<PAGE>   1
 
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
 
                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
 
   
                                  FORM 10-K/A
    
   
                                AMENDMENT NO. 1
    
 
[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE
      ACT OF 1934
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
 
[ ]   TRANSITION REPORT PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITY
      EXCHANGE ACT OF 1934
 
                            COMMISSION FILE NUMBER:
 
                         GLOBAL TELESYSTEMS GROUP, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                   DELAWARE                                      94-3068423
           (State of incorporation)                (I.R.S. Employer Identification Nos.)
</TABLE>
 
                  1751 PINNACLE DRIVE, NORTH TOWER, 12TH FLOOR
                             MCLEAN, VIRGINIA 22102
                    (Address of principal executive offices)
 
                                 (703) 918-4500
                        (Registrant's telephone number)
 
          Securities registered pursuant to Section 12(g) of the Act:
 
                              TITLE OF EACH CLASS
 
Common Stock, par value $0.10 per share and Rights associated with Common Stock,
par value $0.10 per share.
 
     Indicate by check mark whether the registrants (1) have 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) have been subject to such
filing requirements for the past 90 days. Yes [ ]  No [X]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained in this Form 10-K, and will not be
contained, to the best of the registrants' knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.  [X]
 
     The aggregate market value of the voting stock of Global TeleSystems Group,
Inc. held by non-affiliates on February 27, 1998 was approximately
$1,182,668,000. On February 27, 1998, there were outstanding approximately
50,904,000 shares of Common Stock of Global TeleSystems Group, Inc.
 
<TABLE>
<CAPTION>
              ITEM OF FORM 10-K                      DOCUMENT INCORPORATED BY REFERENCE
              -----------------                      ----------------------------------
<S>                                            <C>
Part III, Item 10, 11, 12 and 13               Proxy Statement* (excluding therefrom the
                                               subsections entitled "Report of the
                                               Compensation Committee of the Board of
                                               Directors" and "Performance Graph")
Part IV, Item 14(c)                            Exhibits
</TABLE>
 
---------------
 
* Refers to the definitive Proxy Statement of Global TeleSystems Group, Inc., to
  be filed pursuant to Regulation 14A, relating to the Annual Meeting of
  Stockholders of Global TeleSystems Group, Inc. to be held on May 20, 1998.
 
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>   2
 
   
                         GLOBAL TELESYSTEMS GROUP, INC.
    
 
   
     The registrant hereby amends the following item of its Annual Report on
Form 10-K for the fiscal year ended December 31, 1997, as set forth below:
    
 
   
<TABLE>
<CAPTION>
                            ITEM                               PAGE
                            ----                               ----
<S>                                                            <C>
Item 8. Financial Statements and Supplementary Data.........    81
                                                               106
                                                               108
                                                               119
</TABLE>
    
 
   
    
 
                                        1
<PAGE>   3
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
                                   FORM 10-K
                          YEAR ENDED DECEMBER 31, 1997
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                        PAGE
                                                                        ----
<S>       <C>                                                           <C>
                                   PART I
ITEM 1.   Business....................................................    3
  Introduction........................................................    3
  Business Strategy...................................................    6
  Russia and the CIS..................................................    8
     Sovintel.........................................................   12
     TCM..............................................................   15
     TeleRoss.........................................................   16
     Sovam............................................................   19
     GTS Cellular.....................................................   21
     Certain Considerations Applicable to the Company's Operations in    29
      Russia and the CIS..............................................
  Western Europe......................................................   32
     HER..............................................................   34
     GTS Monaco Access................................................   47
  Central Europe......................................................   50
  Asia................................................................   52
  Certain Considerations Generally Applicable to the Company's           53
     Operations.......................................................
  Glossary of Telecommunications Industry Terms.......................   59
ITEM 2.   Properties..................................................   63
ITEM 3.   Legal Proceedings...........................................   63
ITEM 4.   Submission of Matters to a Vote of Security Holders.........   63
 
                                  PART II
ITEM 5.   Market for the Company's Common Equity and Related
            Stockholder Matters.......................................   64
ITEM 6.   Selected Financial Data.....................................   67
ITEM 7.   Management's Discussion and Analysis of Financial Condition
            and Results of Operations.................................   69
ITEM 8.   Consolidated Financial Statements and Supplementary
            Information for the Company...............................   80
ITEM 9.   Changes In and Disagreements with Accountants on Accounting
            and Financial Disclosure..................................  120
 
                                  PART III
ITEM 10.  Directors and Executive Officers of the Company.............  120
ITEM 11.  Executive Compensation......................................  121
ITEM 12.  Security Ownership of Certain Beneficial Owners and
            Management................................................  121
ITEM 13.  Certain Relationships and Related Transactions..............  121
 
                                  PART IV
ITEM 14.  Exhibits, Financial Statement Schedules and Reports on Form
            8-K.......................................................  122
SIGNATURES............................................................  128
</TABLE>
 
                                        2
<PAGE>   4
 
                                     PART I
 
ITEM 1. BUSINESS
 
     To aid the reader, a "Glossary of Telecommunications Industry Terms," which
defines certain terms used in this "Business" section and elsewhere in this
Report, follows commencing on page 59.
 
INTRODUCTION
 
     The predecessor to Global TeleSystems Group, Inc. (the "Company" or "GTS")
was founded in 1983 as a not-for-profit company under the name San
Francisco/Moscow Teleport, Inc. The Company was incorporated as a California
for-profit corporation on September 25, 1986, and by way of a reincorporation
merger, merged with and into SFMT, Inc., a Delaware corporation formed for that
purpose on September 13, 1993. The Company was renamed Global TeleSystems Group,
Inc., on February 22, 1995. The Company's principal business office is located
at 1751 Pinnacle Drive, North Tower-12th Floor, McLean, Virginia 22102, United
States, and its telephone number is (703) 918-4500.
 
     The Company is a provider of a broad range of telecommunications services
to businesses, other telecommunications service providers and consumers in
Russia, the Commonwealth of Independent States ("CIS") and Central Europe.
Through its subsidiary Hermes Europe Railtel B.V. ("HER"), GTS is developing,
and operating the initial segments of, a pan-European high capacity fiber optic
network that is designed to interconnect a majority of the largest Western and
Central European cities and to transport international voice, data and
multimedia/image traffic for other carriers throughout Western and Central
Europe. GTS's strategy to develop its businesses generally has been to establish
joint ventures with a strong local partner or partners while maintaining a
significant degree of operational control. The Company's business activities
consist of the ownership and operation of (i) international long distance
businesses, which operate through international gateways that provide
international switching services and transmission capacity, (ii) local access
networks, which provide local telephone service, (iii) cellular networks, which
provide wireless telecommunications services, (iv) a domestic long distance
business, (v) data networks and (vi) carriers' carrier networks, which provide
high volume transmission capacity to other carriers.
 
     In Russia and the CIS, GTS's objective is to become the premier alternative
telecommunications operator. To attain its objective, the Company has partnered
with regional telephone companies and with Rostelecom, the national long
distance carrier in Russia. The Company currently operates in 24 oblasts
(regions) and the city of Moscow in Russia, as well as in 11 additional cities
in the CIS, and believes it is well-positioned to become the leading independent
telecommunications service provider in Russia. These businesses include: (i) EDN
Sovintel ("Sovintel"), which provides Moscow, and recently St. Petersburg, with
international long distance and local telephone services and access to the major
domestic long distance carriers; (ii) TeleCommunications of Moscow ("TCM"),
which provides local access services in Moscow; (iii) TeleRoss (as defined
below), which provides domestic long distance services in fourteen cities in
Russia, including Moscow, as well as Very Small Aperture Terminal ("VSAT")
service to customers outside its primary long distance satellite network; (iv)
Sovam Teleport ("Sovam"), which provides data services, including high-speed
data transmission, electronic mail, Internet access services, as well as Russia
On Line, the first Russian language Internet service; and (v) the Company's
cellular operations ("GTS Cellular"), which operates cellular networks in
thirteen regions in Russia and also in Kiev, Ukraine, with licenses covering
regions with an aggregate population of approximately 25 million people at the
end of 1997. Whenever practical, GTS's businesses integrate and co-market their
service offerings in Russia and the CIS, utilizing TeleRoss as the domestic long
distance provider, Sovintel as the international gateway, TCM and GTS Cellular
for local access, and Sovam as the data communications and Internet access
network for business applications and on-line services. Together, GTS's Russian
and CIS ventures carried 442 million minutes of traffic for the year ended
December 31, 1997 and had approximately 33,300 customers, including
approximately 23,400 cellular subscribers, as of December 31, 1997. See "--
Russia and the CIS."
 
     In Western Europe, GTS seeks to position itself as the leading independent
carriers' carrier through the development of two ventures, HER and GTS-Monaco
Access S.A.M. ("GTS-Monaco Access"). HER's
 
                                        3
<PAGE>   5
 
objective is to become the leading pan-European carriers' carrier by providing
centrally managed cross-border telecommunications transmission capacity to
telecommunications companies including traditional public telecommunications
operators ("PTOs") and new entrants, such as alternative carriers, global
consortia of telecommunications operators, international carriers, Internet
backbone networks, resellers, value-added networks and other service providers
("New Entrants") on an approximately 18,000 kilometer pan-European high capacity
fiber optic network designed to interconnect a majority of the largest Western
and Central European cities. As of April 1, 1998, HER's network will link
Brussels, Antwerp, Rotterdam, Amsterdam, London, Paris, and Frankfurt. HER
expects the initial five country network and Switzerland to be placed in
operation in the second quarter of 1998. This segment of the network is expected
to deliver managed transport services over approximately 3,800 kilometers of
fiber optic cable linking, in addition to the cities discussed above, the cities
of Zurich, Geneva, Dusseldorf, Stuttgart, and Munich. The full 18,000 kilometer
network is expected to become fully operational during the year 2000. HER also
plans to lease capacity on a transatlantic cable linking the European network to
North America and is exploring various interconnectivity options to Russia and
Asia. Such intercontinental interconnectivity will help HER to satisfy the needs
of its European customers with respect to outgoing traffic and to attract
additional non-European customers with traffic terminating in Europe. HER
commenced commercial service over the Brussels-Amsterdam portion of the network
in late 1996, and the London-Paris portion in November 1997. GTS-Monaco Access
operates an international gateway in Monaco in partnership with, and utilizing
the existing gateway infrastructure of, the Principality of Monaco and provides
transit and routing of international calls to other telecommunications
operators. Through its HER and GTS-Monaco Access ventures, GTS is building a new
network for transporting voice, data and multimedia/image traffic for other
carriers throughout Western and Central Europe and for worldwide international
voice, data and multimedia/image traffic that either originates or terminates
in, or transits through, Western and Central Europe. See " -- Western Europe."
 
     In Central Europe, GTS's objective is to become one of the leading
alternative telecommunications providers in the region. GTS currently provides
private data communications services to government and commercial customers in
Hungary and the Czech Republic. In the Czech Republic, the Company provides
outgoing voice services and operates an international gateway and a data
services network. In Hungary, GTS operates a VSAT network, which GTS believes is
the largest VSAT network in Central Europe as measured by number of VSAT sites.
The Company has also signed an agreement to provide international data services
in Poland, subject to the receipt of necessary governmental approvals. GTS's
strategy is to expand its service offerings as the regulatory environment
permits, leverage its existing VSAT and international gateway infrastructure
where possible and provide a broad range of services to its target markets. See
" -- Central Europe."
 
     Although GTS does not currently own or operate significant
telecommunication assets in Asia, GTS's objective is to become an established
and diversified telecommunications provider in China and India. GTS seeks to
leverage its position in these countries to capitalize on opportunities as they
arise. See "-- Asia."
 
                                        4
<PAGE>   6
 
     The following table sets forth certain information, as of December 31,
1997, for the principal ventures through which the Company conducts its
business:
 
<TABLE>
<CAPTION>
                        COUNTRY/REGION     GTS                                      PRINCIPAL
     COMPANY NAME       OF OPERATIONS   OWNERSHIP             PARTNERS              BUSINESS
     ------------       --------------  ---------             --------              ---------
<S>                     <C>             <C>              <C>                  <C>
CIS
  Sovintel............  Russia              50%          Rostelecom           International Long
                                                                              Distance; Local
                                                                              Access and Local
                                                                              Access Lines
  TCM.................  Russia              50%(1)       MTU Inform and       Local Access Lines
                                                         others
  TeleRoss............  Russia              50%(2)       Various local PTOs   Domestic Long
                                                                              Distance Data and
                                                                              Internet
  Sovam...............  Russia              67%(3)       Institute for
                                                         Automated Systems
  GTS Cellular........  CIS              25-70%(4)       Primarily various    Basic Cellular
                                                         local PTOs
WESTERN EUROPE
  HER.................  Western Europe      79%(5)       Various              Carriers' Carrier
                                                                              Carriers' Carrier;
  GTS-Monaco Access...  Monaco              50%          Principality of      International Gateway
                                                         Monaco
CENTRAL EUROPE
  GTS-Hungary.........  Hungary             99%          --                   VSAT Network
  EuroHivo............  Hungary             70%          Microsystems         Paging Services
                                                         Telecom Rt.; Gerard
                                                         Aircraft Sales and
                                                         Leasing Company
  CzechNet............  Czech Republic     100%          --                   International Long
                                                                              Distance
  CzechCom............  Czech Republic     100%          --                   Data and Internet
ASIA
  V-Tech..............  China               75%          Shanghai Science     VSAT Network
                                                         and Technology
                                                         Investment
                                                         Corporation
  Beijing Tianmu......  China               47%          China International  VSAT Network
                                                         Travel Service
                                                         Telecom Co.,
                                                         Ltd.(6)
  CDI.................  India              100%          --                   Voice, Data and
                                                                              Internet
</TABLE>
 
---------------
 
(1) GTS holds a 50% indirect interest in TCM through its 52.6% interest in
    GTS-Vox Limited, an intermediate holding company.
 
(2) TeleRoss consists of (i) two wholly owned holding companies and a 99% owned
    subsidiary that operates a domestic long distance network (collectively,
    "TeleRoss Operating Company") and (ii) thirteen joint
 
                                        5
<PAGE>   7
 
    ventures that are 50% beneficially-owned by GTS (the "TeleRoss Ventures").
    See "-- Russia and the CIS -- TeleRoss."
 
(3) GTS purchased its minority partner's 33.3% interest in February 1998,
    thereby making Sovam a wholly owned subsidiary of GTS.
 
(4) GTS conducts its cellular operations through (i) Vostok Mobile B.V. ("Vostok
    Mobile"), a wholly owned GTS subsidiary, which owns between 50% and 70% of a
    series of 12 operational cellular joint ventures in various regions in
    Russia, (ii) PrimTelefone, a 50% owned venture in Vladivostok and four other
    cities in the Primorsky region of Russia and (iii) Bancomsvyaz, an
    approximately 25% beneficially owned venture in Kiev, Ukraine. GTS intends
    to enter into the cellular markets of additional Russian regions through
    Vostok Mobile. See "-- Russia and the CIS -- GTS Cellular."
 
(5) As a result of the sale of shares by one of the other shareholders of HER in
    March 1998, GTS currently owns approximately 89% of HER. See "Western
    Europe -- HER -- HER Recapitalization." The Company's interest is expected
    to decrease due to the stock options for common shares of HER issued to
    certain HER executives under the HER stock option plan established in the
    fourth quarter of 1997. See "Executive Compensation and Other
    Information -- Key Employee Stock Option Plan of Hermes Europe Railtel B.V."
    in the Company's Proxy Statement for its 1998 Annual Meeting.
 
(6) GTS owns 75% of GTS China Investments LLC ("GCI"), which owns 90% of
    American China Investment Corporation ("ACIC"). ACIC owns 70% of the Beijing
    Tianmu China joint venture company.
 
BUSINESS STRATEGY
 
     GTS seeks to develop businesses to meet the rapidly expanding market demand
for telecommunications services. GTS's goal in emerging markets is to establish
itself as the leading alternative to the incumbent telecommunications service
providers and as a premier provider of value-added services. In addition, the
Company seeks to position itself as the leading independent carriers' carrier
within Western and Central Europe through the development of a pan-European
fiber optic network and an international gateway in Monaco.
 
     GTS believes that it will be able to successfully operate its businesses
and develop business opportunities by pursuing the following strategies:
 
     - Identify and Seize Early Market Opportunities. GTS's primary strategy is
       to identify less developed markets in which the incumbent operator offers
       inadequate service and where liberalization of telecommunications
       regulations may be pending. The Company believes entering these less
       developed markets quickly is a key competitive advantage in the global
       telecommunications market. GTS leverages its management's knowledge of
       the markets in which the Company operates to assess and react quickly
       when attractive business opportunities arise.
 
     - Establish Joint Ventures with Experienced Local Partners. GTS seeks to
       establish and maintain strategic partnerships and relationships with key
       telecommunications operators and service providers in the countries in
       which it operates. The Company believes that these relationships increase
       its ability to anticipate and respond to changes in the regulatory and
       legal environment and assist with license renewal and expansion of its
       operating companies.
 
     - Retain Significant Operational Control. In general, GTS actively
       participates in the management of its ventures by (i) providing most of
       the funding for the ventures' operations, (ii) selecting key members of
       the local management team, (iii) developing business plans and marketing
       strategies together with local management, (iv) monitoring operating
       functions, (v) maintaining close working relationships with local
       partners and (vi) integrating its networks and businesses in a manner
       which is consistent with the Company's overall strategic objectives.
 
     - Build Infrastructure to Provide High Quality Services. GTS continues to
       develop and expand its network infrastructure. The Company believes that
       its networks offer service, quality and cost
 
                                        6
<PAGE>   8
 
       advantages over incumbent providers as a result of the Company's customer
       support, network monitoring, management systems and its ability to
       integrate and co-market its service offerings.
 
     - Leverage Management Depth and Experience. GTS's management has
       significant experience in the development and operation of
       telecommunications businesses outside the United States. The Company
       believes that this experience, together with the Company's extensive
       operations, has provided its management with the ability to identify,
       evaluate and pursue international telecommunications business
       opportunities. Additionally, GTS has assembled a management team
       comprised of executives with extensive experience managing
       telecommunications companies in the respective local markets. GTS
       believes that its management team possesses a broad knowledge of relevant
       political and regulatory structures, as well as the cultural awareness
       and fluency with international and local business practices necessary to
       implement the Company's objectives.
 
     - Ability to Access Capital. In general, the Company's financing strategy
       is to establish parent level funding to meet general corporate needs and
       the costs of start-ups and acquisitions and, when it is possible and
       cost-effective, to finance ongoing operations at the venture level. From
       1993 through 1997, the Company raised privately approximately $268
       million in equity and approximately $215 million of debt (of which
       approximately $74 million was raised through shareholders). In addition,
       HER completed a $265 million private placement of senior notes (of which
       $56.6 million was placed in escrow for the first two years' interest
       payments) in 1997. On February 10, 1998, the Company completed an initial
       public offering of its common stock. The Company sold 12,765,000 shares
       in the offering, including 1,665,000 shares sold as a result of the
       exercise of over-allotment options granted to the underwriters of the
       offering and realized net proceeds of $238.7 million from the offering
       after the payment of underwriting fees but, before payment of other
       expenses associated with the offering. On the same date, the Company also
       sold $105 million aggregate principal amount of 9 7/8% Senior Notes due
       2005 ("the Senior Notes"), and realized net proceeds of $82.3 million,
       after the payment of underwriting fees and the deposit of $19.6 million
       in escrow to cover the first four scheduled payments of interest on the
       Senior Notes, but before expenses associated with the sale of the Senior
       Notes.
 
     In addition to its overall business strategy, GTS has developed specific
market strategies to achieve its goals in emerging markets and Western Europe.
 
     Emerging Markets. The Company pursues its goals in emerging markets through
a three-stage approach of market entry, market expansion and market integration.
 
     - Market Entry. GTS identifies a market as a suitable target for entry
       based upon: (i) superior growth prospects for such market, demonstrated
       by growing demand for high quality telecommunications services; (ii) the
       provision of inadequate services by incumbent providers, typically
       resulting from the incumbents' unwillingness to offer high quality
       services with reliable customer support at attractive prices; and (iii)
       attractive regulatory environments in which emerging alternative
       telecommunications providers such as GTS have, or expect to have over a
       clearly defined time horizon, the ability to compete on a substantially
       equal basis with the incumbent providers in terms of certain services and
       the cost of providing those services. Once GTS has identified a market as
       suitable for entry, the Company seeks to establish its presence in that
       market by establishing a venture with a strong local partner or partners.
       In general, GTS maintains a significant degree of operational control in
       such ventures. Through such ventures, the Company benefits from its
       partners' ability to provide infrastructure, regulatory expertise and
       personnel that will provide GTS with a competitive advantage in entering
       that market. When entering a new market, GTS's strategy is to provide its
       customers with higher quality service as compared to the services offered
       by incumbent providers.
 
     - Market Expansion. Having entered a market successfully and established a
       limited service offering to its targeted customer base, GTS then seeks to
       expand the range of services it offers to existing and potential
       customers and to further develop its relationships with local partners.
       By broadening its service offerings, GTS anticipates achieving increased
       economies of scale through the common use of administrative and operating
       functions already in place, increasing the Company's share of its
 
                                        7
<PAGE>   9
 
       customers' telecommunications spending and expanding GTS's base of
       potential customers through the provision of a bundled service offering.
       The Company also seeks to expand its targeted geographic market by
       forming new partnerships, installing infrastructure and offering services
       in additional geographic regions, allowing the Company to further enhance
       its operating leverage and ability to service its customers'
       telecommunications needs.
 
     - Market Integration. GTS ultimately intends to integrate and co-market its
       service offerings in each of the markets in which it operates. The
       Company believes such integration enables it to enhance its operating
       efficiency by leveraging its distribution channels, infrastructure and
       networks, and management information systems. As customers develop a need
       for a broader variety of telecommunications services, the Company
       believes GTS's integrated operations will represent an attractive service
       alternative for customers seeking a single provider with the ability to
       meet all their telecommunications needs.
 
     Western Europe. The Company seeks to position itself as the leading
independent carriers' carrier within Western Europe through the development of
HER's pan-European fiber optic network and the operation of GTS-Monaco Access's
international gateway in partnership with, and utilizing the gateway
infrastructure of, the Principality of Monaco. The overall strategy of GTS in
Western Europe is to complement and enhance the services provided by PTOs and
New Entrants in a way that helps them to more successfully meet the needs of
their end-user customers. HER seeks to enter the market ahead of competition and
encourage a wide variety of carriers to use its network with service offerings
that meet their needs. To establish itself as the leading carriers' carrier for
international telecommunications within Europe, HER intends to provide its
customers with significantly higher quality transmission and advanced network
capabilities at a competitive price by utilizing advanced, uniform technology
across the region and providing redundant routing for higher levels of
reliability.
 
RUSSIA AND THE CIS
 
OVERVIEW
 
     GTS is a leading provider of a broad range of telecommunications services
in Russia. GTS's services include international long distance services, domestic
long distance services, high speed data transmission and Internet access,
cellular services and local access services. GTS was among the first foreign
telecommunications operators in the CIS, where it began offering data links to
the United States in 1986, international long distance services in 1992, local
access to its networks in 1994 and cellular services in 1995. GTS has developed
these businesses into a leading provider of telecommunications service offerings
in Russia by building its own infrastructure, including a fully digital overlay
network and interconnections with its local Russian telecommunications partners.
 
     The Company believes that evolving changes in government policy over the
last several years and the overall inadequacy of basic telecommunications
services throughout Russia have created a significant opportunity. Before 1990,
all international, domestic long distance and local telecommunications in the
Soviet Union were provided by a monopoly state telecommunications company
managed by the Ministry of Posts and Communications. In 1990, the Council of
Ministers established a joint-stock company called Sovtelecom and transferred to
it all of the telecommunications assets and operations of the Soviet Ministry of
Posts and Communications. Following the dissolution of the Soviet Union in 1991,
the name of the company was changed to Intertelecom. In 1992, the Russian
government decided to split Intertelecom into several components to foster
privatization, competition and investment. The international and long-distance
assets and operations were combined into Rostelecom, creating a monopolistic
service provider. The local telecommunications assets and operations were broken
up into 88 independent regional joint-stock companies, seven of which serve
cities, including the Moscow City Telephone Network and the Petersburg Telephone
Network. Most of the regional companies have a telecommunications trunk operator
and provide a domestic long distance service within their service region.
Domestic long distance calls to and from areas outside the companies' service
area, as well as international calls, are switched to and from Rostelecom, which
forwards the calls to and from another regional company or a foreign carrier for
international calls. Exceptions to this
 
                                        8
<PAGE>   10
 
rule include the seven city operators. In Moscow and St. Petersburg, the trunk
operators have been isolated into separate, long distance companies called
Moscow MMT and St. Petersburg MMT. All domestic long distance and international
calls originating from or terminating in Moscow and St. Petersburg are switched
through the MMTs, which forward the calls to and from Rostelecom.
 
     Following the former Soviet Union's transformation from a centralized
economy to a more market-oriented economy, increased demand from emerging
private businesses and from individuals, together with the poor state of the
public telephone network, has led to rapid growth in the telecommunications
sector in Russia and the CIS. In 1991 the Ministry of Communications (the "MOC")
was established as the Russian successor to the Soviet Ministry of Posts and
Communications to regulate and improve the telecommunications industry and to be
the government's representative for its ownership share of the 88 regional
operating companies, the assets currently held by (then the monopoly
international and domestic long distance service provider) and national radio,
television and satellite operating companies. This enabled the MOC and operating
organizations to begin the privatization process, attract foreign investment and
initiate joint ventures with foreign partners.
 
     Although it remains subject to certain restrictions, significant progress
in privatization of the telecommunications industry in Russia and the CIS has
occurred. Under Russian law, state-owned enterprises within the
telecommunications sector were subject to privatization but only pursuant to a
decision of the Russian government in each individual case and with the state
retaining a certain percentage of the stock of the privatized entity for three
years, subject to extension for national security reasons. At present, virtually
all of the former state telecommunications enterprises have been privatized and,
subject to the above restrictions, shares of the newly formed joint stock
companies have been sold to the public. Also, a significant number of private
operators provide a wide variety of telecommunications services pursuant to
licenses from the MOC to a growing number of customers throughout Russia.
According to the MOC, more than 6,000 licenses have been granted to
telecommunications operators in Russia, a large portion of which is assumed to
represent licenses reissued to the same operators as a result of their
reorganization or obligation to hold such licenses on counterfeit-proof paper.
 
     In October 1994, the President authorized the establishment of Svyazinvest
with the stated purpose of fostering greater efficiency and economies of scale
within the industry through competition. As a wholly government-owned company,
Svyazinvest was granted a controlling stake in approximately 85 regional
telecommunications companies in order to compete in these respective markets.
Svyazinvest was also given control of more than 20 million of the 25.5 million
telephone lines in Russia, except in Moscow and St. Petersburg.
 
     In April 1997, President Yeltsin approved the transfer of the federal
government's 51% stake in Rostelecom, as well as similar stakes in Central
Telegraph (the national PTO), the Ekaterinburg City Telephone Network and
Giprosvyaz (a telecommunications research institute), to Svyazinvest. On July
30, 1997, Mustcom Ltd., a Cyprus-based company that represents the interests of
a consortium which includes ICFI Cyprus, Renaissance International Ltd.,
Deutsche Morgan Grenfell, Morgan Stanley, and an affiliate of George Soros,
purchased a 25% stake in Svyazinvest for $1.87 billion. The President has also
authorized the sale of another 24% of Svyazinvest at a future date. This sale is
scheduled to occur in the second half of 1998 and is currently reserved solely
for Russian investors. The Russian government has announced that it will retain
a controlling 51% interest in Svyazinvest.
 
     As a result of the government's actions, a single entity, Svyazinvest, now
owns a majority interest in most of the Company's principal venture partners and
other telecommunication service providers in Russia which together provide a
range of international and domestic long distance and local telecommunications
services throughout Russia. The consolidation of many of its partners under
Svyazinvest and the possible sale of a significant interest in Svyazinvest to
foreign and/or Russian investors will likely subject the Company to more
coordinated competition from Svyazinvest, and may lead to material adverse
changes in the business relationships between the Company and such partners,
which business relationships represent a material component of the Company's
business strategy in Russia. There can be no assurance that the continuing
 
                                        9
<PAGE>   11
 
privatization of Svyazinvest, or the evolution of government policy regarding
Svyazinvest and Rostelecom, will not have a material adverse effect on the
Company or its ventures.
 
     The Russian government's interest in Svyazinvest is held by the MOC, which
was reclassified as the State Committee on Telecommunications and Informatics
during a recent government reorganization. The MOC remains the central body of
federal authority in the Russian Federation, having responsibility for state
management of the communications industry and supervisory responsibility for the
condition and development of all types of communications.
 
     Despite the recent changes in the Russian telecommunications industry, the
level of telecommunications service generally available from most public
operators in Moscow remains significantly below that available in cities of
Western Europe and the United States, although in recent years, the Moscow local
telephone infrastructure has benefited from significant capital investment. By
1995, there were approximately 16 lines per 100 persons in Russia and 45 lines
per 100 persons in Moscow. In comparison, there were 60 and 58 lines per 100
persons in the United States and Western Europe, respectively. In addition, the
quality of services, reflected as the percentage of digital switching in local
telephone networks, currently is approximately 12% in Russia compared to 65% and
66% in the United States and Western Europe, respectively.
 
     Outside Moscow (and to a lesser extent St. Petersburg), most standard
Russian telecommunications equipment is obsolete. For example, many of the
telephone exchanges are electromechanical and most telephones still use pulse
dialing. The Russian population is over 145 million, of which approximately two-
thirds is concentrated in urban areas. The telecommunications market in Russia
currently includes a number of operators that compete in different service
offering segments -- local, inter-city, international, data and cellular
services. In large measure, the relative lack of economic development in the
regions accounts for the lack of improvement in local telecommunications
infrastructure. Although the regions still generally rely on an outdated
infrastructure inherited from the former Soviet Union, they are starting to
resort to sophisticated sources of finance, such as municipal bond offerings, in
order to upgrade it.
 
     Growth in the Russian telecommunications industry has been principally
driven by businesses in Moscow requiring international and domestic long
distance voice and data services and by consumers using mobile telephony. This
growth has been most significant as multinational corporations have established
a presence in Moscow and Russian businesses have begun to expand. The service
sector, which includes operations in distribution, financial services and
professional services and tends to be the most telecommunications-intensive
service sector of the economy, is growing rapidly in Moscow. Since moving to a
more market-oriented economy, the economic conditions in the outlying regions in
Russia have also generally improved. The telecommunications industry in the
outlying regions has experienced recent growth, principally as a result of
growth in the industrial sector as well as the establishment of satellite
offices in the regions by multinational corporations and growing Russian
businesses. The extent of overall market growth will depend in part on the rate
at which the Russian economy expands, although recent revenue growth in the
sector has been significant (in spite of a declining economy in certain regions)
because of increasing traffic from pre-existing customers and the normalization
of tariffs for business services.
 
     The Company believes it is well-positioned to take advantage of market
growth factors due to (i) its early market entry, (ii) its strong infrastructure
position in Moscow, by far the most important regional market, (iii) the local
market experience of its local partners, (iv) the extent of its existing
customer base and (v) its extensive range of international and domestic
telecommunications services. GTS believes it is the only operator in Russia
currently capable of providing a broad range of service offerings and marketing
them as a single end-to-end service offering for its customers.
 
STRATEGY
 
     GTS's objective is to become the premier alternative carrier in Russia and
other key growth markets of the CIS. To attain this objective, the Company has
developed and implemented the following strategy:
 
     - Develop Strong Local Partnerships. The Company has and continues to
       develop its Russian and CIS business through alliances with experienced
       local partners, which to date have been primarily regional
 
                                       10
<PAGE>   12
 
       telephone companies and Rostelecom. These ventures combine the
       management, financial and marketing expertise of GTS together with its
       partner's ability to provide infrastructure and local regulatory
       experience. GTS believes that these relationships lend it credibility and
       increase its ability to anticipate and respond to the evolving regulatory
       and legal environment. GTS maintains a significant degree of managerial
       and operational control in its joint ventures through its foundation
       documents, which enable GTS to develop them in a manner consistent with
       its overall strategic objectives.
 
     - Expand Customer Base. The Company continues to expand its customer base
       through the provision of basic telephone and digital services in markets
       where such services are not currently provided. Once they have
       established a presence in a market, the Company's ventures seek for
       opportunities to expand further into neighboring regions and cities.
 
     - Increase Range of Digital Services. As its business customers expand
      their operations throughout Russia and the CIS and as their
      telecommunications needs become more sophisticated, the Company seeks to
      increase its revenues by expanding the range of integrated digital
      services offered to its customers.
 
     - Offer High Quality Telecommunications Service and Customer Service. The
       Company continues to invest in and build sophisticated high-speed digital
       networks and other infrastructure through which customers can gain local
       access to the Company's services. In addition to providing advanced, high
       quality network infrastructure, the Company emphasizes and offers its
       customers a level of customer service which the Company believes cannot
       be found elsewhere in the market.
 
     To date, GTS has made substantial progress employing this strategy. The
Company provides digital voice, data and local services in Moscow through its
Sovintel, Sovam and TCM ventures and provides these same services to thirteen
additional Russian cities through its TeleRoss long distance network.
 
OPERATIONS
 
     GTS provides a broad range of telecommunications services in Russia,
including international long distance services, domestic long distance services,
cellular services, high speed data transmission, Internet access and local
access services. These services are supported by operator assistance, itemized
call reporting and billing, and other value-added capabilities that leverage
GTS's investment in advanced switching, data collection and processing
equipment. GTS also provides customized systems integration, including PABXs,
key systems, wiring and interconnectivity. GTS's own infrastructure is
supplemented with dedicated and leased capacity to allow GTS to bypass the
severely congested and poorly maintained local, domestic and long distance
circuits of the Russian carriers.
 
     Whenever practical, GTS's business units integrate and co-market their
service offerings, utilizing TeleRoss as the long distance provider, Sovintel as
the international gateway, TCM and GTS Cellular for local access, and Sovam as
the data communications and Internet access network for business applications
and on-line services. Through this integrated marketing approach, GTS is able to
provide comprehensive telecommunications solutions to multinational corporations
operating throughout Russia and the CIS. Several of the TeleRoss Ventures and
the cellular joint ventures were not operational, or had just commenced
operating, in 1995. As a result, TeleRoss and GTS Cellular did not generate
significant revenues in 1995.
 
                                       11
<PAGE>   13
 
     The following table sets forth certain operating data related to the
Company's operating ventures in Russia and the CIS.
 
<TABLE>
<CAPTION>
                                                              AT AND FOR THE
                                                                YEAR ENDED
                                                               DECEMBER 31,
                                                              --------------
                                                              1996     1997
                                                              -----    -----
<S>                                                           <C>      <C>
Cities In Service...........................................     33       40
Total Voice Minutes (millions)(1)
  Inter-city................................................   15.8     57.1
  Local.....................................................  133.0    269.1
  International Outgoing....................................   20.5     46.0
  Incoming..................................................   33.2     69.9
Total Data Customers (thousands)............................    6.2      9.9
Total Cellular Subscribers (thousands)......................    9.8     23.4
</TABLE>
 
---------------
 
(1) Amounts include minutes between Company affiliates.
 
SOVINTEL
 
     GTS owns 50% of Sovintel, a joint venture with Rostelecom, the national
long distance carrier. Sovintel was founded in 1990 by GTS, Rostelecom and GTE
Spacenet, with GTS acquiring GTE Spacenet's interest in 1994. Sovintel markets a
broad range of high quality telecommunications services by (i) directly
providing international direct dial access to over 170 countries and private
line dedicated voice channels and (ii) leveraging the infrastructure and
services of the other GTS ventures, including TeleRoss, TCM and Sovam. In
addition, Sovintel provides and installs for its customers equipment such as
PABXs, key systems and wiring and provides maintenance and other value-added
services. Sovintel customers, which primarily consist of businesses, hotels and
Moscow-based cellular operators, are able to access these telecommunications
services through Sovintel's fully-digital overlay network in Moscow. In
addition, Sovintel has recently commenced construction of a limited network in
St. Petersburg that is interconnected to Sovintel's Moscow network and is
intended to support Sovintel's Moscow clients which have a presence in St.
Petersburg. Sovintel serviced over 43,900 telephone numbers, or "ports," for
business customers and cellular providers and had over 275 employees as of
December 31, 1997.
 
     Sovintel has constructed and operates a fully-digital overlay network in
and around Moscow which consists of (i) an approximately 600-kilometer fiber
optic ring, (ii) over 250 PABXs linked to the fiber optic ring, (iii) a
fully-digital microwave network, (iv) a wireless local loop and (v) an
international gateway connected to the fiber optic ring. In addition, Sovintel
leases dedicated international long distance channels. Customers are connected
to the Sovintel network via last mile connections to over 250 PABXs that provide
"points-of-presence" in and around Moscow. The PABXs are connected to the
network through a direct fiber connection or a digital microwave network. Some
of Sovintel's new customers are temporarily connected to the network through a
wireless local loop. The wireless local loop provides a significant competitive
advantage because it allows Sovintel to connect customers to its network more
quickly than alternative methods. As these customers are provided permanent
connections to Sovintel's network through direct connections to the PABXs,
additional customers are rolled onto the wireless local loop.
 
     After a customer is connected to the Sovintel network, local telephone
services are provided through the Sovintel fiber optic ring's interconnection
with the switches of either TCM or MTU Inform. These switches provide access to
local telephone service in Moscow through interconnections with the Moscow city
telephone network ("MGTS") and the principal Moscow cellular providers. Sovintel
provides its customers access to domestic long distance service through the
TeleRoss long distance network, or through Rostelecom's network in cities not
currently served by TeleRoss. International service is provided primarily
through the Sovintel international gateway, which transmits international
traffic via dedicated international leased long distance channels. Sovintel's
customers also can receive high speed data services through Sovintel's
interconnection
 
                                       12
<PAGE>   14
 
with the Sovam data network. Accordingly, from a customer's perspective,
Sovintel offers a broad range of telecommunication services.
 
     The following table sets forth certain operating data related to Sovintel's
operations:
 
<TABLE>
<CAPTION>
                                                       AT AND FOR THE YEAR ENDED DECEMBER 31.
                                                       ---------------------------------------
                                                          1995          1996          1997
                                                       ----------    ----------    -----------
<S>                                                    <C>           <C>           <C>
MINUTES OF USE(1)
  International Minutes
     Number of Minutes...............................    10,516        20,839         43,664
     Average Rate Per Minute.........................   $  2.06       $  1.55       $   1.12
  Domestic Long Distance Minutes
     Number of Minutes...............................     2,047        10,098         26,606
     Average Rate Per Minute.........................   $  0.86       $  0.65       $   0.52
  Moscow (Local) Fixed Line Minutes
     Number of Minutes...............................        --            --          3,501
     Average Rate Per Minute.........................        --            --       $   0.05
  Moscow (Local) Cellular Minutes Number of
     Minutes.........................................    21,478        83,673        118,447
     Average Rate Per Minute.........................   $  0.06       $  0.08       $   0.08
  Incoming Minutes Number of Minutes.................     3,839        24,306         43,626
     Average Rate Per Minutes........................   $  0.58       $  0.28       $   0.30
PORTS
  Number of Ports (cumulative).......................     6,079        29,646         43,976
NUMBER OF PRIVATE LINE CHANNELS
  International......................................        26            89            201
  Inter- and Intra-City..............................        26           103            243
APPROXIMATE EQUIPMENT SALES (THOUSANDS)..............   $ 1,400       $ 2,200       $  3,400
</TABLE>
 
---------------
 
(1) Minutes in thousands. Amounts include minutes among affiliates.
 
     Services. Sovintel markets a broad range of high quality telecommunications
services by (i) directly providing international direct dial access to over 170
countries and private line dedicated voice services and (ii) by leveraging the
infrastructure and services of the other GTS ventures. Sovintel's services
include:
 
     - Switched International, Domestic Long Distance and Local
       Services. Customers are provided switched international long distance
       services directly through Sovintel's international gateway in Moscow and
       its leased long distance channels. Domestic long distance services are
       marketed by Sovintel and provided either through the TeleRoss long
       distance network or, where the call destination is not served by
       TeleRoss, through Rostelecom's network. Local call service is provided by
       Sovintel indirectly as a result of its interconnection, through TCM or
       MTU Inform, with the Moscow city telephone network. Based on its
       familiarity with the market, the Company believes that Sovintel's
       services are distinguished by a higher level of quality than those of its
       competitors, particularly with respect to call completion rates for its
       domestic long distance and local call services. In addition, the Company
       trains its employees to provide customer service at a level which is
       comparable to that provided by Western telecommunications companies. As a
       result, the Company believes that customers choose Sovintel over its
       competitors because it has earned a reputation for providing high quality
       telecommunications services through an experienced and professional
       customer service staff.
 
     - Private Line Channels. Private line channels, which are provided over
       dedicated leased lines, are principally utilized by customers with
       high-volume data traffic needs, such as Sovam and large data providers.
       Private line customers have access to intra-city service in Moscow
       through Sovintel's fiber optic ring and to inter-city service between
       Moscow and St. Petersburg via fiber leased by Sovintel, in each case
       benefiting from Sovintel's high quality infrastructure. Private line
       domestic long distance
 
                                       13
<PAGE>   15
 
       service is provided through TeleRoss and, for cities not served by
       TeleRoss, through Rostelecom. International private line service is
       provided through dedicated leased fiber channels from Rostelecom.
 
     - Equipment Sales, Installation Services and Project Planning and
       Management Services. In providing the above services to its customers,
       Sovintel installs and maintains equipment on its customers' premises,
       including PABXs, key systems and wiring. Sovintel also provides project
       planning and management services, including system design and management,
       to its customers.
 
     - World Access Service. Customers are able to access Sovintel's
       international long distance services through the World Access Card, which
       provides customers either direct or calling-card-based portable access to
       domestic and international long distance service. The calling card can be
       used in 15 Russian cities, including Moscow and St. Petersburg, and 23
       countries.
 
     Sovintel complements its service offerings by providing a wide range of
value-added services including operator assistance, maintenance and customer
support and itemized call reporting and billing.
 
     Customers and Pricing. Sovintel's customers consist primarily of
high-volume business and professional customers, such as IBM, Credit Suisse
Group and Reuters, other multinational corporations and Russian enterprises, a
number of premium Moscow hotels and other telecommunications carriers. In
addition, Sovintel is one of the primary providers of domestic and international
long distance service for the major cellular service providers in Moscow,
including VimpelCom, MTS and Moscow Cellular. Sovintel's customers typically
demand a higher level of service than generally available in the market.
Sovintel further provides to its large corporate customers data services such as
frame relay and Internet access contracted from Sovam in order to offer
"one-stop shopping" telecommunications solution to these customers, who
increasingly require this type of service.
 
     The pricing structure for international and domestic long distance calls is
based upon traffic volume and overall market rates, with Sovintel's rates
varying depending on the time and destination of the call. Local calls, other
than calls placed to cellular phones, are completed without charge. Sovintel
expects to continue its practice of not charging to complete local calls unless
and until the MGTS begins to charge for completion of such calls. Sovintel
prices its international long distance services slightly below those of its
principal competitors, and has recently reduced its rates in anticipation of
increased competitive pricing pressures. Sovintel's average revenue per minute
for outgoing international long distance calls has declined from approximately
$2.35 per minute for the year ended December 31, 1994 to approximately $1.12 per
minute for the year ended December 31, 1997. Sovintel expects increased pricing
pressure from competitors over time. Sovintel prices domestic long distance
services in line with those of its principal competitors, however, due to its
obligations under certain agreements with affiliated entities, Sovintel's
margins for these services are declining. Prices for domestic long distance
services have increased significantly over the last several years, although such
prices stabilized in the second half of 1996. Sovintel's private line services
are priced competitively. Sovintel provides private line channels by releasing
lines it leases from Rostelecom. The lines are leased by Sovintel from
Rostelecom at wholesale rates and leased by Sovintel to its customers at prices
in line with Rostelecom's retail rate.
 
     Customers are billed monthly with larger-volume customers receiving
discounts of up to 25%. Customers using international services, domestic long
distance or data services are billed in U.S. dollars. To the extent permitted by
law, payment is made either in U.S. dollars or in rubles at the ruble/dollar
exchange rate at the time of payment, plus a conversion charge in order to
minimize the impact of currency fluctuations. Sovintel currently bills on an
invoicing system that was internally developed. Currently, the system is
adequate for Sovintel's present customer base; however, the Company is
evaluating alternatives for upgrading the system in anticipation of future
growth.
 
     Sales and Marketing. Sovintel's sales and marketing strategy targets large
multinational and Russian businesses both directly and through contacts with
real estate developers and business center managers in the greater Moscow area.
These developers and managers typically determine which telecommunications
service provider will service their respective properties. By identifying and
building relationships with these developers and managers at an early stage
(typically up to one year prior to the completion of a new building project),
                                       14
<PAGE>   16
 
Sovintel seeks to enhance the likelihood of winning the service contract. In
addition to its traditional target market, Sovintel has recently begun to market
its services to smaller businesses. Sovintel utilizes a departmentalized sales
force in order to focus its sale efforts on the different segments within its
target market. The sales force is comprised of 40 sales personnel, including 15
account managers, all of whom specialize in serving specific targeted
industries. Dedicated marketing and customer support personnel provide technical
support, customer service, training, market monitoring and promotional functions
for Sovintel. Sovintel's sales and marketing personnel are paid through a
combination of salary, commissions and incentive bonuses.
 
     Ownership and Control. Sovintel is a joint venture between a wholly owned
entity of GTS and Rostelecom with each having a 50% ownership interest. Under
Sovintel's charter, GTS and Rostelecom each have the right to appoint three of
the six members of Sovintel's managing board. Rostelecom has the right to
nominate the Director General (the highest ranking executive officer at
Sovintel), while GTS has the right to nominate the First Deputy Director General
(the next-highest ranking executive officer at Sovintel). In practice, the
Director General and the First Deputy Director General together perform the role
of a chief executive officer. Certain business decisions, including the adoption
of Sovintel's annual budget and business plan as well as the distribution of
profits and losses require the approval of both GTS and Rostelecom. Neither GTS
nor Rostelecom are obligated to fund Sovintel's operations or capital
expenditures. Losses and profits of Sovintel are allocated to the partners in
accordance with their ownership percentages, in consideration of funds at risk.
As of December 31, 1997, GTS and Rostelecom have each made equity contributions
of $1.0 million to Sovintel. The Sovintel joint venture agreement does not have
an expiration date. See "-- Certain Considerations Generally Applicable to the
Company's Operations -- Dependence on Certain Local Parties; Absence of Control"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations Accounting Methodology Profit and Loss Accounting."
 
TCM
 
     GTS beneficially owns approximately 50% of TCM, a joint venture founded in
1994 that provides a licensed numbering plan and interconnection to the Moscow
city telephone network for carriers needing basic local access service in
Moscow. GTS's partners in TCM are MTU-Inform and a group of entrepreneurs with
extensive telecommunications experience. TCM is currently licensed to provide
100,000 numbers in Moscow, of which approximately 50,000 have been leased. TCM
has contracted with MGTS to construct up to an additional 100,000 numbers in
several stages over the next five years, and currently plans to construct 10,000
numbers in each of 2000, 2001 and 2002. Any such construction, however, is
subject to TCM obtaining a license covering the additional numbers and the
availability of such numbers in the portion of the MGTS numbering plan in which
TCM plans to construct such numbers. TCM's switching facilities are fully
integrated with the networks of Rostelecom, Sovintel, and MGTS, allowing it to
provide high quality digital service to its customers.
 
     Services. TCM acts as a local gateway by providing numbers and ports to
carriers in Moscow, including Sovintel, VimpelCom, MTS and Moscow Cellular, and
thus providing interconnectivity to the Moscow city telephone network. Access to
the Moscow city telephone network provides customers with the higher quality and
broader range of services available in Moscow, such as the services provided by
Sovintel. Access from outlying regions is typically obtained through a domestic
long distance service provider such as TeleRoss. See "-- Sovintel" and "--
TeleRoss."
 
     Customers and Pricing. TCM provides its services on the wholesale level to
primary carriers. VimpelCom is TCM's primary customer and accounts for
substantially all of TCM's revenues, hence the loss of VimpelCom as a customer
would have a material adverse effect on the Company. TCM also provides ports to
Sovintel and to other network operators. TCM's ports are leased principally to
carriers in Moscow. Although local access services are priced upon the basis of
supply and demand factors in the local market, in general, for each port
cellular operators pay an approximately $300 installation fee and a $16 flat
monthly fee plus a per minute charge for traffic while other carriers pay a
larger initial fee of approximately $500 and a monthly fee of approximately $25.
Local access services are typically provided pursuant to five-year contracts
that may be renewed upon expiration for additional one-year periods. TCM has
entered into an agreement with Sovintel pursuant to which billing and collecting
functions for TCM-Sovintel joint customers are performed by
                                       15
<PAGE>   17
 
Sovintel, with Sovintel remitting such amounts (less applicable settlement
charges and administrative costs) to TCM. The rapid growth of cellular services
in markets like Moscow has placed a premium on new numbers, which has translated
into attractive prices for these numbers. TCM, however, believes these prices
will decline over time.
 
     Ownership and Control. GTS's indirect interest in TCM is represented by its
approximately 52% interest in a holding company, which owns 95% of TCM. This
structure provides GTS with 50% beneficial ownership interest in TCM. Decisions
of the holding company regarding TCM require unanimous board approval and
neither GTS nor its partner in the holding company is obligated to fund
operations or capital expenditures of the holding company. In addition, neither
the holding company nor the TCM shareholders are obligated to fund operations or
capital expenditures of TCM. At both the holding company and TCM level, losses
and profits are allocated to the partners in accordance with their ownership
percentages, in consideration of funds at risk. GTS acquired its indirect, 50%
beneficial interest in TCM for approximately $700,000 and certain additional
consideration. As of December 31, 1997, GTS had no outstanding loans relating to
TCM. None of the operative charters and agreements relating to the holding
company or TCM have expiration dates. See "Certain Considerations Generally
Applicable to the Company's Operations -- Dependence on Certain Local Parties;
Absence of Control" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations Accounting Methodology Profit and Loss
Accounting."
 
TELEROSS
 
     TeleRoss, which began operations in 1995, consists of (i) two wholly owned
holding companies and a 99% owned subsidiary of GTS that operates a domestic
long distance network (collectively, the "TeleRoss Operating Company") and (ii)
thirteen joint ventures that are 50% beneficially-owned by GTS that originate
traffic and provide local termination of calls (the "TeleRoss Ventures" and,
together with TeleRoss Operating Company, "TeleRoss"). The TeleRoss domestic
long distance network serves fourteen major Russian cities, including Moscow
and, through VSAT technology, 24 customers located outside these cities.
TeleRoss provides digital domestic long distance services and other value-added
services through its own infrastructure as well as access to Sovintel's
international gateway services and access to the Moscow city telephone network
through TCM's switching facilities. Sovam uses the TeleRoss digital channels to
provide regional data service and has co-located its access facilities with
TeleRoss. As of December 31, 1997, TeleRoss employed approximately 188 persons
of which approximately 90 people were based in Moscow and approximately 98
people were deployed in the regions in which TeleRoss operates.
 
     TeleRoss's licenses cover the city of Moscow and a total of 39 regions
throughout Russia. Most of the thirteen cities in which TeleRoss primarily
operates are regional capitals, with an aggregate population of approximately 12
million. TeleRoss's licenses cover the entire oblast surrounding these cities,
with populations totaling approximately 38 million persons, and GTS intends
eventually to extend the reach of the TeleRoss network beyond the regional
capitals to the surrounding areas. The cities in which TeleRoss currently offers
its services are: Arkhangelsk, Ekaterinburg, Irkutsk, Khabarovsk, Krasnodar,
Nizhni Novgorod, Novosibirsk, Syktyvkar, Tyumen, Ufa, Vladivostok, Volgograd and
Voronezh. The Company has formed an additional TeleRoss Venture in the city of
Samara. As of March 1998, this venture was not operational.
 
     The TeleRoss network architecture involves local city switches connected to
remote earth stations which communicate via satellite to a Moscow-based hub.
This hub consists of the network control center, earth station equipment,
multiplexing equipment and a switch. The earth stations, hub and related
equipment are owned by TeleRoss, which gives TeleRoss the flexibility to
redeploy network assets to other locations as necessary. The hub interconnects
to Sovintel's network providing access to Sovam's data networks, TCM's switching
facilities and Sovintel's international gateway, which transports international
traffic via dedicated international leased satellites and fiber channels and
provides access to Rostelecom's long distance networks. Outside of Moscow,
TeleRoss's local joint venture partners provide interconnection to the local
public telephone networks in each of the cities it serves. In addition to
providing services through its network, TeleRoss currently serves 24 customers
in 24 additional cities through VSAT technology which links the customers via
satellite to the Moscow hub.
 
                                       16
<PAGE>   18
 
     The following table sets forth certain operating data related to TeleRoss's
operations:
 
<TABLE>
<CAPTION>
                                                              AT AND FOR THE YEAR
                                                              ENDED DECEMBER 31,
                                                              -------------------
                                                               1996        1997
                                                              -------    --------
<S>                                                           <C>        <C>
MINUTES OF USE(1)
  Domestic Minutes (thousands)..............................   4,035      23,233
  Average Rate Per Domestic Minute..........................  $ 0.99     $  0.63
  International Minutes (thousands).........................     272         744
  Average Rate Per International Minute.....................  $ 2.76     $  2.47
NUMBER OF CITIES SERVED(2)..................................      13          14
WORLD CONNECT DIAL/RUSSIA
  Number of Connect Dial Ports..............................     472       1,112
  Average Revenue Per Port Per Month........................  $  767     $   370
MOSCOW CONNECT
  Number of Ports...........................................      49          78
  Average Revenue Per Port Per Month........................  $1,165     $ 1,358
DEDICATED CIRCUITS
  Number of Dedicated Channels..............................      33          60
  Average Price Per Channel.................................  $4,553     $ 4,140
WORLD ACCESS SERVICE
  Number of World Access Card Users.........................   3,929       4,595
  Average Revenue Per Card Per Month........................  $   52     $    48
VSAT SERVICES
  Number of VSATs...........................................      12          24
</TABLE>
 
---------------
 
(1) Includes minutes among affiliates.
 
(2) Includes connection to Moscow.
 
     Services. Through its network and VSAT offerings, TeleRoss offers the
following services:
 
     - Carriers' Carrier Services. TeleRoss provides services as a "carriers'
       carrier," providing domestic long distance carrier services to cellular
       operators, Sovintel, the TeleRoss Ventures' regional partners and
       competitive bypass operators from the cities in which the TeleRoss
       Ventures operate, and to customers in remote cities using VSAT stations.
       These services are provided to and from Moscow, and are provided by
       TeleRoss at wholesale rates competitive with those offered by Rostelecom.
       TeleRoss also provides private line channels to Sovam in cities where the
       TeleRoss Ventures operate. In addition, TeleRoss has recently received a
       license to provide international private line service.
 
     - World Connect Dial/Russia Connect Dial. Customers in TeleRoss's cities
       are provided dedicated local access to the regional TeleRoss switch
       through lines leased from the TeleRoss Venture's regional joint venture
       partner. These customers then have access to the domestic long distance
       service provided by TeleRoss, international long distance service
       provided by Sovintel and are fully integrated into the local phone
       networks operated by the applicable TeleRoss Venture's partner and to the
       Moscow city telephone network through TCM.
 
     - Moscow Connect. Customers are provided with dedicated last mile
       connection over lines leased from the regional joint venture partner
       which lines are connected to a local TeleRoss switch. The TeleRoss
       network and its interconnection to TCM provide customers with a Moscow
       dial tone which allows users in remote locations better access to
       Moscow's advanced telecommunications infrastructure. In addition, Moscow
       Connect service provides better call quality at lower rates for domestic
       and international long distance. Moscow Connect also facilitates
       communications between users and their Moscow-based associates as calls
       can be made to and from Moscow without the use of prefixes and without
       long distance charges accruing to the Moscow-based parties.
 
                                       17
<PAGE>   19
 
     - Dedicated Circuits. Customers are provided with point-to-point clear
       channel circuits within Russia and internationally through the TeleRoss
       backbone and its interconnection with Sovintel's international gateway in
       Moscow. Dedicated circuits are generally used by news services, banks and
       other commercial customers who require high capacity and high quality
       service. This service can be used for voice or data, depending on the
       user's needs. In providing dedicated circuits, TeleRoss competes against
       other alternative communications providers, however, TeleRoss believes
       that it has a distinct price advantage over its competitors because of
       the use of its own infrastructure and the bulk purchase of satellite
       capacity.
 
     - World Access Service. TeleRoss and Sovintel co-market World Access
       Service to their customers in each of the cities they serve through two
       products: World Access Direct and World Access Card. Through World Access
       Direct, TeleRoss customers can access domestic long distance and
       international service anywhere within the customer's city through the
       local telephone network. The World Access Card is a calling card which
       allows TeleRoss customers portable access to domestic long distance and
       international service from 15 Russian cities, including Moscow and St.
       Petersburg, and 23 countries. This service is provided through Sovintel's
       infrastructure.
 
     - VSAT Services. For customers that are located outside the cities serviced
       by TeleRoss or that cannot be physically linked to TeleRoss's regional
       switches, TeleRoss offers VSAT service which connects these customers
       directly to TeleRoss's Moscow-based hub through a VSAT antenna installed
       at the customer's location. Both dedicated and switched services are
       provided through these VSAT arrangements.
 
     In addition to continuing the development of its core domestic long
distance business, TeleRoss's strategy includes the development of local access
networks to capitalize on demand for local phone service and to capture
additional customers for its long distance and value-added service offerings.
Outside Moscow, TeleRoss has primarily pursued a strategy whereby it develops
its own intra-city trunking network with copper based or fiber optic facilities
leased from the regional joint venture partners. As of December 31, 1997,
TeleRoss, in conjunction with regional joint venture partners, has installed
approximately 25 kilometers of fiber optic cable in 3 cities and plans to
install an aggregate of approximately 100 kilometers of additional fiber optic
cable in up to an additional 6 cities over the next 24 to 30 months. Customers
who obtain local phone numbers from TeleRoss's venture partners are directly
interconnected to the local telephone company and to the Company's long distance
network and Sovintel's international gateway and may obtain a broad range of
value-added services offered by the Company.
 
     Customers and Pricing. TeleRoss's customers include businesses and other
telecommunications service providers such as carriers, PTOs, cellular operators,
Sovintel and Sovam. TeleRoss's business customers consist of large multinational
and Russian businesses in each of the regions it services, as well as medium and
small-sized businesses. Between 1993 and mid-1996, consumer prices in TeleRoss's
industry increased significantly as a result of Rostelecom raising its prices in
an effort to raise capital for investment and development of its network
infrastructure, although prices have stabilized over the past six months. During
the year ended December 31, 1997, TeleRoss increased sales to carriers, which
sales were made at wholesale rates, resulting in a decrease in the average rate
per minute for TeleRoss. TeleRoss strategically prices its domestic long
distance services at a slight premium over similar services offered by
Rostelecom to account for a higher quality of service, but in line with the
prices offered by regional competitors.
 
     Sales and Marketing. TeleRoss markets its services to carriers and
businesses through direct sales channels. As of December 31, 1997, TeleRoss
employed 31 sales and marketing personnel, approximately half of which are based
in Moscow with the other half deployed regionally to identify and contact
prospective customers. The Moscow-based sales and marketing personnel are
organized into industry groups in order to better identify and serve customer
needs. Each region is typically served by one or two sales representatives.
TeleRoss's sales efforts are supported by market research and promotional
activities carried out at the joint venture level and tailored to the specific
market base of each region. TeleRoss's marketing strategy is to attract carrier
customers by focusing on those carriers with high volume minutes operating in
regions where TeleRoss has a competitive advantage. Through cross-marketing
agreements with Sovintel and Sovam, TeleRoss
                                       18
<PAGE>   20
 
markets many of the other service offerings of GTS's Russian businesses to
customers throughout its service regions. Billing functions and the monitoring
of quality control and technical issues are performed centrally through the
Moscow-based hub.
 
     Ownership and Control. TeleRoss consists of the TeleRoss Operating Company,
and the 50% beneficially owned TeleRoss Ventures. GTS controls TeleRoss
Operating Company (which holds the network license) and co-manages the TeleRoss
Ventures under the terms of the applicable TeleRoss Ventures' foundation
agreements and charters. Under some of these charters, GTS generally has the
right to designate the Chairman of the board of directors, and GTS's local
partner has the right to designate the Deputy Chairman, for the first two-year
term (and thereafter GTS and the local partner nominate the Chairman and Deputy
Chairman for approval by the entire board on a rotating basis). The foundation
agreements and charters do not have expiration dates. While GTS has significant
influence within these ventures, decisions, including the decision to declare
and pay dividends, are generally subject to GTS's partner's approval. See
"-- Certain Considerations Generally Applicable to the Company's
Operations -- Dependence on Certain Local Parties; Absence of Control." Neither
GTS nor its respective joint venture partners are obligated to fund operations
or capital expenditures of the TeleRoss Ventures. Losses and profits are
allocated to the partners in accordance with their ownership percentages, in
consideration of funds at risk. As of December 31, 1997, GTS and its partners
had each made equity contributions aggregating $1.7 million to the various
TeleRoss Ventures. Contributions made by the partners include contributions of
cash and intangible assets, such as licenses. In addition, the various TeleRoss
Ventures had outstanding loans of $3.4 million to GTS as of December 31, 1997.
In addition, as of December 31, 1997, GTS had made equity contributions of $5.8
million to the TeleRoss Operating Company and the TeleRoss Operating Company had
outstanding loans of $37.4 million to GTS. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Accounting
Methodology -- Profit and Loss Accounting."
 
SOVAM
 
     Sovam is a venture that is wholly owned by GTS. Sovam was founded in 1990
as a venture equally owned by GTS and the Institute for Automated Systems
("IAS"). In 1992, Cable & Wireless acquired a 33% ownership interest in Sovam,
which interest was subsequently acquired by GTS in 1994, bringing GTS's
ownership interest to 66.7%. GTS purchased IAS's interest in Sovam in February
1998, thereby making Sovam a wholly owned subsidiary of GTS. Sovam provides
high-speed data communications services, electronic mail and database access
over a high-speed packet/frame relay network in 30 major Russian and CIS cities.
Sovam also offers Russia On Line, the first Russian language Internet service,
which provides direct access to the Internet as well as access to a wide range
of local and international information services and databases. (Russia On
Line(TM) is a trademark of the Company.) As of December 31, 1997, Sovam had
approximately 1,571 data service customers and approximately 3,960 Russia On
Line customers. Sovam employed over 110 persons in Moscow and other regions of
the CIS as of December 31, 1997. Sovam provides equipment and maintains
marketing and technical support personnel at each location either through its
own infrastructure or through the infrastructure of TeleRoss.
 
     In addition to serving the Moscow and St. Petersburg markets, Sovam
co-locates its operations with the TeleRoss Ventures, offering its services in
all TeleRoss cities, and also serves 15 additional cities in Russia and the CIS.
Sovam operates under its own license within Russia while services elsewhere in
the CIS are provided through applicable local partner licenses. The local
partners of the TeleRoss Ventures provide facilities, assist in the provision of
leased lines to Sovam customers that allow them to connect with Sovam's local
data switches and also provide technical support. Sovam utilizes Sovintel's
international capabilities and, in TeleRoss-served locations, TeleRoss's
satellite overlay network, to take data through its local data switches and over
the leased lines to its customers. Customers may obtain virtual private data
networks without investing in, acquiring, installing and maintaining their own
network nodes and switches.
 
                                       19
<PAGE>   21
 
     The following table sets forth certain operating data related to Sovam's
operations:
 
<TABLE>
<CAPTION>
                                                           AT AND FOR THE YEAR ENDED
                                                                  DECEMBER 31
                                                           --------------------------
                                                            1995      1996      1997
                                                           ------    ------    ------
<S>                                                        <C>       <C>       <C>
BASIC DATA SERVICE
  Percentage of Total Sovam Revenue......................      91%       79%       81%
  Number of Customers....................................   1,587     1,726     1,571
  Average Revenue Per Month Per Customer.................  $  201    $  446    $  728
  Number of Cities in Service............................      11        25        30
EQUIPMENT AND HARDWARE SALES
  Percentage of Total Sovam Revenue......................       8%       14%        8%
RUSSIA ON LINE SERVICE
  Percentage of Total Sovam Revenue......................       1%        7%       11%
  Number of Subscribers(1)...............................     407     1,854     3,159
  Average Revenue Per Month Per Subscriber...............  $   49    $   52    $   64
</TABLE>
 
---------------
 
(1) In addition to the subscribers included above, Sovam frequently connects
    potential Russia On Line subscribers on a complimentary one-month trial
    basis. As of December 31, 1997, there were approximately 800 such potential
    subscribers.
 
     Services. Sovam's service offerings are comprised of data services,
equipment and hardware sales and its Russia On Line services.
 
     - Data Services. Sovam provided high speed connectivity, electronic mail,
       database access and fax services to approximately 1,571 customers as of
       December 31, 1997, in Russia and the CIS. Sovam customers can use
       electronic mail systems to send and receive messages and data and to
       access public and private data networks (including the Internet)
       worldwide. Customers may obtain virtual private data networks without
       investing in, acquiring, installing and maintaining their own network
       nodes and switches. In addition, Sovam offers its customers value-added
       data services. For example, Sovam offers "one-stop shopping" for
       hardware, software, installation and maintenance support and products
       such as "SovamMail," an e-mail service which allows customers to use
       Sovam's data network to send telex or facsimile messages to overseas
       recipients worldwide. Data services are currently available in 30 cities
       throughout Russia and the CIS, including Moscow, St. Petersburg, each of
       the cities served by TeleRoss and some cities outside of the TeleRoss
       network.
 
     - Equipment and Hardware Sales. Sovam sells communications equipment and
       hardware, and provides related installation, maintenance and support
       functions, to its customers. Sovam's primary customers in the equipment
       and hardware market are banking clients who use the equipment to
       interface with Sovam's network.
 
     - Russia On Line. Russia On Line is the first Russian language, as well as
       the first dual language, graphical user interface online service for
       accessing domestic and international information sources designed to
       appeal to a wide commercial audience. This service, which is distributed
       via GTS's domestic long distance infrastructure, provides customers with
       access to international databases (including the Internet), as well as an
       array of proprietary Russian and English language information services,
       such as news stories and market updates. Sovam had 3,960 Russia On Line
       subscribers (which includes approximately 800 trial subscribers) as of
       December 31, 1997. Sovam has developed a modified version of Netscape's
       Internet browser, which utilizes the Cyrillic alphabet, as part of its
       Russia On Line package. Sovam's enhanced Russian version of Netscape's
       browser is provided by Sovam to its customers under a distribution
       agreement with Netscape. In addition, Sovam has also entered into
       agreements with equipment manufacturers, including Dell, Motorola and
       Acer, to include Russia On Line software with their products.
 
                                       20
<PAGE>   22
 
     Customers and Pricing. Sovam's data communications customers consist
primarily of banking and financial services organizations and large
multinational companies, while Sovam's Russia On Line customers consist of a
wide variety of commercial enterprises. Sovam charges customers an installation
fee when service is commenced and a charge for any equipment which is installed.
Thereafter, customers are billed on a monthly basis for leased line fees, port
access charges and charges for data and Russia On Line services rendered during
the month. Data services are priced on a two-tier structure with high volume
users generally negotiating a flat-rate fee and lower volume uses paying a
volume-based fee which on average was $446 and $728 per subscriber in 1996 and
1997, respectively. Russia On Line customers pay a fixed monthly access charge
plus an additional volume-based fee. Customers are billed in dollars and payment
is remitted in rubles and, to the extent permitted by law, in dollars, with a 5%
conversion fee added to ruble-denominated payments.
 
     Sales and Marketing. Sovam employs a dedicated sales and marketing force
comprised of 23 Russian nationals, 18 of which are based in Moscow with the
remainder deployed in the other Russian and CIS regions. Salespersons are paid a
fixed salary supplemented by sales commissions and performance-based bonuses.
Sovam's sale efforts are focused primarily on the banking and financial
communities and large multinational companies, although small and medium sized
entities are also emerging as potential Sovam customers. Bundled service
packages, which include Sovam's data and Internet service, Sovintel's
international service and TeleRoss's long distance service, are frequently
marketed together in order to offer customers a comprehensive telecommunications
solution. In addition to data communications services, Sovam offers its
customers hardware, installation and maintenance service and is a distributor of
Northern Telecom equipment.
 
     Ownership and Control. At December 31, 1997, GTS owned 66.7% of Sovam and
IAS owned the remaining 33.3%. GTS purchased IAS's interest in Sovam in February
1998, thereby making Sovam a wholly owned subsidiary of GTS. As of December 31,
1997, neither GTS nor IAS were obligated to fund Sovam's operations or capital
expenditures. Losses and profits of Sovam were allocated to the partners in
accordance with their ownership percentages, in consideration of funds at risk.
As of December 31, 1997, GTS and its partner had made equity contributions of
$1.3 million and $0.7 million, respectively, to Sovam. In addition, Sovam had
outstanding loans of $5.7 million to GTS as of December 31, 1997. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation -- Accounting Methodology -- Profit and Loss Accounting."
 
GTS CELLULAR
 
     GTS Cellular operates three cellular businesses in Russia and Ukraine. In
Russia, GTS has a wholly owned subsidiary Vostok Mobile (which is organized in
The Netherlands), which currently operates twelve AMPS cellular companies in
Russian regions west of the Urals under the trade name Unicel. Vostok Mobile
owns between 50% and 70% of these cellular joint ventures (the "Unicel
Ventures") in Russia. In addition, GTS intends to enter into the cellular
markets of additional Russian regions through its Vostok Mobile venture. GTS
also participates in PrimTelefone, a 50% owned joint venture that operates an
NMT-450 network in Vladivostok and four other cities in the Primorsky region of
Russia. In Ukraine, GTS has an approximately 25% beneficial interest in
Bancomsvyaz which operates a DCS-1800 cellular network in Kiev, and an
international overlay network in Ukraine. GTS Cellular entities possess licenses
covering major Russian and Ukrainian markets (excluding Moscow and St.
Petersburg) with an aggregate 1997 population of approximately 25 million
people.
 
                                       21
<PAGE>   23
 
     GTS currently offers cellular services in the following regions as of
December 31, 1997:
 
<TABLE>
<CAPTION>
                                                GTS'S
                OPERATING                      ECONOMIC                           NUMBER OF
                 COMPANY                    INTEREST(1)(2)         CITY          SUBSCRIBERS
                ---------                   --------------         ----          -----------
<S>                                         <C>               <C>                <C>
RUSSIA
  Vostok Mobile(2)
     Arkhangelsk Mobile...................      50.0%         Arkhangelsk             602
     Networks
     Astrakhan Mobile.....................      50.0%         Astrakhan             1,264
     Barnaul Mobile(3)....................      50.0%         Barnaul                  --
     Chuvashi Mobile......................      70.0%         Cheboksary            1,201
     Lipetsk Mobile.......................      70.0%         Lipetsk                 461
     Murmanskaya Mobilnaya Set............      50.0%         Murmansk              1,457
     Penza Mobile.........................      60.0%         Penza                   519
     Saratov Mobile.......................      50.0%         Saratov               1,456
     Parma Mobile.........................      50.0%         Syktyvkar               750
     Volgograd Mobile.....................      50.0%         Volgograd             2,065
     Votec Mobile.........................      50.0%         Voronezh              1,725
     Mar Mobile...........................      50.0%         Yoshkar-ola           2,061
  PrimTelefone............................      50.0%         Vladivostok(4)        6,152
UKRAINE
  Bancomsvyaz.............................      24.9%         Kiev                  3,664
                                                                                   ------
          Total...........................                                         23,377
                                                                                   ------
</TABLE>
 
---------------
 
(1) Represents the indirect economic interest of GTS in each entity.
 
(2) Prior to September 26, 1997, GTS owned 62% of Vostok Mobile. On September
    26, 1997, GTS acquired the minority interest in Vostok Mobile, making Vostok
    Mobile a wholly owned subsidiary of GTS. Vostok Mobile owns between 50% and
    70% of a series of 12 operational cellular joint ventures in various regions
    in Russia. In the second half of 1997, the Company formed three additional
    ventures in the cities of Bryansk, Kostroma and Ufa. As of March 1998, these
    additional ventures were not operational. Moreover, GTS intends to enter
    into the cellular markets of additional Russian regions through its Vostok
    Mobile venture.
 
(3) Joint venture acquired in October 1997; operations commenced in February
    1998.
 
(4) Includes Vladivostok and four other cities in the Primorsky region.
 
                                       22
<PAGE>   24
 
     The following table sets forth certain operating data related to GTS
Cellular's operations:
 
<TABLE>
<CAPTION>
                                                                AT AND FOR THE
                                                                  YEAR ENDED
                                                                 DECEMBER 31,
                                                              ------------------
                                                               1996       1997
                                                              -------    -------
<S>                                                           <C>        <C>
Vostok Mobile
  Total Subscribers.........................................    6,884     13,561
  Average Revenue Per Subscriber Per Month..................  $   128    $   146
  Minutes of Use(1)(thousands)..............................   10,561     27,771
  Population Covered by Licenses (thousands)................   18,400     18,400
  Population Covered by Networks (thousands)................    6,500      6,500
  Subscriber Penetration of Population Covered by
     Networks...............................................     0.11%      0.21%
PrimTelefone
  Total Subscribers.........................................    2,822      6,152
  Average Revenue Per Subscriber Per Month(2)...............  $   236    $   188
  Minutes of Use(1)(thousands)..............................    6,919     14,270
  Population Covered by Licenses (thousands)................    2,200      2,270
  Population Covered by Networks (thousands)................    1,175      1,175
  Subscriber Penetration of Population Covered by
     Networks(2)............................................     0.24%      0.52%
Bancomsvyaz
  Cellular Network Total Subscribers........................      121      3,664
  Average Revenue Per Subscriber Per Month..................  $    62    $   160
  Minutes of Use(1)(thousands)..............................        9      5,085
  Population Covered by Licenses (thousands)................    4,500      4,536
  Population Covered by Networks (thousands)................    1,669      2,507
  Subscriber Penetration of Population Covered by
     Networks...............................................     0.01%      0.15%
  Overlay Network Minutes of Use(1)(thousands)..............       --      4,909
  Number of Ports...........................................       --        751
  Average Revenue Per Minute................................       --    $  0.34
</TABLE>
 
---------------
 
(1) Includes minutes among affiliates.
 
(2) 1997 operating data calculated using 5,212 active subscribers.
 
     Vostok Mobile. Through Vostok Mobile, GTS currently operates twelve
cellular joint ventures in Russia. Vostok Mobile owns between 50% and 70%
interests in each of the twelve Unicel Ventures with regional telephone
companies and, in one instance, a private Russian company, owning the remaining
ownership interest. The Unicel Ventures each operate an AMPS-based cellular
network, which was chosen principally because of the lower licensing fees and
equipment costs associated with AMPS operations. The Company believes that the
Unicel Ventures' AMPS-based networks can be upgraded to digital AMPS ("D-AMPS")
for an incremental capital investment. Cellular networks which utilize digital
technology, such as D-AMPS, DCS and GSM offer several advantages over analog
technology including improved overall signal and sound quality, improved call
security, potentially lower incremental infrastructure costs for additional
subscribers and the ability to provide enhanced data transmission services, such
as facsimile and e-mail. Digital technology also provides increased system
capacity. The ventures intend to convert to D-AMPS at such time as there exists
sufficient competitive pressures and/or market demand for digital services to
merit the additional investment.
 
     AMPS technology is widely used by other cellular networks throughout
Russia, making roaming commercially feasible. The Unicel Ventures have entered
into roaming agreements with other AMPS-based cellular providers, which allow
their subscribers to manually roam throughout Russia. Manual roaming, as opposed
to automated roaming, requires subscribers to notify their local cellular
providers of their travel plans in order to receive roaming capability. Vostok
Mobile is currently working with VimpelCom to develop automated roaming
standards which will provide subscribers with automated roaming capability.
 
                                       23
<PAGE>   25
 
     The Unicel Ventures, collectively, are licensed to provide cellular service
to regions with an aggregate population of approximately 18.4 million people and
the cellular networks of these ventures cover populations of approximately 6.5
million people. Over the next five years, Vostok Mobile plans to expand the
coverage of the cellular networks to approximately 9.8 million people.
 
     The Unicel Ventures are the only cellular operators in many of their
respective regions. Each region, however, has the potential for three licensed
operators, including one operator for each of the AMPS, NMT and GSM cellular
standards, and the Company expects competition to increase in the future as the
Russian economy develops and telephony demands increase. Each of the Unicel
Ventures operates independently within uniform guidelines established by Vostok
Mobile. The Unicel Ventures employ local engineering and marketing personnel,
which helps the ventures maximize their presence in their respective markets and
maintain quality control. Vostok Mobile and its ventures employed over 330
persons as of December 31, 1997, with over 290 persons employed regionally.
 
     PrimTelefone. GTS's cellular operations in Vladivostok are conducted
through PrimTelefone, a 50% owned GTS subsidiary, with the local electrosviaz
owning the remaining 50%. PrimTelefone began operations in 1995 and operates an
NMT-450 network in Vladivostok and four other cities in the Primorsky region.
PrimTelefone entered and penetrated the Vladivostok market by leveraging its
network design and full interconnection with the city telephone network. As a
result, PrimTelefone's total subscriber base has grown to 6,152 (including 5,212
active subscribers) as of December 31, 1997 and PrimTelefone has been able to
capture approximately half of the Vladivostok cellular market. PrimTelefone has
also updated its billing system, which allows it to offer automated roaming.
Although PrimTelefone has experienced significant growth, it does face
competition. PrimTelefone's only current competitor has recently upgraded its
network for more complete coverage and has been fully interconnected to the city
telephone network and may prove to be more competitive in the future.
PrimTelefone employs approximately 60 persons which include dedicated sales,
marketing and customer service personnel.
 
     PrimTelefone holds a license to provide cellular service to a region having
a population of approximately 2.2 million people and, as of December 31, 1997,
its cellular network covered an area with a population of approximately 1.2
million people. PrimTelefone plans to expand its network's coverage to
approximately 1.7 million people over the next five years.
 
     Bancomsvyaz. GTS owns a 50% economic interest in an intermediate holding
company which holds an approximately 49% interest in Bancomsvyaz, giving GTS an
indirect approximately 25% economic interest in Bancomsvyaz. The remaining
approximately 51% interest in Bancomsvyaz is owned by Bancomservice, a private
company whose principals include telecommunications industry participants in
Ukraine, and a Ukranian national. Bancomsvyaz is co-managed by GTS and
Bancomservice, with Bancomservice appointing the General Director and GTS
appointing the Chief Operating Officer, Chief Financial Officer and two Business
Line directors. The current General Director has been active in the development
of the telecommunications industry in Ukraine. Through Bancomsvyaz, GTS
participates in the operation of a cellular network and an international overlay
network. With approximately 100 employees, Bancomsvyaz markets its services and
closely monitors technical and quality-related issues.
 
     Cellular network. Bancomsvyaz operates a cellular network in Kiev utilizing
DCS-1800 cellular technology, and operates under a cellular license that covers
the Kiev oblast. Bancomsvyaz began cellular operations in 1996 by covering the
city center of Kiev and expanded its coverage to include the entire city in
1997. Bamcomsvyaz currently provides automated roaming capability in the U.K.
and has entered into a clearinghouse agreement with a European PTO which
provides Bancomsvyaz customers with automated roaming capability with all GSM
signatories with a roaming agreement with this PTO.
 
     Bancomsvyaz holds a license to provide cellular service to a region having
a population of approximately 4.5 million people and, as of December 31, 1997,
its cellular network covered an area with approximately 2.5 million people.
Bancomsvyaz plans to expand its network's coverage to approximately 3.2 million
people over the next five years.
 
                                       24
<PAGE>   26
 
     Overlay network. Bancomsvyaz provides switched traffic service through its
overlay network in Kiev. Bancomsvyaz owns and operates a partitioned mobile
switch for both its overlay and cellular businesses.
 
     Bancomsvyaz has seven central offices in the city and also provides last
mile connections (which are primarily copper) from the central offices to
customers. Local traffic is routed to the local telephone network through the
mobile switch. International traffic is routed through a government-owned
satellite dish to the GTS-Monaco Access international gateway. Bancomsvyaz
emphasizes its high quality service and markets primarily to multinational
companies, real estate developers and hotels. Bancomsvyaz is also negotiating
with Sovintel to provide a link to Moscow and plans to offer VSAT-based
connections to its network in the future.
 
     Sales and Marketing. The GTS Cellular entities have entered into agreements
with local distributors to more effectively reach their target markets.
Particular emphasis is placed on product branding. Vostok Mobile's sales and
marketing efforts are focused on the branding of its trade name, Unicel, which
is marketed and promoted at the local level by each of the Unicel Ventures. By
promoting the Unicel trade name, local ventures can emphasize their
relationships with Vostok Mobile and the other Unicel Ventures, allowing
customers to view the Unicel Ventures as integrated parts of a large cellular
organization rather than as lone, independent operators. Bancomsvyaz operates
under the trade name Golden Telecom.
 
     Customers and Pricing. GTS Cellular's customers are primarily large,
mid-sized and start-up businesses and wealthy individuals. Increases in the
number of customers for GTS Cellular's ventures is typically linked to the
economic health of the region in which such venture operates. Cellular service
is generally a premium service in the cities in which GTS Cellular operates and
is priced as such. Each venture begins with two tariff plans, a "standard"
tariff plan and a "premium" tariff plan, which includes a fixed amount of
airtime at a discounted per-minute rate. Each plan prices late night and weekend
calls at off-peak rates. The Company expects that prices will decrease as
competition increases. Connection fees are minimized in order to reduce license
fees in AMPS regions (which are partially calculated by reference to connection
fees), as well as to keep market entry costs low. GTS Cellular has benefited
from high margins generated by the sale of handsets, which are marked up in line
with other cellular operators in Russia and the CIS. Value-added services, such
as call forwarding and conference calling, when available, are priced nominally
and discounted when sold in packages. Cellular accounts are recorded in dollars
and customers remit payment in rubles at the exchange rate on the date of the
bill and, in instances permitted by law, in dollars. Ruble accounts generally
are charged a two percent conversion fee and payments in rubles are applied at
the rate of exchange on the date of payment. In order to lessen risks to its
receivables, the Company and its cellular ventures require advance payment from
all customers with prepayments averaging approximately $250 per customer or six
to eight weeks of service.
 
     Ownership and Control. GTS Cellular's Russian operations (except for the
Vladivostok operations) are conducted through ventures that are owned between
50% and 70% by Vostok Mobile, a wholly owned subsidiary of GTS. GTS Cellular's
Vladivostok and Ukrainian operations are conducted through ventures which
require partner approval for most decisions. The applicable foundation
agreements and charters do not have expiration dates. See "-- Certain
Considerations Generally Applicable to the Company's Operations -- Dependence on
Certain Local Parties; Absence of Control." Neither GTS nor any of its
respective partners in its Vladivostok or Ukrainian operations are obligated to
fund operations or capital expenditures. Losses and profits of all such ventures
are allocated to the partners in accordance with their ownership percentages, in
consideration of funds at risk. As of December 31, 1997, GTS and its partners
had made equity contributions aggregating $15.8 million and $15.3 million,
respectively, to the various GTS Cellular Ventures. Contributions made by the
partners include contributions of cash and intangible assets, such as licenses.
In addition, the various GTS Cellular Ventures had outstanding loans of $25.0
million to GTS as of December 31, 1997. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Accounting
Methodology -- Profit and Loss Accounting."
 
LICENSES AND REGULATORY ISSUES
 
     Telecommunications operators in Russia are nominally subject to the
regulations of the Regional Communications Committee (the "RCC"). As a practical
matter, national telecommunications authorities of
 
                                       25
<PAGE>   27
 
the individual CIS countries and certain regional and local authorities
generally regulate telecommunications operators in their markets through their
power to issue licenses and permits.
 
     The Communications Law sets out a comprehensive legal and regulatory
framework for the sector. It also sets forth general principles for the right to
carry on telecommunications activities, describes government involvement in
telecommunications regulation and operation, establishes the institutional
framework involved in regulation and administration of telecommunications, and
deals with various operational matters, such as ownership of networks,
protection of fair competition, interconnection, privacy and liability. This
institutional framework is implemented by separate legislation.
 
     Licenses to provide telecommunications services are issued by the MOC on
the basis of a decision by the Licensing Commission at the MOC. No new licensing
regulations have been issued since the enactment of the Communications Law and
in practice the MOC continues to issue licenses based on the Licensing
Regulations. Under the Licensing Regulations, licenses for rendering
telecommunications services may be issued and renewed for periods ranging from 3
to 10 years and several different licenses may be issued to one person. Once the
licenses are received, the licensee is required to register its right to hold
and operate under the license with Gossvyaznadzor, the national authority
responsible for monitoring compliance with regulatory and technical norms.
Renewals may be obtained upon application to the MOC and verification by
appropriate government authorities that the licensee has conducted its
activities in accordance with the licenses. Officials of the MOC have fairly
broad discretion with respect to both the issuance and renewal procedures. Both
the Communications Law and the Licensing Regulations provide that a license may
not be transferred. However, regional authorities are sometimes in a practical
position to limit these national authorities. In August 1995, the Russian
government created Svyazinvest, a holding company, to hold the federal
government's interests in the majority of Russian local telecommunications
operators. Such entities at the oblast and krai levels (administrative regions
within Russia) and two cities -- Moscow and St. Petersburg -- exercise
significant control over their respective local telephone networks.
 
     License procedures for the Company's cellular services include frequency
licensing from the MOC through a two step process. A license must first be
obtained from the MOC for permission to operate mobile cellular services on a
commercial basis in a specific standard and frequency bandwidth. Thereafter, an
approval to use specific frequencies within the band must be received from the
State Radio Frequencies Commission. Once the licenses are received,
Gossvyaznadzor confirms the rights of an operator to offer radio frequency
transmissions on specific frequencies, administers type acceptance procedures
for radio communications equipment and monitors compliance with licensing
constraints. In each instance, the Company is required to obtain additional
licenses and permits with respect to the use of equipment and the provision of
services.
 
     Telecommunications laws and regulations in Ukraine are similar in many
respects to those of Russia but are subject to greater risks and uncertainties.
Regulations currently prohibit foreign entities from directly owning more than
49% of any telecommunications operating company. GTS's Ukrainian joint venture
agreements provide it with the option of purchasing an additional one percent of
the cellular network if these rules are liberalized. The Ukrainian government
has proposed substantial frequency permit fees in connection with providing GSM
service in Ukraine, and has notified Bancomsvyaz that it has levied a $2.9
million frequency license fee on Bancomsvyaz's cellular license. At this time,
the Company is formulating its response to the government's action and expects
that the authorities will grant a ninety-day extension for payment of such fee.
The Company does not believe the outcome will have a material adverse effect on
the Company. There can be no assurance that additional fees will not be imposed
in the future.
 
     GTS's subsidiaries and ventures hold the following licenses in Russia and
Ukraine:
 
          Switched Services. In Russia, the Company holds two licenses. The
     first license was reissued to Sovintel in November 1996 and authorizes
     Sovintel to operate as an international overlay network with the ability to
     interconnect with the Moscow region and St. Petersburg public switched
     telecommunications network ("PSTN"). This license ultimately requires
     Sovintel to provide service to at least 50,000 subscribers and expires in
     May 2000. It was amended in February 1997 to cover the Leningrad region.
     The second license was reissued to SFIT, Ltd., a wholly-owned subsidiary of
     GTS in February 1997, for
                                       26
<PAGE>   28
 
     provision of intercity services in 39 regions and in Moscow with ability to
     interconnect with the PSTN. In Kiev, Ukraine, the company holds a license
     for provision of overlay network services, including international
     services, in the name of its affiliate, Bancomsvyaz. In addition, Sovintel
     is an ITU recognized private operating agency ("RPOA"), which enables it to
     maintain a separate dialing code (7-501) that can be directly dialed from
     over 170 countries. Sovintel's status as an RPOA also enables it to
     terminate calls directly with other operators. Leased Circuits. In
     September 1996 the MOC issued to Sovintel a five-year license to lease
     local, intercity and international circuits in the territory of Moscow,
     Moscow region and St. Petersburg, valid until September 2001. The total
     number of circuits leased is approximately 444 and may be increased up to a
     total authorized capacity of 2,500.
 
          Data Services. In August 1996, the MOC reissued to Sovam a 2 1/2-year
     license, effective July 1996, to provide data transmission services via a
     dedicated network to a number of oblasts and other regions covering a large
     portion of Russia. The license permits a network capacity of not less than
     5,000 customers, allows it to interconnect with other data transfer
     networks in Russia, and expires January 1, 1999. The Company's purchase of
     IAS's 33.3% interest in Sovam requires that Sovam re-register its license.
     The Company expects that the license will be re-registered.
 
          Local Access Services. In January 1997, the MOC has licensed TCM to
     provide local telephone service in Moscow to not less than 100,000
     subscriber local access lines. The license expires in May 2006. TCM has an
     agreement with MGTS to provide up to 200,000 lines, which would require an
     extension to its license, when its current capacity is reached.
 
          Cellular Services. In connection with cellular operations, Russian law
     apportions the responsibility for regulating and licensing cellular
     businesses between national and regional regulators. National
     telecommunications regulators have been assigned the responsibility of
     regulating and licensing cellular businesses utilizing the GSM and NMT-450
     cellular standards prevalent in Europe. These regulators have auctioned
     licenses to provide these services to a number of ventures that have
     included large, well capitalized western telecommunications providers such
     as U S WEST and Nokia during the last four years. Regional
     telecommunications authorities have been given the rights to supervise the
     observance of licenses by cellular businesses utilizing AMPS cellular
     standard service, which is prevalent in the United States. However, AMPS
     licenses are issued by the MOC. GTS believes that, in many instances,
     cellular operators obtaining AMPS standard licenses, particularly those in
     second tier cities, pay license fees that are lower than those paid for the
     GSM and NMT-450 "national standards". Licenses for cellular providers have
     a term of approximately 10 years.
 
          The Company's twelve Russian cellular companies have licenses which
     expire between 2005 and 2007. One of the companies initially received an
     operating license in 1994, six companies initially received an operating
     license in 1995 and five companies initially received an operating license
     in 1996.
 
          Bancomsvyaz holds a license for provision of DCS-1800 mobile services
     in the Kiev oblast.
 
COMPETITION
 
     Overview. GTS faces significant competition in virtually all of its
existing telecommunications businesses in the CIS. Many of the Company's
competitors and potential competitors, which include large multinational
telecommunications companies, have substantially greater financial and technical
resources than the Company and have the ability to operate independently or with
global or local partners and to obtain a dominant position in these markets. The
Company believes that it has a competitive advantage in each of these markets
because of its operating history, its ability to bundle a broad range of
telecommunications services in the region and its ability to make rapid
decisions in pursuing new business opportunities and addressing customer service
needs. The Company also believes that its local partnerships and reliance on
nationals in the management of its businesses and joint ventures provide it with
better knowledge of local political and regulatory structures, cultural
awareness and access to customers.
 
     International Services. Sovintel faces significant competition from more
than ten other existing service providers in Moscow, including Rostelecom and
joint ventures between local parties and multinational
 
                                       27
<PAGE>   29
 
telecommunications providers. Large competitors include the "Combellga" joint
venture, an RPOA operator in which Alcatel and the Belgian PTO participate as
foreign investors, "Comstar", a joint venture between GPT Plessey and MGTS,
providing services similar to those provided by the Company, TelMos, a joint
venture between AT&T, MGTS, Global One, through its Moscow based ventures, and
Peterstar, in Petersburg, which is part of the PLD Telekom group. Several
smaller companies, such as DirectNet, and Aerocom provide high-volume and
carrier's carrier services in Moscow. Bancomsvyaz competes in the switched
international traffic market with the Kiev electrosviaz and UTel, a joint
venture that includes Western partners with substantial capital and technical
resources who together hold a dominant share of the Kiev market. The Company
expects that market consolidation will take place among the competitive field in
international services.
 
     Domestic Long Distance Services. The Company believes its major competitors
in the Russian domestic long distance market consist of Rostelecom, the
electrosviazs, including those which are partners in the Company's TeleRoss
Ventures, and a variety of ventures that include foreign partners with
substantial financial resources. The most significant of such competitors
include: Global One, through its regional operations; Rustel, a venture that
includes Rostelecom, other Russian partners and International Business
Communication Systems, a Massachusetts telecommunications firm; Belcom, a
private company in which Comsat has a majority interest and which provides VSAT
services primarily to the energy sector; Satcom, a Russian joint venture
licensed to provide local, long distance and international service over private
and public switched networks; Teleport TP, a satellite overlay company jointly
owned by Rostelecom and Petersburg Long Distance that provides satellite
teleports in cities throughout Russia; and Comincom, a Russian private venture.
In the Russian far east, TeleRoss competes with Vostok Telecom, which is owned
by the Japanese companies KDD and NIC and certain Russian partners; and Nakhodka
Telecom, which is owned by Cable & Wireless and certain Russian partners.
 
     GTS both cooperates and competes with Rostelecom. Rostelecom provides only
international and long distance services to international carriers and regional
electrosviazs, and does not provide end-to-end customer services. GTS provides
last mile, account management, and transit services for Rostelecom in Moscow,
and uses Rostelecom channels and switches for both international and long
distance services. GTS provides long distance and international services on an
end-to-end basis, using service elements of Rostelecom, the electrosviazs and
its own resources. However, Rostelecom does compete with Teleross, in that
Teleross provides intercity services to customers, using satellite channels
provided by other state agencies (Intersputnik), and provides transit services
to various electrosviazs, on a traffic overflow basis.
 
     GTS believes that it enjoys a number of competitive advantages in the
Russian domestic long distance market, the most important being the maturity of
its international and data service businesses in Russia. This provides GTS with
access to the services, customers, products, licenses and facilities of its
other businesses. The Company also believes that it has more experienced
management, a more comprehensive strategy to build out a nationwide long
distance network and stronger relationships with many regional telephone
companies and with satellite capacity providers, such as Intersputnik, than most
of its competitors. In addition, the Company believes that it does not have any
significant competitor in the regional inter-city market (i.e., calls between
Russian cities other than Moscow or St. Petersburg).
 
     Data Services. Sovam has several primary competitors in the market for data
services: Global One, which began packet-switched service in Moscow and St.
Petersburg in June 1992, under the Sprint Networks venture; Demos, an Internet
service provider; and Relcom, a cooperative affiliation of computer users that
relies on an older generation of technology that supplies slower and lower-cost
messaging facilities to customers (primarily domestic commodities traders) that
do not require higher levels of service. In addition MCI and Rostelecom have
recently announced their agreement to create a national Internet access network
utilizing Rostelecom's domestic network and MCI's international infrastructure.
Rostelecom has also announced the formation of a new Internet services company
called RTK Internet, with Relcom as its partner. Although Sovam's business has
grown quickly, the Company believes that Global One is the market leader. GTS
believes that other potential competitors, including foreign PSTNs, Infotel,
Infocom and Glasnet, are also active in this market.
 
                                       28
<PAGE>   30
 
     Although the Company faces significant competition in this market, it
believes that it enjoys certain competitive advantages, including the ability to
reach a wide area throughout Russia through TeleRoss, innovative service
offerings such as Russia On Line, the maturity of its business in the key
banking services segment, high levels of customer service and support, and high
speed digital channels through TeleRoss.
 
     Local Access Services. The Company believes that its major competition in
the Moscow local access market consists of a number of ventures with Western
partners, including Telmos (which includes AT&T), Comstar (which includes GPT
Plessey), and Combellga. However, since TCM has obtained an allocation of up to
100,000 numbers, the Company believes that TCM will account for a substantial
proportion of the new capacity to come onto the market within the next five
years.
 
     Cellular Services. Most Russian cellular markets have the potential for
three licensed operators, including one operator for each of the GSM and NMT-450
cellular standards, which Russia has adopted as national standards, and one
operator using the AMPS cellular standard, which has been set as a regional
standard. Many large Western telecommunications operators, including U S WEST,
Deutsche Telekom, STET, Midcom and Millicom, have participated in auctions for
licenses to provide GSM and NMT-450 cellular service to certain significant
Russian urban centers. In addition, a CDMA auction is likely to occur in the
future which could result in one or more CDMA operators entering the market. In
Ukraine, Bancomsvyaz competes primarily with an NMT operator and a GSM operator
in Kiev. Additional GSM licenses were auctioned off in early 1997 and other GSM
operators may enter other markets in 1998.
 
CERTAIN CONSIDERATIONS APPLICABLE TO THE COMPANY'S OPERATIONS IN RUSSIA AND THE
CIS
 
     Substantially all of the Company's revenue is derived from operations in
Russia and the CIS. Foreign companies conducting operations in the former Soviet
Union face significant political, economic, and legal risks.
 
     Political. The political systems of Russia and the other independent
countries of the CIS, which are in a stage of relative infancy, are vulnerable
to instability due to the populace's dissatisfaction with reform, social and
ethnic unrest and changes in government policies. Such instability could lead to
events that could have a material adverse effect on the Company's operations in
these countries. In recent years, Russia has been undergoing a substantial
political transformation. During this transformation, legislation has been
enacted to protect private property against expropriation and nationalization.
However, due to the lack of experience in enforcing these provisions in the
short time they have been in effect and due to potential political changes in
the future, there can be no assurance that such protections would be enforced in
the event of an attempted expropriation or nationalization. Expropriation or
nationalization of the Company, its assets or portions thereof, whether by an
outright taking or by confiscatory tax or other policies potentially without
adequate compensation, would have a material adverse effect on the Company.
 
     The various government institutions and the relations between them, as well
as the government's policies and the political leaders who formulate and
implement them, are subject to rapid and potentially violent change. For
example, the Constitution of the Russian Federation gives the President of the
Russian Federation substantial authority, and any major changes in, or rejection
of, current policies favoring political and economic reform by the President may
have a material adverse effect on the Company. In March 1998, President Yeltsin
dismissed his entire cabinet, including Prime Minister Victor Chernomyrdin,
citing, among other things, a need for more dynamism and initiative in the
Russian government. It was unclear, however, how the change will affect
governmental policy and constitutional issues, including the identity of
President Yeltsin's successor if he were not to survive his term of office. In
addition, it was uncertain whether the resolution of these and other issues
could have a material adverse effect on the Company.
 
     Furthermore, the political and economic changes in Russia have resulted in
significant dislocations of authority. The local press and international press
have reported that significant organized criminal activity has arisen and high
levels of corruption among government officials exist where the Company
operates. While the Company does not believe it has been adversely affected by
these factors to date, no assurance can be given that organized or other crime
will not in the future have a material adverse effect on the Company.
 
                                       29
<PAGE>   31
 
     Economic. Over the past five years the Russian government has enacted
reforms to create the conditions for a more market-oriented economy. Despite
some progress in implementing its reforms, including progress in reducing
inflation and stabilizing the currency and industrial production, there remains
generally rising unemployment and underemployment, high government debt relative
to gross domestic product and high levels of corporate insolvency. No assurance
can be given that reform policies will continue to be implemented and, if
implemented, will be successful, that Russia will remain receptive to foreign
trade and investment or that the economy will improve.
 
     In addition, Russia, the CIS and other emerging countries in which the
Company operates currently receive substantial financial assistance from several
foreign governments and international organizations. To the extent any of this
financial assistance is reduced or eliminated, economic development in Russia,
the CIS and such other countries may be adversely affected.
 
     Russian and CIS businesses have a limited operating history in
market-oriented conditions. The relative infancy of the business culture is
reflected in the Russian banking system's under-capitalization and liquidity
crises. There have been concerns about rumors that many Russian banks continue
to have cash shortages. The Russian Central Bank has reduced banks' reserve
requirements in order to inject more liquidity into the Russian financial
system, but has stressed that it will not bail out the weaker banks. Many of
these banks are expected to disappear over the next several years as a result of
bank failure and anticipated consolidation in the industry. A general Russian
banking crisis could have a material adverse effect on the Company's operations
and financial performance and on the viability of the Company's receivables.
 
     Regulation of the Telecommunications Industry. The Russian
telecommunications system is currently regulated largely through the issuance of
licenses. There is currently no comprehensive legal framework with respect to
the provision of telecommunications services in Russia, although a number of
laws, decrees and regulations govern or affect the telecommunications sector. As
a result, ministry officials have a fairly high degree of discretion to regulate
the industry. Although telecommunication licenses may not be transferred under
Russian law, the Russian MOC has adopted the position that licensees may enter
into agreements with third parties in connection with the provision of services
under the licensee's license; however, the MOC does not generally review
agreements entered into by licensees. There can be no assurances that the
current or future regulation of the Russian telecommunications systems will not
have a material adverse effect on the Company.
 
     Current Russian legislation governing foreign investment activities does
not prohibit or restrict foreign investment in the telecommunications industry.
However, on February 28, 1997, the State Duma, the lower house of parliament,
approved, on the first reading, draft foreign investment legislation which would
restrict any significant future foreign investment in numerous sectors of the
Russian economy, including telephone and radio communications. It is unlikely
that such restrictive legislation will be enacted, unless the political climate
changes dramatically. See "-- Political." More likely is the emergence of
restrictions on foreign investment in strategic industries, which could result
in foreign ownership limitations in industries such as telecommunications which
are not uncommon in many countries. The draft legislation has been referred to
the Russian government for comment. For such draft legislation to become Federal
law, it must be passed by a majority vote of the State Duma at another two
readings, then be approved by a majority of the Federation Council, the upper
house of parliament, and signed by the President of the Russian Federation.
Rejection of such legislation by the Federation Council can be overridden by a
two-thirds majority of the State Duma. Rejection of such legislation by the
President can be overridden by a two-thirds majority of each of the Federation
Council and the State Duma. As of March 1998, there had not been any readings of
the draft legislation beyond the first reading. There can be no assurance that
future regulation of foreign investment in the telecommunications industry will
not have a material adverse effect on the Company.
 
     In addition, a lack of consensus exists over the manner and scope of
government control over the telecommunications industry. Because the
telecommunications industry is widely viewed as strategically important to
Russia, there can be no assurance that recent government policies liberalizing
control over the telecommunications industry will continue. Any change in or
reversal of such governmental policies could have a material adverse effect on
the Company. See "-- Russia and the CIS -- Licenses and Regulatory Issues."
                                       30
<PAGE>   32
 
     Legal Risks. As part of the effort to transform their economies into more
market-oriented economies, the Russian and other CIS governments have rapidly
introduced laws, regulations and legal structures intended to give participants
in the economy a greater degree of confidence in the legal validity and
enforceability of their obligations. Risks associated with the legal systems of
Russia and the other independent republics of the CIS include (i) the untested
nature of the independence of the judiciary and its immunity from economic,
political or nationalistic influence; (ii) the relative inexperience of judges
and courts in commercial dispute resolutions and generally in interpreting legal
norms; (iii) inconsistencies among laws, presidential decrees, government
resolutions and ministerial orders; (iv) frequently conflicting local, regional
and national laws, rules and regulations; (v) the lack of legislative, judicial
or administrative guidance on interpreting the applicable rules; and (vi) a high
degree of discretion on the part of government authorities and arbitrary
decision making which increases, among other things, the risk of property
expropriation. The result has been considerable legal confusion, particularly in
areas such as company law, commercial and contract law, securities and antitrust
law, foreign trade and investment law and tax law. Accordingly, there can be no
assurance that the Company will be able to enforce its rights in any disputes
with its joint venture partners or other parties in Russia or the CIS or that
its ventures will be able to enforce their respective rights in any disputes
with partners, customers, suppliers, regulatory agencies or other parties in
Russia or that the Company can be certain that it will be found to be in
compliance with all applicable laws, rules and regulations.
 
     Russia has adopted currency and capital transfer regulations designed to
prevent the flight of capital from its borders. These regulations require
certain licenses for the movement of capital, which includes the incurrence and
repayment of indebtedness and the payment of capital contributions in foreign
exchange to Russian entities. The Company is resolving licensing issues with
respect to certain intercompany loans and capital contributions with the
applicable government agencies and believes that any licensing irregularities
that may arise will not have a material adverse effect on its financial
condition or results of operations. There can be no assurance, however, that
Russian government authorities will not take an unexpected adverse position
which could materially adversely affect the Company's business.
 
     Taxes. Generally, taxes payable by Russian companies are substantial. In
addition, taxes payable by Russian companies are numerous and include taxes on
profits, revenue, assets and payroll as well as value-added tax ("VAT").
Moreover, statutory tax returns of Russian companies are not consolidated and
therefore, each company must pay its own Russian taxes. Because there is no
consolidation provision, dividends are subject to Russian taxes at each level.
Currently, dividends are taxed at 15% and the payor is required to withhold the
tax when paying the dividend, except with respect to dividends to foreign
entities that qualify for an exemption under treaties on the avoidance of double
taxation. To date, the system of tax collection has been relatively ineffective,
resulting in the continual imposition of new taxes in an attempt to raise
government revenues. This history, plus the existence of large government budget
deficits, raises the risk of a sudden imposition of arbitrary or onerous taxes,
which could adversely affect the Company.
 
     Because of uncertainties associated with the laws and regulations of the
Russian tax system and the increasingly aggressive interpretation, enforcement
and collection activities of the Russian tax authorities, the Company's Russian
taxes may be in excess of the estimated amount expensed to date and accrued on
the Company's balance sheets. It is the opinion of management that the ultimate
resolution of the Company's Russian tax liability, to the extent not previously
provided for, will not have a material adverse effect on the financial condition
of the Company. However, depending on the amount and timing of an unfavorable
resolution of this contingency, it is possible that the Company's future results
of operations or cash flows could be materially affected in a particular period.
 
     In various foreign jurisdictions, the Company is obligated to pay VAT on
the purchase or importation of assets, and for certain other transactions. In
many instances, VAT can be offset against VAT which the Company collects and
otherwise would remit to the tax authorities, or may be refundable. Because the
law in some jurisdictions is unclear, the local tax authorities could assert
that the Company is obligated to pay additional amounts of VAT. In the opinion
of management, any additional VAT which the Company may be obligated to pay
would not be material.
 
                                       31
<PAGE>   33
 
  Exchange Controls and Repatriation Risks Relating to Russian Securities
 
     Russia has adopted currency and capital transfer regulations designed to
prevent the flight of capital from its borders. These regulations require
certain licenses for the movement of capital, which includes the incurrence and
repayment of indebtedness and the payment of capital contributions in foreign
exchange to Russian entities. The Company is resolving licensing issues with
respect to certain intercompany loans and capital contributions with the
applicable government agencies and believes that any licensing irregularities
that may arise will not have a material adverse effect on its financial
condition or results of operations. There can be no assurance, however, that
Russian government authorities will not take an unexpected adverse position
which could materially affect the Company's business.
 
     No assurance can be given that Russian foreign investment and currency
legislation will continue to permit repatriation of the proceeds from
investments. Furthermore, no assurance can be given that further restrictions
will not be imposed on the conversion of ruble earnings into foreign currency
for purposes of making dividend payments or on the repatriation of profits. If
any such further restrictions were imposed, they would have a material adverse
effect on the Company's interests in Russia.
 
     In Russia, where the Company derives most of its revenue, the ruble has
generally experienced a steady depreciation relative to the U.S. Dollar over the
past three years, although there has been some instability in the ruble exchange
rate over this period of time. The Company's tariffs are denominated in U.S.
Dollars but charges are invoiced and collected in rubles, while the Company's
major capital expenditures are generally denominated and payable in various
foreign currencies. To the extent such major capital expenditures involve
importation of equipment and the like, current law permits the Company to
convert its ruble revenues into foreign currency to make such payments. The
ruble is generally not convertible outside Russia. A market exists within Russia
for the conversion of rubles into other currencies, but it is limited in size
and is subject to rules limiting the purposes for which conversion and payment
may be effected. The limited availability of other currencies may tend to
inflate their values relative to the ruble and there can be no assurance that
such a market will continue to exist indefinitely. Moreover, the banking system
in Russia is not yet as developed as its Western counterparts and considerable
delays may occur in the transfer of funds within, and the remittance of funds
out of, Russia. Any delay in converting rubles into a foreign currency in order
to make a payment or delay in the transfer of such foreign currency could have a
material adverse effect on the Company. In addition, since November 1997,
Russian monetary authorities have pegged the ruble/U.S. dollar exchange rate to
fluctuate within a certain narrow range. It is uncertain whether the Russian
authorities will be able to maintain this exchange rate and there can be no
assurance that there will not be a significant and sudden decline in the value
of the ruble. Such a devaluation of the ruble could have a material adverse
effect on the Company and its results of operations and on the Russian economy
generally.
 
  Dependence on Key Personnel
 
     The Company believes that its growth and future success will depend in
large part upon the efforts of a small number of key executive officers, as well
as on its ability to attract and retain highly skilled and qualified personnel
to work in the emerging markets in which it operates, particularly in Russia and
the CIS. The competition for qualified personnel in the telecommunications
industry is intense, particularly in emerging markets where the Company operates
and, accordingly, there can be no assurance that the Company will be able to
hire and retain qualified personnel. Although the Company believes it has
maintained a strong management team, there can be no assurance as to what effect
such personnel changes will have on the Company's operations in Russia and the
CIS.
 
WESTERN EUROPE
 
OVERVIEW
 
     GTS seeks to position itself as the leading independent carriers' carrier
within Western Europe through the development of two ventures, HER and
GTS-Monaco Access. HER's objective is to become the leading pan-European
carriers' carrier by providing centrally managed cross-border telecommunications
transmission capacity to telecommunications companies including traditional PTOs
and New Entrants on an approximately
 
                                       32
<PAGE>   34
 
18,000 kilometer high capacity fiber optic network designed to interconnect a
majority of the largest Western and Central European cities. As of April 1,
1998, HER's network will link Brussels, Antwerp, Rotterdam, Amsterdam,
London,Paris, and Frankfurt. HER expects the initial five country network and
Switzerland to be placed in operation in the second quarter of 1998. This
segment of the network is expected to deliver managed transport services over
approximately 3,800 kilometers of fiber optic cable linking the cities of
London, Rotterdam, Amsterdam, Antwerp, Brussels, Paris, Dusseldorf, Frankfurt,
Stuttgart, Munich, Geneva and Zurich. The full 18,000 kilometer network is
expected to become fully operational during the year 2000. HER also plans to
lease capacity on a transatlantic cable linking the European network with North
America and is exploring various interconnectivity options to Russia and Asia.
Such intercontinental interconnectivity will help HER satisfy the needs of its
European customers with respect to outgoing traffic and attract additional
non-European customers with traffic terminating in Europe. HER commenced
commercial service over the Brussels-Amsterdam portion of the network in late
1996, and the London-Paris portion in November 1997. GTS-Monaco Access operates
an international gateway in Monaco in partnership with, and utilizing the
existing gateway infrastructure of, the Principality of Monaco and provides
transit and routing of international calls to other telecommunications
operators. Through its HER and GTS-Monaco Access ventures, GTS is building a new
network for transporting voice, data and multimedia/image traffic for other
carriers throughout Western and Central Europe and for worldwide international
voice, data and multimedia/image traffic that either originates or terminates
in, or transits through, Western and Central Europe.
 
     The Company believes that the international segment of the Western and
Central European telecommunications market will be an attractive market for new
telecommunications entrants because of its large size, the high operating costs
and low productivity of current providers, and the barriers to entry created by
the need to control a network and its rights-of-way.
 
     The European telecommunications market has historically been dominated by
monopoly PTOs. This system has ensured the development of broad access to
telecommunications services in Europe, but it has also restricted the growth of
high quality and competitively priced pan-European voice and data services. The
current liberalization occurring in Europe is intended to address these
structural deficiencies by breaking down PTO monopolies, allowing new
telecommunications operators to enter the market and increasing the competition
within the European telecommunications market. In March 1996, the European
Commission adopted a directive (the "Full Competition Directive") requiring the
full liberalization of all telecommunications services in most EU member states
by January 1, 1998. The Company expects that full liberalization in these
European countries will lead to the emergence of New Entrants with new and
competitive service offerings. HER expects this increase in competition will
result in lower prices and a substantial increase in the volume of traffic and
range of telecommunication services provided. HER believes that as a result of
the increased call volume and growth in value added services, participants in
these markets will require significant amounts of new cross-border
telecommunications transport capacity to provide their services.
 
     The Hermes network will offer PTOs and New Entrants an attractive
alternative for the transport of cross-border European telecommunications
traffic. In the traditional system, PTOs own and control circuits only within
their national borders, and as a result, cross-border traffic must be passed
from one PTO to another PTO at the national boundary. No single PTO therefore
owns or controls end-to-end circuits for cross-border calls. The alternative for
carriers of this traffic will be to build their own transport capacity or use
International Private Leased Circuits ("IPLCs") which are provisioned by
combining half-circuits on the networks of two or more PTOs. The Company
believes that there are a number of problems with these options that result in
HER being well-positioned to become the leading independent carriers' carrier in
Western and Central Europe. In particular, building their own transport capacity
is unlikely to be an attractive option for most carriers because of the high
traffic volumes required to justify the expense, the need to focus resources on
marketing and customer service, the time commitment and the regulatory and
administrative complexities involved, particularly in obtaining the rights of
way across national borders. Likewise, IPLCs provided by the PTOs also have a
number of disadvantages, including high prices, lack of end-to-end quality
control, lack of redundancy, low quality due to diversity of network systems and
equipment, limited availability of bandwidth and long lead times for
provisioning.
 
                                       33
<PAGE>   35
 
HER
 
     HER's objective is to become the leading pan-European carriers' carrier by
providing centrally managed cross-border telecommunications transmission
capacity to telecommunications companies including PTOs and New Entrants. HER
intends to offer these target customers a better transport system than is
currently available in Europe with a higher and more consistent level of
transmission quality, redundancy, network functionality and service across
Europe at lower prices. Development of the HER network is dependent upon, among
other things, HER's continuing ability to obtain the necessary financing,
rights-of-way, licenses and other regulatory approvals in a timely and
cost-effective manner.
 
     HER is developing an approximately 18,000 kilometer, pan-European high
capacity fiber optic network designed to interconnect a majority of the largest
Western and Central European cities. Each access point of the network will be
placed in operation as it is linked to the network. HER intends to build the
network using the most accessible and cost-efficient infrastructure base in each
of the regions served, including using rights-of-way and existing infrastructure
of railways, motorways, pipeline companies, waterways and power companies. HER
plans a flexible approach to the network build-out plan and intends to fine-tune
the scope, route and design of the network based upon the evaluation of customer
demand. Historically, HER has experienced substantial delays in concluding these
agreements and developing its network. There can be no assurance that HER will
be successful in concluding necessary agreements, or that delays in concluding
such agreements will not materially and adversely affect the speed or successful
completion of the network. The successful and timely completion of the network
will also depend on, among other things, (i) the availability to HER of
substantial amounts of additional capital and financing, (ii) timely performance
by various third parties of their contractual obligations to engineer, design
and construct portions of the network and (iii) HER's ability to obtain and
maintain applicable governmental approvals.
 
     HER expects to roll out full telecommunications service over the initial
five country network and Switzerland in the second quarter of 1998, as discussed
below, and the 18,000 kilometer network to be operational during the year 2000.
Although HER believes that its cost estimates and the build-out schedule are
reasonable, there can be no assurance that the actual construction costs or time
required to complete the network build-out will not substantially exceed current
estimates. Any significant delay or increase in the costs associated with
development of the HER network could have a material adverse effect on HER and
the Company.
 
     HER expects to continue to roll-out full telecommunications transport
service on the initial network in the first five countries and Switzerland
linking the additional cities of Dusseldorf, Stuttgart, Munich, Zurich and
Geneva by June 30, 1998. This initial network is expected to consist of
approximately 3,800 kilometers of fiber optic cable covering countries which, in
1995, originated over 60% of all outgoing calls and terminated over 60% of all
incoming calls in the countries to be served by the full network. HER's Network
Operations Center located in Brussels, Belgium and its backup center located in
Antwerp, Belgium are fully operational and house network management and customer
support services which operate 24 hours a day, seven days a week. Billing and
customer service functions are also operational. Network coverage is planned to
be expanded to include the cities Berlin, Stockholm, Copenhagen, and Milan in
the third quarter of 1998. By the year 2000, the 18,000 kilometer HER network is
expected to have points of presence in at least 33 cities in 15 European
countries, including Southern and Central Europe. HER also plans to lease
capacity on a transatlantic cable linking the European network with North
America and is exploring various interconnectivity options to Russia and Asia.
 
     HER has entered into agreements for the construction and/or lease of fiber
optic routes for the initial network in the first five countries. Contracts have
been concluded with respect to the portion of the network connecting Germany
with each of France, the Netherlands and Switzerland. Additional contracts have
been concluded in Switzerland, Denmark, Sweden, Spain and Italy. HER continues
to negotiate rights-of-way and other infrastructure arrangements in order to
extend its network in Western Europe. HER will need to negotiate similar
agreements to complete the network in four Central European countries. Buildout
of the HER network is subject to numerous risks and uncertainties that could
delay deployment or increase the costs of the network, or make the network
commercially unfeasible.
 
                                       34
<PAGE>   36
 
     Development of the HER network is capital intensive. Management expects
that approximately $290 million in capital expenditures will be incurred in
connection with the buildout of the HER network, with approximately $35 million
required for the roll out of the initial five country network that is expected
to be completed in the second quarter of 1998. While HER raised approximately
$265 million in a private placement of its senior notes in August 1997 (of which
$56.6 million has been placed in escrow for the first two years' interest
payments on the notes), additional financing may need to be obtained to
construct the HER network and there can be no assurance that such additional
financing will be completed. Failure to obtain necessary financing may require
HER to delay or abandon its plans for deploying the remainder of the network and
would adversely affect the viability of HER, or may require the Company to make
additional capital contributions to HER at the expense of the Company's other
operations, either of which could have a material adverse effect on the
operations of the Company. HER's revenues and the cost of deploying its network
and operating its business will depend upon a variety of factors including,
among other things, HER's ability to (i) effectively and efficiently manage the
expansion of its network and operations, (ii) negotiate favorable contracts with
suppliers, (iii) obtain additional licenses, regulatory approvals, rights-of-way
and infrastructure contracts to complete and operate the network, (iv) access
markets and attract sufficient numbers of customers and (v) provide and develop
services for which customers will subscribe. HER's revenues and costs are also
dependent upon factors that are not within HER's control such as regulatory
changes, changes in technology, increased competition and various factors such
as strikes, weather and performance by third-parties in connection with the
development of the network. Due to the uncertainty of these factors, actual
costs and revenues may vary from expected amounts, possibly to a material
degree, and such variations would likely affect HER's future capital
requirements. HER must obtain additional infrastructure provider agreements for
the long-term lease of dark fiber, rights-of-way and other permits to install
fiber optic cable from railroads, utilities and governmental authorities to
build out the network. There can be no assurance that HER will be able to
maintain all of its existing agreements, rights and permits or to obtain and
maintain the additional agreements, rights and permits needed to implement its
business plan on acceptable terms. Loss of substantial agreements, rights and
permits or the failure to enter into and maintain required arrangements for the
HER network could have a material adverse effect to enter on HER's business. In
addition, HER depends on third parties for leases of dark fiber for substantial
portions of its network. There can be no assurance that HER will be able to
enter into and maintain required arrangements for leased portions of the HER
network, which could have a material adverse effect on HER's business.
 
     HER was formed on July 6, 1993 by HIT Rail B.V. ("Hit Rail"). Hit Rail was
incorporated in 1990 by eleven national railways to carry out telecommunications
engineering activities in order to construct and exploit a data communications
network for railway traffic. GTS-Hermes, Inc., a Delaware corporation
("GTS-Hermes") purchased a 34.4% interest in HER in 1994 and has increased its
interest to 50% in 1995 and to 79% in 1997. In March 1998, GTS-Hermes increased
its ownership of HER to 89% by purchasing a portion of Hit Rail's ownership
interest in HER. GTS-Hermes is a wholly owned subsidiary of GTS.
 
  BUSINESS AND MARKETING STRATEGY
 
     The overall strategy of HER is to offer PTOs and New Entrants pan-European
cross-border telecommunications transport services to help them, in turn, more
successfully meet the needs of their end-user customers. The HER network also
provides a vehicle through which a carrier can compete in markets where it does
not own infrastructure. HER expects to enter the market ahead of similar
competition and encourage a wide variety of carriers to use its network with
service offerings that meet their needs. HER's primary service offerings are
large-capacity circuits for "wholesale" customers such as PTOs and New Entrants.
HER's focus on carriers is designed to complement and not compete with carriers'
own business objectives in providing services to end-users.
 
     To establish HER as the leading carriers' carrier for international
telecommunications within Europe, HER offers its customers significantly higher
quality transmission and extended/advanced network capabilities at a competitive
price by focusing on the following:
 
          High Capacity International Network Facilities. The HER network is
     designed to offer its customers access to high capacity network facilities
     outside their domestic markets, providing cross-border
                                       35
<PAGE>   37
 
     capabilities without requiring customers to invest in network
     infrastructure or being constrained by a narrow range of capacity
     offerings. With STM-64 technology and Wavelength Division Multiplexing
     ("WDM") upgrades, HER's fiber deployment plan provides for the equivalent
     of 128 fiber pairs of capacity across Europe.
 
          Uniform Network Architecture. The HER network is designed to offer
     managed transport services from country to country and across multiple
     countries utilizing a single uniform network, in contrast to services
     currently available that use multiple providers over several networks with
     varying technologies and each under the control of separate, not
     necessarily compatible, network control systems. The HER network's uniform
     technology enhances service by providing quality and reliability as well as
     uniformity of features throughout the network.
 
          Diverse Routing. The HER network architecture includes diverse,
     redundant routes that are designed to provide high levels of reliability.
     The network is designed to provide availability of over 99.98% for most
     routes and to provide customers with a wide range of telecommunications
     transmission capacity. To achieve this level of reliability without the use
     of a network similar to the HER network, HER believes that carrier
     customers would need to purchase additional dedicated circuits to provide
     for redundancy.
 
          Rapid Provisioning. HER services provide access to the network, such
     that additional capacity can be provided to customers on the HER network on
     a rapid basis. This access provides a level of capabilities that HER
     believes is unavailable in Europe today. This ability to rapidly provide
     service is largely due to HER's development of capacity substantially in
     excess of HER's forecasted requirements.
 
     - Flexibility. HER services are focused on providing customers flexibility
       across the network through which the customer may minimize risk by
       enabling network rerouting, eventually even under customer direct
       control.
 
     - Advanced Technology. HER is deploying SDH technology which, by using WDM
       techniques and hardware, is upgradeable and will permit significant
       expansion of transmission capacity without increasing the number of fiber
       pairs in the network. This technology also provides the basis for
       structuring advanced operating features, such as virtual private network
       service and ATM-based services. Additionally, the SDH technology deployed
       by HER may be upgraded.
 
     - Innovative Pricing. Currently the price of high-bandwidth E1 equivalent
       circuits on transborder European routes is artificially high and not
       necessarily related to the cost of such circuits. HER offers competitive
       pricing. HER also offers highly tailored contract terms and volume
       discounts, which allow carrier customers to plan more efficiently the
       fixed costs of their service portfolio. Customers can select varying
       capacity, access, guaranteed availability and contract terms at
       competitive prices. Customers sourcing from PTOs are generally limited to
       order from a very narrow set of capabilities offered under inflexible
       pricing plans.
 
     Although HER and GTS have relationships with certain PTOs or other access
providers for specific projects, they do not have wide-ranging alliances with
any of the major consortia or large Western telecommunications companies.
Additionally, HER's strategy calls for it to focus on carriers' carrier
services, so that it will limit overlap of target markets with its carrier
customers in end user markets. HER believes that this independence will make it
an attractive service provider for carriers who may otherwise be reluctant to
obtain services from other providers of intra-European transport that also may
be their competitors in the retail market.
 
SERVICES
 
     HER's primary service is large capacity cross-border European circuits
provided to carriers and service providers over an integrated, managed
pan-European network structure thus providing a service for wholesale customers
such as PTOs and New Entrants. The HER network will be based on SDH technology,
which provides for digital transmission capability upon which a broad range of
advanced functionality may be built
 
                                       36
<PAGE>   38
 
and which offers network availability, flexibility, bandwidth speeds and error
performance not otherwise available to carriers for transport of
telecommunications traffic across national borders in Western and Central
Europe. The network is designed to provide customers with a wide variety of
bandwidth speeds, ranging from VC12/E1 Standard (equivalent to 2.048 Mbps) to
STM-1/E4 Standard (equivalent to 155 Mbps) and beyond.
 
     HER will provide high quality cross-border transmission services for
licensed or otherwise authorized telecommunications providers. Services are
based on the principle of adding greater value than currently available in the
market while retaining competitive prices.
 
     Point-to-Point Transport Service. The current market for cross-border
transport is served by IPLCs provided by PTOs. IPLCs are formed by combining
half-circuits from two PTOs between customer locations, often with additional
PTOs providing transit segments. Under the IPLC service, overall service quality
guarantees generally are not provided and only a limited range of bandwidth is
available, usually only E1 and in certain instances, E3. The Company believes
that HER's Point-to-Point Transport Service will be a major improvement to the
PTO-based approach because it provides a greater range of bandwidths (from 2
Mbps (E1 or VC-12) to 140/155 Mbps (E4 or VC-4)) and allows customers to choose
a service level agreement with guarantees appropriate for their applications,
including guarantees for on-time service delivery and service availability.
 
     Point-to-Point Transport Service consists of two services, "Integrated" and
"Node-to-Node." The HER "Integrated" service provides an end-to-end service
between customer-specified locations where the customer can request for HER to
arrange for "last mile" services from the HER node location to the customer's
location. The HER "Node-to-Node" service can be selected when the customer
prefers to provide its own services to reach the local HER node location. In
Node-to-Node Service, HER guarantees service only on its portion of the network
between HER nodes. Both services are competitively priced relative to current
service offerings. A premium is charged for the highest guaranteed level of
service which incorporates an end-to-end, fully diverse, protected, "Integrated"
service. The customer can choose flexible contract terms from one to five or
more years' duration, with volume discount schemes designed to ensure that HER
remains a cost-effective solution.
 
     Virtual Infrastructure Service. Carriers and operators that plan to expand
their operations to become pan-European service providers as the European
marketplace is liberalized require a flexible and cost-effective means of
telecommunications transport. To date such service providers obtain
international transport service by leasing IPLCs. Leasing IPLCs requires a
carrier to lease channels on a segment-by-segment basis from multiple PTOs,
linking the target cities under arrangements having fixed capacity and pricing
structure for each segment of the carrier's network. Leasing IPLCs has several
disadvantages, including (i) difficulty in obtaining discount/volume pricing
schemes since there is no single provider of pan-European coverage, (ii) delays
in implementation due to numerous contractual negotiations and having to
interconnect numerous IPLCs, (iii) limited availability of pan-European leased
capacity at high bandwidth and (iv) variability of quality due to multiple
operators and the absence of a single uniform network. Operators could also
construct their own network, which is expensive, time-consuming and complex and
which may not be justified by such operators' traffic volume.
 
     HER's Virtual Infrastructure Service will offer a new solution and an
attractive alternative to leasing IPLCs or building infrastructure. This service
will enable HER's customers to obtain a uniform pan-European or cross-border
network under one service agreement by allowing the customer to select any
number of cities along the HER network at a pricing structure based on the
overall amount of leased capacity for the customer's entire network. The key
feature behind Virtual Infrastructure Service is that it gives the customer the
ability to add or reconfigure capacity in 24 hours between locations connected
in the Virtual Infrastructure Service, thereby enabling the customers to respond
almost immediately to changes in traffic. By being able to transfer capacity
among the network routes, HER's customers are able to avoid over- and
under-utilization of leased channels. This service offering provides a customer
with the benefits of ownership (rapid provisioning, freedom to rearrange and
control) with a "pay-as-you-go" managed service offering, without the burdens of
 
                                       37
<PAGE>   39
 
up-front investment and costs required to build a network, and without having to
manage the on-going maintenance and operation of the network.
 
     The service would be delivered through pre-installed physical facilities at
each of the customer locations. These facilities are designed to ensure that
most growth or changes in customer requirements can be addressed purely by
remote logical reconfiguration from the HER Network Operations Center. This
remote network management ability is inherent in SDH technology and allows rapid
provisioning and high quality of service.
 
     Ring Service. Most medium to large carriers and operators purchase network
capacity in excess of actual requirements, and prefer to have physical
configuration control over their networks. The HER Ring Service connects
multiple customer locations with multiple VC-4 paths in a ring configuration.
The customer has direct control over the configuration of the VC-3 and VC-12
paths within the ring, and has exclusive control over the routing. Additional
ring capacity can be added with no service interruption and additional customer
locations may be added to the ring with minimal service interruption. Because
HER is not required to configure 'idle' bandwidth or to manage the 'SDH subnet'
this service can be provided at a very competitive rate vis-a-vis other
point-to-point services.
 
     Sales and marketing of HER's services are conducted through its sales and
marketing department, which includes a director and senior sales managers
responsible for various regions and customer segments. Additionally, HER expects
that certain of its railway shareholders and/or railway or other infrastructure
providers that develop domestic telecommunications businesses, or other local
network access providers, can provide an effective distribution channel to
smaller carrier customers.
 
PRICING
 
     Currently the price of cross-border pan-European calls are often
significantly higher than the underlying cost of transport and terminating such
calls and higher than the price of intra-country calls or transborder calls to
and from liberalized markets. The low cost of operating the network enables HER
to attractively and competitively price services in the face of declining
overall tariffs for telecommunication services. HER's low-cost basis is due to,
among other things, its use of up-to-date technology without the burden of
legacy networks, which requires fewer employees to operate.
 
     The term of a typical customer agreement currently ranges from 1 to 3
years. The customer agrees to purchase, and HER agrees to provide, cross-border
transmission services. In general the customer agrees to pay certain
non-recurring charges upfront and recurring charges on an annual basis, payable
in twelve monthly installments. If the customer terminates the service order
prior to the end of the contract term, it is generally required to pay HER a
cancellation charge equal to three months service for each of the twelve months
remaining in the contract term. HER guarantees transmission services to a
certain service level. If such levels are not met or HER fails to deliver
service by the committed delivery date, the customer is eligible for a credit
against charges otherwise payable in respect of the relevant link.
 
CUSTOMERS
 
     HER's high capacity, SDH-based fiber optic network is designed to enable
PTOs and New Entrants to integrate high quality, cross-border capacity into
their end user offerings. As of January 1998, twenty customers were under
contract for service on the HER network, including PTOs, a global consortium of
PTOs, Internet service providers, an international carrier, value added networks
("VANs") and resellers. HER provided capacity of approximately 446 E1 equivalent
circuits as of January 1998. The type and quality of HER's customers validates
the concept of the HER network, and illustrates the type of customers who will
be attracted to the full network. The success of this limited network also
demonstrates the demand for cross-border transport services. In total, HER is
targeting seven major market segments or customer groups which can be
characterized as follows:
 
     - Existing PTOs. This customer segment consists of the traditional European
       PTOs that generally participate in the standard bilateral agreements for
       cross-border connectivity. Hermes provides a vehicle for PTOs to compete
       in non-domestic markets both before and after January 1, 1998. As of
 
                                       38
<PAGE>   40
 
       January 1, 1998, both reserved and non-reserved traffic can be
       transported by alternative infrastructure providers, thus vastly
       expanding the available PTO market for HER.
 
     - Global Consortia of Telecommunications Operators. Many of the largest
       PTOs and international carriers have pooled resources and formed
       consortia in order to compete more effectively in important
       telecommunications markets such as those in Western Europe particularly
       outside their home markets. Prior to liberalization of the provision of
       switched voice services in Western European markets, one of the primary
       objectives of these consortia is to provide non-reserved pan- European
       services to multinational business customers, including X.25/frame relay
       (high speed data network) service and closed-user group voice services.
       Under the current regulatory framework, consortia would otherwise be
       required to purchase leased lines at negotiated retail rates, even within
       their home countries. HER believes that it provides an attractive
       alternative at better pricing in those environments where such a
       consortium does not already own its infrastructure. Furthermore, HER
       believes that it is well positioned to provide cross-border connectivity
       between different domestic infrastructures of these alliances.
 
     - International Carriers. This customer segment consists of non-European
       carriers with traffic between European and other international gateways.
       Such carriers include Teleglobe, GTS-Monaco Access and eventually the
       U.S. Regional Bell Operating Companies. HER can provide these customers a
       pan-European distribution network to gather and deliver traffic to and
       from their own and other hubs.
 
     - Alternative Carriers. This segment consists of second carriers, cable TV
       and mobile carriers and competitive access providers. These new carriers
       have chosen to compete with the incumbent PTOs in their respective
       countries, and the Company believes that they would look favorably to an
       alternative such as HER. HER believes that this segment will sustain the
       largest growth as competition emerges in Europe. HER also believes that
       non-PTO competitors in Europe will prefer to use a non-PTO alternative
       like HER to meet their cross-border telecommunication transport needs.
 
     - Internet Backbone Networks. Internet backbone networks are a fast
       emerging segment and are expected to generate significant requirements
       for the services HER offers. These require large capacity international
       connectivity services between Internet nodes (point of interconnection
       between local Internet service providers) in all local European markets.
       The Internet segment is experiencing significant growth in demand for
       transmission capacity.
 
     - Resellers. Resellers are carriers that do not own transmission
       facilities, but obtain communications services from another carrier for
       resale to the public. Resellers are also a growing segment of the market
       and are expected to increase in conjunction with the liberalization of
       the European telecommunications market. In the U.S., for example,
       resellers were a significant factor in the expansion of competition.
 
     - VANs and other Service Providers. VANs are data communications systems in
       which special service features enhance the basic data transmission
       facilities offered to customers. Many of these networks are targeted to
       the data transfer requirements of specific international customer
       segments such as airlines and financial institutions. VANs' basic network
       transmission requirement is to connect data switches or processors. VANs
       currently purchase their own international circuits and build additional
       resiliency into their network infrastructure. HER will allow them to meet
       these needs cost-effectively, and to extend their services to new markets
       or customers without substantial capital investment.
 
     HER expects that additional demand for alternative service providers will
come from increased usage of dedicated circuits for Internet access, private
lines for the deployment of wide-area networks by large corporations, "single
source" local and long distance services by small and medium-sized businesses
and emerging broad band applications such as cable TV programming distribution
(other than broadcast) to the end user.
 
                                       39
<PAGE>   41
 
NETWORK DESIGN
 
     Network Architecture. The network architecture is based on a highly meshed
flat topology which covers a wide geographical area with large distances between
individual network nodes. This architecture allows rerouting of traffic at
electronic speeds in the event of a network failure. This approach also lowers
network cost by allowing each node to be sized to match anticipated traffic
volumes rather than to a standard capacity. Individual nodes can be configured
to connect any trunk to any other in the nodes, thus allowing efficient
transmission of traffic. Each node will be connected to at least two other nodes
allowing rerouting of traffic in the event of a network failure. HER believes
that its network will be the first cross border pan-European network with such
redundancy.
 
     The HER network has been designed to be controlled by a single network
management center and supported by advanced operational support systems. A
centralized network center can pinpoint overloaded pathways or malfunctioning
circuitry and reroute traffic much more quickly than networks controlled by
separate network centers operated by PTOs in different countries. HER primarily
uses Alcatel for the supply of transmission equipment and network management
systems. HER's advanced operational support systems allow it to correct network
failures and isolate equipment faults with greater speed and at a lower cost
than is the case with heterogeneous multi-operator networks. Critical elements
of the network, including network maintenance and control systems, are designed
with redundancy in order to ensure a high quality of service. The network design
has several important resilience features including: multiple paths to each
node, built-in hardware redundancy and redundant power supplies. For all network
routings, there will be at least two paths. Should service failure occur on one
route, the network is designed to automatically re-route traffic to another
route. HER believes that these techniques will result in performance of 99.98
percent or better for premium service customers for most routes.
 
     HER expects to operate the entire network and to own substantially all of
the network equipment as well as some segments of the fiber optic cable. A
substantial part of the fiber is leased on a long-term basis. Long-term leases
for fiber are advantageous to HER because they reduce the capital expense burden
of building large quantities of capacity before they can be used. Where HER
leases dark fiber, the infrastructure provider will generally be responsible for
maintaining such fiber optic cable. HER will enter into agreements with Alcatel
and infrastructure providers and other third parties to supply and/or maintain
the equipment for the HER network.
 
     Network Capacity. The network will consist of Synchronous Digital Hierarchy
("SDH") STM-16 links managed by equipment and operating centers owned by HER and
running on dark fiber leased from infrastructure providers or built by HER on
leased rights of way. Each line system and multiplexer works initially at the
2.5 Gbps (STM-16) level. The most important types of equipment used or to be
used in this network are Add-Drop Multiplexors ("ADMs") and regenerators and a
variety of optical amplifiers for boosting optical signals. The STM-16 links are
expected, where needed, to be upgraded to STM-64. Furthermore, fibers will be
multiplexed using WDM, also as required. Additional capacity can be achieved by
adding new fiber accesses to a given city over alternative routes, thereby
achieving more meshing and the resulting improved network availability.
 
     Network Agreements. HER has entered into agreements and letters of intent
with various infrastructure providers for construction and/or dark fiber lease
of portions of the HER network. HER's agreements for leases of portions of the
network typically required the infrastructure provider to provide a certain
number of pairs of dark fiber and node and/or regenerator sites along the
network route commencing on certain dates provided by HER. The term of a lease
agreement typically ranges from 10 to 18 years. An agreement typically contains
optical specification standards for the fiber and methods of testing. HER is
allowed to use the cable for the transmission of messages and in other ways,
including increasing capacity. The infrastructure provider also provides space
for the location of equipment and spare parts and guarantees the provision of
power and other utilities together with environmental controls and security to
ensure the proper functioning of the equipment. The infrastructure provider is
typically responsible for maintenance of the cable and the provision of first
line maintenance to equipment and permits HER access to such facilities. Access
arrangements to the nodes are also provided so that connection may be made to
HER customers or to the rest of the network. An
 
                                       40
<PAGE>   42
 
agreement also provides for an annual price for the provision of fiber and for
the facilities and maintenance. The agreements typically provide for termination
by the parties only for material breach, with a 90 day minimum cure period. The
agreements typically contain a transition period after termination of the
agreement to allow HER to continue to serve its customers until it can reach
agreement with an alternative infrastructure provider.
 
     Local Access. Access to the HER network will be provided to clients through
SDH access lines including at the STM-1 or STM-4 level. However, customers who
continue to use the older PDH technology may also access the HER network. In
each city, as a HER point of presence is deployed, HER may contract with a local
access network supplier for "last mile" services to customer locations. HER will
not invest in building local access infrastructure but such connectivity can be
supplied on a case-by-case basis via preferred local access partner
arrangements. Currently Telfort in the Netherlands and Belgacom in Belgium are
providing local access to the operating Amsterdam-Brussels route. In London and
Paris, HER has contracted with local access providers to connect the HER network
to intra-city networks in those cities. Pursuant to this agreement, HER can
offer its carrier customers local connectivity in those cities. Various Local
Access Network Suppliers may also be interested in HER for the purpose of
linking the business centers in which they are active. Therefore, the Company
believes that the relationships between HER and local access network suppliers
can benefit both parties.
 
     Network Routes. HER's current planning dates for operation in certain
cities and kilometers covered by the initial network in the first five countries
and Switzerland are set forth below.
 
          Expected to be operational by:
 
          April 30, 1998 -- Brussels, Antwerp, Rotterdam, Amsterdam, London,
     Paris, Strasbourg, Frankfurt, Zurich and Geneva -- covering approximately
     3,000 kilometers.
 
          June 30, 1998 -- Above cities and Dusseldorf, Stuttgart and
     Munich -- covering approximately 3,800 kilometers.
 
     HER expects to have an aggregate of approximately 10,000 kilometers
completed at the end of 1998 and the entire 18,000 kilometer network completed
by the year 2000. Hermes also plans to lease capacity on a transatlantic cable
linking the European network with North America in 1999.
 
     The routes planned to be operational in the second quarter of 1998 are
currently under construction. "Under construction" means that with respect to
each of the segments that make up each of these routes, one of the following is
occurring: (i) HER has contracted to build or is contracting to build the fiber
optic cable segment, and (ii) HER has leased or will lease such segment of dark
fiber optic cable from a third party who has built or is currently building such
segment. The dates set forth above may be subject to delays due to a variety of
factors, many of which are beyond the control of the Company.
 
     HER is deploying the network along the rights-of-way of a variety of
alternative sources, including railways, motorways, waterways, pipelines and
utilities. The rights-of-way of HER-built portions of the network will be
provided pursuant to long-term leases or other arrangements entered into with
railways, highway commissions, pipeline owners, utilities or others. It is the
policy of HER to evaluate multiple alternative infrastructure suppliers in order
to maximize flexibility. As a result of its network development activities to
date, HER has gained access to infrastructure for its network routes which, in
certain cases, HER believes will be difficult for its competitors to duplicate.
 
  COMPETITION
 
     The European and international telecommunications industries are
competitive. HER's success depends upon its ability to compete with a variety of
other telecommunications providers offering or seeking to offer cross-border
services, including (i) the respective PTO in each country in which HER operates
and (ii) global alliances among some of the world's largest telecommunications
carriers. HER expects that some of these potential competitors may also become
its customers. HER believes that the ongoing liberalization of the European
telecommunications market will attract New Entrants to the market and increase
the intensity of
                                       41
<PAGE>   43
 
competition. Competitors in the market compete primarily on the basis of price
and quality. HER intends to focus on these factors and on service innovation as
well. HER business plan anticipates substantial head-to-head competition as well
as indirect competition.
 
     WorldCom, Inc. ("WorldCom") recently announced plans to construct a
pan-European fiber network, the first phase of which is expected to connect
London, Amsterdam, Frankfurt, Brussels and Paris by early 1998. Although the
Company believes that the proposed WorldCom pan-European network is primarily
intended to carry WorldCom traffic, WorldCom has stated that any excess capacity
on such network will be used to provide a competitive carrier's carrier service.
 
     Viatel, Inc. ("Viatel") also recently announced its intention to build a
pan-European fiber optic network connecting select cities in Belgium, France,
the Netherlands and the United Kingdom. Excess capacity would be available for
other carriers. Viatel has stated that, assuming that it obtains necessary
financing, construction would begin in spring 1998 and the network would become
operational in 1999.
 
     In addition, Exprit Telecom Group plc ("Esprit") also recently announced
plans to construct an SDH fiber optic ring network that will connect the United
Kingdom, France, the Netherlands and Belgium.
 
     HER also competes with respect to its "point-to-point" transborder service
offering against circuits currently provided by PTOs through International
Private Leased Circuits. In addition, the liberalization of the European
telecommunications market is likely to attract additional entrants to both the
"point-to-point" and other telecommunications markets.
 
     If HER's competitors, many of whom possess greater technical, financial and
other resources than HER, devote significant resources to the provision of
pan-European, cross-border telecommunications transport services to carriers,
such action could have a material adverse effect on HER's business, financial
condition and results of operations. There can be no assurance that HER will be
able to compete successfully against such new or existing competitors. See
"-- Certain Considerations Generally Applicable to the Company's
Operations -- Competition."
 
HER RECAPITALIZATION
 
     During 1997, HER completed a recapitalization (the "HER Recapitalization"),
wherein HER extended rights to subscribe to additional shares of HER to
GTS-Hermes, HIT Rail and the eleven railways comprising the HIT Rail consortium.
Pursuant thereto, GTS-Hermes and two of the eleven railways that comprise the
HIT Rail consortium have exercised their subscription rights, while HIT Rail and
the other nine railways have declined to exercise their subscription rights. HER
has issued (i) 150,592 shares to GTS-Hermes in exchange for the conversion of
loans and additional consideration, (ii) 24,007 shares to HIT Rail in exchange
for the conversion of loans, (iii) 11,424 shares to Societe Nationale des
Chemins de Fer Belges S.A. de Droit Public/Nationale Maatschappij der Belgische
Spoorwegen N.V. Van Publiek Recht (the Belgian national railway) ("SNCB/NMBS")
and (iv) 4,365 shares to AB Swed Carrier (a wholly owned subsidiary of SJ, the
Swedish national railway). As a result, GTS-Hermes owns 79.1%, HIT Rail owns
approximately 12.6%, SNCB/NMBS owns 6.0% and AB Swed Carrier owns 2.3% of the
issued HER shares. Pursuant to the HER Recapitalization, HER, GTS-Hermes, HIT
Rail, SNCB/NMBS and AB Swed Carrier have executed a new Shareholders Agreement,
the principal terms of which are set forth below. In March 1998, Hit Rail sold
all of its shares in HER to GTS-Hermes, SNCB/NMBS and AB Swed Carrier. As a
result of such sale, GTS-Hermes, SNCB/NMBS and AB Swed Carrier currently own
170,307, 13,610, and 6,551 shares of HER, repectively, or 89.4%, 7.2%, and 3.4%,
respectively of HER.
 
     Under the new Shareholders Agreement, actions to be taken by shareholders
will be adopted by a simple majority vote with the exception of certain actions
which will require at least 85% of the votes cast: (i) purchase by HER of its
own shares and any redemption thereof, (ii) exclusion of preemptive rights in
the case of the issuance of new shares and the transfer of shares held by HER,
except in the event of a public listing of the shares or of new shares or of an
offering of shares or options on new shares (warrants) to professional investors
in order to obtain further funding, (iii) winding up or dissolution of HER, (iv)
any amendment to the articles of association other than those pertaining to
increases in the authorized capital of
 
                                       42
<PAGE>   44
 
HER or to convert HER into an N.V. ("Naamloze Vennootschap") to enable a public
listing of shares or new shares, (v) any amendment to the scope of HER's
business, (vi) the declaration of dividends and (vii) the admission of new
shareholders to the Shareholders Agreement. In addition, the Shareholders
Agreement provides that (a) if GTS-Hermes is the owner of at least 50% of the
issued shares, then it will have the right to make a binding nomination for the
appointment of half of the members of the Board of Supervisory Directors or (b)
if GTS-Hermes is the owner of at least two-thirds of the issued shares, then it
will have the right to make a binding nomination for the appointment of half of
the members of the Board of Supervisory Directors plus one member more,
appointed pursuant to nominations by all other shareholders. As long as HIT Rail
is the owner of at least one share, HIT Rail will be entitled to make a binding
nomination for the appointment of at least one member of the Supervisory Board.
The Shareholders Agreement also provides that shareholders who participated in
the capital restructuring other than GTS-Hermes and HIT Rail with a shareholding
of at least 6.8% subject to adjustment in the discretion of the other
shareholders will be entitled to make a binding nomination for the appointment
of one member of the Board of Supervisory Directors. Shareholders who
participated in the capital restructuring other than GTS-Hermes and HIT Rail who
hold fewer than 6.8% of the issued share capital of HER will be entitled on a
rotating basis to make one binding nomination for the appointment of a member of
the Board of Supervisory Directors for two-year periods. As a result of the
March 1998 sale by Hit Rail of all its shares in HER, Hit Rail no longer has any
rights or obligations, except as set forth below, under the Shareholders
Agreement and GTS-Hermes, acting alone, can approve all the matters described
above which require an 85% HER shareholder vote.
 
  Articles of Association and Shareholders Agreement
 
     Under the Articles of Association and the Shareholders Agreement, HER's
shareholders have preemptive rights in connection with issuances of ordinary
shares and options on shares to be issued in proportion to the total nominal
value of the shares held by it. Preemptive rights can be exercised for four
weeks after the date the notice of the offer is received by the shareholders.
 
     The Shareholders Agreement provides that HER or its designated vendor will
provide fiber capacity in its network for use by the shareholders of HER on fair
commercial terms, use, quantity and price to be negotiated on a bilateral basis.
In the Shareholders Agreement, HIT Rail has covenanted to (i) use its best
efforts to establish such commercial agreements between individual HIT Rail
shareholders and HER, to obtain rights of way from individual HIT Rail
shareholders and to cooperate in obtaining such licenses as may advance the
business of HER, (ii) use its best efforts to ensure that the HIT Rail
shareholders cooperate in obtaining such license in accordance with the business
plan of HER and as may be necessary or advisable in furtherance of HER's
business, (iii) will not, so long as both HIT Rail and GTS-Hermes are
shareholders of HER and for one year after HIT Rail ceases to be a shareholder,
agree with any entity other than GTS-Hermes or HER to assist or cooperate in the
development of any pan-European telecommunications operator and (iv) use its
best efforts to obtain on HER's behalf such materials as may be required and
arrange inspection visits of selected rights of way for the purpose of making
initial cost estimates.
 
     The foregoing summary of the Shareholders Agreement does not purport to be
complete and is qualified in its entirety by reference to the Shareholders
Agreement, which is an Exhibit to this Report.
 
LICENSES AND REGULATORY ISSUES
 
     A summary discussion of the regulatory framework in the countries of the
network in the first five countries and the next five countries into which HER
expects to develop the network is set forth below. This discussion is intended
to provide a general outline, rather than a comprehensive discussion, of the
more relevant regulations and current regulatory posture of the various
jurisdictions.
 
     National authorities in individual member states of the EU are responsible
for regulating the operation (and in some cases the construction) of
telecommunications infrastructure. HER believes that the adoption of the Full
Competition Directive and the various related Directives adopted by the European
Parliament and the Council of the EU have resulted in the removal of most
regulatory barriers to the operation of telecommunications infrastructure in the
countries of the initial network in the first five countries.
 
                                       43
<PAGE>   45
 
     HER requires licenses, authorizations or registrations in all countries to
operate the network. There can be no assurance that HER will be able to obtain
such licenses, authorizations or registrations or that HER's operations will not
become subject to other regulatory, authorization or registration requirements
in the countries in which it plans to operate. Licenses, authorizations or
registrations have been obtained in the United Kingdom, the Netherlands,
Belgium, France and Germany and a trial concession has been granted in
Switzerland. HER intends to file applications in other countries in anticipation
of service launch in accordance with the network roll-out plan.
 
     On June 28, 1990, the European Commission, in an effort to promote
competition and efficiency in the European Union, issued a directive (the "1990
Directive") requiring EU member states to immediately liberalize all
telecommunication services with the exception of voice telephony to the general
public (basic voice services provided over the public switched voice network).
This step liberalized value added services and voice services over corporate
networks and/or "closed user groups," although the exact definitions of the
terms used in the 1990 Directive were not altogether clear.
 
     On July 22, 1993, the Council of EU agreed that all voice telephony
services in EU member states should be liberalized by January 1, 1998 subject to
additional transitional periods of up to five years to allow member states with
less developed networks to achieve the necessary adjustments. It was agreed that
such exemptions would be granted to Spain, Ireland, Greece and Portugal, subject
to formal application and satisfaction of certain requirements. Luxembourg,
because of the small size of its market, would be eligible for a special
transitional period of up to two years.
 
     In April 1995, a communication from the European Commission sought to
clarify the types of services that were liberalized by the 1990 Directive,
stating that the burden of proof as to why a service should be considered
"reserved" and therefore not open to competition should be upon the PTOs and the
regulatory authorities of member states. Along with this statement came the
threat of formal procedures under the Treaty of Rome against member states that
do not implement the 1990 Directive "within a reasonable time." Procedures have
been brought so far against Italy, Greece, Germany and Spain for failing to
apply the requirements of the 1990 Directive.
 
     On March 13, 1996, the European Commission adopted the Full Competition
Directive extending the 1990 Directive to all services, requiring that licensing
procedures for these services be transparent and non-discriminatory, requiring
member states to fully liberalize alternative infrastructure to allow a
competitive market for "non-reserved" services such as data, value added
services and non-public (closed-user group) switched voice services by July 1,
1996 and mandating open competition in all public telecommunications services,
including voice telephony to the general public, by January 1, 1998 (except for
countries to which grace periods were granted in accordance with the 1993
Council Resolution).
 
     On April 10, 1997, the European Parliament and the Council of Ministers
adopted a Directive on a common framework for general authorizations and
individual licenses in the field of telecommunications services, including
networks. Licenses must be awarded through open, non-discriminatory and
transparent procedures and applications will be required to be dealt with in a
timely fashion. The number of licenses may only be restricted to the extent
required to ensure the efficient use of radio frequencies or for the time
necessary to make available sufficient numbers in accordance with EC law.
 
     HER believes that many European countries have revised telecommunications
regulations to comply with the 1990 Directive and the Full Competition Directive
and that such changes will enhance HER's ability to obtain other necessary
regulatory approvals for its operations.
 
     As a multinational telecommunications company, HER is subject to varying
degrees of regulation in each of the jurisdictions in which it provides its
services. Local laws and regulations and the interpretation of such laws and
regulations, differ significantly among the jurisdictions in which HER operates.
There can be no assurance that future regulatory, judicial and legislative
changes will not have a material adverse effect on HER, that domestic or
international regulators or third parties will not raise material issues with
regard to HER's compliance or noncompliance with applicable regulations or that
regulatory activities will not have a material adverse effect on HER.
See -- "Certain Considerations Generally Applicable to the Company's
 
                                       44
<PAGE>   46
 
Operations -- Government Regulation." The regulatory framework in certain
jurisdictions in which HER provides its services is briefly described below.
 
  United Kingdom
 
     Since the elimination in 1991 of the United Kingdom telecommunications
duopoly consisting of British Telecommunications and Mercury, it has been the
stated goal of Oftel, the United Kingdom telecommunications regulatory
authority, to create a competitive marketplace from which detailed regulation
could eventually be withdrawn. The United Kingdom has already liberalized its
market beyond the requirements of the Full Competition Directive, and most
restrictions on competition have been removed in practice as well as in law. HER
has received a license from the Secretary of State for Trade and Industry which
grants it the right to run a telecommunications system or systems in the United
Kingdom connected to an overseas telecommunications system and to provide
international services over such systems. Like the licenses granted to other
providers of international facilities-based services, the license granted to HER
on December 18, 1996 was for an initial six months' duration and thereafter is
subject to revocation on one month's notice in writing. The short duration of
these initial licenses was adopted for administrative convenience on the
opening-up of the United Kingdom market for international facilities-based
services. The Department of Trade and Industry ("DTI") has confirmed that it
intends to replace the initial licenses with new licenses and that it would not
normally expect to revoke an initial license without replacing it with another
license giving an equivalent authorization. The DTI is currently discussing with
license holders the arrangements to put these new licenses into effect and
although the DTI has indicated that the new licenses are expected to be of 25
years duration, there can be no certainty that this will be the case or that the
new licenses will not contain terms or conditions unfavorable to HER.
 
  The Netherlands
 
     On July 1, 1997 the Dutch government abolished the prohibition on the use
of fixed infrastructure for the provision of public voice telephony, thereby
complying with the requirements of the Full Competition Directive six months
ahead of schedule. On August 1, 1996, HER was granted a license for the
installation, maintenance and use of a fixed telecommunications infrastructure.
 
     An entirely new Telecommunications Bill was introduced to the Second
Chamber (the House of Representatives) of the Parliament on September 15, 1997.
The new Telecommunications Act is intended to confirm the full liberalization of
the telecommunications market according to European Community standards. It is
not expected that the new Telecommunications Act will detrimentally affect the
conduct of business by HER.
 
  Belgium
 
     Belgium has implemented the "alternative infrastructure" provider provision
of the Full Competition Directive. The decision-making process regarding the
adoption of the full package of liberalization legislation (including licensing
regimes for voice telephony and public network infrastructure) is in the final
stages and is anticipated to be completed by mid -- 1998.] Given the fact that
the implementation of the EC Directives is late, the Belgian authorities have
made public that they will work during the first months of 1998 with a system of
provisional licenses. HER has obtained, through a wholly-owned subsidiary, a
license from the Belgian regulatory authority to provide liberalized services
using alternative infrastructure and is currently operating under its license in
Belgium on the Brussels-Amsterdam route. HER also has authorization to build
infrastructure between major Belgian population centers and the relevant border
crossings. The liberalization legislation is expected to require all previously
licensed operators to apply for new licenses or authorizations. HER expects
that, in such event, its existing licenses and authorizations would be renewed
in due course, although there can be no assurance that this will be the case.
 
                                       45
<PAGE>   47
 
  Germany
 
     Germany has approved legislation to implement the Full Competition
Directive and remove all remaining restrictions on competition from January
1998. HER was granted a license by the German regulatory authorities on July 18,
1997. The license permits HER to operate the portions of the network in Germany
connecting Dusseldorf, Frankfurt and Stuttgart; Dusseldorf to the Dutch border;
and Stuttgart to the French and Swiss borders. HER expects to extend its license
in Germany as appropriate in order to enable it to operate the remaining
portions of the network in Germany.
 
  France
 
     A new regulatory agency, the Autorite de Regulation des Telecommunications
("ART"), was established in France effective January 1, 1997. In 1996, France
approved legislation to implement the Full Competition Directive and to remove
all remaining restrictions on competition from January 1998. HER applied for an
authorization to operate its network in specific regions of France, which was
approved on October 22, 1997. In October 1997, HER obtained authorization to
operate its network in specific regions of France. Such authorization requires
prior notification to and approval of the ART of any substantial changes in the
capital of HER or its controlling shareholder. HER has notified the ART of the
initial public offering of the Company's common stock and intends to notify the
ART of the March 1998 increase to approximately 89% of GTS-Hermes' ownership
interest in HER.
 
  Switzerland
 
     The Swiss Parliament has recently passed a new Telecommunications Law which
will enter into force on January 1, 1998. Although Switzerland is not a Member
State of the EU, the effect of the law is largely to mirror the EC
telecommunications liberalization Directives and therefore from that date
existing voice telephony monopoly will be abolished and such services will be
fully liberalized. An independent national regulatory authority has previously
been established. HER obtained a trial concession on October 30, 1997, in order
to roll out its network and to provide its services in advance of the full
liberalization coming into effect on January 1, 1998. This concession expired on
December 31, 1997. HER has filed an application for a concession for the
operation of a telecommunications infrastructure and was granted a provisional
concession on March 16, 1998. The provisional concession takes retroactive
effect as of January 1, 1998 and HER expects that the Swiss regulatory authority
will grant HER a final concession by the end of the third quarter 1998. However,
no assurance can be given that such final concession will be granted or granted
on terms acceptable to HER.
 
  Italy
 
     Although in the past Italy has been dilatory in implementing EC
liberalization measures, Italy enacted legislation on July 31, 1997 which
substantially completes the liberalization of services in accordance with the
Full Competition Directive. The Parliament has also approved the creation of an
independent national regulatory authority for the telecommunications and
audiovisual sectors. The most recent EC liberalization Directives relating to
licensing and interconnection has been implemented. HER intends to apply for a
license to provide its services in due course.
 
  Spain
 
     Under the Full Competition Directive Spain was granted the right to request
a delay of up to five years in liberalizing fully its telecommunications market.
However, the Spanish government and the European Commission have agreed that
full liberalization should take place on December 1, 1998. In order to ensure
effective liberalization from that date, the Commission Decision granting the
eleven month extension sets out a timetable of interim measures leading up to
full liberalization. These measures include the passing of legislation
authorizing regional cable operators to provide telecommunications services and
the adoption of a new General Telecommunications Bill effectively transposing EC
Directives into Spanish law. Further RETEVISION, S.A. has been granted a second
national operator's license to compete with the national PTO and Spain has
agreed to grant a third national operator license in early 1998. HER intends to
apply for a license to provide its services in due course.
                                       46
<PAGE>   48
 
  Sweden
 
     Full liberalization of the Swedish telecommunications market occurred in
1993. A new Telecommunications Act was passed this year to reinforce the powers
of the national regulatory authority, to ensure conformity with EC Directives
and to supplement the pre-existing licensing regime with a general authorization
regime for services other than telephony services, mobile services and leased
lines. HER intends to register to provide its services in due course.
 
  Denmark
 
     With the liberalization of infrastructure from July 1, 1997 Denmark has
fully liberalized its telecommunications markets in accordance with the
requirements of the relevant EC Directives. An independent national regulatory
authority has been established. According to the Danish rules, HER will not
require any regulatory approval in order to install or operate the network in
Denmark.
 
     In addition, to the discussion above, HER intends to file applications in
other countries in anticipation of service launch in accordance with the HER
network roll-out plan. The terms and conditions of HER's licenses,
authorizations or registrations may limit or otherwise affect HER's scope of
operations. There can be no assurance that HER will be able to obtain, maintain
or renew licenses, authorizations or registrations to provide the services it
currently provides and plans to provide, that such licenses, authorizations or
registrations will be issued or renewed on terms or with fees that are
commercially viable, or that the licenses, authorizations or registrations
required in the future can be obtained by HER. The loss of, or failure to
obtain, these licenses, authorizations or registrations or a substantial
limitation upon the terms of these licenses, authorizations or registrations
could have a material adverse effect on HER and the Company.
 
GTS-MONACO ACCESS
 
     GTS owns a 50% interest in and manages GTS-Monaco Access, a joint venture
with the Principality of Monaco created to develop Monaco's existing
international telecommunications infrastructure into an international gateway
hub for transport of international traffic to European and overseas
destinations. The Principality has constructed and operates a sophisticated
international gateway infrastructure that includes an international digital
switching center and a satellite earth station to support significant amounts of
carriers' carrier traffic. Through Monaco's network, GTS-Monaco Access is linked
to approximately 170 countries worldwide. GTS believes that this partnership
provides it with the opportunity to build a strong international gateway
operator in lucrative Western European markets.
 
     GTS-Monaco Access offers competitively priced international switching and
transit services, primarily to the "wholesale" international gateway and
carrier-to-carrier portion of the international calling market, as distinguished
from "retail" services offered to end users. Basic service offerings include (i)
international switched traffic; (ii) international private lines; (iii)
facilities management, including billing, customer management and fault
reduction systems; (iv) resale distribution for Internet service providers; and
(v) prepaid calling card platform services.
 
     With the cooperation of Monaco Telecom ("MT"), GTS-Monaco Access is
entitled to exercise the privileges of signatories to international treaties
such as the ITU, and to international satellite agreements, such as Intelsat,
Inmarsat and Eutelsat. Other signatories are generally PTOs and other
quasi-governmental telecommunications entities. GTS-Monaco Access purchases
capacity on international fiber routes at rates available only to recognized
operators which are substantially below the rates charged to other service
providers. These fiber-based facilities are an important element for GTS-Monaco
Access's core network and provide it with capacity that may be leased or resold
to customers. Monaco inaugurated its independent country code, 377, on June 21,
1996, which made it eligible for certain privileges, including special terms
(generally reserved for PTOs) in connection with transmission agreements,
transit agreements, settlements and low-cost accounting rates with select
carriers.
 
     GTS's partner in GTS-Monaco Access is an investment fund designated by the
Principality of Monaco to represent its interests. GTS-Monaco Access functions
in cooperation with MT under a commercial agreement
 
                                       47
<PAGE>   49
 
governing, among other things, the terms of use of existing facilities, access
to and acquisition of new international infrastructure, and sales and marketing.
GTS exercises operational control of the joint venture, and provides managerial
and financial support, international telecommunications expertise and strategic
planning. Neither GTS nor its partner is obligated to fund operations or capital
expenditures of GTS-Monaco Access. Losses and profits of GTS-Monaco Access are
allocated to the partners in accordance with their ownership percentages, in
consideration of funds at risk. As of December 31, 1997, GTS and its partner had
each made equity contributions of $0.8 million to GTS-Monaco Access. In
addition, GTS-Monaco Access had outstanding loans of $2.8 million to GTS as of
December 31, 1997. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Accounting Methodology -- Profit and Loss
Accounting." The agreement between GTS-Monaco Access and MT, by its terms,
continues in operation until 2020.
 
BUSINESS AND MARKETING STRATEGY
 
     GTS's strategy for developing GTS-Monaco Access into an international
gateway hub includes the following:
 
     - Develop Advanced Carrier Services Offerings. GTS-Monaco Access may
       develop its "advanced carrier services" offerings to include global 0800
       services and international free phone services, which GTS believes will
       broaden customer relationships, enhance revenues and help to protect it
       from price-based competition.
 
     - Develop Relationships to Broaden Service Offerings. GTS-Monaco Access may
       develop relationships to broaden its service offerings. GTS-Monaco Access
       has entered into agreements with UUNET, one of its gateway customers, to
       provide wholesale Internet access to GTS-Monaco Access's carrier
       customers in a number of Western European countries. The agreement allows
       these services to be "cobranded" with GTS's affiliates.
 
     - Pricing. Price is a critical factor in the market for international
       switching as competition increases due to expanding international
       capacity, advances in technology and falling regulatory barriers. GTS-
       Monaco Access intends to price its services competitively with the
       prevailing price for comparable inter-PTO transit and gateway services.
       GTS-Monaco Access is not bound by legacy systems, infrastructure and
       personnel levels and can, therefore, manage competitive cost operations.
 
     - Leverage Non-Aligned Position. Because GTS's Western European activities
       are not allied with any of the major consortia or large Western European
       telecommunications companies, and generally focus on carriers' carrier
       services, GTS-Monaco Access will not compete with its carrier customers
       in retail markets. This independence should make GTS-Monaco Access an
       attractive service provider for Western European carriers who may
       otherwise be reluctant to obtain services from the larger operators of
       international gateways that are often their competitors in the retail
       market.
 
     - Exploit GTS Synergies. GTS-Monaco Access may ally with other GTS
       companies in Europe and the CIS. GTS-Monaco Access is expected to realize
       significant reductions in its cost structure through access to low-cost
       pan-European transmission capacity through alternative infrastructure
       providers such as HER, Sovintel and C-Datacom International, Inc., GTS's
       Indian venture, already route international traffic through GTS-Monaco
       Access's gateway.
 
CUSTOMERS
 
     Targeted customers for GTS-Monaco Access include:
 
     - Non-Aligned PTOs. GTS believes that various large American and Western
       European PTOs that lack adequate international switching and transport
       facilities of their own may be persuaded to purchase international
       services from GTS-Monaco Access, rather than from competing PTOs or
       consortia.
 
     - Mobile Carriers. GTS believes that some of the non-PTO mobile carriers,
       which currently provide only a small percentage of Western European
       mobile telecommunications traffic, may prefer the "indepen-
 
                                       48
<PAGE>   50
 
       dent" international gateway service offerings of GTS-Monaco Access to
       those of their PTO competitors.
 
     - Internet Service Providers. Growth in Internet usage creates a
       significant opportunity for a nonaligned Internet access provider such as
       GTS-Monaco Access, since many Internet service providers will be in
       direct competition with PTO-owned services in large European markets.
 
     - Second Carriers/Resellers. GTS believes that many second carriers will
       seek to enter new markets quickly without investing in international
       switching capacity.
 
     - Established ("Aligned") PTOs. This customer segment will be a niche
       market for GTS-Monaco Access. As markets are deregulated and carriers
       become increasingly competitive, traditional friendly correspondent
       relations may become strained, and opportunities may emerge to leverage
       GTS's non-aligned status to route traffic between rivals or to displace
       incumbents for transit relationships.
 
     - Other GTS Companies. GTS-Monaco Access currently provides gateway
       services indirectly to Sovintel, CDI and other GTS companies that
       aggregate traffic or provide international long distance services. It may
       also provide these services to HER.
 
     In January 1998, GTS-Monaco Access terminated its relationship with a major
traffic partner as a result of which GTS expects that the venture will lose
approximately $6 million of revenues in 1998. Although GTS-Monaco Access is
putting in place plans to replace such revenues from other sources, no assurance
can be provided that such revenues will be replaced in the current fiscal year.
 
NETWORK
 
     GTS has enhanced MT's existing technology platform of digital switching,
fiber optic transmission, satellite and submarine cable facilities by
interconnecting this existing network infrastructure to multiple terrestrial
routes covering Europe and to undersea fiber optic cables connecting the
GTS-Monaco Access network to Asia and the Americas.
 
     The network infrastructure of GTS-Monaco Access is complementary with that
of HER, with each serving the carriers' carrier market from different
perspectives; HER for bandwidth services and GTS-Monaco Access for switched call
terminations and other carrier services.
 
LICENSES AND REGULATORY ISSUES
 
     Because it operates in coordination with MT, the licensed operator of the
Monaco public network, and in indirect partnership with the government,
GTS-Monaco Access's telecommunications activities in Monaco require no
telecommunications license.
 
     Because the Principality of Monaco is not an EU member state, GTS-Monaco
Access's telecommunications activities in the Principality are not subject to
European law. However, GTS-Monaco Access will have to comply with EU regulation
to the extent it does business in EU member states. The regulatory requirements
established by the EU create general guidelines under which the national
agencies of EU member states regulate. Accordingly, local laws and regulations
may differ significantly among these jurisdictions, and the interpretation and
enforcement of such laws and regulations may vary. Local rules are sometimes
based on the informal views of the local ministries which, in some cases, are
subject to influence by the local PTOs. In certain of the Company's existing and
target markets, there are laws and regulations which affect the number and types
of customers which the Company can address. For instance, certain countries may
and do require licenses for communication companies to interconnect to the
public network to originate traffic.
 
     In addition, one of the services provided by GTS-Monaco Access is a form of
transit service, known in the industry as "re-filing." Re-filing is the practice
of routing traffic through a third country in order to take advantage of
disparities in settlement rates between different countries, allowing traffic to
a potential country to be treated as if it originated in the third country that
enjoys lower settlement rates with the destination country, thereby resulting in
lower overall costs on an end-to-end basis. Re-filing is prevalent in the
industry
 
                                       49
<PAGE>   51
 
even though the practice is technically in contravention of ITU regulations. In
practice, because of the widespread non-observance of these regulations, such a
contravention normally does not give rise to specific legal problems. However,
their enforceability essentially depends on the status given to ITU obligations
by Member countries' domestic laws. Accordingly, there can be no assurance that
GTS-Monaco Access's re-filing services might not be disrupted or be the subject
of legal process at some time in the future. In such event, within the EU a
defense may be available that the ITU regulations are anti-competitive and
contravene the Treaty of Rome, although there can be no certainty that such a
defense would succeed.
 
COMPETITION
 
     GTS-Monaco Access faces competition from consortia of telecommunications
operators, large PTOs and other international telephone operators with advanced
network infrastructures, access to large quantities of long-haul capacity and
established customer bases. PTOs currently providing large amounts of
international traffic have already established direct routes, transit
arrangements and correspondent relations and many have excess capacity that they
resell in competition with GTS-Monaco Access.
 
     With the advent of deregulation in the Western European telecommunications
markets in 1998, opportunities for the establishment of international gateways
will likely develop in Europe and as a result competition in the market for
GTS-Monaco Access's services will increase. GTS intends to evaluate additional
locations in Europe for the establishment of international hubs based upon
prospective costs and the availability of call routing at these locations. GTS
plans to locate these prospective points of presence in cities served by HER and
to allow the termination of traffic through HER. GTS Monaco Access may benefit
from the establishment of these points of presence by incurring reduced
transmission expenses.
 
     While GTS believes that GTS-Monaco Access will be able to compete
effectively in certain identified market segments because most of its targeted
customers are in new and fast growing markets and have not established long-term
relationships with international gateway providers, and because it has equal
access to advanced infrastructure and international fiber routes, potential
access to low cost transport from HER and an "independent" status that allows it
to service a worldwide range of potential customers, GTS intends continually to
review the competitiveness of GTS-Monaco Access with respect to its competitors.
 
CENTRAL EUROPE
 
     In Central Europe, GTS's objective is to become one of the leading
alternative telecommunications providers in the region. GTS currently provides
private data communications services to government and commercial customers in
Hungary and the Czech Republic. In the Czech Republic, the Company provides
outgoing voice services and operates an international gateway and a data
services network. In Hungary, GTS operates a VSAT network which GTS believes is
the largest VSAT network in Central Europe as measured by number of VSAT sites.
The Company has also signed an agreement to provide international data services
in Poland, subject to receipt of necessary governmental approvals. GTS's
strategy is to expand its service offerings as the regulatory environment
permits, leveraging its existing VSAT and international gateway infrastructure
where possible and providing a broad range of services to its target markets.
 
  Hungary
 
     GTS-Hungary. GTS-Hungary, a 99% owned subsidiary of GTS, is a leading
provider of customized data services offering high quality, reliable virtual
private network services to customers throughout Hungary and, through other GTS
affiliates, other countries in Central Europe. GTS-Hungary provides these
services through VSATs installed at customer sites throughout the country and a
microwave-based high speed overlay network for points in the Budapest
metropolitan area. Along with these data transmission services, GTS-Hungary
provides high quality customer service including (i) significant system
integration support in the initial implementation of the customers' networks and
in on-going expansion and improvements and (ii) a unique maintenance and
technical support service, which include "rapid response" service calls and
24-hour hub service operations support, which can be backed by financial
guarantees when required.
 
                                       50
<PAGE>   52
 
     As of December 31, 1997, GTS-Hungary's VSAT network consisted of
approximately 968 owned and operated VSAT sites which the Company believes makes
it the largest VSAT-based network in Central Europe. GTS believes that its
choice of VSAT technology as a way of quickly deploying a full range of business
services nationwide will allow it to capture key customers and market segments.
Such positioning, the Company believes, will enable GTS-Hungary to expand its
service offerings as the Central European market matures and as regulatory
authorities further privatize and deregulate the telecommunications industry.
GTS-Hungary is undertaking a nationwide expansion of its microwave-based
Budapest overlay network. The expansion will increase GTS-Hungary's revenue base
in the region and provide opportunities to leverage further its other service
offerings. There can be no assurance, however, that the expansion will be
completed on a timely and commercially feasible basis.
 
     The Hungarian state lottery is GTS-Hungary's largest customer, accounting
for more than 50% of GTS-Hungary's total revenue for the year ended December 31,
1997. GTS-Hungary has also targeted its VSAT network services to business
customers in the domestic service industry and other government organizations.
Although GTS-Hungary continues to diversify its revenue and customer base, the
loss of the Hungarian state lottery as a customer would have a material adverse
effect on GTS-Hungary's business.
 
     GTS-Hungary generally charges its data services customers a flat monthly
fee for a fixed amount of usage and usage-based fees for use above the
contractual amount. Customers are billed in Hungarian forints (indexed to U.S.
dollars) on a monthly basis. Pricing is generally determined for an individual
client based upon the size of traffic requirements. In general, GTS-Hungary's
strategy is to minimize the initial customer investment in order to lower the
barriers to purchase, while committing customers to long-term contracts.
 
     GTS-Hungary's major competitors include BankNet, Hungaro-DigiTel and MATAV,
the Hungarian PTO, each of which operates a network with at least 200 VSAT
sites. MATAV offers a broad range of services and has recently targeted the
business sector that GTS serves. GTS believes that, while some of its
competitors have stronger financial resources, GTS-Hungary remains the leading
VSAT service provider in Hungary in terms of number of VSAT sites, the size and
quality of its infrastructure and the quality of its service. GTS also believes
it has distinguished itself from its competition by its superior customer
service.
 
     Currently, all VSAT licenses in Hungary have been granted under temporary
telecommunications regulations. The temporary licenses prohibit connection to
public telecommunications networks or other international or domestic
data-transmitting systems. In December 1993, GTS received a temporary service
permit to provide data-transfer services utilizing a VSAT-based wireless
communications system throughout Hungary. In March 1997 the government issued
new telecommunications regulations which require all operations with temporary
licenses to apply for permanent licenses by the end of April 1997. GTS-Hungary
has submitted applications for the conversion of its temporary licenses to
permanent ones. While no assurances can be given, GTS expects permanent licenses
to be issued in due course. The failure to receive such licenses would have a
material adverse effect on the business of GTS-Hungary.
 
     Neither GTS nor its partner in GTS-Hungary are obligated to fund operations
or capital expenditures of GTS-Hungary. Losses and profits of GTS-Hungary are
allocated to the partners in accordance with their ownership percentages, in
consideration of funds at risk. As of December 31, 1997, GTS had made equity
contributions of $12.5 million to GTS-Hungary, GTS' partner has not made any
equity contributions as of December 31, 1997. In addition, GTS-Hungary had
outstanding loans of $2.8 million to GTS as of December 31, 1997. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Accounting Methodology -- Profit and Loss Accounting." Further,
the joint venture does not have an expiration date.
 
     EuroHivo. In addition to its network and data services, GTS also provides
nationwide paging services primarily to the retail consumer market through its
70% owned joint venture, EuroHivo. GTS has concluded that EuroHivo is not a core
business and is currently assessing offers to sell its interests in EuroHivo. In
connection with this anticipated divestiture, the Company wrote-off its
investment in EuroHivo in the third quarter of 1997. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Consolidated Ventures."
 
                                       51
<PAGE>   53
 
  Czech Republic
 
     The Czech Companies. The Czech Companies, which consist of two wholly owned
subsidiaries of GTS, offer the only alternative international telephony service
in the Czech Republic, as well as a full range of private data services,
delivered through a combination of a fully digital microwave overlay network and
an international satellite gateway in Prague and GTS-Hungary's VSAT network.
Through an intercompany arrangement with GTS-Hungary, the Czech Companies
provide all of the same VSAT services offered by GTS-Hungary. In addition, the
Czech Companies offer high-speed Internet access service and are among the
leading Internet access providers in the Czech Republic. The Czech Companies
seek to become the second carrier in the Czech Republic and are also targeting
opportunities in Slovakia, based upon the historic relationship between the
Czech and Slovak markets.
 
     The Czech Companies network consist of an earth station linked to
GTS-Monaco Access and to British Telecom, a series of point-to-point and
point-to-multipoint microwave connections providing dedicated access to the
buildings served by the Czech Companies and individual VSATs based on, and
controlled by, GTS-Hungary's hub in Budapest.
 
     The Czech Companies target customers include real estate developers, hotels
and multinational companies which require international voice or data services
or Internet connectivity, where both GTS's own services and the services of GTS
partners are sold. The Czech Companies provide outgoing international voice
services and high-speed Internet access to large commercial buildings in Prague.
As of December 31, 1997, the Czech Companies had concluded agreements with
building owners to convert PABXs in 25 buildings in Prague. International voice
services are offered at prices similar to those of the Czech PTO. The Czech
market for VSAT services is extremely competitive, with prices at approximately
50% of those in Hungary for basic services. The Czech Companies plan to pursue
customers who require value-added services which may be offered at higher prices
and better margins.
 
     The Czech Companies are licensed to provide international satellite and
domestic private voice and data services. They received their operating licenses
in 1994 and 1995 and began offering services in 1995. The licenses grant
permission to install and operate up to 150 earth stations and, upon
application, an additional 150 earth stations. The licenses currently prohibit
the provision of switched voice services and the interconnection to public
voice, telex and data networks and telecommunications networks of other
providers.
 
     The Czech Companies are the only alternative international telephony
provider licensed in the Czech Republic. As such, their only competitor is SPT
Telecom, the Czech PTO. Should SPT decide to compete aggressively with the Czech
Companies, it has the ability to discount prices below those which could be
easily sustained by the Czech Companies. In data services, Telenor, GITY and
Nextel (a subsidiary of SPT Telecom) are the Czech Companies' three major
competitors for data services in the Czech Republic. GTS believes that its
experience in establishing VSAT services in the region and its emphasis on
integrated voice and data services provides the Czech Companies with a
competitive advantage. Additionally, GTS's transmission facilities and
infrastructure in Hungary and Monaco provide them with a relatively low cost
infrastructure and, as a consequence, greater pricing flexibility than their
competitors. With respect to Internet services, GTS believes that, although this
market consists of a large number of small providers and that SPT Telecom will
seek to enter this market, the dedicated, high-speed infrastructure that the
Czech Companies are installing will provide superior services to its customers.
 
ASIA
 
     Chinese law generally prohibits foreign investment or participation in the
operation of telecommunications services, while Indian law requires foreign
telecommunications operators to conduct certain telecommunications businesses,
including basic switched telephony and cellular services, through joint ventures
that are at least 51% owned by Indian partners. GTS believes that these
restrictive regulations will eventually be liberalized and that its early entry
into these markets and its strong relationships with influential commercial
firms and with local, regional and national-level government entities will
provide it with a strong competitive advantage over competitors that await more
explicit regulatory regimes authorizing direct telecommunications investments.
                                       52
<PAGE>   54
 
  China
 
     GTS participates in the nationwide tourist industry VSAT network through
GTS China Investments LLC, a company in which GTS holds a 75% interest and an
affiliate of a shareholder of the Company owns a 25% interest. See "Certain
Related Party Transactions" in the Company's Proxy Statement for its 1998 Annual
Meeting. GTS China Investments LLC holds an indirect 63% interest in Beijing
Tianmu Satellite Communications Technology Co. Ltd. ("Beijing Tianmu"), which
provides technical, operational and financial support for the VSAT network. In
addition, through Shanghai V-Tech Telecommunications Systems Co., Ltd.
("V-Tech"), a venture in which GTS holds a 75% interest, the Company provides
financing, operational consulting, technical and engineering services to a
Shanghai-based VSAT network operator.
 
     With respect to V-Tech, in addition to the Company's initial equity
contribution of $3.75 million, GTS committed to fund up to an additional $3.0
million (all of which has been funded by the end of the third quarter of 1997).
The joint venture expires in April 2015, and profits and losses are allocated
according to ownership interests in consideration of funds at risk. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Accounting Methodology -- Profit and Loss Accounting." GTS
currently is evaluating adding additional partners to V-Tech which may reduce
GTS's ownership interest in V-Tech.
 
     With respect to Beijing Tianmu, in addition to the Company's initial equity
contribution of $8.75 million, GTS is responsible for arranging additional
financing of up to $14.4 million, subject to the approval of the venture's Board
of Directors, the majority of members of which are elected by GTS. The joint
venture expires in March 2021, and profits and losses are allocated according to
ownership interests, in consideration of funds at risk. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Accounting Methodology -- Profit and Loss Accounting."
 
  India
 
     In India, GTS is following the strategy it implemented in Moscow and is
currently pursuing in Central Europe, in which it initially penetrates the
telecommunications market by developing satellite-based international gateway
networks to provide telecommunications services to targeted business customers.
GTS's operations in India are conducted through C-Datacom International, Inc.
("CDI"), a wholly owned subsidiary which provides digital international private
line communications to and from India for multiple applications, including data
and voice. While not permitted to provide telephony services, CDI is currently
in the process of installing an international gateway switch adjacent to
GTS-Monaco Access's international gateway for the purpose of handling
international traffic.
 
EMPLOYEES
 
     On December 31, 1997, GTS and its consolidated subsidiaries employed a
total of 387 persons. On December 31, 1997, the joint ventures in which GTS
participates employed approximately 1,195 persons. The Company believes its
future success will depend on its continued ability to attract and retain highly
skilled and qualified employees. The Company believes that its relations with
its employees are good.
 
     Although GTS's employees are not unionized, unions represent employees of
the Company's railroad partners in HER. Under the agreements contemplated
between HER and its railroad partners, some of these employees will be required
to construct and maintain certain portions of the HER network. There can be no
assurances that unionized employees of HER's partners will not experience labor
unrest.
 
CERTAIN CONSIDERATIONS GENERALLY APPLICABLE TO THE COMPANY'S OPERATIONS
 
  Managing Rapid Growth
 
     As a result of the Company's past and expected continued growth and
expansion, significant demands have been placed on the Company's management,
operational and financial resources and on its systems and controls. The Company
continues to construct segments of the HER network, expand its operations within
Russia and the CIS and expand into additional geographic and service markets
when business and regulatory
 
                                       53
<PAGE>   55
 
conditions warrant. In order to manage its growth effectively, the Company must
continue to implement and improve its operational and financial systems and
controls, purchase and utilize additional telecommunications facilities and
expand, train and manage its employee base. Inaccuracies in the Company's
forecasts of market demand could result in insufficient or excessive
telecommunications facilities and disproportionate fixed expenses for certain of
its operations. There can be no assurance that the Company will be able to
construct and operate the entire HER network as currently planned, expand with
the markets in which its ventures are currently operating or expand into
additional markets at the rate presently planned by the Company, or that any
existing regulatory barriers to such expansion will be reduced or eliminated. As
the Company proceeds with its development and expansion, there will be
additional demands on the Company's customer support, sales and marketing and
administrative resources and network infrastructure. There can be no assurance
that the operating and financial control systems and infrastructure of the
Company and its ventures will be adequate to maintain and effectively manage
future growth. The failure to continue to upgrade the administrative, operating
and financial control systems or the emergence of unexpected expansion
difficulties could materially and adversely affect the Company's business,
results of operations and financial condition.
 
  Risks Relating to Emerging Markets
 
     Substantially all of the Company's revenue is derived from operations in
emerging markets, where the Company's businesses are subject to numerous risks
and uncertainties, including political, economic and legal risks, such as
unexpected changes in regulatory requirements, tariffs, customs, duties and
other trade barriers, difficulties in staffing and managing foreign operations,
problems in collecting accounts receivable, political risks, fluctuations in
currency exchange rates, foreign exchange controls which restrict or prohibit
repatriation of funds, technology export and import restrictions or
prohibitions, delays from customs brokers or government agencies, seasonal
reductions in business activity, and potentially adverse tax consequences
resulting from operating in multiple jurisdictions with different tax laws,
which could materially adversely impact the Company's business, results of
operations and financial condition.
 
     The political systems of many of the emerging market countries in which the
Company operates or plans to operate are slowly emerging from a legacy of
totalitarian rule. Political conflict and, in some cases, civil unrest and
ethnic strife may continue in some of these countries for a period of time. Many
of the economies of these countries are weak, volatile and reliant on
substantial foreign assistance. Expropriation of private businesses in such
jurisdictions remains a possibility, whether by an outright taking or by
confiscatory tax or other policies. There can be no assurance that GTS's
operations will not be materially and adversely affected by such factors or by
actions to expropriate or seize its operations. The success of free market
reforms undertaken in certain of the emerging market countries in which the
Company operates is also uncertain, and further economic instability may occur.
These factors may reduce and delay business activity, economic development and
foreign investment.
 
     Legal systems in emerging market countries frequently have little or no
experience with commercial transactions between private parties. The extent to
which contractual and other obligations will be honored and enforced in emerging
market countries is largely unknown. Accordingly, there can be no assurance that
difficulties in protecting and enforcing rights in emerging market countries
will not have a material adverse effect upon GTS and its operations.
Additionally, the Company's businesses operate in uncertain regulatory
environments. The laws and regulations applicable to GTS's activities in
emerging market countries are in general new and subject to change and, in some
cases, incomplete. There can be no assurance that local laws and regulations
will become stable in the future, or that changes thereto will not materially
adversely affect the operations of GTS. Additionally, telecommunications
regulations in the more developed Western European markets in which GTS
participates are currently undergoing changes initiated by the Commission of the
European Union.
 
  Adequacy of Management, Legal and Financial Controls in Emerging Markets
 
     Many of the emerging market countries in which the Company operates,
particularly in Russia and the CIS where the Company has to date derived most of
its revenues, are deficient in management and financial reporting concepts and
practices, as well as in modern banking, computer and other control systems. The
                                       54
<PAGE>   56
 
Company historically has had difficulty in hiring and retaining a sufficient
number of qualified employees to work in these markets. As a result of these
factors, the Company has experienced difficulty in establishing management,
legal and financial controls, collecting financial data and preparing financial
statements, books of account and corporate records and instituting business
practices that meet Western standards.
 
     The Company has a policy worldwide of complying with all applicable laws
and seeks to ensure that all persons in its employ comprehend and comply with
such laws. The application of the laws of any particular country, however, is
not always clear, particularly in emerging market countries where commercial
practices differ significantly from practices in the United States and other
Western countries and the legal and regulatory frameworks are less developed. In
addition, some practices, such as the payment of fees for the purpose of
obtaining expedited customs clearance and other commercial benefits, that may be
common methods of doing business in these markets might be unlawful under the
laws of the United States. As a result of the difficulty the Company
historically has experienced in emerging markets in instituting business
practices that meet Western reporting and control standards, it historically has
been unable to ascertain whether certain practices by its ventures, which were
not in accordance with Company policy, were in compliance with applicable U.S.
and foreign laws. If it were to be determined that the Company or any of its
ventures were involved in unlawful practices and were the factual and legal
issues relating thereto to be resolved adversely, the Company or its ventures
could be exposed, among other things, to significant fines, risk of prosecution
and loss of its licenses.
 
     In light of these circumstances, in the second half of 1996 the Company
increased its efforts to improve its management and financial controls and
business practices. The Company recruited a more experienced financial and legal
team, including a new Chief Financial Officer of the Company, a senior finance
officer overseeing all of the regions in which the Company operates, a senior
finance officer for the CIS region, and a senior legal officer for the CIS
region. The Company also established a Treasury group and adopted a more
rigorous Foreign Corrupt Practices Act ("FCPA") compliance program. The Company
has developed and implemented a training program for employees regarding U.S.
legal and foreign local law compliance. The Company also appointed a Compliance
Officer responsible for monitoring compliance with such laws and training
Company personnel around the world. In connection with these developments, the
Company expanded its corporate business practices policy to include, in addition
to compliance with U.S. laws such as the FCPA, compliance with applicable local
laws such as the conflict of interest rules under the 1996 Russian Joint Stock
Company Law, currency regulations and applicable tax laws.
 
     In early 1997, the Company retained special outside counsel to conduct a
thorough review of certain business practices of the Company in the emerging
markets in which the Company operates in order to determine whether deficiencies
existed that needed to be remedied. As a result of this review, the Company
replaced certain senior employees in Russia and instituted additional and more
stringent management and financial controls. As a result of the review, the
Company has not identified any violations of law that management believes would
have a material adverse effect on the Company's financial condition. There can
be no assurances, however, that if the Company or any of its ventures were found
by government authorities to have committed violations of law that, depending on
the penalties assessed and the timing of any unfavorable resolution, the
Company's future results of operations and cash flows would not be materially
adversely affected in a particular period.
 
     Although the Company believes that this review was properly conducted and
was sufficient in scope, there can be no assurance that all potential
deficiencies have been identified or that the control procedures and compliance
programs initiated by the Company will be effective. If the Company or any of
its ventures are ever found to have committed violations of law, depending on
the penalties assessed and the timing of any unfavorable resolution, the
Company's future results of operations and cash flows could be materially
adversely affected in a particular period. Management believes, however, that
the actions taken during the past twelve months to strengthen the Company's
management, financial controls and legal compliance, coupled with the
implementation of the recommendations from the review and the oversight provided
through the Audit Committee of the Board of Directors of the Company to ensure
compliance, will be adequate to address the recurrence of any past possible
deficiencies.
 
                                       55
<PAGE>   57
 
  Dependence on Certain Local Parties; Absence of Control
 
     Many GTS operations including Sovintel, TeleRoss and GTS Cellular have been
developed in cooperation or partnership with key local parties, such as regional
PTOs. The Company is substantially dependent on its local partners to provide
marketing expertise and knowledge of the local regulatory environment in order
to facilitate the acquisition of necessary licenses and permits. Any failure by
the Company to form or maintain alliances with local partners, or the preemption
or disruption of such alliances by the Company's competitors or otherwise, could
adversely affect the Company's ability to penetrate and compete successfully in
the emerging markets it operates in or enters. In addition, in the uncertain
legal environments in which GTS operates, certain GTS businesses may be
vulnerable to local government agencies or other parties who wish to renegotiate
the terms and conditions of, or terminate, their agreements or other
understandings with GTS.
 
     While the Company may have the right to nominate key employees, direct the
operations and determine the strategies of such joint ventures, under the terms
of their respective constituent documents, the Company's partners in some of the
ventures have the ability to frustrate the exercise of such rights. Significant
actions by most of GTS's ventures, such as approving budgets and business plans,
declaring and paying dividends, and entering into significant corporate
transactions effectively require the approval of GTS's local partners. Further,
the Company would be unlikely as a practical matter to want to take significant
initiatives without the approval of its joint venture partners. Accordingly, the
absence of unilateral control by the Company over the operations of its joint
ventures could have a material adverse effect on the Company.
 
     In addition, the Company and its venture partners frequently compete in the
same markets. For example, Rostelecom, GTS's partner in Sovintel, is the
dominant international and domestic long distance carrier in Russia. In
addition, many of the regional telephone companies partnered with GTS in the
TeleRoss Ventures offer cellular services in direct competition with certain of
the operations of GTS Cellular. Such competition with its partners may lead to
conflicts of interest for GTS and its partners in the operations of their
ventures. There can be no assurance that any such conflicts will be resolved in
favor of GTS. In addition, the combination under Svyazinvest of the Russian
government's majority interest in Rostelecom and 85 of the regional telephone
companies gives Svyazinvest a majority interest in entities that provide
international and domestic long distance and local telecommunications services
throughout Russia and may expose the Company to more coordinated competition
from its partners in the Russian telecommunications market.
 
  Government Regulation
 
     As a multinational telecommunications company, GTS through its ventures is
subject to varying degrees of regulation in each of the jurisdictions in which
its ventures provide services. Local laws and regulations, and the
interpretation of such laws and regulations, differ significantly among the
jurisdictions in which the Company and its ventures operate. There can be no
assurance that future regulatory, judicial and legislative changes will not have
a material adverse effect on the Company, that regulators or third parties will
not raise material issues with regard to the Company's or its ventures'
compliance or noncompliance with applicable regulations or that any changes in
applicable laws or regulations will not have a material adverse effect on the
Company or any of its ventures.
 
     Many of GTS's ventures require telecommunications licenses, most of which
have been granted for periods of three to ten years. The terms and conditions of
these licenses may limit or otherwise affect the ventures' scope of operations.
The Company has had favorable experience obtaining, maintaining and renewing
licenses in the past. However, there can be no assurance that it will be able to
obtain, maintain or renew licenses to provide the services it currently provides
and plans to provide, that such licenses will be issued or renewed on terms or
with fees that are commercially viable, or that licenses required by future
ventures can be obtained by the Company or its partners. The loss of or a
substantial limitation upon the terms of these telecommunications licenses could
have a material adverse effect on the Company. See each section under "Business"
entitled "Licenses and Regulatory Issues."
 
     A substantial portion of HER's strategy is based upon the timely
implementation of regulatory liberalization of EU telecommunications market on
January 1, 1998 under existing European Community
                                       56
<PAGE>   58
 
("EC") directives. Although EU member states have a legal obligation to
liberalize their markets in accordance with their requirements, certain more
detailed aspects of the EU regulatory framework to apply in the liberalized
environment after January 1, 1998 still remain to be adopted. In addition,
Ireland, Portugal, Spain, Luxembourg and Greece have been granted extensions
from the January 1, 1998 deadline. There can be no assurance that each EU member
state will proceed with the expected liberalization on schedule, or at all, or
that the trend toward liberalization will not be stopped or reversed in any of
the countries. Accordingly, HER faces the risk that it will establish the HER
network and make capital expenditures in a given country in anticipation of
regulatory liberalization which does not subsequently occur.
 
     In order to give effect to EC directives in each member state, national
governments must pass legislation liberalizing their respective markets. This
applies not only to the liberalization requirements set out in existing EC
directives, but also to requirements set out in directives which have yet to be
adopted. The implementation of EC directives in the telecommunications sector
has been inconsistent or ambiguous in some EU member states. Such implementation
could limit, constrain or otherwise adversely affect HER's ability to provide
certain services. Furthermore, national governments may not necessarily pass
legislation implementing an EC directive in the form required, or at all, or may
pass such legislation only after a significant delay. Even if a national
legislature enacts appropriate regulation within the time frame established by
the EU, there may be significant resistance to the implementation of such
legislation from PTOs, regulators, trade unions and other sources. Further,
HER's provision of services in Europe may be materially adversely affected if
any EU member state imposes greater restrictions on non-EU international
services than on international services within the EU. These and other potential
obstacles to liberalization could have a material adverse effect on HER's
operations by preventing HER from establishing its network as currently
intended, as well as a material adverse effect on the Company.
 
  Competition
 
     GTS faces significant competition in all of its existing telecommunications
businesses and for the types of acquisition and development opportunities it
seeks in both emerging and Western European markets. GTS's competition in these
markets includes national PTOs, multinational telecommunications carriers, other
telecommunications developers and certain niche telecommunications providers. In
addition, certain of the Company's joint venture partners, including Rostelecom
and the regional telephone companies in Russia, certain of HER's rail-based
shareholders and other entities in the emerging markets in which the Company
operates, are also competitors of the Company. As a result of the recent
combination under Svyazinvest of the government's majority interest in
Rostelecom and 85 of the regional telephone companies, the Company may in the
future be subject to more coordinated competition from its partners in the
Russian telecommunications market. Although the Company believes it has a
favorable and cooperative relationship with its joint venture partners, there
can be no assurance that these partners will continue to cooperate with the
Company in the future or that they will not increase competitive pressures on
the Company. Any measures taken by the partners that reduce the level of
cooperation with the Company could jeopardize the Company's ability to
participate in the management and operation of its joint ventures and could have
a material adverse effect on the Company.
 
     HER also competes with respect to its "point-to-point" transborder service
offering against circuits currently provided by PTOs through International
Private Leased Circuits. In addition, the liberalization of the European
telecommunications market is likely to attract additional entrants to both the
"point-to-point" and other telecommunications markets. There can be no assurance
that HER will compete effectively against its current or future competitors. See
also "Western Europe -- HER -- Competition" for a discussion of the plans of
WorldCom, Viatel and Esprit to build fiber optic networks in Western Europe.
 
     Many of the Company's competitors have technical, financial, marketing and
other resources substantially greater than those of GTS. There can be no
assurance that the Company will be able to overcome successfully the competitive
pressures to which it is subject, both in the markets in which it currently
operates and in markets into which it might expand. See each section under
"Business" entitled "Competition." In addition, many of the Company's current
and potential competitors are not subject to, or constrained by the prohibitions
of, the FCPA, including the prohibition against making payments to government
officials in order
                                       57
<PAGE>   59
 
to obtain commercial benefits. The Company is subject to and seeks to comply
with the limitations and prohibitions of such law, and accordingly may be
subject to competitive disadvantages to the extent that its competitors are able
to secure business, licenses or other preferential treatment through the making
of such payments. Accordingly, there can be no assurances that the Company will
be able to compete effectively against companies free from such limitations in
the emerging markets where such commercial practices are commonplace. See
"-- Adequacy of Management, Legal and Financial Controls in Emerging Markets."
 
  Currency and Exchange Risks
 
     All of GTS's operations are conducted outside the United States. A
substantial portion of the Company's anticipated revenues (as well as the
majority of its operating expenses) will be in foreign currency. As a result,
the Company will be subject to significant foreign exchange risks. In
particular, GTS's ventures in countries whose currencies are considered "soft
currencies" subject the Company to the risk that it will accumulate currencies
which may not be readily convertible into hard currency and which may be subject
to significant limitations on repatriation. The Company does not enter into
hedging transactions to limit its foreign currency risk exposure, although the
Company may implement such practices in the future. There can be no assurance
that GTS's operations will not be adversely affected by such factors. In
addition, these factors may limit the ability of the Company to reinvest
earnings from ventures in one country to fund the capital requirements of
ventures in other countries.
 
  Dependence on Effective Information Systems
 
     To complete its billing, the Company must record and process massive
amounts of data quickly and accurately. While the Company believes its ventures'
management information systems are currently adequate, certain of such systems
will have to grow as the ventures' businesses expand. The Company believes that
the successful expansion of its information systems and administrative support
will be important to its continued growth, its ability to monitor and control
costs, to bill customers accurately and in a timely fashion and to achieve
operating efficiencies. There can be no assurance that the Company will not
encounter delays or cost-overruns or suffer adverse consequences in implementing
these systems. Any such delay or other malfunction of the Company's management
information systems could have a material adverse effect on the Company's
business, financial condition and results of operations.
 
  Technology
 
     The telecommunications industry is subject to rapid and significant changes
in technology and such technological advances may reduce the relative
effectiveness of existing technology and equipment. The Company obtains
telecommunications equipment from a number of vendors, upon whom it is dependent
for the adaptation of such equipment to meet varying local telecommunications
standards. The cost of implementation of emerging and future technologies could
be significant. There can be no assurance that the Company will maintain
competitive services or that the Company will obtain appropriate new technology
on a timely basis or on satisfactory terms. Any failure by the Company to
maintain competitive services or obtain new technologies could have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
     Development and operation of the HER network are also subject to certain
technological risks. The network has been designed to utilize SDH technology.
While SDH represents an advanced, new transmission technology, HER's ability to
upgrade technology from this platform may be important in establishing and/or
maintaining a cost advantage over competitive carriers. There can be no
assurance that the HER network will achieve the technical specifications for
which it was designed or that HER will be able to upgrade the network as
technological improvements in telecommunications equipment are introduced.
Failure to achieve current specifications for, or future upgrades of, the
network may materially and adversely affect the viability of the HER network and
could have a material adverse effect on the business and prospects of GTS.
 
                                       58
<PAGE>   60
 
  Difficulty in Obtaining Reliable Market Information
 
     The Company operates in markets in which it is difficult to obtain reliable
market information. The Company's business planning has been based on certain
assumptions concerning subscriber base, usage levels, pricing and operating
expenses based on the Company's experience and the Company's own investigation
of market conditions in the emerging market countries in which it operates. No
assurances can be given as to the accuracy of such assumptions, and such
assumptions may not be indicative of the actual performance of the Company's
operations.
 
  Enforceability of Judgments
 
     Substantially all of the assets of the Company (including all of the assets
of the Company's operating ventures) are located outside the United States. As a
result, it will be necessary for investors to comply with foreign laws in order
to enforce judgments obtained in a United States court (including those with
respect to federal securities law claims) against the assets of the operating
ventures, including foreclosure upon such assets, and there can be no assurance
that any U.S. judgments would be enforced under any such foreign laws.
 
GLOSSARY OF TELECOMMUNICATIONS INDUSTRY TERMS
 
     Accounting Rate Mechanism (ARM) -- The current system of bilateral
settlement agreements between PTOs under which tariffs for cross-border
pan-European-switched voice traffic are determined.
 
     Add-drop multiplexer (ADM) -- A multiplexer which controls cross connect
between individual circuits by software, permitting dynamic cross connect of
individual 64 kbps circuits within an E-1 line.
 
     AMPS -- Advanced Mobile Phone System; the cellular mobile telephone system
based on analog technology that is now used in U.S. systems. Each AMPS cell can
handle 832 simultaneous conversations.
 
     Asynchronous Transfer Mode (ATM) -- A switching and transmission technology
that is one of general class of packet technologies that relay traffic by way of
an address contained within the first five bits of a switching and transmission
of mixed voice, data, and video at varying rates. The ATM format can be used by
many different information systems, including LANs.
 
     Bps -- Bits per second; the basic measuring unit of speed in a digital
transmission system; the number of bits that a transmission facility can convey
between a sending location and a receiving location in one second.
 
     Backbone -- The through-portions of a transmission network, as opposed to
spurs which branch off the through-portions.
 
     Bandwidth -- The information-carrying capability of a transmission medium
is measured by its bandwidth, which is the relative range of frequencies that
can be passed without distortion by such medium. Bandwidth is measured in Hertz,
but may also be expressed as the number of bits that can be transmitted per
second.
 
     Capacity -- Refers to transmission.
 
     Carrier -- A provider of communications transmission services by fiber,
wire, or radio.
 
     CCIT -- International Telegraph and Telephone Consultative Committee.
 
     Closed User Group -- A group of customers with some affiliation with one
another and which are treated for regulatory purposes as not being the public.
 
     Competitive Local Telecommunications Provider -- A company that provides
its customers with an alternative to the local telephone company for local
transport of private line, special access and transport of switched access
telecommunications services. Competitive Local Telecommunications Providers are
also referred to in the industry as alternative local telecommunications service
providers (ALTS), Competitive Access Providers (CAPs) and Competitive Local
Exchange Carriers (CLECs).
 
                                       59
<PAGE>   61
 
     Dark Fiber -- Fiber that lacks the requisite electronic and optronic
equipment necessary to use the fiber for transmission.
 
     Dedicated -- Refers to telecommunications lines dedicated to or reserved
for use by particular customers along predetermined routes (in contrast to
telecommunications lines within the local telephone company's public switched
network).
 
     Digital -- Describes a method of storing, processing and transmitting
information through the use of distinct electronic or optical pulses that
represent the binary digits 0 and 1. Digital transmission/switching technologies
employ a sequence of discrete, distinct pulses to represent information, as
opposed to the continuously variable analog signal.
 
     E1 -- Data transmission rate of approximately 2 Mbps.
 
     E3 -- Data transmission rate of approximately 34 Mbps.
 
     Electrosviaz -- regional telephone company.
 
     Enhanced Network Services -- Telecommunications services providing digital
connectivity, primarily for data applications, via frame relay, ATM, or digital
interexchange private line facilities. Enhanced network services also include
applications on such networks, including Internet access and other Internet
services.
 
     ERMES -- A standard for a pan-European radio message system sponsored by
the EC.
 
     Eutelsat -- European Telecommunications Satellite Organization; an
international satellite organization in which members of the European Union hold
an 88% combined investment.
 
     Frame Relay -- A wide area transport technology that organizes data into
units called frames instead of providing fixed bandwidth as with private lines.
A high-speed, data-packet switching service used to transmit data between
computers. Frame Relay supports data units of variable lengths at access speeds
ranging from 56 kilobits per second to 1.5 megabits per second. This service is
well-suited for connecting local area networks, but is not presently well-suited
for voice and video applications due to the variable delays which can occur.
Frame Relay was designed to operate at high speeds on modern fiber optic
networks.
 
     Gbps -- Gigabits per second, which is a measurement of speed for digital
signal transmission expressed in billions of bits per second.
 
     Gateway -- A network element interconnecting two otherwise incompatible
networks, network nodes, subnetworks or devices; performs a protocol conversion
operation across a wide spectrum of communications functions.
 
     GSM -- Global System for Mobile Communications, formerly known as Groupe
Speciale Mobile. GSM began as a pan-European standard for digital cellular
systems. The name was changed to reflect the fact that the standard has been
adopted by several countries in Asia.
 
     Hertz -- The unit for measuring the frequency with which an electromagnetic
signal cycles through the zero-value state between lowest and highest states.
One Hz (Hertz) equals one cycle per second. kHz (kilohertz) stands for thousands
of Hertz; MHz (megahertz) stands for millions of Hertz.
 
     Inmarsat -- The International Maritime Satellite service, which provides
mobile communications to ships at sea, aircraft in flight and vehicles on the
road.
 
     Intelsat -- International Telecommunications Satellite Organization; a
worldwide consortium of national satellite communications organizations.
 
     Interconnect -- Connection of a telecommunications device of service to the
PSTN.
 
     Interconnection -- Connection of a piece of telephone equipment to the
telephone network, or a data terminal to a data communications network. Also
refers to the connection of one communications network to another so that users
of one network can communicate with users of another network.
 
                                       60
<PAGE>   62
 
     International Simple Resale -- Refers to the wholesale purchase of IPLCs
from facilities-based carriers and the reselling of such capacity to customers
for switched telephone service.
 
     IPLC -- International Private Leased Circuits.
 
     ISDN (Integrated Services Digital Network) -- ISDN is an internationally
agreed standard which, through special equipment, allows two-way, simultaneous
voice and data transmission in digital formats over the same transmission line.
ISDN permits video conferencing over a single line, for example, and also
supports a multitude of value-added switched service applications. ISDN's
combined voice and data networking capabilities reduce costs for end users and
result in more efficient use of available facilities. ISDN combines standards
for highly flexible customer to network signaling with both voice and data
within a common facility.
 
     ITU -- International Telecommunications Union; a United Nations treaty
organization whose purpose is to accredit international telecommunications
standards. ITU signatories can turn ITU-approved standards into law through
international treaties such as the treaties governing use of the radio spectrum
for international satellite telecommunications and broadcasting.
 
     Kbps -- Kilobits per second, which is a measurement of speed for digital
signal transmission expressed in thousands of bits per second.
 
     Local Area Network (LAN) -- The interconnection of computers for the
purpose of sharing files, programs and peripheral devices such as printers and
high-speed modems. LANs may include dedicated computers or file servers that
provide a centralized source of shared files and programs. LANs are generally
confined to a single customer's premises and may be extended or interconnected
to other locations through the use of bridges and routers.
 
     Local Loop -- The local loop is that portion of the local telephone network
that connects the customer's premises to the local exchange provider's central
office or switching center. This includes all the facilities starting from the
customer premise interface which connects to the inside wiring and equipment at
the customer premise to a terminating point within the switching wire center.
 
     Mbps -- Megabits per second, which is a measurement of speed for digital
signal transmission expressed in millions of bits per second.
 
     MGTS -- Moscow city telephone network.
 
     Multiplexing -- The use of some means to inter-leave narrow-band or
slow-speed data from multiple sources in order to make use of a wide-band or
high-speed channel.
 
     NMT -- Acronym for Nordic Mobile Telephone System, a cellular standard
widely used in Northern Europe.
 
     Nodes -- Locations within the network housing electronic equipment and/or
switches which serve as intermediate connection points to send and receive
transmission signals.
 
     PBX/PABX (private branch exchange/private automatic branch exchange) -- A
customer operated switch on customer premises, typically used by large
businesses with multiple telephone lines.
 
     Plesiochronous Digital Hierarchy (PDH) -- A method of controlling the
timing between transmission and switching systems that is not synchronized but
rather relies on highly accurate clocks to minimize the slip rates between
switching nodes.
 
     POCSAG (Postal Office Code Standard Advisory Group) -- A lower-cost paging
technology which can be transmitted on ERMES frequency.
 
     Points of Presence (POPs) -- Locations where a carrier has installed
transmission equipment in a service area that serves as, or relays calls to, a
network switching center of that carrier.
 
     PSTN -- Public switched telecommunications network.
 
                                       61
<PAGE>   63
 
     PTT/PTO -- Postal, Telegraph and Telephone agency/Public Telephony
Operators; a government authority or agency that operates the public
telecommunications network, and sets standards and policies. PTTs/PTOs are
agencies in charge of telecommunications services in many countries, under
direct supervision of the national government.
 
     Redundant Electronics -- Describes a telecommunications facility using two
separate electronic devices to transmit the telecommunications signal so that if
one device malfunctions, the signal may continue without interruption.
 
     Regeneration/amplifier -- Devices which automatically re-transmit or boost
signals on an out-bound circuit.
 
     Route Kilometers -- The number of kilometers along which fiber optic cables
are installed.
 
     Route Mile -- The number of miles along which fiber optic cables are
installed.
 
     SDH -- Synchronous Digital Hierarchy; the international standard for
ultra-high-speed broadband fiber-optic, digital transmission networks that use
equipment from many different manufacturers and carry a variety of services. The
basic communications channel of SDH is a 155.52 Mbps transmission channel that
is multiplexed upward.
 
     STM-1 -- Data transmission rate of approximately 155 Mbps.
 
     STM-4 -- Data transmission rate of approximately 622 Mbps.
 
     STM-16 -- Data transmission of approximately 2,488 Mbps.
 
     STM-64 -- Data transmission rate of approximately 9,952 Mbps.
 
     Switch -- A mechanical or electronic device that opens or closes circuits
or selects the paths or circuits to be used for the transmission of information.
Switching is a process of linking different circuits to create a temporary
transmission path between users.
 
     Synchronous Digital Hierarchy (SDH) -- SDH is a set of standards for
optical communications transmission systems that define optical rates and
formats, signal characteristics, performance, management and maintenance
information to be embedded within the signals and the multiplexing techniques to
be employed in optical communications transmission systems. SDH facilitates the
interoperability of dissimilar vendors' equipment and benefits customers by
minimizing the equipment necessary for telecommunications applications. SDH also
improves the reliability of the local loop connecting customers' premises to the
local exchange provider, historically one of the weakest links in the service
delivery.
 
     TCP/IP -- Transmission Control Protocol/Internet Protocol; an "open"
standard operating and interface protocol for federal government local area
networks that use devices from multiple vendors. TCP/IP, first developed by the
U.S. Defense Department, has been adopted by some academic and business
institutions who deal regularly with the federal government.
 
     Trunk -- A telephone circuit with a switch at both ends. A trunk may
connect two central office switches, or two PBXs, or a PBX and a central office
switch.
 
     VSAT -- Very Small Aperture Terminal; a satellite communications technology
that employs frequencies in the Ku band or C band and very small receiving
dishes. VSAT systems employ satellite transponders; the receiving dishes may be
leased or owned by the VSAT user.
 
     Wavelength Division Multiplexing (WDM) -- A multiplexing technique allowing
multiple different signals to be carried simultaneously on a fiber by allocating
resources according to frequency on non-overlapping frequency bands.
 
     X.25 -- A CCITT standard governing the interface between data terminals and
data circuit termination equipment for terminals on packet-switched data
networks.
 
                                       62
<PAGE>   64
 
ITEM 2. PROPERTIES
 
     The Company leases, under long-term leases, office space to serve as sales
office and/or administrative facilities, including its 15,000 square-foot
headquarters in McLean, Virginia with a five year lease expiring December, 2000.
The Company maintains regional headquarters offices in Moscow and Budapest, as
well as facilities in London. HER is headquartered just outside of Brussels,
Belgium.
 
     HER leases, under long-term leases, portions of railroad, utility and other
rights-of-way for its fiber-optic routes. HER is creating a fiber optic network
consisting of optical fiber pairs, which are leased under long-term leases, and
technical sites leased under long-term leases. See "Business -- Western
Europe -- HER."
 
ITEM 3. LEGAL PROCEEDINGS
 
     In addition to routine legal proceedings incidental to the conduct of its
business, the Company, GTS-Hungaro and GTS-Hungary are named as defendants in an
action captioned USH Ventures and USH Telecom, L.L.C. v. Global TeleSystems
Group, Inc. and GTS-Hungaro, Inc., Civil Action No. 97C-08-86, commenced in
August 1997, which is currently pending in the Superior Court of the State of
Delaware in and for New Castle County. The complaint alleges breach of contract
and interference with a business relationship. While it is not possible at this
time to make a meaningful assessment of the outcome of this litigation, based
upon information currently available and upon consultation with counsel, the
Company does not believe that the outcome of this litigation will have a
material adverse effect upon the financial condition of the Company.
 
     On March 27, 1998, V-Tech brought a claim for approximately $1.1 million
against Gilat Satellite Networks, Ltd. ("Gilat"), the vendor of a Ku-band VSAT
hub and system which V-Tech purchased in 1996, in an arbitration proceeding
under the Rules of Arbitration of the ICC International Court of Arbitration. V-
Tech has demanded in the request for arbitration that Gilat accept return of the
equipment, which V-Tech has not accepted or commissioned because it has failed
to meet contract specifications, and refund purchase amounts already paid under
the contract, plus other sums. Gilat has previously asserted that the equipment
meets specifications and demanded that V-Tech pay the balance due under the
contract, approximately $400,000. It is not possible at this time to make an
assessment of the outcome of the arbitration proceeding.
 
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
 
     During the fourth quarter of 1997 and first quarter of 1998, the Company,
in lieu of calling stockholders meetings, solicited written consents from its
common stockholders with respect to the following three proposed actions:
 
          1) The Company solicited written consents from its common stockholders
     of record on November 14, 1997, regarding a proposal to amend the Company's
     Certificate of Incorporation, as amended (the "Charter"), to:
 
             a) change the par value per share of the Company's common stock
        from $0.0001 to $0.10;
 
             b) effect a 3-for-2 split of the Company's common stock; and
 
             c) increase the authorized common stock from 60 million to 135
        million shares.
 
          As of December 1, 1997, holders representing 17,847,036 shares of the
     Company's common stock, or 71% of the outstanding shares of common stock,
     submitted written consents approving such proposed amendment of the
     Charter. The Company did not receive any responses "against," or
     abstentions with respect to, the proposed amendment.
 
                                       63
<PAGE>   65
 
          2) The Company solicited written consents from its common stockholders
     of record on December 10, 1997 regarding a proposal to amend its Charter
     to:
 
             a) classify its Board of Directors into three classes and stagger
        the election of each such class for three-year terms commencing at the
        annual stockholders meetings to be held in 1998, 1999 and 2000;
 
             b) eliminate the ability of the stockholders to act by written
        consent; and
 
             c) provide that the provisions of the charter set forth in (a) and
        (b) above can be amended only by an affirmative vote of 75% of the
        shares present and eligible to vote (the "Locking Provision").
 
          As of January 29, 1998, holders representing 20,627,807 shares of the
     Company's common stock, or 55% of the outstanding shares of common stock,
     submitted written consents approving such proposed amendments of the
     Charter. The Company received 2,014,287 votes, or 5% of the outstanding
     common stock, against the proposed amendment. The Company did not receive
     any abstentions with respect to the proposed amendment.
 
          3) The Company solicited written consents from its common stockholders
     of record on January 12, 1998 regarding a proposal to amend the Charter to
     require an affirmative vote of 75% of the shares present and eligible to
     vote to amend the Locking Provision. As of January 29, 1998 holders
     representing 23,595,352 shares of the Company's common stock, or 63% of the
     outstanding shares of common stock, submitted written consents approving
     such proposed amendment of the Charter. The Company did not receive any
     responses "against," or abstentions with respect to, the proposed
     amendment.
 
                                    PART II
 
ITEM 5.MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
     The listing of the Company's common stock on the NASDAQ National Market
commenced on February 5, 1997. The high and low sale prices of the Company's
common stock as reported by the NASDAQ National Market from February 5, 1998
through February 27, 1998 were:
 
                         High $38.75;          Low $25
 
     As of February 27, 1997, the Company's common stock was held by 179 holders
of record.
 
     The Company has not paid any dividend on its common stock and does not
intend to pay dividends in the foreseeable future. In addition, the indenture
governing the Company's 9-7/8% Senior Notes due 2005 contains restrictions on
the making of restricted payments (in the form of the declaration or payment of
certain dividends or distributions, the purchase, redemption or other
acquisition of any capital stock of the Company, the voluntary prepayment of
pari passu or subordinated indebtedness and the making of certain investments,
loans and advances) unless no Default or Event of Default (each, as defined in
such indenture) exists, its leverage ratio does not exceed 6.0 to 1.0 and such
restricted payments do not exceed the Basket (as defined in such indenture).
Moreover, GTS is a holding company which has no significant business operations
or assets other than its interests in joint ventures and its subsidiaries.
Accordingly, GTS must rely entirely upon distributions from the joint ventures
and its subsidiaries and investments to generate the funds necessary to pay any
dividends. The joint ventures and the Company's subsidiaries are separate and
distinct legal entities which have no obligation, contingent or otherwise, to
pay any amount to the Company, whether by dividends, loans or other payments,
except for payments under certain intercompany indebtedness. See "Business." In
addition, should the Company receive dividends or other distributions from its
joint ventures, subsidiaries or investments, the ability of the Company to
repatriate such profits and capital is dependent upon the provisions of the
applicable foreign investment and exchange laws and availability of foreign
exchange in sufficient quantities in those countries. The amount of such
dividends and other distributions from these entities will be
 
                                       64
<PAGE>   66
 
affected by the current tax systems in these jurisdictions, primarily the
provisions relating to corporate profits and withholding taxes. Furthermore,
because consent is required of the venture partners in some of the Company's
joint ventures for distributions from such joint ventures, the Company's ability
to receive dividends and other distributions is to some degree dependent on
cooperation from its joint venture partners. Thus, there can be no assurance
that the Company will be able to realize benefits from its joint ventures,
subsidiaries and investments through the receipt of dividends or other
distributions at such times and amounts it desires. In addition, the Company and
certain operating subsidiaries of the Company may enter into future financings,
the terms of which may include dividend restrictions.
 
     The foregoing reflects a 3-for-2 common stock split and an increase in the
par value per share of common stock to $0.10 effective December 1, 1997.
 
     During the year ended December 31, 1997 the Company issued securities which
were not registered under the Securities Act of 1933, as amended (the
"Securities Act") as follows:
 
     On July 14, 1997 and July 31, 1997, the Company issued an aggregate
$141,295,000 of its Senior Subordinated Convertible Bonds due 2000, convertible
into the common stock, par value $0.10 per share, at a purchase price of 100%,
pursuant to a subscription agreement. UBS Securities LLC, Donaldson, Lufkin &
Jenrette Securities Corporation and Merrill Lynch & Co. acted as managers in the
offering and the aggregate discount was $5,651,800. The securities were sold to
a limited number of qualified institutional buyers as defined in Rule 144A under
the Securities Act and to non-U.S. persons outside the United States. Exemption
from registration was claimed under Rule 144A and Regulation S of the Securities
Act. On February 10, 1998, the Company completed a "Complying Public Equity
Offering," as defined in the indenture for such Bonds, and, as a result, such
Bonds became convertible into the common stock at a conversion price of $20 per
share.
 
     On August 15, 1997, August 29, 1997 and September 5, 1997, the Company
issued an aggregate 2,502,686 shares of common stock, par value $0.10 per share,
at a purchase price of $15.67 per share, for an aggregate offering price of
$39.2 million, pursuant to a stock purchase agreement. In addition to (i)
certain investment funds and (ii) certain individual private investors, these
shares were issued to certain members of management and various entities
affiliated with certain members of management. Exemption from registration was
claimed under Section 4(2) of the Securities Act regarding transactions by an
issuer not involving any public offering.
 
     On August 29, 1997, the Company issued $3.5 million of its Senior
Subordinated Convertible Bonds due 2000, convertible into the common stock, par
value $0.10 per share, at a purchase price of 100%. In addition to (i) certain
investment funds and (ii) certain individual private investors, these shares
were issued to certain members of management and various entities affiliated
with certain members of management. Exemption from registration was claimed
under Section 4(2) of the Securities Act regarding transactions by an issuer not
involving any public offering. See the discussion above concering the terms of
conversion of these Bonds.
 
     On September 26, 1997, the Company filed a registration statement
(Commission file no. 333-36555) (the "Stock Registration Statement") with the
Securities and Exchange Commission (the "Commission") to offer and sell to the
public, in an underwritten offering, 11,100,000 shares of its common stock, par
value $0.10 per share (the "Stock Offering"). Merrill Lynch & Co., Donaldson,
Lufkin & Jenrette Securities Corporation, UBS Securities LLC, Lehman Brothers
Inc. and Furman Selz LLC acted as the managers of the U.S. portion (7,400,000
shares) of the Stock Offering. Merrill Lynch International, UBS Limited,
Donaldson, Lufkin and Jenrette International, Lehman Brothers International
(Europe) and Baring Brothers Limited (as agent for ING Bank N.V.) acted as the
managers of the international portion (3,700,000 shares) of the Stock Offering.
The Stock Registration Statement was declared effective by the Commission on
February 5, 1998. In connection with the Stock Offering, the managing
underwriters exercised an overallotment option of 1, 665,000 shares. The Stock
Offering has terminated. The Company realized from the sale of a total of
12,765,000 common shares at $20 per share net proceeds from the Stock Offering,
including shares issued pursuant to exercise of the overallotment option, of
$238,705,500, after payment of $16,594,500 in underwriting discounts. On
December 23, 1997, the Company also filed a registration statement (Commission
file no. 333-43155) (the "Debt Registration Statement") to offer and sell to the
public, in an underwritten offering,
                                       65
<PAGE>   67
 
senior notes due 2005 of the Company (the "Debt Offering"). Donaldson, Lufkin &
Jenrette Securities Corporation, Merrill Lynch & Co. and UBS Securities acted as
managers of this offering. The Debt Registration Statement was declared
effective by the Commission on February 5, 1998. The Debt Offering has
terminated and the Company issued $105 million aggregate principal amount of
9 7/8% Senior Notes due 2005 (the "Senior Notes"). The Company realized from the
sale of the Senior Notes net proceeds of $82.3 million, after payment of
underwriting discounts and commissions of $3,150,000, and the deposit of $19.6
million in escrow to cover the first four scheduled payments of interest on the
Senior Notes. In February 1998, the Company applied a portion of the net
proceeds of the Offerings, approximately $85.2 million, to repay the outstanding
principal of, and accrued interest on, certain loans from related parties. See
Note 5 Debt Obligations the Company's audited consolidated financial statements
for a description of such related party loans. The Company will disclose
additional information regarding expenses incurred in connection with, and
application of net proceeds of, the Offerings in its quarterly report on Form
10-Q for the quarter ended March 31, 1998.
 
                                       66
<PAGE>   68
 
ITEM 6. SELECTED FINANCIAL DATA
 
     Selected financial data for the Company is presented below.
 
                SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
 
     The following selected historical consolidated financial data as of and for
the years ended December 31, 1993, 1994, 1995, 1996 and 1997 are derived from
the Company's audited Consolidated Financial Statements. The selected financial
data presented below should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the audited
Consolidated Financial Statements and related notes thereto appearing elsewhere
in this Prospectus.
 
     Under generally accepted accounting principles, many of the Company's
ventures are accounted for by the equity method of accounting. Under this
method, the operating results of the ventures are included in the Company's
Consolidated Statement of Operations as a single line item, "Equity in (losses)
earnings of ventures." The Company recognizes 100% of the losses in ventures
where the Company bears all of the financial risk (which includes all of the
Company's significant ventures except for Sovintel and, historically, HER).
Also, the assets, liabilities and equity of the ventures are included in the
Company's Consolidated Balance Sheets as a single line item "Investments in and
Advances to Ventures." See Note 3 to the Company's audited Consolidated
Financial Statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview." Financial information about
the Company's equity ventures is included below under "Supplemental
Information -- Selected Historical Financial Data -- Combined Equity
Investments."
<TABLE>
<CAPTION>
                                                                    YEARS ENDED DECEMBER 31,
                                                      ----------------------------------------------------
                                                       1993       1994       1995       1996      1997(1)      1997
                                                      -------   --------   --------   --------   ---------   ---------
<S>                                                   <C>       <C>        <C>        <C>        <C>         <C>
                                                                                                             PRO FORMA
                                                                                                                (2)
                                                                                                             ---------
 
<CAPTION>
                                                                   (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                   <C>       <C>        <C>        <C>        <C>         <C>
STATEMENT OF OPERATIONS DATA:
Revenues, net.......................................  $   328   $  2,468   $  8,412   $ 24,117   $  47,098      47,098
Gross margin........................................      328         23         16      5,176       4,379       4,379
Operating expenses..................................    3,340     12,863     41,014     52,955      78,410      78,410
Equity in earnings (losses) of ventures.............      472       (135)    (7,871)   (10,150)    (14,599)    (14,599)
Other income (expense)..............................      100        990     11,034     (8,729)    (29,551)    (29,551)
Loss before extraordinary loss......................   (2,440)   (11,985)   (40,400)   (67,991)   (116,986)   (116,986)
Extraordinary loss..................................       --         --         --         --          --     (13,213)
Net loss............................................   (2,440)   (11,985)   (40,400)   (67,991)   (116,986)   (130,199)
Loss per share before extraordinary loss............    (0.26)     (0.69)     (1.61)     (2.22)      (3.26)      (3.26)
Extraordinary loss per share........................       --         --         --         --          --       (0.27)
Net loss per share..................................    (0.26)     (0.69)     (1.61)     (2.22)      (3.26)      (2.68)
BALANCE SHEET DATA (AT END OF PERIOD):
Cash and cash equivalents...........................  $ 3,641   $ 29,635   $  9,044   $ 57,874   $ 318,766     551,641
Property and equipment, net.........................      829      8,393     29,523     35,463     236,897     236,897
Investments in and advances to ventures.............      794     13,841     56,153    104,459      76,730      76,730
Total assets........................................    5,968     61,957    115,621    237,378     780,461   1,036,400
Total debt..........................................      725      2,152     27,454     85,547     639,359     672,219
Minority interest and stock subject to repurchase...       --          8      5,273      6,248      31,255      18,766
Shareholders' equity................................    4,685     54,684     55,322    113,668      26,967     266,706
</TABLE>
 
---------------
 
(1) As a result of the Company's increase in ownership interest and amendment to
    the HER Shareholders Agreement that was completed on July 16, 1997, the
    Company accounts for its ownership interest in HER under the consolidation
    method of accounting. Prior to this date, the Company accounted for HER
    under the equity method of accounting.
 
(2) The above unaudited pro forma information gives effect to the underwritten
    public offerings by the Company of common stock and debt securities
    consummated in February 1998, as though the transactions had occurred on
    December 31, 1997. The adjustments include the raising of $255.3 million
    from the sale of 12.8 million shares of common stock at an issue price of
    $20.00 per share. In addition, the Company issued $105.0 million in senior
    notes. Approximately $85.2 million of the net proceeds were used to repay
    the related party debt obligations. See Note 15, Audited Financial
    Statements of the Company.
 
                                       67
<PAGE>   69
 
                SUPPLEMENTAL INFORMATION -- SELECTED HISTORICAL
                 FINANCIAL DATA -- COMBINED EQUITY INVESTMENTS
 
     The following unaudited selected historical financial data -- equity
investments for the years ended December 31, 1995, 1996 and 1997, are derived
from the Company's financial records. It is intended to supplement the
aforementioned selected historical consolidated financial data. The financial
data set forth below represents 100% of the results of operations for each of
the entities.
 
     The Company believes that this information provides additional insight on
the Company's unconsolidated equity method investments. Generally accepted
accounting principles prescribe inclusion of revenues and expenses for
consolidated interests (generally interests of more than 50%, absent some other
factors), but not for equity interests (generally interests of 20% to 50%) or
cost interests (generally interests of less than 20%). Equity accounting
ordinarily results in the same net income as consolidation; however, the net
operating results are reflected on one line within the income statement.
 
<TABLE>
<CAPTION>
                                                          OWNERSHIP               COST OF    OPERATING        NET
                                                         INTEREST(2)   REVENUES   REVENUES   EXPENSES    INCOME/(LOSS)
                                                         -----------   --------   --------   ---------   -------------
                                                                   (IN THOUSANDS, EXCEPT OWNERSHIP INTEREST)
<S>                                                      <C>           <C>        <C>        <C>         <C>
YEAR ENDED DECEMBER 31, 1995
  Sovintel.............................................       50%      $44,292    $26,247     $ 7,047       $ 7,648
  TCM..................................................       50%           49         --          57            (7)
  TeleRoss.............................................       50%          176         59         242          (193)
  Sovam................................................     66.7%        4,434      2,914       3,273        (1,789)
  GTS Cellular Companies...............................       50%(3)     4,574      2,834       2,960        (2,165)
  Other................................................       50%(3)       526        957       9,379        (9,874)
                                                                       --------   --------    -------       -------
        Total..........................................                 54,051     33,011      22,958        (6,380)
  ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(1)......                 (2,270)    (2,215)     (6,967)
YEAR ENDED DECEMBER 31, 1996
  Sovintel.............................................       50%      $75,040    $43,910     $10,411       $14,762
  TCM..................................................       50%       16,507      3,330       1,854         8,874
  TeleRoss.............................................       50%        2,413        832       2,293          (841)
  Sovam................................................     66.7%       11,671      8,236       5,714        (2,138)
  GTS Cellular Companies...............................       50%(3)    25,778     11,883      13,614        (3,406)
  Other................................................       50%(3)    12,063     12,235      21,132       (22,471)
                                                                       --------   --------    -------       -------
        Total..........................................                143,472     80,426      55,018        (5,220)
  ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(1)......                (15,385)   (13,562)     (8,083)
YEAR ENDED DECEMBER 31, 1997
  Sovintel.............................................       50%      $113,962   $72,629     $17,020       $18,464
  TCM..................................................       50%       29,308      7,169       3,286        12,512
  TeleRoss.............................................       50%        6,794      2,138       3,612            71
  Sovam................................................     66.7%       17,808     10,684       5,653           780
  GTS Cellular Companies...............................       50%(3)    44,275     21,355      17,678          (906)
  Other................................................       50%(3)    14,013     13,757      27,596       (26,591)
                                                                       --------   --------    -------       -------
        Total..........................................                226,160    127,732      74,845         4,330
  ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(1)......                (24,927)   (23,250)     (8,357)
</TABLE>
 
---------------
 
(1) The adjustment amounts represent the effect of inter-affiliate transactions
    between the Company's consolidated and equity method ventures. More detailed
    information about inter-affiliate transactions is included under
    "Management's Discussion and Analysis of Financial Condition and Results of
    Operations -- Accounting Methodology."
 
(2) The ownership interest column indicates the Company's legal ownership
    percentage for the respective equity investments. The information is being
    provided to assist an investor or analyst in determining the Company's legal
    rights associated with the presented financial data. See Note 3 in the
    Company's audited Consolidated Financial Statements for additional
    disclosures related to the Company's equity investments.
 
(3) The Company generally maintains a 50% ownership interest in these equity
    investments. See Note 3 in the Company's audited Consolidated Financial
    Statements for additional disclosures related to the Company's equity
    investments.
 
                                       68
<PAGE>   70
 
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
       OF OPERATIONS
 
     The following is a discussion of the financial condition and results of
operations of the Company as of December 31, 1997, 1996 and 1995 and for the
years ended December 31, 1997, 1996, 1995. The following discussion should be
read in conjunction with the Company's Consolidated Financial Statements and the
notes related thereto.
 
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
 
     Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" including, without limitation,
those concerning (i) projected traffic volume, (ii) future revenues and costs,
(iii) changes in the Company's competitive environment and (iv) the performance
of future equity-method investments, contain forward-looking statements
concerning the Company's operations, economic performance and financial
condition. Because such statements involve risks and uncertainties, actual
results may differ materially from those expressed or implied by such
forward-looking statements.
 
     In addition, any statements that express, or involve discussions as to,
expectations, beliefs, plans, objectives, assumptions or future events or
performance (often, but not always, through the use of words or phrases such as
"will likely result," "are expected to," "will continue," "is anticipated,"
"estimated," "intends," "plans," "projection" and "outlook") are not historical
facts and may be forward-looking and, accordingly, such statements involve
estimates, assumptions and uncertainties which could cause actual results to
differ materially from those expressed in the forward-looking statements.
Accordingly, any such statements are qualified in their entirety by reference
to, and are accompanied by, the factors discussed throughout this Report. Among
the key factors that have a direct bearing on the Company's results of
operations are the potential risk of delay in implementing the Company's
business plan; the political, economic and legal aspects of the markets in which
the Company operates; competition and the Company's need for additional
substantial financing. These and other factors are discussed herein under
"Business," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and elsewhere in this Report.
 
     The factors described in this Report could cause actual results or outcomes
to differ materially from those expressed in any forward-looking statements of
the Company made by or on behalf of the Company, and investors, therefore,
should not place undue reliance on any such forward-looking statements. Further,
any forward-looking statement speaks only as of the date on which such statement
is made, and the Company undertakes no obligation to update any forward-looking
statement or statements to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrence of unanticipated
events. New factors may emerge from time to time, and it is not possible for
management to predict all of such factors. Further, management cannot assess the
impact of each such factor on the Company's business or the extent to which any
factor, or combination of factors, may cause actual results to differ materially
from those contained in any forward-looking statements.
 
OVERVIEW
 
     Business. GTS is a provider of a broad range of telecommunications services
to businesses, other telecommunications service providers and consumers in
Russia and the CIS, Central Europe and Asia. In Western Europe, through HER, GTS
is developing and operating the initial segment of a pan-European high capacity
fiber optic network which is designed to interconnect a majority of the largest
Western and Central European cities and to transport international voice, data
and multimedia/image traffic for other carriers throughout Western and Central
Europe. GTS's strategy to develop its businesses generally has been to establish
joint ventures with a strong local partner or partners while maintaining a
significant degree of operational control. The Company's business activities
consist of the ownership and operation of (i) international long distance
businesses, which operate through international gateways that provide
international switching services and transmission capacity, (ii) local access
networks, which provide local telephone service, (iii) cellular networks, which
provide wireless telecommunications services, (iv) a domestic
 
                                       69
<PAGE>   71
 
long distance business, (v) data networks and (vi) carriers' carrier networks,
which provide high volume transmission capacity to other carriers.
 
     The Company began to acquire interests in numerous telecommunications
ventures beginning in 1994 and continued to acquire such interests throughout
1995 and 1996. Ventures with significant financial results in 1994 included
Sovintel (an international long distance and domestic and local access
telecommunications service provider) and GTS-Hungary (a VSAT network
telecommunications service provider); ventures that incurred start-up costs
associated with building out their business infrastructure in 1994 included
Sovam (a data and internet telecommunications service provider) and EuroHivo (a
paging telecommunications service provider). In 1995, TeleRoss (a domestic long
distance telecommunications service provider) and GTS Cellular (a basic cellular
telecommunications service provider) began operations and expanded into numerous
regions within the CIS by the end of 1996. Telecommunications of Moscow ("TCM")
(a local access telecommunications service provider) began operations in 1996.
HER (a carriers' carrier telecommunications service provider) began its network
build-out in 1995, began limited operations at the end of 1996 and expects to
continue to develop its network during 1998 and beyond. The fact that these
ventures are in various stages of development affects the discussion of
comparative results below. See "Business."
 
     GTS has invested significantly in its ventures through capital
contributions and loans. In addition, the Company has made a significant
commitment to its businesses and ventures through the provision of management
assistance and training. GTS has also incurred significant expenses in
identifying, negotiating and pursuing new telecommunications opportunities. GTS
and certain of its ventures are experiencing continuing losses and negative
operating cash flow primarily because the businesses are in the developmental
and start-up phases of operations. Management recognizes that the Company must
generate additional capital resources in order to continue its operations and
meet its new development initiatives. The ultimate recoverability of the
Company's investments in and advances to ventures is dependent on many factors
including, but not limited to, the ability of the Company to obtain sufficient
financing to continue to meet its capital and operational commitments, the
economies of the countries in which it does business and the ability of the
Company to maintain the necessary telecommunications licenses.
 
     The Company's businesses are developing rapidly. Some of the businesses
operate in countries with emerging economies which have uncertain economic,
political and regulatory environments. The general risks of operating businesses
in the CIS and other developing countries include the possibility for rapid
change in government policies including telecommunications regulations, economic
conditions, the tax regime and foreign currency regulations. See
"Business -- Certain Considerations Applicable to the Company's Operations in
Russia and the CIS" and "-- Certain Considerations Generally Applicable to the
Company's Operations."
 
ACCOUNTING METHODOLOGY
 
     Accounting for Business Ventures. Wholly-owned subsidiaries and
majority-owned ventures where the Company has unilateral operating and financial
control are consolidated. Those ventures where the Company exercises significant
influence, but does not exercise unilateral operating and financial control, are
accounted for by the equity method. The Company has certain majority-owned
ventures that are accounted for by the equity method as a result of minority
shareholder rights, super-majority voting conditions or other governmentally
imposed uncertainties so severe that they prevent the Company from obtaining
unilateral control of the venture.
 
     Profit and Loss Accounting. The Company recognizes profits and losses in
accordance with its underlying ownership percentage or allocation percentage as
specified in the agreements with its partners; however, the Company recognizes
100% of the losses in ventures where the Company bears all of the financial risk
(which includes all of the Company's significant ventures except for Sovintel
and, historically, HER). Accordingly, the portion of the losses that would
normally be assigned to the minority interest partner ("Excess Losses") is
recognized by the Company. When such ventures become profitable, the Company
recognizes 100% of the profits until such time as the Excess Losses previously
recognized by the Company have been recovered. As of December 31, 1997, $5.3
million and $10.0 million represent the net unrecovered Excess Losses for the
 
                                       70
<PAGE>   72
 
Company's consolidated and equity method investments, respectively, that is
expected to favorably benefit future period results from operations upon the
Company's existing business ventures becoming profitable. This accounting policy
was adopted prior to 1995; however, 1995 was the first year that the excess loss
amount was deemed material for recognition within the Company's accounting
records. For the period from January 1, 1997, through August 31, 1997, the
Company recognized 100% of HER's losses due to GTS being the financing partner
during this period. As a result of HER's issuance of $265 million aggregate
principal amount of senior notes (of which $56.6 million was placed in escrow
for the first two years' interest payments) in August 1997, the Company no
longer considers itself as the financing partner.
 
     Inter-Affiliate Transactions. Several of the Company's ventures have
entered into business arrangements through which they provide integrated
solutions for their customers by leveraging each others' telecommunications
infrastructure. These arrangements have historically been focused primarily
within a region; however, as GTS has increased its geographic coverage and
telecommunication capabilities, these arrangements have expanded between
regions. In accordance with generally accepted accounting principles, all
significant intercompany accounts and transactions are eliminated upon
consolidation.
 
     Turnover Taxes. The Company's ventures within the CIS region incur a 4%
turnover tax that is based on the revenues earned. The Company includes these
taxes as a component of its operating expenses, since these taxes are incidental
to the revenue cycle.
 
     The following table summarizes the accounting methodology for the principal
business ventures through which the Company conducts its business.
 
<TABLE>
<CAPTION>
                                                COUNTRY/REGION    EFFECTIVE GTS       ACCOUNTING
                 COMPANY NAME                   OF OPERATIONS       OWNERSHIP        METHODOLOGY
                 ------------                   --------------    -------------      ------------
<S>                                             <C>               <C>                <C>
CIS
  Sovintel....................................      Russia               50%            Equity
  TCM.........................................      Russia               50%            Equity
  TeleRoss Operating Company..................      Russia              100%(1)      Consolidated
  TeleRoss Ventures...........................      Russia               50%(2)         Equity
  Sovam.......................................      Russia               67%(3)         Equity
  GTS Cellular................................       CIS             25%-70%(4)         Equity
Western Europe
  HER.........................................  Western Europe           79%         Consolidated(5)
  GTS-Monaco Access...........................      Monaco               50%            Equity
Central Europe
  GTS-Hungary.................................     Hungary               99%         Consolidated
  EuroHivo....................................     Hungary               70%            Equity
  CzechNet....................................  Czech Republic          100%         Consolidated
  CzechCom....................................  Czech Republic          100%         Consolidated
Asia
  V-Tech......................................      China                75%            Equity
  Beijing Tianmu..............................      China                47%            Equity
  CDI.........................................      India               100%         Consolidated
</TABLE>
 
---------------
 
(1) The TeleRoss Operating Company is comprised of two wholly-owned holding
    companies and a 99% owned subsidiary that operates a domestic long distance
    network and holds the applicable operating license for TeleRoss and performs
    the customer invoicing and collection functions for telecommunications
    services. TeleRoss Operating Company is accounted for under the
    consolidation method of accounting because GTS has unilateral control over
    the operations and management decisions. TeleRoss Operating Company's
    operations are further discussed in "-- Results of
    Operations -- Consolidated Ventures" and "Business -- Russia and the
    CIS -- TeleRoss." A significant portion of TeleRoss Operating Company's
    costs of revenue consists of settlement fees paid to the TeleRoss Ventures,
    with such fees being recorded as revenue by the TeleRoss Ventures. In 1996
    and 1997, all of the TeleRoss
 
                                       71
<PAGE>   73
 
    Ventures' revenue was derived from such fees. Any decline in the business or
    operations of the TeleRoss Ventures would have a material adverse effect on
    the results of TeleRoss Operating Company.
 
(2) TeleRoss Ventures is comprised of thirteen operating joint ventures that are
    50% beneficially owned by GTS, which originate traffic and provide local
    termination of calls through agency arrangements with TeleRoss Operating
    Company. GTS does not exercise unilateral control over the TeleRoss
    Ventures, and therefore they are appropriately accounted for under the
    equity method of accounting. TeleRoss Ventures' operations are further
    discussed in "-- Results of Operations -- Non-Consolidated Ventures."
 
(3) GTS purchased the remaining 33% interest in Sovam in February 1998.
 
(4) GTS conducts its cellular operations through (i) Vostok Mobile, a wholly
    owned GTS venture that owns between 50% and 70% of a series of 12 cellular
    joint ventures in various regions in Russia, (ii) PrimTelefone, a 50% owned
    venture in Vladivostok, Russia and (iii) Bancomsvyaz, an approximately 25%
    beneficially owned venture in Kiev, Ukraine.
 
(5) As of July 16, 1997, HER is accounted for by the consolidation as opposed to
    the equity method of accounting.
 
RESULTS OF OPERATIONS -- CONSOLIDATED VENTURES
 
     Management's discussion included within "-- Results of
Operations -- Consolidated Ventures" reflects the following significant
operating ventures: TeleRoss Operating Company, GTS-Hungary, the Czech Companies
and HER (for 1997). See "Results of Operations -- Non-Consolidated Ventures
(Equity Investees)" for a discussion of the operating results of Sovintel, TCM,
Sovam, TeleRoss Ventures, GTS Cellular, HER (prior to 1997), GTS-Monaco Access,
EuroHivo and the Asia business ventures.
 
     Revenue. The Company's consolidated revenue was $47.1 million, $24.1
million and $8.4 million for the years ended December 31, 1997, 1996, and 1995,
respectively. The growth in revenue was attributable to the commencement in 1995
of commercial operations by TeleRoss Operating Company, as well as the continued
expansion of services and customer base in Central Europe, and HER's initial
Amsterdam to Brussels route and further expansion to London and Paris during
1997.
 
     The CIS region's consolidated revenue was $27.1 million, $12.7 million, and
$3.8 million for the years ended December 31, 1997, 1996 and 1995 respectively.
TeleRoss Operating Company generated revenue of $24.7 million, $9.2 million and
$3.8 million, representing 91.1%, 72.4% and 100% of the region's consolidated
revenue for the years ended December 31, 1997, 1996 and 1995, respectively.
Service revenue represented 81.8%, 64.1% and 21.1% of TeleRoss Operating
Company's revenue for the years ended December 31, 1997, 1996 and 1995,
respectively, with the balance of its revenue in such periods principally
represented by installation and equipment sales. The growth in revenue was a
result of increased traffic volume generated by the TeleRoss Ventures as they
expanded to 13 cities for the year ended December 31, 1997, added customers in
existing cities and installed several VSATs at customer locations outside of
cities in which they have a presence.
 
     Within the Central Europe region, GTS-Hungary and the Czech Companies
accounted for 100% of the revenue earned, of which GTS-Hungary and the Czech
Companies provided $8.5 million and $5.1 million of the Company's consolidated
revenue in 1997, respectively, compared to $6.9 million and $2.3 million in
1996, respectively, and $4.2 million and $0.3 million in 1995, respectively. The
growth in revenue of GTS-Hungary from 1995 to 1997 was due to the expansion of
its customer base and the introduction of microwave technology services. The
Hungary state lottery accounted for 50.6%, 55.3% and 65.0% of GTS-Hungary's
revenue in 1997, 1996 and 1995, respectively. The growth in revenue of the Czech
Companies was generated through increases in voice traffic carried from
twenty-five buildings at December 31, 1997, as compared to sixteen buildings at
December 31, 1996.
 
     All of Western Europe's consolidated revenue of $5.4 million for the year
ended December 31, 1997 was derived from HER.
 
                                       72
<PAGE>   74
 
     Gross Margin. GTS's consolidated gross margin was $4.4 million, or 9.3% of
revenue, for the year ended December 31, 1997, $5.2 million, or 21.6% of
revenue, for the year ended December 31, 1996 and $0.02 million, or 0.0% of
revenue, for the year ended December 31, 1995.
 
     The CIS region had a gross margin of $4.0 million, $0.8 million and $(0.9)
million for the years ended December 31, 1997, 1996 and 1995, respectively.
TeleRoss Operating Company had a gross margin of $3.5 million, or 14.2% of
revenues, for the year ended December 31, 1997 and a negative gross margin of
$(1.0) million for each of the years ended December 31, 1996 and 1995, which was
the result of the high fixed cost component of its network hub in Moscow.
GTS-Hungary and the Czech Companies comprised 100% of the Central Europe
region's gross margin. GTS-Hungary had a gross margin of $3.5 million, $3.0
million, and $1.7 million, representing 41.2%, 43.4%, and 40.5% of GTS-Hungary's
revenue for the years ended December 31, 1997, 1996 and 1995, respectively. The
favorable gross margin trend reflected the increased utilization of
GTS-Hungary's 1,000 VSAT capacity hub located in Budapest. The Czech Companies
had a gross margin of $1.5 million, $0.3 million and $(0.1) million for the
years ended December 31, 1997, 1996 and 1995, respectively. HER incurred a
negative gross margin of $(4.6) million for the year ended December 31, 1997,
which was primarily due to the initial cost structure of the new routes and
minimal revenue generated.
 
     Operating Expenses. Consolidated operating costs were $76.7 million, $52.9
million, and $41.0 million for the years ended December 31, 1997, 1996 and 1995,
respectively. The increase in operating costs reflected the growth in
expenditures associated with building business infrastructure for primarily the
TeleRoss Operating Company and GTS-Hungary, the inclusion of HER's operating
expenses in 1997 and increasing corporate staff.
 
     Equity in (Losses)/Earnings of Ventures. GTS recognized losses from its
investments in non-consolidated ventures of $14.6 million, $10.2 million and
$7.9 million for the years ended December 31, 1997, 1996 and 1995, respectively.
Included in these losses were $3.6 million, $5.7 million and $5.2 million for
the years ended December 31, 1997, 1996 and 1995, respectively, that related to
GTS's ownership share of the losses. Also included in the losses for the year
ended December 31, 1997 was a write-off of approximately $5.4 million which
represented the net balance of certain investments in and advances to ventures
in Asia (primarily Beijing Tianmu and V-Tech) and Central Europe (EuroHivo) that
were stated in excess of their net realizable value. The Company followed the
authoritative guidance as prescribed by APB No. 18, "The Equity Method of
Accounting for Investments in Common Stock," for its determination of the $5.4
million charge. The Company's recoverability analysis was based on its projected
undiscounted cash flows of their equity investees, since this is the lowest
level of cash flow information available. The underlying reasons for the
write-down of the Company's investments were the result of the problems that are
more specifically addressed in "Results of Operations -- Non-Consolidated
Ventures (Equity Investees) -- Asia," "Business -- Central Europe" and
"Business -- Asia." Additionally, included within GTS's ownership share of the
losses incurred and the Excess Losses for the year ended December 31, 1997 is
approximately $14.4 million of losses (of the $14.4 million, approximately $13.5
million related to the write-off of advances to several Chinese-owned operating
telecommunications companies to which the Company provides technical and
financial assistance, and $0.9 million related to the write-off of inventories,
receivables, and other assets) which represented the Company's share of asset
write-offs recorded by certain of the ventures in Asia (Beijing Tianmu and
V-Tech). See "-- Results of Operations -- Non-Consolidated Ventures (Equity
Investees) -- Asia." The Company would have recognized earnings from its
investments in non-consolidated ventures of $5.2 million for the year ended
December 31, 1997, had the Company not recognized the write-downs of investments
and assets of approximately $5.4 million and $14.4 million, respectively. The
write-down of Central Europe's investment in EuroHivo was a result of the
Company's decision in the third quarter to recognize the contingent liabilities
associated with the expected liquidation and discontinuation of EuroHivo's
operations as of September 30, 1997. In addition, the Company's results were
negatively affected due to the recognition of Excess Losses of $5.6 million,
$4.5 million and $2.7 million for the years ended December 31, 1997, 1996 and
1995, respectively. See "-- Overview." The Company's losses from its ventures
were primarily the result of most of its ventures being in the early stages of
operations. Sovintel and TCM, however, generated combined earnings of $15.5
million, $11.8 million and $3.8 million for the years ended December 31, 1997,
1996 and 1995, respectively, which partially offset losses generated by other
ventures.
 
                                       73
<PAGE>   75
 
     Other Non-Operating Income. Favorably affecting the 1995 results was the
non-recurring $10.3 million gain that the Company recognized as a result of its
cash settlement of certain claims with a third party in 1995.
 
     Interest, Net. GTS incurred interest expense of $39.1 million, $11.1
million and $0.7 million for the years ended December 31, 1997, 1996 and 1995,
respectively. Interest expense is comprised of interest incurred from debt
maturing within one year, long-term debt obligations, capital lease obligations,
amortization of debt discount on the long-term debt obligations and various
other debt obligations. The significant increase in interest expense was due to
the $409.8 million increase in debt raised in 1997. See "-- Liquidity and
Capital Resources."
 
     GTS earned interest income of $11.4 million, $3.6 million and $2.2 million
for the years ended December 31, 1997, 1996 and 1995, respectively, primarily as
a result of investing the proceeds from private placements of common stock in
various highly liquid investments.
 
     Provision for Income Taxes. The Company's consolidated tax provision was
$2.5 million, $1.4 million and $2.6 million for the years ended December 31,
1997, 1996 and 1995, respectively. The Company's financial statements do not
reflect any provision for benefits that might be associated with the U.S. and
non-U.S. loss carryforwards. There can be no assurance that such non-U.S. loss
carryforwards will be allowed, in part or in full, by local tax authorities
against future income.
 
RESULTS OF OPERATIONS -- NON-CONSOLIDATED VENTURES (EQUITY INVESTEES)
 
  Russia -- CIS
 
     Sovintel. Sovintel's revenue for the years ended December 31, 1997, 1996
and 1995 was $114.0 million, $75.0 million and $44.3 million, respectively. The
increase in revenue was primarily the result of telecommunications service
revenue, which increased to $85.4 million for the year ended December 31, 1997
from $50.8 million and $26.8 million for the years ended December 31, 1996 and
1995, respectively, due to the Moscow customer base growth and traffic from
other GTS ventures that generated increased volume of outgoing international and
domestic minutes carried by Sovintel. Revenue from incoming international
minutes also increased to $13.1 million for the year ended December 31, 1997,
from $6.8 million and $2.2 million for the years ended December 31, 1996 and
1995, respectively. Included in Sovintel's traffic revenue for 1997 and 1996 was
$12.4 million and $5.0 million, respectively, that was related to customers
using phone numbers provided by TCM. This revenue was derived primarily from
international/long distance traffic and local traffic. Sovintel and TCM have an
arrangement whereby Sovintel reimburses TCM 50% of installation charges, monthly
fees and local traffic revenues and approximately 33% of international/long
distance billings from TCM-supplied phone numbers.
 
     Sovintel's non-traffic-related revenue of $28.6 million, $24.2 million and
$17.5 million for the years ended December 31, 1997, 1996 and 1995,
respectively, was primarily attributable to port sales and monthly port fees
revenues.
 
     Sovintel's gross margin was $41.3 million, $31.1 million and $18.0 million,
or 36.2%, 41.5% and 40.6% of revenue, for the years ended December 31, 1997,
1996 and 1995, respectively. The decrease in gross margin percentage was
attributable to a general price decrease in international and domestic revenues
due to competitive pressures and a higher percentage of domestic minutes, which
yield a lower margin.
 
     Operating expenses were $17.0 million, $10.3 million and $7.1 million, or
14.9%, 13.7% and 16.0% of total revenue, for the years ended December 31, 1997,
1996 and 1995, respectively. The increase in operating expenses was related to
increases in turnover taxes associated with revenues and also increased
personnel, advertising and sales force costs required to support Sovintel's
growth.
 
     Income tax expense was $5.7 million, $5.2 million and $2.6 million for the
years ended December 31, 1997, 1996 and 1995, respectively. The increase in
income tax expense was attributable to Sovintel's profitable operations.
 
     TCM. TCM's revenue was $29.3 million and $16.5 million for the years ended
December 31, 1997 and 1996, respectively. TCM had minimal activities in 1995.
TCM had a gross margin of $22.1 million and
 
                                       74
<PAGE>   76
 
$13.2 million, or 75.4% and 80.0% of total revenue. The decrease in gross margin
as a percentage of revenue was attributable to higher infrastructure and
settlement costs. TCM had operating expenses of $3.3 million and $1.9 million,
or 11.3% and 11.5% of total revenue, for the years ended December 31, 1997 and
1996, respectively.
 
     Sovam. Sovam's revenue was $17.8 million, $11.7 million and $4.4 million
for the years ended December 31, 1997, 1996 and 1995, respectively. The increase
in revenues is primarily attributable to the expansion of Sovam's network
throughout Russia and the CIS and the wider variety of service offerings,
including the introduction of Russia On Line services.
 
     Gross margin was $7.1 million, $3.4 million and $1.5 million, or 39.9%,
29.1% and 34.1% of total revenue for the years ended December 31 in 1997, 1996
and 1995, respectively. Operating expenses were $5.7 million, $5.7 million and
$3.3 million, or 32.0%, 48.7% and 75.0% of total revenue, for the years ended
December 31, 1997, 1996 and 1995, respectively.
 
     TeleRoss Ventures. Revenue for the TeleRoss Ventures for the years ended
December 31, 1997, 1996 and 1995 was $6.8 million, $2.4 million and $0.2
million, respectively. Revenues resulted from settlement fees charged to
TeleRoss Operating Company. The growth in total revenue was the result of steady
growth in sales of core switched voice services in the five cities serviced in
1995, an additional seven new cities in the network in 1996 and an additional
city in 1997.
 
     Gross margin for the years ended December 31, 1997, 1996 and 1995 was $4.7
million, $1.6 million and $0.1 million, respectively. Operating expenses of $3.6
million, $2.3 million and $0.2 million were incurred for the years ended
December 31, 1997, 1996 and 1995, respectively.
 
     GTS Cellular. The Company operates three cellular networks through
differing ownership structures: Vostok Mobile, PrimTelefone and Bancomsvyaz.
 
     Revenue for Vostok Mobile was $25.8 million, $16.5 million and $2.0 million
for the years ended December 31, 1997, 1996 and 1995, respectively. Vostok
Mobile's gross margin was $13.6 million, $9.3 million and $1.1 million, or
52.7%, 56.4% and 55.0% of total revenue, and operating expenses were $10.1
million, $9.2 million and $4.7 million for the years ended December 31, 1997,
1996 and 1995, respectively.
 
     Revenue for PrimTelefone was $12.1 million, $8.4 million and $2.2 million
for the years ended December 31, 1997, 1996 and 1995, respectively.
PrimTelefone's gross margin was $6.6 million, $4.7 million and $0.6 million, or
54.5%, 56.0% and 27.3% of total revenue, and operating expenses were $3.6
million, $3.7 million and $0.7 million for the years ended December 31, 1997,
1996 and 1995, respectively.
 
     Bancomsvyaz did not have significant operations until 1997. Revenue for
Bancomsvyaz was $7.2 million and gross margin was $2.8 million, or 38.9% of
total revenue, for the year ended December 31, 1997. Operating expenses were
$4.9 million for the year ended December 31, 1997.
 
  Western Europe
 
     HER. HER earned a small revenue stream in 1996 and no revenue in 1995.
Operating expenses were $16.0 million and $6.7 million for the years ended
December 31, 1996 and 1995, respectively. The increase in selling, general and
administrative expenses reflected HER's continued transition from the start-up
phase to the operational phase. In 1997, HER was included in the consolidated
results of the Company.
 
     GTS-Monaco Access. Limited international traffic was carried from GTS
subsidiaries through GTS-Monaco Access for termination worldwide during 1995
which resulted in minimal revenues earned. Total revenue was $13.0 million and
$3.9 million and gross margin was $0.2 million and $(0.4) million for the years
ended December 31, 1997 and 1996, respectively.
 
  Central Europe
 
     EuroHivo. EuroHivo's operating results were minimal for the years ended
December 31, 1997, 1996 and 1995. In September 1997, the Company recorded a $2.4
million charge to recognize the liabilities associated
 
                                       75
<PAGE>   77
 
with the planned liquidation and discontinuance of EuroHivo's operations. See
Footnote 3 in the Company's audited financial statements for additional
disclosures related to EuroHivo.
 
  Asia
 
     Most of the Company's ventures within the Asia region were in the start-up
phase and had not commenced operations in 1996. The non-consolidated ventures in
the Asia region had revenue of $7.0 million for the year ended December 31,
1996, and had minimal revenues in 1997 and 1995. The revenue in 1996 consisted
principally of equipment sales. The Company believes that future revenue will be
derived primarily from providing telecommunications engineering and consulting
services.
 
     During the year ended December 31, 1997, the V-Tech and Beijing Tianmu
business ventures (the "Asia Ventures") determined that a charge of $14.4
million (GTS's portion) was appropriate as a result of the write-off of $13.5
million of advances to several Chinese-owned operating telecommunications
companies to which the Asia Ventures provide technical and financial assistance
and $0.9 million related to the write-off of inventories, receivables and other
assets. The Asia Ventures followed the authoritative guidance as prescribed by
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," for their determination of the $13.5
million charge as they believed that the advances, as evidenced by legal
agreements between the Asia Ventures and the underlying operating
telecommunications companies, represents long-lived assets. (The Asia Ventures
would have reflected the same charge had they followed the authoritative
accounting guidance as prescribed by APB No. 18 or SFAS No. 5, "Accounting for
Contingencies.") The Asia Ventures recoverability analysis was based on their
projected undiscounted cash flows of their respective operations since this is
the lowest level of cash flow information available. The underlying reasons for
the write-offs were the result of problems dealing with one of the Asian
partners, the inability of the Chinese operating telecommunications companies to
develop markets for their services, and technical problems, all of which
surfaced during the third quarter of 1997. See Footnote 3 in the Company's
audited financial statements for additional disclosures related to the Company's
Asia operations and "Business -- Asia."
 
LIQUIDITY AND CAPITAL RESOURCES
 
     The telecommunications business is capital intensive. The Company generally
is the primary source of funding for its ventures, both for working capital and
capital expenditures. Under a typical arrangement, GTS's venture partner
contributes the necessary licenses or permits under which the venture will
conduct its business, office space and other equipment. GTS's contribution is
generally cash and equipment, but may consist of other specific assets as
required by the joint venture agreement.
 
     The Company has raised capital through the issuance of equity securities
and through various debt agreements. The issuance of equity securities has
raised $36.4 million, $107.7 million, $42.1 million and $62.1 million in 1997,
1996, 1995 and 1994, respectively, net of placement fees, for a total of $248.3
million. In addition, the Company and HER received $409.8 million, $60.0 million
and $23.3 million in 1997, 1996 and 1995, respectively, for a total of $493.1
million under various debt agreements. Included within the debt proceeds
identified above, the Company received $3.5 million, $60.0 million and $10.0
million in 1997, 1996 and 1995, respectively, from lenders who are affiliated
with, and are considered related parties to, the Company as a result of their
(or their affiliates) ownership of the Company's Common Stock.
 
     The Company had working capital of $285.3 million and $46.9 million as of
December 31, 1997 and 1996, respectively. Approximately $190.5 million of
working capital at December 31, 1997 is intended to be used for the buildout of
the HER Network. The Company had an accumulated deficit of $242.9 million as of
December 31, 1997, including net losses of approximately $117.0 million, $68.0
million and $40.4 million for the years ended December 31, 1997, 1996 and 1995,
respectively. During 1997, the Company has incurred and expects to continue to
incur substantial expenditures to fund the working capital requirements of its
ventures, to provide capital equipment for certain of its ventures, and to
engage in new development and acquisitions.
 
     GTS will require substantial capital investment to execute its business
plans and to fund expected operating losses. Management expects that GTS and its
ventures will incur over $515.0 million of capital
                                       76
<PAGE>   78
 
expenditures and investments in ventures during the next three years, of which
approximately $235.0 million will be incurred in 1998. The Company has obtained
funds in 1997 through a variety of financing arrangements, including (i) the
issuance in September 1997 of $39.2 million of Common Stock in a private
placement of equity with a value of $15.67 per common share, (ii) the issuance
in August 1997 of $265.0 million in gross proceeds (of which $56.6 million was
placed into escrow to fund the first two years' interest payments) of 11.5%
Senior Notes due in August 2007 by HER that may be redeemed upon the successful
completion of a complying equity offering by HER or meeting other certain
criteria, and (iii) the issuance in July and August 1997 of $144.8 million in
gross proceeds of the Convertible Bonds by GTS that are convertible into Common
Stock upon the Company's completion of a complying equity offering.
 
     The Company effected a three-for-two split of its common stock effective
December 31, 1997, and the information presented in this "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
reflects that action.
 
     Subsequent to December 31, 1997, the Company raised approximately $255.3
million in gross proceeds from an initial public stock offering of 12.8 million
common shares at $20.00 per share. Such initial public offering constituted a
"complying public equity offering" under the Company's Convertible Bonds. As a
result, the conversion price of the Bonds is $20 per share. In addition, the
Company issued $105.0 million in gross proceeds of 9.875% senior notes due
February 15, 2005, of which $19.6 million was placed in escrow to fund the first
two years' interest payments. The Company believes that the net proceeds from
these offerings, together with existing cash, will be sufficient to fund its
expected capital needs until at least June 1999. The Company expects that it may
require additional capital to execute its current business plan and to fund
expected operating losses, as well as to consummate future acquisitions and
exploit opportunities to expand and develop its businesses.
 
     The actual amount and timing of the Company's future capital requirements
may differ materially from management's estimates. In particular, the accuracy
of management's estimates is subject to changes and fluctuations in the
Company's revenues, operating costs and development expenses, which can be
affected by the Company's ability to (i) effectively and efficiently manage the
expansion of the HER network and operations, (ii) obtain infrastructure
contracts, rights-of-way, licenses and other regulatory approvals necessary to
complete and operate the HER network, (iii) negotiate favorable contracts with
suppliers, including large volume discounts on purchases of capital equipment
and (iv) access markets, attract sufficient numbers of customers and provide and
develop services for which customers will subscribe. The Company's revenues and
costs are also dependent upon factors that are not within the Company's control
such as regulatory changes, changes in technology, increased competition and
various factors such as strikes, weather, and performance by third parties in
connection with the Company's operations. Due to the uncertainty of these
factors, actual revenues and costs may vary from expected amounts, possibly to a
material degree, and such variations are likely to affect the Company's future
capital requirements. Historically, GTS has experienced liquidity problems
resulting in part from the Company's need to meet the capital requirements of
certain of its joint ventures in excess of forecast amounts. In addition,
certain of the Company's joint ventures have not met management's financial
performance expectations or have not been able to secure local country financing
and thus have not been able to generate the expected cash inflows. In addition,
if the Company expands its operations at an accelerated rate or consummates
acquisitions, the Company's funding needs will increase, possibly to a
significant degree, and it will expend its capital resources sooner than
currently expected. The Company may also be required to repay its Convertible
Bonds upon maturity in the year 2000 to the extent such bonds are not converted
into Common Stock. As a result of the foregoing, or if the Company's capital
resources otherwise prove to be insufficient, the Company may need to raise
additional capital. See "Business."
 
     There can be no assurances that the Company will be able to consummate
additional financing on favorable terms. As a result, the Company may be subject
to additional or more restrictive financial covenants, its interest obligations
may increase significantly and its existing shareholders may be adversely
diluted. Failure to generate sufficient funds in the future, whether from
operations or by raising additional debt or equity capital, may require the
Company to delay or abandon some or all of its anticipated expenditures, to sell
assets, or both, either of which could have a material adverse effect on the
operations of the Company.
                                       77
<PAGE>   79
 
HER
 
     Construction of the HER fiber optic network is one of the Company's most
significant business activities. The buildout of the network is expected to
require approximately $290.0 million of capital expenditures, with approximately
$35 million required for the initial five country network. See
"Business -- Western Europe -- HER." As of December 31, 1997, approximately
$34.3 million has been spent on network capital expenditure. In August 1997, HER
completed the issuance of $265.0 million in gross proceeds of 11.5% Senior Notes
due in August 2007. The Senior Notes are general unsecured obligations of HER.
HER currently estimates that its capital resources will be sufficient to fund
operations and expected network development through December 1998, at which time
it may be required to obtain additional funds. Sources of capital to fund
network development after 1998 may include internally generated funds, bank debt
and vendor financing. HER is currently in discussions with a number of financial
institutions to obtain debt financing and to negotiate vendor financing with key
suppliers of network equipment. Any failure to obtain necessary financing may
require HER to delay or abandon its plans for deploying the remainder of the
network and would jeopardize the viability of HER, or may require the Company to
make additional capital contributions to HER at the expense of the Company's
other operations, either of which could have a material adverse effect on the
operations of the Company. There can be no assurance that GTS or its partners in
HER would have sufficient capital to make contributions to HER, or that they
would be willing to do so.
 
     Pursuant to the HER Recapitalization, in 1997, HER offered to GTS-Hermes,
HIT Rail and the eleven individual members of the HIT Rail consortium the right
to subscribe to additional common stock of HER. GTS-Hermes and two of the
members of HIT Rail exercised their rights, while HIT Rail and the nine
remaining members of HIT Rail declined to participate.
 
     As a result of the finalization of the HER Recapitalization, total
shareholder loans of ECU 39.4 million (approximately $48.5 million) from,
collectively, GTS-Hermes, HIT Rail and two of the members of HIT Rail, were
converted into equity. Additionally, GTS-Hermes contributed ECU 46.0 million
(approximately $51.8 million) and one of the members of HIT Rail contributed a
ten-year fiber optic cable lease which was valued at ECU 1.8 million
(approximately $2.0 million). The ownership of HER subsequent to the HER
Recapitalization was as follows: GTS-Hermes, 79.08%; HIT Rail, 12.63%; and the
two members of HIT Rail combined, 8.29%. See "Business -- Western
Europe -- HER -- HER Recapitalization." In March 1998, Hit Rail sold a portion
of its ownership interest to GTS-Hermes for ECU 13.5 million (approximately
$14.6 million) and, as a result, GTS-Hermes increased its ownership of HER to
89.42%. See "Business -- Western Europe -- HER -- HER Recapitalization."
 
LIQUIDITY ANALYSIS
 
     The Company had cash and cash equivalents of $318.8 million and $57.9
million as of December 31, 1997 and 1996, respectively. Approximately $190.5
million of the $319.0 million of cash and cash equivalents at December 31, 1997,
is intended to be used for the build-out of the HER network. The Company had
restricted cash of $66.9 million and $16.2 million as of December 31, 1997 and
1996, respectively. Restricted cash included $29.0 million held in escrow to pay
the first two years' interest payments on the Senior Notes of HER, amounts held
for equipment purchases under various debt agreements, and cash maintained in
foreign financial institutions that may not be readily convertible into dollars
or easily repatriated.
 
     During the years ended December 31, 1997 and 1996, the Company used $48.6
million and $39.0 million, respectively, of cash for operating activities. Cash
used for investing activities was $103.4 million and $80.9 million for the years
ended December 31, 1997 and 1996, respectively. The use of cash in operations
and for investing activities reflected primarily the development and buildout of
existing telecommunications networks and the funding of fully operational
ventures. There can be no assurance that the Company's operations will achieve
or sustain profitability or positive cash flow in the future. If the Company
cannot achieve and sustain operating profitability or positive cash flow from
operations, it may not be able to meet its debt service obligations or working
capital requirements.
 
     Substantially all of the Company's operations are in foreign countries and
therefore the Company's consolidated financial results are subject to
fluctuations in currency exchange rates. The Company's
                                       78
<PAGE>   80
 
consolidated operations transact their business in the following significant
currencies: Russian Ruble, Hungarian Florint, Belgium Franc and the European
Currency Equivalent. For those operating companies that transact their business
in currencies that are not readily convertible, the Company attempts to minimize
its exposure by indexing its invoices and collections to the applicable
dollar/foreign currency exchange rate to the extent its costs (including
interest expense, capital expenditures and equity) are incurred in U.S. dollars.
Although the Company is attempting to match revenues, costs, borrowing and
repayments in terms of their respective currencies, the Company may experience
economic loss and a negative impact on earnings with respect to holdings solely
as a result of foreign currency exchange rate fluctuations, which include
foreign currency devaluations against the U.S. dollar. Furthermore, certain of
the Company's operations have notes payable and notes receivable which are
denominated in a currency other than their own functional currency or loans
linked to the U.S. dollar. The Company may also experience economic loss and a
negative impact on earnings related to these monetary assets and liabilities.
See "Business -- Russia and the CIS -- Certain Considerations Applicable to the
Company's Operations in Russia and the CIS -- Exchange Controls and Risks
Relating to Russian Securities" and "Business -- Certain Considerations
Generally Applicable to the Company's Operations -- Currency and Exchange
Risks."
 
     The Company has developed risk management policies that establish
guidelines for managing foreign exchange risk. The Company is currently
evaluating the materiality of foreign exchange exposures in different countries
and the financial instruments available to mitigate this exposure. The Company's
ability to hedge its exposure is limited since certain of its operations are
located in countries whose currencies are not easily convertible. Financial
hedge instruments for these countries are nonexistent or limited and also
pricing of these instruments is often volatile and not always efficient. The
Company is designing reporting processes to monitor the potential exposure on an
ongoing basis and expects to implement this process before the end of 1998. The
Company will use the output of this process to execute financial hedges to cover
foreign exchange exposure when practical and economically justified.
 
     The Company is considering alternatives to hedge the foreign exchange
exposure resulting from the issuance of $265 million senior notes by HER. It
expects to have a transaction which eliminates this risk consummated by the end
of April 1998.
 
YEAR 2000 COMPLIANCE
 
     The Company is currently in the process of assessing its year 2000
compliance costs and of converting its computer systems to year 2000 compliant
software. This process includes obtaining confirmations from the Company's
primary vendors that plans are being developed or are already in place to
address processing of transactions in the year 2000. The Company does not expect
that the cost of converting such systems will be material to its financial
condition or results of operations. The Company currently believes it will be
able to achieve year 2000 compliance by the end of 1999, and currently does not
anticipate any material disruption in its operations as the result of any
failure by the Company to be in compliance or that year 2000 compliance costs
will have a material effect on the Company's earnings.
 
                                       79
<PAGE>   81
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                         INDEX TO FINANCIAL STATEMENTS
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
YEAR END FINANCIAL STATEMENTS
  Report of Ernst & Young LLP, Independent Auditors.........    81
  Consolidated Balance Sheets as of December 31, 1996 and
     1997...................................................    82
  Consolidated Statements of Operations for the years ended
     December 31, 1995, 1996,
     and 1997...............................................    83
  Consolidated Statements of Cash Flows for the years ended
     December 31, 1995, 1996,
     and 1997...............................................    84
  Consolidated Statements of Shareholders' Equity for the
     years ended December 31, 1995,
     1996, and 1997.........................................    85
  Notes to Consolidated Financial Statements................    86
</TABLE>
 
                                  EDN SOVINTEL
                         YEAR END FINANCIAL STATEMENTS
 
<TABLE>
<S>                                                           <C>
Report of Ernst & Young (CIS) Limited, Independent
  Auditors..................................................   108
Balance Sheets as of December 31, 1997 and 1996.............   109
Statements of Income and Retained Earnings for the years
  ended December 31, 1997, 1996,
  and 1995..................................................   110
Statements of Cash Flows for the years ended December 31,
  1997, 1996, and 1995......................................   111
Notes to Financial Statements...............................   112
</TABLE>
 
                                       80
<PAGE>   82
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors
Global TeleSystems Group, Inc.
 
     We have audited the accompanying consolidated balance sheets of Global
TeleSystems Group, Inc. as of December 31, 1996 and 1997, and the related
consolidated statements of operations, cash flows, and shareholders' equity for
each of the three years in the period ended December 31, 1997. 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 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 provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Global
TeleSystems Group, Inc. at December 31, 1996 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
 
                                                    Ernst & Young LLP
 
Vienna, Virginia
February 26, 1998, except for
Note 17, as to which the date
is November 12, 1998
 
                                       81
<PAGE>   83
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
                          CONSOLIDATED BALANCE SHEETS
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                              ----------------------
                                                                1996         1997
                                                              ---------    ---------
                                                                  (IN THOUSANDS,
                                                                EXCEPT SHARE DATA)
<S>                                                           <C>          <C>
CURRENT ASSETS
  Cash and cash equivalents.................................  $  57,874    $ 318,766
  Accounts receivable, net..................................      8,920       17,079
  Restricted cash...........................................     13,627       30,486
  Prepaid expenses..........................................      2,537       14,101
  Other assets..............................................      2,396        6,707
                                                              ---------    ---------
          TOTAL CURRENT ASSETS..............................     85,354      387,139
Property and equipment, net.................................     35,463      236,897
Investments in and advances to ventures.....................    104,459       76,730
Goodwill and intangible assets, net of accumulated
  amortization of $3,916 and $10,184 at December 31, 1996
  and 1997, respectively....................................      9,548       43,284
Restricted cash.............................................      2,554       36,411
                                                              ---------    ---------
          TOTAL ASSETS......................................  $ 237,378    $ 780,461
                                                              =========    =========
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
CURRENT LIABILITIES
  Accounts payable and accrued expenses.....................  $  15,211    $  61,984
  Debt maturing within one year.............................     16,261        6,390
  Current portion of capital lease obligations..............         --       21,490
  Related party debt maturing within one year...............      4,947        5,708
  Other current liabilities.................................      2,040        6,301
                                                              ---------    ---------
          TOTAL CURRENT LIABILITIES.........................     38,459      101,873
Long-term debt, less current portion........................      5,260      408,330
Long-term portion of capital lease obligations..............         --      117,645
Related party long-term debt, less current portion..........     59,079       79,796
Taxes and other non-current liabilities.....................     14,664       14,595
                                                              ---------    ---------
          TOTAL LIABILITIES.................................    117,462      722,239
COMMITMENTS AND CONTINGENCIES
  Minority interest.........................................      1,915       18,766
Common stock, subject to repurchase (325,000 shares and
  797,100 shares outstanding at December 31, 1996 and 1997,
  respectively).............................................      4,333       12,489
SHAREHOLDERS' EQUITY
  Preferred stock, $0.0001 par value (10,000,000 shares
     authorized; none issued and outstanding)...............         --           --
  Common stock, $0.10 par value (135,000,000, shares
     authorized; 34,589,106, and 37,606,814 shares issued
     and outstanding, net of 116,639 and 195,528 shares of
     treasury stock at December 31, 1996 and 1997,
     respectively)..........................................      3,459        3,761
  Additional paid-in capital................................    238,268      274,359
  Cumulative translation adjustment.........................     (2,161)      (8,269)
  Accumulated deficit.......................................   (125,898)    (242,884)
                                                              ---------    ---------
          TOTAL SHAREHOLDERS' EQUITY........................    113,668       26,967
                                                              ---------    ---------
          TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........  $ 237,378    $ 780,461
                                                              =========    =========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
                                       82
<PAGE>   84
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                                    YEAR ENDED DECEMBER 31,
                                                            ---------------------------------------
                                                               1995          1996          1997
                                                            ----------    ----------    -----------
                                                             (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                         <C>           <C>           <C>
REVENUES, NET:
  Telecommunication and other services....................   $  5,979      $ 19,210      $  41,300
  Equipment sales.........................................      2,433         4,907          5,798
                                                             --------      --------      ---------
                                                                8,412        24,117         47,098
                                                             --------      --------      ---------
OPERATING COSTS AND EXPENSES
  Cost of revenues:
     Telecommunication and other services.................      8,150        14,741         37,206
     Equipment sales......................................        246         4,200          5,513
  Selling, general and administrative.....................     37,291        47,940         68,425
  Depreciation and amortization...........................      3,491         4,165          6,227
  Non-income taxes........................................        234           850          2,085
                                                             --------      --------      ---------
                                                               49,412        71,896        119,456
  Write-off of venture-related assets.....................         --            --          1,673
  Equity in losses of ventures............................      7,871        10,150         14,599
                                                             --------      --------      ---------
Loss from operations......................................    (48,871)      (57,929)       (88,630)
OTHER INCOME/(EXPENSE):
  Other non-operating income..............................     10,270            --             --
  Interest income.........................................      2,177         3,569         11,361
  Interest expense........................................       (728)      (11,122)       (39,086)
  Foreign currency losses.................................       (685)       (1,176)        (1,826)
                                                             --------      --------      ---------
                                                               11,034        (8,729)       (29,551)
                                                             --------      --------      ---------
Net loss before income taxes and minority interest........    (37,837)      (66,658)      (118,181)
Income taxes..............................................      2,565         1,360          2,482
                                                             --------      --------      ---------
Net loss before minority interest.........................    (40,402)      (68,018)      (120,663)
Minority interest.........................................          2            27          3,677
                                                             --------      --------      ---------
Net loss..................................................   $(40,400)     $(67,991)     $(116,986)
                                                             ========      ========      =========
Net loss per share........................................   $  (1.70)     $  (2.33)     $   (3.26)
                                                             ========      ========      =========
Weighted average common shares outstanding................     23,707        29,157         35,833
                                                             ========      ========      =========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       83
<PAGE>   85
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31,
                                                            ---------------------------------
                                                              1995        1996        1997
                                                            --------    --------    ---------
                                                                     (IN THOUSANDS)
<S>                                                         <C>         <C>         <C>
OPERATING ACTIVITIES
  Net loss................................................  $(40,400)   $(67,991)   $(116,986)
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH USED IN
  OPERATING ACTIVITIES:
  Depreciation and amortization...........................     3,721       7,444       14,843
  Amortization of discount on note payable................        --       3,598        5,023
  Equity in losses of ventures, net of dividends
     received.............................................     7,871      11,123       17,474
  Deferred interest.......................................        --       6,583       12,970
  Write-off of venture related assets.....................        --          --        1,673
  Non-cash compensation...................................        --          --        4,571
  Minority interest.......................................        (2)        (27)      (3,677)
  Other...................................................     2,577       1,342        2,985
  Changes in assets and liabilities, excluding effects of
     acquisitions and ventures:
     Accounts receivable..................................    (1,557)     (6,996)     (10,900)
     Prepaid expenses.....................................      (438)       (605)      (7,522)
     Accounts payable and accrued expenses................    12,820      (1,694)      34,925
     Other changes in assets and liabilities..............     9,474       8,207       (3,984)
                                                            --------    --------    ---------
          NET CASH USED IN OPERATING ACTIVITIES...........    (5,934)    (39,016)     (48,605)
INVESTING ACTIVITIES Investments in and advances to
  ventures, net of repayments.............................   (45,102)    (54,932)       5,943
  Purchases of property and equipment.....................   (24,324)    (12,195)     (45,148)
  Restricted cash.........................................    (2,543)    (13,138)     (62,924)
  Acquisitions, net of cash acquired......................    (1,871)         --        1,050
  Goodwill and other intangibles..........................    (6,181)       (487)      (2,196)
  Other investing activities..............................     2,069        (125)        (149)
                                                            --------    --------    ---------
          NET CASH USED IN INVESTING ACTIVITIES...........   (77,952)    (80,877)    (103,424)
FINANCING ACTIVITIES
  Proceeds from debt......................................    23,325      63,599      409,817
  Payment of debt issue costs.............................      (779)     (2,777)     (24,927)
  Net proceeds from issuance of common stock..............    42,175     107,775       36,432
  Other financing activities..............................      (750)         --         (536)
                                                            --------    --------    ---------
          NET CASH PROVIDED BY FINANCING ACTIVITIES.......    63,971     168,597      420,786
Effect of exchange rate changes on cash and cash
  equivalents.............................................      (676)        126       (7,865)
                                                            --------    --------    ---------
Net (decrease) increase in cash and cash equivalents......   (20,591)     48,830      260,892
Cash and cash equivalents at beginning of year............    29,635       9,044       57,874
                                                            --------    --------    ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR..................  $  9,044    $ 57,874    $ 318,766
                                                            ========    ========    =========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       84
<PAGE>   86
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
             FOR THE YEARS ENDED DECEMBER 31, 1995, 1996, AND 1997
 
<TABLE>
<CAPTION>
                                                   COMMON STOCK     ADDITIONAL   CUMULATIVE                      TOTAL
                                                  ---------------    PAID-IN     TRANSLATION   ACCUMULATED   SHAREHOLDERS'
                                                  SHARES   AMOUNT    CAPITAL     ADJUSTMENT      DEFICIT        EQUITY
                                                  ------   ------   ----------   -----------   -----------   -------------
                                                                               (IN THOUSANDS)
<S>                                               <C>      <C>      <C>          <C>           <C>           <C>
BALANCE AT DECEMBER 31, 1994....................  20,781   $2,078    $ 70,359      $  (246)     $ (17,507)     $  54,684
  Proceeds from the sale of common stock, net of
    expenses of $3,680..........................   5,091      509      41,629           --             --         42,138
  Translation adjustment........................      --       --          --       (1,289)            --         (1,289)
  Net loss......................................      --       --          --           --        (40,400)       (40,400)
  Other.........................................     333       33         156           --             --            189
                                                  ------   ------    --------      -------      ---------      ---------
BALANCE AT DECEMBER 31, 1995....................  26,205    2,620     112,144       (1,535)       (57,907)        55,322
  Proceeds from the sale of common stock, net of
    expenses of $3,567..........................   8,349      835     106,909           --             --        107,744
  Issuance of 7,223 warrants in connection with
    debt financing..............................      --       --      20,184           --             --         20,184
  Translation adjustment........................      --       --          --         (626)            --           (626)
  Net loss......................................      --       --          --           --        (67,991)       (67,991)
  Other.........................................      35        4        (969)          --             --           (965)
                                                  ------   ------    --------      -------      ---------      ---------
BALANCE AT DECEMBER 31, 1996....................  34,589    3,459     238,268       (2,161)      (125,898)       113,668
  Proceeds from the sale of common stock, net of
    expenses of $2,777..........................   2,503      250      36,182           --             --         36,432
  Translation adjustment........................      --       --          --       (6,108)            --         (6,108)
  Net loss......................................      --       --          --           --       (116,986)      (116,986)
  Other.........................................     515       52         (91)          --             --            (39)
                                                  ------   ------    --------      -------      ---------      ---------
BALANCE AT DECEMBER 31, 1997....................  37,607   $3,761    $274,359      $(8,269)     $(242,884)     $  26,967
                                                  ======   ======    ========      =======      =========      =========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       85
<PAGE>   87
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1: NATURE OF BUSINESS OPERATIONS
 
     Global TeleSystems Group, Inc. ("GTS" or "the Company"), is a provider of a
broad range of telecommunications services to businesses, other
telecommunications service providers and consumers through its operation of
voice and data networks, international gateways, local access and cellular
networks and the provision of various value-added services in the Commonwealth
of Independent States ("CIS"), primarily Russia, Central Europe, and India and
China ("Asia"). The Company, through two of its ventures, is also building a new
infrastructure for transporting international voice, data and video traffic for
other carriers throughout Western Europe and for worldwide international voice,
data and video traffic that either originates or terminates in, or transits
through, Western Europe. See further discussion of the Company's business
operations within Note 3, "Investments In and Advances to Ventures," and Note
14, "Segment Information and Certain Geographical Data."
 
     Certain of the Company's ventures are in the early stages of operations in
the telecommunications industry. The Company's businesses are developing
rapidly; some are in countries with an emerging economy, which by nature have an
uncertain economic, political and regulatory environment. The general risks of
operating businesses in the CIS and other developing countries include the
possibility for rapid change in government policies, economic conditions, the
tax regime and foreign currency regulations.
 
     The ultimate recoverability of the Company's investments in and advances to
ventures is dependent on many factors including, but not limited to, the
economies of the countries in which it does business; the ability of the Company
to maintain the necessary telecommunications licenses; and the ability of the
Company to obtain sufficient financing to continue to meet its capital and
operational commitments.
 
     On December 1, 1997, the Company filed an amendment to its Certificate of
Incorporation to effect an increase in the authorized common shares from
60,000,000 to 135,000,000; a 3 for 2 common share stock split, 1 1/2 common
shares for every common share issued and outstanding; and an increase in the par
value of its authorized common shares from $0.0001 to $0.10 on a post-split
basis. Accordingly, the Company has presented share and per share data for
issued and outstanding shares as well as options and warrants on a restated
basis to give effect to the increase in authorized common shares, the stock
split and the increase in par value for its capital stock.
 
     Subsequent to year end, the Company completed an initial public offering of
12.8 million shares of common stock at $20 per common share (the "Stock
Offering"). The Company also issued aggregate principal amount $105.0 million of
9.875% senior notes due 2005 (the "Notes Offering" and together with the Stock
Offering, the "Offerings"). See Note 15, "Subsequent Events."
 
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
PRINCIPLES OF CONSOLIDATION
 
     Wholly-owned subsidiaries and majority-owned ventures where the Company has
unilateral operating and financial control are consolidated. Those ventures
where the Company exercises significant influence, but does not exercise
unilateral operating and financial control are accounted for by the equity
method. The Company has certain majority-owned ventures that are accounted for
by the equity method as a result of minority shareholder rights, super majority
voting conditions or other governmentally imposed uncertainties so severe that
they prevent the Company from obtaining unilateral control of the venture. If
the Company has little ability to exercise significant influence over a venture,
the venture is accounted for by the cost method. All significant intercompany
accounts and transactions are eliminated upon consolidation.
 
     The Company recognizes profits and losses in accordance with its underlying
ownership percentage or allocation percentage as specified in the agreements
with its partners; however, the Company recognizes 100% of the losses in
ventures where the Company bears all of the financial risk. When such ventures
become
 
                                       86
<PAGE>   88
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
profitable, the Company recognizes 100% of the profits until such time as the
excess losses previously recognized have been recovered.
 
RECLASSIFICATIONS
 
     Certain reclassifications have been made to the 1995 and 1996 consolidated
financial statements in order to conform to the 1997 presentation.
 
CASH AND CASH EQUIVALENTS
 
     The Company considers all highly liquid investments with a maturity of
three months or less at the time of purchase to be cash equivalents. The Company
had $16.2 million and $66.9 million of restricted cash at December 31, 1996 and
1997, respectively. The restricted cash is primarily related to cash held in
escrow for interest payments associated with the Company's debt obligations.
 
PROPERTY AND EQUIPMENT
 
     Property and equipment is stated at cost. Depreciation, which includes the
amortization of assets recorded under capital leases, is calculated on a
straight-line basis over the lesser of the estimated lives, ranging from five to
ten years for telecommunications equipment and three to five years for
furniture, fixtures and equipment and other property, or their contractual term.
Construction in process reflects amounts incurred for the configuration and
build-out of telecommunications equipment and telecommunications equipment not
yet placed into service. Maintenance and repairs are charged to expense as
incurred.
 
     In accordance with Statement of Financial Accounting Standards ("SFAS") No.
34, "Capitalization of Interest Costs," the Company intends to capitalize
material interest costs associated with the construction of capital assets for
business operations and amortize the costs over the assets' useful lives. The
Company has not capitalized any interest costs through December 31, 1997.
 
GOODWILL AND INTANGIBLE ASSETS
 
     Goodwill represents the excess of acquisition costs over the fair market
value of the net assets of acquired businesses and is being amortized on a
straight-line basis over their estimated useful lives ranging from three to ten
years. Intangible assets, principally telecommunications service contracts,
licenses and deferred financing costs, are amortized on a straight-line basis
over the lesser of their estimated useful lives, generally three to fifteen
years, or their contractual term. In accordance with Accounting Principles Board
("APB") Opinion No. 17, "Intangible Assets," the Company continues to evaluate
the amortization period to determine whether events or circumstances warrant
revised amortization periods. Additionally, the Company considers whether the
carrying value of such assets should be reduced based on the future benefits of
its intangible assets.
 
LONG-LIVED ASSETS
 
     In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," long-lived
assets to be held and used by the Company are reviewed to determine whether any
events or changes in circumstances indicate that the carrying amount of the
asset may not be recoverable. For long-lived assets to be held and used, the
Company bases its evaluation on such impairment indicators as the nature of the
assets, the future economic benefit of the assets, any historical or future
profitability measurements, as well as other external market conditions or
factors that may be present. If such impairment indicators are present or other
factors exist that indicate that the carrying amount of the asset may not be
recoverable, the Company determines whether an impairment has occurred through
the use of an undiscounted cash flows analysis of assets at the lowest level for
which identifiable cash flows exist. If an
 
                                       87
<PAGE>   89
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
impairment has occurred, the Company recognizes a loss for the difference
between the carrying amount and the estimated value of the asset. The fair value
of the asset is measured using quoted market prices or, in the absence of quoted
market prices, fair value is based on an estimate of discounted cash flow
analysis. During the year ended December 31, 1996, the Company's analyses
indicated that there was not an impairment of its long-lived assets. During the
year ended December 31, 1997, the Company's analyses indicated that there was an
impairment of its long-lived assets. Accordingly, the Company recorded a
write-down of long-lived assets associated with its investments in the Asia and
Central Europe regions (see Note 3, "Investments in and Advances to Ventures").
 
INCOME TAXES
 
     The Company uses the liability method of accounting for income taxes.
Deferred income taxes result from temporary differences between the tax basis of
assets and liabilities and the basis as reported in the consolidated financial
statements. The Company does not provide for deferred taxes on the undistributed
earnings of its foreign companies, as such earnings are intended to be
permanently reinvested in those operations.
 
FOREIGN CURRENCY TRANSLATION
 
     The Company follows a translation policy in accordance with SFAS No. 52,
"Foreign Currency Translation." In most instances, the local currency is
considered the functional currency for the Company's subsidiaries and ventures,
except for operations in the CIS, where the U.S. dollar has been designated as
the functional currency. Assets and liabilities of these subsidiaries and
ventures are translated at the rates of exchange at the balance sheet date.
Income and expense accounts are translated at average monthly rates of exchange.
The resultant translation adjustments are included in the cumulative translation
adjustment, a separate component of shareholders' equity. Gains and losses from
foreign currency transactions of these subsidiaries and ventures are included in
the operations of the subsidiary or venture.
 
     For those ventures operating in the CIS, the temporal method for
translating assets and liabilities is used. Accordingly, monetary assets and
liabilities are translated at current exchange rates while non-monetary assets
and liabilities are translated at their historical rates. Income and expense
accounts are translated at average monthly rates of exchange. The resultant
translation adjustments are included in the operations of the subsidiaries and
ventures.
 
REVENUE RECOGNITION
 
     The Company records as revenue the amount of telecommunications services
rendered, as measured primarily by the minutes of traffic processed, after
deducting an estimate of the traffic that will be neither billed nor collected.
Revenue from service or consulting contracts is accounted for when the services
are provided. Equipment sales revenue is generally recognized upon shipment of
the equipment. Billings received in advance of service being performed are
deferred and recognized as revenue as the service is performed.
 
NET LOSS PER SHARE
 
     During 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which
requires the Company to present basic and fully diluted earnings per share for
all years presented. The Company's net loss per share calculation (basic and
fully diluted) is based upon the weighted average common shares issued. There
are no reconciling items in the numerator or denominator of the Company's net
loss per share calculation. Employee stock options, warrants, and convertible
debt instruments have been excluded from the net loss per share calculation
because their effect would be anti-dilutive (see Note 5, "Debt Obligations,"
Note 6, Shareholders' Equity and Note 7, "Stock Option Plans").
 
                                       88
<PAGE>   90
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
FAIR VALUE OF FINANCIAL INSTRUMENTS
 
     The Company believes that the carrying amount of its financial instruments
reported in the balance sheets approximates their fair value.
 
OFF BALANCE SHEET RISK AND CONCENTRATION OF CREDIT RISK
 
     Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash and cash equivalents and accounts and
notes receivable. The Company maintains most of its cash and cash equivalents in
one high-quality U.S. financial institution. The Company extends credit to
various customers and establishes an allowance for doubtful accounts for
specific customers that it determines to have significant credit risk. The
Company provides allowances for potential credit losses when necessary.
 
     The Company does not currently hedge against foreign currency fluctuations,
although the Company may implement such practices in the future. Under current
practices, the Company's results of operations could be adversely affected by
fluctuations in foreign currency exchange rates.
 
STOCK BASED COMPENSATION
 
     SFAS No. 123, "Accounting for Stock-Based Compensation," establishes a fair
value method of accounting for employee stock options and similar equity
instruments. The fair value method requires compensation cost to be measured at
the grant date based on the value of the award and is recognized over the
service period. SFAS No. 123 allows companies to either account for stock-based
compensation under the new provisions of SFAS No. 123 or under the provisions of
APB No. 25, "Accounting for Stock Issued to Employees." The Company has elected
to account for its stock-based compensation in accordance with the provisions of
APB No. 25 and presents pro forma disclosures of net loss as if the fair value
method had been adopted.
 
USES OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
 
     The preparation of these consolidated financial statements, in conformity
with generally accepted accounting principles, requires management to make
estimates and assumptions that affect amounts in the financial statements and
accompanying notes and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
NEW ACCOUNTING STANDARDS
 
     The Financial Accounting Standards Board has issued two new standards which
become effective for reporting periods beginning after December 15, 1997. SFAS
No. 130, "Reporting Comprehensive Income," requires additional disclosures with
respect to certain changes in assets and liabilities that previously were not
required to be reported as results of operations for the period. The Company
will begin making the additional disclosures required by SFAS No. 130 in the
first quarter of 1998. SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," requires financial and descriptive
information with respect to "operating segments" of an entity based on the way
management disaggregates the entity for making internal operating decisions. The
Company will begin making the disclosures required by SFAS No. 131 with
financial statements for the period ending December 31, 1998.
 
NOTE 3: INVESTMENTS IN AND ADVANCES TO VENTURES
 
     The Company has various investments in ventures that are accounted for by
the equity method. The Company's ownership percentages in its equity method
investments range from 49% to 80%. The Company has no investments in ventures
that are accounted for by the cost method.
 
                                       89
<PAGE>   91
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The components of the Company's investments in and advances to ventures are
as follows:
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              -------------------
                                                                1996       1997
                                                              --------    -------
                                                                (IN THOUSANDS)
<S>                                                           <C>         <C>
Equity in net assets acquired...............................  $ 41,105    $31,183
Excess of investment cost over equity in net assets acquired
  net of amortization of $4,347 and $4,851 at December 31,
  1996 and 1997, respectively...............................    11,288      7,582
Accumulated (losses) earnings recognized....................   (13,840)    14,659
Dividends...................................................      (973)    (3,848)
Cash advances and other.....................................    66,879     27,154
                                                              --------    -------
          Total investments in and advances to ventures.....  $104,459    $76,730
                                                              ========    =======
</TABLE>
 
     In applying the equity method of accounting, the Company's policy is to
amortize the excess of investment cost over equity in net assets acquired based
upon an assignment of the excess to the fair value of the venture's identifiable
tangible and intangible assets, with any unassigned amounts designated as
goodwill. The Company then amortizes the allocated costs in accordance with its
policies defined in Note 2, "Summary of Significant Accounting Policies."
 
     The Company has financed the operating and investing cash flow requirements
of several of its ventures in the form of cash advances. The Company anticipates
that these ventures will generate sufficient cash inflows for the repayment of
the cash advances as their businesses mature. Also, due to the long-term nature
of the anticipated repayment period and the potential risk associated with the
repatriation of the cash advances, the Company has aggregated its investments in
and cash advances to the ventures.
 
     The Company's share of the ventures' foreign currency translation
adjustments is reflected in the investment accounts.
 
INVESTMENT RECOVERABILITY
 
     The Company periodically evaluates the recoverability of its equity
investments, in accordance with APB No. 18, "The Equity Method of Accounting for
Investments in Common Stock," and if circumstances arise where a loss in value
is considered to be other than temporary, the Company will record a write-down
of excess investment cost. The Company's recoverability analysis is based on the
projected undiscounted cash flows of the operating ventures, which is the lowest
level of cash flow information available. As of December 31, 1997, the Company
recorded a write-off of approximately $5.4 million, which represented the net
balance of certain investments in and advances to ventures located in Asia
(primarily Beijing Tianmu and V-Tech) and Central Europe (Eurohivo) which were
stated in excess of their net realizable value. The entire net balance of these
investments in and advances to ventures was written-off based on the fact that
these ventures project overall negative cash flows for the foreseeable future.
The ventures projected future operations deteriorated during 1997 as a result of
problems dealing with one of its partners, the inability of the
 
                                       90
<PAGE>   92
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
ventures to develop markets for its services, and technical problems. The
components of the charge, which was classified as equity in losses of ventures,
were as follows:
 
<TABLE>
<S>                                                           <C>
Equity in net assets acquired...............................  $ 17,093
Excess of investment cost over equity in net assets
  acquired..................................................       593
Accumulated (losses) earnings recognized....................   (23,253)
Dividends...................................................        --
Cash advances and other.....................................    10,921
                                                              --------
Net write-off as of December 31, 1997.......................  $  5,354
                                                              ========
</TABLE>
 
     Prior to the write-off detailed above, the Company included approximately
$14.4 million in its accumulated losses (of the $14.4 million, approximately
$13.5 million related to the write-off of advances to several Chinese owned
operating telecommunications companies to which the Company provides technical
and financial assistance and $0.9 million related to the write-off of
inventories, receivables, and other assets) which represented the Company's
share of asset write-offs recorded by certain of the Company's equity method
investments in Asia during the year ended December 31, 1997. Such write-offs,
for the same reasons mentioned in the previous paragraph, were recorded by the
Company's equity method investments pursuant to SFAS No. 121 and are included in
the $(23.3) million accumulated (losses) detailed above. Additionally, during
the year ended December 31, 1997 the Company recorded a charge of $1.7 million
in order to write off certain holding company assets associated with the
ventures located in Asia and Central Europe. This charge has been included as a
separate line item in the Company's statement of operations.
 
HERMES EUROPE RAILTEL B.V. ("HER") RECAPITALIZATION
 
     During the year ended December 31, 1997, HER recapitalized its equity
structure and amended its existing shareholder agreement. In connection with the
HER recapitalization the Company contributed approximately $51.8 million and
converted existing note receivables of approximately $28.4 million in exchange
for an additional 29% equity interest in HER. As a result of the
recapitalization and amended shareholder agreement, the Company obtained
unilateral control over HER. As such, HER has been consolidated into the
Company's financial statements effective July 6, 1997, the effective date of the
recapitalization. The Company recognized approximately $8.7 million of goodwill
in connection with the recapitalization. As a result of the Company's loss
recognition policy, the consolidation of HER would not have a material impact on
the Company's historical financial position or operating results and thus no pro
forma information is disclosed herein.
 
     As of December 31, 1997, the consolidation of HER resulted in reductions of
$72.9 million, $10.0 million, and $4.6 million in the equity in net assets
acquired, excess of investment cost over equity in net assets acquired, and cash
advances and other, respectively. Additionally, as of December 31, 1997 the
consolidation of HER had a $21.4 million favorable impact on the accumulated
(losses) earnings recognized.
 
                                       91
<PAGE>   93
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
CHANGES IN THE INVESTMENTS IN AND ADVANCES TO VENTURES
 
     The changes in the investments in and advances to ventures are as follows:
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                                1996        1997
                                                              --------    --------
                                                                 (IN THOUSANDS)
<S>                                                           <C>         <C>
Balance, at beginning of period.............................  $ 56,153    $104,459
Equity in net assets acquired...............................    22,441      80,054
Excess of investment cost over equity in net assets
  acquired..................................................     5,288      10,187
Dividends...................................................      (973)     (2,875)
Cash advances (repayments) and other........................    31,700     (24,171)
Effect of consolidating equity method company...............        --     (76,325)
                                                              --------    --------
                                                                58,456     (13,130)
Equity ownership in losses..................................    (3,122)     (5,552)
Excess losses recognized over amount attributable to
  ownership
  interest..................................................    (4,451)    (10,610)
Amortization of excess of investment cost over equity in net
  assets acquired...........................................    (2,577)     (3,313)
Loss in value that is other than temporary..................        --      (5,354)
Effect of consolidating equity method company...............        --      10,230
                                                              --------    --------
                                                               (10,150)    (14,599)
                                                              --------    --------
Balance, at end of period...................................  $104,459    $ 76,730
                                                              ========    ========
</TABLE>
 
     As of December 31, 1997, the significant investments accounted for under
the equity method and the percentage interest owned consist of the following:
 
<TABLE>
<CAPTION>
                 EQUITY OWNED SUBSIDIARIES                    OWNERSHIP %
                 -------------------------                    -----------
<S>                                                           <C>
EDN Sovintel................................................     50%
Sovam Teleport..............................................     67%
GTS Ukrainian TeleSystems, L.L.C. (holds a 49% interest in
  Bancomsvyaz)..............................................     60%
GTS-Vox Limited (holds a 95% interest in TeleCommunications
  of Moscow)................................................   52.64%
TeleRoss Ventures -- 13 joint ventures in various regions in
  the CIS...................................................     50%
Vostok Ventures -- 12 joint ventures in various regions in
  the CIS...................................................   50-70%
PrimTelefone................................................     50%
GTS Monaco Access S.A.M.....................................     50%
</TABLE>
 
     In connection with a purchase of a venture during 1995, the Company is
required to pay additional consideration through 1998, in shares of the
Company's common stock, based on the actual earnings of the venture. The
Company's maximum obligation pursuant to this agreement is to issue 1,121,640
shares of common stock. The Company will recognize any additional consideration
paid under this agreement as goodwill. During the first quarter of 1998, the
Company will issue additional shares based on the venture's 1997 earnings (see
Note 15, "Subsequent Events").
 
     During 1996 and 1997, the Company, in connection with a venture investment,
entered into two financing agreements with a shareholder of the Company for a
total of approximately $8.6 million. Subject to certain conditions, the
shareholder has the right to require the repayment of this amount in cash or by
exchange for 713,311 shares of the Company's common stock. Subsequent to the
Stock Offering, repayment of this financing is due on demand and must be in
exchange for the Company's common stock. This amount has been included in "Other
financing agreements" (see Note 5, "Debt Obligations").
 
                                       92
<PAGE>   94
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Subsequent to year end, the Company purchased the remaining interest in
Sovam Teleport, one of its equity method investments in the CIS.
 
     The following tables present condensed financial information of the
Company's ventures that are accounted for by the equity method of accounting as
of December 31, 1996 and 1997.
 
YEAR ENDED DECEMBER 31, 1996
 
<TABLE>
<CAPTION>
                                                   MAJORITY OWNED    50% OR LESS      TOTAL EQUITY
             EQUITY METHOD ENTITIES                   VENTURES      OWNED VENTURES   METHOD VENTURES
             ----------------------                --------------   --------------   ---------------
                                                                    (IN THOUSANDS)
<S>                                                <C>              <C>              <C>
Revenue..........................................     $36,202          $107,270         $143,472
Gross margin.....................................      17,109            45,937           63,046
Net income (loss)................................       3,240            (8,460)          (5,220)
Equity in net losses.............................      (1,091)           (6,482)          (7,573)
Current assets...................................      27,293            50,689           77,982
Total assets.....................................      48,174           146,483          194,657
Current liabilities..............................      19,416            68,474           87,890
Total liabilities................................      24,987           102,332          127,319
Net assets.......................................      23,187            44,151           67,338
Ownership interest in equity in net assets.......      14,912            19,513           34,425
</TABLE>
 
YEAR ENDED DECEMBER 31, 1997
 
<TABLE>
<CAPTION>
                                                   MAJORITY OWNED    50% OR LESS      TOTAL EQUITY
             EQUITY METHOD ENTITIES                   VENTURES      OWNED VENTURES   METHOD VENTURES
             ----------------------                --------------   --------------   ---------------
                                                                    (IN THOUSANDS)
<S>                                                <C>              <C>              <C>
Revenue..........................................     $47,986          $178,174         $226,160
Gross margin.....................................      29,292            69,136           98,428
Net (loss) income................................     (10,370)           14,700            4,330
Equity in net (losses) earnings..................     (11,538)            5,131           (6,407)
Current assets...................................      20,841            59,959           80,800
Total assets.....................................      35,090           176,117          211,207
Current liabilities..............................      18,719            68,503           87,222
Total liabilities................................      27,653           102,758          130,411
Net assets.......................................       7,438            73,359           80,797
Ownership interest in equity in net assets.......       9,541            45,638           55,179
</TABLE>
 
                                       93
<PAGE>   95
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 4: SUPPLEMENTAL BALANCE SHEET INFORMATION
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              -------------------
                                                               1996        1997
                                                              -------    --------
                                                                (IN THOUSANDS)
<S>                                                           <C>        <C>
Accounts Receivable Consists Of:
  Trade accounts receivable.................................  $ 6,769    $ 15,725
  Value added taxes receivable..............................    1,971       3,350
  Other receivables.........................................      962       2,089
                                                              -------    --------
                                                                9,702      21,164
    Less: allowance for doubtful accounts...................      782       4,085
                                                              -------    --------
        Total accounts receivable, net......................  $ 8,920    $ 17,079
                                                              =======    ========
Property And Equipment Consists Of:
  Telecommunications equipment..............................  $28,302    $231,996
  Furniture, fixtures and equipment.........................    5,877       9,760
  Other property............................................      837       3,470
  Construction in process...................................    7,009       7,799
                                                              -------    --------
                                                               42,025     253,025
    Less: accumulated depreciation..........................    6,562      16,128
                                                              -------    --------
        Total property and equipment, net...................  $35,463    $236,897
                                                              =======    ========
Accounts Payable And Accrued Expenses Consists Of:
  Accounts payable..........................................  $ 6,761    $ 25,005
  Interest payable..........................................      213      17,483
  Accrued compensation......................................    3,151       6,165
  Other accrued expenses....................................    5,086      13,331
                                                              -------    --------
        Total accounts payable and accrued expenses.........  $15,211    $ 61,984
                                                              =======    ========
</TABLE>
 
NOTE 5: DEBT OBLIGATIONS
 
     Company debt consists of:
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              -------------------
                                                               1996        1997
                                                              -------    --------
                                                                (IN THOUSANDS)
<S>                                                           <C>        <C>
Senior notes of HER, due August 15, 2007 at 11.5% interest
  payable semiannually......................................  $    --    $265,000
Senior subordinated convertible bonds, due June 30, 2000 at
  an effective interest rate of 15%, and a stated rate of
  8.75%-9.75% payable semiannually..........................       --     144,787
Related party debt obligations, with principal payments
  beginning April 1, 1998 and maturing on March 31, 2001 at
  10% interest, net of unamortized discount for warrants to
  purchase 7,778 common shares..............................   59,079      72,233
Other financing agreements..................................   26,468      18,204
                                                              -------    --------
                                                               85,547     500,224
  Less: debt maturing within one year.......................   21,208      12,098
                                                              -------    --------
          Total long-term debt..............................  $64,339    $488,126
                                                              =======    ========
</TABLE>
 
     In the third quarter of 1997, HER issued $265.0 million aggregate principal
amount of senior notes due August 15, 2007 (the "Senior Notes"). The Senior
Notes are general unsecured obligations of the subsidiary with interest payable
semiannually at a rate of 11.5%. Approximately $56.6 million of the net proceeds
of the offering of the Senior Notes is being held in escrow for the first four
semiannual interest payments commencing in 1998. HER may redeem the Senior
Notes, in whole or in part, any time on or after August 15,
 
                                       94
<PAGE>   96
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
2002 at specific redemption prices. HER may also redeem a portion of the Senior
Notes at a price equal to 111.5% of the principal amount prior to August 15,
2000 with net cash proceeds of a public equity offering of HER with gross
proceeds of at least $75 million or in certain other circumstances specified in
the indenture for the Senior Notes, provided, however, that at least two-thirds
of the principal amount of the Senior Notes originally issued remain outstanding
after each such redemption.
 
     In July 1997, the Company issued $144.8 million aggregate principal amount
of senior subordinated convertible bonds (the "Bonds") due June 30, 2000. The
Bonds constitute direct, unsecured senior subordinated indebtedness after
existing debt of $82.7 million. Upon completion of a complying public equity
offering as defined in the Bond agreement (an "Offering") or in certain other
circumstances as defined in the Bond agreement, the Bonds may be converted at
the option of the holders from time to time, in whole or in part, prior to the
close of business on June 30, 2000, into shares of the Company's common stock,
par value $0.10 per share. The Bonds will be convertible into such number of
shares of the Company's common stock as is equal to the principal amount of such
Bonds divided by the applicable conversion price as defined in the Bond
Agreement. The Bonds bear interest payable semiannually at a stated rate of
8.75% for the first year, 9.25% for the second year and 9.75% for the final
year. In the event of an Offering, the interest rate will remain at the interest
rate prevailing at the time of the Offering until maturity. In the event that an
Offering has not occurred by the maturity date, the Bonds will be redeemed at
121% of their principal amount. As a result of the redemption feature, interest
expense is being accrued and accreted at a 15% annual rate. (Subsequent to year
end, the Company completed the Stock Offering at $20.00 per common share which
will result in the Bonds being convertible into approximately 7.2 million shares
of the Company's common stock. In addition, due to the completion of the Stock
Offering, the interest rate will remain at 8.75% until maturity (see Note 15,
"Subsequent Events").)
 
     In 1996, the Company entered into long-term obligations ("Debt
Obligations"), totaling $70.0 million, with lenders (the "Lenders"). The Lenders
are affiliated with and are considered related parties to the Company, as a
result of their ownership of the Company's common stock (see Note 12, "Related
Party Transactions"). The Debt Obligations require principal payments beginning
in the third year, to maturity in the fifth year. The Debt Obligations bear an
interest rate of 10.0% and require interest payments beginning in the first
fiscal quarter subsequent to the date of issuance. At the Company's discretion,
the initial interest accrued until the first principal payment can be deferred
until maturity. Upon commencement of principal payments, the Company is
obligated to make concurrent interest payments. Further, in connection with the
Debt Obligations, the Company issued warrants to purchase 7,777,776 common
shares, valued at $20.7 million. In accordance with the terms of the warrant
agreement, the exercise price of the warrants was reduced from $10.27 per share
to $9.33 per share, as the outstanding debt had not been repaid prior to
December 31, 1996. The warrants may be exercised up to six years after the date
of the relevant agreements. The Company is subject to certain restrictive
covenants pursuant to these Debt Obligations, including restrictions on the
payment of dividends and indebtedness to affiliated ventures. As of December 31,
1997, the Debt Obligations have been classified within "Related party long-term
debt, less current portion" on the balance sheet. Subsequent to year end the
Company repaid the Debt Obligations by using a portion of the proceeds from the
Offerings (see Note 15, "Subsequent Events").
 
     Certain of the Company's consolidated ventures maintain credit facilities
for their local operations. Borrowings under such credit facilities bear
interest at prevailing negotiated market rates.
 
     Aggregate maturities of long-term debt, as of December 31, 1997, are as
follows: 1998 -- $12.1 million, 1999 -- $1.1 million, 2000 -- $149.4 million,
2001 -- $0.2 million and $349.5 million thereafter.
 
     The Company paid interest of $0.7 million, $0.2 million and $2.0 million in
1995, 1996 and 1997, respectively. The Company incurred interest expense of
$39.1 million in 1997 and would have recorded $33.1 million in additional
interest expense in 1997 had the Senior Notes and Bonds been outstanding on
January 1, 1997.
                                       95
<PAGE>   97
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 6: SHAREHOLDERS' EQUITY
 
COMMON STOCK
 
     The following table summarizes the Company's equity private placements for
the periods ending:
 
<TABLE>
<CAPTION>
                                                     SHARES ISSUED   SHARE PRICE   NET PROCEEDS
                                                     -------------   -----------   ------------
                                                         (IN THOUSANDS, EXCEPT SHARE DATA)
<S>                                                  <C>             <C>           <C>
December 31, 1995..................................    5,090,876       $ 9.00        $42,138
December 31, 1996..................................    8,348,532        13.33        107,744
December 31, 1997..................................    2,502,686        15.67         36,432
</TABLE>
 
     During 1995, the Company issued 400,000 shares of common stock to an
independent third party in connection with the purchase of an interest in a
venture within the CIS region. At the discretion of the holder of these shares,
the Company is obligated to repurchase these shares at the prevailing fair
market value of the Company's common stock on the date of repurchase. During
1995, the Company repurchased 75,000 shares at $10.00 per share and the
repurchased shares became treasury stock. In March 1997, the Company repurchased
32,500 shares at $13.33 per share, and these shares became treasury stock. The
Company will be required to repurchase the remaining shares over the next three
years. During 1997, the Company issued 504,600 shares of common stock pursuant
to a purchase agreement with a seller for a portion of their interest in a
venture within the CIS region. Pursuant to the purchase agreement, the Company
is obligated to assist the seller in locating a purchaser for the common stock,
and if unable to do so, to repurchase the issued common stock. The Company has
accreted the value of the outstanding common stock subject to repurchase
(325,000 shares at December 31, 1996 and 797,100 shares at December 31, 1997),
to the fair value of the Company's common stock as of December 31, 1996 and 1997
($13.33 and $15.67 per share, respectively).
 
     During 1996, the Company entered into the Debt Obligations totaling $70.0
million with the Lenders. In connection with the Debt Obligations, the Company
issued warrants to purchase 7,777,776 common shares at $10.27 per share. The
exercise price of the warrants was automatically reduced to $9.33 per share as
of December 31, 1996, because the Debt Obligations remained outstanding. The
warrants expire during the first and second quarters of 2002.
 
     The Company does not intend to pay dividends on common stock in the
foreseeable future. In addition, certain of the Company's financing agreements
include covenant restrictions precluding the payment of dividends by the
Company.
 
     The Company has reserved 15,572,260 shares of common stock for issuance
upon conversion of the exercise of outstanding and future stock options,
warrants and similar rights.
 
PREFERRED STOCK
 
     As of December 31, 1996 and 1997, there were 10,000,000 shares of $0.0001
par value preferred stock authorized, with rights and preferences to be
determined by the Board of Directors. As of December 31, 1996 and 1997, no
shares of preferred stock had been issued.
 
NOTE 7: STOCK OPTION PLANS
 
     The Company applies the provisions of APB No. 25 in accounting for its
stock option incentive plans. The effect of applying SFAS No. 123 on the net
loss as reported is not representative of the effects on reported net loss for
future years due to the vesting period of the stock options and the fair value
of additional stock options in future years. Had compensation expense been
determined in accordance with the methodology of SFAS No. 123, the Company's net
loss for the years ended December 31, 1995, 1996 and 1997 would have been
approximately $40.9 million, $69.4 million and $123.4 million, respectively. The
fair value of options
 
                                       96
<PAGE>   98
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
granted during 1995 and 1996 are estimated as $2.19 and $2.93 per common share,
respectively, on the date of grant using the minimum value option pricing model
with the following assumptions: dividend yield 0%, risk free interest rate of
5.50% for 1995 and 6.13% for 1996, and an expected life of five years. The fair
value of options granted during 1997 are estimated as $7.35 per common share, on
the date of grant using the Black Scholes option valuation model with the
following assumptions: dividend yield 0%, risk free interest rate of 5.74%, an
expected life of five years, and an expected volatility of .50. The Company
determined its volatility factor with the assistance of an investment banker,
based on peer group public companies.
 
     The Company maintains the 1992 Stock Option Plan, the Non-Employee
Directors Stock Option Plan and the GTS Equity Compensation Plan (the "Option
Plans"). As of December 31, 1997, the maximum number of shares of common stock
available for grant under the Option Plans was 8,836,534. All options granted
under the Option Plans are at exercise prices that were at least equal to the
fair market value of common stock at the date of grant. Generally, all options
granted under the Option Plans vest over a three-year period from the date of
grant and expire ten years from the date of grant.
 
     Additional information with respect to stock option activity is summarized
as follows:
 
<TABLE>
<CAPTION>
                                                   YEAR ENDED DECEMBER 31,
                              ------------------------------------------------------------------
                                      1995                   1996                   1997
                              --------------------   --------------------   --------------------
                                          WEIGHTED               WEIGHTED               WEIGHTED
                                          AVERAGE                AVERAGE                AVERAGE
                                          EXERCISE               EXERCISE               EXERCISE
                               SHARES      PRICE      SHARES      PRICE      SHARES      PRICE
                              ---------   --------   ---------   --------   ---------   --------
<S>                           <C>         <C>        <C>         <C>        <C>         <C>
Outstanding at beginning of
  year......................  2,431,800    $3.65     3,422,399    $ 5.56    4,869,360    $ 7.31
Options granted.............  1,210,800     9.04     1,612,962     11.10    2,215,296     14.53
Options exercised...........    (28,001)    4.46       (56,498)     6.70      (89,312)     6.34
Options canceled or
  expired...................   (192,200)    3.57      (109,503)     8.73     (433,173)     7.38
                              ---------              ---------              ---------
Outstanding at end of
  year......................  3,422,399     5.56     4,869,360      7.31    6,562,171      9.75
                              =========              =========              =========
Options exercisable at year
  end.......................    995,617    $3.59     1,992,236    $ 4.65    2,962,110    $ 6.06
</TABLE>
 
     The following table summarizes information about stock options outstanding:
 
<TABLE>
<CAPTION>
                                                  OPTIONS OUTSTANDING               OPTIONS EXERCISABLE
                                       -----------------------------------------   ----------------------
                                                         WEIGHTED
                                                         AVERAGE        WEIGHTED                 WEIGHTED
                                                        REMAINING       AVERAGE                  AVERAGE
       RANGE OF EXERCISE PRICE           NUMBER      CONTRACTUAL LIFE   EXERCISE     NUMBER      EXERCISE
        AT DECEMBER 31, 1997:          OUTSTANDING      (IN YEARS)       PRICE     EXERCISABLE    PRICE
       -----------------------         -----------   ----------------   --------   -----------   --------
<S>                                    <C>           <C>                <C>        <C>           <C>
$1.42 to $2.75.......................   1,446,000           6            $ 2.69     1,371,000     $ 2.68
$4.67 to $9.00.......................   1,270,650           7              7.88       986,679       7.66
$10.00 to $15.67.....................   3,845,521           8             13.03       604,431      11.13
                                        ---------                                   ---------
                                        6,562,171           7            $ 9.75     2,962,110     $ 6.06
                                        =========                                   =========
</TABLE>
 
     In addition, prior to the establishment of the Option Plans, certain
options were granted in 1991 to certain key employees and former employees to
purchase 1,172,250 shares of the Company's common stock at an exercise price of
$0.53 per share. All options were granted at an exercise price equal to the fair
value of the underlying common stock at the date of grant. The options vested in
equal increments over a three-year period. During 1993, 603,000 of the options
were canceled and in 1994, 50,250 options were exercised, leaving 519,000 fully
vested options outstanding at December 31, 1995, 1996 and 1997.
 
                                       97
<PAGE>   99
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     During 1996, the Company implemented the GTS 1996 Top Talent Retention
Program (the "Program"), which granted options to certain employees under the
1992 Stock Option Plan. The Program was offered to 28 employees, who had an
aggregate of 339,524 options, and provided for an altered vesting period based
on certain revenue levels achieved and certain stock price levels maintained. If
these performance-based achievements are not attained, the options vest in April
2001. As of December 31, 1997 no performance levels were met.
 
     In the fourth quarter of 1997, HER implemented a stock option plan for its
key officers and employees (the "HER Plan"). The ownership dilution caused by
the HER Plan is not expected to be significant. As a result of issuing options
under the HER Plan, HER will incur a non-cash charge of approximately $3.7
million, of which $2.6 million was recorded during the fourth quarter and the
remaining $1.1 million will be recognized in 1998.
 
NOTE 8: EMPLOYEE BENEFIT PLAN
 
     The Company has a 401(k) retirement savings plan (the "Savings Plan")
covering all U.S. citizen employees. The Savings Plan qualifies under section
401(k) of the Internal Revenue Code and as such, participants may defer pretax
income in accordance with federal income tax limitations. The Company provides a
50% matching contribution on the first 5% contributed by the employee. The
Company may also, at its discretion, make non-matching contributions. Both
matching and non-matching contributions by the Company vest 100% after three
years of service. The Company's expense under the Savings Plan was approximately
$0.1 million, $0.2 million and $0.2 million for the years ended December 31,
1995, 1996 and 1997, respectively. The Company made no discretionary
(non-matching) contributions for the years ended December 31, 1995, 1996 or
1997.
 
     HER established a pension plan in 1995 that covers all HER employees upon
twenty-five years of age and at least one year of service. HER has entered into
an insurance arrangement (an annuity contract) whereby an insurance provider has
undertaken a legal obligation to provide specific benefits to participants in
return for a fixed premium. As such, HER does not bear significant financial
risk for its pension plan. HER's expense under the pension plan was $0.05
million, $0.4 million and $0.7 million for the years ended December 31, 1995,
1996 and 1997, respectively.
 
NOTE 9: OTHER NON-OPERATING INCOME
 
     Favorably affecting the 1995 results was the non-recurring $10.3 million
gain the Company recognized as a result of its cash settlement of certain claims
with a third party in 1995.
 
NOTE 10: INCOME TAXES
 
     The components of loss before income taxes and minority interest were as
follows:
 
<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                                                     --------------------------------
                                                       1995        1996        1997
                                                     --------    --------    --------
                                                              (IN THOUSANDS)
<S>                                                  <C>         <C>         <C>
Pretax loss:
  Domestic.........................................  $(22,398)   $(41,554)   $(64,920)
  Foreign..........................................   (15,437)    (25,077)    (53,261)
                                                     --------    --------    --------
                                                     $(37,835)   $(66,631)   $(118,181)
                                                     ========    ========    ========
</TABLE>
 
     For the years ended December 31, 1995, 1996 and 1997, the Company recorded
$2.6 million, $1.4 million and $2.5 million, respectively, in income tax expense
that related exclusively to its current provision for foreign taxes.
 
                                       98
<PAGE>   100
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The reconciliation of the U.S. statutory federal tax rate of 34.0% to the
Company's effective tax rate is as follows:
 
<TABLE>
<CAPTION>
                                                 YEAR ENDED DECEMBER 31,
                               ------------------------------------------------------------
                                      1995                 1996                 1997
                               ------------------   ------------------   ------------------
                                AMOUNT    PERCENT    AMOUNT    PERCENT    AMOUNT    PERCENT
                               --------   -------   --------   -------   --------   -------
                                                      (IN THOUSANDS)
<S>                            <C>        <C>       <C>        <C>       <C>        <C>
Taxes at U.S. statutory
  rates......................  $(12,865)    34.0%   $(22,655)    34.0%   $(40,181)    34.0%
Foreign operating losses
  generating no tax
  benefit....................     6,550    (17.3)      8,526    (12.8)     18,108    (15.3)
Domestic operating losses
  generating no tax
  benefit....................     6,315    (16.7)     14,129    (21.2)     22,073    (18.7)
Other -- net.................     2,565     (6.8)      1,360     (2.1)      2,482     (2.1)
                               --------    -----    --------    -----    --------    -----
                               $  2,565     (6.8)%  $  1,360     (2.1)%  $  2,482     (2.1)%
                               ========    =====    ========    =====    ========    =====
</TABLE>
 
     Deferred tax assets and liabilities are recorded based on temporary
differences between earnings as reported in the financial statements and
earnings for income tax purposes. The following table summarizes major
components of the Company's deferred tax assets and liabilities:
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                                1996        1997
                                                              --------    --------
                                                                 (IN THOUSANDS)
<S>                                                           <C>         <C>
Deferred Tax Assets:
  Net operating loss carryforwards..........................  $ 20,720    $ 38,029
  Other deferred tax assets.................................     1,326       3,912
                                                              --------    --------
Total deferred tax asset....................................    22,046      41,941
Deferred Tax Liability......................................     1,161       2,292
                                                              --------    --------
Net deferred tax asset......................................    20,885      39,649
  Less: valuation allowance.................................   (20,885)    (39,649)
                                                              --------    --------
          Total.............................................  $     --    $     --
                                                              ========    ========
</TABLE>
 
     As of December 31, 1997, the Company had net operating loss carryforwards
for U.S. federal income tax purposes of approximately $110 million expiring in
fiscal years 2003 through 2012. Because of the "change in ownership" provisions
of the Tax Reform Act of 1986, the utilization of the Company's net operating
loss carry-forwards will be subject to an annual limitation.
 
     The Company's investment in EDN Sovintel is treated for U.S. tax purposes
as a partnership and, therefore, the Company's share of EDN Sovintel's income or
loss flows through to the Company's consolidated federal income tax return on a
current basis. Undistributed earnings of the Company's other foreign investments
are considered to be indefinitely reinvested and, accordingly, no provision for
U.S. federal and state income taxes, or foreign withholding taxes has been made.
Upon distribution of those earnings, the Company would be subject to foreign
withholding taxes and U.S. income taxes (subject to reduction for foreign tax
credits).
 
     Certain of the Company's foreign ventures have foreign tax loss
carryforwards in excess of $60 million. The Company's financial statements do
not reflect any provision for benefits that might be associated with such loss
carryforwards.
 
                                       99
<PAGE>   101
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 11: COMMITMENTS AND CONTINGENCIES
 
LEASES
 
     The Company has various lease agreements for office space, equipment and
fiber. The obligations extend through 2018. Most of the leases contain renewal
options of one to twelve years. Assets under capital leases are included in the
consolidated balance sheets as follows:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                              1996       1997
                                                              -----    --------
                                                               (IN THOUSANDS)
<S>                                                           <C>      <C>
Telecommunications equipment................................  $  --    $150,787
Less: accumulated amortization..............................     --         482
                                                              -----    --------
                                                              $  --    $150,305
                                                              =====    ========
</TABLE>
 
     Rental expense aggregated $2.0 million, $2.2 million, and $3.1 million for
the years ended December 31, 1995, 1996 and 1997, respectively.
 
     Future minimum payments, by year and in the aggregate, under the capital
leases and other non-cancellable operating leases with initial or remaining
terms in excess of one year as of December 31, 1997 were as follows:
 
<TABLE>
<CAPTION>
                                                          CAPITAL LEASES    OPERATING LEASES
                                                          --------------    ----------------
                                                                    (IN THOUSANDS)
<S>                                                       <C>               <C>
December 31, 1998.......................................     $ 26,679           $ 3,311
                1999....................................       14,217             2,982
                2000....................................       15,300             1,604
                2001....................................       16,465             1,143
                2002....................................       16,630               933
Thereafter..............................................      152,016             1,155
                                                             --------           -------
Total minimum lease payments............................      241,307           $11,128
                                                                                =======
Less amount representing interest.......................      102,172
                                                             --------
Present value of net minimum lease payments.............      139,135
Less current portion of capital lease obligations.......       21,490
                                                             --------
Long-term portion of capital lease obligations..........     $117,645
                                                             ========
</TABLE>
 
OTHER COMMITMENTS AND CONTINGENCIES
 
     In September 1997, the Company purchased the remaining interest in one of
its subsidiaries, which owns interests in cellular ventures within the CIS
region, for $5.2 million, which was paid in October 1997. Furthermore, the
Company is required to pay additional consideration of a minimum of $2.4 million
when certain revenue levels are met, certain other events occur or, if neither
has occurred, on April 1, 1999. The purchase price and consideration have been
allocated to net assets based on the fair value at the date of acquisition. The
excess of the purchase price over the fair value of the net assets acquired was
$5.9 million, which has been recorded as goodwill and is being amortized on a
straight-line basis over five years.
 
     The Company's consolidated and non-consolidated ventures have future
purchase commitments amounting to $2.7 million and $1.1 million, respectively,
as of December 31, 1997.
 
                                       100
<PAGE>   102
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     In the ordinary course of business, the Company has issued financial
guarantees on debt and equities for the benefit of certain of its
non-consolidated ventures. The total amount guaranteed at December 31, 1997 was
approximately $29.0 million.
 
MAJOR CUSTOMERS
 
     In 1995, the Company had one major customer, a foreign governmental agency
in Central Europe, representing $2.7 million, or 32.1%, of total revenue. In
1996, the Company had two major customers, a foreign governmental agency in
Central Europe and a customer in the CIS, representing $3.8 million, or 15.8%,
of total revenue and $2.6 million, or 10.8%, of total revenue, respectively.
There were no major customers in 1997.
 
TAX MATTERS
 
     The taxation system in Russia ("Russian Taxes") is evolving as the central
government transforms itself from a command to a market oriented economy. The
Russian Federation has introduced and continues to introduce new tax and royalty
laws and related regulations. These laws and regulations are not always clearly
written and their interpretation is subject to the opinions of the local tax
inspectors, Central Bank officials and the Ministry of Finance. Instances of
inconsistent opinions between local, regional and federal tax authorities and
between the Central Bank and Ministry of Finance are not unusual.
 
     The Company's policy is to accrue for contingencies in the accounting
period in which a liability is deemed probable and the amount is reasonably
determinable. In this regard, because of the uncertainties associated with the
Russian Taxes, the Company's Russian Taxes may be in excess of the estimated
amount expensed to date and accrued at December 31, 1996 and 1997. It is the
opinion of management that the ultimate resolution of the Company's Russian Tax
liability, to the extent not previously provided for, will not have a material
effect on the financial condition of the Company. However, depending on the
amount and timing of an unfavorable resolution of this contingency, it is
possible that the Company's future results of operations or cash flows could be
materially affected in a particular period.
 
     In various foreign jurisdictions, the Company is obligated to pay value
added taxes ("VAT") on the purchase or importation of assets, and for certain
other transactions. In many instances, VAT can be offset against VAT the Company
collects and otherwise would remit to the tax authorities, or may be refundable.
Because the law in some jurisdictions is unclear, the local tax authorities
could assert that the Company is obligated to pay additional amounts of VAT. In
the opinion of management, any additional VAT the Company may be obligated to
pay would not be material.
 
OTHER MATTERS
 
     In the ordinary course of business, the Company may be party to various
legal and tax proceedings, and subject to claims, certain of which relate to the
developing markets and evolving fiscal and regulatory environments in which the
Company operates. In the opinion of management, the Company's liability, if any,
in all pending litigation, other legal proceeding or other matter other than
what is discussed above, will not have a material effect upon the financial
condition, results of operations or liquidity of the Company.
 
NOTE 12: RELATED PARTY TRANSACTIONS
 
     As discussed within Note 5, "Debt Obligations," the Company entered into
the Debt Obligations during 1996 with the Lenders. The Lenders are shareholders
of the Company. As part of these transactions, the Company provided one of the
Lenders with the opportunity, at its discretion, to co-invest with the Company
in all of the Company's new ventures within the Asia region. The Company repaid
the Debt Obligations subsequent to year end (see Note 15, "Subsequent Events").
 
                                       101
<PAGE>   103
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     During 1996 and 1997, the Company, in connection with a venture investment,
entered into two financing agreements with a shareholder of the Company for a
total of approximately $8.6 million. Subject to certain conditions, the
shareholder has the right to require the repayment of this amount in cash or
713,311 shares of the Company's common stock. Subsequent to the Stock Offering,
repayment of this financing must be in exchange for the Company's common stock.
This amount has been included in "Other financing agreements" (see Note 5, "Debt
Obligations").
 
     During 1997, the Company issued 504,600 shares of common stock pursuant to
a purchase agreement with a seller for a portion of their interest in a venture
within the CIS region. As a result of the issuance of the common shares, the
seller became a shareholder of the Company (see Note 3, "Investments in and
Advances to Ventures," and Note 6, "Shareholders' Equity").
 
     The Company has entered into certain consulting agreements with directors
of the Company and paid $0.2 million, $0.2 million and $0.4 million in 1995,
1996, and 1997, respectively, pursuant to those agreements.
 
     The Company had notes receivable due from employees aggregating $0.1
million and less than $0.1 million as of December 31, 1996 and 1997,
respectively, with no single amount due from any individual in excess of $0.1
million.
 
     The Company derived revenue from affiliates of $3.3 million and $4.4
million in 1996 and 1997, respectively. There was no significant revenue earned
from affiliate sales in 1995.
 
NOTE 13: SUPPLEMENTAL CASH FLOW INFORMATION
 
     The following table summarizes non-cash investing and financing activities
for the Company:
 
<TABLE>
<CAPTION>
                                                                  YEAR ENDED
                                                                 DECEMBER 31,
                                                              ------------------
                                                               1996       1997
                                                              ------    --------
                                                                (IN THOUSANDS)
<S>                                                           <C>       <C>
Purchase of additional interest in Western Europe region
  subsidiary with conversion of debt to equity..............  $   --    $  9,139
Line of credit issued as payment on note payable and
  reclassification of restricted cash.......................      --       7,887
Conversion of a note payable to stock as additional
  consideration in relation to purchase of interest in a CIS
  region subsidiary.........................................   4,497       4,250
Note payable issued for additional capital infusion in CIS
  region subsidiary.........................................   4,500       4,125
Capitalization of leases....................................      --     139,136
</TABLE>
 
     No significant non-cash investing activities were incurred for the year
ended December 31, 1995.
 
NOTE 14: SEGMENT INFORMATION AND CERTAIN GEOGRAPHICAL DATA
 
     The Company operates predominantly in a single industry segment, the
telecommunications industry. The industry consists of a wide range of
telecommunications services to international business customers, including long
distance voice and data services and electronic messaging services. The
following tables present
 
                                       102
<PAGE>   104
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
consolidated financial information by geographic area for 1995, 1996 and 1997.
Transfers between geographic areas were not considered material for disclosure
purposes.
 
<TABLE>
<CAPTION>
                                                                                                 CORPORATE
                                                    WESTERN               CENTRAL                 OFFICE &
                                                     EUROPE      CIS       EUROPE      ASIA     ELIMINATIONS     TOTAL
                                                    --------   --------   --------   --------   ------------   ---------
                                                                               (IN THOUSANDS)
<S>                                                 <C>        <C>        <C>        <C>        <C>            <C>
Year Ended December 31, 1995
  Total revenue...................................  $    179   $  3,838   $  4,361   $    140     $   (106)    $   8,412
  Gross margin....................................      (318)      (949)     1,380          9         (106)           16
  Operating loss..................................    (5,469)   (16,681)    (6,312)    (4,831)     (15,578)      (48,871)
  Net loss........................................    (5,452)   (19,415)    (7,091)    (4,771)      (3,671)      (40,400)
  Identifiable assets.............................     5,898     73,816     15,639      9,167       11,101       115,621
  Liabilities.....................................    11,766     78,440     26,834     13,936      (75,950)       55,026
  Net (liabilities)/assets........................    (5,868)    (4,624)   (11,195)    (4,769)      87,051        60,595
</TABLE>
 
<TABLE>
<CAPTION>
                                                                                                 CORPORATE
                                                    WESTERN               CENTRAL                 OFFICE &
                                                     EUROPE      CIS       EUROPE      ASIA     ELIMINATIONS     TOTAL
                                                    --------   --------   --------   --------   ------------   ---------
                                                                               (IN THOUSANDS)
<S>                                                 <C>        <C>        <C>        <C>        <C>            <C>
Year Ended December 31, 1996
  Total revenue...................................  $     --   $ 12,696   $  9,355   $  1,561     $    505     $  24,117
  Gross margin....................................        --        811      3,292        652          421         5,176
  Operating loss..................................   (10,679)   (14,608)    (4,651)    (5,057)     (22,934)      (57,929)
  Net loss........................................   (10,700)   (15,572)    (5,295)    (4,951)     (31,473)      (67,991)
  Identifiable assets.............................    19,607     96,773     17,339     14,973       88,686       237,378
  Liabilities.....................................    35,728    116,961     33,826     24,753      (93,806)      117,462
  Net (liabilities)/assets........................   (16,121)   (20,188)   (16,487)    (9,780)     182,492       119,916
</TABLE>
 
<TABLE>
<CAPTION>
                                                                                                 CORPORATE
                                                    WESTERN               CENTRAL                 OFFICE &
                                                     EUROPE      CIS       EUROPE      ASIA     ELIMINATIONS     TOTAL
                                                    --------   --------   --------   --------   ------------   ---------
                                                                               (IN THOUSANDS)
<S>                                                 <C>        <C>        <C>        <C>        <C>            <C>
Year Ended December 31, 1997
  Total revenue...................................  $  5,373   $ 27,045   $ 13,513   $  1,016     $    151     $  47,098
  Gross margin....................................    (4,599)     3,940      4,985        (99)         152         4,379
  Operating loss..................................   (25,926)    (7,088)    (5,076)   (28,066)     (22,474)      (88,630)
  Net loss........................................   (29,064)    (9,505)    (6,882)   (28,043)     (43,492)     (116,986)
  Identifiable assets.............................   505,593     99,926     23,840     (6,544)     157,646       780,461
  Liabilities.....................................   451,171     62,862     40,465     19,161      148,580       722,239
  Net (liabilities)/assets........................    54,422     37,064    (16,625)   (25,705)       9,066        58,222
</TABLE>
 
NOTE 15: SUBSEQUENT EVENTS
 
THE OFFERINGS
 
     In February 1998, the Company completed the Stock Offering in which the
Company raised $255.3 million in gross proceeds, including $33.3 million
attributable to the sale of shares resulting from the exercise by the
underwriters of an over-allotment option, from the sale of 12.8 million shares
of common stock at an issue price of $20.00 per share. The Stock Offering
resulted in the Company's common stock being listed in the United States on the
National Association of Securities Dealers Automated Quotation Market and
internationally on the European Association of Securities Dealers Automated
Quotation Market. Also in February 1998, the Company completed the Notes
Offering and issued $105.0 million aggregate principal amount of senior notes,
due February 15, 2005. Interest at 9.875% on the Notes will be payable in cash
semiannually on February 15 and August 15 of each year, commencing August 15,
1998. Net proceeds from the Offerings were approximately $336.7 million.
Approximately $19.6 million of the net proceeds of the Notes Offering is being
held in escrow for the first four semiannual interest payments commencing in
1998.
 
                                       103
<PAGE>   105
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Approximately $85.2 million of the net proceeds of the Offerings has been used
to repay the related party Debt Obligations (see Note 5, "Debt Obligations") of
$70.0 million plus accrued interest that were due March 31, 2001. In addition,
approximately $13.2 million in unamortized discount and debt issuance costs on
the Debt Obligations was written off at the time of repayment. The remaining net
proceeds from the Offerings will primarily be used to provide working capital
for existing ventures, particularly in Russia and the CIS, to expand the
Company's operations and for general corporate purposes, including strategic
acquisitions.
 
     As a result of the completion of the Stock Offering, the interest rate for
the Bonds will remain at 8.75% until maturity (see Note 5, "Debt Obligations")
and the 6.25% additional interest that was previously accrued, $4.2 million, has
been reflected as an increase to additional paid-in capital. The Bonds are
convertible into approximately 7.2 million common shares at a conversion price
of $20.00 per share.
 
     The following unaudited pro forma condensed balance sheet and results of
operations of the Company give effect to the Offerings as though the
transactions had occurred on December 31, 1997. The pro forma shares and per
share data have been calculated assuming the Stock Offering occurred on January
1, 1997. The pro forma results are presented for informational purposes only and
do not purport to be indicative of the results of operations which actually
would have been obtained if the transactions had occurred in such periods, or
which may exist or be obtained in the future.
 
                                       104
<PAGE>   106
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                                                        AS ADJUSTED
                                                                                          FOR THE
            CONDENSED BALANCE SHEET (UNAUDITED)               REPORTED    ADJUSTMENTS    OFFERINGS
            -----------------------------------               ---------   -----------   -----------
                                                                         (IN THOUSANDS)
<S>                                                           <C>         <C>           <C>
Cash and cash equivalents...................................  $ 318,766    $ 232,875    $  551,641
Other assets................................................    461,695       23,064       484,759
                                                              ---------    ---------    ----------
        Total Assets........................................  $ 780,461    $ 255,939    $1,036,400
                                                              =========    =========    ==========
Long-term debt, less current portion........................  $ 408,330    $ 105,000    $  513,330
Related party debt..........................................     85,504      (72,140)       13,364
Other liabilities...........................................    228,405       (4,171)      224,234
                                                              ---------    ---------    ----------
        Total Liabilities...................................    722,239       28,689       750,928
Minority interest...........................................     18,766           --        18,766
Common stock subject to repurchase..........................     12,489      (12,489)           --
Common stock and additional paid-in capital.................    278,120      252,952       531,072
Cumulative translation adjustment...........................     (8,269)          --        (8,269)
Accumulated deficit.........................................   (242,884)     (13,213)     (256,097)
                                                              ---------    ---------    ----------
        Total Shareholders' Equity..........................     26,967      239,739       266,706
                                                              ---------    ---------    ----------
        Total Liabilities and Shareholders' Equity..........  $ 780,461    $ 255,939    $1,036,400
                                                              =========    =========    ==========
</TABLE>
 
<TABLE>
<CAPTION>
                                                                                        AS ADJUSTED
                                                                                          FOR THE       LOSS
       CONDENSED STATEMENT OF OPERATIONS (UNAUDITED)          REPORTED    ADJUSTMENTS    OFFERINGS    PER SHARE
       ---------------------------------------------          ---------   -----------   -----------   ---------
                                                                      (IN THOUSANDS, EXCEPT SHARE DATA)
<S>                                                           <C>         <C>           <C>           <C>
Loss before extraordinary item..............................  $(116,986)   $     --      $(116,986)    $(2.41)
Extraordinary item..........................................         --     (13,213)       (13,213)     (0.27)
                                                              ---------    --------      ---------     ------
        Net loss............................................  $(116,986)   $(13,213)     $(130,199)    $(2.68)
                                                              =========    ========      =========     ======
Weighted average common shares outstanding..................     35,833      12,765         48,598
</TABLE>
 
OTHER SUBSEQUENT EVENT TRANSACTIONS
 
     Pursuant to a purchase agreement that the Company has with a venture's
partner in the CIS region (see Note 3, "Investments in and Advances to
Ventures," Note 6, "Shareholders' Equity," and Note 12, "Related Party
Transactions") the Company is obligated to pay additional consideration, via
shares of common stock, based on the subsidiary's earnings performance. Based on
the 1997 results, the Company is obligated to issue 336,630 shares of common
stock during the first quarter of 1998.
 
     Subsequent to December 31, 1997, HER entered into contractual commitments
to lease fiber pairs, including facilities and maintenance and utilizing the
partial routes for laying fiber optic cable. Based on the contract provisions,
these commitments are currently estimated to aggregate approximately $12.9
million. The commitments have expected lease terms of ten to twenty-one years
with options for renewal rights of one and one-half to five additional years.
 
     The Company entered into a rights agreement (the "Rights Agreement") on
February 2, 1998, and accordingly, the Company authorized the distribution of
one right (a "Right") for each common share outstanding from February 2, 1998
through the distribution date (the "Distribution Date"). Each Right entitles the
registered holder, subject to the terms of the Rights Agreement, to purchase
from the Company one one-thousandth of a share (a "Unit") of Series A Preferred
Stock at an exercise price of $75 per Unit, subject to adjustment. The
Distribution Date, as defined in further detail within the Rights Agreement, is
triggered when a person acquires 15% of the outstanding common stock of the
Company, or a tender or exchange offer is commenced for 15% of such outstanding
stock, except in the case of two related party shareholders in which case the
acquisition threshold that applies is 20% of such outstanding stock. Under
certain circumstances thereafter, certain Rightholders may have the right to
purchase common stock of the Company, or of an Acquiring Person, as defined in
the Rights Agreement, having a value equal to two times
 
                                       105
<PAGE>   107
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
based on the subsidiary's earnings performance. Based on the 1997 results, the
Company is obligated to issue 336,630 shares of common stock during the first
quarter of 1998.
 
     Subsequent to December 31, 1997, HER entered into contractual commitments
to lease fiber pairs, including facilities and maintenance and utilizing the
partial routes for laying fiber optic cable. Based on the contract provisions,
these commitments are currently estimated to aggregate approximately $12.9
million. The commitments have expected lease terms of ten to twenty-one years
with options for renewal rights of one and one-half to five additional years.
 
     The Company entered into a rights agreement (the "Rights Agreement") on
February 2, 1998, and accordingly, the Company authorized the distribution of
one right (a "Right") for each common share outstanding from February 2, 1998
through the distribution date (the "Distribution Date"). Each Right entitles the
registered holder, subject to the terms of the Rights Agreement, to purchase
from the Company one one-thousandth of a share (a "Unit") of Series A Preferred
Stock at an exercise price of $75 per Unit, subject to adjustment. The
Distribution Date, as defined in further detail within the Rights Agreement, is
triggered when a person acquires 15% of the outstanding common stock of the
Company, or a tender or exchange offer is commenced for 15% of such outstanding
stock, except in the case of two related party shareholders in which case the
acquisition threshold that applies is 20% of such outstanding stock. Under
certain circumstances thereafter, certain Rightholders may have the right to
purchase common stock of the Company, or of an Acquiring Person, as defined in
the Rights Agreement, having a value equal to two times the exercise price of
the Rights. In addition, the Rights are redeemable or exchangeable under certain
circumstances.
 
NOTE 16: EVENTS OCCURRING SUBSEQUENT TO DATE OF AUDIT REPORT
 
     In March 1998, the Company purchased an additional 10% interest in HER from
an existing shareholder of HER for ECU 13.5 million (approximately $14.6
million). As a result of the purchase, the Company owns approximately 89% of
HER.
 
NOTE 17: RECENT DEVELOPMENTS
 
     On August 17, 1998 the exchange rate of the Russian ruble, relative to
other currencies, declined significantly. The following measures were
implemented by the Russian government: 1) The repayment of sovereign securities
were suspended; subsequently, secondary trading therein was halted. Since many
Russian banks had substantial investments in these securities, severe liquidity
problems resulted for the banks. 2) The value of the ruble was allowed to
fluctuate below the ruble/US dollar exchange rate corridor that the government
had previously committed to support; this represented an effective devaluation
of the ruble. 3) A 90-day moratorium on offshore credit repayments was issued.
The 90-day moratorium was not extended when it expired on November 16, 1998 and
it is anticipated that the ruble will continue to be devalued. Due to the
devaluation and the end of the 90-day moratorium, there is an ongoing risk that
many Russian banks may be declared bankrupt. Deposits held at Russian banks,
other than Sberbank, are not insured. The official exchange rate as of September
30, 1998 was 16.0645 per US dollar. The last official exchange rate prior to the
suspension of trading on August 17, 1998 was 6.2725 rubles per US dollar.
 
     As a result of the devaluation of the ruble and the consequences of the
banking and economic crisis within Russia, the Company recorded a $13.1 million
pre-tax charge within its financial statements for the third quarter 1998, that
is mainly comprised of foreign currency exchange losses for ruble-denominated
net monetary assets with the remainder associated with estimates for
uncollectible accounts receivable and unrecoverable cash deposits in Russian
banks.
 
                                       106
<PAGE>   108
 
                          AUDITED FINANCIAL STATEMENTS
 
                                  EDN SOVINTEL
 
                  YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                      WITH REPORT OF INDEPENDENT AUDITORS
 
                                       107
<PAGE>   109
 
                         REPORT OF INDEPENDENT AUDITORS
 
The Board of Directors and Shareholders
EDN Sovintel
 
     We have audited the accompanying balance sheets of EDN Sovintel as of
December 31, 1997 and 1996, and the related statements of income and retained
earnings, and cash flows for each of the three years in the period ended
December 31, 1997. 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 EDN Sovintel at December 31,
1997 and 1996, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1997, in conformity with
accounting principles generally accepted in the United States of America.
 
     We have also audited the financial statements of the Company at December
31, 1997 and 1996 and for each of the three years ended December 31, 1997, not
presented herewith, prepared in compliance with the regulations for bookkeeping
and accounting for income tax and statutory reporting purposes in the Russian
Federation on which we expect to report separately for the 1997 audited
financial statements and have reported separately for the 1996 and 1995
financial statements. The significant differences between the accounting
principles applied in preparing the statutory financial statements and
accounting principles generally accepted in the United States of America are
summarized in Note 2.
 
                                            Ernst & Young (CIS) Ltd.
 
Moscow, Russia
February 16, 1998
except for Note 12,
as to which the date is
November 12, 1998
 
                                       108
<PAGE>   110
 
                                  EDN SOVINTEL
 
                                 BALANCE SHEETS
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              ------------------
                                                               1997       1996
                                                              -------    -------
                                                               (IN THOUSANDS OF
                                                                 US DOLLARS)
<S>                                                           <C>        <C>
Current assets:
  Cash and cash equivalents.................................  $ 5,620    $ 3,606
  Cash deposit with related party...........................      485        476
  Accounts receivable, net of allowances....................   16,223     15,329
  Due from affiliates.......................................    1,586      1,879
  Inventories...............................................    1,697      1,749
  Prepaid expenses and other assets.........................    1,630      1,171
  VAT receivable, net.......................................    3,688      1,157
  Deferred income taxes.....................................      186
                                                              -------    -------
          Total current assets..............................   31,115     25,367
Property and equipment, net.................................   38,709     27,709
Deferred expenses...........................................      945      1,080
                                                              -------    -------
          Total assets......................................  $70,769    $54,156
                                                              =======    =======
 
                      LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Note due shareholder......................................  $    39    $ 5,700
  Trade payables............................................    5,725      8,382
  Accrued liabilities and other payables....................    3,194      1,661
  Taxes accrued or payable..................................    1,088        555
  Amounts due to shareholder and affiliates.................   10,104      5,703
  Amount due to partner in commercial venture...............    1,350      1,350
                                                              -------    -------
          Total current liabilities.........................   21,500     23,351
Commitments and contingencies
Shareholders' equity:
  Capital contributions.....................................    2,000      2,000
  Retained earnings.........................................   47,269     28,805
                                                              -------    -------
          Total shareholders' equity........................   49,269     30,805
                                                              -------    -------
          Total liabilities and shareholders' equity........  $70,769    $54,156
                                                              =======    =======
</TABLE>
 
                            See accompanying notes.
 
                                       109
<PAGE>   111
 
                                  EDN SOVINTEL
 
                   STATEMENTS OF INCOME AND RETAINED EARNINGS
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31
                                                              ------------------------------
                                                                1997       1996       1995
                                                              --------    -------    -------
                                                               (IN THOUSANDS OF US DOLLARS)
<S>                                                           <C>         <C>        <C>
Revenues, net:
  Service revenues..........................................  $105,288    $63,488    $29,920
  Installation revenues.....................................     5,241      9,312     12,981
  Product sales.............................................     3,433      2,240      1,391
                                                              --------    -------    -------
                                                               113,962     75,040     44,292
Cost of revenues:
  Service costs.............................................    67,174     37,884     18,545
  Cost of installation......................................     2,621      4,656      6,491
  Cost of products..........................................     2,834      1,370      1,211
                                                              --------    -------    -------
                                                                72,629     43,910     26,247
                                                              --------    -------    -------
Gross profit................................................    41,333     31,130     18,045
Selling, general and administrative expenses................    17,020     10,291      7,145
Interest expense............................................       503        638        703
Interest income.............................................      (392)       (87)       (59)
Other (income) loss.........................................       (57)       120        (98)
Foreign exchange loss on net monetary items.................       131        252        112
                                                              --------    -------    -------
Income before taxes.........................................    24,128     19,916     10,242
Income taxes................................................     5,664      5,154      2,594
                                                              --------    -------    -------
Net income..................................................    18,464     14,762      7,648
Retained earnings, beginning of year........................    28,805     14,043      6,395
                                                              --------    -------    -------
Retained earnings, end of year..............................  $ 47,269    $28,805    $14,043
                                                              ========    =======    =======
</TABLE>
 
                            See accompanying notes.
 
                                       110
<PAGE>   112
 
                                  EDN SOVINTEL
 
                            STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                  YEARS ENDED DECEMBER 31
                                                              -------------------------------
                                                                1997        1996       1995
                                                              --------    --------    -------
                                                               (IN THOUSANDS OF US DOLLARS)
<S>                                                           <C>         <C>         <C>
OPERATING ACTIVITIES
  Net income................................................  $ 18,464    $ 14,762    $ 7,648
  Adjustments to reconcile net income to net cash provided
     by operating activities:
     Depreciation...........................................     5,312       3,638      2,448
     Provision for deferred income taxes....................      (186)
     Provision for doubtful accounts........................       345         678        132
     Write-off of accounts receivable.......................      (602)       (147)      (492)
     Write-down of network equipment and inventories........                   100        196
     Foreign exchange loss..................................       131         252        112
  Changes in operating assets and liabilities:
     Accounts receivable....................................      (637)     (8,460)    (2,759)
     Due from affiliates....................................       293        (683)    (1,011)
     Inventories............................................        52        (911)      (309)
     Prepaid expenses and other assets......................      (538)     (1,108)       599
     VAT receivable, net....................................    (2,609)         54       (906)
     Trade payables.........................................    (2,491)       (193)     2,983
     Accrued liabilities and other payables.................     1,533         310      1,233
     Taxes accrued or payable...............................       570         326        229
     Amounts due to shareholder and affiliates..............     4,401       3,039      2,165
                                                              --------    --------    -------
          Net cash provided by operating activities.........    24,038      11,657     12,268
INVESTING ACTIVITIES -- purchases of and advances for
  property and equipment....................................   (16,177)     (9,863)    (9,259)
FINANCING ACTIVITIES
  Borrowings from shareholder...............................    10,760      11,300     11,888
  Repayments to shareholder.................................   (16,421)    (11,100)    (9,271)
  Repayments of long-term debt..............................                  (694)    (3,979)
  Cash deposited with related party.........................       (41)       (476)
                                                              --------    --------    -------
Net cash used in financing activities.......................    (5,702)       (970)    (1,362)
Effect of exchange rate changes on cash and cash
  equivalents...............................................      (145)       (312)
                                                              --------    --------    -------
Net increase in cash and cash equivalents...................     2,014         512      1,647
Cash and cash equivalents at beginning of year..............     3,606       3,094      1,447
                                                              --------    --------    -------
Cash and cash equivalents at end of year....................  $  5,620    $  3,606    $ 3,094
                                                              ========    ========    =======
</TABLE>
 
                            See accompanying notes.
 
                                       111
<PAGE>   113
 
                                  EDN SOVINTEL
 
                         NOTES TO FINANCIAL STATEMENTS
              (US DOLLAR AMOUNTS IN TABLES EXPRESSED IN THOUSANDS)
 
1. DESCRIPTION OF BUSINESS
 
     EDN Sovintel (the "Company") was created in August 1990 to design,
construct, and operate a telecommunications network in Moscow. This network
provides worldwide communications services, principally to major hotels,
business offices and mobile communication companies. Telecommunications services
are subject to local licensing. The Company's license for international,
intercity and local calls was most recently renewed on November 4, 1996 and is
valid until May 1, 2000. The Company received a license for leased lines on
September 20, 1996 valid for 5 years. The Company began operating in December
1991, providing services under long-term contracts payable in US dollars.
 
     The Company initially registered as a Soviet-American joint venture. The
venture re-registered as a Russian limited liability partnership in November
1992. The Company is 50% owned by Open Joint Stock Company "Rostelecom", an
intercity and long-distance carrier which is 38% owned by Svyazinvest, and 50%
owned by Sovinet, a US general partnership, owned by two wholly-owned Global
TeleSystems Group, Inc. ("GTS") subsidiaries.
 
2. BASIS OF PRESENTATION
 
     The Company maintains its records and prepares its financial statements in
Russian roubles in accordance with the requirements of Russian accounting and
tax legislation. The accompanying financial statements differ from the financial
statements used for statutory purposes in Russia in that they reflect certain
adjustments, not recorded on the Company's books, which are appropriate to
present the financial position, results of operations and cash flows in
accordance with generally accepted accounting principles in the United States of
America ("US GAAP"). The principal adjustments are related to certain accrued
revenue and expenses, foreign currency translation, deferred taxation, and
depreciation and valuation of property and equipment.
 
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
USE OF ESTIMATES
 
     The preparation of financial statements, in conformity with US GAAP,
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.
 
FOREIGN CURRENCY TRANSLATION
 
     The Company's functional currency is the US dollar because the majority of
its revenues, costs, property and equipment purchased, and debt and trade
liabilities are either priced, incurred, payable or otherwise measured in US
dollars. Accordingly, transactions and balances not already measured in US
dollars (primarily Russian roubles) have been remeasured into US dollars in
accordance with the relevant provisions of US Financial Accounting Standard
("FAS") No. 52, "Foreign Currency Translation".
 
     Under FAS No. 52, revenues, costs, capital and non-monetary assets and
liabilities are translated at historical exchange rates prevailing on the
transaction dates. Monetary assets and liabilities are translated at exchange
rates prevailing on the balance sheet date. Exchange gains and losses arising
from remeasurement of monetary assets and liabilities that are not denominated
in US dollars are credited or charged to operations.
 
     The rouble is not a convertible currency outside the territory of Russia.
Official exchange rates are determined daily by the Central Bank of Russia
("CBR") and are generally considered to be a reasonable approximation of market
rates. The translation of rouble denominated assets and liabilities into US
dollars for the purpose of these financial statements does not indicate that the
Company could realize or settle in
 
                                       112
<PAGE>   114
                                  EDN SOVINTEL
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
US dollars the reported values of the assets and liabilities. Likewise, it does
not indicate that the Company could return or distribute the reported US dollar
values of capital and retained earnings to its shareholders.
 
     The exchange rates at December 31, 1997, 1996 and 1995 for one US dollar
were RUR 5,960, RUR 5,560 and RUR 4,640 respectively. At February 16, 1998, the
CBR rate had changed to RUR 6,050. The effect of this devaluation of the rouble
on monetary assets and liabilities has not been determined.
 
     On January 1, 1998, the CBR introduced a new rouble to replace existing
roubles. The new rouble has been redenominated so that one new rouble is
equivalent to one thousand old roubles. The old rouble will continue in
circulation until December 31, 1998 and will be accepted as legal tender until
December 31, 2002.
 
     All rouble amounts reflected in these financial statements are stated in
old roubles.
 
CASH AND CASH EQUIVALENTS
 
     Cash and cash equivalents consist of cash on hand and in the bank.
 
ACCOUNTS RECEIVABLE
 
     Accounts receivable are shown at their net realizable value which
approximates fair value. Accounts receivable are shown in the balance sheet net
of an allowance for uncollectible accounts of $643,000 and $900,000 at December
31, 1997 and 1996, respectively.
 
INVENTORIES
 
     Inventories consist of telecommunications equipment held for resale and are
stated at the lower of cost or market. Cost is computed on a weighted average
basis.
 
PROPERTY AND EQUIPMENT
 
     Property and equipment are recorded at their historical cost. Depreciation
is provided on the straight-line method over the following estimated useful
lives:
 
<TABLE>
<S>                                                           <C>
Network equipment...........................................   10 years
Other property and equipment................................  3-5 years
</TABLE>
 
     There is no depreciation charge for construction-in-progress. Depreciation
commences upon completion of the related project.
 
DEFERRED EXPENSES
 
     Deferred expenses represent the Company's interest in the historical cost
of network equipment owned by MTU Inform, a partner in a commercial venture
(Note 8). These expenses are amortized over the equipment's useful life of 10
years.
 
REVENUE RECOGNITION AND TAXES ON REVENUE
 
     Revenues from telecommunication traffic are recognized in the period in
which the traffic occurs. Revenues from product sales, connection fees, and
other services are recognized in the period in which the products are shipped,
connections made, and services rendered. Taxes on certain revenues were charged
at rates ranging from 1.5% to 4.0% over the three years ended December 31, 1997,
1996 and 1995 and amounted to $4,458,000, $2,792,000 and $1,166,000,
respectively, and are charged to selling general and administrative expenses.
 
                                       113
<PAGE>   115
                                  EDN SOVINTEL
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
ADVERTISING
 
     The Company expenses the cost of advertising as incurred. Advertising
expenses for the years ended December 31, 1997, 1996 and 1995 were $671,000,
$512,000 and $395,000, respectively, and are included in selling, general and
administrative expenses.
 
INVESTMENT INCENTIVE DEDUCTIONS
 
     Russian legislation allows for certain additional tax deductions related to
new asset investments. These deductions are accounted for as a reduction to
current income taxes in the year in which they arise.
 
INCOME TAXES
 
     The Company computes and records income taxes in accordance with FAS No.
109, "Accounting for Income Taxes".
 
GOVERNMENT PENSION FUNDS
 
     The Company contributes to the Russian Federation state pension fund,
social fund, medical insurance fund, unemployment fund and transport fund on
behalf of all its Russian employees. Contributions were 40.5%, 40.5% and 41.0%
from base payroll for 1997, 1996 and 1995, respectively.
 
FAIR VALUE OF FINANCIAL INSTRUMENTS
 
     The fair value of financial instruments included in current assets and
liabilities is considered to be the carrying value.
 
NEW ACCOUNTING PRONOUNCEMENTS
 
     In 1997, the Company adopted 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." SFAS 121 requires recognition of
impairment of long-lived assets in the event the net book value of such assets
exceeds the future undiscounted cash flows attributable to such assets. The
adoption of SFAS No. 121 had no impact on the Company's financial position or
results of operations.
 
     In June 1997, SFAS No. 130, "Reporting Comprehensive Income", was issued.
SFAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements and is effective for fiscal years beginning after December
15, 1997. The Company will adopt SFAS No. 130 in fiscal 1998. SFAS No. 130
expands or modifies disclosures and, accordingly, will have no impact on the
Company's reported financial position, results of operations or cash flows.
 
RECLASSIFICATIONS
 
     Certain 1996 and 1995 comparative figures have been reclassified to conform
to the presentation adopted in the current year.
 
                                       114
<PAGE>   116
                                  EDN SOVINTEL
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
4. PROPERTY AND EQUIPMENT
 
     Property and equipment consists of the following at December 31:
 
<TABLE>
<CAPTION>
                                                                1997       1996
                                                              --------    -------
<S>                                                           <C>         <C>
Network equipment...........................................  $ 43,876    $31,251
Other property and equipment................................     4,527      3,108
                                                              --------    -------
                                                                48,403     34,359
Accumulated depreciation....................................   (14,557)    (9,380)
Construction-in-progress....................................     4,409      1,796
Network equipment and advances for network equipment not yet
  in service................................................       454        934
                                                              --------    -------
Net book value..............................................  $ 38,709    $27,709
                                                              ========    =======
</TABLE>
 
     Total depreciation expense on property and equipment for 1997, 1996 and
1995 was $5,177,000, $3,503,000 and $2,253,000, respectively.
 
5. INCOME TAXES
 
     The Russian Federation was the only tax jurisdiction in which the Company's
income was taxed. The income tax expense reported in the accompanying statements
of income and retained earnings for the years ended December 31, 1997, 1996 and
1995 represents the provision for current and deferred taxes.
 
     Significant components of the provision for income taxes for the years
ended December 31 are as follows:
 
<TABLE>
<CAPTION>
                                                            1997      1996      1995
                                                           ------    ------    ------
<S>                                                        <C>       <C>       <C>
Current tax expense......................................  $5,850    $5,154    $2,594
Deferred tax benefit.....................................    (186)
                                                           ------    ------    ------
Provision for income taxes...............................  $5,664    $5,154    $2,594
                                                           ======    ======    ======
</TABLE>
 
                                       115
<PAGE>   117
                                  EDN SOVINTEL
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     The following is a reconciliation of the tax basis and book basis of the
taxable income reported in the Russian statutory financial statements to the
income before taxes reported in the accompanying financial statements presented
in accordance with US GAAP for the years ended December 31:
 
<TABLE>
<CAPTION>
                                                         1997       1996       1995
                                                        -------    -------    -------
<S>                                                     <C>        <C>        <C>
Taxable income reported for Russian tax purposes......  $16,184    $14,726    $ 7,411
  Investment incentive deductions.....................   12,337      9,030      7,220
  Tax loss carry-forwards utilized....................       97        113
  Net permanent difference related to revenues and       (2,455)
     expenses incurred in the ordinary course of
     business which are not assessable or deductible
     for Russian tax purposes.........................              (1,174)    (2,595)
                                                        -------    -------    -------
Russian income before taxes...........................   26,163     22,695     12,036
Adjustments to present financial statements in
  accordance with US GAAP:
  Reversal of excess depreciation due to statutory       (2,101)
     revaluations.....................................              (1,497)      (293)
  Depreciation rate differences.......................     (279)      (424)      (236)
  Allowances for uncollectible accounts...............       35        369       (132)
  Inventory write-downs...............................                (100)      (249)
  Accrual of deductible expenses......................   (3,234)    (2,437)    (1,339)
  Accrual of revenue..................................    2,704      1,093         19
  Foreign exchange differences........................      236        280      1,425
  Other...............................................      604        (63)      (989)
                                                        -------    -------    -------
Income before taxes under US GAAP.....................  $24,128    $19,916    $10,242
                                                        =======    =======    =======
</TABLE>
 
     A reconciliation between the statutory rate and the effective income tax
rate is as follows for the years ended December 31:
 
<TABLE>
<CAPTION>
                                                         1997       1996       1995
                                                        -------    -------    -------
<S>                                                     <C>        <C>        <C>
Income tax expense computed on financial income before
  taxes at statutory tax rate of 35%..................  $ 8,445    $ 6,970    $ 3,585
Tax effect of permanent differences:
  Investment incentive deductions.....................   (4,318)    (3,161)    (2,594)
  Tax loss carryforwards utilized.....................      (34)       (40)
  Other permanent differences.........................      859        411        805
  Adjustments made to compute income before taxes for
     US GAAP financial reporting......................    1,142        813        555
Increase (decrease) in the valuation allowance for
  deferred tax assets.................................     (430)       161        243
                                                        -------    -------    -------
Income tax expense reported in the financial
  statements..........................................  $ 5,664    $ 5,154    $ 2,594
                                                        =======    =======    =======
</TABLE>
 
                                       116
<PAGE>   118
                                  EDN SOVINTEL
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     The deferred tax balances are calculated by applying the statutory tax
rates in effect at the respective balance sheet dates to the temporary
differences between the tax basis of assets and liabilities and the amount
reported in the accompanying financial statements, and consist of the following
at December 31:
 
<TABLE>
<CAPTION>
                                                            1997      1996      1995
                                                           ------    -------    -----
<S>                                                        <C>       <C>        <C>
Deferred tax assets (liabilities):
  Depreciation...........................................  $  398    $   300    $ 151
  Inventory write-downs and allowances...................     235        235      147
  Accrual of expenses....................................   1,132        898      469
  Accrual of revenue.....................................    (946)      (383)      (7)
  Allowance for uncollectible accounts...................     (13)                129
                                                           ------    -------    -----
Deferred tax assets......................................     806      1,050      889
Valuation allowance for deferred tax assets..............    (620)    (1,050)    (889)
                                                           ------    -------    -----
          Net deferred tax assets........................  $  186    $    --    $  --
                                                           ======    =======    =====
</TABLE>
 
     For financial reporting purposes, a valuation allowance has been recognised
to reflect management's estimate of the deferred tax assets that are less likely
than not to be realized.
 
     The Company paid Russian profits tax of $4,302,000, $5,849,000 and
$2,660,000 in 1997, 1996 and 1995, respectively.
 
6. NOTE DUE TO SHAREHOLDER AND LONG-TERM DEBT
 
     In October 1995, the Company entered into a $5,000,000 credit facility with
Sovinet, one of the Company's shareholders. It was subsequently increased to
$7,000,000. In January 1997, this facility was repaid and on January 16, 1997, a
new six-month facility was established with GTS Finance, Inc. for $7,000,000
which was then extended to December 19, 1997. The loan was repaid prior to
December 31, 1997 except for withholding taxes on interest. The loan carried
interest at a rate equal to the then current six month LIBOR rate (5.6%) plus
5.0 percent per annum. As of December 31, 1997, 1996 and 1995, the outstanding
borrowings under this agreement were $39,000, $5,700,000 and $5,500,000,
respectively.
 
     The Company believes that the carrying value of the above loans
approximates fair values.
 
     The Company paid interest of $697,000, $542,000 and $576,000 in 1997, 1996
and 1995, respectively.
 
7. SHAREHOLDERS' EQUITY
 
     The Company's capital structure as specified in the charter capital
document is as follows as of December 31:
 
<TABLE>
<CAPTION>
                                                                 1997          1996
                                                              ----------    ----------
<S>                                                           <C>           <C>
Registered capital in Russian roubles:
  Rostelecom................................................     600,000       600,000
  Sovinet...................................................     600,000       600,000
                                                              ----------    ----------
                                                               1,200,000     1,200,000
                                                              ==========    ==========
Historical value of the Company's capital in US dollars.....  $    2,000    $    2,000
                                                              ==========    ==========
</TABLE>
 
     As a Russian limited liability company, the Company has no capital stock;
rather, it has only contributed and locally registered capital in accordance
with its charter. As such, no earnings per share data are presented in these
financial statements.
 
                                       117
<PAGE>   119
                                  EDN SOVINTEL
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     Retained earnings available for distribution at December 31, 1997 amounted
to 256 billion roubles or approximately $42,953,000 at applicable year-end
exchange rates.
 
8. RELATED PARTY TRANSACTIONS
 
     Transactions and balances with Rostelecom (one of the Company's
shareholders) and its affiliates were as follows, as of and for the years ended
December 31:
 
<TABLE>
<CAPTION>
                                                           1997       1996      1995
                                                          -------    ------    ------
<S>                                                       <C>        <C>       <C>
Sales...................................................  $ 2,310    $1,525    $   62
Telecommunication lease and traffic costs...............   11,183     4,586     1,506
Amounts due to shareholder and affiliates...............    4,184       656       460
Cash deposit with related party.........................      485       476
</TABLE>
 
     At the request of Rostelecom, a shareholder, the Company placed a deposit
of 2.65 billion roubles in August 1996 with a Russian bank related to this
shareholder. The bank deposit agreement states a deposit term of one year, which
was rolled over for an additional year during 1997. The deposit earns interest
quarterly at a rate of 15% per annum plus any devaluation losses against the US
dollar up to a maximum of 4.8% per quarter. Management is aware that the
deposited amount collateralizes certain obligations of the shareholder.
 
     Transactions and balances with Sovinet (one of the Company's shareholders),
GTS and affiliates were as follows, as of and for the years ended December 31:
 
<TABLE>
<CAPTION>
                                                            1997      1996      1995
                                                           ------    ------    ------
<S>                                                        <C>       <C>       <C>
Sales....................................................  $4,974    $3,115    $1,041
Management service fees and reimbursements of expenses of
  expatriate staff.......................................   1,318       927     2,062
Balances due under credit facility.......................      39     5,700     5,500
Interest expense.........................................     503       626       461
Amounts due from affiliates..............................   1,586     1,879     1,196
Amounts due to shareholder and affiliates................   5,919     5,047     2,204
</TABLE>
 
     Transactions and balances with MTU Inform, an entity with which the Company
entered into a commercial agreement to co-develop and operate a "258" phone
exchange were as follows, as of and for the years ended December 31:
 
<TABLE>
<CAPTION>
                                                         1997       1996       1995
                                                        -------    -------    -------
<S>                                                     <C>        <C>        <C>
Telecommunication settlement and rent expense.......    $19,003    $15,889    $10,491
Balances in trade payables..........................                 1,237      2,184
Balances in accounts receivable.....................        487
Amount due to partner in commercial venture.........      1,350      1,350      1,350
Balances in prepaid expenses and other assets.......        800
</TABLE>
 
     The Company also has an interest in the cost of the related network
equipment owned by MTU Inform, which is reflected in the balance sheet, net of
related amortization, as deferred expenses. In 1997 the Company prepaid $800 of
1998 rent to MTU-Inform for additional office space to be occupied during 1998.
 
9. CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS
 
     Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of temporary cash deposits and trade accounts
receivables. The Company deposits its available cash with several Russian
financial institutions. The Company's sales and accounts receivable are made to
and due
 
                                       118
<PAGE>   120
                                  EDN SOVINTEL
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
from a variety of international and Russian business customers. As of December
31, 1997, two customers accounted for 16% and 11% of revenues and 11% and 7% of
accounts receivable, respectively. As of December 31, 1996, these same two
customers accounted for 17% and 16% of revenues and 25% and 10% of accounts
receivable, respectively. As of December 31, 1995, these two customers accounted
for 1% and 14% of revenues and 10% and 11% of accounts receivable, respectively.
The Company has no other significant concentrations of credit risk.
 
10. COMMITMENTS
 
     The Company has several cancelable operating leases for office and
warehouse space and telecommunications lines with terms ranging from one to five
years.
 
     Total rent expense for 1997, 1996 and 1995 was $2,794,000, $2,137,000 and
$1,234,000, respectively.
 
11. CONTINGENCIES
 
     Legislation and regulations regarding taxation, foreign currency
transactions and licensing of foreign currency loans in the Russian Federation
continues to evolve as the central government manages the transformation from a
command to a market-oriented economy. The various legislation and regulations
are not always clearly written and their interpretation is subject to the
opinions of the tax inspectors, Central Bank officials and the Ministry of
Finance. Instances of inconsistent opinions between local, regional and national
tax authorities and between the Central Bank and Ministry of Finance are not
unusual.
 
     The Company believes that it has paid or accrued all taxes that are
applicable. Where practice concerning the provision of taxes is unclear, the
Company has accrued tax liabilities based on management's best estimate. The
Company's policy is to accrue contingencies in the accounting period in which a
loss is deemed probable and the amount is reasonably determinable.
 
     Because of the uncertainties associated with the Russian tax and legal
systems, the ultimate amount of taxes, penalties and interest, if any, assessed
may be in excess of the amount expensed to date and accrued at December 31,
1997. It is the opinion of the Company's management that any material amounts
are either not probable, not reasonably determinable, or both.
 
     The Company's operations and financial position will continue to be
affected by Russian political developments, including the application of
existing and future legislation and tax regulations. The Company does not
believe that these contingencies, as related to its operations, are any more
significant than those of similar enterprises in Russia.
 
12. SUBSEQUENT EVENTS
 
     On August 17, 1998 the exchange rate of the Russian ruble, relative to
other currencies, declined significantly. The following measures were
implemented by the Russian government: 1) The repayment of sovereign securities
were suspended; subsequently, secondary trading therein was halted. Since many
Russian banks had substantial investments in these securities, severe liquidity
problems resulted for the banks. 2) The value of the ruble was allowed to
fluctuate below the ruble/US dollar exchange rate corridor that the government
had previously committed to support; this represented an effective devaluation
of the ruble. 3) A 90-day moratorium on offshore credit repayments was issued.
The 90-day moratorium was not extended when it expired on November 16, 1998 and
it is anticipated that the ruble will continue to be devalued. Due to the
devaluation and the end of the 90-day moratorium, there is an ongoing risk that
many Russian banks may be declared bankrupt. Deposits held at Russian banks,
other than Sberbank, are not insured. The official exchange rate as of September
30, 1998 was 16.0645 per US dollar. The last official exchange rate prior to the
suspension of trading on August 17, 1998 was 6.2725 rubles per US dollar.
 
                                       119
<PAGE>   121
                                  EDN SOVINTEL
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     As a result of the devaluation of the ruble and the consequences of the
banking and economic crisis within Russia, the Company recorded a $7.4 million
pre-tax charge within its financial statements for the third quarter 1998, that
is mainly comprised of foreign currency exchange losses for ruble-denominated
net monetary assets with the remainder associated with estimates for
uncollectible accounts receivable and unrecoverable cash deposits in Russian
banks.
 
                                       120
<PAGE>   122
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE
 
     None.
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
 
     Information regarding Directors appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
 
     The executive officers of the Company and their ages and business
experience since at least January 1, 1993 are as follows.
 
     Gerald W. Thames, 51, President and Chief Executive Officers. Mr. Thames
joined GTS as Chief Executive Officer in February 1994, and has served as a
director of GTS since February 1994. From 1990 to 1994, Mr. Thames was President
and Chief Executive Officer for British Telecom North America and Syncordia, a
joint venture company focused on the international outsourcing market. Mr.
Thames has spent over 18 years in senior positions with telecommunications
companies, where he was responsible for developing start-up telecommunications
companies, including 15 years with AT&T, where he rose to the position of
General Manager of Network Services for the Northeast Region of AT&T
Communications.
 
     Bruno d'Avanzo, 56, Executive Vice President and Chief Operating Officer.
Mr. d'Avanzo joined GTS as Executive Vice President and Chief Operating Officer
in August 1996. From 1994 to 1996, Mr. d'Avanzo was Executive Vice President and
Chief Operating Officer of Intelsat, the largest telecommunications satellite
operator in the world. From 1992 to 1994, Mr. d'Avanzo was a senior executive
with Olivetti Corporation, serving as Vice President and General
Manager -- Europe and as Vice President -- U.S., Canada and South America. Mr.
d'Avanzo also spent 15 years with Digital Equipment Corporation, a diversified
computer manufacturer where his last position was Vice President -- European
Sales and Marketing.
 
     William H. Seippel, 41, Executive Vice President of Finance and Chief
Financial Officer. Mr. Seippel joined GTS as Executive Vice President of Finance
and Chief Financial Officer in October 1996. From July 1992 to October 1996, Mr.
Seippel was Vice President -- Finance and Chief Financial Officer of Landmark
Graphics Corporation. From August 1990 to July 1992, Mr. Seippel was Director of
Finance for Covia, Inc., an affiliate of United Airlines. From April 1984 to
August 1990, Mr. Seippel held the positions of Group Business Controller (1989
to 1990), Group Controller Sales/Marketing (1986 to 1989), and Product Line
Controller (1984 to 1986) with Digital Equipment Corporation, a diversified
computer manufacturer.
 
     Jan Loeber, 54, Senior Vice President -- HER. Mr. Loeber joined GTS in
January 1995. From October 1992 to December 1994, Mr. Loeber was a Managing
Director of BT Securities Corporation. From April 1990 to September 1992, Mr.
Loeber held positions as Managing Director of Unitel Ltd. (now One 2 One) in the
United Kingdom, Group President of Nokia North America Inc., Vice President of
ITT Corporation, and Marketing and Product Management Director of ITT Europe.
Mr. Loeber also spent almost 10 years with AT&T, where his last position was
Executive Director, Bell Laboratories. Mr. Loeber has over 22 years of
experience in the telecommunications industry and an additional 9 years of
experience in information technology with the Pentagon, IBM and Chemical Bank of
New York.
 
     Raymond I. Marks, 51, Senior Vice President -- Asia. Mr. Marks joined GTS
as Senior Vice President -- Asia in July 1994. From October 1986 to June 1994,
Mr. Marks served as Vice President and General Manager of GTE Spacenet
Corporation, where he had overall responsibility for strategic planning,
domestic and international business development, creation of joint ventures and
international alliances, as well as the worldwide management of the marketing,
sales and technical support organizations. Mr. Marks has also served as Vice
President for the Digital Information Group for MCI Communications Corporation.
Mr. Marks has 28 years of experience in the telecommunications and computer
industries.
 
                                       121
<PAGE>   123
 
     Kevin Power, 44, Managing Director -- GTS Monaco Access. Prior to joining
GTS Monaco Access in October 1995, Mr. Power was Vice President, Carrier
Relations for the Company beginning in November 1994, where he was responsible
for assisting and coordinating the carrier activities of the GTS group of
companies. In 1988, Mr. Power was one of a group of five people who started the
commercial operations of Orion Network Systems and he stayed with the company
until the launch of its first satellite in 1994. His last position there was
Vice President of Carrier Services. Prior to that, he held positions with
INTELSAT, National Economic Research Associates (NERA) and the U.S. Department
of Commerce.
 
     Grier C. Raclin, 45, Senior Vice President and General Counsel. Mr. Raclin
joined GTS as its Senior Vice President and General Counsel in September, 1997,
and was elected Secretary of the Company in December 1997. Prior to joining GTS,
Mr. Raclin served as Vice-Chairman and a Managing Partner of the Washington,
D.C. office of Gardner, Carton & Douglas, a 250-attorney, corporate law firm
based in Chicago, Illinois, where his practice was concentrated in the area of
international telecommunications. Mr. Raclin received his undergraduate and law
degrees from Northwestern University and attended the University of Chicago
School of Business Executive Program.
 
     Stewart P. Reich, 53, Senior Vice President -- Russia. Mr. Reich joined GTS
as President -- GTS Russia in September 1997. From September 1992 to August
1997, Mr. Reich was President of UTEL, a joint venture of AT&T, Deutsche
Telekom, PTT Telecom (Netherlands), and Ukrtelecom (a Ukrainian
telecommunications company) which provides international and interregional
telecommunications services in Ukraine. From 1982 to 1992, Mr. Reich held
various positions at AT&T where his last position was Financial Manager, AT&T
International Communications Switched Services. Mr. Reich was also employed for
20 years with Western Electric Company from 1961 to 1981.
 
     Eileen K. Sweeney, 46, Senior Vice President -- Human Resources. Ms.
Sweeney joined GTS as Senior Vice President -- Human Resources in November,
1997. Prior to joining GTS, Ms. Sweeney was President of Global Resource
Associates, a consulting company specializing in international human resource
issues. Prior to that time, Ms. Sweeney spent 10 years with ITT Corporation in a
variety of human resource management positions, including eight years based in
Europe and in the Middle East. Ms. Sweeney holds a Master's Degree in Business
Administration from Simmons Graduate School of Management in Boston.
 
     Louis T. Toth, 55, Senior Vice President -- Central Europe. Mr. Toth joined
GTS as Senior Vice President -- Central Europe in July 1993. From February 1987
to July 1991, Mr. Toth served as President of Dynaforce Inc. and as Partner and
General Manager for the pan-European expansion of Andlinger & Company. Mr. Toth,
who is currently based in London, has 23 years of telecommunications experience
with ITT Corporation in Europe, Latin America and Asia.
 
     There are no family relationships among any of the officers listed above.
Officers are elected annually to serve for the following year or until the
election and qualification of their successors.
 
ITEM 11. EXECUTIVE COMPENSATION
 
     Information regarding this item appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     Information regarding this item appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
 
ITEM. 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     Information regarding this item appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
 
                                       122
<PAGE>   124
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
     a) The following documents are filed as part of this report:
 
1  Financial Statements
 
     The following consolidated financial statements of the Company are included
in Part II, Item 8 of this report:
 
     - Independent Auditors' Report
 
     - Consolidated Statements of Operations for each of the Three Years Ended
       December 31, 1995, 1996 and 1997
 
     - Consolidated Balance Sheets as of December 31, 1996 and 1997
 
     - Consolidated Statements of Cash Flows for each of the Three Years Ended
       December 31, 1995, 1996 and 1997
 
     - Consolidated Statements of Changes in Stockholders' Equity for each of
       the Three Years Ended December 31, 1995, 1996 and 1997
 
     - Notes to Consolidated Financial Statements
 
     The following financial statements of EDN Sovintel are included in Part II,
Item 8 of this report:
 
     - Independent Auditors' Report
 
     - Statements of Income and Retained Earnings for each of the Three Years
       Ended December 31, 1997, 1996 and 1995
 
     - Balance Sheets as of December 31, 1997 and 1996
 
     - Statements of Cash Flows for each of the Three Years Ended December 31,
       1997, 1996 and 1995
 
     - Notes to Financial Statements
 
2  Consolidated Financial Statement Schedules
 
     The Company has furnished Schedule II -- Valuation and Qualifying Accounts
on Page
 
     All other schedules are omitted because they are not applicable or not
required, or because the required information is either incorporated herein by
reference or included in the financial statements or notes thereto included in
this report.
 
     b) Reports on Form 8-K
 
<TABLE>
<CAPTION>
         DATE OF REPORT                    SUBJECT OF REPORT
         --------------                    -----------------
<S>                                <C>
None
</TABLE>
 
     c) Exhibits
 
<TABLE>
<CAPTION>
      DESIGNATION                                DESCRIPTION
      -----------                                -----------
<C>                      <S>
        3.1**            -- Certificate of Incorporation of SFMT, Inc.
        3.2**            -- Certificate of Correction to the Certificate of
                            Incorporation of SFMT, Inc., filed with the Delaware
                            Secretary of State on October 8, 1993
        3.3**            -- Certificate of Ownership and Merger Merging San
                            Francisco/Moscow Teleport, Inc. into SFMT, Inc., filed
                            with the Delaware Secretary of State on November 3, 1993
</TABLE>
 
                                       123
<PAGE>   125
 
   
<TABLE>
<CAPTION>
      DESIGNATION                                DESCRIPTION
      -----------                                -----------
<C>                      <S>
        3.4**            -- Certificate of Amendment to the Certificate of
                            Incorporation of SFMT, Inc., filed with the Delaware
                            Secretary of State on January 12, 1995
        3.5**            -- Certificate of Amendment to the Certificate of
                            Incorporation of SFMT, Inc., filed with the Delaware
                            Secretary of State on February 22, 1995
        3.6**            -- Certificate of Amendment to the Certificate of
                            Incorporation of Global TeleSystems Group, Inc., filed
                            with the Delaware Secretary of State on October 16, 1996
        3.7**            -- By-laws of SFMT, Inc.
        3.8**            -- Certificate of Amendment to the Certificate of
                            Incorporation of Global TeleSystems Group, Inc., filed
                            with the Delaware Secretary of State on December 1, 1997
        3.9**            -- Form of Amended and Restated By-laws of Global
                            TeleSystems Group, Inc. supersedes By-laws of SFMT, Inc.
                            filed as Exhibit 3.7)
        3.10+            -- Certificate of Amendment to the Certificate of
                            Incorporation of Global TeleSystems Group, Inc. filed
                            with the Delaware Secretary of State on January 29, 1998.
        3.11+            -- Certificate of Amendment to the Certificate of
                            Incorporation of Global TeleSystems Group, Inc. filed
                            with the Delaware Secretary of State on February 9, 1998.
        3.12+            -- Certificate of Designation, of the Series A Preferred
                            Stock of the Company.
        4.1**            -- Form of Specimen Stock Certificate for Common Stock of
                            the Registrant
        4.2**            -- Indenture dated as of July 14, 1997 between the Company
                            and The Bank of New York (including the form of Senior
                            Subordinated Convertible Bond due 2000 as an exhibit
                            thereto)
        4.3**            -- Registration Rights Agreement, dated as of July 14, 1997,
                            between Global TeleSystems Group, Inc. and UBS Securities
                            LLC.
        4.4**            -- Indenture dated as of August 19, 1997 between Hermes
                            Europe Railtel B.V. and The Bank of New York (including
                            the form of 11 1/2% Senior Note due 2007 as an exhibit
                            thereto)
        4.5**            -- Registration Rights Agreement dated as of August 19, 1997
                            between Hermes Europe Railtel B.V. and Donaldson, Lufkin
                            & Jenrette Securities Corporation, UBS Securities LLC,
                            and Lehman Brothers, Inc
        4.6**            -- Form of Rights Agreement between Global TeleSystems
                            Group, Inc. and The Bank of New York as Rights Agent.
        4.7+             -- Indenture dated as of February 10, 1998 between Global
                            TeleSystems Group, Inc. and The Bank of New York
                            (including the form of 9 7/8% Senior Notes due 2005 as an
                            exhibit thereto).
       10.1**            -- Senior Note Purchase Agreement, dated as of January 19,
                            1996, among Global TeleSystems Group, Inc., The Open
                            Society Institute and Chatterjee Fund Management, L.P.
       10.1(a)**         -- Amendment to Senior Note Purchase Agreement dated January
                            19, 1996 among Global TeleSystems Group, Inc., The Open
                            Society Institute and Chatterjee Fund Management, L.P.,
                            dated June 6, 1996
       10.1(b)**         -- Amendment to Senior Note Purchase Agreement dated January
                            19, 1996 among Global TeleSystems Group, Inc., The Open
                            Society Institute and Chatterjee Fund Management, L.P.,
                            dated June 6, 1996
</TABLE>
    
 
                                       124
<PAGE>   126
 
<TABLE>
<CAPTION>
      DESIGNATION                                DESCRIPTION
      -----------                                -----------
<C>                      <S>
       10.1(c)**         -- Amendment to Senior Note Purchase Agreement dated January
                            19, 1996 among Global TeleSystems Group, Inc., The Open
                            Society Institute and Chatterjee Fund Management, L.P.,
                            dated July 23, 1996
       10.1(d)**         -- Amendment to Senior Note Purchase Agreement dated January
                            19, 1996 among Global TeleSystems Group, Inc., The Open
                            Society Institute and Chatterjee Fund Management, L.P.,
                            dated September 16, 1996
       10.1(e)**         -- Amendment to Senior Note Purchase Agreement dated January
                            19, 1996 among Global TeleSystems Group, Inc., The Open
                            Society Institute and Chatterjee Fund Management, L.P.,
                            dated July 11, 1997
       10.1(f)**         -- Amendment to Senior Note Purchase Agreement dated January
                            19, 1996 among Global TeleSystems Group, Inc., The Open
                            Society Institute and Chatterjee Fund Management, L.P.,
                            dated July 29, 1997
       10.1(g)**         -- Amendment to Senior Note Purchase Agreement dated January
                            19, 1996 among Global TeleSystems Group, Inc., The Open
                            Society Institute and Chatterjee Fund Management, L.P.,
       10.2**            -- Registration Rights Letter Agreement, dated as of January
                            19, 1996, among Global TeleSystems Group, Inc., The Open
                            Society Institute and Chatterjee Fund Management, L.P.
       10.3**            -- Warrant Agreement, dated as of January 19, 1996, among
                            Global TeleSystems Group, Inc., The Open Society
                            Institute and Chatterjee Fund Management, L.P.
       10.4**            -- Joint Venture Letter Agreement, dated January 19, 1996,
                            among Global TeleSystems Group, Inc., The Open Society
                            Institute and Chatterjee Fund Management, L.P.
       10.5              -- Intentionally Omitted
       10.6**            -- Registration Rights Letter Agreement, dated June 6, 1996,
                            among the Company, The Open Society Institute, Winston
                            Partners II LDC and Winston Partners II LLC
       10.7**            -- Warrant Agreement, dated as of June 6, 1996, between
                            Global TeleSystems Group, Inc., The Open Society
                            Institute, Winston Partners II LDC and Winston Partners
                            II LLC
       10.8**            -- Senior Note Purchase Agreement, dated as of February 2,
                            1996, between Global TeleSystems Group, Inc. and Emerging
                            Markets Growth Fund, Inc.
       10.8(a)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated June 6,
                            1996 (see Exhibit No. 10.1(b))
       10.8(b)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated June 6,
                            1996
       10.8(c)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated July 25,
                            1996
       10.8(d)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated September
                            10, 1996
       10.8(e)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated September
                            16, 1996
</TABLE>
 
                                       125
<PAGE>   127
 
   
<TABLE>
<CAPTION>
      DESIGNATION                                DESCRIPTION
      -----------                                -----------
<C>                      <S>
       10.8(f)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated December
                            30, 1996
       10.8(g)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated May 13,
                            1997
       10.8(h)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated June 20,
                            1997
       10.8(i)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated July 11,
                            1997
       10.8(j)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated July 21,
                            1997
       10.8(k)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated August 14,
                            1997
       10.8(l)**         -- Amendment to Senior Note Purchase Agreement, dated as of
                            February 2, 1996, between Global TeleSystems Group, Inc.
                            and Emerging Markets Growth Fund, Inc., dated September
                            29, 1997
       10.9**            -- Registration Rights Letter Agreement, dated as February
                            2, 1996, between Global TeleSystems Group, Inc. and
                            Emerging Markets Growth Fund, Inc.
       10.10**           -- Warrant Agreement, dated as of February 2, 1996, between
                            Global TeleSystems Group, Inc. and Emerging Markets
                            Growth Fund, Inc.
       10.11             -- Intentionally Omitted
       10.12**           -- Registration Rights Letter Agreement, dated as February
                            2, 1996, between Global TeleSystems Group, Inc. and
                            Capital International Emerging Markets Funds
       10.13**           -- Warrant Agreement, dated as of February 2, 1996, between
                            Global TeleSystems Group, Inc. and Capital International
                            Emerging Markets Funds
       10.14+            -- Restated and Amended Global TeleSystems Group, Inc.
                            Non-Employee Directors' Stock Option Plan
       10.15**           -- GTS-Hermes, Inc. 1994 Stock Option Plan
       10.16**           -- Restricted Stock Grant letter, dated as of January 1,
                            1995
       10.17**           -- Employment Agreement dated as of January 1995 between
                            SFMT, Inc. and Jan Loeber
       10.18**           -- Employment Agreement dated as of April 1996 between GTS
                            Group, Inc. and Louis Toth
       10.19**           -- Employment Agreement dated as of April 1996 between GTS
                            Group, Inc. and Gerald W. Thames
       10.20**           -- Employment Agreement dated as of April 1996 between GTS
                            Group, Inc. and Raymond J. Marks
       10.21**           -- Employment Agreement dated as of April 1996 between GTS
                            Group, Inc. and Henry Radzikowski
       10.22**           -- SFMT, Inc. Equity Compensation Plan
       10.23**           -- Form of Non-Statutory Stock Option Agreement
</TABLE>
    
 
                                       126
<PAGE>   128
 
   
<TABLE>
<CAPTION>
      DESIGNATION                                DESCRIPTION
      -----------                                -----------
<C>                      <S>
       10.24+            -- Third Amended and Restated 1992 Stock Option Plan of
                            Global TeleSystems Group Inc. dated September 25, 1997
       10.25**           -- GTS-Hermes 1994 Stock Option Grant, Non-Qualified Stock
                            Option Grant
       10.26**           -- Agreement on the Creation and Functions of the Joint
                            Venture of EDN Sovintel, dated June 18, 1990
       10.27**           -- Stock Purchase Agreement among Global TeleSystems Group,
                            Inc, Kompaniya "Invest-Project," Swinton Limited, GTS-Vox
                            Limited, and MTU-Inform, dated September 6, 1995
       10.28**           -- Certificate of Registration of Revised and Amended
                            Foundation Document in the State Registration of
                            Commercial Organizations, dated May 30, 1996
       10.29**           -- Agreement on the Creation and Functions of the Joint
                            Venture Sovam Teleport, dated May 26, 1992
       10.30**           -- Amended and Restated Joint Venture Agreement between GTS
                            Cellular, Tricor B.V., Gerard Essing, Ivan Laska, and
                            Erik Jennes, dated July 6, 1995
       10.31**           -- Amended and Restated Shareholders' Agreement between HIT
                            Rail B.V., GTS-Hermes, Inc., Nationale Maatschappu Der
                            Belgische Spoorwegen, Teleport B.V., AB Swed Carrier, and
                            Hermes Europe Railtel B.V., dated July, 1997
       10.31(a)**        -- Shareholders' Agreement among the Hermes Europe Railtel
                            B.V., GTS-Hermes Inc., HIT Rail B.V., SNCB/NMBS and AB
                            Swed Carrier (incorporated by reference to Exhibit 10.1
                            to the Hermes Europe Railtel B.V.'s Registration
                            Statement on Form S-4 (File No. 333-37719) filed on
                            December 11, 1997) (supersedes the Amended and Restated
                            Shareholders' Agreement filed as Exhibit 10.31 to this
                            Registration Statement)
       10.32**           -- Company Agreement between The Societe National de
                            Financement, GTS S.A.M. and The Principality of Monaco,
                            dated September 27, 1995
       10.33**           -- Joint Venture Agreement between SFMT-Hungaro Inc. and
                            Montana Holding Vagyonkezelo Kft., dated December 23,
                            1993
       10.34**           -- Joint Venture and Shareholders' Agreement among Gerard
                            Aircraft Sales and Leasing Company, SFMT-Hungaro Inc.,
                            and Microsystem Telecom Rt., dated August 5, 1994
       10.35**           -- Agreement on the Establishment of Limited Liability
                            Company between SFMT-Czech, Inc. and B&H s.r.o., dated
                            July 12, 1994
       10.36**           -- Formation of the Equity Joint Venture between GTS and
                            SSTIC, dated April 12, 1995
       10.37**           -- Contract to Establish the Sino-foreign Cooperative Joint
                            Venture Beijing Tianmu Satellite Communications
                            Technology Co., Ltd, amended, by and between China
                            International Travel Service Telecom Co., Ltd. and
                            American China Investment Corporation, dated March 27,
                            1996
       10.38**           -- Joint Venture Contract between GTS TransPacific Ventures
                            Limited and Shanghai Intelligence Engineering, Inc.,
                            dated March 28, 1996
       10.39**           -- Agreement between Global TeleSystems Group, Inc. and
                            Cesia S.A., dated June 21, 1997
       10.40**           -- Consulting Agreement between SFMT, Inc. and Alan B.
                            Slifka, dated March 1, 1994
       10.41**           -- Consulting Agreement between Global TeleSystems Group,
                            Inc. and Bernard J. McFadden, dated August 15, 1996
</TABLE>
    
 
                                       127
<PAGE>   129
 
   
<TABLE>
<CAPTION>
      DESIGNATION                                DESCRIPTION
      -----------                                -----------
<C>                      <S>
       10.42**           -- Consulting Agreement between CESIA S.A. and Hermes Europe
                            Railtel B.V., dated June 20, 1997
       10.43+            -- Key Employee Stock Option Plan of Hermes Europe Railtel
                            B.V.
       21.1+             -- List of Subsidiaries of the Registrant
       23.2*             -- Consent of Ernst & Young LLP
       23.3*             -- Consent of Ernst & Young (CIS) LTD.
       24.1+             -- Powers of Attorney (included on signature page to this
                            report)
       27.1+             -- Financial Data Schedule extracted from December 31, 1997
                            audited financial statements
</TABLE>
    
 
---------------
 
   
*  Filed herewith.
    
 
** Incorporated by reference to the correspondingly numbered Exhibit to
   Amendment No. 6 to the Company's registration statement on Form S-1 dated
   February 5, 1998 (Commission File No. 333-36555)
   
+ Previously filed.
    
 
     (d) Schedules
 
          Schedule II -- Valuation and Qualifying Accounts. The other financial
     statement schedules of the Company have been omitted because the
     information required to be set forth therein is not applicable or is shown
     in the Financial Statements or Notes thereto.
 
                                       128
<PAGE>   130
 
   
                                   SIGNATURES
    
 
   
     Pursuant to the requirements of this Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized in the City of McLean, Commonwealth of
Virginia, on this 7th day of December, 1998.
    
 
   
                                          GLOBAL TELESYSTEMS GROUP, INC.
    
 
   
Date: December 7, 1998                    By:      /s/ GRIER C. RACLIN
    
                                            ------------------------------------
   
                                            Name: Grier C. Raclin
    
   
                                            Title: Senior Vice President and
                                              General Counsel
    
 
   
     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 and in the capacities indicated on the 7th day of December, 1998.
    
 
   
<TABLE>
<CAPTION>
                      SIGNATURE                                       TITLE                        DATE
                      ---------                                       -----                        ----
<C>                                                     <S>                                <C>
                          *                             President, Chief Executive Officer   December 7, 1998
-----------------------------------------------------     and Director (principal
                  Gerald W. Thames                        executive officer)
 
                          *                             Executive Vice President --          December 7, 1998
-----------------------------------------------------     Finance and Chief Financial
                 William H. Seippel                       Officer (principal financial and
                                                          accounting officer)
 
                          *                             Chairman of the Board of Directors   December 7, 1998
-----------------------------------------------------
                   Alan B. Slifka
 
                                                        Director                             December 7, 1998
-----------------------------------------------------
                   Robert J. Amman
 
                          *                             Director                             December 7, 1998
-----------------------------------------------------
                   Michael Greeley
 
                          *                             Director                             December 7, 1998
-----------------------------------------------------
                  Bernard McFadden
 
                          *                             Director                             December 7, 1998
-----------------------------------------------------
                 Stewart J. Paperin
 
                          *                             Director                             December 7, 1998
-----------------------------------------------------
                    W. James Peet
 
                          *                             Director                             December 7, 1998
-----------------------------------------------------
                    Jean Salmona
 
                                                        Director                             December 7, 1998
-----------------------------------------------------
                      David Dey
</TABLE>
    
 
                                       129
<PAGE>   131
 
   
<TABLE>
<CAPTION>
                      SIGNATURE                                       TITLE                        DATE
                      ---------                                       -----                        ----
<C>                                                     <S>                                <C>
 
                          *                             Director                             December 7, 1998
-----------------------------------------------------
                     Joel Schatz
 
                                                        Director                             December 7, 1998
-----------------------------------------------------
                    Adam Solomon
 
                                                        Director                             December 7, 1998
-----------------------------------------------------
                    Roger W. Hale
 
     *By:                    /s/ GRIER C. RACLIN
  -------------------------------------------------
                          Grier C. Raclin
                          Attorney-in-Fact
                         for the Directors
</TABLE>
    
 
                                       130
<PAGE>   132
 
                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
 
<TABLE>
<CAPTION>
                 COL. A                     COL. B             COL. C              COL. D       COL. E
                 ------                     ------     -----------------------     ------       ------
                                                              ADDITIONS
                                                       -----------------------
                                          BALANCE AT   CHARGED TO   CHARGED TO                BALANCE AT
                                          BEGINNING    COSTS AND      OTHER                      END
              DESCRIPTION                 OF PERIOD     EXPENSES     ACCOUNTS    DEDUCTIONS   OF PERIOD
              -----------                 ----------   ----------   ----------   ----------   ----------
<S>                                       <C>          <C>          <C>          <C>          <C>
Allowance for doubtful accounts at
  12/31/95..............................       0            30                                     30
Allowance for doubtful accounts at
  12/31/96..............................      30           752                                    782
Allowance for doubtful accounts at
  12/31/97..............................     782         3,303                                  4,085
</TABLE>
 
                                       131
<PAGE>   133
 
                                 EXHIBIT INDEX
 
   
<TABLE>
<CAPTION>
      DESIGNATION                                DESCRIPTION
      -----------                                -----------
<C>                      <S>
       23.2*             -- Consent of Ernst & Young LLP
       23.3*             -- Consent of Ernst & Young (CIS) LTD.
</TABLE>
    
 
---------------
 
* Filed herewith.