of the next three years. The agreement provided
for the imposition of penalties of up to $500,000 annually for
failure to meet the purchase requirements. The Company also
assumed 36 employees. The Company recently entered into an
agreement in principle with Lucent pursuant to which the Company
and Lucent will amend the original agreement. Effective April 1,
1998, the Company will be the exclusive supplier of PBX and Key
System products in its Operating Areas while retaining the
non-exclusive rights to service other Hungarian customers outside
of the Operating Areas. In addition, the Company will be entitled
to sell large call centers on a commission basis. The Company's
minimum purchase requirements have been reduced to $2 million
annually with potential penalties reduced to a maximum of
$200,000 annually for failure to meet the purchase requirements.
As part of the renegotiated relationship, the Company agreed to
transfer back $400,000 of assets to Lucent and pay Lucent
$150,000. The Company will transfer 28 of its 36 assumed
employees back to Lucent or to a subcontractor. As a result, the
Company has recorded a charge of $600,000 for the year ended
December 31, 1997.
(10) Common Stock
In connection with a 1992 private placement and public offering, in
addition to a 1994 private placement, the Company issued warrants to
purchase 141,950 shares of Common Stock at prices ranging from $3.60 to
$14.00 per share. During 1995, the Company issued 55,025 shares of Common
Stock upon the exercise of such warrants at prices ranging from $3.60 to
$10.15 per share. During 1996, warrants to purchase 3,016 shares of
Common Stock at $10.15 were exercised. Proceeds from the exercise of
these warrants totaled $284,000 in 1995 and $31,000 in 1996.
F-21
In 1995, a former officer exercised options to purchase 328,494 shares of
Common Stock at prices ranging from $4.00 to $12.25 per share. Proceeds
from the exercise of these options totaled $2,012,000. During 1996,
options to purchase 5,000 shares of Common Stock at $10 per share were
exercised. Proceeds from the exercise of these options amounted to
$50,000.
During 1997, options to purchase 70,000 shares of Common Stock at prices
ranging from $7.00 to $10.00 per share and warrants to purchase 11,586
shares of Common Stock at $10.15 per share were exercised. Proceeds from
the exercise of these options and warrants amounted to approximately
$635,000. In addition, the Company granted options to purchase up to
70,000 shares of Common Stock at below market prices to three officers as
compensation, resulting in compensation expense of $70,000 and an
increase to additional paid-in capital.
During the third quarter of 1997, the Company entered into various
agreements with TD pursuant to which TD agreed to exchange its ownership
interest and outstanding loans in each of two Operating Companies for a
total of 969,158 shares of the Company's Common Stock. The value of
shares on the dates of issue totaled $10,689,000 which was recorded as an
increase to Common Stock and additional paid-in capital. As a result of
these transactions, TD has increased its share ownership in the Company
to 18.8% of shares presently outstanding (see note 7).
The Company has reserved 7,200,859 shares for issuance under stock option
plans and agreements and warrants.
(11) Stock Based Compensation
Stock Option Plans
The Company adopted a stock option plan (the "Plan") in April 1992 which
provided for the issuance of an aggregate of 90,000 stock options which
was increased to 750,000. Under the Plan, incentive and non-qualified
options may be granted to officers, directors and consultants to the
Company. The plan is administered by the Board of Directors, which may
designate a committee to fulfill its responsibilities. Options granted
under the Plan are exercisable for up to 10 years from the date of grant.
As of December 31, 1997, 545,000 options provided for by the Plan had
been issued, of which 167,500 were exercised and 377,500 remained
outstanding.
In 1997, the Company adopted a directors stock option plan (the
"Directors' Plan") which provides for the issuance of an aggregate of
250,000 stock options. Options granted under the Directors' Plan are
exercisable for up to 10 years from the date of grant. As of December 31,
1997, 50,000 options provided for by the Directors' Plan had been issued,
of which 5,000 were exercised, 5,000 were cancelled and reverted back to
the Directors' Plan, and 40,000 remained outstanding.
The Company applies APB Opinion No. 25 and related interpretations in
accounting for stock options issued under the Plan and the Directors'
Plan. Accordingly, no compensation cost has been recognized in the
financial statements for options issued with an exercise price equal to
or greater than the fair market value of the stock at the date of grant.
Had the Company determined compensation cost for options issued under the
F-22
plans based on the fair value at the grant date according to SFAS No.
123, the Company's net pro forma income and Earnings Per Share would
have been as follows:
1997 1996 1995
(in thousands)
Net loss As reported ($36,236) ($54,769) ($20,024)
Pro forma ($36,468) (54,982) (20,237)
Earnings Per Share As reported ($7.97) ($13.14) ($6.30)
Pro forma ($8.02) (13.19) (6.37)
For purposes of the pro forma calculation under SFAS 123, the fair value
of each option grant has been estimated on the date of grant using the
Black Scholes option-pricing model with the following assumptions: (1) a
risk free rate of 6.56% in 1997, 5.4% in 1996 and 7.39% in 1995, (2) an
expected life of 7 years for 1997, 6 years for 1996 and 5 years for 1995,
and (3) volatility of approximately 33% for 1997 and 53% for both 1996
and 1995.
Pro forma net loss reflects only options granted during 1995, 1996 and
1997. Therefore, the full impact of calculating compensation cost for
stock under SFAS 123 is not reflected in the pro forma net loss amounts
because compensation cost is reflected over the options' vesting period
and compensation cost for options granted prior to January 1, 1995 is not
considered.
The following is a summary of stock options and warrants, including those
issued under the Plan and Directors' Plan referred to above, issued to
officers, directors, and consultants, exercised and cancelled for the
three years ended December 31, 1997:
-------------------------- ------------------------ --------------------
Outstanding Option/Warrant Price
Options/Warrants Per Share
-------------------------- --------------------- -----------------------
December 31, 1994 760,941 $3.60-$20.00
Granted 170,000 $12.25-$14.00
Exercised (383,449) $3.60-$12.25
Cancelled (29,000) $10.00-$10.25
-------------------------- --------------------- -----------------------
December 31, 1995 518,492 $3.60-$20.00
Granted 200,000 $14.00
Exercised (8,016) $10.00-$10.15
Cancelled (5,000) $14.00
-------------------------- --------------------- -----------------------
December 31, 1996 705,476 $3.60-$20.00
Granted 140,000 $8.75-$11.69
Exercised (81,586) $7.00-$10.15
Cancelled (5,793) $10.15
-------------------------- --------------------- -----------------------
December 31, 1997 758,097 $3.60-$20.00
-------------------------- --------------------- -----------------------
F-23
The following table summarizes information about shares subject to
outstanding options and warrants as of December 31, 1997 which were
issued to current or former employees, directors or consultants pursuant
to the Plan, Directors' Plan, employment or other agreements.
Options/Warrants Outstanding Options/Warrants Exercisable
Weighted-
Weighted- Average Weighted-
Number Range of Average Exercise Remaining Life Number Average
Outstanding Exercise Prices Price in Years Exercisable Exercise Price
253,647 $3.60-$4.00 $3.99 6.58 253,647 $3.99
120,000 $8.75-$9.44 $9.04 5.06 120,000 $9.04
97,500 $11.69-$12.25 $12.16 2.52 97,500 $12.16
261,950 $14.00 $14.00 3.06 261,950 $14.00
25,000 $20.00 $20.00 1.80 25,000 $20.00
------- ------ ------
758,097 $3.60-$20.00 $9.10 4.44 758,097 $9.10
======= =======
Stock Grants
In March 1997, the Company issued 5,000 shares to a former officer as
compensation. An amount of $51,875, representing the fair market value of
the stock on the date of grant, has been recorded as compensation expense
with a corresponding increase in Common Stock and additional
paid-in-capital.
In October 1996, the Board of Directors of the Company amended and
restated employment agreements with three executive officers. As part of
these agreements, the Company issued 8,000 shares to three executives. An
amount of $101,000, representing the fair market value of the stock on
the date of grant, was recorded as compensation expense with a
corresponding increase in Common Stock and additional paid-in-capital.
In March 1997, based on performance in 1996, options to purchase
70,000 shares of stock at an exercise price of $8.75 were granted
to these three executive officers which became effective April 1, 1997.
In December 1995, the Company entered into employment agreement with
three executives which provided for, among other things, the granting of
a total of 102,500 shares of Common Stock. The Common Stock grants vest
over a four year period from the effective date of each agreement. As a
result of these employment agreements, in 1995 the Company recorded an
increase in additional paid-in-capital of $1,050,000, and a corresponding
increase in deferred compensation which is being amortized over the
vesting period.
F-24
(12) Reconciliation of Net Income to Net Cash Used in Operating Activities
The reconciliation of net loss to net cash provided by (used in)
operating activities for the years ended December 31, 1997, 1996 and 1995
follows:
1997 1996 1995
(in thousands)
Net loss $ (36,236) (54,769) (20,024)
Adjustments to reconcile net loss to
net cash provided by operating activities:
Depreciation and amortization 8,349 4,270 2,211
Asset write-downs 2,005 562
Equity in net loss of affiliates 248
Non-cash compensation 407 485 6,365
Unrealized foreign currency loss 209 1,084 602
Extraordinary items 7,318
Termination benefits 6,260
Other expense 386
Minority interest (2,994) (2,838)
Deferred Payment of interest 34,963 6,279 40
Changes in operating assets and liabilities
net of effects of
acquisitions:
Accounts receivable (6,273) (3,663) (1,399)
Restricted cash 4,797 (4,974) 2,065
VAT receivable 1,864 (1,757) (3,305)
Other assets (1,087) (5,976) 825
Accounts payable and accruals (3,955) 10,955 12,311
Advanced subscriber payments (2,851) 1,066 (312)
Due to related parties 4,364 (1,430) 2,183
------- ------ ------
Net cash provided by (used in) operating activities $ 4,937 (35,841) (466)
=========== ======= ====
Cash paid during the year for:
Interest $ 196 16,961 1,672
=========== ====== =====
Summary of non-cash transactions (figures in dollars):
During 1997 the Company:
Issued 969,158 shares of Common Stock valued at
$10,689,000 to TD in exchange for interests and loans in
two operating subsidiaries.
Issued 5,000 shares of Common Stock to a former officer
and options to purchase 70,000 shares of Common Stock to
three officers at exercise prices below market as
compensation.
During 1996 the Company:
Issued 250,000 shares of Common Stock valued at $3,219,000
and also issued 875,850 options and modified the terms of
other options to purchase Common Stock valued at
$11,219,000 in consideration for certain financial support
from Citizens.
Retired 101,429 shares of Common Stock valued at
$1,775,000, not yet delivered as a purchase price
adjustment related to acquisitions.
Issued 8,000 shares as compensation to three executive
officers valued at $101,000.
F-25
During 1995 the Company:
Issued 571,429 shares of Common Stock valued at
$10,000,000 subject to adjustment, for acquisitions.
Issued 250,000 shares of Common Stock valued at $3,436,000
and 626,155 options to purchase Common Stock valued at
$3,481,000 in consideration for certain financial support
from Citizens.
Issued 2,908 shares of Common Stock as payment of
approximately $40,000 of interest to Citizens.
Issued 102,500 restricted shares to certain officers
pursuant to their employment agreements.
(13) Related Parties
Transactions entered into with certain related parties are as follows:
(a) Transactions with former officers and directors
On July 26, 1996, the Company entered into Termination and Release
Agreements, Consulting Agreements and Non-competition Agreements
with its former Chairman and Chief Executive Officer; former Vice
Chairman; and former Chief Financial Officer, Treasurer, Secretary
and Director. Pursuant to these agreements, the Company agreed to
make payments for severance, consulting fees and non-competition
agreements amounting to $7.25 million, in equal monthly
installments over a 72 month period commencing August 31, 1996,
and also issued options to purchase 200,000 shares of Common Stock
to the former Vice-Chairman at an exercise price of $14.00 per
share. These commitments are supported by letters of credit. The
Company recorded a charge of approximately $6.3 million in 1996
and made payments aggregating approximately $1,208,000 in 1997 and
$503,000 in 1996 related to these agreements.
On September 12, 1995 the Board of Directors of the Company had
extended the employment contracts of its former Chairman,
President and Chief Executive Officer and its former Chief
Financial Officer, Treasurer, Secretary and Director for one year
and vested all of the options contained in such employment
agreements immediately instead of over the term of such employment
contracts. Stock compensation expense for the year ended December
31, 1995 (including a charge for the entire amount related to the
accelerated vesting of options of the Company's prior president,
chief executive and chief financial officer) amounted to
$6,365,000.
In 1996 and 1995, the Company paid legal fees to the former Chief
Financial Officer, Treasurer, Secretary and Director of
approximately $146,000 and $158,000, respectively. Included in
other assets at December 31, 1996 is $250,000 plus accrued
interest due from the former Vice Chairman for funds advanced on a
personal mortgage which was repaid in February 1997.
(b) Transactions with Teleconstruct
In addition to transactions related to Pilistav (see note 16) in
1996, the Company purchased the premises used as offices by the
Company and a residential apartment in Budapest, Hungary from
Teleconstruct in two separate transactions for an aggregate
purchase price of $643,000.
F-26
(c) Agreements with TD
Amounts paid to TD in 1996 and 1995 under previously existing
management services agreements amounted to approximately $976,000
and $1,778,000, respectively. The management services agreements
with TD were terminated in August 1996.
(d) Transactions with Citizens Utilities Company
Transactions with Citizens including those under the Management
Service Agreements are discussed in Footnote 14.
Amounts payable to related parties as of December 31, 1997 and 1996, were
as follows:
1997 1996
Payable to former officers and directors $ 4,199,000 $ 4,839,000
Due to Citizens 7,175,000 1,491,000
Due to TD 770,000
Due to Teleconstruct 34,000 34,000
-------- --------
$ 11,408,000 $ 7,134,000
============= =============
(14) Agreements with Citizens
During 1995, the Company and certain subsidiaries of Citizens entered
into a Master Agreement, a Loan Agreement and related Promissory Note, a
Warrant to Purchase Shares of Common Stock to Citizens (the Warrant), a
Stock Pledge Agreement, a Stock Option Agreement (the "First Stock Option
Agreement") and second Stock Option Agreement (the "Second Stock Option
Agreement"), a Registration Agreement and a Management Services Agreement
(altogether, the "Citizens Agreements"). Simultaneously, Citizens entered
into voting agreements with three affiliates of the Company and
consummated the purchase of 300,000 shares of Common Stock of the Company
from the then President, Chief Executive Officer and Chief Financial
Officer and Director of the Company. Certain of these agreements were
subsequently amended in connection with Citizens providing additional
financial support to the Company.
The Citizens Agreements, as amended, resulted in and provide for the
following:
The nomination by Citizens of one representative to the Company's
board of directors (out of a minimum of six directors) for as long
as Citizens owns at least 300,000 shares of Common Stock of the
Company.
Citizen's receipt of options and a warrant to purchase an
aggregate of 3,638,832 (as adjusted for items described below)
additional shares of Common Stock of the Company at exercise
prices ranging from $13 to $18 per share under the First Stock
Option Agreement and the Second Stock Option Agreement and
Warrant, as amended (the "Citizens Options and Warrant"). The
Citizens Options and Warrant were originally due to expire at
various dates from May 31, 1997 to September 12, 2000. Expiration
dates of the warrant and certain of the options were extended as
discussed below. All of the options are subject to customary
anti-dilution provisions which result in adjustments to the number
and price per share of the options.
F-27
Financial support under the Citizens Loan Agreements, as amended,
to the Company by Citizens through advances or the arrangement of
advances through Chemical Bank of approximately $31 million and
guarantees by Citibank of $16 million totaling $47 million as of
December 31, 1995. Chemical Bank provided such advances based upon
a guarantee provided by Citizens on the Company's behalf.
Consideration for Citizens commitment to provide the financial
support in excess of the initial $5.2 million provided in the 1995
Citizens Loan Agreement included the grant to Citizens of an
additional five year option to purchase 626,155 shares of Common
Stock and its subsequent repricing, and the issuance of 250,000
shares of Common Stock to Citizens. The cost of this consideration
to the Company, representing the fair value of the newly granted
options and the subsequent repricing, and the fair value of the
Common Stock amounted to $6,917,000. The fair value of the options
granted and repriced were determined using the Black Scholes
option pricing model.
The 1995 Citizens Loan Agreement provided for certain events
of default and remedies. Advances under the 1995 Loan Agreement
bore interest at a variable rate equal to the prime rate plus 2%,
payable quarterly in cash. To the extent the interest rate payable
by the Company to Chemical was less than the applicable interest
rate under the 1995 Citizens Loan Agreement, the Company was
required to pay to Citizens the difference, as partial
consideration for Citizens making its guaranty. The Company's
option to repay advances and interest in Common Stock under the
terms of the 1995 Citizens Loan Agreement was waived in connection
with Citizen's commitment in February 1996 to provide additional
financial support to the Company as described below.
The maturity date of the loan was July 25, 1997; however, the 1995
Citizens Loan Agreement provided that in the event the Company
issues or sells for cash, pursuant to any public or private
offering, any shares of its capital stock (or any other securities
or any obligations convertible into or exchangeable for Common
Stock) or receives a bank loan or any bridge financing related to
such offering, then the Company must repay the outstanding
principal and accrued but unpaid interest from such net offering
proceeds or related financing, subject to the prior repayment of
any such advances made through third party lenders.
On February 26, 1996, the Company and Citizens entered into, among
other agreements, the 1996 Citizens Loan Agreement pursuant to
which Citizens agreed to lend the Company up to an additional $46
million (the "Additional Citizens Financial Support"), including
(i) an advance of up to $16 million to enable the Company to
satisfy its obligations to Citibank, if Citibank's payment
obligations to MATAV arose pursuant to its payment guaranty to
secure Hungarotel's asset purchase and (ii) advances of up to $30
million, composed of up to $20 million for certain limited
purposes and up to $10 million reserved for anticipated
obligations under construction contracts to be approved by
Citizens.
Citizens commitment to provide the loan advances of up to $16
million in connection with the Hungarotel asset purchase expired
on the earlier of June 28, 1996 or the termination of Citibank's
payment guaranty. Citizens commitment to provide the loan advances
in connection with the remaining $30 million of Additional
Citizens Financial Support expired on June 28, 1996, with respect
to the $20 million reserved for other limited purposes.
Consideration for Citizen's commitment to provide the Additional
Citizens Financial Support included the issuance of an additional
250,000 shares of Common Stock. The cost of this consideration to
the Company representing the fair value of the Common Stock
amounted to $3,219,000.
F-28
Total consideration to Citizens related to these transactions
amounted to $10,136,000 and was capitalized as deferred financing
fees. As discussed in note 5, all amounts outstanding in
connection with the Citizens Loan Agreements and additional
Citizens' financial support were repaid in April 1996 and any
remaining unamortized deferred financing costs pertaining to such
agreements were expensed and reflected as an extraordinary loss.
Certain corporate, financial, technical, construction, marketing
and operational services are to be provided by Citizens to the
Company under the terms of the Management Services Agreement. Such
services commenced on July 1, 1995 with a 12-year term. The
Management Services Agreement currently provides for a fee equal
to the greater of 5% of Adjusted Gross Revenues, as defined, or a
fixed amount ranging from $100,000 to $395,800 per month from July
1995 through December 31, 1996, and $416,600 per month for each
month commencing January 1997 for the remainder of the term,
subject to adjustment for inflation. The monthly management fees
during 1995 and 1996 were payable in cash or, with Citizen's
consent, in shares of Common Stock of the Company equal in value
to the fee, based upon a three-month market price average.
Management fees payable to Citizens during 1997 amounted to
$5,000,000 plus reimbursable costs of $691,000, in 1996 such fees
amounted to $3,640,000 plus reimbursable costs of $1,862,000,
while in 1995 such fees amounted to $900,000 plus reimbursable
costs of $1,491,000. Cash payments made to Citizens in 1996 for
management services totaled $5,865,000. As of December 31, 1997,
the Company has accrued, but not paid, $7.2 million pursuant to
the Management Services Agreement with Citizens. The Company and
Citizens presently have a disagreement regarding certain issues
with respect to the Management Services Agreement. The Company is
currently in discussions with Citizens in an attempt to resolve
these issues. Until such time as these issues are resolved, the
Company currently intends to withhold any payments to Citizens
with respect to the Management Services Agreement.
The right for Citizens to receive an option to purchase
additional shares of Common Stock, if the Company issues in
certain circumstances, in connection with any public or private
offering, shares of Common Stock, other stock of the Company or
any securities convertible into, or exchangeable or exercisable
for shares of Common Stock or other stock of the Company prior to
September 12, 1997, on the same terms applicable to the original
two-year option granted under the Citizens Options and Warrant, to
purchase the number or amount of shares sufficient to maintain
Citizens' then existing percentage ownership on a fully diluted
basis. If the issuance occurs after September 12, 1997, then the
Company must grant Citizens the right to purchase at the
applicable offering price the number of shares as is necessary to
maintain Citizens' then existing percentage ownership on a fully
diluted basis. The Company and Citizens currently have a
disagreement regarding certain issues with respect to 1.9 million
shares of Common Stock subject to Citizens' preemptive rights to
date. The Company is currently in discussions with Citizens in an
attempt to resolve these issues.
F-29
In connection with the Postabank Credit Facility (see note 6), on
October 18, 1996, the Company entered into certain agreements with
Citizens in consideration for, among other things, Citizens'
support in HTCC fulfilling all terms under the Citicorp Credit
Facility, as amended, and in obtaining the Postabank Credit
Facility. Under such agreements, the Company agreed to (i) extend
to September 12, 2000 the exercise periods of a warrant and
certain stock options to purchase approximately 2,142,041 shares
of Common Stock (as presently adjusted), (ii) grant Citizens the
option to purchase an additional 875,850 shares of Common Stock at
an exercise price of $12.75 exercisable through September 12,
2000, and (iii) pay Citizens $750,000 in cash. The cost of this
consideration to the Company representing the increase in fair
value of the options previously granted, the fair value of the
newly granted options and the cash payment amounted to $11.97
million. The fair value of the options was determined using the
Black Scholes option pricing model. The Company has reflected the
portion of the cost related to the financial support in fulfilling
the terms of the Citicorp Credit Facility, $5.7 million, as a
current period charge in 1996. The remaining $6.27 million has
been capitalized in other assets with other direct costs incurred
in obtaining the Postabank Credit Facility and is being amortized
over the term of the related debt.
Additionally, the Company is also obligated to bear the cost of
registering shares it has issued to Citizens, including shares
issuable under the Citizens Options and Warrant. As a result of
the above transactions and certain open market purchases by
Citizens, on December 31, 1997 Citizens held 17.3% of the
Company's outstanding Common Stock and 4,514,682 options and
warrants to purchase Common Stock. In addition to such options
and warrant, the Company and Citizens are currently in a dispute
with respect to Citizens preemptive rights as to 1.9 million
shares of Common Stock. Citizens' ownership of the Company's
outstanding shares on a fully diluted basis (including its shares
of Common Stock, options, warrant and preemptive rights subject
to dispute) is approximately 58.9% at December 31, 1997.
(15) Employee Benefit Plan
Effective December 1996, the Company established a 401(k) salary deferral
plan (the "401(k) Plan") on behalf of its U.S. employees. The 401(k) Plan
is a qualified defined contribution plan and allows participating
employees to defer up to 15% of their compensation, subject to certain
limitations. Under the 401(k) Plan, the Company has the discretion to
match contributions made by the employee. No matching contributions were
made by the Company in 1997 and 1996.
(16) Investment in Pilistav
In March 1995, the Company acquired Teleconstruct's 68% ownership
interest in Pilistav for $919,000, raising its ownership interest to 94%.
The Company has consolidated the accounts of Pilistav from April 1, 1995.
Pilistav had applied for but did not receive a concession to own and
operate a local telephone network in Hungary and as such had no
operations. In the second quarter of 1995, subsequent to the Company
acquiring Teleconstruct's interest in Pilistav, a writedown of $562,000
was recorded to reduce the net assets of Pilistav to their estimated fair
value of approximately $75,000. In March 1996, the Company sold the
assets of Pilistav to MATAV for approximately $220,000.
F-30
(17) Quarterly Financial Data (unaudited)
($ in thousands)
Revenue Net Loss Net loss
Per share
1997
First quarter $ 7,924 $ (6,948) $ (1.66)
Second quarter 9,297 (8,183) (1.95)
Third quarter 9,669 (9,050) (1.96)
Fourth quarter 11,001 (12,055) (2.33)
1996
First quarter $ 5,159 $ (5,768) $ (1.41)
Second quarter 4,534 (15,623) (3.70)
Third quarter 5,034 (13,105) (3.14)
Fourth quarter 6,183 (20,273) (4.86)
The net loss for the third quarter of 1997 has been restated to reflect a
decrease in capitalized interest of $1.65 million as a result of
revisions to estimated completion dates of construction work in process
amounts outstanding during the period.
F-31
HUNGARIAN TELEPHONE AND CABLE CORP.
Index to Exhibits
Exhibit No. Description
21 Subsidiaries of the Registrant