UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(MARK ONE)

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004

COMMISSION FILE NUMBER 1-5706

METROMEDIA INTERNATIONAL GROUP, INC.

8000 Tower Point Drive, Charlotte, North Carolina 28227
(Address and zip code of principal executive offices)

(704) 321-7380
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES o NO x

     The number of shares of common stock outstanding as of November 30, 2004 was 94,034,947.

METROMEDIA INTERNATIONAL GROUP, INC.
Index to
Quarterly Report on Form 10-Q

1

METROMEDIA INTERNATIONAL GROUP, INC.

See accompanying notes to unaudited consolidated condensed financial statements.

2

METROMEDIA INTERNATIONAL GROUP, INC.

See accompanying notes to unaudited consolidated condensed financial statements.

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METROMEDIA INTERNATIONAL GROUP, INC.

See accompanying notes to unaudited consolidated condensed financial statements.

4

METROMEDIA INTERNATIONAL GROUP, INC.

See accompanying notes to unaudited consolidated condensed financial statements.

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Metromedia International Group, Inc.

Notes to Unaudited Consolidated Condensed Financial Statements

1. Basis of Presentation, Description of Business, Recent Developments and Going Concern

Basis of Presentation and Description of Business

     The accompanying consolidated financial statements include the accounts of Metromedia International Group, Inc. (the “Company”) and its consolidated subsidiaries. All significant intercompany transactions and accounts have been eliminated.

     The Company is a holding company with ownership interests in telephony and cable television businesses in Northwest Russia and the Republic of Georgia. For the nine months ended September 30, 2004, the telephony businesses generated substantially all of the Company’s consolidated revenues. Substantially all of the Company’s assets are located and revenues are generated outside of the United States (“U.S.”).

     On September 30, 2003, the Board of Directors formally approved management’s plan of disposing its remaining non-core media businesses. As of September 30, 2004, the Company had entered into agreements for the disposition of all of its non-core media businesses that were classified as discontinued components. These consolidated financial statements also include the results of the Company’s discontinued business components (see Note 11, “Discontinued Business Components”).

     The accompanying interim consolidated condensed financial statements have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the U.S. (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures made are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the consolidated financial statements and related footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company as of September 30, 2004, and the results of its operations for the three and nine month periods ended September 30, 2004 and 2003 and its cash flows for the nine month periods ended September 30, 2004 and 2003, have been included. The results of operations for the interim period are not necessarily indicative of the results of operations that may be realized for the full year.

     Certain reclassifications have been made to prior period’s financial information to conform to the current period presentation.

     The Company reassessed its accounting and presentation of the withholding taxes that were remitted to foreign governments on dividends distributed by its business ventures located outside the U.S. Historically, the Company included such amounts within its selling, general and administrative expenses. The Company will prospectively present such withholding tax amounts as a component of income taxes. In addition, the historical withholding tax amounts have been reclassified in the current period presentation for consistent presentation purposes and the following table identifies those historical withholding tax amounts, for selected historical periods (in thousands):

     Such amounts do not have an impact on earnings per share in prior period financial results or result in an adjustment to the Company’s accumulated deficit.

Recent Developments and Going Concern

Proposed Merger

     On November 4, 2004, the Company announced that it had entered into exclusive negotiations with an investor group (the “Investor Group”) composed of Emergent Telecom Ventures (“Emergent”), First National Holding (“First National”), Capital International Private Equity Fund IV, L.P. (“Capital International”) and Baring Vostok Capital Partners (Cyprus) Limited (“Baring Vostok”) concerning the Investor Group’s preliminary proposal to acquire the Company by merger (the “Proposed Merger”). The Investor Group’s proposal assigns an aggregate preliminary enterprise value to the Company of $300.0 million, which amount would be payable in cash and allocated as follows:

•

Approximately $152.0 million would be allocated to the retirement, following the closing of the acquisition of the Company by the Investor Group, of the Company’s outstanding aggregate principal amount and fully accreted 10½% Senior Discount Notes due 2007 (the “Senior Notes”);

•

An additional amount, estimated to be in the range of approximately $11.7 million to $16.5 million, would be used to fulfill certain contractual obligations to the Company’s senior executives. These contractual arrangements are currently being finalized between the Company’s Board of Directors and the respective senior executives, and the Company intends to update its public filings with the modified senior executive contractual arrangements when complete; and

•

The remainder would be allocated between the Company’s preferred and common stockholders in a manner determined by the Company’s Board of Directors prior to the execution of the definitive merger agreement and paid out to the stockholders in connection with the consummation of the Proposed Merger.

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The proposal contains a number of conditions, including without limitation, the Investor Group’s successful completion of due diligence during a limited exclusivity period, the Investor Group obtaining commitments for all financing contemplated in its acquisition proposal, the Company meeting currently projected corporate cash balance and liability levels, and negotiation and execution of definitive transaction agreements. The Company has granted the Investor Group exclusivity until January 17, 2005 to pursue a due diligence review of the Company and negotiate a definitive merger agreement, subject to earlier termination under certain circumstances.

     If undertaken, the Proposed Merger would result in the Company being merged with and into an entity wholly-owned by the Investor Group. The Company’s current common and preferred stockholders would not become stockholders of the post-merger entity and would receive cash consideration for their stock holdings in an amount dependent on the aforementioned Board-determined allocation. The Proposed Merger will require approval by a majority of the Company’s common stock. This approval will be solicited via a proxy statement that will include further details of the Proposed Merger, the Board of Directors recommendation, and other information customarily contained in merger proxy statements. Preparation of a proxy statement and solicitation of a common stockholder vote would follow signing of definitive agreements with the Investor Group. The Company anticipates that a common stockholder vote on the Proposed Merger will not occur before the end of the first quarter 2005. Although no vote of the Company’s preferred stockholders is required to approve the Proposed Merger, as a practical matter discussions with significant holders of the Company’s preferred stock concerning disposition of merger proceeds are likely to occur prior to concluding any definitive merger agreement.

     The Company has been actively assessing for some time practical financial restructuring alternatives and business development opportunities available to the Company. This work included assessment of current core business valuations and a pragmatic assessment of the opportunities and risks associated with continued pursuit and development of the Company’s core businesses on an as currently organized basis. In connection with this work, the Company also received and carefully considered several third party merger and acquisition proposals and various opportunities to refinance the Company’s Senior Notes. The Board of Directors has concluded that the Proposed Merger, if consummated, offers the best opportunity reasonably available to maximize value for the Company’s stakeholders.

     There can be no assurances that any transaction with the Investor Group or any other party will take place nor can any assurance be given with respect to the timing or terms of any such transaction. Details of the terms of a final agreement, if any, will be disclosed upon signing of definitive agreements. The preliminary proposal made by the Investor Group is non-binding and the Company has agreed, under certain circumstances, to reimburse the Investor Group for a limited amount of its out-of-pocket expenses incurred in connection with its due diligence review and negotiation of definitive agreements.

Restructuring

     In the first quarter of 2003, the Company embarked on an overall restructuring of its business (the “Restructuring”). The Restructuring was prompted by and was intended to resolve the severe liquidity issues that had confronted the Company since the beginning of 2002. In this Restructuring, the Company undertook to sell its non-core businesses, which at the beginning of the Restructuring included nine cable television networks, twenty radio broadcasting stations and various non-core telephony businesses located in Western, Central and Eastern Europe. Cash proceeds from these sales have mitigated short-term corporate liquidity concerns and reduced the Company’s dependence upon cash distributions from its core businesses and thus provided additional cash reserves to the core businesses to enable them to further pursue their respective business development initiatives. In connection with the Restructuring, the Company also substantially downsized its corporate headquarters staff and undertook actions with the intended objective of significantly decreasing its corporate overhead cash-burn rate. The Company had substantially completed all of the initiatives attributable to the Restructuring at the end of the third quarter of 2004, and as such, exited the Restructuring with the intent, prior to engaging in the Proposed Merger, to focus on the continued development of its core telephony businesses in Northwest Russia and the Republic of Georgia.

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          The Company’s core telephony businesses are now:

•

PeterStar, the leading competitive local exchange carrier in St. Petersburg, Russia, in which the Company has a 71% ownership interest; and

•

Magticom, the leading mobile telephony operator in the Republic of Georgia, in which the Company has an effective 34.5% ownership interest.

          Both PeterStar and Magticom are currently self-financed and hold leading positions in their respective markets. Furthermore, the Company also currently intends to retain its ownership in Ayety LLC (“Ayety”), a cable television provider in Tbilisi, Georgia, in which the Company has an 85% ownership interest and Telecom Georgia, a long-distance transit operator in Tbilisi, Georgia, in which the Company has a 30% ownership interest. The Company expects that these businesses can be further developed to strengthen the market position of Magticom. In addition, as of September 30, 2004 the Company has one radio broadcast station and one cable television network which are subject to pending sales agreements with prospective acquirers, which are reflected at the lower of cost, less accumulated losses or estimated net proceeds. Prior to engaging in the Proposed Merger, the Company intended to use its corporate cash reserves to provide for the development of these core businesses, with the expectation that their future dividend distributions will be sufficient to meet, on a timely basis, the Company’s corporate overhead requirements and indebtedness interest payment obligations, including those associated with its Senior Notes.

Corporate Liquidity

          The Company is a holding company; accordingly, it does not generate cash flows from operations. As a result, the Company is dependent on the earnings of its subsidiaries and equity investees and the distribution or other payment of these earnings to it to meet its long term corporate cash outlay requirements (the “Long Term Corporate Cash Outlay Requirements”), in addition to making any cash distributions to its stockholders. The Company’s Long Term Corporate Cash Outlay Requirements consist of cash outlays for its corporate overhead expenditure requirements, extinguishment of its Historic Corporate Liabilities, and interest payment obligations associated with its Senior Notes. As such, the Company’s Long Term Corporate Cash Outlay Requirements do not include funding necessary to retire or repay its outstanding Senior Notes. The Company’s business ventures are separate legal entities that have no obligation to pay any amounts the Company owes to third parties. As a result, although cash balances exist in these business ventures, due to legal and contractual restrictions cash balances of the business ventures cannot be readily accessed to meet the Company’s liquidity needs without the distribution of dividends, which require formal declarations to effect transfers to the Company. Furthermore, the dividend policy of Magticom must be approved by the Company’s partners and thus, is not under the Company’s exclusive control.

          The Company has legacy liabilities as a result of the Company’s prior U.S. based business operating activities, principally attributable to the business activities when the Company operated under the names of “The Actava Group, Inc.” and “Fuqua Industries, Inc.”, which include, but are not limited to, employee benefit obligations to former employees (pension obligations and provisions for medical and life insurance), self-insurance reserves attributable to product liability and workers compensation claims and environmental claims (collectively, the “Historic Corporate Liabilities”).

          As of September 30, 2004 and November 30, 2004, the Company had $40.5 million and $34.7 million, respectively, of unrestricted cash on hand, which is principally held in banks in the U.S. In addition, as of September 30, 2004, the Company’s consolidated business ventures held $0.7 million of cash on hand, which is held in banks in Russia. Furthermore, as of September 30, 2004, the Company’s unconsolidated business ventures had $13.4 million of cash on hand, which is held in banks in the Republic of Georgia.

          The Company projects that its anticipated continuing dividends from its core business operations and its current corporate cash reserves will be sufficient for the Company to meet on a timely basis its Long Term Corporate Cash Outlay Requirements through September 30, 2007, the maturity date of the Senior Notes. However, the Company cannot provide assurance that its core businesses will perform to expectations and therefore generate the forecasted cash flows for dividend distribution purposes, or that the core businesses’ free cash flows or their available cash reserves will be distributed as shareholder dividends in accordance with the Company’s current expectations. Therefore, the Company cannot provide assurance that it will be able to meet its Long Term Corporate Cash Outlay Requirements through at least September 30, 2007. The Company also is subject to legal and contractual restrictions, including those under the indenture for the Senior Notes, on its use of any cash proceeds from the sale of its assets or those of its business ventures.

          Separately, the Company projects that, as of today, it has sufficient corporate cash on hand to support the Company’s planned Long Term Corporate Cash Outlay Requirements through at least March 31, 2005, including the Company’s $8.0 million semi-annual interest payment on its Senior Notes due on March 31, 2005 and its planned cash outlays between now and March 31, 2005 attributable to the extinguishment of certain of the Company’s Historic Corporate Liabilities as related to employee benefit obligations (see Note 15, “Subsequent Events – Employee Benefits”). This projection does not include cash inflows that might reasonably arise from cash proceeds realized from dividend distributions from either PeterStar or Magticom, which would further strengthen the Company’s liquidity position.

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     However, the Company does not believe that, as of today, it has sufficient corporate cash on hand to support the Company’s planned Long Term Corporate Cash Outlay Requirements through September 30, 2005, including the Company’s $8.0 million semi-annual interest payment on its Senior Notes due on September 30, 2005, its planned cash outlays between now and September 30, 2005 attributable to the extinguishment of certain of the Company’s Historic Corporate Liabilities as related to employee benefit obligations and the cash outlays attributable to the restructuring of Dr. Jokhtaberidze’s ownership interest in Magticom, of $18.2 million, (as discussed in further detail in Note 14, “Acquisitions and Other Transactions – Magticom Activity”).

     As previously indicated, the outstanding principal on the Senior Notes becomes due in full on September 30, 2007 and the Company does not currently anticipate that it can retire the Senior Notes with internally generated cash flows, without the sale of either its interest in PeterStar or its interests in both PeterStar and Magticom. In addition, failure on the part of the Company to make any required payment of interest on the Senior Notes would represent a default under the Senior Notes. A default, if not waived, could result in acceleration of the Company’s indebtedness, in which case the full amount of the Senior Notes would become immediately due and payable. If an uncured default were to occur, the Company does not currently anticipate that it can retire the Senior Notes with internally generated cash flows without the sale of either its interest in PeterStar or its interests in both PeterStar and Magticom.

     Furthermore, the Company has not been successful with past refinancing initiatives associated with the Senior Notes, and as such, the Company might not be able to borrow sufficient funds to remedy a situation where it’s obligated to retire the Senior Notes, either due to a uncured default situation or as a result of the ultimate maturity of the Senior Notes.

     If the Company is not able to satisfactorily address the corporate liquidity issues described above, the Company may have to resort to certain other measures, including ultimately seeking the protection afforded under the U.S. Bankruptcy Code. The Company cannot provide assurances at this time that it will be successful in avoiding such measures. Additionally, the Company has a stockholders’ deficit and has suffered recurring operating losses and operating cash deficiencies.

     The factors discussed above raise substantial doubt about the Company’s ability to continue as a going concern. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

     In June 2004, the Company reached an agreement (the “Board of Director Nominee Agreement”) with certain holders of the Company’s 7¼% cumulative convertible preferred stock (the “Preferred Stock”) who represented to the Company that they held discretionary authority (including the power to vote) with regard to 2.4 million shares or approximately 58% of the outstanding 4.1 million shares of Preferred Stock (the “Participating Preferred Stockholders”). Under the terms of the Board of Director Nominee Agreement, the Participating Preferred Stockholders irrevocably waived the right to request a special meeting of holders of Preferred Stock to elect directors or take any action to request such a meeting; such waiver to remain effective until immediately after the next annual meeting of the Company’s stockholders is held. In consideration of this waiver, Messrs. Gale and Henderson, who were identified by the Participating Preferred Stock Holders as director candidates, were elected as Class III Directors by the Company’s Board of Directors. Their terms will expire at the Company’s next annual meeting of stockholders. At the next annual meeting, the holders of Preferred Stock will have the right to vote separately as a class for the election of two directors. It is expected that Messrs. Gale and Henderson will be nominated for election by the holders of Preferred Stock to fill these two directorships.

     The execution of the Board of Director Nominee Agreement was the culmination of several discussions that the Company had with several holders of the Company’s Preferred Stock, which began in late 2003 and had originated due to the fact that the Company had not made six consecutive dividend payments on the Preferred Stock. According to the terms of the Preferred Stock, holders of 25% of the voting power of the outstanding Preferred Stock became entitled to compel the Company to call a special meeting of the holders of the Preferred Stock for the purpose of electing two new directors. The Company believes that the Board of Director Nominee Agreement was advantageous to the Company because it eliminated the need to hold a special meeting, which would have been both time consuming and expensive.

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2. Summary of Significant Accounting Policies

Stock Option Plans

     The Company has elected to use the intrinsic value-based method to account for its stock-based compensation in accordance with the provisions of Accounting Principles Board (“APB”) No. 25, “Accounting for Stock Issued to Employees” and disclose the pro forma effects on results of operations as if the fair value method had been adopted to account for its stock-based employee compensation plans.

Accounting Change

     Effective January 1, 2003, the Company changed its policy regarding the accounting for certain business ventures previously reported on a lag basis. All of the Company’s current operating business ventures with the exception of PeterStar, have historically reported their financial results on a three-month lag. In an effort to provide more timely and meaningful financial information on the Company’s business operations, the Company determined that all business ventures should be reported on a real-time basis. As a result of this change, a $2.5 million decrease to the accumulated deficit as of January 1, 2003 was recorded, of which $2.0 million is reflected as income related to the cumulative effect of a change in accounting principle and the remaining $0.5 million is included as a cumulative effect of a change in accounting principle in income from discontinued components for the nine months ended September 30, 2003.

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     The effect of this change on the consolidated statement of operations for the nine months ended September 30, 2003 is as follows (in thousands, except per share data):

3. Change in Basis of Presentation

     The Company is in a commercial dispute with Mtatsminda Ltd. (“Mtatsminda”), the Company’s 15% minority partner in its Ayety business venture.

     On June 2, 2004, Mtatsminda sent a letter to the Company in which it addressed four issues. First, Mtatsminda requested that the Company cause Ayety to renegotiate the terms pursuant to which Ayety is using 11 broadcast frequencies which belong to Mtatsminda. Second, Mtatsminda alleges that the Company has an obligation to pay property taxes on the buildings owned by an affiliate of the Company in Tbilisi and that the Company has failed to meet this obligation. Third, Mtatsminda disputes the validity of loans made by the Company to Ayety. Fourth, Mtatsminda alleges that the Company may have violated laws against bribery of foreign officials and possibly engaged in other improper or illegal conduct. These issues were again raised by Mtatsminda in a letter addressed to the Company, dated June 25, 2004.

     With respect to the broadcast frequencies, Ayety has been using the 11 frequencies under an agreement with Mtatsminda which recently expired. Ayety is intending to enter into negotiations with Mtatsminda to secure continued long-term use of these frequencies. The Company believes that the risk of Mtatsminda withdrawing the right to use its frequencies is remote. With respect to the property tax issue, the Company has investigated this allegation and it believes that the amount of tax due, if any, is negligible and it has been advised by outside legal counsel that the risk of a tax assessment is remote. Further, the Company believes that the allegations related to the loans made to Ayety are unfounded and intends to vigorously defend itself on this issue.

     The Company believes that the fourth allegation is substantially similar to those raised previously by certain Georgian individuals and described in Note 12, “Commitments and Contingencies — Georgian Matters.” The Company’s Board of Directors

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authorized the Company’s outside counsel to conduct an independent inquiry into the allegations of possible improper or illegal conduct made by the Georgian individuals. The investigation has been completed and the results have been reported by the Company’s outside counsel to the Board of Directors of the Company. The investigation did not uncover any specific factual support for the allegations regarding violations of laws against bribery of foreign officials, including the Foreign Corrupt Practices Act, or other alleged improper or illegal conduct. The Audit Committee of the Company’s Board of Directors has reviewed the June 2, 2004 letter sent by Mtatsminda and believes that the allegations made with respect to violations of laws and other improper or illegal conduct are substantially similar to those previously investigated by the Company’s outside counsel. For this reason, the Audit Committee has determined not to re-open the investigation.

     At the request of Mtatsminda, the Company agreed to participate in a meeting of Ayety shareholders on June 28, 2004. At that meeting, the Company’s intent was to address matters raised in Mtatsminda’s letter to the Company dated June 2, 2004 and to also address matters relative to the poor financial performance of Ayety, including the Company’s decision to remove and appoint a new General Director of the business. However, at such meeting, Mtatsminda notified the Company that in March 2003, a new charter of Ayety was prepared and filed in the Georgian courts (which are responsible for company registration in Georgia) (the “New Charter”). Mtatsminda represented that, pursuant to the terms of the New Charter, unanimous shareholder approval is required for certain key decisions, including the removal and appointment of a new General Director; whereas previously only a 75% vote was required. Further, at the meeting, Mtatsminda informed the Company that it would not vote “for” the Company’s proposal regarding the removal of Ayety’s General Director. The Company believes that the legality of the changes to the New Charter is questionable and can be disputed by the Company on the basis that the New Charter was adopted in a manner that was not in compliance with applicable law. However, since the New Charter has already been filed and accepted by the Georgian courts, the New Charter is valid until successfully challenged.

     Mtatsminda did not present a registered copy of the New Charter at the June 28, 2004 meeting of Ayety shareholders or subsequently, nor had the Company previously received any such copy from Ayety. Nonetheless, the Company’s representatives concluded from that meeting that Mtatsminda had secured practical control over Ayety; both by virtue of its claims with respect to the New Charter and through its direct associations with the General Director of Ayety. The Company is pursuing legal remedies with respect to the New Charter and continues to seek removal of Ayety’s General Director. However, management has concluded that, based on these events, the Company does not at present control the day-to-day business affairs of Ayety. Accordingly, effective June 30, 2004, the Company no longer accounts for its ownership interest in Ayety following the consolidation method of accounting but follows the equity method of accounting.

     As discussed in further detail in Note 12, “Commitments and Contingencies”, on July 25, 2004, Mtatsminda filed a claim in the courts within the Republic of Georgia against International Telcell SPS, Inc. (“ITSPS”), a subsidiary of the Company, Ayety and Zurab Chigogidze, the General Director of Ayety, for damages in the amount of GEL 185,000 (US $90,000), GEL 23,000 (US $13,000) and GEL 258,000 (US $130,000), respectively. In its complaint, Mtatsminda alleges that it suffered damages because Ayety had used its cash resources to make payments to ITSPS in repayment of a credit facility between Ayety and ITSPS. Mtatsminda also claims that Ayety has not authorized the credit facility. Mtatsminda further alleges that Ayety’s funds should have been used to make dividend payments to Mtatsminda. The Company disputes these claims and has filed a counter-suit in the Georgian courts. Based on the information available and due to the relatively low amounts of damages claimed, the Company believes that these matters will not result in any material adverse effect on the Company’s business financial condition or results of operations.

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     Summarized results of operations of the Company’s consolidated financial statements and proforma results of operations of the Company with Ayety unconsolidated for all periods presented are as follows (in thousands):

     Summarized balance sheet information of the Company’s consolidated financial statements and proforma balance sheet information of the Company as if Ayety had been unconsolidated as of December 31, 2003 are as follows (in thousands):

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4. Investments In and Advances to Business Ventures

Credit Agreements with Business Ventures

     The Company had historically entered into credit agreements with its business ventures and subsidiaries, including those classified as discontinued operations, and had made advances to the business ventures in the form of cash, for working capital purposes, payment of expenses or capital expenditures, or in the form of equipment purchased on behalf of the business ventures. Interest rates charged to the business ventures and subsidiaries have ranged from prime rate to prime rate plus 6%. The credit agreements generally provided for the payment of principal and interest from 90% of the business ventures’ and subsidiaries’ available cash flow, as defined, prior to any substantial distributions of dividends to the business venture partners. As of September 30, 2004, the credit agreement with Ayety, with an aggregate outstanding balance of $15.9 million, was the sole remaining credit line outstanding, which has been fully provided for. As discussed in further detail in Note 3, “Change in Basis of Presentation” and Note 12, “Commitments and Contingencies”, the Company has been involved in several commercial disputes with Mtatsminda, the Company’s 15% minority partner in its Ayety business venture, and one of the claims being made by Mtatsminda is that the $15.9 million credit agreement between the Company and Ayety is not valid. In its complaint, Mtatsminda alleges that it suffered damages because Ayety had used its cash resources to make payments to ITSPS in repayment of a credit facility between Ayety and ITSPS. Mtatsminda also claims that Ayety has not authorized the credit facility. Mtatsminda further alleges that Ayety’s funds should have been used to make dividend payments to Mtatsminda. The Company disputes these claims and has filed a counter-suit in the Georgian courts. The Company believes that these matters will not result in any material adverse effect on the Company’s consolidated business financial conditions or results of operations, due to accumulated losses recognized related to the Company’s investment in Ayety.

     All other credit agreements between the Company and its business ventures have either been repaid or terminated/assigned pursuant to the terms and conditions of the sale agreements associated with the disposition of the respective business ventures.

Investments In and Advances to Business Venture

     As of September 30, 2004 and December 31, 2003, the Company’s “investment in and advances to business ventures” balance included within the Company’s consolidated balance sheet reflects the Company’s 49% equity investment in Magticom through Telcell Wireless, LLC, a 70.41% owned subsidiary holding company for which the Company follows the consolidation method of accounting. The Company’s effective ownership of Magticom is 34.5%.

     As further described in Note 3, “Change in Basis of Presentation,” and as reflected below, the Company’s “investment in and advances to business ventures” balance also includes activity associated with the Company’s net investment in Ayety, effective June 30, 2004.

     The components of the Company’s investments in and advances to business ventures are as follows (in thousands):

     As of September 30, 2004, the Company’s investments in and advances to business venture balance reflects only the Company’s investment in Magticom, since the Company’s U.S. GAAP investment carrying balance (net of accumulated losses and currency translation adjustments) in both Telecom Georgia and Ayety is zero.

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Changes in the Investments in and Advances to Business Ventures

     The changes in the investments in and advances to business ventures are as follows (in thousands):

     Certain cable and telephony business ventures in which the Company disposed of its interests were accounted for using the equity method of accounting.

     Such ventures principally included:

     Comstar and Kosmos TV were disposed as a part of the Adamant transaction while MTR Svyaz and Teleport TP were disposed as a part of the Technocom transaction (see Note 11, “Discontinued Business Components”). The remaining transactions are as follows:

Cosmos TV Transaction

     On March 26, 2004, the Company announced that it had completed the sale of its interests in various cable ventures, including Cosmos TV (“Cosmos”), to Star Broadband Limited, a British Virgin Islands company, which is controlled by Dominic Reid, former General Director of the Company’s cable business group, for $0.7 million. The Company recorded neither a gain nor a loss on the sale of Cosmos, due to the fact that the Company had written down its investment in Cosmos in the fourth quarter of 2003 to the estimated fair value less costs to sell, and as such, recorded a $1.5 million impairment charge.

Teleplus Transaction

     On November 21, 2003, the Company sold all of its interest in the St. Petersburg, Russia cable television company, Teleplus, to a Russian company “Svyaz-Kapital” and AVT Systems Ltd., a company organized under the laws of Cayman Islands, for cash consideration of $0.9 million. The Company recognized a gain of $0.7 million on the disposition in the three months ended December 31, 2003.

Tyumenruskom Transaction

     On September 24, 2003, the Company sold its interest in the Russian mobile phone company Tyumenruskom to a Russian company for cash consideration of $1.2 million. In addition, the Company was released from its guarantee of Tyumenruskom’s debt by a vendor. The Company had previously recorded a reserve related to this guarantee that totaled $1.4 million on the date of the

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transaction. The Company recognized a gain on the disposition of $2.6 million, which was recorded in the three months ended September 30, 2003.

Baltcom TV Transaction

     On August 1, 2003, the Company sold all of its interest in the Latvian cable television company Baltcom TV (“Baltcom”) to the Latvian company SIA Alina (“Alina”) for cash consideration of $14.5 million. Alina was the owner of 45% of Baltcom prior to the transaction. The Company recognized a gain of $9.3 million on the disposition, which was recorded in the three months ended September 30, 2003.

Financial Information

     The following tables represent condensed financial information for the Company’s operating unconsolidated business ventures, including those disposed, up to the date of disposition, as of and for the three and nine months ended September 30, 2004 and 2003. The results of operations presented below are before the elimination of intercompany interest (in thousands):

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Combined Balance Sheets

     The condensed balance sheets of Magticom and Ayety as of September 30, 2004 and the condensed balance sheet of Magticom as of December 31, 2003 are as follows (in thousands):

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5. Long-term Debt

10½% Senior Notes

     In September 1999, the Company entered into a trust agreement to issue the Senior Notes in the face amount of $210.6 million. The Senior Notes are unsecured but rank senior to all existing and future subordinated indebtedness of the Company. The Senior Notes are not subject to sinking fund requirements and are redeemable at the Company’s option at any time. The principal is due, in its entirety, in September 2007. The Senior Notes bear interest at a rate of 10½% per annum, payable semiannually on March 31^st and September 30^th, respectively.

     Under the terms of the indenture governing the Senior Notes, the Company and certain of its subsidiaries are subject to certain covenants pertaining to its financing activities. Such covenants restrict the Company and certain of its subsidiaries from paying dividends, acquiring its capital stock, prepaying subordinated indebtedness, investing in and selling assets and subsidiary stock, and incurring additional indebtedness, among other activities. In addition, upon the occurrence of a change of control of the Company (as defined), the holders of the Senior Notes have the right to require the Company to repurchase all or any part of the Senior Notes at a cash purchase price of 101% of the face value of the Senior Notes plus accrued interest as of the date of repurchase, unless the Company provides a redemption notice to the holders of the Senior Notes prior to the holders of the Senior Notes exercising their change of control right. In the event of the Company issuing a redemption notice, the Company would repurchase all Senior Notes at a cash purchase price of 100% of the face value of the Senior Notes plus accrued interest as of the date of repurchase.

     On April 24, 2003, the Company completed an exchange with Adamant Advisory Services (“Adamant”) of its ownership interest in certain of its business units in Russia for, among other things, approximately $58.6 million face value of Senior Notes held by Adamant, $5.0 million in cash and a release of its $3.5 million obligation to pay interest accrued on the Senior Notes being exchanged (See Note 11, “Discontinued Business Components – Adamant Transaction"). With the completion of this transaction, the outstanding principal balance on the Senior Notes was reduced to $152.0 million.

6. Stockholders’ Equity

Common Stock

     On September 24, 2003, the Company’s equity securities were removed from quotation on the OTC Bulletin Board trading system (“OTCBB”) because the Company was not then in compliance with NASD Rule 6530. As a result, the Company’s common stock and Preferred Stock were then quoted on the Pink Sheets. On June 18, 2004, the Company filed its first quarter 2004 Form 10-Q, and became compliant with OTCBB trading eligibility requirements. As such, on August 6, 2004, the Company’s Common Stock (OTCBB: MTRM.OB) began trading on the OTC Bulletin Board after a market maker had successfully filed a petition with the NASD seeking their permission for the Company’s common stock to be quoted on the OTCBB. The Company’s Preferred Stock (OTCPK: MTRMP) remains quoted on the Pink Sheets.

Preferred Stock

     There are 70.0 million authorized shares of preferred stock of which 4.1 million shares have been designated as 7¼% cumulative convertible preferred stock with a liquidation preference of $50.00 per share, all of which were outstanding as of September 30, 2004 and December 31, 2003.

     Dividends on the Preferred Stock are cumulative from the date of issuance and payable quarterly, in arrears. The Company may make any payments due on the Preferred Stock, including dividend payments and redemptions (i) in cash; (ii) through issuance of the Company’s common stock or (iii) through a combination thereof.

     Through March 15, 2001, the Company paid its quarterly dividends in cash. The Company has elected not to declare a dividend for any quarterly dividend periods ending after June 15, 2001. As of September 30, 2004, total dividends in arrears are $59.8 million. The dividend requirement for the twelve months ending September 30, 2005 will be $19.8 million, inclusive of the effects of compounding and assuming no payments of the dividends.

     The Preferred Stock is redeemable at any time, in whole or in part, at the discretion of the Company, initially at a price of $52.5375 per share in the year 2000 and thereafter at prices declining to $50.00 per share on or after September 15, 2007, plus in each case all accrued and unpaid dividends as of the redemption date. As of September 30, 2004, the Company has not redeemed any of the Preferred Stock. The Preferred Stock is not subject to any sinking fund provisions.

     The Preferred Stock is convertible at any time at the option of the holders into shares of common stock of the Company. The rate used to determine the number of shares of common stock is a function of the liquidation preference, any accrued and unpaid dividends and the initial conversion price of $15.00. As of September 30, 2004, no shares of Preferred Stock have been converted into shares of common stock. In the event of any voluntary or involuntary dissolution, liquidation or winding up of the Company, the holders of the Preferred Stock will be entitled to be paid out of the Company’s assets available for distribution to its stockholders,

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before any payment or distribution is made to the holders of common stock or other class of stock subordinated to the Preferred Stock. The holders of the Preferred Stock are entitled to receive a liquidation preference in the amount of $50.00 per share, plus all accrued and unpaid dividends, or a pro rata share of the full amounts to which the holders of the Preferred Stock are entitled in the event the liquidation preference cannot be paid in full. Under the terms of the Certificate of Designation governing the Preferred Stock the Proposed Merger would not be deemed a voluntary or involuntary liquidation, dissolution or winding up of the Company. Except as described below, the holders of the Preferred Stock have no voting rights.

     In June 2004, the Company entered into the Board of Director Nominee Agreement with certain holders of the Preferred Stock who represented to the Company that they held discretionary authority (including the power to vote) with regard to 2.4 million shares or approximately 58% of the outstanding 4.1 million shares of Preferred Stock. Under the terms of the Board of Director Nominee Agreement, the Participating Preferred Stock Holders irrevocably waived the right to request a special meeting of holders of Preferred Stock to elect directors or take any action to request such a meeting; such waiver to remain effective until immediately after the next annual meeting of the Company’s stockholders is held. In consideration of this waiver, Messrs. Gale and Henderson, who were identified by the Participating Preferred Stock Holders as director candidates, were elected as Class III Directors by the Company’s Board of Directors. Their terms will expire at the Company’s next annual meeting of stockholders. At the next annual meeting, the holders of Preferred Stock will have the right to vote separately as a class for the election of two directors. It is expected that Messrs. Gale and Henderson will be nominated for election by the holders of Preferred Stock to fill these two directorships.

     The execution of the Board of Director Nominee Agreement was the result of several discussions that the Company had with several holders of the Company’s Preferred Stock, which began in late 2003, and had originated due to the fact that the Company had not made six consecutive dividend payments on the Preferred Stock. According to the terms of the Preferred Stock, holders of 25% of the voting power of the outstanding Preferred Stock became entitled to compel the Company to call a special meeting of the holders of the Preferred Stock for the purpose of electing two new directors. The Company believes that the Board of Director Nominee Agreement was advantageous to the Company because it eliminated the need to hold a special meeting, which would have been both time consuming and expensive. See Note 1, “Basis of Presentation, Description of Business, Recent Developments and Going Concern – Proposed Merger,” for further discussion related to the effect of a merger of the Company with regard to the Preferred Stockholders

7. Employee Benefit Plans

     Until the third quarter of 2004, the Company sponsored two tax-qualified defined benefit pension plans in the U.S. These plans covered certain former employees of the Company and one of its subsidiaries. The plan covering Company personnel was amended effective December 31, 1995 and plan benefits were frozen as of that date. The plan covering the former subsidiary’s personnel was amended effective December 31, 2002 and plan benefits were frozen as of that date. The plans were merged at the end of September 2004 to reduce administrative and related expenditures (the “Merged Plan”). The Merged Plan is a noncontributory defined benefit pension plan, under which pension benefits are calculated based on years of service and participants’ compensation. As of September 30, 2004, the unfunded status of the Merged Plan was approximately $3.3 million as compared with $3.8 million as of December 31, 2003. The Company’s policy is to contribute annually, at a minimum, the amounts required by the Internal Revenue Code and the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). However, the Company may from time to time make contributions in amounts that are larger than those legally required. The Company expects to contribute $1.5 million to the Merged Plan in 2004, of which $0.7 million is in excess of the minimum funding requirements set forth in ERISA and the Internal Revenue Code. Furthermore, as disclosed in further detail in Note 15, “Subsequent Events”, on October 7, 2004, the Board of Directors of the Company approved management’s recommendation to terminate the Merged Plan, pursuant to a standard termination in accordance with provisions of Section 4041 of the ERISA, which will result in additional contributions, beyond the ERISA mandated minimums in 2005.

     The Company also maintains a nonqualified, unfunded supplemental retirement plan (“SERP”) for certain former executives based in the U.S. The plan is a noncontributory defined benefit pension plan, under which pension benefits are calculated based on a formula incorporating years of service and participants’ compensation. In addition, the Company also provides an unfunded group medical plan and life insurance coverage for certain former employees subsequent to retirement (the “Retiree Medical Plan”). As of September 30, 2004, the unfunded status of the SERP and Retiree Medical Plan was approximately $3.7 million as compared with $3.8 million as of December 31, 2003. The Company anticipates that it will distribute approximately $0.4 million in 2004 to participants of the SERP and Retiree Medical Plan. As disclosed in further detail in Note 15, “Subsequent Events”, the Company’s intent is to settle its legal obligation with regard to the benefits attributable to the SERP and the Retiree Medical Plan within the next twelve months.

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     Components of net periodic benefit costs are as follows (in thousands):

     The components of net periodic benefit costs for the three months ended September 30, 2004 and 2003 are not considered significant.

8. Earnings Per Share of Common Stock

     Basic earnings per common share (“EPS”) are computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue Company common stock were exercised or converted into Company common stock. The weighted average number of common shares outstanding for computing basic and diluted EPS was 94.0 million for each of the periods ended September 30, 2004 and 2003. For the periods ended September 30, 2004 and 2003, 21.1 million and 21.9 million shares, respectively, attributable to the exercise of outstanding options, warrants and convertible Preferred Stock were excluded from the calculation of diluted EPS because the effect was antidilutive.

9. Business Segment Data

     The Company has continuing operations in northwest Russia and the Republic of Georgia. The Company’s reporting segments are comprised of (i) fixed telephony, (ii) wireless telephony and (iii) cable television. The Company evaluates the performance of its operating segments based on operating income and earnings before income taxes. Equity in income (losses) of unconsolidated investees reflects elimination of intercompany interest expense and management fees.

     In 2004, consolidated fixed telephony is comprised solely of PeterStar. In 2003, consolidated fixed telephony was comprised of both PeterStar and Baltic Communications Ltd. (“BCL”), a former wholly-owned subsidiary that provided telecommunication services in St. Petersburg, Russia. On October 1, 2003, PeterStar acquired the Company’s ownership rights in BCL.

     In 2004, unconsolidated wireless telephony is comprised of Magticom. In 2003, unconsolidated wireless telephony was comprised of both Magticom and Tyumenruskom. The Company disposed of its interest in Tyumenruskom in September 2003.

     Consolidated cable television through June 30, 2004 is comprised of Ayety. As discussed in further detail in Note 3, “Change in Basis of Presentation”, subsequent to June 30, 2004, Ayety’s results are presented in equity in losses of unconsolidated investees.

     In addition to these business segments, the Company had other operating activities that were carried out in business ventures which are considered discontinued components (See Note 11, “Discontinued Business Components”). Further, the Company had other unconsolidated activities that were carried out in business ventures, which were disposed of during 2004 and 2003 (See Note 4, “Investments in and Advances to Business Ventures”).

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     The Company’s segment information is set forth for the three and nine months ended September 30, 2004 and 2003 in the following tables (in thousands):