Back to GetFilings.com
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, 2001
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.)
32 Center Street, Darien, CT 06820
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (203) 656-3882
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 American Stock Exchange
per share
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirement for the past 90 days.
Yes X No
-
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of March 25, 2002, 12,103,180 shares of the Registrant's Common Stock
were outstanding, of which 12,095,467 were held by non-affiliates of the
Registrant. The aggregate market value of the Registrant's Common Stock held by
non-affiliates, computed by reference to the closing price of the Common Stock
on the American Stock Exchange as of March 25, 2002, was $61,686,881. The
exclusion of shares owned by any person from such amount shall not be deemed an
admission by the Registrant that such person is an affiliate of the Registrant.
Documents Incorporated by Reference
Part III - Portions of the Registrant's proxy statement for the Annual
Meeting of Stockholders for the fiscal year ended December 31, 2001.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained herein which express "belief,"
"anticipation," "expectation," or "intention" or any other projection, insofar
as they may apply prospectively and are not historical facts, are
"forward-looking" statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Because such statements include risks and uncertainties, actual results may
differ materially from those expressed or implied by such forward-looking
statements. Factors that could cause actual results to differ materially from
those expressed or implied by such forward-looking statements include, but are
not limited to, the factors set forth in Item 7 "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and Item 7A
"Quantitative and Qualitative Disclosures about Market Risk."
PART I
In this Form 10-K, all references to "$" or "U.S. dollars" are to United
States dollars, all references to "EUR" or "euros" are to the euro which is the
currency of the European Monetary Union, 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 euro or 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, 2001 exchange rates.
The forint/U.S. dollar middle exchange rate as of December 31, 2001 was
approximately 279.03 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 three defined regions within the Republic of Hungary
("Bekes", "Nograd" and "Papa/Sarvar", each an "Operating Area" and together, the
"Operating Areas") pursuant to five separate 25-year telecommunications
concessions granted by the Hungarian government. Until December 31, 2001 HTCC
provided its services through its four majority-owned Hungarian operating
subsidiaries in its five concession areas. As of January 1, 2002 HTCC merged
its four Hungarian operating subsidiaries into one Hungarian operating
subsidiary, Hungarotel T[aacute]vk[ouml]zlesi Rt. ("Hungarotel" or the
"Operating Company") in which HTCC has a 99.9% equity ownership stake.
On January 1, 2002 HTCC also consolidated the five concession areas into three
Operating Areas to realize operational efficiencies. Hungarotel 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 "TTW Ministry")
for $11.5 million (at historical exchange rates) and purchased the existing
telecommunications infrastructure in the Operating Areas in 1995 and 1996,
including approximately 61,400 access lines, from Magyar
T[aacute]vk[ouml]zl[eacute]si Rt. ("Matav"),the
-2-
formerly State-controlled monopoly telephone company, for $23.2 million (at
historical exchange rates). Since the acquisition of such existing networks, the
Company has incurred capital expenditures through December 31, 2001 of $197
million (at historical exchange rates) to expand and upgrade the network
facilities which has resulted in the completion of a modern telecommunications
network in each of the Operating Areas. As of December 31, 2001, the Company's
telecommunications networks had approximately 203,500 access lines in service,
an addition of approximately 142,100 access lines to the 61,400 access lines
acquired from Matav. The Company's networks have the capacity, with only normal
additional capital expenditures required, to provide basic telephone services to
virtually all of the estimated 279,600 homes and 38,500 business and other
institutional subscribers (including government institutions) within its
Operating Areas.
The Company completed its network modernization and construction program in each
of its Operating Areas primarily through turnkey construction contracts with
Siemens, Ericsson and F[aacute]zis Telecommunication System Design and
Construction Corporation. The build-out was primarily financed through a $170
million credit facility with Postabank es Takarekpenztar Rt., a Hungarian
commercial bank ("Postabank"), which was subsequently refinanced and a $47.5
million contractor financing facility. See Item 3 "Legal Proceedings," Item 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources," and Notes 5 and 8(d) of Notes to
Consolidated Financial Statements.
The following table sets forth certain information as of December 31,
2001 with respect to each of the Operating Areas.
Bekes Nograd Papa/Sarvar Total
----- ------ ----------- -----
Population.......... 391,700 147,900 128,400 668,000
Residences.......... 166,900 62,400 50,300 279,600
Businesses /(1)/.... 23,100 8,900 6,500 38,500
Access Lines:
Residential...... 97,200 39,900 36,700 173,800
Business /(2)/... 17,000 7,100 5,600 29,700
------- ------- ------- -------
Total 114,200 47,000 42,300 203,500
Pay phones.......... 1,074 434 375 1,883
Population
Penetration /(3)/... 29.2% 31.8% 32.9% 30.5%
Residential
Penetration /(4)/.... 58.2% 63.9% 73.0% 62.2%
- ----------------------------------
/(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.
-3-
The following table sets forth the number of access lines served in each
of the Operating Areas at takeover from Matav and at the end of 1995, 1996,
1997, 1998, 1999, 2000 and 2001.
Takeover 1995 1996 1997 1998 1999 2000 2001
------- ---- ---- ---- ---- ---- ---- ----
Bekes 42,100 42,100 47,800 102,000 105,300 112,300 116,300 114,200
Nograd 13,000 14,200 20,500 35,500 40,000 46,300 47,700 47,000
Papa
/Sarvar 6,300 8,900 25,100 37,600 39,700 41,900 42,900 42,300
------ ------ ------ ------ ------- ------- ------- -------
Total 61,400 65,200 93,400 175,100 185,000 200,500 206,900 203,500
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 currently located at 32
Center Street, Darien, Connecticut 06820; telephone (203) 656-3882. The
Company's principal office in Hungary is currently located at Ter[eacute]z krt.
46, H-1066, Budapest; telephone (361) 474-7700.
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 million inhabitants, approximately 1.8 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 one of the most developed countries in
Central and Eastern Europe. Since 1989, foreign direct investment has been
approximately $22.4 billion. Foreign direct investment was approximately $2.5
billion in 2001. Together Hungary, Poland and the Czech Republic are the
recipients of more than 50% of the total foreign direct investment into the
former Communist countries in the region.
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; 4.9% in 1999; 5.3% in 2000; and 3.8% in 2001. The
unemployment rate has gradually decreased from 11.1% in 1995 to 5.8% in 2001.
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; 10.0% in 1999; 9.8% in 2000; and 9.2% in
2001.
Hungary's application for membership in the European Union ("EU") was
accepted in 1998. Hungary is now in the process of negotiating the terms of its
accession into the EU. Hungary is not expected to become a member of the EU
until 2004 at the earliest. Hungary joined the North Atlantic
-4-
Treaty Organization in 1999. Hungary is also a member of the World Trade
Organization.
OVERVIEW OF HUNGARIAN TELECOMMUNICATIONS INDUSTRY
The Hungarian Telecommunications Industry Prior to Privatization
In 1989, the Hungarian 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 18% of Hungary's population
resides). In the Company's Operating Areas, access line penetration was
approximately 9 access lines per 100 inhabitants as of December 31, 1995.
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 MagyarCom, a company then wholly
owned by Deutsche Telekom AG, the German public telephone operator ("Deutsche
Telekom"), and Ameritech, a United States based telecommunications company. (In
2000 Deutsche Telekom purchased the entire ownership interest of SBC
Communications Inc. (Ameritech's successor) in MagyarCom). 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, 2001, MagyarCom owned 59.5% of Matav while 40.5% was
publicly traded.
In 1992 the TTW 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. The TTW ministry allowed
Matav to continue its monopoly in the provision of domestic and international
long distance services through 2001. In 1993, the TTW 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. The TTW Ministry
awarded 23 concessions out of the 25 that the TTW Ministry solicited bids for.
Holders of those 23 concessions today (each a Local Telephone Operator, "LTO",
and together the "LTOs") include: the Company (5 concession areas); Vivendi
Telecom Hungary ("Vivendi") owned by affiliates of Vivendi Universal of France
and General Electric Capital Corp. (9 concession areas); an affiliate of United
Pan-European Communications NV ("UPC") (1 concession area); and Matav (8
concession areas). Matav also retained the rights to service the 2 concession
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 through 2002 (2001 in the
case of Matav except for 5
-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. Today Matav's local basic telephone service covers approximately 72% of
Hungary's population and approximately 70% of its geographic area.
Domestic and International Long Distance Services
In 1998 the TTW Ministry awarded Pan-Tel Rt., a Hungarian company
("PanTel") licenses to provide such services as data transmission, voice mail
and other services which were not subject to exclusive concessions. PanTel
built its own countrywide telecommunications network. The current shareholders
of PanTel are M[Aacute]V Rt. (the Hungarian railway company) (10.1%); KFKI
Computer Systems Kft. (a Hungarian information technology firm) (14.7%); and
Royal KPN NV, the Dutch telecommunications company (75.2%).
At the end of 2001 the domestic and international long distance market
was opened up to competition when Matav's right to provide exclusive domestic
and international long distance voice transmission expired.
Cellular Service
In 1993 the TTW Ministry awarded Westel and Pannon licenses to provide
nationwide digital cellular telephone services. Westel already had a license to
provide analog cellular telephone services. Today Matav owns 100% of Westel and
Telenor AS (the Norwegian telecommunications company) owns 100% of Pannon.
In 1999, the TTW Ministry awarded a consortium comprised of Vodafone
Group Plc. (50.1%), RWE Telliance (19.9%), and Antenna Hungaria (30%)
(together, "Vodafone") a digital 1800-megahertz (or DCS frequency) mobile phone
license following a bidding process. Vodafone began operations in late 1999.
The Regulatory Framework
During 2000 the Hungarian government moved the responsibility for the
regulation of telecommunications from the TTW Ministry to the Prime Minister's
Office. The Prime Minister's Office is headed by the Chancellor (who is
effectively the Deputy Prime Minister). An Information Technology Commissioner
was appointed to assist the Chancellor. The Communications Authority, a central
administrative organization, reports to the Chancellor and the Hungarian
government. The Communications Authority is divided into three units: the
Communications Inspectorate; the Regional Communications Office; and the
Communications Arbitration Committee.
The Liberalization Act
In June 2001 the Hungarian government enacted Act XL of 2001 on
Communications (the "Communications Act") which took effect on December 23,
2001. The goal of the Communications Act is to provide for a more liberalized
telecommunications market by making market entry easier, promoting
-6-
competition and harmonizing Hungary's telecommunications laws with those of the
European Union. The Communications Act is a framework piece of legislation with
the detailed governing regulations to be contained in a series of implementing
decrees. See "- Summary of the Liberalization Act" and "- Regulation."
The Hungarian Telecommunications Industry Today
Since 1994 the LTOs and Matav have spent approximately $1 billion (at
historical exchange rates) to build modern state-of-the-art telecommunications
networks throughout Hungary. As a result of such investment, at the end of 2001
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. At the end
of 2001 the Company had 31 access lines per 100 inhabitants in its Operating
Areas as compared to 37 access lines per 100 inhabitants in all of Hungary.
At the end of 2001 Westel had a mobile cellular phone subscriber base of
2.5 million, while Pannon's subscriber base was 1.95 million and Vodafone's
subscriber base was 447,000. The overall penetration rate for cellular service
in Hungary was close to 50% at the end of 2001.
COMPANY STOCKHOLDERS
The Company has four large stockholders who together own 71.1% of the
Company's outstanding common stock ("Common Stock"). The remaining 28.9% of the
Common Stock is held by the public and traded on the American Stock Exchange.
Set forth below is a brief description of the four largest stockholders of the
Company.
Citizens Communications Company
Citizens Communications Company (together with its subsidiaries,
"Citizens"), a New York Stock Exchange listed company ("CZN"), currently is the
seventh largest local telephone exchange company in the United States, serving
2.5 million telephone access lines in 24 states. Citizens owns approximately
85% of Electric Lightwave, Inc. (NASDAQ: ELIX), a facilities-based, integrated
communications provider that offers a broad range of services to
telecommunications-intensive businesses in the western part of the United
States. At December 31, 2001, Citizens had $10.6 billion of total assets and
$1.9 billion in shareholders' equity. For the year ended December 31, 2001,
Citizens had $2.5 billion of revenue and $233.0 million in operating income
from continuing operations.
In 1995 Citizens purchased 300,000 shares of HTCC's common stock from a
former executive 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,
the "Citizens Agreements"). Citizens also purchased 103,000 shares of Common
Stock on the open market. As of March 27, 2002, Citizens owned 19.1% of the
outstanding Common Stock. 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. For a more detailed
description of some of the Citizens Agreements, see Notes 9 and 12 of Notes to
Consolidated Financial Statements, and see also Item 12
-7-
"Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters."
TDC
TDC A/S, formerly known as Tele Danmark A/S (together with its
affiliates, "TDC") is a Danish-based European full-service provider of
communications solutions. It is organized into seven main business lines. TDC
is the leading provider of communications services in Denmark, the second-
largest communications provider in Switzerland and holds significant interests
in a range of communications companies across Northern and Continental Europe.
TDC's stock trades on the Copenhagen Stock Exchange and the New York Stock
Exchange ("TLD"). SBC Communications, Inc. of San Antonio, Texas owns 42% of
the shares, with the remaining shares held by individual and institutional
shareowners all over the world.
At December 31, 2001, TDC had total assets of Danish Kroner 92.2 billion
(approximately $10.9 billion at current exchange rates) and shareholders'
equity of Danish Kroner 29.6 billion (approximately $3.5 billion at current
exchange rates). During 2001, TDC had net income excluding one-time items of
Danish Kroner 1.317 billion (approximately $156 million at current exchange
rates) on net revenues of Danish Kroner 51.564 billion (approximately $6.1
billion at current exchange rates.)
As a result of certain agreements between the Company and TDC (the "TDC
Agreements"), the Company has issued 2,579,588 shares of Common Stock to TDC.
As of March 27, 2002, TDC owned 21.3% of the outstanding Common Stock. The TDC
Agreements provide TDC 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. See Notes 5, 9 and 12 of Notes to Consolidated
Financial Statements, and see also Item 12 "Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters."
Postabank
Postabank was established in 1988 and provides a wide range of commercial
and retail banking services to its private and corporate customers in Hungary.
As of December 31, 2001, its total assets were HUF 363 billion ($1.3 billion).
The Hungarian government owns a controlling interest in Postabank.
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 and terminated the Original Postabank Credit Facility. In April 2000 the
Company paid off the outstanding balance on the Postabank Bridge Loan Agreement
with the proceeds of a syndicated loan agreement. See Item 7 "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources," and Notes 5, 9 and 12 of Notes to
Consolidated Financial Statements.
As of March 27, 2002, Postabank owned 20.1% of the outstanding Common
Stock and 31.0% of
-8-
the outstanding Common Stock on a fully diluted basis. For a more detailed
description of some of the Postabank Agreements, see Notes 5, 9 and 12 of Notes
to Consolidated Financial Statements, and see also Item 12 "Security Ownership
of Certain Beneficial Owners and Management and Related Stockholder Matters."
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. The
purpose of the Danish Fund is to promote Danish direct investments in Central
and Eastern Europe and to enhance the possibilities for closer cooperation
between Danish and Central and Eastern European companies. The Danish Fund
engages in projects with Danish companies via equity capital and/or loans. As
of March 27, 2002, the Danish Fund owned 10.6% of the outstanding Common Stock.
See Notes 5, 9 and 12 of Notes to Consolidated Financial Statements, and see
also Item 12 "Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters."
DIRECTORS
The current directors and executive officer of the Company are Ole
Bertram, a Company director and the Company's President and Chief Executive
Officer; Daryl A. Ferguson, a Company director and the retired President and
Chief Operating Officer of Citizens; Thomas Gelting, a Company director and a
Vice-President in the Mergers and Acquisitions department at TDC; Torben V.
Holm, a Company director and the head of the Mergers and Acquisitions
department at TDC; John B. Ryan, a Company director and a financial consultant;
William E. Starkey, a Company director and a retired Senior Executive with GTE
Corporation; and Leonard Tow, a Company director and currently the Chairman and
Chief Executive Officer of Citizens.
SERVICES AND PRICING
Services
The Company currently provides non-cellular local voice telephone
services in its Operating Areas which allows subscribers to have facsimile, and
modem transmission capabilities and has made available to its subscribers,
through interconnection with Matav, domestic and international long distance
services. (As noted above, Matav's exclusivity rights to domestic and
international long distance services have expired.) In addition to these
standard services, the Company currently offers its subscribers data
transmission and other value-added services, including Internet, voice mail,
Internet Protocol-based voice services, 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, detailed billing and other customer
services, including revenues from the sale and lease of telephone equipment.
The Company's customers are on a one-month billing cycle.
-9-
Measured Service. The Company has two basic rates, peak and off-peak, for
each of local and domestic long distance charges and one rate for international
long distance charges. For all local calls within an Operating Area, the
Company retains all of the revenues associated with the call. For local calls,
the Company may choose to increase its rates up to the permitted amount or
charge a lower rate. Up until now and until the full implementation of the
Communications Act, for all domestic long distance calls outside of an
Operating Area and all international calls, the Company has a revenue sharing
arrangement with Matav the terms of which have been governed by a decree of the
Prime Minister's Office. Pursuant to this revenue sharing arrangement, the
Company charges for and collects from its customers the fees which are set by
Matav, but subject to regulation, for domestic and international long distance
calls. The Company then pays those fees to Matav but retains an
interconnection fee for initiating the call. For domestic and international
long distance calls to the Company's customers, the Company receives an
interconnection fee from Matav for completing the call. When the
Communications Act is fully implemented during 2002, the Hungarian
telecommunications customers will be able to choose their domestic and
international long distance carrier. If one of the Company's customers chooses
Matav or another long distance carrier, Matav or that other carrier will be
responsible for billing the Company's local customer for long distance charges
and paying the Company an interconnection fee for initiating that call.
Pursuant to the Communications Act, the Company's interconnection fees for
initiating and terminating long distance calls for its local customers will be
regulated by a government-approved interconnection rate scheme. If the
Company's local customer chooses the Company as its long distance provider, the
Company will bill its local customer for long distance calls and the Company
must pay, if the call goes outside of the Company's network, Matav or another
carrier a fee for transmitting the call outside of the Company's network and a
fee to the telecommunications provider completing the call. Up until now (and
until the full implementation of the Communications Act), the rates for calls
from a Hungarian cellular phone to a Company customer and calls from a Company
customer to a Hungarian cellular phone have been set by the cellular carriers
and the Company received a government regulated interconnection fee for
terminating or initiating the call. When the Communications Act is fully
implemented, the Company will still get a government regulated interconnection
fee for initiating and terminating cellular phone calls. However, the fees for
calls from the Company's customers to cellular telephones will now be
regulated. See "- Summary of the Liberalization Act."
Measured Service Price Regulation. Maximum pricing levels have historically
been set by the TTW Ministry (now by the Prime Minister's Office) and such rate
increases have generally tracked inflation, as measured by either the Hungarian
Producer Price Index ("PPI") or the Hungarian Consumer Price Index ("CPI"). In
1997, the TTW 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, which included a rebalancing
formula, which provides for greater increases in charges for subscription fees
and local calls than in domestic long distance and international calls. In
addition to using the CPI in setting rates, the Prime Minister's Office has
used an efficiency factor in calculating the maximum allowable price increase.
For 2001, the Prime Minister's Office approved an overall price increase of
approximately 6% for measured service calls and subscription fees. For 2002,
the Prime Minister's Office has approved an overall price increase for measured
service calls and subscription fees of approximately 4%.
Since 1998 the TTW Ministry and now the Prime Minister's Office have 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 within the parameters of European Union standards. To
-10-
that end, starting in 1999, the interconnection fees were revised to compensate
the LTOs more favorably for costs than in the prior years. The Company expects
government approved interconnection rates to continue to follow this cost-based
interconnection fee regime. The Communications Act provides for LTOs
(including the Company) to be compensated for interconnection initiation and
termination fees based on a Reference Interconnection Offer ("RIO"). The LTOs
are responsible for submitting a RIO to the Communications Authority for
approval. The RIO should be based on cost plus a reasonable profit. See "-
Summary of the Liberalization Act."
Subscription and Connection Fees. The Company collects a monthly
subscription fee from its customers. The basic monthly subscription fee is HUF
3,000 ($10.75). In an effort to retain low usage customers, the Company has
introduced several different subscription fee options for its residential
customer base. For a reduced monthly subscription fee, a residential customer
agrees to pay his regular monthly measured service fee plus an additional
percentage of such measured service fee which should lower the overall bill for
low volume users. The Prime Minister's Office regulates the subscription fees.
The Company charges its customers connection fees when they are added to
the Company's 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. Connection fees are recognized as income over the expected customer
life (presently seven years) from the date that the connection is made.
Connection fees are regulated by the Prime Minister's Office and the maximum
fees are currently HUF 30,000 ($107.51) for residential customers and HUF
90,000 ($322.54) for business and other institutional subscribers (including
government institutions). Customers requesting additional access lines are
charged an additional connection fee per line. The Company can offer special
promotions on the connection fees if it so chooses. In the past the Company
has allowed its customers to pay connection fees on various installment plans.
Other Operating Revenue. The Company supplies private line service (point-
to-point and point-to-multi-point) primarily to businesses. As of December 31,
2001, approximately 1,672 leased lines were in service. In addition, as of
December 31, 2001, the Company had 1,883 public pay phones in the Operating
Areas. 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 rental of
telephone equipment.
NETWORK DESIGN AND PERFORMANCE
The Company has constructed a versatile modern communications network which
substantially replaced the antiquated system purchased from Matav. This 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.
-11-
Conventional Network Design
In developing its networks, the Company has implemented service quality and
redundancy objectives on par with Western European and North American digital
network standards. Certain of the networks constructed are based on digital
hosts and remotes with fiber optic rings and copper feeder and distribution.
Such a distribution system is the conventional system used in the United States
and Western Europe. Telecommunications services are transmitted to the home
through twisted pair copper wire telephone cable.
The 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 using 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 the same services as a conventional copper network such as
voice mail, call forwarding and call barring.
Network Administration
-12-
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.
STRATEGY
With the recent enactment of the Communications Act and the key
implementing decrees, Hungary has taken some significant action towards
facilitating a more competitive telecommunications market as it seeks to join
the European Union. A more competitive environment will provide the Company
with many opportunities and challenges.
On November 1, 2002 the Company's right to be the exclusive provider of
non-cellular local voice telephone services in its Operating Areas will expire.
Matav's rights to be the exclusive provider of non-cellular local voice
telephone services in its concession areas (which cover approximately 70% of
the area of Hungary) expired at the end of 2001 in the majority of its
concession areas while its exclusivity rights in its remaining concession areas
will expire in November 2002. All of the other LTOs' markets will also become
open to competition in November 2002 as their exclusive rights to provide
non-cellular local voice telephone services in their markets expire.
Matav's exclusivity rights to provide domestic and international long
distance non-cellular voice services expired at the end of 2001. Therefore,
while the Company may be subject to some competition in its Operating Areas by
the end of this year, the Company is now permitted to compete in the domestic
and international long distance market and in the majority of Matav's markets
for the provision of non-cellular local voice telephone services. By the end
of the year, the Company will be permitted to compete in the other LTOs' and
the rest of Matav's markets for the provision of non-cellular local voice
telephone services. The Company, Matav and the other LTOs will still retain
their rights to provide telecommunications services in their existing markets
but, as noted above, by November 2002, not with exclusivity.
To effectively compete in a more open Hungarian telecommunications market,
the Company's primary focus is to maintain its market dominance in the
provision of non-cellular local voice telephone services in its Operating
Areas. To accomplish this goal, the Company is continuing and expanding its
efforts to increase its product and service offerings and their usage, increase
its marketing to its entire customer base, improve its customer service, and
increase its operational efficiencies. Such efforts are intended to enable the
Company to reduce operating costs and increase call revenues from its customer
base to offset any market share lost to competitors. In addition to continuing
to service its existing market, the Company also intends to selectively compete
within and outside its Operating Areas by offering newly liberalized services
either by itself or in conjunction with other telecommunications providers.
The Company has implemented the following operational strategies in order to
further its business objectives.
Products and Service Offerings
While the Company's business and other institutional subscribers account
for only 15% of the Company's access lines, these customers accounted for a
greater share of the Company's revenue in 2001. The Company believes that its
business customers have the greatest need for the variety of new
-13-
products and services that a modern telecommunications company can offer. The
Company also believes that its business customers will be the primary target
for competition in its Operating Areas once competition opens up. Therefore,
the Company intends to continue to solidify its relationship with its business
customers to maintain helping them solve their communications needs.
Since the availability of modern telecommunications services is still a
relatively new phenomena in Hungary, educating the business customer on the
availability and benefits of the Company's products and services is a
continuing goal of the Company. The Company emphasizes increasing the
installation of products and services and the usage levels of the Company's
business customers by focusing on the marketing and sales of various products
and 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 an account manager assigned 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.
For residential customers, the Company is focusing its efforts on educating
the 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 rate packages 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 continues to offer the latest telecommunications products and
services as they become available in the telecommunications marketplace. The
Company introduced Internet Protocol-based voice services to its customers in
2000. This has enabled the Company to offer long distance and international
calling services at discounted rates. During 2001 the Company become an
Internet Service Provider in all of its Operating Areas under the brand name
"Globonet". The Company is also reviewing options with respect to such
offerings as pre-paid calling plans, loyalty programs and teleconferencing to
increase usage.
Marketing
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. 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. To get new customers the Company has
implemented short marketing campaigns targeting those residences without phone
service. To induce potential new customers the Company has offered special
limited time only rates on the connection fee and special rate plans for
infrequent telephone users. The Company has also used its special rate plans
in an attempt to limit the disconnection of customers. For business customers,
the Company's primary marketing tool has been direct contact with the business
customers through the Company's account managers.
Customer Service
-14-
The Company believes that providing a high level of customer service is
important in attracting additional customers, increasing the usage of its
existing products and services by its current customer base and retaining
customers in a competitive environment. Prior to completion of the Company's
telecommunications networks, 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 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. The Company
also operates customer service centers in each of the Operating Areas which
offer facsimile, Internet, photocopying and telephone bill payment services.
These service centers also sell communications equipment, process telephone
service applications and handle billing inquiries. The Company reorganized its
customer service centers 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 to work with businesses to help them achieve
their objectives with innovative telecommunications solutions.
Operational Efficiency
The Company has increased 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 a centralized operating and accounting system to serve all of its
Operating Areas, which has given the Company a more efficient customer billing
system and greater financial accountability. To capitalize on the Company's
contiguous concession areas, the Company reorganized its operations into three
Operating Areas rather than four which the Company expects will help it achieve
certain economies of scale. Further, in an effort to reduce more overhead and
maximize efficiencies, the Company merged its four Hungarian operating
subsidiaries into one Hungarian operating subsidiary as of January 1, 2002. As
of result of such productivity measures, the newly consolidated Operating
Company now has 323 access lines per employee. During 2002 the Company will
continue its ongoing efforts to streamline its operations.
Newly Liberalized Services
With the Hungarian telecommunications market becoming open to competition,
the Company intends to take advantage of select market opportunities. For
example, the Hungarian domestic and international long distance market for
non-cellular voice services in now open for competition. Therefore, the
Company can now offer under its own brand name domestic and international long
distance services to its existing customer base in its Operating Areas.
For calls originating in one of the Company's Operating Areas and
terminating in another of the Company's Operating Areas, the Company now has
both the capability and right to carry the call from the initiating caller to
the recipient completely over its own network without passing through Matav's
network, thus saving the Company from any revenue sharing with Matav. For
calls originating in one of the Company's Operating Areas and terminating in
certain other parts of Hungary outside of the Company's Operating Areas, the
Company is capable of delivering the call to the local network of the recipient
for completion. In this case, the Company would keep more revenue by not
having to pay for
-15-
transmission services between local networks. The Company would have to pay
the recipient's local carrier a fee for completing the call. For calls
originating in one of the Company's Operating Areas and terminating in other
parts of Hungary, the Company may have to use another provider such as Matav to
carry the calls to the local network of the recipient for completion. In this
case, the Company would have to pay a transmission fee and a completion fee to
the other carriers. For international calls from the Company's Operating
Areas, the Company has the capability and right to carry the call on its
network for handoff to an international carrier for completion.
The Company is also free to enter markets outside its Operating Areas to
provide long distance voice and data services and Internet services. The
Company does not presently own the network capability to provide such services
entirely over its own network but it could enter the market as a reseller and
use another carrier's network as needed. In November 2002 the Company may
enter all of Matav's and the other LTOs' markets as a provider of local
non-cellular voice services using the local carriers network through regulated
unbundling agreements. See "- Summary of the Liberalization Act."
The Company is currently evaluating its opportunities to offer liberalized
services and will enter markets that its deems appropriate for its business
strategy and goals.
Mergers and Strategic Alliances
As the Hungarian telecommunications market continues to develop and become
more liberalized as the monopolies of Matav and the LTOs continue to expire and
new telecommunications providers enter and expand their presence in Hungary,
the Company will continue to review its options with respect to any merger or
strategic alliance possibilities that may enable the Company to offer some of
the newly liberalized services discussed above.
THE OPERATING AREAS
The following is a brief description of each of the Operating Areas:
Bekes
The Bekes Operating Area encompasses the southern portion of Bekes County,
which borders Romania. The Bekes Operating Area is comprised of 75
municipalities and has a population of approximately 391,700 with an estimated
166,900 residences and 23,100 business and other potential subscribers
(including government institutions). B[eacute]k[eacute]s 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, 2001, the
Company had 114,200 access lines connected to its network in the Bekes
Operating Area. The Company's network in the Bekes Operating Area utilizes a
combination of a conventional build, fiber optic and wireless local loop
technology.
Nograd
The Nograd Operating Area is comprised of 74 municipalities in the eastern
portion of Nograd
-16-
County, which borders Slovakia. The Nograd Operating Area has a population of
approximately 147,900, with an estimated 62,400 residences and 8,900 business
and other potential subscribers (including government institutions). The
principal economic activities in the Nograd Operating Area include light
manufacturing, tourism, some coal mining and agriculture. Foreign investors in
the region include the dairy producer, Sole, and the Japanese company,
Paramount Glass. The Nograd Operating Area's proximity to Budapest, 1.5 hours
by car, and its many cultural attractions makes it a desirable weekend and
tourist destination. As of December 31, 2001, the Company had 47,000 access
lines connected to its network in the Nograd Operating Area. The Company's
network in the Nograd Operating Area utilizes a combination of a conventional
build, fiber optic and wireless local loop technology.
Papa/Sarvar
The Papa/Sarvar Operating Area is composed of 114 municipalities located in
the counties of Veszprem and Vas. The population of the Papa/Sarvar Operating
Area is approximately 128,400 with an estimated 50,300 residences and 6,500
business and other potential subscribers (including government institutions).
The portion of the Papa/Sarvar Operating Area in Veszprem County is relatively
underdeveloped economically with the principal economic activities centering
around light industry, appliance manufacturing, agriculture and forest
products. Significant foreign investors in Veszprem County include ATAG, the
Dutch appliance maker, and Electricit[eacute] de France. The principal economic
activities in the portion of the Papa/Sarvar Operating Area located in Vas
County include heavy manufacturing and assembling, agriculture and tourism.
Significant employers include: Linde (a German natural gas distributor):
Philips (a Dutch-owned electronics manufacturer); EcoPlast (a plastics
producer); Saga (a British-owned poultry processor); and Flextronics
International, which assembles Microsoft's video game console Xbox in the
Papa/Sarvar Operating Area. As of December 31, 2001, the Papa/Sarvar Operating
Area had 42,300 access lines connected to its network. The Company's network in
the Papa/Sarvar Operating Area utilizes a combination of a conventional build,
fiber optic and wireless local loop technology.
SUMMARY OF THE LIBERALIZATION ACT
In June 2001 the Hungarian Parliament enacted the Communications Act, which
took effect on December 23, 2001. The goal of the Communications Act is to
provide for a more liberalized telecommunications market by making market entry
easier, promoting competition and harmonizing Hungary's telecommunications laws
with those of the European Union. The Communications Act is a framework piece
of legislation with the detailed regulations to be contained in a series of
implementing decrees. Some of the key provisions of the Communications Act and
the implementing decrees that have been adopted to date are summarized by topic
below. The provisions are subject to change and legal interpretation by the
Hungarian regulatory system and could also change based upon Hungary's
accession into the European Union. While the key decrees have been passed, the
Communications Act has not been fully implemented, resulting in a delay in the
opening up of the long distance market to full competition.
Administration
The Communications Authority is the central administrative body that
reports to the Chancellor in the Prime Minister's Office and the Hungarian
government. It is divided into three units: the Regional Communications Office
which is responsible for administrative tasks such as issuing licenses,
verifying reports and market supervision; the Communications Inspectorate which
is responsible for such matters as
-17-
market surveillance and frequency management; and the Communications
Arbitration Committee which identifies providers with significant market power,
reviews reference interconnection and local loop unbundling offers for approval
and settles disputes between parties.
Market Entry
Today market entry from a legal standpoint is relatively easier than in
the past when a concession from the government was required. A potential
telecommunications service provider need only notify the Communications
Inspectorate that it intends to provide a telecommunications service; provided
that the service is no longer protected by an exclusive concession in the
specific market that the provider wants to enter.
Significant Market Power
The Communications Arbitration Committee is empowered to determine which
telecommunications service providers in the provision of fixed-line
non-cellular voice services, mobile cellular telephone services, leased line
services, and interconnection services have what is deemed Significant Market
Power ("SMP"). A telecommunications operator is deemed to have SMP when it has
at least a 25% market share in a specific geographic area in one of the four
services noted above. Under the terms of the Communications Act and because of
its exclusivity rights, the Company is deemed to be a telecommunications
provider with SMP in its Operating Areas until the Communications Arbitration
Committee meets to determine which telecommunications providers have SMP. The
Company expects that the Communications Arbitration Committee will designate
the Company as a telecommunications provider with SMP in its Operating Areas.
The Communications Arbitration Committee also has discretionary authority to
designate a telecommunications operator as a telecommunications operator with
SMP based on several factors including, among other factors, net revenue,
access to capital and the necessary asset infrastructure to reach customers.
Telecommunications operators with SMP have additional obligations which are
summarized below.
Interconnection
Upon request, all telecommunications operators are required to
interconnect their networks to another telecom operator provided that it is
financially and technically feasible. A telecommunications operator designated
as having SMP must submit a Reference Interconnection Offer ("RIO") to the
Communications Arbitration Committee. Once the Communications Arbitration
Committee approves a RIO, the telecom operator must provide interconnection on
the terms of the RIO to any telecom operator that wants interconnection. The
RIO must be based on cost plus a reasonable profit. For example, if a telecom
operator wants to connect to the Company's network in order to provide domestic
and international long distance service to the Company's customers, the Company
must provide interconnection on the terms of its RIO.
Local Loop Unbundling
The LTOs (including Matav and the Company) with SMP in the provision of
fixed-line non-cellular local voice telephone services are required to
"unbundle" their local loop networks when their exclusivity period expires.
This means that the Company, following the expiration of its exclusivity period
in November 2002, will be required to allow a telecom operator to use its
network to provide
-18-
competing non-cellular local voice telephone services in its Operating Areas.
The unbundling agreement must be on the terms of a reference unbundling offer
approved by the Communications Arbitration Committee, which offer must be based
on cost to the LTO plus a reasonable profit. All third parties who want to use
an LTO's network to provide competing non-cellular local voice telephone
service must take it on the terms approved by the Communications Arbitration
Committee. A potentially important exception to this requirement that the LTOs
with SMP unbundle their networks is that a SMP-designated LTO does not have an
obligation to unbundle its network if the party requesting the use of the LTO's
network is another SMP-designated telecommunications operator that is in a
better position than that LTO with respect to assets, finances, revenues or the
development of the international communications market. The exact meaning of
this regulatory provision is not certain at this time but the Company could
assert that it does not have to let certain other telecom service providers in
Hungary, including Matav, use the Company's network to compete against the
Company in the provision of non-cellular local voice telephone services in the
Company's Operating Areas. However, a potential competitor is not barred from
building its own network in the Company's Operating Areas. The term of this
regulatory provision is also not certain at this time and the Company does not
know with any certainty whether such provision would survive Hungary's entry
into the EU.
Carrier Selection
Customers in Hungary now have a choice on a call-by-call basis or on a
continuing basis which provider of domestic and international long distance
voice services they wish to use. That long distance provider is then
responsible for billing its customers for long distance charges and paying the
LTO an interconnection fee for the initiation of the long distance call. The
interconnection fee will be based on the LTO's RIO approved by the
Communications Arbitration Committee.
Universal Services
The Communications Act provides for a Universal Services Fund in order to
provide (i) country-wide access to fixed line telecommunications services at
reasonable prices, (ii) public pay telephones, (iii) operator assisted
services, and (iv) free emergency services. Every cellular and non-cellular
telecommunications operator in Hungary is now required to contribute to a
Universal Service Fund ("USF"). The contributions are to be based on a
percentage of net revenue from services in Hungary. The money from the USF
will be paid out to the LTOs at a fixed rate based on the number of
subscribers. In return for the funds, the LTOs will have certain universal
service obligations to connect certain customers to their networks at
discounted rates. The Company anticipates that it will receive more funds from
the USF than it pays into the USF.
Price Regulation
Although prices charged for some telecommunications services will not be
regulated, the charges for local and long distance non-cellular calls,
subscription fees and connection fees will still be regulated. The price for
Internet services will also be regulated. Calls from a fixed line to a
cellular phone which were set by cellular carriers in the past will also now be
regulated.
Internet Service
Provided that it is technically feasible, telecommunications providers
designated as having SMP
-19-
must allow Internet Service Providers access to their networks to provide
Internet access to customers. The access will be subject to the terms of an
access agreement to be entered into between the telecommunications provider and
the Internet Service Provider. The charges for Internet service in Hungary
will be regulated and the LTOs will be obligated to pass on some of the
regulated fees to the Internet Service Providers.
REGULATION
In November 1992, the Hungarian Parliament enacted the Hungarian
Telecommunications Act of 1992 (the "Telecom Act") which took effect in 1993.
The 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
Telecom Act also gave the TTW 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. The oversight of the telecommunications
industry has been transferred to the Prime Minister's Office. See "- Overview
of Hungarian Telecommunications Industry - The Regulatory Framework."
With the passage of the Communications Act, many of the provisions of the
Telecom Act were superceded. The Prime Minister's Office has indicated to the
Company its desire to enter into discussions regarding the possible termination
or amendment of the Company's Concession Contracts. At this time the Company
is reviewing its options with respect to its Concession Contracts and cannot
predict with certainty whether the Concession Contracts will be amended or
terminated or remain unchanged. Presently the Concession Contracts are still
in force. In any event the Company will retain the necessary licenses to
continue its services in the Operating Areas. The terms and applicability of
the Concession Contracts are further complicated by the fact that four
subsidiaries of the Company entered into the Concession Contracts with the TTW
Ministry. Those four subsidiaries ("KNC", "Raba-Com", "Papatel", and
"Hungarotel") were merged into Hungarotel as of January 1, 2002. The terms of
the Company's Concession Contracts are summarized below.
Concession Contracts
Pursuant to the 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 TTW 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, 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 TTW Ministry (now the Prime Minister's Office) 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.
Hungarotel, the surviving subsidiary of the Company's
-20-
merged Hungarian subsidiaries, is currently in compliance with this requirement.
Exclusivity. The Concession Contracts provide that each concession holder
has the exclusive right to provide non-cellular local voice telephone services
for eight years until November 2002. Thereafter the Hungarian government will
have the right to grant additional licenses for the provision of non-cellular
local voice telephone services in the Operating Areas.
Royalties. Each of the Company's former subsidiaries was required by the
terms of its individual Concession Contract to pay annual royalties equal to a
percentage of net revenue from basic telephone services. Net revenue for this
purpose is generally defined as gross revenue from basic telephone services
less the fees paid to Matav. The royalty percentage may also differ by region.
For example, the former subsidiaries were obligated to 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. At this time the Company does not know with certainty
whether the Company will be obligated to pay such royalties for 2002 given the
Prime Minister's Office's desire to amend or terminate the Concession
Contracts.
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. At this time the Company does not know with
certainty whether the Company will be obligated to pay such contributions for
2002 given the Prime Minister's Office's desire to amend or terminate the
Concession Contracts.
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. With the
enactment of the Communications Act, this renewal provision will not be
applicable. The Company will retain a license to continue service.
Termination upon Lack of Performance. If an LTO is unable to comply with
the terms of its concession contract, the Prime Minister's Office has the right
to abrogate the concession contract. In such an instance, the Prime Minister's
Office has authority to determine alternative provisions for such service,
which may include the sale of the LTO's telecommunications assets to an
alternative provider. The Company believes that it has demonstrated substantial
performance to date under its Concession Contracts and that its relations with
the Prime Minister's Office are good.
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 TTW Ministry stipulated in the Concession Contracts for Hungarotel and
Papatel, as amended on June 3, 1996, that Hungarotel and Papatel must meet
certain Hungarian ownership requirements so that by the seventh year
anniversary of such amendments (June 3, 2003) 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
-21-
Hungarian ownership was required. For the seven-year period ending June 3,
2003, 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 Hungarotel
or Papatel 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
25% plus one share Hungarian ownership requirement can also be met 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 strict 25% plus one share Hungarian
ownership requirement. However, the TTW Ministry stated, pursuant to a letter
dated September 18, 1996, that it intended to treat all of the Company's
subsidiaries equally (as set forth in Hungarotel's and Papatel's Concession
Contracts) 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 Prime Minister's Office, which may then require
the LTO to rectify the situation within three months, or a shorter period if it
is determined that there has been a delay in the required notification. With
respect to the Company, Postabank, a Hungarian commercial bank, owns
approximately 20.1% of HTCC which is the majority owner of Hungarotel, the
Operating Company. Therefore, the Company is currently deemed in compliance
with the current 10% ownership requirement. The Company believes that the
Prime Minister's Office will eliminate all Hungarian equity ownership
requirements. In the event that the Prime Minister's Office does not change
the present Hungarian ownership requirements or adopts new Hungarian equity
ownership requirements, which the Company does not expect, the Company will
formulate plans to meet any such Hungarian equity ownership requirements
although there can be no assurance that the Company will be able to increase
the Hungarian ownership in Hungarotel in a manner sufficient to comply with
such requirements in the future.
Hungarian Taxation
Corporate Income Tax. The operations of the Company's Hungarian
subsidiaries, including the Operating Company, are subject to Hungarian
corporate income tax. Generally, Hungarian corporations are subject to tax at
an annual rate of 18.0%. Companies which fulfilled certain criteria were
entitled to a 100.0% reduction in income taxes for the five year period ending
December 31, 1998 and a 60.0% reduction in income taxes for the subsequent five
year period ending December 31, 2003, provided certain criteria continue to be
met. See Note 1(j) of Notes to Consolidated Financial Statements. The
Operating Company is 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 Company 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
-22-
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 2001 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 3,900 ($13.98) per month for each employee for health insurance.
COMPETITION
The Company's concession rights provide for an eight-year period of
exclusivity in the provision of non-cellular local voice telephone services,
which ends on November 1, 2002, while the initial 25-year terms of the
concession contracts are scheduled to expire in 2019. See also "- Regulation --
Concession Contracts". As a result of the Communications Act, other
telecommunications service providers can enter the long distance voice market
anywhere in Hungary in 2002. Following November 1, 2002, other
telecommunications service providers can enter the Company's Operating Areas to
compete with the Company in the non-cellular local voice services market.
However, such competitors would have to develop their own telecommunications
network (wire or wireless) or may use, in some cases, the Company's network
pursuant to an unbundling agreement. There may be some restrictions on the
rights of certain telecommunications service providers to access the Company's
networks through unbundling. See "- Summary of the Liberalization
Act."
Today, three telecommunications service providers have built long distance
networks capable of servicing substantially all of Hungary: Matav; PanTel; and
Vivendi. These companies are capable of entering the Company's Operating Areas
following November 1, 2002 and competing for the Company's customers,
particularly the business customers. To date, Matav has been the exclusive
provider of domestic and international long distance services. PanTel has
substantially built a nationwide fiber optic backbone network along the
rights-of-way of MAV, the Hungarian railway. PanTel has been providing
business communications services such as digital data, fax and video
transmission using Internet Protocol ("IP") data transmission technology and
IP-based voice services primarily to large customers. PanTel also owns a
majority stake in one of Hungary's largest Internet Service Providers. Vivendi
provides local non-cellular voice telephone service in nine concessions areas
(covering approximately 15% of the country) and has built an extensive fiber
optic network throughout Hungary. Most existing telecommunications service
providers in Hungary have already entered the marketplace for voice-over IP
services, which did not violate Matav's now-expired exclusivity rights to long
distance voice services.
Other Hungarian telecommunications providers, and potential providers,
include the following entities which have either entered, or plan to enter, the
telecommunications marketplace, particularly the business marketplace: Novacom
Telecommunications Kft., which is owned by affiliates of RWE, the German
utility conglomerate, EnBW AG, a German electricity provider and Elmu Rt., the
Hungarian electricity distributor ("Elmu"), is expanding the fiber optic
infrastructure of Elmu; GTS Hungary Kft. ("GTS") which provides data and voice
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 controlled by the state;
Global One Telecommunications Kft., which provides IP-based data and voice
transmission services; Ireland-based eTel Hungary, which is targeting
-23-
the corporate market; BT Hungaria, an affiliate of British Telecom; Sweden's
Telia AB; Germany's Infigate GmbH; and U.S.-based UUNet, an affiliate of MCI
WORLDCOM.
The Company faces intense competition from the three Hungarian cellular
providers: Westel; Pannon; and Vodafone. The cellular market growth has been
very fast in Hungary with a penetration rate now over 50%. Unlike the United
States and Western Europe, many Hungarians have gone from having no telephone
(wireline or wireless) straight to cellular without getting a traditional
wireline telephone. Historically, the airtime and monthly fees charged by the
cellular operators are generally more than the fees for comparable services
charged by the Company. The cellular telephone providers are, however,
currently deploying various discounted pre-paid plans, which make pricing
comparisons difficult.
The Hungarian cable television market is highly fragmented with over 150
cable television providers. The Hungarian cable television industry is
undergoing consolidation. An affiliate of United Pan-European Communications
NV ("UPC") is the largest cable television operator in Hungary and owns a LTO
with one concession area. UPC's controlling shareholder is UnitedGlobalCom
Inc., the global television operator of Denver, Colorado.
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 EU until 2004 at the earliest. Some of
Hungary's laws affecting the telecommunications markets, including those
recently enacted, could be affected by Hungary's entry into the EU.
EMPLOYEES
The Company had a total of approximately 630 employees, including 5
expatriates, as of March 2002. The Company considers its relations with its
employees to be satisfactory.
ITEM 2. PROPERTIES
The Company leases its principal executive offices in Budapest, Hungary
and also has a United States office currently located at 32 Center Street,
Darien, CT. In addition, the Operating Company owns or leases properties
throughout its Operating Areas in Hungary. The Company has secured all the
necessary rights-of-way with respect to its telecommunications networks. The
Company believes that its leased and owned office space and real property is
adequate for its present needs but is currently reviewing its alternatives as
to its future needs.
ITEM 3. LEGAL PROCEEDINGS
Dialcont
Hungarotel is a defendant in a lawsuit filed by Dialcont Kft. ("Dialcont")
on March 28, 1996 alleging a breach of contract for services allegedly provided
by Dialcont during 1994 and 1995. Dialcont claimed HUF 222 million ($795,600).
The Metropolitan Court in Budapest awarded Dialcont HUF 77.7 million ($278,500)
plus interest and costs in a judgement issued in October 2000. Hungarotel has
filed an appeal to the Hungarian Supreme Court in October 2000, but no hearing
date has been set yet. As of
-24-
March 27, 2002 the lower court's judgment with accumulated interest and costs
totaled approximately HUF 154.5 million ($554,000). The Hungarian Supreme
Court has the power to decide the case anew and could award up to the full
amount of the original claim (HUF 222 million) plus interests and costs. The
Company believes that it has it has a defense to such action and is vigorously
defending itself.
Local Business Tax
A provision in Hungarotel's Concession Contracts provided for a payment by
Hungarotel of a sum equal to ten times the local municipal business tax. At
the time of the inception of the Concession Contracts, the local business tax
was 0%. When this increased in one of the regions within the Hungarotel
Operating Area in 1996, one municipality claimed that Hungarotel was liable to
pay the local business tax at ten times the prevailing rate. However, the
municipality has not been able to enforce this undertaking because it is not a
party to the Concession Contracts. The municipality has taken this matter up
with both the Communications Authority and the TTW Ministry. In May 1999, the
then Hungarian Deputy State Secretary gave a verbal confirmation that the TTW
Ministry would not enforce the undertaking against Hungarotel. Subsequently,
in November 1999, the TTW Ministry sent a letter to the municipality informing
it that the disputed business tax provision was not enforceable because the
indefinite nature of the undertaking constituted an unjustified burden on
Hungarotel and that the undertaking was not in compliance with the laws on
Local Business Tax. The most recent development in this matter is a letter
from the municipality to the Company dated January 18, 2001, demanding the sum
of HUF 648.0 million ($2.3 million). The letter states that, in the absence of
payment, the municipality will take the matter up with the Prime Minister's
Office, the Communications Authority and others. Hungarotel intends to defend
this action and believes that such provision is unenforceable.
Fazis
During 1996 and 1997, the Company entered into several construction
contracts with Fazis, a Hungarian contractor ("Fazis") which totaled $59.0
million in the aggregate, $47.5 of which was financed by a contractor financing
facility. Fazis financed the facility through Postabank. The Company and
Fazis have a disagreement with respect to several issues relating to the
quality and quantity of the work done by Fazis. The Company has rejected
invoices from Fazis in the amount of approximately HUF 700 million
(approximately $2.5 million).
In order to resolve these issues in 1999, the Company purchased from
Postabank some of Postabank's receivables owed by Fazis to Postabank
(approximately $14 million) with respect to the contractor financing facility.
The Company also purchased from Postabank some of the obligations which the
Company owed to Fazis under the contractor financing facility which were
assumed by Postabank (approximately $25 million). The Company then set off its
remaining uncontested liabilities owed to Fazis (approximately $3.2 million)
against the amounts owed to the Company by Fazis (approximately $14 million).
Fazis has challenged these actions by the Company in a lawsuit filed in 2001
with the Metropolitan Court in Budapest. The Company has filed counterclaims
in this matter. There is a court hearing scheduled for April 2002.
Fazis 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 contractual claims against
Fazis of approximately $31 million attributable to deficiencies in the work
performed by Fazis.
-25-
In 1999 Reorg Rt. ("Reorg"), a company responsible for collecting
Postabank's bad debts, initiated debt collection proceedings against Fazis. In
June 2000 Reorg claimed the benefit of certain invoices in the amount of HUF
455 million ($1.6 million) that Fazis had issued to the Company, asserting that
Fazis had assigned those invoices to it as security in the debt collection
proceedings. The Company rejected Reorg's claim on the grounds that Fazis had
no right to assign the invoices and that, in any event, the Company has a
substantive defense and a counterclaim on the merits to the underlying claims
on the invoices. Reorg subsequently reduced its demand of HUF 455 million but
the Metropolitan Court of Budapest dismissed Reorg's claim asserting that the
Metropolitan Court did not have jurisdiction and that the contractual claims
should be decided by arbitration proceedings. Reorg has appealed the
Metropolitan Court's decision to the Hungarian Supreme Court.
At this time the outcome of any of these legal proceedings and disputes
cannot be predicted with certainty. The Company believes that it will prevail
on the merits. There can, however, be no assurances as to the final outcome or
course of action of such dispute.
Other
The Company is 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 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, 2001.
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 2000 and 2001.
-26-
High Low
---- ---
Quarter Ended:
- -------------
2000
- ----
March 31, 2000 . . . . . . . . . . . $10-1/2 $ 6-7/8
June 30, 2000. . . . . . . . . . . . 8-5/8 5-1/2
September 30, 2000 . . . . . . . . . 7-3/8 4-3/4
December 31, 2000. . . . . . . . . . 6-3/8 4-1/8
2001
- ----
March 31, 2001 . . . . . . . . . . . $ 9.50 $ 5.63
June 30, 2001. . . . . . . . . . . . 8.04 5.05
September 30, 2001 . . . . . . . . . 5.35 2.65
December 31, 2001. . . . . . . . . . 5.30 3.65
On March 25, 2002, the closing sale price for the Common Stock on the
Amex was $5.10.
STOCKHOLDERS
As of March 25, 2002, the Company had 12,103,180 shares of Common Stock
outstanding held by 100 holders of record. The Company believes that it has
approximately 1,200 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, 2001, including financial statements filed therewith.
Stockholders wishing a copy may send their request to the Company at 32 Center
Street, Darien, CT 06820.
DIVIDEND POLICY
In 1999, the Company issued 30,000 shares of its Series A Cumulative
Convertible Preferred Stock with a liquidation value of $70 per share to
Citizens. Any holder of such Preferred Shares is entitled to receive cumulative
cash dividends in arrears at the annual rate of 5%, compounded annually on the
liquidation value. As of December 31, 2001, the total arrearage on the
Preferred Shares was $282,000. Under Delaware law, HTCC has been restricted
from paying dividends due to its stockholders' deficiency. Therefore, the
Company has not paid any dividend on its preferred stock. The Company intends
to reevaluate its preferred stock 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 on its common stock 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 cash is payments from intercompany
loans, payments under its management service agreement with the Operating
Company, and dividends, if any, from the Operating Company. The Operating
Company's ability to pay dividends or make other capital distributions to the
Company is governed by Hungarian law, and is significantly restricted by
certain obligations of the
-27-
Operating Company. The Operating Company is the borrower under a Banking Credit
Facility which provides that the Operating Company can only make distributions
without consent to HTCC for limited purposes. See Item 7 "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Note 16 of Notes to Consolidated Financial Statements.
RECENT SALES OF UNREGISTERED SECURITIES
On May 12, 1999 the Company entered into a series of transactions with
Citizens, the Danish Fund, Postabank and TDC pursuant to which the Company
revised its capital structure. As part of such transactions, the Company
issued: 1,300,000 shares of Common Stock to Citizens; 1,285,714 shares of
Common Stock to the Danish Fund; 2,428,572 shares of Common Stock to Postabank;
and 1,571,429 shares of Common Stock to TDC. The Company also issued 30,000
shares of its Series A Cumulative Convertible Preferred Stock to Citizens. The
30,000 shares of preferred stock are convertible by Citizens into 300,000
shares of Common Stock. The shares of preferred stock are redeemable by the
Company at the liquidation value of $70 per share. The Company also issued
warrants to Postabank to purchase 2,500,000 shares of Common Stock at $10 per
share. The exercise period is from January 1, 2004 through March 31, 2007. For
a more detailed description of these agreements, see Notes 9 and 12 of Notes to
Consolidated Financial Statements.
On December 21, 2000, the Company issued 72,000 shares of Common Stock to
the International Finance Corporation, a member of the World Bank Group (the
"IFC"). The Company issued the shares in exchange for the IFC's 20% equity
interest in Papatel.
On March 14, 2001, the Company issued 14,001 shares of Common Stock to
TDC for $7.00 per share pursuant to TDC's preemptive rights in connection with
the issuance to the IFC.
All of these unregistered issuances were in reliance upon an exemption
from the registration provisions of the Securities Act of 1933 (the "Securities
Act") set forth in Section 4(2) thereof relative to transactions by an issuer
not involving any public offering. Each of the purchasers was informed that the
transactions were being effected without registration under the Securities Act
and that the shares acquired could not be resold without registration under the
Securities Act unless the sale is effected pursuant to an exemption from the
registration requirements of the Securities Act.
-28-
ITEM 6. SELECTED FINANCIAL DATA
HUNGARIAN TELEPHONE AND CABLE CORP.
AND SUBSIDIARIES
Selected Financial and Operating Data
(Dollars in Thousands, Except Per Share Amounts)
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
For the Year
Operating revenues, net $45,236 $42,974 $45,438 $38,707 $26,522*
Operating income (loss) $18,340 $16,469 $16,189 $(6,059) $(1,263)
Operating income (loss) per
common share (basic) $ 1.51 $ 1.37 $ 1.68 $ (1.14) $ (0.28)
Income (loss) before
extraordinary items $11,099 $(5,331) $(17,773) $(50,612) $(36,236)
Net income (loss) $11,099 $(5,331) $3,172 $(50,612) $(36,236)
Net income (loss) per common share
(basic) $ 0.91 $(0.45) $ 0.33 $ (9.53) $ (7.97)
At Year-End
Total assets $136,071 $147,318 $154,683 $177,067 $186,485
Long-term debt, excluding
current installments $104,882 $124,814 $139,661 $202,881 $194,537
Total stockholders' equity
(deficiency) $ 366 $(10,878) $(6,946) $(89,037) $(41,837)
*Revenues are adjusted to reflect the requirements of the Securities and
Exchange Commission's Staff Accounting Bulletin 101 ("SAB 101") which requires
the deferral of installation revenue and related installment costs. These
adjustments did not affect the previously reported net losses; such adjustments
resulted in a reduction of previously reported revenues and costs of
$11,369,000 in 1997.
-29-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
The Company is engaged primarily in the provision of telecommunications
services through its operating subsidiaries, KNC, Raba-Com, Papatel and
Hungarotel (which have all been merged into Hungarotel effective January 1,
2002). 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 networks are built-out, the ability of the Company
to generate sufficient revenues to satisfy cash requirements and maintain
profitability will depend upon a number of factors, including the Company's
ability to attract additional customers both in and outside its Operating Areas
and increased revenues per customer. These factors are expected to be primarily
influenced by the success of the Company's operating and marketing strategies,
as well as market acceptance of telecommunications services both in and outside
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 Company funded its construction costs and working capital needs over
several years primarily through credit facilities with Postabank and a $47.5
million contractor financing facility. On March 30, 1999, and May 12, 1999, the
Company entered into a series of transactions (see Notes 5 and 9 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, 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."
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
$197 million through December 31, 2001 (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
142,100 access lines through December 31, 2001 to the 61,400 access lines
acquired directly from Matav. As a result, the Company had 203,500 access lines
in operation at year-end 2001. During the past year, due to the Company's
revised collection procedures, as well as economic developments within the
areas the Company operates in and competition from the mobile market, the
Company's number of disconnections has increased such that the total number of
access lines in service is lower than at the beginning of 2001 by 2%. The
Company is attempting to deal
-30-
with this decrease in access lines by developing new subscription packages, as
well as through expanding into other markets within Hungary.
CRITICAL ACCOUNTING POLICIES
The Company's discussion and analysis of its financial condition and
results of operations are based upon its consolidated financial statements that
have been prepared in accordance with generally accepted accounting principles
in the United States ("US GAAP"). This preparation requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and the disclosure of contingent assets and
liabilities. US GAAP provides the framework from which to make these estimates,
assumption and disclosures. The Company chooses accounting policies within US
GAAP that management believes are appropriate to accurately and fairly report
the Company's operating results and financial position in a consistent manner.
Management regularly assesses these policies in light of current and forecasted
economic conditions. The Company's accounting policies are stated in Note 1 to
the Consolidated Financial Statements. The Company believes the following
accounting policies are critical to understanding the results of operations and
the effect of the more significant judgments and estimates used in the
preparation of the consolidated financial statements:
Revenue Recognition Policies -- The Company recognizes revenues, net of
interconnect charges, when services are rendered to the customer. The Company's
pricing is subject to oversight by the Hungarian regulators. Such regulation
also covers interconnection, competition and other public policy issues.
Regulatory interpretation of the Communications Act and related Decrees,
Hungary's planned accession into the EU and changes in the political
environment within Hungary all could result in changes in the level of the
Company's revenues. The Company monitors the decisions of the regulator and the
Hungarian market closely, and will make adjustments to revenue and associated
expenses if necessary. The Company records deferred costs and revenues related
to the costs and related installation revenue associated with connecting new
customers to the Company's networks. Based on the SEC's Staff Accounting
Bulletin 101 ("SAB 101"), the Company amortizes these amounts over an estimated
seven year average period. If a significant number of customers were to leave
the service of the Company, the amortization of those deferred costs and
revenues would accelerate.
Allowance for Doubtful Accounts -- The Company reviews the valuation of
accounts receivable on a monthly basis. The allowance for doubtful accounts is
estimated based on historical experience and future expectations of conditions
that might impact the collectibility of accounts.
Long-lived Asset Recovery -- Long-lived assets, consisting primarily of
property, plant and equipment and intangibles, comprise a significant portion
of the Company's total assets. Changes in technology or changes in the
Company's intended use of these assets may cause the estimated period of use or
the value of these assets to change. These assets are reviewed for impairment
whenever events or changes in circumstances indicate that their carrying
amounts may not be recoverable. Estimates and assumptions used in both setting
depreciable lives and reviewing recoverability require both judgement and
estimation by management. Impairment is deemed to have occurred if projected
undiscounted cash flows related to the asset are less than its carrying value.
If impairment is deemed to have occurred, the carrying values of the assets are
written down, through a charge against earnings, to their fair value.
-31-
Contingent Liabilities -- The Company establishes accruals for estimated
loss contingencies when it is management's assessment that a loss is probable
and the amount of the loss can be reasonably estimated. Revisions to contingent
liabilities are reflected in income in the period in which different facts or
information become known or circumstances change that affect the previous
assessments as to the likelihood of and estimated amount of loss. Accruals for
contingent liabilities are based upon management's assumptions and estimates,
after giving consideration to the advice of legal counsel and other information
relevant to the assessment of the probable outcome of the matter. Should the
outcome differ from the assumptions and estimates, revisions to the estimated
accruals for contingent liabilities would be required.
Income Taxes -- In assessing the realizability of deferred tax assets,
management considers whether it is more likely than not that some portion or
all of the deferred tax assets will be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable income
during the periods in which those temporary differences become deductible.
Management considers projected future taxable income and tax planning in making
these assessments. Actual income taxes could vary from these estimates due to
future changes in the income tax laws or the results from reviews of the
Company's tax returns by taxing authorities.
COMPARISON OF YEAR ENDED DECEMBER 31, 2001 TO YEAR ENDED DECEMBER 31, 2000
The Company's Hungarian subsidiaries' functional currency is the
Hungarian forint. The average Hungarian forint/U.S. dollar exchange rate for
the year ended December 31, 2001 was 286.49, as compared to an average
Hungarian forint/U.S. dollar exchange rate for the year ended December 31, 2000
of 281.10. When comparing the year ended December 31, 2001 to the year ended
December 31, 2000, it should be noted that all U.S. dollar reported amounts
have been affected by this 2% devaluation in the Hungarian subsidiaries'
functional currency.
Net Revenues
Year ended
(dollars in millions) 2001 2000
Measured service revenues $ 29.2 $ 30.7
Subscription revenues 16.1 13.1
Net interconnect charges (6.5) (6.5)
------ -----
Net measured service and subscription revenues 38.8 37.3
Connection fees 2.2 2.1
Other operating revenues, net 4.2 3.6
---- ----
Telephone Service Revenues, Net $ 45.2 $ 43.0
====== =======
The Company recorded a 5% increase in net telephone service revenues to
$45.2 million for the year ended December 31, 2001 from $43.0 million for the
year ended December 31, 2000.
Net measured service and subscription revenues increased to $38.8 million
for the year ended December 31, 2001 from $37.3 million for the year ended
December 31, 2000. Measured service revenues decreased 5% to $29.2 million in
2001 from $30.7 million in 2000, while subscription revenues increased 23% to
$16.1 million in 2001 from $13.1 million in 2000. Measured service revenues
decreased in functional currency terms by approximately 3% as a result of an
average 3.6% decrease in call tariffs
-32-
between 2000 and 2001 as a result of continued tariff re-balancing which was
introduced during 2000, offset by an increase in average access lines in
service from approximately 202,400 for the year ended December 31, 2000 to
approximately 204,900 for the year ended December 31, 2001. Subscription
revenues increased in functional currency terms by approximately 25% as a
result of continued tariff re-balancing. Under tariff re-balancing, a more
cost-driven payment structure is envisaged, with the actual monthly
subscription fees increasing to cover network infrastructure expenses over
time. In Hungary, as in many other countries over the past several years,
cheaper local call charges have been subsidized by expensive international and
domestic long-distance calls. The overall effect on a gross revenue basis for
the Company and the telecom industry as a whole is expected to be neutral. The
increase in subscription revenues in functional currency terms has been offset
to an extent by the approximate 2% devaluation of the functional currency
between the periods and, therefore, subscription revenues show only a 23%
increase in U.S. dollar terms.
These revenues have been reduced by net interconnect charges, which
totaled $6.5 million for each of the years ended December 31, 2001 and 2000. As
a percentage of call and subscription revenues, net interconnect charges have
declined from 14.8% for the year ended December 31, 2000 to 14.3% for the year
ended December 31, 2001. Due to the regulatory regime not liberalizing the
market in Hungary as quickly as expected, the Company does not expect net
interconnect charges as a percentage of call and subscription revenues to
decrease considerably in 2002 as compared with 2001 levels.
Connection fees, which represent fees paid by customers to connect to the
Company's networks, increased 5% for the year ended December 31, 2001 to $2.2
million from $2.1 million for the year ended December 31, 2000. In the fourth
quarter of 2000, the Company implemented the Securities and Exchange's Staff
Accounting Bulletin No. 101 ("SAB 101"), with effect from January 1, 2000,
which requires connection fees and corresponding direct incremental costs to be
deferred and amortized over future periods. As a result of the implementation
of SAB 101, certain connection fees and costs recognized in prior periods have
been deferred and are being amortized over the estimated average subscriber
life of 7 years. There was no cumulative effect on earnings from the adoption
of SAB 101, nor has its adoption had a material impact on the Company's results
of operations. Following the adoption of SAB 101, the amortization of deferred
connection fee revenue and associated direct incremental costs is included in
telephone service revenues and operating and maintenance expenses, respectively.
Other operating revenues, which include revenues generated from the
provision of direct lines, operator services and other miscellaneous telephone
service revenues, increased 17% to $4.2 million for the year ended December 31,
2001, as compared to $3.6 million during the year ended December 31, 2000.
Operating and Maintenance Expenses
Operating and maintenance expenses increased 3% to $17.5 million for the
year ended December 31, 2001, as compared to $17.1 million for the year ended
December 31, 2000. In functional currency terms, operating and maintenance
expenses increased approximately 9% for the year ended December 31, 2001, as
compared to the year ended December 31, 2000, due to inflationary increases in
costs. In U.S. dollar terms, however, the increase in such costs in functional
currency terms has been offset by the 2% devaluation of the Hungarian forint
between the periods and a reduction in the Company's U.S. dollar denominated
operating expenses between the periods.
-33-
Depreciation and Amortization
Depreciation and amortization charges remained consistent at $9.4
million for each of the years ended December 31, 2001 and 2000. Depreciation
and amortization charges increased in functional currency terms by
approximately 2% due to additional capital expenditures during the period.
Income from Operations
Income from operations increased 11% to $18.3 million for the year
ended December 31, 2001 from $16.5 million for the year ended December 31,
2000. Contributing to such improvement were higher net telephone service
revenues, partially offset by slightly higher operating and maintenance
expenses.
Foreign Exchange Gains (Losses)
Foreign exchange gains amounted to $5.3 million for the year ended
December 31, 2001, compared to foreign exchange losses of $4.8 million for the
year ended December 31, 2000. The foreign exchange gains resulted primarily
from the appreciation of the Hungarian forint against the Company's average EUR
84.3 million denominated debt outstanding during the period. At December 31,
2001, the Hungarian forint had appreciated in value by approximately 7% against
the euro and by approximately 2% against the U.S. dollar as compared to January
1, 2001. Included in foreign exchange gains for the year ended December 31,
2001 is approximately $0.7 million of foreign exchange losses relating to the
Company's foreign currency forward contracts. When non-Hungarian forint debt is
re-measured into Hungarian forints, the Company reports foreign exchange
gains/losses in its consolidated financial statements as the Hungarian forint
appreciates/devalues against such non-forint currencies. See "- Inflation and
Foreign Currency," and Item 7A "Quantitative and Qualitative Disclosures About
Market Risk - Market Risk Exposure."
Interest Expense
Interest expense decreased 27% to $13.6 million for the year ended
December 31, 2001 from $18.5 million for the year ended December 31, 2000. This
$4.9 million decrease is attributable to lower interest rates paid on the
Company's borrowings. The decrease results from the Company's medium-term
credit facility entered into in April 2000, pursuant to which the Company's
borrowings went from being mostly Hungarian forint denominated to mostly euro
denominated, and the Company's weighted average interest rate on its debt
obligations went from 10.70% for the year ended December 31, 2000, to 8.48% for
the year ended December 31, 2001, a 21% decrease. Included in interest expense
for the year ended December 31, 2000 is approximately $1.6 million of
amortization of forward points on forward foreign currency contracts accounted
for under SFAS 52. The Company adopted the provisions of SFAS 133 and SFAS 138
on January 1, 2001 and the foreign currency forward contracts the Company has
entered into during 2001 do not qualify for hedge accounting as defined under
SFAS 133 and SFAS 138.
-34-
Interest Income
Interest income decreased to $1.3 million for the year ended December
31, 2001 from $1.5 million for the year ended December 31, 2000, primarily due
to lower interest rates on Hungarian forint deposits during the period.
Net Income (Loss)
As a result of the factors discussed above, the Company recorded net
income ascribable to common stockholders of $11.0 million, or $0.91 per share,
or $0.89 per share on a diluted basis, for the year ended December 31, 2001 as
compared to a net loss ascribable to common stockholders of $5.4 million, or
$0.45 per share on a basic and diluted basis, for the year ended December 31,
2000.
COMPARISON OF YEAR ENDED DECEMBER 31, 2000 TO YEAR ENDED DECEMBER 31, 1999
The Company's Hungarian subsidiaries' functional currency is the
Hungarian forint. The average Hungarian forint/U.S. dollar exchange rate for
the year ended December 31, 2000 was 281.10, as compared to an average
Hungarian forint/U.S. dollar exchange