ITEM 1. BUSINESS. - -----------------
GENERAL.
Cellular Communications International, Inc. ("CCII" or the "Company") was incorporated in Delaware on May 30, 1984 to own and operate cellular telephone systems in various markets. Prior to 1987, CCII filed applications with the Federal Communications Commission to provide cellular telephone service in various markets. Beginning in 1989, CCII entered into joint ventures to obtain licenses to own and operate mobile telephone networks in various foreign countries.
CCII's activities to date have focused on participating in strategic joint ventures to acquire overseas cellular telephone systems.
Currently, CCII's primary asset is its participation in Omnitel-Pronto Italia ("OPI"), a strategic joint venture consortium that operates the second Global System for Mobile Communications ("GSM") cellular telephone license in Italy (including San Marino and Vatican City) (the "License").
OMNITEL AND OPI.
In January, 1995, the award of Italy's second GSM cellular license to OPI was made official with the publication of an announcement in the Italian public register. The publication of the award was the final step in the award process which began in March 1994 when the original announcement of the selection of OPI was made by the Italian government. CCII holds a 10.267% indirect interest in OPI through its 14.667% ownership interest in Omnitel-Sistemi Radiocellulari Italiani S.p.A. ("Omnitel"), a strategic joint venture organized in May 1990 to apply for the License. The principal other joint venturers in Omnitel are Ing. C. Olivetti & C., S.p.A., Bell Atlantic International, Inc. and Telia (formerly Swedish Telecom International, AB).
In February 1994, Omnitel and Pronto Italia S.p.A. ("Pronto Italia") entered into an agreement to jointly form OPI as their combined applicant for the License. Pronto Italia is owned principally by AirTouch Communications, Inc. and Mannesmann AG. Omnitel is a 70% shareholder of OPI and Pronto Italia is a 30% shareholder.
Cellular Service in Italy. The Italian cellular market has been one of the ------------------------- fastest growing cellular markets in Europe over the past several years, growing from approximately 3.9 million subscribers in 1995 to approximately 6.4 million in 1996. OPI competes with Telecom Italia Mobile (which in 1995 was spun out to shareholders of Telecom Italia, the public switched telephone network ("PSTN")), for cellular users in Italy. OPI and Telecom Italia Mobile both use the digital GSM standard, but Telecom Italia Mobile also has nearly 3.8 million subscribers using the older, analog standard. OPI competes with Telecom Italia Mobile by stressing the quality of its digital network (which was custom designed for the GSM standard), the benefits of the GSM standard (pan European roaming, privacy and security, and advanced features), and the quality of its customer service.
OPI began offering commercial service in December 1995, and OPI has reported that as of December 31, 1996 it had approximately 713,000 subscribers.
Performance Bond./1/ OPI has provided an approximate 219 billion lire ---------------- ($129.6 million) performance bond to the Italian government linked to OPI's meeting certain performance goals relating to territory coverage, investment, employment and payment of license fees. OPI has met all of the requirements of this bond that have matured to date. OPI must now (i) cover 98% of Italian territory with its cellular network by May 1998, (ii) invest 1,552 billion lire ($918.7 million) by May 1998, (iii) employ 2,686 people by May 1998 and (iv) pay an annual license fee of 3.5% of OPI's annual sales, net of amounts paid to public landline telephone operators for their services. OPI is subject to monetary penalties for failing to achieve such goals. There can be no assurance that OPI will be able to achieve all of its performance bond goals. The maximum liability of CCII under the performance bond would be approximately 22.5 billion lire ($13.3 million), reflecting its proportionate interest in OPI.
Arrangements with Telecom Italia and Telecom Italia Mobile. ----------------------------------------------------------
Fees and Pricing with Telecom Italia. Pursuant to the License, OPI has connected its mobile cellular telephone network to the PSTN. The rates charged by Telecom Italia approximate 200 lire ($.12) per minute, which are among the highest in Europe. OPI has begun a process of negotiating these rates with the Italian Ministry of Post and Telecommunications ("MPT"), but there can be no assurance as to the outcome of this process.
Roaming Agreements. OPI has entered into a mutual roaming agreement with Telecom Italia Mobile to guarantee all subscribers roaming service throughout areas covered by only one of the GSM cellular providers. Pursuant to the terms of the License after the initial two years of OPI's operations, subsequent agreements on national roaming may not include the capital cities of the Italian provinces.
OPI has negotiated roaming agreements with other GSM operators throughout Europe in order to provide customers with Pan-European roaming.
Competition. Competition within the Italian market is substantial. Telecom ----------- Italia Mobile, which operates the state owned cellular system, has for several years through its predecessor SIP, S.p.A. ("SIP") operated a 450-MHz analog cellular system in Italy, and during 1989 began to bring into service a 900-MHz analog cellular system. The established market presence and recognition of Telecom Italia Mobile has resulted in Telecom Italia Mobile being a significant competitor.
Telecom Italia Mobile has approximately 5.7 million subscribers as of December 31, 1996. Telecom Italia Mobile has certain advantages over OPI which will continue for the foreseeable future, such as a larger installed customer base and a wider coverage area. Furthermore, because OPI did not provide cellular service until December 1995, many potential high usage business customers were already Telecom Italia Mobile cellular customers. While OPI and Telecom Italia Mobile are currently the only cellular telephone operators licensed in Italy, it is anticipated that a third GSM license will be granted in the future. Moreover, OPI may also face significant potential competition from other communications technologies that are being or may be developed or perfected in the future.
Risks of Italian Operations. Business conditions in Italy are generally --------------------------- viewed by those in the international business community as favorable. CCII does not perceive any material risk of nationalization of independent telecommunications service providers in Italy.
The Omnitel Agreement. Reference is made to the description of the Omnitel --------------------- joint venture agreement (the "Omnitel Agreement") that is attached as exhibit 10.1 to this Form 10-K.
The Omnitel-Pronto Italia Agreement. Omnitel and Pronto Italia have ----------------------------------- entered into an agreement (the "OPI Agreement") that contains provisions governing the relationship between the two parties, including, but not limited to, provisions relating to the governance and financing of OPI.
__________________________ /1/ Italian lire have been translated solely for the convenience of the reader of this Form 10-K at an exchange rate of 1,689.30 lire = $1.00, the Noon Buying Rate on March 24, 1997.
CUSTOMER DEPENDENCE AND SEASONALITY.
CCII currently has no customers. OPI is not dependent upon any single customer for any material portion of its business. The cellular communications industry is not generally characterized as having a material seasonal element. The businesses of CCII and OPI are not expected to become seasonal in the foreseeable future.
OTHER CONSIDERATIONS.
CCII's ability to sell or transfer its ownership interest in Omnitel is subject to limitations contained in the agreements between the relevant shareholders. The shareholders of Omnitel have pledged to the MPT pursuant to the terms of the License to maintain certain levels of ownership in the respective companies for a period of at least five years from the date of grant of the License. Such restrictions effectively require 86% of the capital stock of Omnitel to remain held by the present shareholders for at least five years from the License grant. There can be no assurance that the MPT or the Italian government will permit transfers of indirect ownership or that the MPT will not suspend or terminate the License if such transfers occur.
In addition, Omnitel currently has no publicly traded securities and there can be no guarantee that there will in the future be either a public or private market for the securities of Omnitel. As a result, CCII's ability to liquidate any or all of its investment may be substantially limited.
The Company or its affiliates generally will be subject to tax in the foreign jurisdictions in which they operate. In addition, such foreign jurisdictions may impose withholding taxes on distributions (by way of interest, dividends or otherwise) to the Company. For example, under applicable treaties currently in effect, dividends distributed by an Italian company to a United States person would be subject to a withholding tax of 15%, if paid to a United States company which has owned less than 25% of the voting stock of the company paying the dividends for a 12-month period ending on the date the dividend is declared. In general, the Company's ability to claim a foreign tax credit against its U.S. federal income tax expense for foreign taxes is subject to various limitations. These limitations and the inability of the Company to offset losses in one foreign jurisdiction against income earned in another foreign jurisdiction could result in a high effective tax rate on the Company's earnings.
Special U.S. tax rules apply to U.S. taxpayers that own stock in a "passive foreign investment company" (a "PFIC"). In general, a non-U.S. corporation will be treated as a PFIC if at least 75% of its income is "passive income" or if at least 50% of its assets are held for the production of "passive income". A non- U.S. corporation that owns 25% or more of the stock of a non-U.S. subsidiary is treated as receiving a proportionate share of the income of, and as owning a proportionate share of the assets of, such subsidiary.
Omnitel may be considered to be a PFIC. Generally, except to the extent the Company makes an election to treat a PFIC in which it owns stock as a "qualified electing fund" (a "QEF") in the first taxable year in which the Company owns the PFIC's stock, (i) the Company would be required to allocate gain recognized upon the disposition of stock in the PFIC and income recognized upon receiving certain dividends ratably over the Company's holding period for the stock in the PFIC, (ii) the amount allocated to each year other than the year of the disposition or dividend payment would be taxable at the highest U.S. tax rate applicable to corporations, and an interest charge for the deemed deferral benefit would be imposed with respect to the tax attributable to each year, and (iii) gain recognized upon disposition of PFIC shares would be taxable as ordinary income.
If the Company were to make the QEF election, as described above, the Company would be required in each year that PFIC qualification tests are met to include its pro rata share of the QEF's earnings as ordinary income and its pro rata share of the QEF's net capital gain as long-term capital gain, whether or not such amounts are actually distributed. The Company has not made any QEF election with respect to any non-U.S. corporations in which it holds stock, including Omnitel.
Applicable laws often limit foreign investors to minority equity positions. CCII's minority voting position may preclude it from affirmatively controlling the companies in which it has an interest even though CCII is involved in the management of Omnitel and intends to participate in the future only in operating companies in which it can participate in management. Thus, CCII may be unable to cause implementation of strategies it favors.
The acquisition, development, ownership and operation of wireless communications networks require substantial capital investment. OPI will require significant amounts of capital to construct its cellular networks and for its research and development programs, operating expenses, expansion of its marketing and distribution capabilities, license fees and royalties. Adequate funds for these purposes, whether through equity or debt financing, collaborative or other arrangements with corporate partners or from other sources, may not be available when needed (including due to a failure by CCII or another shareholder to provide a required capital contribution) or available on terms acceptable to OPI. Insufficient funds could require OPI to delay, scale back or eliminate certain of its planned activities. OPI currently has a syndicated loan facility of 1,800 billion lire ($1.1 billion) and a credit agreement with Finnish Export Credit Ltd. in the amount of 306 billion lire ($181.1 million) for financing Nokia Telecommunications equipment. As of December 31, 1996, OPI has utilized 677 billion lire ($400.8 million) of the syndicated loan facility and all of the Finnish Export Credit Ltd. credit.
There can be no assurance that the laws or administrative practice relating to taxation, foreign exchange or otherwise in Italy will not change, and any such change could have a material adverse effect on the financial affairs of OPI. The value of CCII's indirect investment in OPI may also be affected by changes in tax law and other laws and other political, economic, socioeconomic or diplomatic developments in or affecting Italy.
Omnitel and OPI will receive all of their revenues in Italian lire. Currently there are no foreign exchange controls in Italy. There can be no assurance that foreign exchange control restrictions will not be introduced in the future.
Exchange rates for the lire may fluctuate in relation to the U.S. dollar, and such fluctuations may have an adverse effect on CCII's earnings or assets when translating lire into U.S. dollars. Any weakening in the value of the lire against the U.S. dollar could result in lower revenues and earnings for CCII when translated into U.S. dollars. In addition, as CCII's primary financing will be in U.S. dollars and CCII's commitments to Omnitel and OPI are in lire, a currency exchange rate risk exists. While CCII may consider entering into transactions to hedge the risk of exchange rate fluctuations, there can be no assurance that CCII will engage in such transactions, or, if CCII decides to engage in such transactions, that they will be successful and that shifts in the currency exchange rates will not have a material adverse effect on CCII.
Wireless communications operations are subject to governmental regulation, including, among others, price controls and service requirements, which may change from time to time, including due to changes in the political structure or government representatives. There can be no assurance that material and adverse changes in the regulation of OPI will not occur in the future.
EMPLOYEES.
CCII has 22 full and part time employees.
PATENTS, COPYRIGHTS AND LICENSES.
Neither CCII, OPI nor Omnitel has any material patents or copyrights in their businesses. CCII does not believe patents or copyrights play a material role in its business or any potential business of OPI or Omnitel. OPI has a license to provide cellular service from the appropriate governmental authorities.
ITEM 2.
ITEM 2. PROPERTIES. - -------------------
CCII leases office space, which is adequate to meet its needs at present from one of its former affiliates, NTL Incorporated, and is charged for its share of the rent by NTL.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS. - --------------------------
OPI is engaged in ordinary legal disputes and court proceedings that have arisen in the course of its operations, none of which is expected to have a material effect on its operations. OPI and Telecom Italia Mobile have each filed lawsuits in Italy against each other involving various competitive matters. The outcome of these lawsuits are not presently expected to have a material effect on OPI's operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS. - --------------------------------------------------------
There were no matters that were submitted to a vote of CCII's stockholders during the quarter ended December 31, 1996.
PART II -------
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED - ------------------------------------------------------------- STOCKHOLDER MATTERS. -------------------
CCII's Common Stock trades on the Nasdaq Stock Market's National Market under the symbol "CCIL". The following table sets forth for the periods indicated the high and low last sales prices as reported on the Nasdaq Stock Market's National Market.
On March 24, 1997, the closing price for the Common Stock, as reported on the Nasdaq Stock Market's National Market, was $28.00. As of March 24, 1997, there were approximately 359 record holders of the Common Stock. This figure does not reflect beneficial ownership of shares held in nominee names.
CCII has never paid cash dividends on its Common Stock and does not intend to pay cash dividends in the foreseeable future on shares of its Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA. - ---------------------------------
The following table sets forth certain financial data for the years ended December 31, 1996, 1995, 1994, 1993, and 1992. This information should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K.
(1) 1995 includes a gain on sale of investment in joint venture of $25,286,000, net of tax of $13,615,000 ($2.14 per common share) and a charge of $1,474,000, net of income tax benefit of $794,000, from early extinguishment of debt (($.12) per common share).
(2) After giving retroactive effect to the 3-for-2 stock split by way of a stock dividend, which was paid on May 13, 1994.
(3) In 1995, CCII issued $281,571,000 aggregate principal amount of 13-1/4% Senior Discount Notes due 2000 at a price to the public of 52.783% or $148,622,000.
CCII did not declare or pay any cash dividends during the years indicated.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF - ----------------------------------------------------------- OPERATIONS AND FINANCIAL CONDITION. ----------------------------------
RESULTS OF OPERATIONS
Years Ended December 31, 1996 and 1995 - --------------------------------------
Equity in net loss of Omnitel increased to $29,850,000 from $14,636,000 because of the increase in the net loss of Omnitel. The increase is due to an increase in Omnitel's share of OPI's net loss to $201,622,000 from $98,428,000. OPI's net loss increased to $284,557,000 from $138,168,000 as a result of the increase in all costs due to the commencement of operations in December 1995. OPI began depreciation and amortization of certain previously capitalized costs in December 1995 upon the commencement of operations.
General and administrative expenses decreased to $3,397,000 from $3,805,000 primarily because, as of December 1995, CCII no longer participates in an entity that owns one of the two GSM cellular licenses for Delhi, India, and CCII reduced its efforts to obtain new cellular licenses.
Amortization of investments in joint ventures increased to $691,000 from $537,000 as a result of the amortization of additional costs capitalized in connection with the investment in Omnitel.
Interest and other income increased to $5,125,000 from $1,963,000 primarily because of an increase in funds available for investment.
Interest expense increased to $23,330,000 from $7,230,000 primarily due to the interest on the Senior Discount Notes. Interest expense in 1995 does not include interest of $5,571,000 which was capitalized during the year ended December 31, 1995. The Company discontinued interest capitalization in December 1995 upon the commencement of OPI's operations.
The fees to the Company's former parent company, Cellular Communications, Inc. ("CCI"), in connection with the bank loan decreased to none from $101,000 as a result of the termination of the CCI guarantee in July 1995. This expense does not include fees to CCI of $1,220,000 which were capitalized during the year ended December 31, 1995.
The income tax benefit in 1996 of $1,200,000 is the result of net operating loss carrybacks to 1995.
Years Ended December 31, 1995 and 1994 - --------------------------------------
Equity in net loss of Omnitel increased to $14,636,000 from $2,421,000 because of the increase in the net loss of Omnitel. The increase is due to an increase in Omnitel's share of OPI's net loss to $98,428,000 from $15,407,000. OPI's net loss increased to $138,168,000 from $19,531,000 as a result of the increase in all costs due to the construction of OPI's cellular network, the creation of an organization to prepare for the provision of service to customers and the commencement of operations in December 1995. Depreciation and amortization of certain previously capitalized costs began in December 1995 upon the commencement of operations.
General and administrative expenses increased to $3,805,000 from $3,394,000 primarily due to an increase in expenses related to CCII's participation in an entity that owns one of the two GSM cellular licenses for Dehli, India and an increase in payroll costs. In December 1995, CCII waived and released its claim to participate in this entity and will no longer incur costs associated with the cellular business in Delhi.
CCII capitalizes costs incurred in connection with potential new licenses until a license is awarded or CCII determines it will not be successful in obtaining a license. In 1995 and 1994, investments in joint ventures of $602,000 and $481,000, respectively, and deferred costs of $1,167,000 and $376,000, respectively, were written-off in connection with unsuccessful efforts to obtain licenses.
Depreciation expenses increased to $28,000 from $9,000 due to the depreciation of equipment acquired in 1995.
Amortization of investments in joint ventures increased to $537,000 from $96,000 as a result of the amortization of costs capitalized in connection with the investment in Omnitel.
Interest and other income increased to $1,963,000 from $211,000 primarily because of an increase in funds available for investment from the proceeds of the Senior Discount Notes.
Interest expense increased to $7,230,000 from $1,848,000 primarily due to the issuance of the Senior Discount Notes. Interest expense does not include interest of $5,571,000 and $1,312,000 which was capitalized during the years ended December 31, 1995 and 1994, respectively. Interest expense in 1995 consists principally of Senior Discount Notes interest of $5,263,000, amortization of deferred financing costs of $1,523,000 and amortization of debt discount of $264,000.
The fees to CCI in connection with the bank loan were $101,000 and $95,000 in 1995 and 1994, respectively. This expense does not include fees to CCI of $1,220,000 and $679,000 which were capitalized during the years ended December 31, 1995 and 1994, respectively.
In December 1995, CCII waived and released its claim to participate in an entity that owns one of the two GSM cellular licenses for Delhi, India in exchange for $40,000,000 in cash. CCII recorded a gain on this transaction of $38,901,000.
In connection with the repayment of debt, CCII recorded as an extraordinary loss the write-off of $2,268,000 ($1,474,000 net of income tax benefit) of unamortized deferred financing costs and debt discount.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements are primarily based upon the agreements and requirements of the joint ventures in which it is now or may become a participant. The Company also requires capital to pay for corporate overhead expenses, personnel costs and taxes, as well as capital to explore other opportunities that may arise. The Company has no material commitments for capital expenditures, except as described below.
As a result of the award of Italy's second GSM cellular license to OPI, OPI requires capital to construct its cellular system and to fund its operations. OPI has a syndicated bank loan facility for 1,800 billion lire ($1.1 billion) and has received capital contributions of 1,450 billion lire ($858 million) from its partners (1,015 billion lire ($601 million) from Omnitel and 435 billion lire ($257 million) from Pronto Italia). Omnitel funded its share of OPI capital contributions plus its own capital needs through capital contributions from its shareholders of 1,040 billion lire ($616 million). The Company's total cumulative contribution to Omnitel was approximately 152.5 billion lire ($96.8 million at the exchange rates in effect at the time of each contribution).
OPI has provided an approximate 219 billion lire ($129.6 million) performance bond that requires payments to the Italian government if OPI fails to meet certain operational targets. There can be no assurance that OPI will be able to achieve all of its performance bond goals. The Company's maximum liability under the performance bond is approximately 22.5 billion lire ($13.3 million), reflecting its proportionate interest in OPI.
OPI is anticipating an approximately 200 billion lire ($118 million) increase in OPI's paid-in capital in 1997. Omnitel's shares of this increase is 70% of the OPI increase or 140 billion lire ($83 million) and CCII would be required to make capital contributions to Omnitel of approximately 20.53 lire ($12.2 million) in order to fund the Company's 14.667% share of the capital requirements of Omnitel. These additional capital contributions would require capital calls by Omnitel which are expected to occur during 1997. OPI will also require additional debt financing in excess of the amount available from the syndicated bank loan and the 1997 capital calls. The Company currently expects that OPI would obtain such additional financing from bank
borrowings.
The Company has not recently been successful in obtaining any new cellular licenses since there is more competition for licenses and the costs of obtaining them has increased. This has occurred because more companies recognize the potential value of obtaining cellular licenses and governments increasingly realize they can extract some part of this value from license applicants. There can be no assurance that the Company will be successful in obtaining new cellular licenses or in developing other opportunities in the future.
The information in the preceding paragraphs include projections; in reviewing such information it should be kept in mind that actual results may differ materially from those in such projections. These projections were based on various factors and were derived utilizing numerous assumptions. Important assumptions and factors that could cause actual results to differ materially from those in these projections include OPI's ability to continue to design network routes, install facilities, obtain and maintain any required governmental licenses or approvals and finance construction and development, all in a timely manner, at reasonable costs and on satisfactory terms and conditions, as well as assumptions about customer acceptance, churn rates, overall market penetration and competition from providers of alternative services. Other factors and assumptions not identified above were also involved in the derivation of these projections, and the failure of such other assumptions to be realized as well as other factors may also cause actual results to differ materially from those projected. The Company assumes no obligation to update these projections to reflect actual funding requirements, capital expenditures and results, changes in assumptions or changes in other factors affecting such projections.
In August 1995, the Company issued $281,571,000 aggregate principal amount of 13-1/4% Senior Discount Notes due 2000 (the "Notes") and 281,571 warrants to purchase 317,049 shares of common stock. The Notes were issued at a price to the public of 52.783% or $148,622,000. The original issue discount accretes at a rate of 13-1/4%, compounded semiannually, to an aggregate principal amount of $281,571,000 by August 15, 2000. The Notes are senior unsecured obligations of the Company and rank senior in right of payment to all future subordinated indebtedness of the Company. The indenture governing the Notes contains restrictions relating to, among other things: (i) the incurrence of additional indebtedness, (ii) the issuance of preferred stock, (iii) dividends and other payments and (iv) mergers, consolidations and sales of assets.
The indenture required that $51,800,000 of the proceeds be placed in an escrow account until it was needed to finance the Company's additional capital contribution obligations to Omnitel, provided that Omnitel was not in default of any obligation to fund capital contributions of OPI. The Company utilized the entire escrow account balance plus interest to make its required capital contributions to Omnitel in 1995 and 1996.
Pursuant to the Notes Indenture, any net proceeds from an asset sale that are not applied within 12 months after such asset sale to an investment in a related business will be deemed excess proceeds. When the aggregate amount of excess proceeds exceeds $5,000,000, the Company is required to make an offer to purchase the maximum principal amount of Notes that may be purchased using the excess proceeds, at an offer price in cash equal to 100% of the accreted value of the Notes. As a result of the Company's waiver and release of its claim to participate in an entity that owns one of the two GSM cellular licenses for Delhi, India in December 1995 in exchange for cash of approximately $40,000,000, the Company had approximately $38,900,000 of excess proceeds in December 1996. The Company made an offer to purchase Notes at the accreted value of $635.65 per $1,000 Note. In January 1997, upon the expiration of the offer, $70,000 principal amount of Notes were tendered and the Company paid approximately $44,500.
To the extent that the Company obtains financing in U.S. dollars and the Company's future commitments to Omnitel are in Italian lire, it will encounter currency exchange rate risks. Omnitel's revenues will be received in Italian lire and currently there are no foreign exchange controls in Italy. There can be no assurance that foreign exchange restrictions will not be introduced in the future.
The Company expects that cash on hand is sufficient to meet all obligations of the Company at least through the next twelve months.
The Company is primarily a holding company with limited business operations of its own. The Company's assets consist primarily of cash, marketable securities and its ownership interest in Omnitel. The Company does not hold, nor is it likely that the Company will hold, a majority interest in any operating systems. The Company's minority voting position in Omnitel currently precludes it from controlling Omnitel or OPI, even though the Company is involved in the management of Omnitel and intends to participate in the future only in operating companies in which it can be involved in management. Thus, the Company may be unable to cause the implementation of strategies that it favors and, in the event of a disagreement between the Company and one or more of its partners, the strategies adopted and actions taken by an affiliate company may in some cases be contrary to the Company's preferred strategies and actions. In addition, the Company may be unable to access the cash flow of affiliated companies since (i) it does not have the requisite control to cause such entities to pay dividends, (ii) substantially all of such entities are expected to be parties to credit or other borrowing agreements that severely restrict or prohibit the payment of dividends, and such entities are likely to continue to be subject to such restrictions and prohibitions for the foreseeable future and (iii) some countries tax payment and repatriation of dividends. As a result, the Company does not expect to receive significant cash through dividends or other distributions from an affiliate in the foreseeable future.
Because the Company does not currently have any cash flow and does not expect any cash flow for the foreseeable future, its ability to repay the Notes at maturity will be dependent on developing one or more sources of cash at or prior to maturity. The Company may (i) seek to refinance all or a portion of the Notes at maturity through sales of additional debt or equity securities of the Company, (ii) if possible and subject to the appropriate consents and approvals and certain other limitations set forth in the OPI Agreement and the Omnitel Agreement, seek to sell all or a portion of its interest in Omnitel, (iii) negotiate with its partners to permit any cash produced by OPI to be distributed to equity holders rather than invested in the business and/or (iv) seek to invest in companies that will make substantial cash distributions on or before the maturity of the Notes. There can be no assurance that (i) there will be a market for the debt or equity securities of the Company in the future, (ii) the Company will be permitted to sell particular assets or be able to sell assets in a timely manner or on commercially acceptable terms or in an amount that (giving effect to the substantial corporate income taxes which could be due in the event of such a sale) will be sufficient to repay the Notes when due, (iii) the Company will be able to persuade its partners that cash generated by the operations of its affiliated entities should be distributed to equity holders
(in fact, the Company expects that Omnitel and OPI will utilize all of their respective cash flow for debt repayment or internal development opportunities for the foreseeable future) or (iv) the Company will be able to locate and invest in companies that will be mature enough to make substantial cash distributions to investors prior to the maturity of the Notes.
Cash used in operating activities was $2,282,000 and $3,858,000 in 1996 and 1995, respectively. The decrease in cash used in operating activities is because the Company no longer participates in the entity that owns one of the two GSM cellular licenses for Delhi, India and the Company reduced its efforts to obtain new cellular licenses. Cash used in investing activities was $15,112,000 in 1996 as a result of purchases of marketable securities, net of proceeds from sales.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - ------------------------------------------------------
The financial statements are included herein commencing on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON - ---------------------------------------------------------- ACCOUNTING AND FINANCIAL DISCLOSURE. ----------------------------------- Not applicable.
PART III --------
ITEMS 10, 11, 12, AND 13. - -------------------------
The information required by PART III (Items 10, 11, 12 and 13) is incorporated by reference from the Company's definitive proxy statement involving the election of directors which the Company expects to file, pursuant to Regulation 14A, within 120 days following the end of its fiscal year.
PART IV -------
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT - --------------------------------------- SCHEDULES AND REPORTS ON FORM 8-K. ---------------------------------
(a) (1) Financial Statements - See list of Financial Statements on page.
(2) Financial Statement Schedules - See list of Financial Statements on page.
(3) Exhibits - See Exhibit Index on page 13.
(b) During the quarter ended December 31, 1996, there were no Current Reports on Form 8-K filed by CCII.
(c) Exhibits - The response to this portion of Item 14 is submitted as a separate section of this report.
(d) Financial Statement Schedules - See list of Financial Statements on page. See the Index to Financial Statements of Omnitel Sistemi Radiocellulari Italiani S.p.A. and Omnitel Pronto Italia S.p.A. on page S-1.
EXHIBIT INDEX
Exhibit No. - -----------
3.1 Restated Certificate of Incorporation (Incorporated by Reference to Exhibit 3.1, 1991 Form 10-K, File No. 0-19363).
3.1(a) Certificate of Designation of Series A Junior Participating Preferred Stock (Incorporated by Reference to Exhibit 3.1(a), 1991 Form 10-K, File No. 0-19363).
3.1(c) Certificate of Designation of Series B Preferred Stock (Incorporated by reference to Exhibit 3.1(c), File No. 33-90980).
3.2 Amended By-Laws (Incorporated by Reference to Exhibit 3.2, File No. 33-38398).
4.1 Specimen of Common Stock Certificate (Incorporated by Reference to Exhibit 4.1, 1991 Form 10-K, File No. 0-19363).
4.2 Rights Agreement, dated as of December 19, 1990, between CCII and Continental Stock Transfer Trust Company as the Rights Agent (Incorporated by Reference to Exhibit 4.2, File No. 33-38398).
4.3 Warrant dated July 25, 1994, between CCII and Cellular Communications, Inc. (Incorporated by Reference to Exhibit 4.3., 1994 Form 10-K, File No. 0-19363)
4.4 Indenture dated as of August 22, 1995 between CCII and Chemical Bank as Trustee (Incorporated by Reference to Exhibit 4.2, File No.33- 90980).
10.1 Description of Omnitel Joint Venture Agreement.
10.2 Compensation Plan Arrangement - Cellular Communications International, Inc. 1991 Stock Option Plan (amended and restated effective June 2, 1994). (Incorporated by Reference to Exhibit 10.2., 1994 Form 10-K, File No. 0-19363)
10.3 Compensation Plan Arrangement - Cellular Communications International, Inc. Non-Employee Directors Stock Option Plan (amended and restated effective June 2, 1994) (Incorporated by Reference to Exhibit 10.3., 1994 Form 10-K, File No. 0-19363)
10.4 Warrant Agreement between the Company and CCII Funding, Inc. (Incorporated by reference to Exhibit 10.10, File No. 33-90980).
11 Statement re Computation of Per Share Earnings
23 Consent of Ernst & Young LLP.
23.1 Consent of Coopers & Lybrand S.p.A.
27 Financial Data Schedule.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CELLULAR COMMUNICATIONS INTERNATIONAL, INC.
Dated: March 27, 1997
By: /s/ William B. Ginsberg ------------------------------------------- William B. Ginsberg Chairman of the Board, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the date indicated.
Signature Title Date - --------- ----- ----
/s/William B. Ginsberg - ------------------------- William B. Ginsberg President, Chairman of the Board, Chief Executive Officer and Director (Principal Executive Officer)
/s/ J. Barclay Knapp - ------------------------- J. Barclay Knapp Executive Vice President and Director
/s/ Gregg Gorelick - ------------------------- Gregg Gorelick Vice President-Controller March 27, 1997 (Principal Accounting Officer)
/s/ Stanton N. Williams Vice President and Chief - ------------------------- Stanton N. Williams Financial Officer (Principal Financial Officer)
/s/ Sidney R. Knafel - ------------------------- Sidney R. Knafel Director
/s/ Ted H. McCourtney - ------------------------- Ted H. McCourtney Director
/s/ Del Mintz - ------------------------- Del Mintz Director
/s/ Alan J. Patricof - ------------------------- Alan J. Patricof Director
/s/ Warren Potash - ------------------------- Warren Potash Director
Form 10-K--Item 14(a)(1) and (2)
Cellular Communications International, Inc. and Subsidiaries
Index to Consolidated Financial Statements
The following consolidated financial statements of Cellular Communications International, Inc. and Subsidiaries are included in Item 8:
Report of Independent Auditors............................................ Consolidated Balance Sheets--December 31, 1996 and 1995................... Consolidated Statements of Operations--Years Ended December 31, 1996, 1995 and 1994......................................... Consolidated Statement of Shareholders' (Deficiency) Equity--Years Ended December 31, 1996, 1995 and 1994......................................... Consolidated Statements of Cash Flows--Years Ended December 31, 1996, 1995 and 1994......................................... Notes to Consolidated Financial Statements................................
All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
Report of Independent Auditors
Shareholders and Board of Directors Cellular Communications International, Inc.
We have audited the consolidated balance sheets of Cellular Communications International, Inc. and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, shareholders' (deficiency) equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of Omnitel Sistemi Radiocellulari Italiani S.p.A. ("Omnitel") (a corporation in which the Company has a 14.667% interest) have been audited by other auditors whose report has been furnished to us; insofar as our opinion on the consolidated financial statements relates to data included for Omnitel, it is based solely on their report.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audit and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cellular Communications International, Inc. and Subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP New York, New York March 18, 1997
Cellular Communications International, Inc. and Subsidiaries
Consolidated Balance Sheets
See accompanying notes.
Cellular Communications International, Inc. and Subsidiaries
Consolidated Statements of Operations
See accompanying notes.
Cellular Communications International, Inc. and Subsidiaries
Consolidated Statement of Shareholders' (Deficiency) Equity
See accompanying notes.
Cellular Communications International, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Cellular Communications International, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (continued)
See accompanying notes.
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. ORGANIZATION
Cellular Communications International, Inc. ("CCII" or the "Company") was incorporated on May 30, 1984 to own and operate telephone systems in various markets. Prior to July 31, 1991, CCII was a wholly-owned subsidiary of Cellular Communications, Inc. ("CCI"). On July 25, 1990, CCI entered into a Merger and Joint Venture Agreement, as amended as of December 14, 1990 with AirTouch Communications, Inc. ("AirTouch") whereby CCII was distributed to CCI's shareholders on July 31, 1991 (the "Distribution"). CCII's principal line of business is its participation in Omnitel, a joint venture that owns 70% of OPI, the consortium that owns and operates a cellular telephone network in Italy, San Marino and Vatican City.
2. SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of CCII and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
CASH EQUIVALENTS
Cash equivalents are short-term highly liquid investments purchased with a maturity of three months or less. Cash equivalents were $46,418,000 and $62,209,000 at December 31, 1996 and 1995, respectively. At December 31, 1996 and 1995, cash equivalents consisted of money market instruments.
MARKETABLE SECURITIES
Marketable securities are classified as available-for-sale, which are carried at fair value. Unrealized holding gains and losses on securities, net of tax, are carried as a separate component of shareholders' equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest and other income. Realized gains and losses and declines in value judged to be other than temporary will be included in interest and other income. The cost of securities sold or matured is based on the specific identification method. Interest on securities is included in interest and other income.
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
At December 31, 1996 and 1995, the cost and the aggregate fair market value of marketable securities was $34,404,000 and $17,068,000, respectively. Marketable securities at December 31, 1996 and 1995 consists of U.S. Treasury securities, obligations of U.S. government agencies and U.S. corporate debt securities. During the years ended December 31, 1996 and 1995, there were no realized gains or losses on sales of securities. Primarily all of the marketable securities as of December 31, 1996 had a contractual maturity of less than one year.
INVESTMENTS IN JOINT VENTURES
Capital contributions and costs directly incurred in connection with investments in joint ventures to acquire licenses are capitalized. Costs applicable to unsuccessful joint ventures are charged to expense at such time as CCII determines that the joint venture will be denied a license or the joint venture decides not to pursue its license application. In 1995 and 1994, $602,000 and $481,000, respectively, was written-off in connection with unsuccessful efforts to obtain licenses. Additional costs applicable to successful joint ventures, once a license is awarded or operations commence, are charged to expense. For joint ventures that are awarded a license, the difference between CCII's investment in the joint venture and CCII's underlying equity in the joint venture's net assets, which is primarily the capitalized costs directly incurred by CCII in connection with the joint venture, are amortized over the life of the license from the date of commencement of operations (OPI license--15 years). Investments in joint ventures in which the Company exercises significant influence but does not have control through majority ownership are accounted for using the equity method of accounting.
CAPITALIZED INTEREST
Interest was capitalized as a component of the cost of the investment in Omnitel through the start of OPI's operations in December 1995. Interest of $5,571,000 and $1,312,000 and fees to CCI in connection with the bank loan of $1,220,000 and $679,000 were capitalized in 1995 and 1994, respectively.
LONG-LIVED ASSETS
In March 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which requires impairment losses to be recorded on long-lived assets when indicators of impairment are present and the
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
undiscounted cash flows are not sufficient to recover the assets' carrying amount. The Company adopted SFAS No. 121 in 1995, which had no material effect on the Company's financial statements. The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
EQUIPMENT
Equipment is stated at cost. Depreciation is computed by the straight-line method over the estimated useful lives of the assets. Estimated useful lives range from three to five years.
DEFERRED FINANCING COSTS
Deferred financing costs represent costs incurred for the issuance of debt and are amortized over the term of the related debt.
DEFERRED COSTS
Costs incurred in connection with potential new licenses are capitalized. Costs applicable to successful new licenses will be amortized over the estimated life of the license from the date of commencement of operations. When CCII determines that it will not be successful in obtaining a license, the related capitalized costs are charged to expense. In 1995 and 1994, $1,167,000 and $376,000, respectively, was written off in connection with unsuccessful efforts to obtain licenses.
NET INCOME (LOSS) PER SHARE
Net income (loss) per share is computed based on the weighted average number of common shares outstanding during the periods presented, including common stock equivalents in the net income per share computation. Common stock equivalents are excluded from the net loss per share computations because they are antidilutive.
RECLASSIFICATION
Certain of the prior year amounts have been reclassified to conform to the 1996 presentation.
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 defines a fair value based method of accounting for stock-based employee compensation plans (including stock option plans). Under the fair value based method, compensation cost is measured at the grant date based upon the value of the award and is recognized over the service period. The Company applies APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for its plans.
3. CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES
RISKS INHERENT IN FOREIGN INVESTMENT
There can be no assurance that the laws or administrative practice relating to taxation, foreign exchange or other matters in Italy will not change. The value of CCII's interest in Omnitel may also be affected by changes in tax and other laws and other political, economic, socioeconomic or diplomatic developments in or affecting Italy.
CURRENCY RISKS
To the extent that CCII obtains financing in U.S. dollars and CCII's commitments to Omnitel are in Italian lire, it will encounter currency exchange rate risks. Omnitel's revenues are received in Italian lire and currently there are no foreign exchange controls in Italy. There can be no assurance that foreign exchange restrictions will not be introduced in the future.
LICENSE CONDITIONS
OPI must comply with the standards of service, territorial coverage goals and other conditions contained in its Italian cellular license. The failure to meet these requirements could result in the loss of the license.
COMPETITION FOR CELLULAR LICENSES
CCII has not recently been successful in obtaining any new cellular licenses since there is more competition for licenses and the costs of obtaining them has increased. There can be no assurance that CCII will be successful in obtaining new cellular licenses or in developing other opportunities in the future.
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
4. INVESTMENT IN OMNITEL
The investment in Omnitel consists of the following:
DECEMBER 31 1996 1995 ----------------------------- Capital contributions $ 96,805,000 $ 52,627,000 Capitalized costs including interest 9,725,000 9,725,000 Equity in accumulated net loss (46,907,000) (17,057,000) ----------------------------- 59,623,000 45,295,000 Accumulated amortization (1,260,000) (569,000) ----------------------------- $ 58,363,000 $ 44,726,000 =============================
In May 1990, CCII entered into a joint venture with Ing. C. Olivetti & C., S.p.A., Bell Atlantic International, Inc., Shearson Lehman Hutton Eurocell Inc. and Swedish Telecom International AB, to build, own and operate a cellular mobile telephone network and to offer mobile telephone services in Italy, San Marino and Vatican City ("Omnitel"). In February 1994, Omnitel and Pronto Italia S.p.A. ("Pronto") entered into an agreement to jointly form a new consortium ("OPI") as their combined applicant for the second GSM cellular license in Italy. Omnitel is a 70% shareholder of OPI and Pronto a 30% shareholder. The award of Italy's second GSM cellular license to OPI was made official with the publication of an announcement in the January 31, 1995 issue of the Italian public register. The publication of the award was the final step in the award process which began in March 1994 when the original announcement of the selection of OPI was made by the Italian government. CCII, through its 14.667% ownership interest in Omnitel, holds a 10.267% interest in OPI.
The following financial information of Omnitel and OPI is prepared in accordance with U.S. generally accepted accounting principles and is reflected in U.S. dollars; the balance sheet information has been translated at the exchange rate on the balance sheet date and the statement of operations information has been translated at the average exchange rate for the period. The following information of Omnitel and OPI as of and for the year ended December 31, 1995 has been reclassified.
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
4. INVESTMENT IN OMNITEL (CONTINUED)
The following summarizes the assets, liabilities and stockholders' equity of Omnitel:
DECEMBER 31 1996 1995 ------------------------------ ASSETS Current assets $ 9,542,000 $ 5,912,000 Investment in OPI 341,842,000 236,635,000 ------------------------------ $351,384,000 $242,547,000 ==============================
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities $ 1,400,000 $ 1,258,000 Stockholders' equity 349,984,000 241,289,000 ------------------------------ $351,384,000 $242,547,000 ==============================
The following summarizes the results of operations of Omnitel:
YEAR ENDED DECEMBER 31 1996 1995 1994 ------------------------------------------------
Revenues $ - $ - $ - Costs and expenses (784,000) (862,000) (1,951,000) Equity in net loss of OPI (201,622,000) (98,428,000) (15,407,000) ------------------------------------------------ Operating loss (202,406,000) (99,290,000) (17,358,000) Interest income, net 543,000 859,000 1,842,000 ------------------------------------------------ Net loss $(201,863,000) $(98,431,000) $(15,516,000) ================================================
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
4. INVESTMENT IN OMNITEL (CONTINUED)
The following summarizes the assets, liabilities and stockholders' equity of OPI:
DECEMBER 31 1996 1995 ---------------------------------- ASSETS Current assets $ 299,576,000 $ 104,718,000 Property, plant and equipment, net 697,069,000 388,341,000 Intangible assets, net 566,804,000 566,968,000 Deferred tax asset 129,644,000 - Other 14,925,000 2,829,000 ---------------------------------- $1,708,018,000 $1,062,856,000 ==================================
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities $ 559,905,000 $ 402,264,000 Long term debt 647,806,000 315,557,000 Other liabilities 11,961,000 6,985,000 Stockholders' equity 488,346,000 338,050,000 ---------------------------------- $1,708,018,000 $1,062,856,000 ==================================
The following summarizes the results of operations of OPI:
YEAR ENDED DECEMBER 31 1996 1995 1994 ----------------------------------------------
Revenues $ 488,472,000 $ 30,092,000 $ -
Costs and expenses 707,098,000 150,550,000 28,036,000 Depreciation and amortization 131,888,000 22,020,000 1,088,000 ---------------------------------------------- 838,986,000 172,570,000 29,124,000 ---------------------------------------------- Operating loss (350,514,000) (142,478,000) (29,124,000) Interest income (expense), net (61,616,000) 4,310,000 9,593,000 Income tax benefit 127,573,000 - - ---------------------------------------------- Net loss $(284,557,000) $(138,168,000) $(19,531,000) ==============================================
In 1996, based on an evaluation of the business plan of OPI, expectation of future market conditions and operating performance, management of OPI determined that a substantial portion of the valuation allowance on net deferred income tax assets was not required.
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. GAIN ON SALE OF INVESTMENT IN JOINT VENTURE
In March 1992, CCII entered into an agreement to create a joint venture called Sterling Cellular Ltd. ("Sterling") for the purpose of developing new wireless communication business opportunities in India. In 1993, Sterling was selected as one of the two GSM cellular licensees for the city of Delhi, India and was awarded the license in December 1994. In December 1995, CCII waived and released its claim to participate in Sterling in exchange for approximately $40,000,000 in cash. CCII recorded a gain on this transaction of $38,901,000.
6. BANK LOAN PAYABLE AND CREDIT AGREEMENT
CCII obtained an $85,000,000 line of credit in April 1994. Amounts borrowed under the line of credit accrued interest, at CCII's election, either at the bank's prime rate or LIBOR plus .12%. The terms also included an unused commitment fee of .14% per annum. This line of credit expired on July 26, 1994, at which time CCII refinanced the $22,226,000 principal amount outstanding.
CCII obtained a $60,000,000 line of credit in July 1994. The terms of the line of credit included interest, at CCII's election, either at the bank's prime rate or LIBOR plus .75%. The terms also included an unused commitment fee of .25% per annum and a one-time facility fee of $120,000. This line of credit expired, and amounts borrowed plus unpaid interest and fees were paid on July 17, 1995.
On June 9, 1995, the Company entered into an agreement (the "Bridge Agreement") with CCII Funding, Inc. ("DLJ Bridge"), an affiliate of Donaldson, Lufkin & Jenrette Securities Corporation, which provided for the purchase of up to $80,000,000 in the aggregate principal amount of senior unsecured notes (the "Bridge Notes"). The Bridge Notes were scheduled to mature no later than June 12, 1996. DLJ Bridge purchased $50,000,000 of Bridge Notes on July 17, 1995, the proceeds of which were used to repay the bank loan and related fees to CCI (see Note 8) of approximately $48,750,000 and to pay fees incurred in connection with the Bridge Notes of approximately $1,250,000. The Company incurred costs of $1,293,000 in connection with the Bridge Agreement.
7. LONG-TERM DEBT
In August 1995, the Company issued $281,571,000 aggregate principal amount of 13-1/4% Senior Discount Notes due 2000 (the "Notes") and 282,000 warrants to purchase 317,000 shares of common stock. The Notes were issued at a price to the public of 52.783% or $148,622,000. The Company incurred $7,554,000 in fees and expenses in connection with the issuance of the Notes and warrants, of which $7,242,000 is included in deferred financing costs and $312,000 reduced paid-in capital.
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT (CONTINUED)
The original issue discount accretes at a rate of 13-1/4%, compounded semiannually, to an aggregate principal amount of $281,571,000 by August 15, 2000. In 1996 and 1995, $21,214,000 and $7,097,000, respectively, of the original issue discount was added to principal. The fair value of the Notes based on quoted market prices was $188,653,000 and $156,272,000 as of December 31, 1996 and 1995, respectively.
The warrants were valued at $21.96 each, resulting in deferred debt discount and a corresponding addition to paid-in capital of $6,182,000. In 1996 and 1995, $969,000 and $332,000, respectively, of the deferred discount was amortized.
The Notes are senior unsecured obligations of the Company and rank senior in right of payment to all future subordinated indebtedness of the Company. The indenture governing the Notes contains restrictions relating to, among other things: (i) the incurrence of additional indebtedness, (ii) the issuance of preferred stock, (iii) dividends and other payments and (iv) mergers, consolidations and sales of assets.
The indenture required that $51,800,000 of the proceeds be placed in an escrow account until it was needed to finance the Company's additional capital contribution obligations to Omnitel. In 1996 and 1995, cash of $44,178,000 and $9,116,000, respectively, was used for additional contributions to Omnitel. The remaining $420,000 in the escrow account was released to the Company in 1996.
Proceeds from the issuance of the Notes and warrants of $50,000,000 were used to repay the Bridge Notes. In connection with the repayment of the Bridge Notes, the Company recorded as an extraordinary loss the write-off of $2,268,000 ($1,474,000 net of income tax benefit) consisting of unamortized deferred financing costs and debt discount.
Pursuant to the Notes indenture, any net proceeds from an asset sale that are not applied within 12 months after such asset sale to an investment in a related business will be deemed excess proceeds. When the aggregate amount of excess proceeds exceeds $5,000,000, the Company is required to make an offer to purchase the maximum principal amount of Notes that may be purchased using the excess proceeds, at an offer price in cash equal to 100% of the accreted value of the Notes. As a result of the Company's waiver and release of its claim to participate in Sterling in December 1995 in exchange for cash of approximately $40,000,000, the Company had approximately $38,900,000 of excess proceeds in December 1996. The Company made an offer to purchase Notes at the accreted value of $635.65 per $1,000 Note. In January 1997, upon the expiration of the offer, $70,000 principal amount of Notes were tendered and the Company paid approximately $44,500.
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. RELATED PARTY TRANSACTIONS
CCI provided management, financial, legal and technical services to CCII. Amounts charged to CCII consist of salaries directly attributable to CCII, and indirect costs allocated utilizing direct labor hours as reported by the common officers and employees of CCI and CCII. For the years ended December 31, 1996, 1995 and 1994, CCI charged CCII $232,000, $896,000 and $914,000, respectively, which is included in general and administrative expenses. In August 1996, upon the merger of CCI with AirTouch, NTL Incorporated ("NTL") (formerly International CableTel Incorporated) commenced providing management, financial, legal and technical services to CCII. Amounts charged to CCII consist of salaries directly attributable to CCII, and indirect costs allocated utilizing direct labor hours as reported by the common officers and employees of NTL and CCII. In 1996, NTL charged CCII $351,000, which is included in general and administrative expenses. It is not practicable to determine the amounts of these expenses that would have been incurred had CCII operated as an unaffiliated entity. However, in the opinion of management of CCII, the allocation method is reasonable.
In January 1997, CCII and NTL agreed to a change in NTL's fee for the provision of management, financial, legal and technical services to CCII. NTL will charge CCII for direct costs where identifiable and a fixed percentage of its corporate overhead beginning January 1, 1997.
In connection with the Distribution, CCI was obligated to guarantee certain CCII indebtedness through July 31, 1994 if requested by CCII. As a result, CCI had guaranteed CCII's obligations under the $85,000,000 line of credit note. CCI earned a guarantee fee based upon the amount of indebtedness guaranteed. In June 1994, CCII reached an agreement with CCI for an extension of CCI's guarantee of up to $60,000,000 of CCII indebtedness until July 1995. This agreement provided for the payment of a guarantee fee to CCI on the amount drawn down under the guarantee, the reimbursement to CCI of a portion of the unused commitment fee that CCI paid to its banks, and the issuance to CCI of common stock warrants to purchase 133,000 shares of CCII common stock at fair market value on the effective date of the agreement. The fees to CCI of $2,094,000 were paid in July 1995. In July 1994, in exchange for CCII's payment of $2,400,000 to AirTouch, AirTouch gave its required consent to this extension pursuant to the CCI certificate of incorporation and as the sole holder of CCI's Class A Preference Stock.
Pursuant to the above referenced agreement, CCII issued warrants to CCI to purchase 133,000 shares of CCII common stock at an exercise price of $30.25 per share in July 1994. The value of these warrants was determined to be $1,810,000 which is included in deferred financing costs.
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. INCOME TAXES
The 1996 income tax benefit differs from the statutory rate because no deferred tax benefit was recorded for the Company's net operating loss carryforwards and deductible temporary differences. The 1996 income tax benefit primarily represents the carryback of 1996 federal tax loss to 1995.
The 1995 income tax provision differs from the statutory rate principally because no deferred tax benefit was recorded for the Company's deductible temporary differences. The provision for income taxes in 1995 consists of current federal income taxes.
In 1995, the Company recorded an income tax benefit to additional paid-in capital of $2,157,000 attributable to the exercise of stock options including a portion of its income tax loss carryforward attributable to stock options.
The 1994 income tax provision differs from the statutory rate as no benefit has been given for the losses.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of CCII's deferred tax assets and liabilities are as follows:
DECEMBER 31 1996 1995 ---------------------------- Deferred tax assets: Equity in net loss of Omnitel $ 13,650,000 $ 3,714,000 Net operating loss carryforward 5,978,000 - Other 122,000 140,000 ---------------------------- Total deferred tax assets 19,750,000 3,854,000 Valuation allowance for deferred tax assets (19,750,000) (3,854,000) ---------------------------- Net deferred tax assets - - Deferred tax liabilities - - ---------------------------- Net deferred taxes $ - $ - ============================
At December 31, 1996, the Company had a net operating loss carryforward of approximately $17,000,000 for U.S. federal income tax purposes that expires in 2011.
10. SHAREHOLDERS' EQUITY
STOCK SPLIT
On April 21, 1994, the Company declared a 3-for-2 stock split by way of stock dividend, which was paid on May 13, 1994. All common stock data in the Consolidated Financial Statements give effect to the stock split.
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
10. SHAREHOLDERS' EQUITY (CONTINUED)
SHAREHOLDER RIGHTS PLAN
On November 8, 1990, the Board of Directors adopted a Rights Agreement which provides that one Right will be issued with each share of common stock. The Rights are not exercisable until the occurrence of certain potential takeover events and will expire on July 31, 2001 unless previously redeemed by CCII. When exercisable, each Right entitles the owner to purchase from CCII one one- hundredth of a share of Series A Junior Participating Preferred Stock ("Series A Preferred Stock") at a purchase price of $88.
The Series A Preferred Stock will be entitled to a minimum preferential quarterly dividend payment of $.01 per share and will be entitled to an aggregate dividend of 100 times the dividend, if any, declared per share of common stock. In the event of liquidation, the holders of Series A Preferred Stock will be entitled to a minimum preferential liquidation payment of $1 per share and will be entitled to an aggregate payment of 100 times the payment made per share of common stock. Each share of Series A Preferred Stock will have 100 votes and will vote together with the common stock. In the event of any merger, consolidation or other transactions in which shares of common stock are changed or exchanged, each share of Series A Preferred Stock will be entitled to receive 100 times the amount received per share of common stock. The rights are protected by customary antidilution provisions.
There are 1,000,000 shares of Series A Preferred Stock designated from the 2,500,000 authorized shares of Series Preferred Stock. No shares of Series A Preferred Stock are issued or outstanding.
WARRANTS
In August 1995, 282,000 warrants to purchase 317,000 shares of common stock at $37.00 per share were issued in connection with the 13-1/4% Senior Discount Notes. The warrants expire in August 2003. Warrants to purchase 133,000 shares of common stock at $30.25 per share were issued to CCI in July 1994 in connection with the bank loan. These warrants expire in July 1999.
STOCK OPTIONS
There are 2,284,500 shares of common stock reserved for issuance under the 1991 Stock Option Plan (the "Plan"). The Plan provides that incentive stock options be granted at fair market value of CCII's common stock on the date of grant, and nonqualified stock options be granted at not less than 85% of the fair market value of CCII's common stock on the date of grant. Options are exercisable as to 20% of the shares subject thereto on the date of grant and become exercisable as to an additional 20% of the shares subject thereto on each January 1 thereafter, while the optionee remains an employee of CCII. Options will expire ten years after the date of the grant.
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
10. SHAREHOLDERS' EQUITY (CONTINUED)
There are 150,000 shares of CCII common stock reserved for issuance to members of the Board of Directors who are not CCII employees under the Non-Employee Directors Stock Option Plan (the "Directors Plan"). The Directors Plan provides that all options be granted at the fair market value of CCII's common stock on the date of grant. Options are exercisable as to 20% of the shares subject thereto on the date of grant and become exercisable as to an additional 20% of the shares subject thereto on each anniversary of the grant date, while the optionee remains a director of CCII. Options will expire ten years after the date of the grant. The Directors Plan provides for the automatic grant of options to purchase 7,500 shares to each member of the Board of Directors who is not an employee of CCII in 1997.
Pro forma information regarding net income (loss) and net income (loss) per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for 1996 and 1995: risk-free interest rates of 6.56% and 6.61%, respectively, dividend yield of 0%, volatility factor of the expected market price of the Company's common stock of .388 and a weighted-average expected life of the option of 10 years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Following is the Company's pro forma information:
Year ended December 31 1996 1995 --------------------------
Pro forma net income (loss) $(52,933,000) $3,957,000 Pro forma net income (loss) per share $(5.04) $0.34
Cellular Communications International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
10. SHAREHOLDERS' EQUITY (CONTINUED)
A summary of the Company's stock option activity and related information for the years ended December 31, follows:
Weighted-average fair value of options, calculated using the Black-Scholes option pricing model, granted during 1996 and 1995 is $20.83 and $25.88, respectively.
The following table summarizes the status of the stock options outstanding and exercisable at December 31, 1996:
Form 10-K--Item 14(d)
Omnitel Sistemi Radiocellulari Italiani S.p.A.
S-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Omnitel Sistemi Radiocellulari Italiani S.p.A.
We have audited the accompanying balance sheets of Omnitel Sistemi Radiocellulari Italiani S.p.A. ("the Company") as of December 31, 1996 and 1995, and the related statements of income, stockholders' equity and cash flows for each of the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Omnitel Sistemi Radiocellulari Italiani S.p.A. as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.
COOPERS & LYBRAND S.p.A.
Turin, Italy February 28, 1997
S-2
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Statements of Income (in millions of Italian Lira except per share data)
For the years ended December 31, ------------------------- 1996 1995
Income - 75 Operating expenses: - third parties (1,210) (1,455) - related parties - (24) Equity in loss of Omnitel Pronto Italia S.p.A. (311,032) (160,331) -------- -------- Operating loss (312,242) (161,735)
Interest income, net 838 1,400 -------- --------
Net loss (311,404) (160,335) -------- -------- Net loss per common share 471 337 ======== ========
Weighted average number of common shares outstanding 661 475 ======== ========
The accompanying notes are an integral part of these financal statements.
S-3
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Balance sheets (in millions of Italian Lira)
December 31, December 31, ASSETS 1996 1995 ----------------- ---------------
Cash and cash equivalents (Note 3) 13,519 8,632 Receivables from related parties (Note 8) 90 98 Other current assets 876 637 ------- -------
Total current assets 14,485 9,367 ------- -------
Investment in Omnitel Pronto Italia S.p.A. (Note 4) 518,916 374,948 ------- -------
Total non-current assets 518,916 374,948 ------- -------
Total assets 533,401 384,315 ======= =======
The accompanying notes are an integral part of these financial statements.
S-4
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Balance sheets (in millions of Italian Lira)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, December 31, - ------------------------------------ 1996 1995 ------------ ------------ Accounts payable 141 54 Due to related parties (Note 8) 214 36 Other current liabilities (Note 5) 1,681 1,903 -------- --------
Total current liabilities 2,036 1,993 -------- --------
Deposit payable (Note 6) 90 - -------- -------- Total Liabilities 2,126 1,993 -------- --------
Commitments and contingencies (Note 9)
Common stock (1996 757,500,000 and 1995 525,000,000 shares, par value Lit.1,000, authorized issued and outstanding) 757,500 525,000 Additional paid in capital 282,500 50,000 Accumulated deficit (508,725) (192,678) -------- -------- Total stockholders' equity (Note 10) 531,275 382,322 -------- -------- Total liabilities and stockholders' equity 533,401 384,315 ======== ========
The accompanying notes are an integral part of these financial statements.
S-5
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Statements of cash flows (in millions of Italian Lira)
For the years ended December 31, -------------------- 1996 1995
Cash flows from operating activities: - ------------------------------------ Net loss (311,404) (160,335) Adjustment to reconcile net loss to net cash used in operating activities: Equity in loss of Omnitel Pronto Italia S.p.A. 311,032 160,331 Change in operating assets and liabilities (Increase) decrease in receivables from related parties 8 21,313 (Increase) decrease in other current assets (239) (194) Increase (decrease) in accounts payable 87 (906) Increase (decrease) in other current liabilities (222) 477 Increase (decrease) in due to related parties 178 (9,239) -------- --------
Net cash used in/provided by operating activities (560) 11,447 ======== ========
Cash flows from investing activities: - ------------------------------------ Investment in Omnitel Pronto Italia S.p.A. (455,000) (280,000) Increase (decrease) in deposit payable 90 - -------- --------
Net cash used in investing activities (454,910) (280,000) ======== ========
Cash flows from financing activities: - ------------------------------------ Proceeds from issue of common stock 465,000 275,000 Tax on issue of common stock (4,643) (2,747) -------- --------
Net cash provided by financing activities 460,357 272,253 ======== ========
Increase (decrease) in cash and cash equivalents 4,887 3,700 Cash and cash equivalents at beginning of the year 8,632 4,932 -------- --------
Cash and cash equivalents at the end of the year 13,519 8,632 ======== ======== Supplemental cash flow data: Cash paid during the year for: Interest - 2 ======== ======== Income taxes - - ======== ========
The accompanying notes are an integral part of these financial statements.
S-6
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Statements of changes in Stockholders' equity (in millions of Italian Lira)
The accompanying notes are an integral part of these financial statements.
S-7
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Notes to financial statements (in millions of Italian Lira unless otherwise stated)
1. DESCRIPTION AND OWNERSHIP OF THE BUSINESS
Omnitel Sistemi Radiocellulari Italiani S.p.A. ("the Company" or "Omnitel S.R.I.") was established on June 19, 1990 with the objective of constructing and operating cellular mobile telephone networks.
The Company owns a 70% interest in Omnitel Pronto Italia S.p.A. ("OPI") a start up company until December 6, 1995 that was awarded a fifteen year license to operate a mobile cellular system based on the GSM standard on the Italian territory effective from February 1, 1995. Revenue from operations commenced at the end of 1995 following the launch of a fully operational service on December 7, 1995.
Although the Company owns 70% of the shares of OPI, both the statutes of OPI and the stockholders' agreement between Omnitel Sistemi Radiocellulari Italiani S.p.A. and Pronto Italia S.p.A. stipulate significant restrictions on the Company's ability to control OPI. Among the restrictions are the requirements that members of the Board of Directors designated by other stockholders approve any changes in the companies' corporate purpose, management, auditors, issuance or redemption of stock, payment of dividends, and annual budget. In addition, transactions not included in the annual budget and exceeding certain immaterial amounts regarding the purchase of assets, the assumption of debt, the subjection of the companies' assets to liens or pledges, the extension of guarantees to third parties, the acceptance of any terms and conditions necessary to obtain or renew a license, require approval by members of the Board of Directors designated by other stockholders. Consequently OPI is accounted for on an equity basis.
OPI must comply with the standards of service, territorial coverage goals and other conditions contained in its Italian cellular concession. The failure to meet these requirements could result in the loss of the concession.
The Company's stockholders are Ing. C. Olivetti S.p.A., Bell Atlantic International Inc., Cellular Communication International Inc., Telia International AB and Lehman Brothers Holding Inc.
On December 23, 1996 Ing. C. Olivetti S.p.A. sold 62,567,265 of its common stock to Bell Atlantic International Inc., increasing the latters holding in the Company to 24.93%.
S-8
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Notes to financial statements (in millions of Italian Lira unless otherwise stated) Continued
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the most significant accounting policies used by the Company to prepare the financial statements.
2.1 BASIS OF PRESENTATION
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
In order to conform with accounting principles generally accepted in the United States of America ("US GAAP"), certain adjustments are reflected in the financial statements which are not recorded in the Italian books of account. These adjustments relate primarily to the recording of the loss on equity for the investment in OPI for US GAAP purposes (see Note 11.).
2.2 CASH AND CASH EQUIVALENTS
The Company considers all highly liquid monetary instruments with original maturities of three months or less to be cash equivalents.
Short-term securities held under purchase and resale agreements are valued at cost plus the accrued difference between purchase and resale price matured as of the balance sheet date. The related income is classified as interest income.
2.3 RECEIVABLES AND PAYABLES
Receivables and payables are reflected at their stated value. Receivables are reduced to their expected realizable value by an allowance for doubtful accounts.
Receivables and payables denominated in foreign currencies are stated using the year-end exchange rates. The resulting gains or losses are recorded in the Statement of Income.
S-9
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Notes to financial statements (in millions of Italian Lira unless otherwise stated) Continued
2.4 INCOME TAXES
The Company is subject to income taxes in the Republic of Italy.
The provision for current income taxes is based on an estimate of taxable income for the year.
Deferred income tax balances reflect the impact of temporary differences between the carrying amount of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when taxes are actually paid or recovered.
Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities.
2.5 NET LOSS PER COMMON SHARE
Net loss per common share is calculated by dividing the net loss by the weighted average number of common stock shares outstanding.
3. CASH AND CASH EQUIVALENTS
December 31, December 31, 1996 1995 ------------ ------------
Cash and cash equivalents consist of: - Cash and bank balances 423 1,636 - Italian state bonds 13,096 6,996 ------ ----- Total 13,519 8,632 ====== =====
The Italian state bonds are subject to a purchase and resale agreement which provides that the Company resell them at a pre-determined price.
S-10
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Notes to financial statements (in millions of Italian Lira unless otherwise stated) Continued
4. INVESTMENTS
The movements in the investment account during 1996 were as follows:
As of December 31, 1996 and 1995 the Company held 735,000,000 and 507,500,000 shares of OPI respectively representing 70% of its outstanding common stock.
The following is a summary of the financial information of OPI for the twelve months ended December 31, 1996 and 1995:
S-11
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Notes to financial statements (in millions of Italian Lira unless otherwise stated) Continued
S-12
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Notes to financial statements (in millions of Italian Lira unless otherwise stated) Continued
S-13
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A
Notes to financial statements (in millions of Italian Lira unless otherwise stated) Continued
6. DEPOSIT PAYABLE
On September 18, 1996 the Company signed an agreement with a former employee of OPI and member of the Board of Directors of Omnitel S.R.I. giving him an option, for an amount totalling Lit. 90 million, to buy from Omnitel S.R.I. 262,500 shares of OPI for a price of Lit. 5,500 per share. The option will be exercisible during July 2000.
7. INCOME TAXES
No provision for current income taxes has been made as the Company is in a loss position.
Significant components of the Company's deferred tax accounts are as follows:
The deferred tax asset of Lit. 268,386 million and Lit.85,296 million relates principally to the temporary differences arising from the adjustment of the investment in OPI to the equity method at the period end for financial reporting purposes but not for fiscal purposes.
Full valuation allowance has been provided at December 31, 1996 and 1995 since it is not possible as at either date to establish that it is more likely than not that the assets will be realized.
S-14
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A
Notes to financial statements (in millions of Italian Lira unless otherwise stated) Continued
8. RELATED PARTY TRANSACTIONS
The Company does not have its own personnel and utilized the resources of its stockholders, in particular Olivetti and its subsidiaries in the prior period.
In the periods ended December 31, 1996 and 1995 transactions with related parties have been as follows:
S-15
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A.
Notes to financial statements (in millions of Italian Lira unless otherwise stated) Continued
9. COMMITMENTS AND CONTINGENCIES
As required by the terms of OPI's cellular concession, the Banca Commerciale Italiana has issued a guarantee to the Italian Ministry of Post and Telecommunications as of December 31, 1996 and 1995 on behalf of OPI for Lit.219.4 billion. The Company has provided a counter guarantee to the Banca Commerciale Italiana as of December 31, 1996 and 1995 in the amount of Lit.153.6 billion.
10. STOCKHOLDERS' EQUITY
On March 24, 1995, the Board of Directors approved, on the basis of authorization obtained from the stockholders a share capital increase up to Lit.757,500 million by means of the issue of new shares of Lit.1,000 par value with a share premium of Lit.1,000 each for a total paid up capital of Lit.1,040,000 million. The subscription and payment of these amounts was completed before December 31, 1996.
11. RECONCILIATION TO GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ITALY ("ITALIAN GAAP")
In order to conform with accounting principles generally accepted in the United States of America, certain adjustments are reflected in the financial statements which are not recorded in the Italian statutory financial statements.
S-16
OMNITEL SISTEMI RADIOCELLULARI ITALIANI S.p.A
Notes to financial statements (in millions of Italian Lira unless otherwise stated) Continued
As of December 31, 1996 and 1995 these adjustments which principally related to a different treatment of the investment in OPI, are summarized as follows:
S-17
[LETTERHEAD OF COOPERS & LYBRAND APPEARS HERE]
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Omnitel Pronto Italia S.p.A.
We have audited the accompanying balance sheets of Omnitel Pronto Italia S.p.A. as of December 31, 1996 and 1995 and the related statements of income, stockholders' equity and cash flows for each of the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Omnitel Pronto Italia S.p.A. as of December 31, 1996 and 1995, and the results of its operations and its cash flows for the each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.
COOPERS & LYBRAND S.p.A.
/s/ [SIGNATURE APPEARS HERE]
Turin, Italy February 28, 1997
S-18
Omnitel Pronto Italia S.p.A.
Statement of Income (in millions of Italian Lira except per share data)
The accompanying notes are an integral part of these Financial Statements
S-19
Omnitel Pronto Italia S.p.A.
Balance Sheet (in millions of Italian Lira except per share data)
The accompanying notes are an integral part of these Financial Statements
S-20
Omnitel Pronto Italia S.p.A.
Balance Sheet (in millions of Italian Lira except per share data)
The accompanying notes are an integral part of these Financial Statements
S-21
Omnitel Pronto Italia S.p.A.
Statement of Cash Flows (in millions of Italian Lira)
The accompanying notes are an integral part of these Financial Statements
S-22
Omnitel Pronto Italia S.p.A.
Statement of Changes in Stockholders' Equity (in millions of Italian Lira unless otherwise stated)
The accompanying notes are an integral part of these Financial Statements
S-23
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated)
1. Description and ownership of the business
The Company was established in 1985 as a subsidiary of the Olivetti Group. It remained substantially dormant until February 22, 1994 when it was acquired by Omnitel Sistemi Radiocellulari Italiani S.p.A. and Pronto Italia S.p.A. and changed its name to Omnitel Pronto Italia S.p.A.
The Company's corporate purpose is to construct and operate a mobile cellular system in Italy based on the GSM standard (Group Special Mobile).
During 1994 Omnitel Pronto Italia S.p.A. obtained a fifteen year license to operate the cellular mobile telephone network effective February 1, 1995. In the course of 1995, the Company carried out an experimental service exercise between October 3, 1995 and December 6, 1995 and launched a full operational service from December 7, 1995.
Activities carried out during 1996 were mainly related to the construction of the network and to the launch of operational service. In accordance with the clauses of the license, on March 13, 1996 the National roaming access was obtained from Telecom Italia Mobile S.p.A., thus granting to the Company the same operational level as its competitor.
As of December 31, 1996, the stockholders of Omnitel Pronto Italia S.p.A. were as follows:
Omnitel Sistemi Radiocellulari Italiani (Omnitel S.R.I.) S.p.A. 70% Pronto Italia (P.I.) S.p.A. 30% ----- Total 100% ====
The Company currently purchases predominantly all of the hardware and software for the construction of the network from Nokia Telecommunications Italia, although alternative suppliers are readily available.
In accordance with the Italian law, the Financial Statements must be approved by the annual stockholders' meeting. The present financial statements have not yet been approved by the above meeting.
In the course of 1996, the Italian Government was empowered by the Parliament which propose to modify the fiscal tax rules related to local tax ("ILOR"). Temporary differences considered for the computation for deferred tax assets and liabilities do not consider potential changes to the existing tax rules, in accordance with Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes".
S-24
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
2. Summary of significant accounting policies
The following is a summary of the most significant accounting policies used by the Company to prepare the financial statements.
2.1 Basis of presentation and preparation of financial statements
The financial statements are prepared under the historical cost convention and in accordance with applicable accounting principles. The preparation of the Company's financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant areas which require the use of management's estimates relate to provision for bad debt and the estimate of depreciation of fixed assets.
Prior to December 7, 1995, the Company was considered to be in a development stage in accordance with the requirements of Statement of Financial Accounting Standards No. 7 "Accounting and Reporting by Development stage Enterprises". The deficit accumulated during the development stage was Lit. 222,311 million.
2.2 Cash and cash equivalents
The Company considers all highly liquid monetary instruments with original maturities of three months or less to be cash equivalents.
Short-term securities held under purchase and resale agreements (Repos) are valued at cost plus the accrued difference between purchase and resale price matured as of the balance sheet date. The related income is classified as interest income.
S-25
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
2.3 Receivables and payables
Receivables and payables are reflected at their stated value. Receivables are reduced to their expected realizable value by an allowance for bad debt.
Receivables and payables denominated in foreign currencies are stated using the year-end exchange rates. The resulting gains or losses are recorded in the statement of income.
2.4 Equipment and Leasehold Improvements
Equipment and Leasehold Improvements are stated at cost. Depreciation and amortization are computed on a straight-line basis over the estimated useful lives (five to eight years) or lease life. Major replacements and improvements are capitalized, and maintenance and repairs which do not improve or extend the useful lives of the respective assets are charged to operations. The assets and related accumulated depreciation or amortization accounts are adjusted for assets retirement or disposal with the resulting gain or loss shown in operating expenses.
Expenditure for maintenance, repairs and minor replacements are charged to current operations. Expenditure for major replacements and improvements are capitalized.
2.5 Assets under construction
Assets under construction consist of the direct costs relating to the construction of the network. These include costs such as hardware, software, direct labour costs incurred in construction, as well as other costs relating to Network Planning and Implementation. All costs not directly related to the development and construction of the network have been charged to current operations. The depreciation of completed and operational sites started from the launch date of December 7, 1995.
2.6 Intangible assets
The direct and indirect costs incurred to obtain the concession as well as the interest on the related bank loan up to inception of service were capitalized in 1995 and are amortized over the license period starting from the month in which the commercial telephone service began. All other intangible assets are amortized on a straight-line basis over their estimated useful lives.
S-26
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
2.7 Inventories
Inventories, consisting principally of those related to the Company's product distribution business, are stated at the lower of cost (first-in, first-out method) or market.
2.8 Income taxes
The provision for current income taxes is based on the taxable income for the year.
Deferred income tax balances reflect the impact of temporary differences between the carrying amount of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when taxes are actually paid or recovered.
Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities.
2.9 Accrual for severance pay
Under Italian law, deferred compensation accrues in favour of employees which they (or in the event of their death, their heirs) are entitled to collect upon termination of employment. The amount payable related to each year's service is calculated on the basis of the remuneration for that year and will be subject to annual revaluations based on increases in the Italian cost-of-living index (ISTAT). Provision for the effect of such revaluations is made as increases in the cost-of-living index are realized.
2.10 Financial Instruments
The company utilizes derivative financial instruments such as interest rate swap, interest rate collar and cap agreements to limit its exposure to changing interest rates but does not hold or issue such financial instruments for trading purposes.
Premiums to obtain interest rate caps are deferred and applied over the period of the related commitment and are included in prepaid financial charges within other current assets. Net cash paid or received on interest rate swaps and interest rate collar and cap agreements are reflected as an increase or decrease of the interest expense during the period.
S-27
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
2.11 Commission on Syndicated loan facility
Up-front costs such as commission incurred in respect of the Syndicated loan facility (see Note 8) have been capitalized and are being amortized on a straight-line basis over the period of the facility, which approximates the interest method.
2.12 Revenue Recognition
Operating revenues for communications services, which exclude value added tax and other sales tax, are recognized as services are rendered. Unbilled revenues resulting from cellular services provided from the billing cycle date to the end of each month are calculated and recorded.
Operating revenues for the Company's product distribution business are recognized upon delivery of products to customers.
2.13 Software costs
Software costs are capitalized and amortized over five years. Software development costs are expensed as incurred.
2.14 Advertising costs
In accordance with SOP 93-7, advertising costs are charged to the statement of income in the period in which they are occurred.
2.15 Accounting Pronouncements
In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121"). SFAS 121 establishes the accounting standards for the impairment of long-lived assets acquired to be held and used, and for long-lived assets and certain intangible assets to be disposed of. During 1996, the statement became effective; management have applied the provisions of SFAS 121 and are satisfied that this has not had any impact on the financial statements.
S-28
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
2.16 Stock option
In October 1995, the Financial Accounting Standards Board issued Statement No. 123 "Accounting for Stock-Based Compensation". This Statement defines a fair value based method of accounting for stock-based employee compensation plans. Although all entities are encouraged to adopt this method of accounting for all employee stock compensation plans, SFAS 123 allows an entity to continue to measure compensation costs for its plans as prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees". The company intends to follow the option that permits entities to apply APB Opinion No. 25.
2.17 Net loss per common share
Net loss per common share is computed by dividing the net loss as reported in the statements of income by the weighted average number of common shares outstanding during the period.
2.18 Reclassification of statement of income
Certain amounts in the 1995 financial statements have been reclassified to conform with the 1996 presentation. These reclassification have no effect on previously reported net loss or stockholders' equity.
3. Accounts receivable, net
Accounts receivable, net, consisted of the following (in millions of Italian Lira):
S-29
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
4. Transactions with related parties
As of December 31, 1996 and 1995 the analysis of related parties balances, including VAT, was as follows:
Accounts with Olivetti group companies are regulated by written contract and mainly relate to the payment of payroll costs performed at group level and to V.A.T. balances, paid in accordance with Italian law at group level. The debit balance is due primarily to the V.A.T. position.
On the basis of the contract, the VAT debit balance will be repaid beginning January 1, 1997.
S-30
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated)
Continued
The analysis of amounts charged to the Company by related parties, is as follows:
Related party expenses relate principally to the services of personnel rendered to the Company. In addition, the Company has a relationship with Ing. C. Olivetti & Co. S.p.A. who provide payroll services to the Company on an ongoing basis.
The amounts debited by related parties in 1996 include Lit. 39,776 million of network services, Lit. 20,740 million of general and administrative expenses, Lit. 10,746 million of cost of sales and network maintenance and Lit. 453 million of consultant fees. The revenues include local services outgoing for an amount of Lit. 1,572 million, hardware sales for a total amount of Lit. 4,600 million, other revenues for a total amount of Lit. 327 million.
S-31
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated)
Continued
5. Other current assets
The balances as of December 31, 1996 and 1995 are analyzed as follows:
Prepaid rents mainly relate to the contracts for the utilization of the fixed network of Telecom S.p.A. and to the sites utilized for the network.
Prepaid financial charges included Lit. 996 million relating to the deferral of premium paid in order to obtain interest rate swaps (see Notes 2.10 and 15).
6. Inventories
Inventories, net of obsolescence reserve, consist of:
S-32
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
7. Property, plant and equipment
Property, plant and equipment as of December 31, 1996 and 1995 consist of the following:
S-33
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
8. Intangible assets
The balances for intangible assets as of December 31, 1996 and 1995 can be detailed as follows:
On November 30, 1994, the Company made a lump-sum payment (Lit.750,000 million) for the concession by the Ministry for Post and Telecommunications for the installation and operation, on a non- exclusive basis, of the GSM service on the Italian territory. The concession was effective from February 1, 1995 and will have a duration of fifteen years.
S-34
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
9. Other assets
The balances as of December 31, 1996 and 1995 are analyzed as follows:
The deposit paid to the Ministry of Post and Telecommunications will remain in place throughout the duration of the concession and earns interest at the annual rate of 3.5%.
Special cash collateral consists of remunerative pledged accounts issued for the purposes of securing the obligations of the Company towards the Principal Issuing Banks of the Syndicated loan facility (see Note 10.1).
Omnitel Gestioni S.p.A. is a subsidiary that manages mobile phone retail shops. The shares of the Company are pledged in favour of the Agent Bank of the Syndicated loan facility, in accordance with the clauses of the facility contract.
Long term receivables relate to display corners sold to the Company's dealers. Payment is received in instalments.
S-35
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
10. Debt
The amount due to banks and financial institutions as of December 31, 1996 and 1995 can be further detailed as follows:
The short term bank loan relates to a loan granted for a period not exceeding one month.
The bridge loan jointly granted by three Italian banks (Banca di Roma, Banca Commerciale Italiana and Crediop) was repaid on February 13, 1996 using the first drawdown of the Syndicated Loan Agreement. As the Company signed the Syndicated Loan facility on November 30, 1995 and the agreement provided for the first drawdown to be used to repay the above bank loan, this bridge loan was classified in 1995 as a long term liability as required by Statement of Financial Accounting Standards No. 6 "Classification of Short Term Obligations expected to be refinanced".
10.1 Syndicated loan facility
On November 30, 1995 the Company signed a Syndicated loan facility amounting to Lit.1,800 billion with a number of financial institutions.
S-36
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
The facility consists of three tranches, being two tranches of Lit.1,000 billion and Lit. 200 billion linked to LIBOR (London Inter-Bank Offered Rate) and the third tranche of Lit. 600 billion linked to RIBOR (Rome Inter-Bank Offered Rate). The interest rate of the facility is linked to the cash flows of the Company. The rate was initially set at the interbank rate plus 1.75%, subsequently falling to a minimum of 0.625% with increasing operating cash flows.
This was reduced to 1.625% on December 7, 1995 due to the Company achieving 40% territory coverage. Commitment fees are due from the Company on the unutilized amount of the facility at a rate of 0.5% per annum, payable quarterly in arrears.
The two LIBOR tranches consist of a facility for a maximum amount of Lit. 1,000 billion available by way of term loan advances and of a revolving short term advances facility for a maximum amount of Lit. 200 billion. The two facilities are available in predetermined freely available multicurrencies subject to appropriate hedging. The total borrowed under these two facilities as at December 31, 1996 amounts to Lit. 667,021 million and was completely drawn down in yen.
The RIBOR tranche, for a maximum amount of Lit. 600 billion, is available by way of term loan advances in Italian Lira and/or the issue of guarantees. The tranche has been utilised for outstanding guarantees required by Finnish Export Credit Ltd. (FEC) for a total amount of Lit. 334,305 million and by Lit. 10,348 million for a term loan advance.
The facility has a duration of 10 years of which the first 4 years relate only to utilization. Repayment is at increasing rates commencing from the end of the fifth year.
In accordance with the contract, the aggregate of advances outstanding was limited to Lit. 1,400 billion for the period ending December 31, 1996, stepping-up to Lit. 1,600 billion up to June 1997 and Lit. 1,800 billion thereafter.
The facility includes several financial and operating covenants such as dividend distribution restrictions, minimum territory coverage, and restrictions over changes in direct and indirect ownership of the Company. There are also provisions for the use of several pledged cash collateral accounts under the terms of the facility.
S-37
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
As a requirement of the above facility, the Company entered into an insurance security agreement, whereby the Company pledged all of its present and future rights arising from a number of the Company's insurance policies. This pledge is in favour of the financial institutions providing the facility.
10.2 Nokia/Finnish Export Credit Ltd.
The Company signed an agreement with Nokia during 1994 for the supply of basic telecommunications equipment for a minimum expected purchase value of Lit. 360,000 million.
The contract included a financing agreement with Finnish Export Credit Ltd (FEC), a wholly owned subsidiary of the Finnish Government, for 85% of the amounts involved. On December 31, 1995 the credit agreement with Finnish Credit Export Ltd for a total value of Lit. 306,000 million was signed.
The credit facility has been fully utilized in 1996. Interest is payable at LIBOR plus 0.225% during the drawingdown period and at a fixed rate of 9% thereafter. The facility is repayable in equal semi-annual instalments over 5 years from the completion date of October 1996. A portion of the loan will be repayed in the course of 1997 (Lit. 61,200 million). This loan is completely classified as a long term liability in accordance with Statement of Financial Accounting Standards No. 6 "Classification of Short Term Obligations expected to be refinanced".
The credit facility is collateralized by a guarantee from the Syndicated Loan Facility for Lit. 334,305 million (109.25% of the credit line).
The agreement provides for the use of a pledged cash collateral account, partially utilized in the course of 1996.
10.3 Other
The Company has entered into interest rate swap agreements (see Note 15) in order to manage its exposure to interest rate fluctuations.
At December 31, 1996 the Company had short-term credit facilities with several financial institutions totalling Lit. 228 billion of which Lit. 139 billion were unused.
S-38
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
The Company's weighted average interest rates calculated as at December 31, 1996 and as of December 31, 1995 were 13.37% and 11.23% per annum respectively.
11. Other current liabilities and accrued liabilities
Other current liabilities are analyzed as follows:
Other tax payable includes Lit. 30,230 million relating to the government concession tax collected monthly from each customer, Lit. 14,429 million of stamp duty on new contracts and Lit. 12,445 million relating to the annual concession charge computed on GSM service gross revenues (see Note 16.1).
S-39
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
12. Accrual for severance pay
Under Italian law, deferred compensation accrues in favour of employees which they (or in the event of their death, their heirs) are entitled to collect upon termination of employment. The amount payable related to each year's service is calculated on the basis of the remuneration for that year and will be subject to annual revaluations based on increases in the Italian cost-of-living index (ISTAT). Provision for the effect of such revaluations is made as increases in the cost-of-living index are realized. The balance consists of:
13. Income taxes
A tax credit has been recorded in 1996. No provision for income taxes has been made for 1995.
Based on the statutory results and the estimate of investment incentive deductions as of December 31, 1996 the Company has net operating loss carryforwards at that date of Lit. 1,366,000 million (1995: Lit. 844,000 million) which expire in the years 1999 through 2001. Approximately Lit. 50,000 million (1995: Lit. 699,000 million) are the result of investment incentives granted in the form of deductions from taxable income.
The enacted corporation tax rate for the Company in the years 1996 and 1995 was 53.2% comprising local ("ILOR") tax at 16.2% and national ("IRPEG) tax at 37%. For IRPEG purposes only, net operating losses may be carried forward and applied against the taxable income of the following 5 years. No such loss carryforward facility exists for ILOR purposes.
For 1996 and 1995, deferred tax assets and liabilities arising from temporary differences have been computed at the full rate of 53.2%; the asset represented by net operating loss carryforwards has been computed at the IRPEG rate of 37%.
S-40
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated)
Continued
Deferred tax balances as at December 31, 1996 and 1995 can be summarized as follows:
A valuation allowance was provided against the total deferred tax assets as of December 31, 1995 as the Company had not sufficient assurance that the assets would be realized.
In 1996, based on an evaluation of the business plan, expectation of future market conditions and operating performance, management determined that a substantial portion of the valuation allowance was not required. A valuation allowance of Lit. 406,877 million has been maintained primarily for remaining tax loss carryforwards for which it is more likely than not that the deferred tax assets will not be realized.
14. Statement of Income
As specified in note 2.18, the 1995 statement of income amounts have been reclassified in order to permit a better comparability with the 1996 amounts.
S-41
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
15. Financial instruments
The Company has entered into interest rate swap, cap and collar agreements to manage the impact of interest rate fluctuations.
At December 31, 1996 and December 31, 1995, the Company was party to interest rate swap agreements, for hedging purposes, to exchange variable rate payments for fixed rate payments periodically over the life of the agreements. At the same dates, the Company was also party to a cap agreement, whereby the Company is protected in the event that interest rates rise over the relevant strike level. At December 31, 1996 the Company was party to collar agreements under which the Company buys a cap in order to protect itself in the event interest rates increase and writes a floor, in order to reduce the cost of buying a cap.
The Company recognizes gains and losses in relationship to the maturity dates of the underlying debt.
At December 31, 1996 and 1995 the Company had outstanding interest rate swap agreements which converted variable rate debt to fixed rate debt with a weighted average interest rate of 11.69% while, at the same date, the three month market rate was 7.23%. The total notional principal amounted to Lit.150,000 million at the year end. The agreements all terminate on May 31, 2000.
At December 31, 1996 and 1995 the Company had a cap agreement outstanding, with total notional principal amounting to Lit. 50,000 million, at a strike rate of 12.50% which terminates on May 31, 2000.
At December 31, 1996 the Company had two collar agreements outstanding, with total notional principal amounting to Lit. 100,000 million, at an average strike cap rate of 9.105% and at a beginning strike floor rate of 8.25% declining quarterly up to 7.5% starting from April 1997. The agreements will terminate on July 15, 1998. The floor strike rate for the quarter from October 15, 1996 to January 15, 1997 was 8%. As at December 31, 1996, the three month market rate was 7.19%.
S-42
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
16. Commitments and contingencies
16.1 Commitments deriving from the concession
Under the concession awarded for the GSM public mobile telephone service, the Company undertakes to pay to the Ministry an annual concession charge corresponding to 3.5% of the GSM service gross revenues, net of all service charges paid to the other public telephone network license holder. The concession charge cannot be lower than a minimum annual amount, established for each of the next three years of the concession, as follows:
1997 25,400 1998 51,000 1999 77,100 ------- Total minimum payments 153,500 =======
The Company must guarantee a minimum coverage of 70% of the Italian territory and 90% of the population within 5 years from the date of the concession. Failure to meet these requirements could result in cancellation of the concession.
In addition under the Concession, the company has to fulfill some obligations prescribed by the Performance Bond (see 16.2).
16.2 Guarantees provided by financial institutions on behalf of the Company
As of December 31, 1996 and 1995 the Company has an undertaking of Lit.669,105 and Lit. 491,599 million respectively for guarantees issued by financial and ministerial institutions as analyzed below:
S-43
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
As collateral for the loan obtained by Finnish Export Credit Ltd, the Company obtained letters of credit from banks, subsequently cancelled after the issuance of the guarantee provided by the Syndicated Loan (see Notes 10.1 and 10.2).
The performance bond of Lit. 219,400 million was provided by Banca Commerciale Italiana to the Ministry of Post and Telecommunications as a guarantee for the fulfillment of the obligations prescribed by the above mentioned concession, including, but not limited to, employment levels, achievement of minimum territorial coverage (at least 98% of the Italian territory by May 1998) and minimum cumulative investments (at least Lit.1,552 billion by May 1998). The performance bond matures on June 30, 2000. Failure to achieve the objectives specified in the performance bond could result in charges to the Company.
Other guarantees mainly include (Lit. 106.6 billion) bank guarantees granted to the V.A.T. office in order to obtain V.A.T. repayments.
16.3 Other commitments and contingencies
16.3.1 Nokia
The Company signed an agreement with Nokia in 1994 for the supply of basic telecommunication equipment for a minimum expected purchase value of Lit. 360 billion. Prior to 31 December, 1996, the Company fulfilled its purchase obligation related to the original commitment . In the course of 1996, amendments were signed to the original contract. One amendment stated a commitment of Lit. 290 billion for the purchase of further telecommunication equipment. At December 31, 1996 the remaining purchase commitment outstanding in relation to this amendment amounted to some Lit. 170 billion.
S-44
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
16.3.2 Rent and leasing commitments
The Company rents buildings utilized for operations and network sites and leases vehicles assigned to certain employees, with future minimum rentals as follows:
17. Stockholders' equity
A stockholders' meeting held on January 30, 1995 authorized the Board of Directors to increase the Company's share capital up to a maximum of Lit.1,050 billion by means of the issue of a maximum of 400 million shares at a value of Lit.2,000 per share, consisting of Lit.1,000 par value plus Lit.1,000 share premium. This increase was approved by the Board of Directors at a meeting on March 24, 1995. The issue of these shares was at the discretion of the Board of Directors and was valid until December 31, 1996.
The first tranche of these shares was issued in 1995 for a total amount of 75 million common shares.
In the course of 1996 the Company issued a total amount of 325 million common stock shares with a par value of Lit. 1,000 each, and Lit. 1,000 additional paid in capital. This increased the Company's issued common stock to Lit. 1,050,000 million and its additional paid in capital to Lit. 400,000 million. The proceeds from the issues of 1996, net of taxation, amounted Lit. 643,500 million.
Under Italian tax legislation the company is liable to an annual tax of 0.75% on the value of the stockholders' equity as reported under Italian GAAP, which is accounted for as a charge to the income statement.
S-45
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
In December 1996, the Company launched a stock option program in favour of some executives of Omnitel Pronto Italia. On the basis of the program the executives subscribed 3,324,000 warrants for a total amount of Lit. 1,140 million. The warrants which each carry the right to purchase one common stock unit will be exercisible on June 30, 2001. The price payable on exercise of the warrant is a total of Lit. 5,500 per warrant of which Lit. 4,500 additional paid in capital. Early exercise of warrants is not permitted.
18. Subsequent events
National roaming agreement
Access under the National roaming agreement is currently being disputed by Telecom Italia Mobile in connection with OPI's territorial coverage. The Ministry have confirmed that OPI have achieved the coverage necessary for obtaining access.
19. Disclosures about Fair Values of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Values of Financial Instruments" ("SFAS 107"), as amended by Statement of Financial Accounting Standards No. 119 "Disclosure about Derivative Financial Instruments and fair value of financial instruments" requires certain disclosures about the fair values of all financial instruments, including both assets and liabilities.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value:
Cash and cash equivalents, Accounts receivable, Trade payables, Amounts due to and from related parties
The carrying amount approximates the fair value due to the short term maturity of these instruments. This includes the short term bank loans.
S-46
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
Accrual for severance pay
The accrual for severance pay required under Italian legislation equates to the present value of vested benefits to which the employee is immediately entitled on termination of their employment. Upon this basis, the carrying amount approximates to the fair value of this financial instrument.
Interest rate swap agreements
The fair value of interest rate swap agreements is the estimated amount that the Company would pay or receive to terminate the agreements at the balance sheet date, taking into account current interest rates.
The estimated fair values of the Company's financial instruments are as follows (Lit./millions):
S-47
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
20. Reconciliation to Generally Accepted Accounting Principles in Italy ("Italian GAAP")
In order to comply with the accounting principles generally accepted in the United States of America, certain adjustments are reflected in the financial statements which are not recorded in the Italian statutory financial statements.
As of December 31, 1996 and 1995 these adjustments which principally related to the application of SFAS 109 and to a different treatment of costs sustained during the development stage respectively, are summarized as follows:
S-48
Omnitel Pronto Italia S.p.A.
Notes to the Financial Statements (in millions of Italian Lira unless otherwise stated) Continued
S-49