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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, 1999
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, par value $.001 per share American Stock Exchange
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 April 11, 2000, 12,009,479 shares of the Registrant's Common
Stock were outstanding, of which 12,007,179 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 April 10, 2000, was $92,305,189. The
exclusion of shares owned by any person from such amount shall not be deemed an
admission by the Registrant that such person is an affiliate of the Registrant.
Documents Incorporated by Reference
Part III - Portions of the Registrant's proxy statement for the Annual
Meeting of Stockholders for the fiscal year ended December 31, 1999.
Cautionary Statement Regarding Forward-Looking Statements
Certain statements contained herein which express "belief,"
"anticipation," "expectation," or "intention" or any other projection, insofar
as they may apply prospectively and are not historical facts, are
"forward-looking" statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Because such
statements include risks and uncertainties, actual results may differ materially
from those expressed or implied by such forward-looking statements. Factors that
could cause actual results to differ materially from those expressed or implied
by such forward-looking statements include, but are not limited to, the factors
set forth in "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations."
PART I
In this Part I of Form 10-K, all references to "$" or "U.S. dollars"
are to United States dollars all references to EUR are to euros and all
references to "HUF" or "forints" are to Hungarian forints. Certain amounts
stated in euros and 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, 1999 exchange rates. The
forint/U.S. dollar middle exchange rate as of December 31, 1999 was
approximately 252.52 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 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, 1999
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of $181 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. As of December 31, 1999, the Company's
telecommunications networks had approximately 200,500 access lines in service
(including pay phones). The completion of the Company's network construction
program has resulted in the addition of approximately 139,100 new access lines
in service (including pay phones) 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 Company's
networks now have the capacity, with some additional capital expenditures, to
provide basic telephone services to virtually all of the estimated 276,500 homes
and 36,200 business and other institutional subscribers (including government
institutions) within its Operating Areas. The build-out was primarily financed
through a $170 million credit facility with Postabank es Takarekpenztar (the
"Original Postabank Credit Facility"), a Hungarian commercial bank
("Postabank"), which was subsequently refinanced and a $47.5 million contractor
financing facility. See "- Revision of Capital Structure," "- Recent
Developments," Item 3 "Legal Proceedings," Item 7 Management Discussion and
Analysis of Financial Conditions and Results of Operations - Introduction" and
Notes 1(a) and 10(d) of Notes to Consolidated Financial Statements.
The following table sets forth certain information as of December 31,
1999 with respect to each of the Operating Companies.
Raba-Com KNC Papatel Hungarotel Total
Population 65,300 146,400 64,000 398,500 674,200
Residences 26,300 59,600 24,000 166,600 276,500
Businesses and other(1) 4,300 6,300 3,300 22,300 36,200
Access lines in operation:
Residential 19,800 40,400 17,400 97,300 174,900
Business and other(2) 2,500 5,900 2,200 15,000 25,600
-------- -------- -------- --------- --------
Total 22,300 46,300 19,600 112,300 200,500
Pay phones 165 477 195 1,079 1,916
Population Penetration rate(3) 34.2 31.6 30.6 28.2 29.7
Residential Penetration rate (4) 75.3 67.8 72.5 58.4 63.3
- --------
(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. Includes ISDN equivalent lines.
(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.
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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,
1997, 1998 and 1999.
Takeover 1995 1996 1997 1998 1999
-------- ---- ---- ---- ---- ----
Raba-Com 2,500(1) 5,100 14,000 20,600 21,400 22,300
KNC 13,000(1) 14,200 20,500 35,500 40,000 46,300
Papatel 3,800(2) 3,800 11,100 17,000 18,300 19,600
Hungarotel 42,100(2) 42,100 47,800 102,000 105,300 112,300
---------- ---------- --------- --------- --------- --------
Total 61,400 65,200 93,400 175,100 185,000 200,500
(1) 1st Quarter 1995
(2) Year-End 1995
The Republic of Hungary
Hungary is located in Central Europe bordering on Austria, Slovenia,
Croatia, Yugoslavia, Romania, Ukraine and Slovakia. Six West European capitals
are within a one-hour flight. Its total area is approximately 93,030 square
kilometers. It has 10.1 million inhabitants, approximately 2 million of whom
reside in Hungary's capital, Budapest.
For nearly 40 years, Hungary was under central state control with a
one-party government and a centrally planned economy. Democracy was restored and
the foundations of a market economy were built between 1988 and 1990. Free
elections were held in 1990. Today, Hungary has a parliamentary democracy with a
single-chamber National Assembly. As a result of a large scale privatization
effort, private enterprise has become the basis of the Hungarian economy.
Today, Hungary is considered the most developed country in Central
Europe. Since 1989, foreign direct investment has been approximately $20
billion. Foreign direct investment was approximately $2 billion in 1999 and is
expected to stay at that level in 2000. On a per capita basis, Hungary has been
the largest Central European recipient of foreign direct investment since the
transition to a market economy. In comparison to Poland and the Czech Republic,
Hungary received (on a per capita basis) nearly 3 times the level of foreign
direct investment of Poland and twice that of the Czech Republic.
Since 1995, the Hungarian government has embarked on an economic
stabilization effort aimed at putting the economy on a sustainable path of
low-inflationary growth. Hungary has experienced the following annual GDP growth
rates since the initiation of that effort: 1.7% in 1995; 1.3% in 1996; 3.5% in
1997; 5% in 1998, and 4.9% in 1999. The unemployment rate has gradually
decreased from 11.1% in 1995 to 7.0% in 1999. The Hungarian inflation rate has
been steadily decreasing as well as evidenced by the following declining annual
inflation rates: 28.2% in 1995; 23.6% in 1996; 18.2% in 1997; 14.5% in 1998; and
10.0% in 1999.
In March 1998, Hungary's application for membership in the European
Union ("EU") was accepted. Hungary is now in the process of negotiating the
terms of its official accession into the EU. Hungary is not expected to become a
member of the EU until 2003 at the earliest. In March 1999, Hungary joined the
North Atlantic Treaty Organization. Hungary is also a member of the World Trade
Organization.
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Overview of Hungarian Telecommunications Industry
Early State of Hungarian Telecommunications Industry
In 1989, the state-owned Post, Telegraph and Telephone ("PTT") was
divided into three separate companies: the Hungarian Broadcasting Company
("Antenna Hungaria"), the Hungarian Post Office ("Magyar Posta") and Matav. The
Hungarian PTT was historically the exclusive provider of telecommunications
services in Hungary. The Hungarian telecommunications market was significantly
underdeveloped without the necessary investment in the 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 a 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.
Privatization of Matav and Local Telephone Service
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 AG, the German public telephone
operator ("Deutsche Telekom"), and Ameritech, the United States based
telecommunications company. In 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%. The Hungarian
State also retained certain shareholder rights by retaining one "Golden Share."
In 1999 the Hungarian State sold its remaining 6% ownership interest in Matav
but retained its "Golden Share." As of December 31, 1999, MagyarCom owned 59.5%
of Matav while 40.5% was publicly traded.
In 1992 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, 1999, 23 of the 25
concessions for which the Ministry solicited bids had been awarded. Holders of
those concessions today (each a Local Telephone Operator, "LTO", and together
the "LTOs") include: the Company (presently 5 areas); United Telecom Investment
Rt. ("UTI"), a consortium formed by Alcatel Austria AG and US Telecom East, Inc.
(4 areas); Vivendi-Telecom Hungary ("Vivendi") owned by affiliates of Vivendi SA
of France and General Electric Capital Corp. (5 areas); an affiliate of United
Pan-Europe Communications NV ("UPC") (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. Each
of the LTOs (including Matav) received 25 year licenses to provide local basic
telephone service with exclusivity rights in their respective concessions
-5-
through 2002 (2001 in the case of Matav except for 5 areas in which Matav has
exclusivity rights through 2002). 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.
Cellular Service
In addition to the liberalization of basic telephone services, the
Ministry also initially selected two consortia to provide nationwide cellular
telephone services. A consortium comprised of Matav and MediaOne Group Inc.,
formerly part of U.S. West, was granted two licenses to provide both analog
(NMT-450) ("Westel 450") and digital (GSM-900) ("Westel 900") services while
Pannon GSM Tavkozlesi ("Pannon") was granted a license to provide only digital
cellular services. Pannon's shareholders include Telenor Invest A/S, Norway
(25.8%); Tele Danmark A/S (6.6%); Sonera Holding NV (23%), Media Tel Holding Rt.
(15.2%); and KPN NV, the Dutch phone company ("KPN") (29.4%). In 1999, MediaOne
announced that it was going to sell its holdings in Westel 450 and Westel 900 to
Deutsche Telekom. Matav has announced that it intends to exercise an option it
has to purchase the interests in Westel 450 and Westel 900 that Deutsche Telekom
is acquiring from MediaOne.
In June 1999, a consortium comprised of Vodaphone Air Touch Plc.
(50.1%), RWE Telliance (19.9%), Antenna Hungaria (20%) and Magyar Posta (10%)
(together, "Vodaphone") was the winning bidder for a digital 1800-megahertz (or
DCS frequency) mobile phone license. It began operations in late 1999.
Domestic and International Long Distance Services
At the end of 2001, Matav's right to provide exclusive domestic and
international long distance voice transmission is due to expire. In 1998, to
further stimulate future competition in this market, the Ministry awarded
Pan-Tel Rt., a newly formed Hungarian company ("Pan-Tel"), the licenses to
provide such services as data transmission, voice mail and other services which
are not subject to exclusive concessions. Pan-Tel started building its
telecommunications network in 1998 which network is nearly complete. The current
shareholders of Pan-Tel include MAV Rt. (the Hungarian railway company) (25.1%),
PT Investment Holding Company (25.9%) and KPN (49%).
The Hungarian Telecommunications Industry Today
The Ministry recently announced that it will revise its laws in 2000
regarding the regulation of the telecommunication market in accordance with
European Union standards. The regulation of telephony, cable television and the
Internet would be affected. However, the Company does not expect that the
exclusivity period of its concession rights will be affected.
-6-
Since the privatization of the Hungarian telecommunications market, the
LTOs and Matav have spent approximately $822 million as of September 30, 1998
(at September 30, 1998 exchange rates) to build modern state-of-the-art
telecommunications networks throughout Hungary. As a result of such
construction, Matav had approximately 2.9 million access lines connected to its
telecommunications networks and the other LTOs (including the Company) had over
800,000 access lines connected to their telecommunications networks as of
December 31, 1999.
In the mobile telecommunications marketplace, Westel 450 and Westel 900
had 98,000 and 842,000 subscribers, respectively, as of December 31, 1999.
Pannon had approximately 669,000 subscribers as of December 31, 1999.
Due to the completion of the Company's network modernization and
construction program, access line penetration in the Company's Operating Areas
has increased to 30 access lines per 100 inhabitants as of December 31, 1999.
Given that the Company's, Matav's, and the other LTOs' investments in the
Hungarian telecommunications market over the last several years produced a
significant increase in the overall penetration rate in Hungary to approximately
34% as of December 31, 1999 and the expansion of the mobile telecommunications
market, the Company expects to benefit from a continued increase in the use of
its telecommunications services by its customer base as the overall Hungarian
telecommunications market continues to expand. 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 2001.
HTCC conducts its operations through the Operating Companies. Set forth
below is an organizational chart of the Company and its principal stockholders
as of April 11, 2000. Share ownership percentages of HTCC are based on shares of
HTCC's common stock (the "Common Stock") owned as of April 11, 2000, without
giving effect to outstanding options or warrants. Additionally, ownership
percentages for the Operating Companies do not give effect to future Hungarian
equity ownership requirements. See "-Regulation - Hungarian Equity Ownership
Requirements."
-7-
[CHART]
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. As of May 1, 2000,
the U.S. offices will be at Suite 32, Tokeneke Center, 30 Center Street, Darien,
CT 06820. The Company's principal office in Hungary is located at Terez krt. 46,
H-1066, Budapest; telephone (361) 474-7700.
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 company which provides telecommunications
services and public services including gas distribution, electric distribution,
water distribution and wastewater treatment services to approximately 1.9
million customers. Citizens also owns 82% of Electric Lightwave, Inc. (NASDAQ:
ELIX), a facilities-based, integrated communications provider that offers a
broad range of services to telecommunications-intensive businesses throughout
the United States. During 1999, Citizens announced that it had entered into
various agreements to purchase approximately 900,000 telephone access lines from
GTE Corp. and US West Communications, Inc. In addition, Citizens announced that
it was divesting its public services businesses and that it had entered into
agreements to sell its electric and water and wastewater operations. Citizens
plans to use the proceeds from the divestitures to fund the acquisitions. At
December 31, 1999, Citizens had $5.8 billion of total assets and $2.1 billion in
shareholders' equity. For the year ended December 31, 1999, Citizens had $1.1
billion of revenues from continuing operations and $144.5 million of net income.
-8-
In May 1995, Citizens purchased 300,000 shares of Common Stock from
a former executive officer of the Company and has since acquired an
additional 1,902,908 shares of Common Stock and 30,000 shares of the Company's
Series A Preferred Stock convertible into 300,000 shares of Common Stock,
pursuant to certain agreements entered into with HTCC (as amended and restated
in certain cases to date, the "Citizens Agreements"). Citizens also purchased
103,000 shares of Common Stock on the open market bringing its ownership of the
outstanding Common Stock as of April 11, 2000, to 19.2%. In addition, as a
result of the Citizens Agreements, Citizens has received certain options to
purchase 4.5 million shares of Common Stock. These options expire on September
12, 2000, with per share exercise prices ranging from $12.75 to $18.00. 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 in order to maintain its percentage ownership interest on
a fully diluted basis. Assuming the exercise of all of its outstanding rights
and options to purchase Common Stock as of April 11, 2000, Citizens would own
35.1% of the outstanding Common Stock on a fully-diluted basis. For a more
detailed description of some of the Citizens Agreements, see Notes 11 and 15 of
Notes to Consolidated Financial Statements, Item 13 "Certain Relationships and
Related Party Transactions," Item 12 "Security Ownership of Certain Beneficial
Owners and Management," "- Revision of Capital Structure" and "- Recent
Developments."
Tele Danmark A/S
Tele Danmark A/S (together with its affiliates, "Tele Danmark") is the
preeminent provider of telecommunications services in Denmark. Tele Danmark
provides a full range of telecommunications services in Denmark, including
landline and cellular telephone services, data communications, Internet, leased
lines, directory and operator services and cable television. Domestic operations
include 3,628,000 telephone subscriber lines, 1,311,000 cellular users, 825,000
cable television customers and 393,000 Internet dial-up customers.
At December 31, 1999, Tele Danmark had total assets of Danish Kroner
54,625 billion (approximately $7.0 billion at current exchange rates) and
shareholders' equity of Danish Kroner 21,456 (approximately $2.7 billion at
current exchange rates). During 1999, Tele Danmark had net income of Danish
Kroner 3,513 billion (approximately $452 million at current exchange rates) on
net revenues of Danish Kroner 38,206 billion (approximately $4.9 billion at
current exchange rates.)
Tele Danmark's activities abroad have been an important growth areas
over the last several years. Tele Danmark operates in 12 European countries.
International operations accounted for more than 42% of Tele Danmark's net
revenues in 1999. Tele Danmark has investments in the Nordic region, continental
Western Europe as well as Central and Eastern Europe--among them Belgagom
(Belgium), Ben (the Netherlands), Sunrise (Switzerland), Talkline (Germany),
Polkomtel (Poland), Contactel (the Czech Republic) and UMC (Ukraine). In
Hungary, Tele Danmark also holds a 6.6% stake in Pannon, one of the three
digital cellular phone providers in Hungary.
-9-
As a result of certain agreements between the Company and Tele Danmark
(the "Tele Danmark Agreements"), the Company has issued 2,565,587 shares of
Common Stock to Tele Danmark. As of April 11, 2000, Tele Danmark owned 21.3% of
the Company's outstanding Common Stock. The Tele Danmark Agreements provide Tele
Danmark with certain preemptive rights to purchase, upon the issuance of Common
Stock in certain circumstances to third parties, shares of Common Stock in order
to maintain its percentage ownership interest of the outstanding Common Stock.
For a more detailed description of some of the Tele Danmark Agreements, see
Notes 8 and 11 of Notes to Consolidated Financial Statements, Item 13 "Certain
Relationships and Related Party Transactions," Item 12 "Security Ownership of
Certain Beneficial Owners and Management," "- Revision of Capital Structure,"
and "- Recent Developments."
Tele Danmark's stock trades on the Copenhagen Stock Exchange and the
New York Stock Exchange. SBC Communications of San Antonio, Texas owns 42% of
the shares, with the remaining shares held by individual and institutional
shareowners all over the world.
Postabank Rt.
Postabank was established in 1988 and provides a wide range of
commercial and retail banking services to its private and corporate customers in
Hungary. The bank has achieved significant growth since its inception. As of
December 31, 1999, its total assets were HUF 330 billion ($1.3 billion). Today
it is the fifth largest Hungarian financial institution in terms of total assets
and second in retail deposits with a 10% market share (6% market share in
corporate loans).
In October 1996, the Company entered into a $170 million 10-Year
Multi-Currency Credit Facility with Postabank (the "Original Postabank Credit
Facility"). In May 1999, as part of a revision of its capital structure, the
Company issued 2,428,572 shares of Common Stock, warrants to purchase 2,500,000
shares of Common Stock and notes in the aggregate amount of $25 million to
Postabank. The Company also entered into a $138 million Dual-Currency Bridge
Loan Agreement with Postabank (the "Postabank Bridge Loan Agreement"). As a
result of such issuances and other agreements, the Company paid off the balance
on the Original Postabank Credit Facility and terminated such agreement. The
Company expects to pay off the outstanding balance on the Postabank Bridge Loan
Agreement with the proceeds of a syndicated loan agreement.
As of April 11, 2000, Postabank owned 20.2% of the outstanding Common
Stock and 24.3% of the outstanding Common Stock on a fully diluted basis. For a
more detailed description of some of the Postabank Agreements, see Notes 4, 5, 6
and 19 of Notes to Consolidated Financial Statements, Item 13 "Certain
Relationships and Related Party Transactions," Item 12 "Security Ownership of
Certain Beneficial Owners and Management," "- Revision of Capital Structure" and
"- Recent Developments."
The Danish Investment Fund for Central and Eastern Europe
The Investment Fund for Central and Eastern Europe (the "Danish Fund")
is a Danish government initiated and financed investment fund founded in 1989 by
the Ministry of Foreign Affairs. The purpose is to promote Danish direct
investments in Central and Eastern Europe and to enhance the possibilities for
-10-
closer cooperation between Danish and Central and Eastern European companies.
The Danish Fund engages in projects via equity capital and/or loans in joint
ventures with a participation of one or more Danish companies. The Danish Fund
has experience in Hungary (currently four projects) and in particular the
Hungarian telecommunications sector, as it has been involved in Pannon from 1994
to 1996 and in two of the Operating Companies from 1994 to 1997. As of April 11,
2000, the Danish Fund owned 10.7% of the outstanding Common Stock. See Note 8 of
Notes to Consolidated Financial Statements.
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.
Revision of Capital Structure
In May 1999, the Company entered into various agreements as part of a
revision of its capital structure with the following parties: Postabank; Tele
Danmark; the Danish Fund; and CU CapitalCorp and Citizens International
Management Services Company, each of which is a wholly-owned subsidiary of
Citizens Utilities Company. As a result of such agreements, the Company
extinguished all of its obligations (i) to Postabank under the Original
Postabank Credit Facility in the amount of approximately $193 million and the
amounts borrowed to settle a portion due under a contractor financing facility
in the amount of approximately $16 million; (ii) to one of its contractors under
a contractor financing facility in the amount of approximately $35 million; and
(iii) to Citizens under a $8.4 million promissory note which was payable in 2004
and an obligation to pay Citizens $21 million in 28 quarterly installments of
$750,000 each from 2004 through and including 2010. The Company borrowed $138
million from Postabank under a one-year Dual-Currency Bridge Loan Agreement in
Hungarian forints and euros and $25 million pursuant to certain unsecured notes
which mature in 2007. Some of the various agreements which were entered into as
of May 10, 1999 are described herein. (The descriptions and summaries herein do
not purport to be complete, and are subject to, and qualified in their entirety
by, reference to each such agreement, copies of which are filed as exhibits
hereto. See Item 14 below).
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The Company and Postabank entered into a Dual-Currency Bridge Loan
Agreement (the "Postabank Bridge Loan Agreement") pursuant to which HTCC's
subsidiaries borrowed the equivalent of $111 million in Hungarian forints (at
historical exchange rates) and $27 million in euros (at historical exchange
rates) which funds were applied to the repayment of the Original Postabank
Credit Facility. The loan is repayable by May 2000. HTCC and one of its
subsidiaries, HTCC Consulting Rt. were guarantors for the HTCC subsidiaries
under the Postabank Bridge Loan Agreement. The Company pledged all of its
intangible and tangible assets, including HTCC's ownership interests in its
subsidiaries, and its real property to secure all of the obligations under the
Postabank Bridge Loan Agreement. The Company and Postabank entered into a series
of agreements to secure such obligations under the Postabank Bridge Loan
Agreement. On April 11, 2000, the Company entered into a EUR 130 million senior
security syndicated bank credit facility which funds will be used to pay off the
Postabank Bridge Loan Agreement. See " - Recent Developments."
The Company and Postabank also entered into a Securities Purchase
Agreement (the "Securities Purchase Agreement") pursuant to which Postabank
purchased 2,428,572 shares of Common Stock for an aggregate purchase price of
$34 million. The Securities Purchase Agreement provides for one person
designated by Postabank to be nominated for election to the Company's Board of
Directors. Postabank cannot transfer its shares until the earlier of (x) the
repayment in full of all the obligations under the Postabank Bridge Loan
Agreement or (y) May 10, 2000, and then Postabank can only transfer such shares
incrementally through 2003 subject to the Company's right of first refusal. The
Company's right of first refusal expires in January 2003 and is assignable by
the Company to any beneficial holder of more than 10% of the Company's
outstanding Common Stock. The Company applied the proceeds from the stock
issuance to the repayment of the Original Postabank Credit Facility. Pursuant to
the Securities Purchase Agreement, the Company issued notes to Postabank in an
aggregate amount of $25 million (the "Notes") with detachable warrants (the
"Warrants"). The Notes accrue interest, which is payable semi-annually, at
3-1/2% plus the LIBOR rate for the applicable six month interest period. The
Notes which mature in 2007 are transferable subject to applicable security laws.
The Warrants which were issued pursuant to a series of Warrant Agreements
between the Company and Postabank enable Postabank to purchase 2,500,000 shares
of the Company's common stock at an exercise price of $10 per share. The
exercise period commences on January 1, 2004 and terminates on March 31, 2007.
The Company has the right to terminate the Warrants in full or proportionately
prior to January 1, 2004 provided that the Company repays a proportionate amount
of the Notes and up to 7-1/2% of the aggregate principal amount of the Notes
repaid concurrently with the termination of the Warrants.
The Company and Tele Danmark entered into a Stock Purchase Agreement
(the "TD Stock Purchase Agreement") pursuant to which the Company issued
1,571,429 shares of Common Stock in exchange for $11 million. The Company
applied the proceeds from the TD Stock Purchase Agreement to the repayment of
the Original Postabank Credit Facility. Tele Danmark agreed not to transfer the
shares to any party prior to May 11, 2000 without the prior written consent of
the Company.
The Company and the Danish Fund entered into a Stock Purchase Agreement
(the "Danish Fund Stock Purchase Agreement") pursuant to which the Company
issued 1,285,714 shares of Common Stock in exchange for $9 million. The Company
applied the proceeds from the Danish Fund Stock Purchase Agreement to the
repayment of the Original Postabank Credit Facility. The Danish Fund agreed not
to transfer the shares to any party except for Tele Danmark prior to May 11,
2000 without the prior written consent of the Company.
The Company and Citizens entered into a Stock Purchase Agreement (the
"Citizens Stock Purchase Agreement') pursuant to which the Company issued to
Citizens 1,300,000 shares of Common Stock and 30,000 shares of the Company's
Series A Preferred Stock, par value $0.001 (the "Preferred Shares"). In
consideration for such shares, Citizens (i) transferred to the Company for
cancellation a $8.4 million promissory note issued by the Company to Citizens
which was to mature in 2004, and (ii) agreed to renounce and forego any rights
whatsoever to any payment of the $21 million which was payable by the Company to
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Citizens in quarterly installments of $750,000 from 2004 through and including
2010. Citizens, as the holder of the Preferred Shares, is entitled to receive
cumulative cash dividends at an annual rate of 5%, compounded annually on the
liquidation value of $70 per share. The Company may redeem the Preferred Shares
at any time. Citizens can convert each of the Preferred Shares into shares of
the Company's common stock on a one for ten basis. The Citizens Stock Purchase
Agreement requires Citizens not to transfer any shares of HTCC common stock
which it may hold prior to May 15, 2000 without the prior written consent of the
Company and Postabank. Citizens also waived any and all preemptive and anti-
dilution rights in connection with the transactions described above.
Recent Developments
The April 2000 Syndicated Credit Facility
On April 11, 2000, the Company entered into a EUR 130 million Senior
Secured Debt Facility Agreement (the "Debt Agreement") with a European banking
syndicate which was arranged by Citibank N.A. ("Citibank") and Westdeutsche
Landesbank Girozentrale ("WestLB"). The Company intends to draw down the entire
EUR 130 million ($124 million at current exchange rates), which funds will be
used in their entirety, along with another $6 million of other Company funds, to
pay off the entire outstanding balance (EUR 128 million, approximately $122
million at current exchange rates) of the Postabank Bridge Loan Agreement which
will result in the termination of the Postabank Bridge Loan Agreement which
matures on May 12, 2000, as well as fees associated with the Debt Agreement. The
borrowers under the Debt Agreement are the Operating Companies who were the
borrowers under the Postabank Bridge Loan Agreement. The Debt Agreement and some
of the related agreements are described below. (The descriptions and summaries
herein do not purport to be complete, and are subject to, and qualified in their
entirety by, reference to each such agreement, copies of some of which are filed
as exhibits hereto. See Item 14 below).
The Debt Agreement has two facilities. Facility A is a floating rate
term loan in the amount of EUR 125 million (the "Term Facility") which principal
is repayable semi-annually on each June 30 and December 31 beginning on June 30,
2001 and ending on December 31, 2007. The amounts of the principal repayments on
the Term Facility are to be an escalating percentage of the amounts drawn down
(EUR 125 million). Any amounts borrowed under the Term Facility have to be drawn
down within thirty days of the execution of the Debt Agreement in either euros
or Hungarian forints. The Company intends to borrow the full EUR 125 million, or
its equivalent in euros and Hungarian forints. Any amounts borrowed in Hungarian
forints are repayable in Hungarian forints. The Term Facility loans denominated
in euros accrue interest at the rate of the Applicable Margin (defined below)
plus the EURIBOR rate for the applicable interest period. The EURIBOR rate is
the percentage rate per annum determined by the Banking Federation of the
European Union for the applicable interest period. The portion of the Term
Facility loan denominated in Hungarian forints accrues interest at the rate of
the Applicable Margin (defined below) plus the BUBOR rate for the applicable
interest period. The BUBOR rate is the percentage rate per annum determined
according to the rules established by the Hungarian Forex Association and
published by the National Bank of Hungary for the applicable interest period.
The applicable interest period for the portion of the Term Facility loans
denominated in euros is, at the Company's option, one, three or six months. The
Company intends to choose six months. The applicable interest period for the
portion of the Term Facility loans denominated in Hungarian forints is, at the
Company's option, in one or three months. The Company intends to choose three
months. Interest is payable at the end of each interest period. The Applicable
Margin is initially 1.75%. The Applicable Margin may be adjusted downward
incrementally to a minimum of 1.15% subject to the financial performance of the
Company as measured by the ratio of the Company's senior debt to its earnings
before interest, taxes, depreciation and amortization.
Facility B is a floating rate revolving loan in the amount of EUR 5
million (the "Revolving Facility") which can only be drawn down in euros. The
-13-
Revolving Facility will be reduced to EUR 2.5 million on December 31, 2005. The
Revolving Facility is available until December 31, 2007. The Company intends to
borrow the full amount of the Revolving Facility to pay off the balance of the
Postabank Bridge Loan Agreement and fees associated with the transaction. The
principal amount borrowed under the Revolving Facility is due at the end of each
interest period at which point the Company can, subject to certain conditions,
roll over the amount of principal borrowed. The applicable interest period for
the Revolving Facility is, at the Company's option, one, three, or six months.
The Company intends to choose six months. Interest is payable at the end of each
interest period calculated similar to a Term Facility loan denominated in euros.
As part of the Debt Agreement, the Company is required to hedge at
least 50% of the euro borrowings until a minimum of 50% of Facility A has been
cancelled, prepaid or repaid. Dependent on its cash flow, commencing in 2001,
the Company will be required to prepay the equivalent of $25 million on Facility
A until such time as $25 million has been prepaid. The amount of the prepayment
in any year shall be at least 50% of the Company's excess cash flow, if any, for
the previous financial year as defined in the Debt Agreement. The prepayment
amount is due within 15 days of the publication of each annual Form 10-K filing.
The Company is obligated to pay a commitment fee equal to the lower of
.75% or 50% of the Applicable Margin on any available unused commitment. Since
the Company intends to borrow the full amount of the Debt Agreement soon, there
is no commitment fee payable at the present time. The Company will pay an
arrangement fee in the amount of EUR 2,665,000 (approximately $2.5 million at
current exchange rates) and an agency fee in the amount of $60,000. HTCC and one
of its subsidiaries, HTCC Consulting Rt., are guarantors for the HTCC
subsidiaries under the Debt Agreement. The Company pledged all of its intangible
and tangible assets, including HTCC's ownership interests in its subsidiaries,
and its real property to secure all of the obligations under the Debt Agreement.
The Company and Citibank Rt.(as security agent) entered into a series of
agreements to secure all of the Company's obligations under the Debt Agreement.
The Debt Agreement contains the customary representation and warranties. The
Company is subject to some restrictive covenants including restrictions
regarding the ability of the Company to pay dividends, borrow funds, merge with
another company and dispose of its assets. The Debt Agreement contains the
customary events of default, which would trigger early repayment of the balance
on the Debt Agreement including those related to a change of control. If prior
to the later of December 31, 2001 or the Trigger Date (as defined below), Tele
Danmark sells any of the shares of Common Stock that it currently owns or Tele
Danmark and the Danish Fund no longer own, in the aggregate, at least 30.1% of
the outstanding Common Stock, the Company would be in default under the Debt
Agreement. Tele Danmark and the Danish Fund currently own 32.1% of the
outstanding Common Stock. The Trigger Date is defined as the date on which for
the prior two fiscal quarters the Company's debt to EBITDA ratio is less than
3.5 to 1. Following the Trigger Date, Tele Danmark can only transfer its shares
with the prior written consent of banks holding at least 66.7% of the Company's
outstanding debt under the Debt Agreement.
Strategy
The Company's primary focus is to continue to increase call revenues
and reduce operating costs while continuing to add residential and business
customers to its networks. To accomplish these goals, the Company is continuing
its efforts to expand its product and service offerings to its entire customer
base, increase its operational efficiencies and increased its marketing efforts.
The Company has implemented the following operational strategies in order to
further its business objectives.
-14-
Revenue Growth
The Company intends to continue to increase its call revenues by
increasing the usage of its product and service offerings by both its
residential and business customers. Since the availability of modern
telecommunications services is a relatively new phenomena in Hungary, the key
factor in increasing the usage is educating both customer segments on the
availability and benefits of the Company's products and services. For the
residential customers, the Company is focusing its efforts on educating the
residential customer on the availability of such products and services as voice
mail, caller ID and call waiting, which are all new to the Company's residential
customer base. The Company is also highlighting the benefits of the Internet and
encouraging its use by offering special discounted rates for Internet usage. One
of the tools that the Company is deploying to increase customer awareness of
these services is video and personal demonstrations in the customer service
centers which are located in each of the Operating Areas. The Company is also
focusing its marketing and educating efforts at its business customers, which
represent 44% of the Company's total call revenues. The Company has placed
emphasis on increasing the installation and usage levels of the Company's
business customers by focusing on the marketing and sales of deregulated
services including managed lease lines, PBX sales and services, ISDN, Internet
and Digifon Services (e.g. call forwarding, call waiting, call barring). The
Company has assigned an account manager to each business customer who is
responsible for meeting with each business customer to find out such customer's
telecommunications needs. The account manager can then demonstrate each of the
Company's products and services and, working together with that customer,
develop a telecommunications strategy using the Company's products and services
which can best enhance that customer's business.
The Company plans to continue its revenue growth by increasing the
penetration levels in the residential sector. To that end, the Company is
continuing its mass marketing efforts to the residences who have not yet had
service. The Company is also marketing the benefits of additional lines to its
existing residential and business customer.
New Products and Services
The Company continues to offer the latest telecommunications products and
services as they become available in the telecommunications marketplace. The
Company plans to introduce Internet Protocol- based voice services to its
customers in 2000. This will enable the Company to offer long distance and
international calling services at discounted rates without violating Matav's
domestic long distance and international calling monopoly.
Marketing
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.
-15-
For its residential customers and potential customers, the Company's
marketing efforts include advertising on radio and television, door-to-door
marketing surveys, newspaper advertising, participation in local trade shows,
direct mail, community meetings and billboard advertising. The Company is also
offering discounts for Internet users. To increase the residential penetration
rate, the Company has implemented short marketing campaigns targeting those
residences without phone service. To induce the potential customers the Company
has offered special limited time only special rates on the connection fee. Since
many Hungarians still prefer face-to-face personal marketing, the Company has
leveraged the benefits of having a customer service center in each Operating
Area to give personal demonstrations.
For its larger business customers, the Company has trained account
managers to service these customers and potential customers by educating them on
the availability of "turn-key" business communications solutions and 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). The
Company believes that this effort will result in a greater understanding by its
business customers and potential business customers of the potential revenue
gains that can be achieved with advanced telecommunications technology.
Customer Service
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 7 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 on a 24 hour basis. 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. The Company reorganized its customer
service centers by implementing the necessary changes to make such centers more
"customer friendly." The Company is providing more choices for its customers and
more product information instruction. For its business customers, the Company
has account representatives for each customer.
Most of the Company's subscriber base consists of residential
customers. As of December 31, 1999, 87% of subscribers were residential
customers and 13% were business and other institutional subscribers (including
government institutions).
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 has
implemented its own centralized operating and accounting system in all of its
Operating Areas. A significant increase in operational efficiency has resulted
-16-
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 facilitates 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 December 31, 1999, the
Operating Companies had a total of 296 access lines per employee.
Mergers and Strategic Alliances
As the Hungarian telecommunications market continues to develop and
become more liberalized as the monopolies of Matav and the LTOs expire and the
newer entrants expand their presence in Hungary, the Company will continue to
review its options with respect to any merger or strategic alliance
possibilities that will enhance shareholder value.
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, ISDN, caller ID, call waiting, call forwarding, three-way
calling, toll free calling services and audio text services.
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 12.0 ($.048) per pulse for all local calls. The Ministry has
traditionally adjusted such fees annually based on the Hungarian Consumer Price
Index. However, the Ministry did not change the fees per pulse in 2000 as
compared to 1999 because of the Ministry's efforts to rebalance the fees for
telecommunications services. To that end, the Ministry did not change the length
between pulses for local calls but increased the length between pulses for
domestic long distance and international calls. The net result is that the fees
for local calls will not change from 1999 to 2000 while the fees for domestic
long distance and international calls in 2000 will decrease 40% from the rates
in 1999. For all local calls within an Operating Area, the Company retains all
of the revenues associated with the call. For domestic long distance calls
-17-
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. Pursuant to this revenue sharing arrangement, the Company charges
for and collects from its customers the fees for domestic long distance and
international calls. The Company then pays these fees to Matav but retains an
interconnection fee. For domestic long distance and international calls to the
Company's customers, the Company receives an interconnection fee. 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. Since 1998 the Ministry has taken gradual steps to
regulate the interconnection fees in accordance with internationally accepted
benchmarks with the goal of creating a cost-based interconnection fee regime.
The Company believes that this revised regulatory policy has resulted in an
overall increase in the Company's revenue per call in 1999 for domestic long
distance and international calls over the amount received in 1998 and that the
Company will realize additional benefits in the future. 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 customers of HUF 1,532 ($6.07) for residential customers and HUF 2,672
($10.58) for business and other institutional subscribers (including government
institutions). These rates increased 32% from 1999. The company also offers some
of its low usage customers a reduced subscription fee with a limited amount of
local calls at the regular local calling rate but a higher local calling rate
for usage over such limit. See "- Regulation - Rate Setting and Revenue
Sharing."
Connection fees are earned when a customer is added to the network. The
Company may collect the full connection fee provided that the customer is
connected within 30 days; otherwise, the Company may only collect a portion of
the connection fee and must connect the subscriber within one year. Upon
connection, the Company may collect the remaining portion of the fee. 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
($118.80) for residential customers and HUF 90,000 ($356.41) 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, 1999, approximately 3,323 leased lines were in service. In
addition, as of December 31, 1999, the Company had 1,916 public pay phones in
the Operating Areas in accordance with the terms of the Concession Contracts.
The Company generates additional revenues from the provision of value-added
services, including ISDN, 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 either the Hungarian Producer
Price Index ("PPI") or the Hungarian Consumer Price Index ("CPI"). In 1997, the
Ministry 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. In addition to separate price caps for such
categories of services, the Ministry enacted a rebalancing formula, which
-18-
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 or charge a lower
rate. 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. Customers can choose to buy the phone or lease the phone and
pay a monthly fee of HUF 180 ($0.71). Although there is no Ministry or other
governmental regulation relating to lease rates, the Company adjusts such rates
annually according to the Hungarian PPI. Approximately 49% of the Company's
subscribers as of December 31, 1999 leased their phones from the Company.
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.
-19-
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 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.
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 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.
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:
-20-
Hungarotel
The Company holds 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 398,500 with an estimated 166,600 residences and 22,300
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,
1999, Hungarotel had 112,300 access lines connected to its network. The
Hungarotel network utilizes a combination of a conventional build, fiber optic
and wireless local loop technology.
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 146,400, with an estimated 59,600 residences and 6,300 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, 1999, KNC had 46,300 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
64,000 with an estimated 24,000 residences and 3,300 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, 1999,
Papatel had 19,600 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
-21-
Slovenia. The Raba-Com Operating Area has a population of approximately 65,300,
with an estimated 26,300 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, 1999, Raba-Com had 22,300 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.
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.
-22-
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. Each of the Operating Companies met their build-out
requirements in 1999.
See "- Fines."
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.
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. The
applicability and enforceability of such obligation is presently uncertain.
However, the Ministry stated in a letter to Hungarotel that it will not enforce
this particular provision of Hungarotel's Concession Contract.
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. Each of the Operating
Companies met their build-out requirements in 1999.
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 is remote.
-23-
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 Hungarian owners
of a 10% equity holding in an Operating Company 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.
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. The equity ownership requirements expressly set forth in KNC's and
Raba-Com's Concession Contracts call for a stricter 25% plus one share Hungarian
ownership requirement. 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.
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. With respect
to the Company, Postabank, a Hungarian commercial bank, owns approximately 20.2%
of HTCC which is the majority owner of all of the Operating Companies.
Therefore, the Ministry deems the Company in compliance with the current 10%
ownership requirement, however, the Company is currently not in compliance with
the 25% ownership requirement. The Ministry is, however, currently reviewing the
Hungarian equity ownership requirements and has indicated that it is not going
to enforce at this time the 10% Hungarian equity ownership requirement. In the
event that the Ministry adopts new Hungarian equity ownership requirements, the
Company will formulate plans to meet any such 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 might 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.
-24-
The Hungarian ownership requirements would 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
formally 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.
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.
In 1997 the Ministry adopted Decree No. 31/1997 of the KHVM on Fees
Related to Telecommunication Services Subject to Concession (the "1997 Tariff
Decree") which regulated the Operating Companies' subscription fees, fees for
local calls, and fees collected on behalf of Matav for long distance and
international calls. The 1997 Tariff Decree set separate price caps for each
category of service through 2000, which price caps provided for annual rate
increases based on the CPI for the prior year. The Ministry may also reduce the
CPI percentage increase by an efficiency factor to obtain the maximum allowable
price increase. The 1997 Decree also provided for a rebalancing formula which
allowed greater increases in the charges for subscription fees and local calls
than in domestic long distance or international calls. For 2000, in accordance
with the general policies set forth in the 1997 Tariff Decree, the Ministry
adopted Decree No. 1/2000 (I.18) (the "2000 Tariff Decree") which provides for:
a 32% increase in the subscription fee for the Company's residential customers;
a 60% increase in the subscription fee for the Company's business customers; no
increase in local calls within an Operating Area; and a 40% decrease in long
distance and international calls. The intended effect of the 2000 Decree was to
provide for an overall 2000 price increase of a maximum 6% based on the
anticipated inflation rate in 2000. The 1999 increase in the Hungarian CPI was
10%.
The Ministry also regulates the revenue sharing arrangements between
the LTOs (including the Operating Companies) and Matav with respect to long
distance and international calls. The revenue sharing arrangements provide for
the Operating Companies to retain an interconnection fee from the fees collected
from the Operating Companies' customers for long distance and international
calls and for Matav to pay the Operating Companies an interconnection fee for
domestic long distance or international calls terminating with one of the
Operating Company's customers. In 1998 the Ministry announced that it intended
to start regulating the interconnection fees based on internationally accepted
benchmarks with the goal of creating a cost-based interconnection fee regime
within the parameters of European Union standards. To that end, starting in
1999, the interconnection fees were revised to compensate the LTOs more
favorably for costs than in the prior years. For 2000, the Ministry adopted
Decree 8/2000 (III.29) (the "2000 Interconnection Decree") which provides for
each LTO to receive in 2000 an average interconnection fee of HUF 13.22/minute
for the initiation of a domestic long distance or international call and an
average fee of HUF 8.02/minute for the termination of a domestic long distance
or international call. For future years, the LTOs other than Matav as part of a
formal association (the "LTO Association") recently provided the Ministry with a
paper outlining its position with respect to the implementation of a longer term
cost-based interconnection fee regime, which is already a requirement for EU
members. See " - Competition."
-25-
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"). The Connection Fee Decree provides for maximum subscriber connection
fees at HUF 90,000 ($415.70) for business customers and HUF 30,000 ($138.57) for
residential customers. See "- Operations - Services - Subscription and
Connection Fees."
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%. The Operating Companies fulfilled certain criteria which
entitled them 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. In 1999 employers were
required to pay the state 33% of an employee's gross salary as a social security
contribution and 3.0% of an employee's gross salary as the employer's
contribution to the unemployment fund. In addition, the Company must pay an
additional HUF 3,600 ($14.26) per month for each employee for health insurance.
The Company's share of pension, unemployment, social security and health
insurance payments are reflected in operating and maintenance expenses.
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.
-26-
In 1998, the Ministry awarded Pan-Tel the license to provide
non-exclusive telecommunications services such as data transmission and voice
mail. The current shareholders of Pan-Tel include MAV Rt. (the Hungarian railway
company, "MAV"), PT Investment Holding Company and KPN NV (the Dutch telephone
company). In 1998 Pan-Tel started building its nationwide fiber optic backbone
network along the rights-of-way of MAV which is expected to be completed by the
end of 2000. Pan-Tel is currently providing business communications services
such as digital data, fax and video transmission using Internet Protocol ("IP")
data transmission technology, primarily to large customers. Pan-Tel focused on
the large, multinational companies and government organizations as its initial
target market. In 1999, the Hungarian government granted Pan-Tel two separate
licenses to provide IP-based voice services to residential and business
customers. The Hungarian government determined that such service did not violate
Matav's monopolistic voice concession since voice-over IP is considered "data
transfer". Matav has recently initiated its own voice-over IP service. Pan-Tel
also owns a majority stake in one of Hungary's largest Internet Service
Providers.
The Company faces competition from the four Hungarian cellular
providers: Westel 450; Westel 900; Pannon; and the newest entrant Vodaphone.
Presently, the airtime and monthly fees charged by the cellular operators are
generally more than the fees for comparable services charged by the Company.
Another entrant into the marketplace, Novacom Telecommunications Kft.
("Novacom") owned by affiliates of RWE Telliance AG, a German telecommunications
company, EnBW AG, a German electricity provider and Elmu Rt., the Hungarian
electricity distributor ("Elmu"), is expanding the fiber optic infrastructure of
Elmu in order to compete in the telecommunications market. Novacom offers its
customers corporate network services, managed leased lines, ISDN, frame relay,
X25, ATM IP-based data transmission, closed user group voice and PBX services.
Novacom also recently initiated voice-over IP service.
Other Hungarian telecommunications providers include the following
entities: GTS Hungary Kft. ("GTS") which provides data transmission services
through a nationwide microwave network and a satellite based network (GTS also
owns one of the leading Hungarian ISPs); Antenna Hungaria, the national
broadcaster which is still state-owned, has a national microwave network and
recently announced plans to establish a joint venture with Hungarian Electricity
Works Rt. ("MVM") to operate MVM's existing telecom network; and Global One
Telecommunications Kft., which provides IP-based data transmission services.
There are also several other VSAT (very small aperture terminal) providers in
Hungary.
The Hungarian cable television market is highly fragmented with over
150 cable television providers. The Hungarian cable television industry is
undergoing consolidation. United Pan-Europe Communications NV ("UPC") is the
largest cable television operator in Hungary. UPC owners include UnitedGlobalCom
Inc., the global television operator of Denver, Colorado (51%), and Microsoft
Corp. (8%) of Redmond, Washington.
The Ministry recently announced that it will revise its laws in 2000
regarding the regulation of the telecommunication market in accordance with
European Union standards. The regulation of telephony, cable television and the
Internet would be affected. The Company does not expect that the exclusivity
period of its concession rights, which expire in 2002, will be affected.
-27-
Hungary's application for membership in the European Union (the "EU")
was accepted. Hungary is now in the process of negotiating the terms of its
accession into the EU. The EU has adopted numerous directives providing for an
open telecommunications market among its member nations. Hungary is not expected
to become a member of the European Union until 2003 at the earliest by which
time the exclusivity rights of the LTOs and Matav will have expired.
Employees
The Company had a total of approximately 665 employees, including 10
expatriates, as of March 1999. The Company considers its relations with its
employees to be satisfactory.
Item 2. Properties
The Company leases its office space in Budapest at a current monthly
rental of DM 30,749 (approximately $15,000 at current exchange rates). The
Company is in the process of selling its old office headquarters in Budapest.
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 Company is moving its
U.S. office to Suite 32, Tokeneke Center, 30 Center Street, Darien, CT 06820
effective May 1, 2000 at a monthly rental of $1,500. The Company believes that
its leased and owned office space is adequate for its present needs but is
currently reviewing its alternatives as to its future needs.
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.
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 claims are without merit and is vigorously defending
itself against such claims. Dialcont is seeking HUF 222 million ($879,000). This
action is still pending in the Hungarian court system.
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 in the lower court. The
plaintiff appealed the case in the appellate court which court overturned the
lower court's decision. Raba-Com filed an appeal with the Hungarian Supreme
Court which is still pending. Should, however, Raba-Com lose its appeal at the
Supreme Court level, the Company could be subject to additional claims for
refunds. The Company believes it has meritorious defenses to this claim and any
others that may be filed regarding this matter.
HTCC Consulting Rt. ("Consulting") and Papatel are involved in
several disputes with the Hungarian taxing authorities (the "APEH") pursuant
to which the APEH alleges that Consulting owes HUF 105 million (approximately
-28-
$416,000) and Papatel owes HUF 26 million (approximately $103,000) for
various reasons. The Operating Companies believe that the APEH claims are
without merit and are vigorously defending themselves against such claims.
During 1996 and 1997, the Company entered into several construction
contracts with a Hungarian contractor which totaled $59.0 million in the
aggregate, $47.5 of which was financed by a contractor financing facility. The
contractor financed the facility through Postabank. As of December 31, 1998, the
balance owed by the Company on the contractor financing facility was
approximately $36.6 million. The Company and the contractor have a disagreement
with respect to several issues relating to the quality and quantity of the work
done by the contractor. The Company has rejected invoices of approximately HUF
700 million (approximately $2.8 million). In order to resolve these issues, the
Company purchased from Postabank the receivables owed by the contractor to
Postabank with respect to the contractor financing facility. The Company also
purchased from Postabank some of the obligations which the Company owed to the
contractor under the contractor financing facility which were assumed by
Postabank. The Company then set off its uncontested liabilities to the
contractor against the amounts owed to the Company by the contractor. The
contractor is now seeking payment under separate invoices in the amount of
approximately $24 million for work which the Company is disputing because of
quality and quantity issues. The Company still has claims against the contractor
of approximately $31 million which is more than the contractor's claim. The
Company is reviewing its options with respect to such dispute. At this time the
outcome of such dispute cannot be predicted with certainty. The Company believes
that it will prevail on the merits such that it will not be responsible for the
full amount of the contractor's claims. There can, however, be no assurances as
to the final outcome or course of action of such dispute.
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.
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, 1999.
-29-
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Information
The Company's Common Stock trades on the American Stock Exchange (the
"Amex") under the symbol "HTC." 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. In 1998, NASD, parent of The Nasdaq Stock Market, merged with
the American Stock Exchange. Subsequent to the merger, The Nasdaq-Amex Market
Group was created as a holding company under which both The Nasdaq Stock Market
and the American Stock Exchange function as independent subsidiaries, with
separate listed companies.
The following table sets forth the high and low sale prices for the
Common Stock as reported by the Amex for each quarter in 1998 and 1999.
High Low
Quarter Ended:
- -------------
1998
March 31, 1998 . . . . . . . . . . . $11-1/8 $ 7-1/2
June 30, 1998. . . . . . . . . . . . 8-3/4 4-7/8
September 30, 1998 . . . . . . . . . 6-1/8 2-1/8
December 31, 1998. . . . . . . . . . 6-5/8 3
1999
March 31, 1999 . . . . . . . . . . . $ 5-1/4 $ 3-1/4
June 30, 1999. . . . . . . . . . . . 7 3-3/4
September 30, 1999 . . . . . . . . . 6-1/2 4-9/16
December 31, 1999. . . . . . . . . . 7-1/4 4-13/16
On April 11, 2000, the closing sale price for the Common Stock on the
Amex was $7-1/2.
Stockholders
As of April 11, 2000, the Company had 12,009,479 shares of Common Stock
outstanding held by 114 holders of record. The Company believes that it has
approximately 1,500 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, 1999, 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 until April 30, 2000 and to Suite
32, Tokeneke Center, 30 Center Street, Darien, CT 06820 thereafter.
-30-
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.
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. Currently, the Operating Companies have
negative net equity and are not permitted to pay dividends.
Item 6. Selected Financial Data
HUNGARIAN TELEPHONE AND CABLE CORP.
AND SUBSIDIARIES
Selected Financial and Operating Data
(Dollars in Thousands, Except Per Share
Amounts)
<
1999 1998 1997 1996 1995
---------- --------- --------- --------- --------
For the Year
Operating revenues $ 45,438 $ 38,707 $ 37,891 $ 20,910 $ 4,070
Operating income (loss) $ 16,189 $ (6,059) $ (1,263) $(20,553) $(17,829)
Net loss before extraordinary items, net $(17,773) $(50,612) $(36,236) $(54,769) $(20,024)
Net income (loss) $ 3,172 $(50,612) $(36,236) $(54,769) $(20,024)
Net income (loss) per common share $ 0.33 $ (9.53) $ (7.97) $ (13.14) $ (6.30)
At Year-End
Total assets $154,683 $177,067 $186,485 $156,615 $110,387
Long-term debt, excluding
current installments $122,917 $202,881 $194,537 $148,472 $ 23,467
Total stockholders' (deficiency)
equity $ (6,946) $(89,037) $(41,837) $(23,790) $ 15,739
The extraordinary item in 1999 arose on the extinguishment of
liabilities to Citizens and amounts due under a contractor financing facility
offset in part by the write off of the remaining unamortized deferred costs
pertaining to a credit facility with Postabank, which was also extinguished
during the year.
-31-
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Introduction
HTCC is engaged primarily in the provision of telecommunications
services through its majority-owned operating subsidiaries, KNC, Raba-Com,
Papatel and Hungarotel. The Company earns substantially all of its
telecommunications revenue from measured service fees, monthly line rental fees,
connection fees, public pay telephone services and ancillary services (including
charges for additional services purchased at the customer's discretion).
During 1996 and 1997 the Company embarked on a significant network
development program which met its substantial demand backlog, increased the
number of basic telephone access lines in service and modernized existing
facilities. The development and installation of the network in each of the
Company's Operating Areas required significant capital expenditures.
Now that the Company's network is substantially built-out, 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 on-going
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 increased usage and the addition of new subscribers.
The Company funded its construction costs and working capital needs
over the past several years primarily through a $170 million Postabank Credit
Facility (the "Original Postabank Credit Facility") and a $47.5 million
contractor financing facility. The Company and the Hungarian contractor which
granted the contractor financing facility have a disagreement with respect to
several issues relating to the quality and quantity of the work done by the
contractor. In addition, on March 31, 1999, the Company did not have sufficient
funds on hand to pay the first installment due on the Original Postabank Credit
Facility. Due to this fact, as well as the disagreement the Company has with the
Hungarian contractor, on March 30, 1999, and May 12, 1999, the Company entered
into a series of transactions (see notes 4, 5, 6, 8 and 11 of Notes to
Consolidated Financial Statements) which restructured the Company's debt and
capital structure. As the final step in the Company's debt and equity
restructuring which started in 1999, on April 11, 2000, the Company entered into
a EUR 130 million Senior Secured Debt Facility with a European banking
syndicate. See "- Liquidity and Capital Resources" below.
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 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
$181 million through December 31, 1999 (at historical exchange rates) on the
development and construction of its telecommunications infrastructure. Since
commencing the provision of telecommunications services in the first quarter of
1995, the Company's network construction and expansion program has added 139,100
access lines through December 31, 1999 to the 61,400 access lines acquired
directly from Matav. As a result, the Company had 200,500 access lines in
operation at year end 1999.
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Comparison of Year Ended December 31, 1999 to Year Ended December 31, 1998
Net Revenues
Year ended
(dollars in millions) 1999 1998
Measured service revenues $ 35.2 $ 32.2
Subscription revenues 10.9 10.7
Net interconnect charges (7.0) (9.8)
----- -----
Net measured service and subscription revenues 39.1 33.1
Connection fees 1.8 2.0
Other operating revenues, net 4.5 3.6
----- -----
Telephone Service Revenues, Net $45.4 $38.7
====== =====
The Company recorded a 17% increase in net telephone service revenues
to $45.4 million for the year ended December 31, 1999 from $38.7 million for the
year ended December 31, 1998.
Net measured service and subscription revenues increased 18% to $39.1
million for the year ended December 31, 1999 from $33.1 million for the year
ended December 31, 1998. Measured service revenues increased 9% to $35.2 million
in 1999 from $32.2 million in 1998 while subscription revenues increased 2% to
$10.9 million in 1999 from $10.7 million in 1998. These increases in call and
subscription fee revenues are the result of a 7% increase in average access
lines in service from approximately 178,000 lines for the year ended December
31, 1998 to approximately 190,000 lines for the year ended December 31, 1999.
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.
These revenues have been offset by net interconnect charges which
totaled $7.0 million for the year ended December 31, 1999 as compared to $9.8
million for the year ended December 31, 1998. As a percentage of call and
subscription revenues, net interconnect charges have declined from 23% for the
year ended December 31, 1998 to 15% for the year ended December 31, 1999, due to
a higher proportion of local traffic as additional access lines are placed in
service plus a negotiated reduction in interconnect fees effective January 1,
1999. Based upon recent negotiations with Matav and the Hungarian Ministry of
Telecommunications, the Company expects net interconnect, as a percentage of
call and subscription revenues, to remain consistent with 1999 levels in 2000.
Connection fees for the year ended December 31, 1999 totaled $1.8
million as compared to $2.0 million for the year ended December 31, 1998.
Connection fees increased in functional currency terms by 5% due to additional
access lines being connected in 1999 as compared to 1998. However, due to the
devaluation of the Hungarian forint during the period, connection fees for the
year have remained relatively consistent in U.S dollar terms with 1998 amounts.
-33-
Other operating revenues increased 25% to $4.5 million during the year
ended December 31, 1999 compared to $3.6 million during the year ended December
31, 1998 due to revenues generated from the provision of direct lines and other
miscellaneous telephony service revenues.
Operating and Maintenance Expenses
Operating and maintenance expenses for the year ended December 31, 1999
decreased to $17.5 million compared to $19.6 million for the year ended December
31, 1998. On a per line basis, operating and maintenance expenses decreased to
approximately $92 per average access line for the year ended December 31, 1999
from $110 for the year ended December 31, 1998 as the Company achieved
productivity improvements and increased its focus on reducing operating
expenses, particularly through reductions in the number of expatriates working
for the Company. The Company does not expect significant decreases in operating
and maintenance expenses in 2000. However, on a per line basis, operating and
maintenance costs are expect