NETIA HOLDINGS S.A. (Exact name of Registrant as specified in its charter)

Transcription

1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C FORM 20-F ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 Commission file number NETIA HOLDINGS S.A. (Exact name of Registrant as specified in its charter) THE REPUBLIC OF POLAND (Jurisdiction of incorporation or organization) UL. POLECZKI 13, , WARSAW, POLAND (Address of principal executive offices) Securities registered or to be registered pursuant to Section 12(b) of the Act: None Securities registered or to be registered pursuant to Section 12(g) of the Act: Ordinary Shares, nominal value PLN 6.00 per share American Depositary Shares, each representing one Ordinary Share Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: 10¼% Series B Senior Notes due ¼% Series B Senior Discount Notes due % Series B Senior DM Discount Notes due / 8% Series B Senior Notes due ½% Series B Euro Senior Notes due 2009 (Title of Class) Indicate the number of outstanding shares of each of the Registrant s classes of capital or common stock as of the close of the period covered by the annual report: Ordinary Shares, nominal value PLN 6.00 per share: 26,494,172 shares Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No Indicate by check mark which financial statement item the Registrant has elected to follow. Item 17 Item 18

2 Page CERTAIN TERMINOLOGY... 1 PRESENTATION OF FINANCIAL INFORMATION... 1 FORWARD-LOOKING STATEMENTS... 1 Part I... 3 Item 1. Description of Business... 3 Item 2. Description of Property Item 3. Legal Proceedings Item 4. Control of Registrant Item 5. Nature of Trading Market Item 6. Exchange Controls and Other Limitations Affecting Security Holders Item 7. Taxation Item 8. Selected Financial and Operating Data Item 9. Management s Discussion and Analysis of Financial Condition and Results of Operations Item 9A. Quantitative and Qualitative Disclosures About Market Risks Item 10. Directors and Officers of Registrant Item 11. Compensation of Directors and Officers Item 12. Options to Purchase Securities from Registrant or Subsidiaries Item 13. Interest of Management in Certain Transactions Item 14. Description of Securities to Be Registered Part II Item 15. Defaults Upon Senior Securities Item 16. Changes in Securities and Changes in Security for Registered Securities Part III Item 17. Financial Statements Item 18. Financial Statements Item 19. Financial Statements and Exhibits i

3 CERTAIN TERMINOLOGY Netia, the Company and we as used in this Annual Report refer to Netia Holdings S.A. and its subsidiaries as a combined entity, except where we make clear that such terms mean only the parent company, Netia Holdings S.A. In this Annual Report, references to Polish Zloty or PLN are to the lawful currency of the Republic of Poland, references to U.S. Dollars, US$ or $ are to the lawful currency of the United States of America, references to ε or Euro are to the common European Union currency, and references to German Marks or DM are to the lawful currency of the Federal Republic of Germany. For the convenience of the reader, this Annual Report contains translations of certain Polish Zloty amounts into U.S. Dollars. Unless otherwise stated, such U.S. Dollar amounts have been derived by converting Polish Zloty to U.S. Dollars at the rate of PLN per $1.00, the exchange rate published by the National Bank of Poland ( NBP ) and effective on December 31, This translation should not be construed as a representation that such Polish Zloty amounts actually represent such U.S. Dollar amounts or could be, or could have been, converted into U.S. Dollars at the rates indicated or at any other rate. The translation rate used may differ from the actual rates in effect during the periods covered by the financial information discussed in this Annual Report. Connected lines represents the number of lines that have been connected to our switching nodes and for which we had or expect to have interconnection agreements with the Polish incumbent operator at the end of referenced period. Subscriber lines represents the number of connected lines generating revenue at the end of referenced period. PRESENTATION OF FINANCIAL INFORMATION Unless otherwise stated, the financial statements included in Item 18 of this Annual Report (the Financial Statements ) have been prepared in accordance with International Accounting Standards ( IAS ), which differ in certain respects from generally accepted accounting principles in the United States ( U.S. GAAP ). You should read note 22 to the Financial Statements for a discussion of these differences. Amounts and percentages appearing in this Annual Report may not total due to rounding. FORWARD-LOOKING STATEMENTS This Annual Report contains forward-looking statements. These statements appear in a number of places in this Annual Report and include statements regarding our intentions, beliefs or current expectations concerning, among other things, the build-out of our telecommunications network; the development of the Polish telecommunications market; the growth in demand for business Internet services; our plans for the development of our business, including our plans to provide voice telephone service in Warsaw, domestic long distance service and expanded Internet services; our financing plans and our need for substantial capital resources to build our network and fund our operating losses; trends affecting our financial condition or results of operations, as described in Item 9 Management s Discussion and Analysis of Financial Condition and Results of Operations ; the impact of competition on our business; and changes in the regulatory environment affecting our business. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those 1

4 in the forward-looking statements as a result of various factors. The information contained in this Annual Report identifies important factors that could cause such differences. You should read Item 1 Description of Business Investment Considerations for a discussion of some of these factors. We undertake no obligation to publicly update or revise any forward-looking statements. 2

5 PART I Item 1. Description of Business. Overview We are the leading alternative fixed-line telecommunications provider in Poland. We own, operate and are continuing to build a state-of-the-art fiber-optic network, which currently spans approximately 2,300 route kilometers (1,429 miles) and connects over 250,000 active subscriber lines, including over 50,000 business lines. We provide a broad range of telecommunications services including voice, data and Internet-access services. Our goal is to be the preeminent national provider of integrated telecommunications and Internet solutions to the business, premium residential and carriers' carrier markets in Poland. We are expanding our current Internet-access business with the roll-out of our branded service, Internetia, and we aim to become Poland s leading full service nationwide provider of Internet and Internet-related products and services. We have focused on servicing Poland s growing business market. Business customers accounted for 20.5% of our total subscriber lines at December 31, 1999, up from 14.7% at December 31, 1998, and during 1999, accounted for approximately 28.7% of our new subscriber lines. In July 1999, we became the first Polish company to list its shares on the Nasdaq Stock Market. We currently provide local voice telephone service in 21 territories throughout Poland, including in five of Poland's ten largest cities (Katowice, Krakow, Gdansk, Lublin and Poznan). We recently won a tender for a license to provide local voice telephone service in Warsaw, the capital of Poland and the country s largest city. Approximately 40% of the population of Poland and approximately 70% of the population living in Poland's ten largest urban areas live in our local voice license territories and Warsaw. Our voice telephone services include switched, fixed-line voice telephone service, ISDN and voice mail. We have started to provide Internet-access and data services in major urban areas and expect to begin offering domestic long distance telephone service to the Polish market over our network, initially in Poland s 12 largest cities, in We also offer leased lines in connection with our voice, Internet and data services. We intend to expand our services to include additional value-added Internet services, such as voice over Internet protocol ("VoIP"), virtual private networks, web design, web hosting and colocation services; data services including LAN-to-LAN and frame relay; and, upon completion of our national backbone, carrier s carrier transmission services. We are operating and continuing to construct intra-city fiber-optic networks in our licensed territories, including in five of Poland s ten largest cities, and in the suburbs of Warsaw. In Warsaw and the remaining four of Poland s ten largest cities, we are constructing fiber-optic networks with a view towards completing those networks by We are also constructing broadband radio access networks in several large cities, including Warsaw, using radio frequency spectrum we acquired in February These radio access networks will allow us to rapidly connect business customers while our intra-city fiber-optic networks are being constructed and will continue to complement our fiber-optic networks when they are completed. We have commenced the construction, and at December 31, 1999, had completed approximately 1,650 route kilometers of a planned 3,500 route kilometer national inter-city fiber-optic backbone which we plan to complete by the end of This backbone network will link Poland s ten largest cities in addition to other cities along the backbone s route. Using this network infrastructure, we plan to maximize our penetration of the growing market for telecommunications and Internet solutions in Poland. We believe that this market includes an increasing number of customers operating in multiple locations who require advanced value-added services such as Internet and data services. The advanced technology of our network, combined with our emphasis on superior customer service, have allowed us to provide our customers with reliable, high-quality services and to compete 3

6 successfully with our principal competitor, Telekomunikacja Polska S.A. ( TPSA ), the state-controlled telecommunications carrier. Upon its completion, our backbone will have substantial capacity, and we intend to offer wholesale (i.e., carrier s carrier) services, which we believe will give us a significant opportunity to enhance our operating margins and leverage our investment in our infrastructure. We plan to provide international inbound termination, international data, Internet protocol ( IP ) access and transmission and managed bandwidth services and leased capacity to other carriers among other wholesale services. In addition, our substantial capacity will give us the flexibility to sell or swap capacity and dark fiber, domestically and internationally, with a view to being the leading alternative bandwidth provider in the Polish carriers carrier market. The Internet is starting to make an impact in Poland and Internet usage is expected to grow at an estimated annual rate of 28% through 2004 (source: International Data Corporation, 1999). In September 1999, we acquired TopNet S.A. ( TopNet ), one of Poland s pioneering Internet service providers ("ISPs"), to increase our presence in the Internet market. We are building upon this acquisition to expand our current Internet-access services and plan to offer our customers reliable high-speed Internet access both on a dial-up and dedicated-line basis, which we will also make available through ISDN or DSL connections. We have established Internet points of presence ( POPs ) in 28 cities and expect to have POPs in each of Poland s ten largest urban areas by the end of We launched Internetia, our branded Internet access service in seven cities in April We intend to integrate our access services with a content-rich consumer portal. We believe our integrated access and portal service has the potential to generate additional revenue from e-commerce applications and advertising. In addition, we plan to offer web hosting and are developing intranet, extranet and other services for business customers including a business portal which will support business-to-business applications and transactions. We will enhance the content of our portals by pursuing joint ventures with experienced content providers, such as media companies. We expect that when we complete our fiber-optic backbone, we will be able to provide transmission services for third-party ISPs and thereby increase our network utilization and improve our operating margins. Our Strengths We have competitive strengths that we believe will allow us to continue to grow and position us to take advantage of the significant unmet demand for high-quality telecommunications and Internet services in Poland. These strengths include the following: Established Market Position. Since commencing commercial operations in 1994, we have established a well-recognized brand name and made significant investments in our network and corporate infrastructure. We believe that our significant size and marketing, sales and customer service experience give us a competitive advantage over other alternative providers, many of whose networks and operations are at earlier stages of development than ours. Significant Shareholder Support and Expertise. Telia AB (publ.) ( Telia ), one of Europe s leading telecommunications providers, continues to play a significant role in the development of our operations through a broad range of strategic, financial and operational support. As of the date of this Annual Report, Telia had invested an aggregate of $109.8 million and owned a 29.4% equity interest in Netia and an 11.0% interest in Netia 1 Sp. z o.o. ( Netia 1 ), our joint venture for providing domestic long distance voice telephone service. In addition to its existing ownership interest, in March 2000, Telia has received internal approval for the purchase of up to 2,250,000 of newly issued 4

7 shares, subject to the completion of our initial listing on the Warsaw Stock Exchange, which we are planning for the second or third quarter of 2000, and subject to market conditions. Technologically Advanced Digital Network. Our network is technologically advanced, high-speed, high-capacity and, we believe, low cost. We believe that our fully digital, fiber-optic network allows us to provide our customers with a significantly higher quality of telephone service than is generally available in much of Poland and positions us to serve the growing demand for Internet, data and carrier s carrier services. Our fiber-optic network is being constructed in ring-structures to provide alternative transmission paths to ensure continuous high-quality service. Our backbone network consists of eight conduits, one of which initially will carry 48 fiber pairs, giving us substantial capacity for future growth and the flexibility to sell or swap excess conduits and/or bandwidth capacity. In addition, we believe that our fully digital network enhances our ability to control operating and maintenance costs and that our cost structure allows us to continue to charge competitive prices. Attractive License Portfolio. We benefit from an array of licenses which allows us to provide local and domestic long distance voice telephone, Internet and data services. Our ability to provide multiple services enables us to provide bundled telecommunications services. Our licensed local voice telephone territories and Warsaw rank among the most economically developed in Poland, have a relatively high concentration of businesses and collectively have a GDP per capita that is higher than, and an unemployment rate that is lower than, the national average. Moreover, we have generally secured our existing licenses on relatively attractive terms as compared to other alternative operators. We consider this cost comparison to be particularly favorable in light of the average demographics of our licensed territories. Superior Customer Service. We believe that the level of customer service offered by our principal competitor, TPSA, generally has not been up to the standards of Western telecommunications companies. We were among the first telecommunications operators to introduce Western-style customer service programs in Poland, including 24-hour call centers to respond to customer inquiries, 24-hour repair service and two-week guaranteed line installation. We believe that the quality of our customer service is a key competitive advantage over TPSA. Experienced Management. Our senior management team has extensive experience in the management of both Western and Polish corporations involved in the telecommunications, media and technology sectors. We combine this experience with our strong shareholder support and the application of Western management policies and techniques in areas such as financial planning, accounting, treasury, network construction, marketing and customer service, while working with local managers to adapt these policies and techniques to the Polish market. In addition to the above strengths, we believe that Poland is an attractive telecommunications market for alternative telecommunications providers. Poland is one of the fastest-growing economies in Europe and had real gross domestic product annual growth rates of 6.9%, 4.8% and 4.1% in 1997, 1998 and 1999, respectively. Moreover, we believe that there is substantial unmet demand for telecommunications services in Poland, as evidenced by a low fixed-line telephone penetration rate and generally long waiting periods for the connection of telephone services. Poland s fixed-line telephone penetration rate was approximately 25.0% as of December 31, 1999, which is significantly lower than penetration rates in Western Europe. Since the enactment of the Polish Telecommunications Act of 1990, as amended (the Communications Act ), the Polish government has been liberalizing the regulatory environment, and we believe that recent and anticipated changes in Poland s regulatory regime will further improve the competitive and regulatory environment for alternative providers, such as Netia. 5

8 Business Strategy We intend to build upon our position as the leading alternative fixed-line telecommunications operator in Poland to become the country s preeminent provider of bundled voice, data and Internet services. To accomplish this objective, we intend to focus on the following key areas: Complete National Backbone and Expand Network. In order to enhance our ability to provide a full range of services to our target customers nationally, we are focusing on completing the construction of a national fiber-optic backbone which will link the intra-city networks we are constructing in Poland. Our plan is to complete this backbone before the end of We are also continuing to develop intra-city networks in Poland s ten largest cities and, in anticipation of the issuance of a voice telephone license for Warsaw, have accelerated our network development in that city. Target High Revenue-Generating Customers. We primarily target business and high revenuegenerating residential customers. Business customers often purchase multiple lines, generate a significantly higher level of telecommunications traffic and purchase more value-added services than residential customers. Businesses typically generate up to four times the average revenues per line of residential customers, and we believe that they are generally under-served in our licensed territories. In the residential market, we have designed promotions to identify and enroll customers with demonstrated high telephone usage levels. We will continue to pursue opportunities to expand the scope and quality of our services to generate additional revenues and to maximize the utilization of our network. Focus on Providing Internet Services in Poland. Through our high-capacity network and building on our acquisition of TopNet, one of Poland s pioneering ISPs, we plan to offer a complete suite of Internet services, including an Internetia branded Internet access and consumer portal service on both a dial-up basis and dedicated lines, which we will also make available via ISDN and DSL connections. We also plan to offer web design, web hosting, co-location services, business portals and e-commerce applications to business customers. We will enhance the content of our portals by pursuing joint ventures or other partnerships with experienced content providers. We believe that by combining our Internet-access product with an attractive portal service we will be well positioned to compete in the Polish ISP market and, in addition to receiving access revenues, generate revenues from advertising and e-commerce. Expand Our Telecommunications Services. We intend to provide our target customers with a broad range of advanced value-added telecommunications solutions. We plan to build upon our significant investment in our network by offering high-value services including enhanced voice services such as toll-free and premium-rate calling, VoIP, virtual private networks, extranet and intranet services, and data services such as frame relay and LAN-to-LAN. We plan to generate additional revenue by selling unused network capacity to third parties either as managed bandwidth or dark fiber. We believe this strategy will enhance our operating margins by increasing revenues from our network at minimal additional cost. Continue to Provide Superior Customer Service at Competitive Prices. We are seeking to build a sustainable competitive advantage by offering services that are consistently superior to those available from TPSA at competitive prices. Delivering a level of customer service similar to that provided by leading Western telecommunications operators is a key element in establishing customer loyalty and attracting new customers. We intend to utilize our customer service program to distinguish ourselves from our competitors. 6

9 Pursue Strategic a Initiatives. Following the success in being awarded a local voice telephone license for Warsaw and a domestic long distance license, and in obtaining licenses for Internet and data services, we intend to continue to seek to expand the scope of our services. We intend to acquire a license to provide international long distance service and to bid for a license to provide third generation mobile services should the Ministry of Communications (the MOC ) put mobile licenses out for tender. We also intend to explore selected acquisitions of other telecommunications operators as well as opportunities for joint ventures with other providers and users of telecommunications services, including Internet, media and information technology partners. Services and Pricing Services We provide our customers with a broad range of basic and value-added telecommunications services under the Netia brand name. The services we presently offer include the following: Switched Telephone Services. We provide basic voice telephone service, including local, domestic and international long distance calling. We also provide enhanced voice services such as call waiting and call forwarding, and service categorized billing as part of a basic monthly service package. For additional charges, we offer other special services such as personalized ( easy-to-remember ) phone numbers, conference calling, itemized billing and call barring. In 1999, we became the first Polish fixed-line operator to make voice mail services available across all of its networks. We offer voice mail both as a stand-alone service and as part of a basic voice service package. To date, we have derived substantially all our telecommunications revenues from providing voice telephone services. ISDN. All of our switches are ISDN-equipped and all of our existing or potential customers have access to this service. We expect demand for this service to grow with the increasing service and capacity requirements of our customers. Basic Internet and Data Services. We currently provide basic Internet access to all of our customers on a dial-up basis. We recently launched our Internetia branded Internet access service, through which we are providing Internet-access on both a dial-up and dedicated-line basis in seven cities. We will offer this service to our customers as well as to the customers of other service providers. A return call mechanism will enable us to target Internet-users who are currently not customers for our voice telephone service. Under the current interconnection regime, we will retain 100% of the local call revenues we bill to these customers for connection time. Currently, each subscriber receives a free CD-ROM with a browser and tools, three addresses, 15 megabytes of free space, five free hours of connection time, discounted off-peak usage and space for a web page on our server. Our data services are currently limited to reselling services provided by other telecommunications operators; however, we expect to introduce LAN-to-LAN and frame relay services before the end of Leased Lines. We currently offer our customers within our existing voice telephone license areas leased line connections having transmission speeds from 64 kilobits per second to two megabits per second. We expect significant growth in our leased line business as our network expands and we implement additional services. Other Services. We offer PABX solutions, Centrex solutions and private corporate networks as well as Netia-brand public payphones and fax mail. 7

10 In addition to the services we currently offer, we plan to offer VoIP, web design, web hosting and co-location services, and to develop Internet services for business customers, including virtual private networks and a business portal to support business-to-business applications and transactions. Upon the completion of our national backbone, we intend to offer wholesale transmission services including international inbound termination, international data, IP-access and transmission and managed bandwidth services and leased capacity to other carriers. Pricing Telephone Services. We charge a fixed monthly fee as well as call charges for our basic voice telephone services. Our call charges for telephone calls originated over our network depend on a number of factors, including on the type of customer placing the call, the type of call (local, domestic long distance or international), the duration of the call and the time of day and the day of the week on which the call is placed. Our fixed monthly fees vary based on the service package subscribed for by our customers. In addition to fixed monthly fees and call charges, we charge installation fees for installing direct connections to our customers. Historically, our pricing strategy for voice service has been to set fixed monthly fees, call charges and installation fees in line with those established by TPSA, with discounts on installation fees given to high-usage business customers as an incentive to subscribe to our services. Accordingly, we have offered and continue to offer our customers a package matching TPSA's pricing structure. Beginning in 1997, however, we began to offer an additional package, targeted to high-usage customers, under which call charges were lowered and our fixed monthly fee was raised. This additional tariff structure provides us with a marketing distinction by offering customers a pricing option not presently available to TPSA customers. We are currently reviewing our pricing structure for voice service to determine whether to offer more pricing options to our subscribers, including to our business customers. Consistent with our strategy of matching TPSA's fee structure, we have followed TPSA's practice of adjusting local call charges semi-annually. Thus, in January 1999, July 1999 and January 2000, we increased our local call charges by 10.5%, 14.0% and 12.5%, respectively, in response to corresponding increases by TPSA. We have also from time to time increased our fixed monthly fees to match TPSA's increases of such fees. In January 2000, we increased our monthly fees between 28.0% and 33.0% to match corresponding increases by TPSA. For local calls we currently bill our customers using a pulse-based system. Although it varies according to the time of day and day of the week a call is made, on average, one pulse is charged for the initial three-minute connection for local calls, with an additional pulse charged for each additional minute. For long distance calls, we charge per-minute charges which depend on the distance of the call traffic and the country called (for international connections routed through TPSA). We are currently reviewing additional billing options available through our new operating support system (the OSS ). Such options could include a transition from the pulse-based billing to billing based on actual connection time. 8

11 Other Services. We charge fixed fees for our data services, generally based on the range of services and capacity provided. We do not currently charge subscription fees for our Internet-access service but collect call charges for connection time. We charge monthly fixed fees for our ISDN services and individually negotiated fees for our leased lines and other services. Interconnection Agreements and Fees TPSA is currently the only entity authorized to provide international telephone services in Poland over its own network and, although other operators have been awarded licenses to provide domestic long distance services and are expected to complete networks to provide these services by the end of 2000, TPSA is currently the only operator with the facilities to provide domestic long distance services in Poland. Accordingly, we must access TPSA s network in order to send or receive domestic long distance and international calls originating from, or received by, our customers and are required to pay interconnection fees to TPSA for those calls that originate on our network. In addition, we are required to pay interconnection fees for calls to mobile phones that originate on our network and which are carried over TPSA s network. Once our network backbone is complete, we will be able to provide domestic long distance telephone services over our own network, which will allow us to reduce the interconnection charges we pay to TPSA. All operators of public networks, including TPSA, are obliged by law to provide interconnection to other operators, and each of our fixed-line operating subsidiaries has an interconnection agreement with TPSA which establishes both technical specifications for interconnection and payment settlement procedures. See Telecommunications Regulations Interconnection. Generally, under our interconnection agreements with TPSA, settlement costs paid to TPSA for outgoing (i.e., those originating from our customers) international calls are up to 72.0% of TPSA s tariffs for these calls. Settlement costs for outgoing domestic long distance calls range from 22.5% to 38.5% of TPSA s tariffs for these calls. These settlement costs are independent of the rates we charge our customers for placing these calls, although our basic tariff option is effectively pegged to the rates charged by TPSA for similar calls. We are paid by GSM operators (but not fixed-line operators) who directly connect to our network for calls terminating on our network. In April 1999, we instituted anti-monopoly proceedings against TPSA relating to interconnection fees. We cannot assure you that the proceedings will be successful or that they will result in our obtaining more favorable interconnection arrangements. As of April 1, 2000, the proceedings were still pending. See Item 3 Legal Proceedings. In September 1999, the MOC issued an ordinance on general terms of interconnection and settlement among fixed-line telecommunications operators. The MOC has also stated that in the future, settlement rates among operators should be based on actual costs incurred and the investments undertaken by each operator, as well as by reasonable overhead costs. The MOC announced that the target date for issuing new regulations setting the framework for the new interconnection regime and for finalizing interconnection negotiations between TPSA and each alternative operator will be May 31, We believe that our future negotiations with TPSA will benefit from the introduction of the new interconnection regime announced by the MOC. In 1999, we entered into direct co-operation agreements with operators of the GSM 900/1800 MHz mobile networks, Polska Telefonia Cyfrowa S.A. ( Era or Era GSM ) and Polkomtel S.A. ( GSM Plus ). The co-operation agreements provide for a direct exchange of traffic between our networks and Era and GSM Plus via interconnection points that are being constructed by the parties. Our goal is to interconnect directly with these mobile networks in all regions, thereby bypassing TPSA for this fixed-to- 9

12 mobile traffic. In 1999, we completed seven physical interconnection points with these mobile operators, and we expect that an additional six points will become operational in We expect that the interconnection fees payable by us to these mobile operators will continue to be significantly lower than those we currently pay for calls connected through TPSA. Tariff Rebalancing TPSA has stated that, historically, it has not based its tariffs (and hence the interconnection fees charged to other operators such as Netia) on the actual cost of services provided. The lack of cost transparency, according to TPSA, has resulted in an imbalance between the relatively low charges for local traffic and relatively high charges for domestic long distance and international traffic in Poland. In 1998, TPSA announced that it had begun rebalancing its tariff structure by decreasing the ratio of tariffs for certain domestic long distance and international calls to tariffs for local calls. Consistent with these statements, TPSA increased its local call charges by 10.5%, 14.0% and 12.5%, in January 1999, July 1999 and January 2000, respectively. In April 1999 and January 2000, TPSA also increased its monthly fees. In each case, we adjusted our tariff schedules to match TPSA s increase. TPSA decreased long distance tariffs by 16.0% to 21.0% in September 1998, by 16.0% to 17.0% in July 1999 and by 25.0% to 33.0% in April We adjusted our tariff schedules to reflect these decreases as well. In March 2000, the Polish government announced that the process of tariff rebalancing would be extended until the end of 2003, with no price ceilings to be imposed by the MOC during this period. Accordingly, we expect that Poland s telecommunications market will continue to undergo further tariff rebalancing as the country moves toward European Union ( EU ) standards. Since our revenues are derived primarily from local tariffs, we expect to benefit in the near and medium term from this rebalancing trend if it continues. Product Development and Sales and Marketing Organization In March 2000, we began reorganizing our sales, marketing and product development functions. Our sales organization will be separated, along product market lines, into three groups: Retail Services Group; Business Internet Services Group; and Carrier s Carrier Group. Our Retail Services Group will be responsible for local, long distance and enhanced voice services, as well as for ISDN and Internet-access services. Our Business Internet Services Group will be responsible for web hosting, web design, virtual private networks, intranets, business-to-business portals and other business application services. Our Carriers Carrier Group will be responsible for sales of wholesale services to other telecommunications operators and service providers. Each sales group will be supported by a corresponding product development group. Sales and Marketing Strategy Our sales and marketing strategy consists of the following elements: Focus on Businesses and Premium Residential Customers. In focusing our sales and marketing efforts on high-volume customers, we divide the telecommunications market into the business and premium residential markets. We use a different marketing program for each of these markets. Business Customers. We focus the majority of our direct sales efforts on identifying and acquiring business customers, which we separate into the large and small and medium-sized enterprises ( SME ) categories. In marketing to potential business customers, a sales and marketing manager leads a team of salespersons trained to understand our services and the general telecommunications 10

13 needs of our business customers. Our sales force identifies and then makes formal presentations and personal visits to each potential business customer. During the marketing process, our sales force, assisted by our technicians, works with the potential customer to assess its specific telecommunications needs and, where appropriate, offers a package of services designed specially to meet those needs. Our sales force has a dedicated team of business managers who serve high-volume business accounts. As of March 1, 2000, approximately 5% of the top 500 Polish businesses used Netia as their main telecommunications provider. We plan to continue to aggressively market our services to Poland s large corporations and will intensify our marketing and sales initiatives for these customers once we enter the Warsaw market. In April 1999, we launched a promotional campaign exclusively targeting the business sector. This campaign, which is continuing into 2000, promotes our Netia Business brand and our special tariff schedule for high usage customers. We have also conducted promotions offering telephone equipment at a discount to businesses that choose Netia as their long-term telecommunications provider. We believe that these efforts have been successful, as evidenced by the fact that in 1999 new business lines accounted for approximately 28% of total new subscriber lines, and business lines comprised 20.5% of our total subscriber lines at December 31, 1999, up from 14.7% at December 31, Premium Residential Customers. In marketing to potential residential customers, we primarily rely on mass advertising and our customer service centers. Our residential marketing efforts are focused on targeting potential high-usage residential customers. Before our network becomes operational in an area, our customer service representatives distribute promotional materials describing our services and encouraging potential subscribers to contact our local customer service center to sign contracts. From time to time, we also offer high-usage residential subscribers who switch to Netia from TPSA specific incentives, such as free cordless phones and/or periods of free local calling. In the fourth quarter of 1999, we sold approximately 42,800 lines as a result of these promotions, almost 50% of which we sold to former customers of TPSA. Promote a National Brand Name. Our advertising and promotional strategy centers around the promotion of a nationwide brand name, Netia, which we believe is viewed positively by the Polish consumer and is associated with quality and advanced technology. Although we believe that the Netia brand name is generally well recognized throughout our licensed territories, we intend to continue efforts to broaden our market recognition by extending our brand to new services such as our new Internet access and consumer portal service, Internetia. Emphasize Superior-Quality Service. Our promotional strategy emphasizes superior-quality service at competitive prices. We offer 24-hour repair service with a money-back guarantee. We also continue to promote our image as the preferred choice for business users, mainly through testimonial advertising. Stimulate Telephone Usage. An important element of our marketing and sales strategy is an effort to stimulate telephone usage. Our sales and customer service personnel have been trained to recognize opportunities for encouraging increased telephone usage. For example, Netia s sales force works with our product development personnel to offer telephone applications for business customers, such as telemarketing, to enhance their productivity. To support these efforts, all of our recent promotions have included traffic-stimulating, value-added service packages. We are also providing an attractively-priced ISDN service to facilitate business usage. 11

14 Billing and Subscriber Management We typically bill our customers on a monthly basis. We provide service category billing at no extra cost and itemized call billing for additional charges. We presently utilize software that collects data from each switch and that processes that data to produce bills and to generate accurate and timely subscriber information and analyses. This capability allows us to implement a more effective credit management system. We are completing the final implementation of our new advanced OSS, which we began installing in 1999 to process billing for our voice services. Through this system, we have introduced a centralized billing and collection system with a view to assuring accurate and timely billing and minimizing bad debts. The OSS s main features are: centralized customer care billing and collections, based on a common customer database; and a centralized hardware platform based on high-reliability servers and a centralized printing house to process customer invoices. The OSS provides support for 350,000 lines, with an upgrade available to one million lines. All regions have been or are being connected to the OSS over our existing corporate network. In the future, we expect to upgrade the OSS further or replace it entirely to accommodate the needs of our data transmission, long distance and Internet services customers. We are considering transitioning from the pulse-based billing generally used in Poland to billing based on actual connection time, which is the unit of measurement generated by the OSS. We bill our customers in arrears and, as is customary in Poland, most of our residential customers pay their bills through their local post office or bank. We have strict revenue collection policies to encourage timely payment and are taking steps to further improve cash collection. These policies include notices of late payment, visits from service personnel and, ultimately, disconnection of non-paying customers after 60 days of a past-due bill. In 1999, bad debt expense was approximately PLN 13 million ($3.1 million), representing approximately 5% of total revenues. Network Overview Our network once completed will consist of a nationwide backbone network, a series of intra-city networks and local access networks. We expect to complete our backbone network by the end of 2000, at which time it will link Poland s ten largest cities and carry voice, Internet and data transmissions throughout Poland. We are constructing intra-city networks in 21 of our local voice telephone license territories and have commenced operations in five major cities where we expect to have substantially completed construction by the end of We are also constructing intra-city networks in Warsaw and four additional major cities. We will initially construct broadband radio access networks to more rapidly access customers in these cities while we complete the build-out of our fiber-optic networks in these cities. The broadband networks will continue to complement our fiber-optic networks when completed. We expect to complete construction of these fiber-optic networks by the end of 2001 other than in Warsaw, where we expect to complete a 350-route kilometer fiber-optic network by the end of Our 12

15 network currently has over 250,000 subscriber lines, and our goal is to expand our network to include approximately 700,000 subscriber lines by the end of We anticipate that a significant portion of our additional lines will be connected in Warsaw, where we plan to have approximately 250,000 connected lines by We expect the cost of building an access network in Warsaw, including the costs of our radio access and intra-city fiber-optic network, will be consistent with the cost we have incurred in building our existing intra-city networks of approximately $1,000 per connected line, after taking account of the cost to build our Warsaw radio access network at an equipment cost of approximately $30.0 million. To expand our capability to provide telecommunications services internationally, we have entered into negotiations with Telia to obtain dark fiber and other capacity on certain of Telia s international telecommunications routes. Should we obtain an international telecommunications license, we expect that we would need to extend our backbone network to access international connection points, acquire additional international gateway switches and secure international transmission capacity. Technology and Architecture We are using advanced technologies and network architectures to develop a highly reliable infrastructure for delivering quality, high-speed digital transmissions of voice and data telecommunications. The basic transmission platform consists primarily of optical fiber equipped with high-capacity Synchronous Digital Hierarchy ( SDH ) equipment deployed in our intra-city networks in bi-directional rings. Our SDH rings give us the capability to route customer traffic in both directions around the ring, thereby reducing the risk of loss of service in the event of a cable cut. Networks based on alternative designs, such as star network architecture, are more vulnerable to service loss in the event of a cut cable because transmissions have only one route to reach the nodes. In order to limit line cuts or damage, our fiber-optic and copper cables are installed in either protective tubing or subducted PVC pipes and generally placed approximately two feet underground. Our backbone network is being constructed with eight conduits, one of which have 48 fiber pairs and seven of which will be available for future expansion or sale or lease to other telecommunications providers. We are currently in negotiations with Telia and expect to enter into a definitive agreement to provide duct capacity to Telia over various segments of our network. Under these arrangements Telia would provide us with dark fiber or capacity on certain of its international telecommunications routes. Business customers are increasingly demanding higher capacity and better quality service in Poland. We are in the process of introducing two new technologies to meet these demands. First, we have begun to introduce fiber in the loop, which consists of a set of network fiber elements that make it economically feasible to use fiber-optic cable instead of copper cable over the last mile to the customer, thereby enabling the customers to gain a substantial increase in bandwidth. Second, we are beginning to install broadband radio access connections, which make it possible to serve business customers requiring two megabits per second (and multiples thereof) via a wireless link within two months after receiving the order. In addition we are planning to deploy DSL technology which will allow us to offer our customers bandwidth connections of up to nine megabits per second. In order to begin connecting customers before our intra-city fixed line networks are complete, we expect to accelerate the implementation of this latter technology in Warsaw and the other four cities in which we are commencing network construction this year. In February 2000, we acquired a 27 GHz broadband radio frequency spectrum in Poland s 15 largest cities allowing us to provide broadband access services. Using these frequencies, we are constructing broadband wireless access networks in Warsaw and certain other major cities. This network 13

16 will allow us to offer multiples of two megabits per second bandwidth in these cities and will allow us to rapidly connect business customers while our fiber-optic networks in these cities are being completed. We expect to employ broadband as well as narrowband wireless local loop technology to access customers in certain areas where fixed-line build-out of the network is not practicable (e.g., in historical city centers where construction is restricted) and to supplement our fixed-line network roll-out. We had approximately 43,000 wireless local loop connections as of December 31, As of March 31, 2000, we have installed 27 digital switches. Our switches within a licensed territory are connected with a series of bi-directional fiber-optic rings. We service the majority of our customers through remote switching units ( RSUs ) which collect traffic and send it to a switch. RSUs are also connected to switches by the bi-directional fiber-optic rings. Customers are connected to RSUs or, in the case of customers located near a switch, directly to switches, primarily by copper cables. Due to the extensive use of RSUs in our network, the average distance between a customer and a point of entry into our network is less than 500 meters. This enables us to provide DSL broadband services using our existing network on a cost-effective basis. In order to exchange traffic with TPSA, all of our switches are interconnected with TPSA s network. We have designed our network so that it interconnects with the parts of TPSA s network that use the international S7 signaling standard. The use of this standard makes the two networks compatible and reduces interconnection difficulties. We have also designed all parts of our network to interconnect with TPSA through at least two TPSA switches (at least one of which is digital) at each connection point thereby protecting our signal quality. Pursuant to our interconnection agreements with Era and GSM Plus, Poland s two main mobile telephone operators, we completed seven direct interconnection points with them in high traffic areas in 1999, and currently have six more interconnection points under construction. In constructing our network, we acquire the majority of the rights-of-way we need from municipalities or private parties. In addition, where possible, we are installing our cable along railroad tracks in order to reduce costs and expedite construction of the network. Our four regional network management centers currently oversee network operations. We monitor our network 24 hours a day and have technicians on call to rapidly respond to any problems. Since we commenced operations, we have not experienced any material network failure. To accommodate the needs of our growing network, we plan to implement during 2000 a national network operations center, through which we will be able to manage our traffic from one central location. We did not experience any material Year 2000 disruptions. Network Equipment and Construction Historically, Alcatel Polska supplied all of our switching and transmission equipment as one of the three suppliers certified by the MOC to provide switching and transmission equipment in Poland. However, in 1998 we entered into an agreement to obtain a new generation of switching equipment from Lucent Technologies. We obtain radio access technology and equipment from Tadiran and Bosch and Internet routing equipment from Ericsson and Cisco. In the second half of 1999, we entered into an agreement with ZWUT S.A., a Polish subsidiary of Siemens A.G. pursuant to which we have agreed to purchase Hicom servers from Siemens for use in providing ISDN and IP services. In the same period, we entered into a turn-key contract with Ericsson for 14