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                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
 
                                   FORM 10-K
 
     [X]         ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
 
     [ ]       TRANSITION REPORT PURSUANT TO SECTIONS 13 OR 15(d)
                      OF THE SECURITY EXCHANGE ACT OF 1934
 
                        COMMISSION FILE NUMBER: 0-23717
 
                         GLOBAL TELESYSTEMS GROUP, INC.
             (Exact name of registrant as specified in its charter)
 
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                   DELAWARE                                      94-3068423
           (State of incorporation)                (I.R.S. Employer Identification Nos.)
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                  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 [X]  No [ ].
 
     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.  [ ]
 
     The aggregate market value of the voting stock of Global TeleSystems Group,
Inc. held by non-affiliates on February 26, 1999 was approximately
$3,631,368,516. On February 26, 1999, there were outstanding approximately
81,131,491 shares of Common Stock of Global TeleSystems Group, Inc.
 
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              ITEM OF FORM 10-K                     DOCUMENT INCORPORATED BY REFERENCE
              -----------------                     ----------------------------------
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             Part IV, Item 14(c)                                 Exhibits
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                         GLOBAL TELESYSTEMS GROUP, INC.
 
                                   FORM 10-K
                          YEAR ENDED DECEMBER 31, 1998
 
                               TABLE OF CONTENTS
 
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                                   PART I
ITEM 1.   Business....................................................     2
ITEM 2.   Properties..................................................    56
ITEM 3.   Legal Proceedings...........................................    57
ITEM 4.   Submission of Matters to a Vote of Security Holders.........    57
 
                                  PART II
ITEM 5.   Market for the Company's Common Equity and Related
          Stockholder Matters.........................................    57
ITEM 6.   Selected Financial Data.....................................    59
ITEM 7.   Management's Discussion and Analysis of Financial Condition
          and Results of Operations...................................    60
ITEM 7A.  Quantitative and Qualitative Disclosure about Market Risk...    70
ITEM 8.   Financial Statements and Supplementary Information for the
          Company.....................................................    72
ITEM 9.   Changes In and Disagreements with Accountants on Accounting
          and Financial Disclosure....................................   102
 
                                  PART III
ITEM 10.  Directors and Executive Officers of the Company.............   102
ITEM 11.  Executive Compensation......................................   110
ITEM 12.  Security Ownership of Certain Beneficial Owners and
          Management..................................................   123
ITEM 13.  Certain Relationships and Related Transactions..............   125
 
                                  PART IV
ITEM 14.  Exhibits, Financial Statement Schedules and Reports on Form
          8-K.........................................................   127
SIGNATURES............................................................   135
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                                     PART I
 
ITEM 1. BUSINESS
 
                                  INTRODUCTION
 
     We were founded in 1983 as a not-for-profit company under the name San
Francisco/Moscow Teleport, Inc. We incorporated as a for-profit corporation in
1986, and reincorporated into Delaware in 1993 and changed our name to Global
TeleSystems Group, Inc. in February 1995. Our principal business office is
located at 1751 Pinnacle Drive, North Tower -- 12th Floor, McLean, Virginia
22102, United States, and our telephone number is (703) 918-4500.
 
     From our inception until 1998, we focused on (1) providing
telecommunications services in emerging markets, particularly in Russia and (2)
establishing and developing Hermes Europe Railtel B.V., a venture designed to
provide a high speed transmission network across national borders in Western
Europe. We intended to capitalize on the rapidly growing demand for
telecommunications services in countries emerging from totalitarian rule and
state-controlled economies. In addition, in Western Europe growing
liberalization of regulations governing the provision of telecommunications
services has resulted in a proliferation of new competitors to incumbent public
telecommunications operators. At the same time, with the trend toward the
increasing globalization of business, there has been a substantial growth in
demand for high quality voice and data telecommunications. We perceived a need
for a fast, efficient and lower cost cross-border network that would carry the
traffic of established public telecommunications operators and other carriers.
Since we began operating our Hermes Railtel network in late 1996, the demand for
its services has validated our decision to build and develop such a network.
 
     In 1998, we changed our strategy in response to the economic crisis in
emerging markets and the advent on January 1, 1998 of the deregulation of the
provision of telecommunications services in Western Europe. We also sought to
build on the success of our Hermes Railtel network by developing a plan to
provide telecommunications services, including local access services, directly
to businesses and other customers. Accordingly, during 1998, we acquired two
companies that provide such services to businesses and other high usage
customers in Western Europe and developed a plan to provide local access
services in 12 major Western European cities. In addition, we realigned our
operations into five lines of business to facilitate the coordination and
management of our activities. For more information on our lines of business, see
"-- Business Summary."
 
                               INDUSTRY OVERVIEW
 
EUROPEAN TELECOMMUNICATIONS MARKET
 
     Liberalization in the European telecommunications markets has proceeded
rapidly since the late 1980's. Historically, the European public
telecommunications operators monopolized the provision of telecommunications
services in their home markets and designed their networks according to national
rather than continental and international considerations. Between 1990 and 1997,
however, the European Union implemented a series of directives designed to open
up the telecommunications markets to competition. These directives required
member states to implement legislation liberalizing their respective
telecommunications markets to permit alternative telecommunications companies
both to provide telecommunications services and to access the existing
telecommunications infrastructure controlled by these national and regional
providers. In response to these European regulatory changes, a number of new
interests, including our company, have emerged to compete with the European
public telecommunications operators. For a discussion of the risks we face with
public telecommunications operators, see "Failure to be competitive with
national public telecommunications operators could adversely affect our
business."
 
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INTERNET INDUSTRY
 
     The Internet is a global collection of interconnected computer networks
that allows commercial organizations, educational institutions, government
agencies and individuals to communicate, access and share information and
conduct business electronically. The Internet originated with the ARPAnet, a
restricted network that was created in 1969 by the United States Department of
Defense Advanced Research Projects Agency to provide efficient and reliable long
distance data communications among the disparate computer systems used by
government-funded researchers and academic organizations. The networks that
comprise the Internet, or its backbone, are connected in a variety of ways,
including by public switched telephone networks and by high speed, dedicated
leased lines. Communications on the Internet are enabled by Internet Protocol or
IP, which is a market-based standard computer language broadly adopted on the
Internet and elsewhere that allows computers with different architectures and
operating systems software to communicate with each other on the Internet.
 
     Over time, as businesses have begun to utilize e-mail, file transfer and,
more recently, intranet and extranet services, commercial usage has become a
major component of Internet traffic. In 1989, the U.S. government effectively
ceased directly funding any part of the Internet backbone. In the mid-1990s,
contemporaneous with the increase in commercial usage of the Internet, a new
type of provider called an Internet service provider became more prevalent.
Internet service providers offer access, e-mail, customized content and other
specialized services and products aimed at allowing both commercial and
residential customers to obtain information from, transmit information to, and
utilize resources available on the Internet.
 
     Internet service providers generally operate networks composed of dedicated
lines leased from public telecommunications operators, local access providers
and internet service providers using IP-based switching and routing equipment
and server-based applications and databases. Customers are connected to the
Internet service provider switching equipment by facilities obtained by the
customer or the Internet service provider from either public telecommunications
operators or local access providers through a dedicated access line or the
placement of a circuit-switched local telephone to the Internet service
provider.
 
IP COMMUNICATIONS TECHNOLOGY
 
     There are two widely used switching technologies in currently deployed
communications networks: circuit-switching systems and packet-switching systems.
Circuit-switch based communications systems establish a dedicated channel for
each communication (such as a telephone call for voice or fax), maintain the
channel for the duration of the call and disconnect the channel at the
conclusion of the call. Packet-switch based communications systems format the
information to be transmitted, such as e-mail, voice, fax and data, into a
series of shorter digital messages called "packets." Each packet consists of a
portion of the complete message plus the addressing information to identify the
destination and return address.
 
     Packet-switch based systems offer several advantages over circuit-switch
based systems, particularly the ability to commingle packets from several
communications sources together simultaneously onto a single channel. For most
communications, particularly those with bursts of information followed by
periods of "silence," the ability to commingle packets provides for superior
network utilization and efficiency, resulting in more information being
transmitted through a given communication channel. There are, however, some
disadvantages to packet-switch based systems as currently implemented. Rapidly
increasing demands for data, in part driven by the Internet traffic volumes, are
straining capacity and contributing to latency (delays) and interruptions in
communication transmissions. In addition, there are concerns about the adequacy
of the security and reliability of packet-switch based systems as currently
implemented.
 
     Initiatives are under way to develop technology to address these
disadvantages of packet-switch based systems. We believe that the evolving IP
standard will remain a primary focus of these development efforts. We expect the
benefits of these efforts to be improved communications, reduced latency and
declining networking hardware costs.
 
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                                BUSINESS SUMMARY
 
     We are a leading independent provider of telecommunications services to
businesses, other high usage customers and telecommunications carriers in
Europe. We also provide telecommunications services in Russia and the
Commonwealth of Independent States (CIS). In October 1998 we realigned our
operations into five lines of business: GTS Carrier Services, GTS Business
Services, GTS Access Services, GTS Business Services - CIS and GTS Mobile
Services - CIS. In March 1999, we added a sixth line of business, GTS Wholesale
Services.
 
GTS CARRIER SERVICES
 
     GTS Carrier Services has three components: Hermes Europe Railtel B.V.,
Transoceanic Services and IP Services. Through Hermes Railtel, we operate a
centrally managed fiber optic network that is designed to carry high volumes of
telecommunications traffic across national borders in Europe and to the United
States. We sell this capacity to other telecommunications carriers and, through
our subsidiary, Ebone A/S, we connect Internet service providers in Europe to
the Internet. Through Transoceanic Services, we intend to expand our ability to
provide these services between the United States and Europe by utilizing the
resources of FLAG Atlantic Limited, a joint venture in formation in which we
have a 50% equity interest. Through IP Services, we intend to offer web site
management services and other services related to the use of the Internet to
carry telecommunications traffic. We intend to utilize the three components of
our Carrier Services line of business to become a leading provider of seamless
transatlantic city-to-city managed services to businesses and telecommunications
providers.
 
     Hermes Railtel Network. At March 3, 1999, Hermes Railtel operated
approximately 12,200 kilometers of fiber optic cable connecting 19 cities in 10
countries in Europe. When completed by the end of 2000, our network will extend
approximately 25,000 kilometers with points of presence, or locations with
equipment for switching or relaying traffic, in approximately 50 cities in 20
European countries. At March 3, 1999, Hermes Railtel had 54 customers which
included public telecommunications operators and other carriers, global
consortia, Internet service providers, resellers and other service providers. We
believe that we are able to provide our customers with a service offering that
is superior to comparable services currently available through public
telecommunications operators or through other independent telecommunications
providers.
 
     Our services are characterized by high transmission quality and
reliability, flexibility and competitive pricing. We offer our customers a wide
range of capacity levels for contract periods ranging from one to ten years. In
1998, we began upgrading Hermes Railtel's network with dense wavelength division
multiplexing technology. This is a cost-effective technology that substantially
increases the transmission capacity of an existing fiber optic network by
multiplying the number of signals that it can carry simultaneously. In February
1999, we announced our plan to introduce a network platform that will apply IP
technology directly over dense wavelength division multiplexing by the end of
the second quarter of 1999. We expect this to enhance the efficiency of our
network and its capacity to carry IP-based traffic. We initially plan to deploy
this platform in six European countries.
 
     Transoceanic Services. In January 1999, we entered into a 50/50 joint
venture with FLAG Telecom Inc., called FLAG Atlantic Limited. This joint venture
will build and operate a new transatlantic dual cable system, called FLAG
Atlantic-1, designed to carry voice, data and video traffic at much faster
speeds than currently available on existing transatlantic links. We expect that
this system will become operational in the last quarter of 2000. We have
committed to purchase capacity at favorable prices on FLAG Atlantic-1 to provide
Hermes Railtel customers a more cost-effective means for transmitting
telecommunications traffic between the United States and any city on the Hermes
Railtel network.
 
     IP Services. In order to capitalize on the projected growth in demand for
voice and data services over the Internet using Internet Protocol and to take
full advantage of Hermes Railtel's network, FLAG Atlantic-1 and Ebone, we plan
to offer IP-based services to businesses, other high usage customers and
telecommunications carriers. These services will range from Internet access and
IP transport to other services, such as helping
 
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other companies to set up and maintain their web sites. For a comprehensive
discussion on our Carrier Services line of business, see "-- Business -- GTS
Carrier Services."
 
GTS BUSINESS SERVICES
 
     Through our Business Services line of business, we focus on providing high
quality, competitively priced telecommunications services to businesses and
other high usage customers in the United Kingdom, Germany, The Netherlands,
Spain, France, Italy, Norway, Sweden, Belgium, Denmark and Ireland. This line of
business uses the existing infrastructure of our Business Services, Carrier
Services, Access Services and Wholesale Services lines of business as well as
third-party carrier networks. We currently conduct our Business Services line of
business through our two recently acquired subsidiaries, Esprit Telecom Group
plc and NetSource Europe ASA. We provide a range of telecommunications services
organized in the following two segments:
 
     -  retail services: long distance voice and fax services for corporate
        customers to worldwide destinations; and
 
     -  service provider/reseller services: network management, access and
        termination services to telecommunications service providers, such as
        calling card companies and resellers.
 
     At December 31, 1998, we had over 35,000 business customers and
approximately 44,000 small office and home office and residential customers in
11 countries throughout Europe. Our Business Services customers are
predominantly small and medium sized businesses but also include large corporate
customers. Our retail distribution force consists of over 700 direct and
indirect salespeople and sales agents. We intend to increase our Business
Services product offering to include a wide range of enhanced services such as
toll free services, calling cards and switched data services, some of which we
will jointly market and supply with our Access Services line of business.
 
     We intend to integrate the marketing and service offerings of our Business
Services with the network infrastructure of our Carrier Services, Wholesale
Services and Access Services lines of business. Our Business Services line of
business plans to utilize Hermes Railtel's network to transport city-to-city
traffic within Europe and to utilize the least cost routing infrastructure of
Wholesale Services to terminate international traffic outside of Europe. We
intend to offer direct local access to our Business Services customers in those
cities where Access Services establishes operations. In addition, both Business
Services and Access Services plan to work closely together to identify key
customers and to develop joint service offerings. For a discussion of our
Business Services line of business, see "-- Business -- GTS Business Services."
 
GTS WHOLESALE SERVICES
 
     In March 1999, we introduced Wholesale Services as our sixth line of
business. Wholesale Services provides international traffic termination services
to other telecommunications service providers, including public
telecommunications operators, global alliances and regional telephone companies.
In Wholesale Services, we will integrate the wholesale services activities of
Esprit Telecom with the international switching and transit service operations
of our GTS-Monaco Access operations. At a later date, Wholesale Services will
also incorporate NetSource's wholesale activities. For a discussion of our
Wholesale Services line of business, see "-- Business -- GTS Wholesale
Services." For a discussion of risks associated with integration, see "-- Risk
Factors -- We may fail to successfully integrate recent acquisitions."
 
GTS ACCESS SERVICES
 
     Through our Access Services line of business, we plan to offer local access
for voice and data traffic to businesses, other high usage customers and
telecommunications carriers in 12 major Western European cities by 2001. In
addition, our existing operations in Hungary and the Czech Republic currently
provide alternative
 
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local access and other services to businesses and governmental customers in
those markets. We plan to develop our infrastructure through one or more of the
following:
 
     -  constructing, purchasing or leasing fiber optic cable networks;
 
     -  obtaining licenses for telecommunications networks utilizing microwave
        transmissions; or
 
     -  forming partnerships with or acquiring existing network operators.
 
     We plan to provide a broad array of advanced voice and data
telecommunications and support services. In addition to targeting new customers,
we intend to reduce local access costs that we now incur for our Carrier
Services and Business Services customers by providing such local access
ourselves instead of purchasing it from third parties. We currently purchase
local access either from incumbent public telecommunications operators or other
local access providers to link customers to Hermes Railtel's network. A number
of our existing Business Services customers are currently linked to our network
via leased lines provided by other operators.
 
GTS BUSINESS SERVICES - CIS
 
     Through our Business Services - CIS line of business we offer
telecommunications services to businesses in Russia and other countries in the
Commonwealth of Independent States. These businesses include:
 
     -  international long distance, local telephone services and access to
        domestic long distance carriers in Moscow and St. Petersburg;
 
     -  domestic long distance services in Moscow and several other cities in
        Russia; and
 
     -  data services, including high-speed data transmission, electronic mail
        and Internet access services.
 
     We currently operate in 31 regions, including 14 cities and the city of
Moscow, in Russia and the CIS. For a comprehensive discussion of our Business
Services - CIS line of business, see "-- Business -- GTS Business Services - CIS
and Mobile Services - CIS -- GTS Business Services - CIS."
 
GTS MOBILE SERVICES - CIS
 
     Through our Mobile Services - CIS line of business, we offer cellular
telephone services to business customers in 14 regions in Russia and in Kiev,
Ukraine. For discussion of our Mobile Services - CIS line of business, see
"Business -- GTS Business Services - CIS and Mobile Services - CIS -- GTS Mobile
Services - CIS."
 
                               BUSINESS STRATEGY
 
     In order to achieve our objective of becoming Europe's premier independent
provider of telecommunications services to businesses, other high usage
customers and telecommunications carriers, we intend to implement the following
key strategies:
 
CONTINUE BUILDOUT OF HERMES RAILTEL NETWORK
 
     We intend to make Hermes Railtel's service offerings more attractive to our
carrier customers by expanding the geographic reach and reliability of our core
network. We are continuing to build our Hermes Railtel network by extending its
coverage to include approximately 50 cities throughout Europe by the end of 2000
and by putting in place a high speed, cost-efficient transatlantic link through
our FLAG Atlantic Limited joint venture. We are also deploying dense wavelength
division multiplexing technology that will permit significant expansion of the
core network's transmission capacity and allow us to upgrade the reliability and
efficiency of the network.
 
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DEVELOP LOCAL ACCESS INFRASTRUCTURE
 
     In order to facilitate our customers' access to our network and to exploit
what we believe to be an expanding market, we intend to build, lease or acquire
local access infrastructure in 12 major metropolitan markets throughout Europe
by 2001. We believe that the increasing liberalization of telecommunications
regulation in Europe and the existing level of competition in Europe for local
access services offer an attractive opportunity to build out local access
infrastructure. We believe that implementing this strategy will also benefit our
Carrier Services and Business Services lines of business.
 
CAPITALIZE ON GROWTH IN DATA/IP TRAFFIC
 
     In anticipation of continued rapid growth in data and Internet traffic, we
plan to expand our IP-based capabilities and product offerings. We intend to
apply IP technology to Hermes Railtel's fiber optic network in order to enhance
its efficiency and capacity. In addition to offering IP transport services, we
intend to offer Internet access and IP-based services, such as web site
management.
 
REINFORCE AND EXTEND MARKET PENETRATION OF HERMES RAILTEL'S NETWORK
 
     We intend to reinforce and extend the market penetration of Hermes
Railtel's network by enhancing the scope, capacity, reliability and efficiency
of our infrastructure, and by providing our own local access. As a result of
these enhancements, we believe that we are well-positioned to generate
additional revenues from existing carrier customers and attract new customers as
demand for seamless transatlantic city-to-city services increases. Targeted new
customers include the U.S. regional Bell operating companies, as well as U.S.
and European Internet service providers.
 
INCREASE HIGH USAGE RETAIL CUSTOMER BASE AND ROUTE TRAFFIC OVER OUR OWN NETWORK
 
     As a result of the Esprit Telecom and NetSource acquisitions, we have an
established retail customer base of leading international businesses,
organizations and governmental agencies. We intend to continue to focus our
retail marketing efforts on small, medium and large-sized businesses,
governmental agencies and other organizations that have extensive
telecommunications needs and which generate substantial volumes of
telecommunications traffic. By routing this traffic over our Hermes Railtel,
Business Services and Access Services networks, we seek to realize the benefits
of owning our own infrastructure. In order to build our customer base, we
anticipate significantly increasing the size of our direct sales force. We also
seek to offer a level of service superior to that provided by incumbent
telecommunications providers. We believe that providing a high level of customer
service is a key element in establishing customer loyalty and attracting new
customers. For a discussion of the risks associated with our business strategy,
see "We may encounter delays in implementing key elements of our business
strategy."
 
                              RECENT DEVELOPMENTS
 
OUR NEW CHIEF EXECUTIVE OFFICER
 
     In March 1999, our board of directors elected H. Brian Thompson as Chairman
and Chief Executive Officer. Mr. Thompson served as chairman and chief executive
officer of LCI International, Inc. from 1991 until June 1998, when Qwest
Communications International, Inc. acquired LCI. During Mr. Thompson's tenure at
LCI, that company grew in annual revenues from $220 million to $1.6 billion in
1997. LCI provided long-distance voice and data services in the United States
and to more than 230 international locations. In addition, our board elected
Robert J. Amman, a board member, President of our company.
 
ESPRIT TELECOM ACQUISITION
 
     On February 2, 1999, we commenced an offer to purchase all of the issued
share capital of Esprit Telecom on the following basis:
 
     -  for each Esprit Telecom ordinary share, 0.1271 of a share of our common
        stock; and
 
     -  for each Esprit Telecom American depositary share, 0.89 of a share of
        our common stock.
 
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     On March 4, 1999, we declared the exchange offer unconditional in all
respects and accepted ordinary shares and American depositary shares
representing approximately 97.9% of the issued share capital of Esprit Telecom.
In exchange, we issued approximately 15.7 million shares of our common stock.
 
     We are in the process of developing our business plan and strategy for
Esprit Telecom, including the manner in which Esprit Telecom will be integrated
into our existing lines of business and corporate structure. We have accounted
for this transaction as a pooling of interests. For a discussion of risks
associated with the integration of this acquisition, see "-- Risk Factors -- We
may fail to successfully integrate recent acquisitions."
 
HERMES DEBT OFFERING
 
     On January 4, 1999, Hermes Railtel, an 89.9% owned subsidiary, completed a
private placement of $200 million principal amount of 10 3/8% senior notes due
2009 and E85 million principal amount of 10 3/8% senior notes due 2006. Hermes
Railtel will use the proceeds of this offering to finance the cost of building
the remainder of the network and increasing transatlantic capacity and enhancing
the speed and capacity of the network.
 
NETSOURCE ACQUISITION
 
     On November 30, 1998, we acquired NetSource Europe ASA for 4,037,500 shares
of our common stock and $46.1 million in cash for an aggregate initial purchase
price of $145.4 million. We have agreed to make additional payments of up to $35
million in either cash or shares of our common stock if NetSource achieves
agreed performance targets during the first two quarters of 1999. We will
integrate the NetSource business and assets into our Business Services and
Wholesale Services lines of business. We have accounted for this transaction as
a purchase. For a discussion of the risks associated with the integration of
this acquisition, see "-- Risk Factors -- We may fail to successfully integrate
recent acquisitions."
 
                                    BUSINESS
 
GTS CARRIER SERVICES
 
  OVERVIEW
 
     Our Carrier Services line of business is made up of three components:
 
     - Hermes Railtel;
 
     - Transoceanic Services; and
 
     - IP Services.
 
     Cross-border transmission capacity has historically been used predominantly
for the transmission of voice traffic. We believe that cross-border transmission
capacity will increasingly be used to transport data traffic and in several
years the volume of capacity used for transporting data traffic will
significantly exceed that used for transporting voice traffic. This trend is
being driven by the rapid growth of the Internet and other data-intensive
applications such as videoconferencing, multimedia, and medical and business
imaging, among others.
 
     We intend to participate in this developing market by providing
comprehensive telecommunications transport services to established and emerging
telecommunications carriers, Internet service providers and other significant
consumers of transmission services. We believe that our customers will
increasingly demand network connection to the world's major commercial and
financial centers. In addition, we believe that our customers will demand
Internet or IP-based services such as Internet access, web hosting and
management services in order to participate in the expected growth of the
Internet.
 
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  HERMES RAILTEL NETWORK
 
     We are one of the leading providers of telecommunications services to other
telecommunications carriers. We operate a centrally managed fiber optic network
that is designed to carry high volumes of telecommunications traffic across
national borders in Europe and to the United States. At March 3, 1999, the
network operated over approximately 12,200 kilometers connecting 19 cities in 10
countries. We expect the network to extend approximately 25,000 kilometers with
points of presence, or equipment for switching or relaying traffic, in
approximately 50 cities in 20 European countries by the end of 2000.
 
     Capacity on the Hermes Railtel network is sold to public telecommunications
operators, other carriers, Internet service providers, resellers of unused
telecommunications capacity and other telecommunication service providers. We
believe that we are able to provide our customers a service that is superior to
other services currently available through public telecommunications operators
or through other independent providers.
 
     At March 3, 1999, we operated the Hermes Railtel network in Belgium, The
Netherlands, the United Kingdom, France, Germany, Switzerland, Italy, Denmark,
Sweden and Spain, linking the following 19 cities: Brussels, Antwerp, Rotterdam,
Amsterdam, London, Paris, Frankfurt, Strasbourg, Zurich, Geneva, Stuttgart,
Dusseldorf, Munich, Milan, Berlin, Copenhagen, Stockholm, Hamburg and Madrid. If
completed as expected by the end of 2000, our network will extend approximately
25,000 kilometers. During 1999, we plan to extend our network through France to
Barcelona and commence operating in Austria, the Czech Republic, Luxembourg and
Portugal.
 
     We currently lease capacity on transatlantic cables linking the network
with North America and are exploring various interconnectivity options to
Russia. At March 3, 1999, 54 customers were under contract for service on the
Hermes Railtel network, and at December 31, 1998 our customers were
contractually obligated to pay us an aggregate of $418 million for future
services, provided Hermes Railtel performs in accordance with contractual
specifications.
 
     We intend to continue to build Hermes Railtel's network using
cost-efficient access to an infrastructure of railways, motorways, pipeline
companies, waterways and power companies. We have a flexible approach to the
network plan and intend to fine-tune the scope, route and design of the network
based on our evaluation of customer demand. We have entered into agreements for
the construction and/or lease of fiber optic routes for the network in the
countries where we currently operate. We continue to negotiate rights-of-way and
other infrastructure arrangements in order to extend the network. We expect to
incur approximately $750 million in additional capital expenditures, including
capital lease obligations, through 2000 in connection with the build-out of the
network.
 
     In June 1998, we acquired our 75% interest in Ebone, a Danish company which
connects European Internet service providers to the Internet over its own
network. As of December 31, 1998, Ebone served 83 customers in 25 countries. As
part of the transaction, Ebone purchased approximately $100 million of long-
term capacity rights on Hermes Railtel's network. It will provide Ebone with
capacity of up to 622 megabits per second between the majority of European
cities that Ebone serves. Many of Ebone's existing customers own a portion of
Ebone's shares through an association.
 
     MANAGED BANDWIDTH SERVICES
 
     Hermes Railtel provides primarily large capacity cross-border European
circuits and transatlantic services to carriers and service providers over an
integrated, managed network. The Hermes Railtel network, based on dense
wavelength division multiplexing and synchronous digital hierarchy technology (a
form of packet switched transmission technology), provides digital transmission
capability upon which a broad range of advanced functionality may be built. The
Hermes Railtel network 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. Our network is designed to provide customers with a wide variety of
bandwidth speeds, ranging from a data transmission rate of 2.048 Mbps (or
millions of bits per second) to a data transmission rate of 2.5 gigabits per
second (or billions of bits per
 
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second). For more information on technology in the telecommunications industry,
see "-- Industry Overview -- IP Communications Technology."
 
     Point-to-Point Transmission Capacity. The current market for cross-border
transport is also served by international private leased circuits provided by
public telecommunications operators. Traditionally, such private leased circuits
are formed by combining half-circuits from two public telecommunications
operators between customer locations, often with additional public
telecommunications operators providing transit segments. Under such private
leased circuits, overall service quality guarantees generally are not provided
and only a limited range of bandwidth is available, usually only at a data
transmission rate of 2.048 Mbps, and in certain instances, at a data
transmission rate of 34 Mbps. We provide a Point-to-Point Transmission Capacity
service to our customers. We believe this service is a significant improvement
to private leased circuits because it provides a greater range of bandwidths
from 2,048 Mbps to multiples of 140 Mbps or 155 Mbps and allows customers to
choose a service level agreement which provides service guarantees appropriate
for their applications, including guarantees for on-time service delivery and
service availability.
 
     Our point-to-point transmission capacity consists of "integrated" and
"node-to-node" services. Our network integrated service provides an end-to-end
service between customer-specified locations where we arrange for the connection
between the network node location and the customer's location. The node-to-node
service can be selected when the customer prefers to provide its own connection
to the local network node location. In node-to-node service, we guarantee
service only on our network and not from our network node to the customer's
location. Our network prices for both services are competitive relative to
current service offerings. Our customers can choose flexible contract terms from
one to ten years in duration, with discount schemes designed to ensure that we
remain a cost-effective solution.
 
     Virtual Network Transmission Services. As the European marketplace
liberalizes and carriers and other telecommunications service providers plan to
expand their operations across Europe, a need arises for a flexible and
cost-effective means of telecommunications transport. Such service providers
have traditionally obtained international transport service by leasing
international private leased circuits. Leasing private leased circuits requires
a carrier to lease channels on a segment-by-segment basis from multiple public
telecommunications operators, linking the target cities under arrangements
having a fixed capacity and pricing structure for each segment of the carrier's
network. Private leased circuits have several disadvantages, including (1)
difficulty in obtaining discount/volume pricing schemes since there is no single
provider of pan-European coverage, (2) delays in implementation due to numerous
contractual negotiations and the need to interconnect numerous leased circuits,
(3) limited opportunities to lease high-bandwidth pan-European capacity and (4)
variability of quality due to the absence of a centrally managed single uniform
network. Telecommunications carriers could also construct their own network,
which is expensive, time-consuming and complex and which may not be justified by
traffic volume.
 
     Our network transmission service provides a new solution and an attractive
alternative to leasing circuits or building infrastructure. This service enables
our 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
our network with a pricing structure based on the overall amount of leased
capacity for the customer's entire network.
 
     Ring Service. Most medium to large carriers and operators purchase network
capacity in excess of actual requirements and prefer to have control over the
physical configuration of their networks. This service connects multiple
customer locations with multiple paths in a ring configuration. We provide the
customer with reliable and direct control over the paths dedicated to its
traffic within the ring and exclusive control over the routing. We can add
additional ring capacity with no service interruption and additional customer
locations with minimal service interruption. We can provide this ring service at
a very competitive rate compared to other point-to-point services. For a
discussion of the risks associated with the Hermes Railtel network technology,
see "-- Risk Factors -- The technology of the Hermes Railtel network could
become obsolete."
 
                                       10
<PAGE>   12
 
     INTERNET ACCESS AND IP TRANSPORT
 
     Ebone Internet Access Services. Internet service providers, which are
companies that provide Internet access to end-users, have purchased Internet
access from Ebone since 1991. Ebone has one of the largest installed bases of
Internet service provider customers in Europe. Building on the expertise
developed since the advent of the Internet in Europe, Ebone now offers Internet
service providers a high quality Internet access service with the following
significant features:
 
     - Reliable access to Internet service throughout Ebone's network, which is
       made possible by always dedicating excess bandwidth capacity on its
       network;
 
     - Access to other Internet networks through links with major Internet
       backbone providers in Europe and in the United States; and
 
     - Access speeds ranging up to 620 Mbps.
 
     IP Transport Services. We are developing IP transport services for service
providers that focus on building their own Internet backbone, Intranet or voice
over IP services. This IP traffic has been traditionally supported by a
combination of managed bandwidth services (like the ring or the point-to-point
services of Hermes Railtel's network) and Internet network services (like
Ebone's Internet services).
 
     Today, large service providers building their Internet networks demand the
speed offered by fiber infrastructure, the reliability of managed bandwidth
services and the flexibility of Internet network services.
 
     We intend to carry the international Internet traffic of service providers
between their private points of presence and/or Internet exchange points. We
expect these services to combine high quality transmission services with the
ability to upgrade transmission capacity and speed and to control configurations
which are the strengths of large Internet network providers. For a discussion of
the risks associated with the Hermes Railtel network technology, see "-- Risk
Factors -- The technology of the Hermes Railtel network could become obsolete."
 
     BUSINESS AND MARKETING STRATEGY
 
     The overall strategy of Hermes Railtel is to offer public
telecommunications operators and other carriers pan-European cross-border
telecommunications transport services. Our Hermes Railtel network provides a
vehicle through which a carrier can compete in markets where it does not own
infrastructure. Our primary service offering is the sale of large capacity
cross-border circuits to our customers. Our network's focus on carriers is
designed to complement and not compete with such carriers' own business
objectives in providing services to their end-users.
 
     As a result of our acquisition of Ebone, we are now accelerating our plans
to become a leading player in the provision of seamless transatlantic
city-to-city services in order to take advantage of the increased market demand
for low cost transatlantic city-to-city services. In 1998, we contracted for
long-term leased capacity on transatlantic cables linking the Hermes Railtel
network to North America. In addition, we intend to further increase our
transatlantic capacity through the purchase of capacity from the FLAG Atlantic
Limited joint venture. We also intend to invest further in extending and
increasing the capacity of the Hermes Railtel network.
 
     To establish ourselves as the leading provider of telecommunications
services to carriers within Europe, we offer our customers significantly higher
quality transmission and advanced network capabilities at a competitive price by
focusing on the following:
 
     - High Capacity Cross-Border Network Facilities. Our network is designed to
       offer our customers high capacity network facilities outside their
       domestic markets, providing cross-border capabilities without requiring
       customers to invest in network infrastructure or being constrained by a
       narrow range of capacity offerings. By utilizing dense wavelength
       division multiplexing technology over our network, we anticipate that,
       once fully deployed, this technology will enable our network to provide a
       minimum
 
                                       11
<PAGE>   13
 
       speed of 800 gigabits per second on all major routes. Options are in
       place to expand fiber capacity further on a number of routes.
 
     - Uniform Network Architecture. Our 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 under the control of separate, not necessarily compatible,
       network control systems. The Hermes Railtel network's uniform technology
       enhances service by providing quality and reliability as well as
       uniformity of features throughout the network.
 
     - Diverse Routing. We have designed our network over multiple routes to
       provide high levels of reliability so that if a failure occurs on one
       route, traffic can be diverted to an alternate route. The network is
       designed to provide availability of over 99.9% for most routes and to
       provide customers with a wide range of telecommunications transmission
       capacity. We believe that to achieve this level of reliability without
       the use of a network similar to Hermes Railtel's network, carrier
       customers would need to purchase additional dedicated circuits.
 
     - Rapid Provisioning. Our customers can quickly obtain additional capacity
       on our network. This ability to rapidly provide service is largely due to
       our development of capacity substantially in excess of our forecasted
       requirements.
 
     - Flexibility. Our services provide customers flexibility across Hermes
       Railtel's network so that the customer may minimize risk by enabling
       network rerouting, eventually even under customer direct control.
 
     - Advanced Technology. We are deploying dense wavelength division
       multiplexing and synchronous digital hierarchy technology that can be
       upgraded and will permit significant expansion of transmission capacity
       without increasing the number of fiber pairs on a network. This
       technology also provides the basis for structuring advanced operating
       features, such as virtual private network services and IP-based services.
 
     - Innovative Pricing. We believe that the price of high-bandwidth circuits
       on transborder European routes is artificially high and not necessarily
       related to the cost of such circuits. We offer competitive pricing with
       tailored contract terms and volume discounts. This allows our customers
       to plan more efficiently the fixed costs of their service portfolio. Our
       customers can select varying capacity, access, guaranteed availability
       and contract terms at competitive prices. Customers purchasing capacity
       from public telecommunications operators generally choose from a narrow
       set of capabilities under inflexible pricing plans.
 
     For a discussion of the risks associated with our business strategy, see
"-- Risk Factors -- We may encounter delays in implementing key elements of our
business strategy."
 
     PRICING AND DISTRIBUTION
 
     We primarily conduct sales of Hermes Railtel's services through Hermes
Europe Railtel (Ireland) Limited, a subsidiary.
 
     Currently, the price of cross-border pan-European calls is often
significantly higher than the underlying cost of transport and termination of
such calls and higher than the price of intra-country calls or transborder calls
to and from liberalized markets. The low cost of operating our network enables
us to attractively and competitively price services even as overall tariffs for
telecommunication services decline. Our low cost basis is a result of, among
other things, the application of new technologies to our network, which allows
us to operate our network with fewer employees than legacy networks.
 
     The term of a typical customer agreement currently ranges from one to three
years in length. The customer agrees to purchase, and we agree to provide,
cross-border transmission capacity. 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
                                       12
<PAGE>   14
 
contract term, the customer is generally required to pay us a cancellation
charge equal to three months' service for every twelve months remaining in the
contract term. We guarantee transmission services to a certain service level. If
such levels are not met or we fail to deliver service by the committed delivery
date, the customer is eligible for a credit against charges otherwise payable
for the failed link.
 
     CUSTOMERS
 
     At March 3, 1999, 54 customers were under contract for service on Hermes
Railtel's network, including public telecommunications operators and other
carriers, global consortia, Internet service providers and resellers. As of
December 31, 1998, our customers were contractually obligated to pay us an
aggregate of $418 million for future services, provided our network performs in
accordance with contractual specifications. We believe that the type and quality
of our customers validate our business plan and network concept and illustrate
the type of customers we expect to be attracted to the full network. The success
of our network to date also demonstrates the demand for cross-border transport
services. We are targeting seven major market segments or customer groups, which
can be characterized as follows:
 
     - Existing Public Telecommunications Operators. This customer segment
       consists of the traditional European public telecommunications operators
       that generally participate in the standard bilateral agreements for
       cross-border connectivity. We provide a vehicle for public
       telecommunications operators to compete in non-domestic markets. As of
       January 1, 1998, all public telecommunications traffic can be transported
       by carriers other than the domestic public telecommunications operator,
       thus vastly expanding the potential demand from public telecommunications
       operators for our services.
 
     - Global Consortia of Telecommunications Operators. Many of the largest
       public telecommunications operators 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 was to
       provide pan-European services to multinational business customers,
       including X.25/frame relay (high speed data network) service and voice
       services for a closed user group. We believe that we provide an
       attractive alternative at better pricing in those environments where such
       a consortium does not already own its infrastructure. Furthermore, we
       believe that we are 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.
       Existing customers in this segment include Teleglobe and targeted future
       customers include the United States regional Bell operating companies. We
       can provide these customers a pan-European distribution network to gather
       and deliver traffic to and from their own and other hubs.
 
     - Other Carriers.  This segment consists of other European carriers
       competing with existing public telecommunications operators, cable TV and
       mobile carriers and competitive access providers. These other carriers
       have chosen to compete with the incumbent public telecommunications
       operators in their respective countries. We believe that these other
       carriers will prefer to use the services of independent carriers such as
       ourselves to meet their cross-border telecommunication transport needs.
 
     - Internet Backbone Networks.  Internet backbone networks are providers of
       large capacity international connectivity services between Internet nodes
       (points of interconnection between local Internet service providers).
       These networks are a fast-emerging segment and are expected to generate
       significant demand for the services we offer. The Internet segment is
       experiencing significant growth in demand for transmission capacity.
 
     - Resellers.  Resellers are telecommunications service providers that do
       not own transmission facilities, but obtain communications services from
       other carriers for resale to the public. Resellers are a growing segment
       of the market and are expected to increase in conjunction with the
       liberalization of the
 
                                       13
<PAGE>   15
 
European telecommunications market. In the United States, for example, resellers
were a significant factor in the expansion of competition.
 
     - Other Service Providers.  We also target 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. Their basic network
       transmission requirement is to connect data switches or processors, and
       they currently purchase their own international circuits and build
       additional resiliency into their network infrastructure. We expect to
       allow them to meet these needs cost-effectively and to extend their
       services to new markets or customers without substantial capital
       investment.
 
     We expect 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 for small and medium-sized
businesses and emerging broadband applications such as cable TV programming
distribution (other than broadcast) to the end-user.
 
     NETWORK DESIGN
 
     Network Architecture. Our network design is based on a layered architecture
that separates physical, optical and telecom layers of our network with standard
interfaces in order to optimize design and operation and provide flexibility for
introducing new technologies, such as IP.
 
     Physical Layer. The physical layer of our network is based on a mesh of
routes comprised of dark fiber, or fiber optic cable that is not yet equipped or
activated for commercial use. When the network is completed, the physical layer
will interconnect cities on the network via at least two or three different
paths to minimize service interruptions when fiber or equipment failures occur.
In each major city, we intend to locate two additional customer access sites for
maximum reliability.
 
     Optical Layer. The optical layer of our network is based on dense
wavelength division multiplexing. This is a cost-effective technology that
substantially increases the capacity of an existing fiber optic network by
multiplying the number of signals that it can carry simultaneously.
Specifically, this layer:
 
     - supports the provision of optical services directly to customers at 2.5
       gigabits per second, representing the speed for digital signal
       transmission expressed in billions of bits per second; and
 
     - provides for the operation of multiple synchronous digital hierarchy
       transmission networks and/or IP systems to run concurrently on a single
       fiber pair in a highly cost-efficient manner. Ciena 40 wavelength systems
       are currently installed on our network in five countries with a potential
       capacity of 100 gigabits per second on a fiber pair.
 
     Telecom Layer. The synchronous digital hierarchy layer of our network,
running via dense wavelength division multiplexing channels in the core of the
network, and directly on fiber elsewhere, supports the provision of
point-to-point services to customers at speeds of 2 Mbps up to 155 Mbps. The
synchronous digital hierarchy layer is itself a multi-layered architecture
consisting of multiple synchronous digital hierarchy rings, or cables, which are
optimized for different telecommunications traffic characteristics. Each
synchronous digital hierarchy ring supports fully automatic re-routing of
traffic in the case of a break in the ring.
 
     We expect to add an IP layer to our network starting in the second quarter
of 1999. This layer will support high capacity IP routers, or computer devices
for routing packet-switched data traffic, which can deliver IP services to
customers at speeds up to 2.5 gigabits per second. These routers will be
supported on the dense wavelength division multiplexing layer of the network
directly and/or through asynchronous transfer mode technology in the core of our
network and on top of the synchronous digital hierarchy layer elsewhere. These
changes will also enhance the services that Ebone can offer to its Internet
service provider customers. We plan to extend our enhanced IP transport
capabilities to all cities on our network by 2000. This layer will be able to
handle failures independently of the lower layers by re-routing at the IP level.
 
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<PAGE>   16
 
     Our network is controlled by a single active network operations center in
Brussels, Belgium. We maintain a backup center in Amsterdam, The Netherlands
that has equivalent management systems continuously synchronized with the
primary center.
 
     Our network operations center can pinpoint potential service problems and
deal with service re-routing much more effectively than other networks that are
controlled by multiple operators in different countries. Our advanced
operational support systems also provide comprehensive support for:
 
     - managing the large number of network components and local repair
       organizations required for an extensive international network of our
       size; and
 
     - providing advanced customer support for customer operational activities.
 
     Overall, our combination of backup paths and management components enable
recovery from individual failures at the optical, synchronous digital hierarchy
and IP layers. Our resilient approach provides for a high level of network
performance and reliability. As a result, we are able to enter into strong
performance commitments with our customers, and services on most routes of our
network have performed at or above 99.9% availability.
 
     We expect to operate our network and to own substantially all of our
network equipment as well as some segments of the fiber optic cable. A
substantial portion of the fiber is leased from third parties on a long-term
basis. Long-term leases for fiber are advantageous to us because they reduce or
eliminate the costly burden of building large quantities of capacity before they
can be fully utilized. Where we lease dark fiber, the owner of such fiber will
generally be responsible for maintaining such fiber optic cable. In general, we
will enter into agreements with equipment vendors and infrastructure providers
and other third parties to supply and/or maintain the necessary equipment for
our network. For a discussion of the risks associated with the Hermes Railtel
network technology, see "-- Risk Factors -- The technology of our Hermes Railtel
network could become obsolete."
 
     NETWORK CAPACITY
 
     We are building our network to include Ciena 40 dense wavelength division
multiplexing systems on a majority of our routes. This allows for synchronous
digital hierarchy and IP systems of 2.5 gigabits per second to be installed only
when required, thus providing for efficient management of capital investment.
 
     Should capacity be required beyond the initial 100 gigabits per second on
the first fiber pair, we can bring additional fiber pair(s) into operation that
utilize either higher capacity dense wavelength division multiplexing systems at
2.5 gigabits per second or at 10 gigabits per second. Such systems have been
available on some routes on our network since 1998. The remaining routes are
planned to have this upgrade in 1999. We plan to have a minimum of two fiber
pairs on all routes. This approach will extend capacity as we implement it on
new paths and on selected existing paths over time.
 
     NETWORK AGREEMENTS
 
     We have entered into agreements and letters of intent with various
infrastructure providers for construction and/or leasing of dark fiber for
portions of our network. Our agreements for leases of portions of our network
typically require the infrastructure provider to provide a certain number of
pairs of dark fiber and in some cases facilities along our network route
commencing on dates we provide. 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. We are allowed to use the cable
for the transmission of messages and other purposes, including increasing
capacity. The infrastructure provider is responsible for maintenance of the
cable facilities. The infrastructure provider may also provide space for the
location of our equipment and related maintenance. The agreements typically
provide for termination by the parties only for material breach, but allow the
breaching party 90 days to cure their breach. The agreements typically contain a
transition period after termination of the agreement to allow us to continue to
serve our customers until we can reach agreement with an alternative
infrastructure provider. In certain areas of our network where it is not
possible to lease dark fiber, we have signed agreements or letters of intent for
the right to use managed
                                       15
<PAGE>   17
 
bandwidth. The terms of these agreements typically range from 10 to 25 years.
For a discussion of the risks associated with our network agreements, see
"-- Risk Factors -- We may incur losses on the leased portions of our network."
 
     We are also deploying our network along the rights-of-way of a variety of
alternative sources, including railways, motorways, waterways, pipelines and
utilities. We constantly evaluate multiple alternative infrastructure suppliers
in order to maximize our flexibility. Many portions of our network utilize
long-term right-of-way agreements with landowners. As a result of our network
development activities to date, we have gained access to infrastructure for our
network routes which we believe will be difficult for competitors to duplicate.
 
     LOCAL ACCESS
 
     We expect to provide customer access to our network primarily through our
Access Services line of business using synchronous digital hierarchy access
lines in those cities where Access Services will be present and the Hermes
Railtel network has nodes. Arrangements with our Access Services line of
business are expected to be on an arms length basis. In each city, as one of our
points of presence is deployed, we may contract with one or more suppliers to
provide local access service to customer locations. Currently, we have
contracted with a number of unaffiliated local access providers to connect our
network to intra-city networks. Pursuant to these agreements, we can offer our
carrier customers service from their premises in one city to their premises in
another city. Various local access network suppliers may also be interested in
linking the business centers in which they are active to our network. Therefore,
we believe that the relationships between ourselves and local access network
suppliers can benefit both parties.
 
  TRANSOCEANIC SERVICES
 
     In January 1999, we signed an agreement with FLAG Telecom, to establish a
50/50 joint venture to build and operate the world's first transoceanic dual
cable system designed to carry voice, high-speed data and video traffic at
speeds up to 1.28 terabits or trillions of bits per second. The high-capacity
fiber optic link between Europe and the United States, to be known as FLAG
Atlantic-1, is expected to begin offering services in the last quarter of 2000.
The joint venture plans to offer a direct link between New York City, London and
Paris, with connections to numerous other cities in the United States, Europe
and other countries in the Middle East and Asia Pacific. The project is subject
to financing, the execution of related agreements and other conditions.
 
     Construction of the initial 160 Gbps portion of FLAG Atlantic-1 will cost
approximately US$1 billion. Financing will be provided by a combination of
equity contributions and capacity purchases by the joint venture participants,
customer sales, and non-recourse bank debt. A contract to build the cable has
been awarded to Alcatel Submarine Networks, the general contractor. The system's
design allows for 160 Gbps incremental upgrades as demand warrants. Under the
terms of the joint venture agreement, we will be responsible for the
construction and maintenance of the land-based portion of FLAG Atlantic-1.
 
     The two subsea sections of the cable are approximately 5,900 kilometers and
6,350 kilometers for each link, with an overall system length of approximately
12,500 kilometers. The joint venture will provide links from the European
landing points to the cities of Paris and London where plans are for customers
to be able to connect to Carrier Services' network as well as to other networks
that customers may choose.
 
     BUSINESS AND MARKETING STRATEGY
 
     We believe that a large portion of Carrier Services' market growth will
come in the form of IP-based voice and data services. Because a majority of the
world's IP traffic originates in the United States, our Carrier Services line of
business has chosen to invest in its own capacity infrastructure through
Transoceanic Services' participation in FLAG Atlantic Limited. We believe that
owning a large volume of capacity will provide us with a competitive low cost
position to serve existing and future customers. We also intend to utilize FLAG
Atlantic Limited as a lessor of transatlantic capacity to Hermes Railtel, thus
extending the Hermes Railtel network at favorable prices. Transoceanic Services
will also provide backhaul services which it will market
 
                                       16
<PAGE>   18
 
through a newly developed sales force. For a discussion of the risks associated
with our business strategy, see "-- Risk Factors -- We may encounter delays in
implementing key elements of our business strategy."
 
     CUSTOMERS
 
     In addition to selling capacity to Hermes Railtel, Transoceanic Services
intends to target customers, including emerging alternative carriers, incumbent
telecommunications carriers and Internet service providers that require high
quality dedicated transmission capacity to major commercial and financial
centers. Sales will be made with our direct sales forces, as well as through
indirect channels.
 
  IP SERVICES
 
     In order to capitalize on the projected growth in IP voice and data
transmission services and to take full advantage of Hermes Railtel's network, as
well as its Ebone subsidiary and transoceanic capacity, we intend to offer
IP-based services to telecommunications carriers, businesses and other high
usage customers. We have recently developed a strategic plan which envisions
progressing from a service offering focused on IP transport to one which focuses
on value-added IP-based service offerings.
 
     PRODUCTS AND SERVICES
 
     We intend to offer a broad array of competitively priced comprehensive IP
services to meet our customers' requirements.
 
     - Connectivity. Connectivity services may include dial-up and dedicated
       access, IP transport, voice over IP, fax over IP, virtual private
       networks and IP clearinghouse services;
 
     - Network and Management Services. These services may include security and
       network integration as well as router and server management, billing and
       information services to managed IP networks; and
 
     - Value Added Services. These services may include web hosting,
       collocation, unified messaging and basic Internet service provider
       services such as newsgroups, mail, groupware and directory services. We
       are also considering metering and billing services as well as e-commerce
       and call center applications.
 
     BUSINESS AND MARKETING STRATEGY
 
     We estimate that a large portion of our market growth will come in IP-based
voice and data services. These services will range from Internet access and IP
transport to value-added services such as e-commerce and unified messaging. We
expect to use a number of complementary strategies to enter these service
markets, including:
 
     - acquisition or partnership with emerging providers of value-added
       services and IP-based application companies;
 
     - expansion of Internet access and IP transport capabilities and service
       offerings;
 
     - development of a full web hosting capability either through acquisition,
       partnership or our own development; and
 
     - expansion of virtual private network, intranet and extranet service
       offerings.
 
     For a discussion of the risks associated with our business strategy, see
"-- Risk Factors -- We may encounter delays in implementing key elements of our
business strategy."
 
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<PAGE>   19
 
GTS BUSINESS SERVICES
 
  OVERVIEW
 
     Through our Business Services line of business we provide high quality,
competitively priced long distance voice and fax services for retail business
customers to worldwide destinations and network management, access and
termination services to telecommunications service providers such as calling
card companies and resellers in the United Kingdom, Germany, The Netherlands,
Spain, France, Italy, Norway, Sweden, Belgium, Denmark and Ireland. We provide
these services using our switches, fiber optic cable and other infrastructure,
as well as leased lines and capacity provided by other carriers and service
providers. We established our Business Services customer base and sales network
and acquired additional switches, routers and other infrastructure through the
recent acquisitions of Esprit Telecom and NetSource.
 
     We are in the process of developing our plans for integrating Esprit
Telecom and NetSource into our Business Services, Carrier Services and Wholesale
Services lines of business. We may have one or more of our other entities
purchase assets from Esprit Telecom as part of our strategy. Any such
transaction must be effected in accordance with the applicable covenants in the
indentures governing the Esprit Telecom 11.5% senior notes due 2007 and 10.875%
senior notes due 2008. In addition, we may also decide in the future to execute
a tender or exchange offer or consent solicitations with respect to these notes,
if we determine that it is advisable to better integrate Esprit Telecom into our
overall corporate structure.
 
  PRODUCTS AND SERVICES
 
     We currently offer a range of telecommunications services to two targeted
business customer segments: (i) retail business customers consisting of small,
medium and large-sized businesses, governmental agencies and other organizations
with significant international traffic and (ii) telecommunications service
providers and resellers. We have recently introduced a new category of
service -- enhanced services -- to complement our established telecommunications
services and products. In some markets, we plan to target small and medium-
sized enterprises, small and home offices and high-value residential customers.
 
     Retail Services. The largest share of the business and corporate retail
market is currently international voice and fax transmission services. In most
of our Business Services markets, we also provide our retail clients with
national long distance services. As we integrate Esprit Telecom and NetSource
and build out local access in targeted metropolitan markets throughout Europe,
we intend to provide our retail clients with seamless national and international
city-to-city service through our Carrier Services and Access Services
infrastructure. We believe that customers have selected us as a provider on the
basis of competitive pricing, network quality, responsive account management and
customized services. See "-- Competition Faced by Our Lines of Business."
 
     We distinguish our retail business customers between direct access retail
customers and indirect access retail customers. Our direct access customers use
our owned or dedicated leased lines, while our indirect access customers access
our services indirectly on a switched basis using the public telecommunications
operator network by means of an access code. Our direct access retail customers
are generally users of telecommunication services who generate relatively large
amounts of long distance traffic, with such traffic usually being important to
the execution of their core businesses. We offer retail direct access in all of
our existing Business Services markets.
 
     Our indirect access retail clients access our services by dialing an access
code, generally either using an auto dialer or via a code programmed directly
into their own switches so that it is transparent to the user. These customers
generally consist of small and medium-size businesses whose telecommunication
requirements do not warrant the costs associated with the dedicated leased lines
of direct access service. Contracts for both direct and indirect access are
typically for a period of one year. See "-- Business and Marketing Strategy
-- Target High Users of Long Distance Traffic." For a discussion of regulatory
issues relating to the provision of retail indirect access services, see
"-- Licenses and Regulatory Issues."
 
     Service Provider/Reseller Services. We provide network management, access
and termination services to a number of telecommunications service providers,
such as calling card companies and Internet service
 
                                       18
<PAGE>   20
 
providers, and to resellers which distribute our telecommunication services to
customers with average monthly revenue levels below those that we currently
target. These companies are typically marketing-focused rather than
network-focused, and we are able to provide a high degree of telecommunication
support to such providers, including stationing their equipment at our switch
sites, incoming call verification and bill generation. In some cases, these
customers use competitor carriers to either seek lower costs overall or to have
backup services. Contracts for our service provider and reseller services are
typically for a period of one year.
 
     Enhanced Services. We focus on developing new products and services which
address the specific needs of our customer base including calling cards, an
international toll free service and itemized billing, which we target to
organizations that require their customers or employees to be able to simply and
cost-effectively call them from other countries. We plan to introduce additional
services, including unified messaging, interactive voice services, prepaid
calling cards and prepaid mobile phone services. Our target customers include
calling card operators, hotels and information technology companies. In
addition, we provide itemized billing and detailed costing for accounting and
control purposes, national freephone services, as well as limited prepaid and
account-based calling card services in some markets, and limited data services
on a trial basis.
 
     Fixed-to-Mobile Traffic. This service allows our Business Services
customers with a router to place calls to cellular phone subscribers at more
favorable rates than if they were placed directly to the relevant cellular phone
service through the public telecommunications operator. Due to the relatively
high penetration of cellular phones throughout Europe, the cost of calls to such
phones are an increasingly significant part of companies' total telephony costs.
Consequently, we believe that this service will continue to prove attractive.
 
  BUSINESS AND MARKETING STRATEGY
 
     In order to achieve our objective of becoming one of the largest
pan-European independent telecommunications service providers to business and
other high-usage customers, we intend to implement the following strategies:
 
     TARGET HIGH USERS OF LONG DISTANCE TRAFFIC
 
     We have an established retail customer base of leading international
businesses, organizations and governmental agencies, including a number of
international financial institutions and large global hotel chains. We intend to
continue to focus a significant part of our retail marketing efforts on medium-
to large-sized businesses, governmental agencies and other organizations that
have extensive telecommunications needs and which typically generate long
distance telecommunications expenditures in excess of $5,000 per month. We will
increasingly focus our marketing efforts on small to medium-sized enterprises
that utilize significant amounts of long distance services, and plan to target
small offices and home offices and high value residential customers in certain
countries. We believe that these market segments offer significant
opportunities, because a substantial portion of them have traditionally been
under-served by the public telecommunications operators.
 
     PROVIDE CUSTOMER VALUE AND SERVICE
 
     We seek to offer our business services to our customers not only at a
discount to the prices charged by public telecommunications operators, but with
a level of service superior to that provided by such other service providers. We
believe that providing a high level of customer service is a key element in
establishing customer loyalty and attracting new customers. We focus on
providing individual attention to potential and current customers, beginning
early in the sales cycle and continuing throughout a customer's relationship
with us. We offer each client direct, personalized service to ensure full access
and a smooth transition to the services we provide.
 
     DEVELOP OUR PRODUCT AND SERVICES PORTFOLIO
 
     We seek to develop new products and services which address the specific and
changing needs of our current customer base and to attract and retain new
customers. Our infrastructure gives us the flexibility to offer new products and
services without undertaking major network modifications, and we believe that we
are
                                       19
<PAGE>   21
 
well positioned, both from a technical and marketing perspective, to add
additional products and service offerings. The provision of national long
distance services is one of our rapidly growing businesses and we expect that
this will offer us major opportunities, as liberalization leads to more
favorable public telephone operator connection rates in Europe.
 
  NETWORK AND OPERATIONS
 
     Through our acquisitions of Esprit Telecom and NetSource, we have acquired
a core infrastructure network for providing services to business customers. This
consists of three components: the switching equipment, the transmission
infrastructure and network between those switches, and systems to support the
management of the network.
 
     SWITCHING EQUIPMENT
 
     We utilize advanced digital switching equipment and network routing
architecture from recognized industry manufacturers to form a reliable network
platform for the delivery of quality telecommunications transmissions. We own
and operate three switches at switching centers in London, Dusseldorf and
Amsterdam for switching national and international long distance calls. We own
and operate a switch in Mannheim, Germany and a switch in Dublin, Ireland for
switching national and international long-distance calls. We have has also
acquired additional switches, in Dusseldorf, Frankfurt and Hamburg. We have
installed and are currently testing additional switches which have been
installed in Paris and Barcelona. We will add more switches to the network as
traffic flows, capacity and business conditions warrant and as we expand into
new markets.
 
     We continuously evaluate developments in switching technology and products
offered by other companies, and will add different platforms which are
complementary and beneficial to our service network. We maintain our switches
with up-to-date software and ensure their compatibility with the large number of
signaling systems in use in the European and United States markets. Using
least-cost routing technologies, each switch is programmed to select the most
cost-efficient route or carrier for the required destination. We also employ
dynamic compression equipment to improve utilization of our most costly
transmission lines.
 
     TRANSMISSION INFRASTRUCTURE AND NETWORK
 
     We currently maintain network sites in 31 locations in 11 European
countries, 11 of which locations are primary switching centers and 20 are local
points of presence, as well as network connections to certain carriers located
in the United States. In most cases, network sites are situated at the site of
the sales offices. We intend to extend the reach of our services network by
linking new sales offices and terminating sites with a view to providing
seamless and cost-effective transmission. Overall management of our services is
carried out centrally from our network management center in the United Kingdom,
with additional support staff based locally to facilitate complete oversight of
all network functions. Thus, we are able to evaluate current and projected
traffic patterns in order to establish buildout priorities.
 
     One of our key services is least cost routing. The equipment required to
provide this service consists of a small programmable call router which is
connected to the PBX of a corporate customer or, in the case of a smaller office
without a PBX, connected directly to an outbound telephone cable. In certain
service areas such as The Netherlands, we also market telephone equipment with
routing technology already incorporated into the equipment (called a dialer). We
offer different types of routers depending on the market being served and local
technological requirements.
 
     MONITORING AND MAINTENANCE
 
     From our network management center in the United Kingdom, we monitor our
equipment and facilities and provide technical assistance and support 24 hours a
day, year-round. Various quality measures are monitored on an ongoing basis,
with the aim of identifying problems at an early stage before they affect the
customer. Through the use of sophisticated network management equipment, we are
able to effectively control
 
                                       20
<PAGE>   22
 
bandwidth and provide diagnostic services. We use an internal staff of
technicians both to install and repair electronics and to provide service to
customers.
 
     NETWORK RESILIENCE
 
     Our network infrastructure is designed to provide resilience through
back-up power systems, automatic traffic re-routing and computerized automatic
network monitoring. If our network experiences a failure of one of its links,
the routing intelligence of the switch is designed to enable the call to be
transferred to the next choice route or, if all other routes are unavailable, to
the public switched telephone network, thus ensuring call delivery without
affecting the customer.
 
  SALES
 
     The local managing directors in each country are responsible for all local
sales activities and local marketing, local regulatory compliance and licensing
requirements, and the relationship with the local telecommunications companies.
A central marketing organization is responsible for coordinating the country
market initiatives, driving product development, market research and analysis,
and promotion and advertising. From our network management center in the United
Kingdom we provide transmission, technical support and billing services to each
of our sales offices and terminating sites. In addition, our network management
center is also responsible for the implementation, upgrading and functionality
of information technology systems (including the billing and management
information systems).
 
     Direct sales constitute our principal sales method in the United Kingdom,
Germany, Spain, France, Belgium, Luxembourg, Italy, Sweden, Norway, Denmark, The
Netherlands and Ireland. We support our direct sales effort by telemarketing and
telesales, and complement it to a lesser extent by independent sales
intermediaries and resellers. In Sweden, Denmark and Norway we market our
products and services principally through sales agents. In addition, because we
have begun to increase our focus on specific industry groups, such as financial
institutions, hotels, travel service organizations and transport companies, we
have assigned specialists to particular industries.
 
     We currently operate in eleven countries that account for approximately 80%
of the international long distance telecommunications minutes that originated in
EU member states in the 1998 calendar year, and maintain sales offices in 42
cities. Each country's sales operation is run as a profit center by a country
manager, and varies from smaller operations in the early stages of development,
to fully operational businesses in the more developed markets consisting of
support and sales staff, as well as customer service personnel. The sales
operation in each country is responsible for originating and managing business
in its respective local market, and is staffed with employees who understand our
Business Services line of business, philosophy, products and systems and local
telecommunication systems and products, business practices, languages and
customs. As of December 31, 1998 we had approximately 245 direct sales people,
300 sales agents and 150 full-time equivalent telemarketing employees in our
Business Services line of business.
 
     The United Kingdom. From sales offices in London, Reading, the Midlands,
Manchester and Glasgow, we currently offer both direct and indirect retail
access and service provider and reseller services to all international and
national long distance destinations in our Business Services line of business.
 
     Germany. We offer both direct and indirect retail access and service
provider and reseller services to all international and national long distance
locations and through NetSource, we also provide services to small-office and
home-office and residential customers. In addition, we offer retail services to
businesses through six regional sales offices located in Frankfurt, Hamburg,
Berlin, Munich, Oberhausen and Stuttgart and through relationships with
third-party distributors. In June 1998, Esprit Telecom acquired the switch-based
telecommunications services business of Plusnet, which at that date offered
national and international long distance voice telephony to approximately 700
business customers.
 
     The Netherlands. We have sales offices in Amsterdam, Rotterdam, Leiden,
Zwolle, Eindhoven and Venray. We currently offer both direct and indirect retail
access, wholesale and service provider and reseller services to all
international and national long distance destinations.
 
                                       21
<PAGE>   23
 
     Scandinavia. We operate in Sweden, Norway and Denmark as a reseller,
providing our business customers with indirect retail access and service
provider and reseller services to all international and national long distance
destinations using least cost routing.
 
     Spain. We operate one of the few alternative telecommunications providers
currently operating in the Spanish market. From sales offices in Madrid,
Barcelona and Bilbao, we currently offer both direct and indirect retail access
and service provider and reseller services to all international and national
long distance destinations.
 
     France. We operate sales offices in Paris, Lille, Lyon, and Strasbourg. We
currently offer both direct and indirect retail access, wholesale and service
provider and reseller services to all international and national long distance
destinations.
 
     Belgium. From sales offices in Brussels and Antwerp, we currently offer
direct and indirect retail access wholesale and service provider and reseller
services to all international and national long distance destinations.
 
     Italy. From a sales office in Milan, we currently offer direct and indirect
retail access to all international and national long distance destinations.
 
     Ireland. From sales offices in Dublin and Cork, we offer both direct and
indirect retail access services to all international and national long distance
destinations.
 
  BILLING AND MANAGEMENT INFORMATION SYSTEMS
 
     Our detail records for customers we acquired through the acquisition of
Esprit Telecom are collected and backed-up locally and transmitted to the
internal billing center in the United Kingdom for processing. Call records are
transmitted electronically to Tel Labs Inc., a data processing company in the
United States, for final processing of customer records, which are then returned
for verification, printing and distribution to customers. In 1997, we began to
consider an upgrade to our information and management systems, which we believed
to be required in order to provide the capability and flexibility to support our
anticipated growth. We have selected a new customer care and billing system from
Seville Systems, a billing system vendor headquartered in Edmonton, Canada. The
new system is undergoing final customization and testing. The introduction of
the new system will be accompanied by additional systems designed to support the
critical service activation, customer care and service assurance processes. We
expect that investment will continue with major additional systems in the
billing, customer care, network management, product management, prospect
management and information systems areas being introduced over the next several
years. We expect to integrate the acquired legacy billing systems at NetSource
and Esprit Telecom into our new Business Services billing process by mid-1999.
See "-- Risk Factors -- Dependence on effective billing and management
information systems."
 
GTS WHOLESALE SERVICES
 
  OVERVIEW
 
     By utilizing the existing infrastructure of Esprit Telecom, we are creating
a sixth line of business to be known as Wholesale Services. Wholesale Services
will provide international traffic termination services to other
telecommunication carriers, including public telecommunications companies, new
operators, global alliances and regional telephone companies, to which it is
able to provide highly responsive and flexible services. Wholesale traffic will
enable us to benefit from greater purchasing power and higher network
utilization. Through our Wholesale Services line of business, we will integrate
the wholesale services activities of Esprit Telecom with the international
switching and transit service activities of GTS -- Monaco Access. At a later
date, our Wholesale Services line of business will also incorporate the
wholesale activities of NetSource.
 
     Through our Wholesale Services line of business, we offer competitively
priced international switching and transit services, primarily to the
"wholesale" international gateway and carrier-to-carrier portion of the
 
                                       22
<PAGE>   24
 
international calling market, as distinguished from "retail" services offered to
end-users. These services include:
 
     - international switched traffic;
 
     - international private lines;
 
     - facilities management, including billing, customer management and fault
       reduction systems;
 
     - resale distribution for Internet service providers; and
 
     - prepaid calling card platform services.
 
     Wholesale customers are other international and national carriers that
connect with Wholesale Services to carry their traffic to destinations where our
rates are competitive, both on the Hermes Railtel network and on other
off-network routes. Wholesale Services has contracts with these customers, but
they generally do not include minimum usage levels. Our wholesale customers
generally maintain relationships with a number of telecommunications providers.
In several cases, Wholesale Services will also use its wholesale customers as
suppliers for termination of its off-network calls. We believe that success in
the wholesale business is predicated on high network quality at a low cost base.
At present, the majority of our Wholesale Services' wholesale customers are
located throughout Europe. We expect that demand for our Wholesale Services line
of business will further increase in other European markets as these markets
mature. As we continue to increase the capacity of Hermes Railtel's network, we
anticipate that our resultant cost base will enable us to price our wholesale
services more competitively and therefore increase the volume of such services.
 
     Our partner in GTS-Monaco Access, SNF, is an investment fund designated by
the Principality of Monaco to represent its interests. We exercise operational
control of the joint venture, and provide managerial and financial support,
international telecommunications expertise and strategic planning. We are
currently in negotiations with the Principality of Monaco to terminate the
GTS-Monaco Access joint venture and transfer its customers and revenues to the
UK as we combine with Esprit's wholesale activities.
 
     By utilizing our Carrier Services and Access Services networks as well as
over 25 third-party carriers in London and 40 third-party carriers across Europe
and North America, we provide telecommunications termination to destinations
world-wide and a wide range of alternative routing paths that facilitate cost-
effective termination and ensure reliability and increased call/termination
success rates. Calls are carried from the entry switch point to the switch point
from which the call can be terminated most economically. If this exit switch
site is within the country of the termination, we consider the call to be an
"on-net" call, whereas we otherwise consider it to be an "off-net" call. Off-net
calls are passed on to other carriers for transmission and termination. In
general, we realize higher gross margins with respect to on-net calls because we
utilize our own infrastructure. We expect that the expansion of the our Carrier
Services and Access Services networks will allow us to increase the proportion
of on-net calls as well as further reduce the cost of these calls.
 
  BUSINESS AND MARKETING STRATEGY
 
     Our strategy for developing our Wholesale Services line of business
includes the following:
 
     - Develop Advanced Carrier Services Offerings. Wholesale Services may
       develop its "advanced carrier services" offerings to include global 0800
       services and international free phone services, which we believe will
       broaden customer relationships, enhance revenues and help to protect us
       from price-based competition.
 
     - Develop Relationships to Broaden Service Offerings. Our Wholesale
       Services line of business may develop relationships to broaden its
       service offerings. Wholesale Services has entered into agreements with
       UUNET, one of its gateway customers, to provide wholesale Internet access
       to Wholesale Services' carrier customers in a number of Western European
       countries. The agreement allows these services to use the same brand
       names as those of our affiliates.
 
                                       23
<PAGE>   25
 
     - 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.
       Wholesale Services intends to price its services competitively with the
       prevailing price for comparable inter-public telecommunications operators
       transit and gateway services. Wholesale Services is not bound by legacy
       systems, infrastructure and personnel levels and can, therefore, manage
       competitive cost operations.
 
     - Attractiveness of Independence. Because our Western European activities
       are not affiliated with any of the major consortia or large Western
       European telecommunications companies, our Wholesale Services line of
       business may be considered 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 Internal Opportunities. Wholesale Services may collaborate with
       our other companies in Europe and the CIS. Wholesale Services is expected
       to realize significant reductions in its cost structure through access to
       low-cost European transmission capacity through an alternative
       infrastructure provider such as Hermes Railtel. Wholesale Services will
       act as the international carrier for traffic generated by our other lines
       of business.
 
     For a discussion of the risks associated with our business strategy, see
"-- Risk Factors -- We may encounter delays in implementing key elements of our
business strategy."
 
  TARGETED CUSTOMERS
 
     Targeted customers for our Wholesale Services line of business include:
 
      - Non-Affiliated Public Telecommunications Operators. We believe that
        various large American and Western European public telecommunications
        operators that lack adequate international switching and transport
        facilities of their own may be persuaded to purchase international
        services from Wholesale Services rather than from competing public
        telecommunications operators or consortia;
 
      - Mobile Carriers. We believe that some of the alternative mobile
        carriers, which currently provide only a small percentage of Western
        European mobile telecommunications traffic, may prefer the "independent"
        international gateway service offerings of Wholesale Services to those
        of their public telecommunications operator competitors;
 
      - Internet Service Providers. Growth in Internet usage creates a
        significant opportunity for a nonaligned Internet access provider such
        as Wholesale Services, since many Internet service providers will be in
        direct competition with public telecommunications operator-owned
        services in large European markets;
 
      - Second Carriers/Resellers. We believe that many second carriers will
        seek to enter new markets quickly without investing in international
        switching capacity; and
 
      - Established Public Telecommunications Operators. This customer segment
        will be a niche market for Wholesale Services. As markets are
        deregulated and carriers become increasingly competitive, opportunities
        may emerge to leverage our non-aligned status to route traffic between
        those new competitors.
 
                                       24
<PAGE>   26
 
GTS ACCESS SERVICES
 
  OVERVIEW
 
     Through Access Services, we intend to capitalize on our experience in
developing and operating local telecommunications networks in Russia and Central
Europe by building, acquiring or leasing technologically advanced fiber optic
networks in order to provide local access services in up to 12 metropolitan
markets throughout Europe, by 2001. We presently provide local telecommunication
access infrastructure and leased lines in several cities in Russia, the CIS and
Central Europe, including Moscow, St. Petersburg, Kiev, Prague and Budapest.
Currently, the regulatory regimes in Europe vary from country to country and
some countries do not permit alternative providers of local access to operate.
 
  PRODUCTS AND SERVICES
 
     Together with our Business Services line of business, we intend to offer
through Access Services a broad array of competitively priced, comprehensive
services to meet customer telecommunications service requirements, including
private line services, local, national and international switched telephony
services, high-speed local access network interconnection services, virtual
private network services, video transmission services and IP-based services,
including voice over IP, web hosting and data transmission services. According
to industry sources, demand for data transmission in the United States is
currently growing much faster than voice, and we expect that this trend will
develop in Europe as competitively priced telecommunications services become
available. In addition, we intend to develop competitively priced value-added
telecommunications services that are tailored to the specific needs of
individual customers.
 
     The types of services that we intend to offer in combination with our
Business Services include:
 
     - Switched Services. Switched services involve the transmission of voice,
       data or video to locations specified by end-users or carriers. Through
       our Business Services, we have the technological capability to offer a
       full range of switched service, including local, national and
       international calls as well as enhanced services. We intend to own and
       operate switches and enter into interconnection agreements with other
       telecommunication service providers and carriers, including Hermes
       Railtel's network, in order to offer to customers cost-effective local,
       national and international calling services. Switched service features
       are expected to include, to the extent allowed by local regulations,
       enhanced services such as conference calling, call forwarding, analog or
       digital connectivity, desk-to-desk calling, four digit dialing, full
       network monitoring and maintenance, caller ID, voice mail/messaging and
       e-mail to voice-mail conversion.
 
     - Non-Switched Services. Non-switched services involve a fixed, dedicated
       communications link between two or more specific locations. Businesses
       commonly use this service to obtain a private direct link between
       multiple business facilities or to another end-user/carrier. We expect to
       provide high capacity, advanced technology to deliver customer traffic
       with a lower cost and higher reliability as compared to the local public
       telephone operator. Through a highly reliable and cost-efficient network
       that can carry significant amounts of capacity, we intend to provide
       non-switched voice, data and video transmission between (1) end users,
       (2) end users and carriers and (3) multiple carriers, allowing our
       customers the option to bypass the older, less efficient technology and
       higher priced services of the incumbent public telecommunications
       operators.
 
     - Other Services. We also intend to develop service offerings to take
       advantage of new market opportunities. We expect such services to include
       one or more of the following: high speed data transmission services,
       IP-based services, including Internet for multi-media applications, Web
       hosting, voice over IP, calling card services, and enhanced voice
       services. These products are expected to be developed and offered as
       customer demand dictates and as the relevant regulatory environment
       permits. We believe that there will be substantial demand for data and
       Internet services by large business and other high-usage customers, and
       that a bundled service offering of national and international data and
       voice services will be attractive to this targeted customer base.
 
                                       25
<PAGE>   27
 
  BUSINESS AND MARKETING STRATEGY
 
     We believe that the size and growth potential of the European
telecommunications market, and the increasing liberalization of
telecommunications regulations in Europe, offer considerable opportunities to
expand into the provision of local access to retail customers in metropolitan
markets throughout Europe.
 
     Our strategy for entering into a specific metropolitan market will be
determined through an analysis of a number of demographic and economic factors,
including:
 
     - business concentration;
 
     - presence of governmental, financial and business customers;
 
     - local economic trends and prospects;
 
     - demand and spending for switched and non-switched voice, data and video
       telecommunications services;
 
     - feasibility of construction;
 
     - presence of existing and potential competitors;
 
     - the regulatory environment;
 
     - the market's proximity to the Hermes Railtel network; and
 
     - the presence of local access companies that may be potential acquisition
       candidates.
 
In targeting cities in which our entry strategy will be the construction of a
fiber optic cable network, we will initially focus on cities in which there are
no competitive local exchange carrier competitors providing local access
services or only one other such competitor. Our current intention is to enter
two metropolitan markets by the end of 1999 and to provide services in up to 12
target metropolitan markets by 2001.
 
     We expect to use one or more of the following strategies to enter a market:
 
     - constructing a fiber-loop network;
 
     - purchasing or leasing fiber optic cable which has not been equipped or
       activated for commercial use;
 
     - obtaining licenses for telecommunications networks utilizing microwave
       transmissions; or
 
     - forming partnerships with or acquiring providers of local access services
       that own and operate their own fiber loops and network equipment.
 
  CUSTOMERS
 
     We plan to offer local access and other telecommunications services
primarily to telecommunications-intensive businesses for which reliable
telecommunications services are critical, as well as to our Carrier Services and
Business Services lines of business. We will use our fiber switches and other
equipment where available and/or reselling other carriers' equipment as needed.
These businesses include financial services companies, multi-national companies,
governmental agencies, resellers, Internet service providers and wireless
communications companies.
 
  NETWORK
 
     In those markets in which we determine to build our own fiber loops, we
intend to construct, acquire or lease facilities to operate advanced,
competitive local telecommunications networks employing current transmission
technology with dual ring architecture and central system monitoring and
maintenance. We believe that a base of uniform, reliable networks, which employ
the most current technology and support a broad array of high quality services,
will allow us to compete cost-effectively against products and services offered
by public telecommunications operators and, in certain markets, other
competitive providers of local access.
                                       26
<PAGE>   28
 
     Our plan for our basic transmission platform is fiber optic cable deployed
in rings, equipped with high-capacity synchronous digital hierarchy equipment.
Such rings will provide redundancy by using dual paths for telecommunications
transmissions and will extend to a customer facility either directly or on a
point-to-point link from the rings. Such rings will finally connect to the
customer through customer-dedicated or shared electronics on or near the
customer premises.
 
     NETWORK CONSTRUCTION
 
     Prior to undertaking acquisition or construction of a network in a
particular market, we will undertake an analysis of a number of factors, as
discussed above, to determine whether such acquisition or construction is
economically justifiable. Wherever appropriate, we will seek to purchase or
lease fiber optic cable that is not equipped or has not been activated for
commercial use or utilize high-frequency short-haul microwave transmissions as a
method of accelerated entry into a selected market.
 
     We expect that we will contract construction and installation services to
independent contractors selected through a competitive bidding process. Our
personnel are expected to provide project management services, including
contract negotiation, construction supervision, testing and certification of
installed facilities. The construction period of a network is expected to vary
greatly, depending on such factors as network route kilometers, number of
buildings involved in the initial installation and local construction
regulations. Upon completion of the first phase of construction, or the initial
loop, we expect to commence generating revenue. Further expansion of the network
will be dictated by customer growth and customers' relative proximity to the
initial loop.
 
     Our initial capital requirement to develop our Access Services business in
Europe will be financed with a majority of the proceeds from our July 1998 stock
and convertible debt offerings. In addition, we contemplate that we will raise
additional financing, the proceeds of which will be applied toward the
construction of our local access infrastructure. We have not yet determined the
size and timing of such financing. We cannot estimate with any degree of
certainty the amount and timing of our future capital requirements for the
development of our Access Services line of business, which will be dependent on
many factors, including the success of our Access Services business, the rate at
which we expand our networks and develop new networks, the types of services we
offer, staffing levels, acquisitions and customer growth, as well as other
factors that are not within our control including competitive conditions,
regulatory developments and capital costs. We believe that as we develop, our
Access Services line of business, it is likely that we will need to raise
additional capital. See "-- Risk Factors -- We may be unable to raise additional
capital necessary to implement our business strategy."
 
  SALES AND MARKETING
 
     In each of our target markets, we intend to establish our own direct sales
force. As we will be targeting large financial, corporate and governmental
customers with demanding telecommunications service requirements, we expect that
our internal sales force will include dedicated sales and customer service
representatives. Our Access Services sales force will offer direct local access
to Business Services customers in those metropolitan markets in which our Access
Services builds local fiber loops. In addition, our Access Services will work
closely with our Business Services to identify key customers and develop joint
service offerings.
 
  GTS ACCESS SERVICES IN CENTRAL EUROPE
 
     In Central Europe, we currently provide private data communications
services to government and commercial customers in Hungary, the Czech Republic,
Slovakia and Romania. In the Czech Republic, we provide outgoing voice services
and high-speed Internet access to business customers and operate an
international gateway and a data services network. In Hungary, we provide data
transmission services through a nationwide microwave network and a
satellite-based network installed at customer sites throughout the country. We
plan to develop two fiber loops in Budapest. Subject to certain regulatory
approvals, we have also obtained a license to provide international data
services in Poland and expect to begin operations during the first quarter of
1999.
 
                                       27
<PAGE>   29
 
     In January and February 1999, we acquired an interest in two Internet
providers in Central Europe, DataNet in Hungary and NetForce in the Czech
Republic. In addition, we also acquired interests in two of the largest Internet
service providers in Poland, Internet Technologies and ATOM.
 
     Our strategy in Central Europe is to expand our service offerings as the
regulatory environment permits, utilizing our existing infrastructure where
possible and providing a broad range of services to our target markets. The
establishment of competitive providers of local access in various Central
European cities is a major component of this strategy.
 
  BILLING AND INFORMATION SYSTEMS
 
     Sophisticated information and processing systems will be vital to the
success of Access Services. Specifically, we will need to develop systems to
enter, schedule, provision, and track a customer's order from the point of sale
to the initiation of service and such systems will need to include, or interface
with, trouble-shooting systems, management, billing, collection and customer
service systems. We expect the development of our systems to require substantial
capital and management resources. See "-- Risk Factors -- Dependence on
effective billing and management information systems."
 
GTS BUSINESS SERVICES - CIS AND MOBILE SERVICES - CIS
 
     We provide digital voice, data, Internet and local services in Moscow
through our Sovintel, Sovam and TeleCommunications of Moscow ventures and
provide these same services to fourteen additional cities in the CIS through our
TeleRoss long distance network. We continue to evaluate the business environment
in Russia and the CIS for possible attractive opportunities for investments that
may complement our existing operations in Russia and the CIS. We continuously
consider a number of potential transactions, some of which may involve the
contribution of certain of our Russian businesses in exchange for an interest of
equivalent or greater value in the surviving entity and, if consummated, may be
material to our operations and financial condition.
 
  BACKGROUND ON THE POLITICAL, ECONOMIC AND TAX ENVIRONMENT IN RUSSIA
 
     Political. In recent years, Russia has been undergoing a substantial
political transformation. The various government institutions in Russia and the
other independent countries of the CIS 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.
 
     The political and economic changes in Russia have resulted in significant
dislocations of authority. As a result of the turmoil at the federal government
level and the continuing absence of a strong central government, the regions of
Russia are exercising more independence in both political and economic policies.
Significant organized criminal activity and high levels of corruption among
government officials exist where we operate. For a description of political
risks our operations in Russia and the CIS face, see "-- Risk Factors -- Turmoil
in Russia and the CIS creates significant uncertainty for our operations."
 
     Economic. In May and early June 1998, the Russian Central Bank and other
Russian governmental authorities adopted a number of measures, including
increasing the inter-bank lending rate charged by the Russian Central Bank and
the rate offered on sovereign debt obligations, in order to maintain the value
of the ruble and reduce the risk of the flight of foreign capital from the
Russian economy. These measures failed to stabilize the economy or provide
adequate liquidity.
 
     On August 17, 1998, the Russian government and the Central Bank of Russia
announced emergency steps to improve liquidity. Pursuant to this decision, the
ruble's value was allowed to float between 6.0 and 9.5 rubles to the United
States Dollar. Also, a 90-day moratorium was placed on the payment of foreign
exchange to meet certain obligations of Russian entities. Finally, the Russian
government announced that it intended to restructure the payment terms of
certain treasury bills. Since the decision on August 17th, the ruble's value has
declined substantially below the 9.5 ruble/United States Dollar floor set on
that date. Although the 90-day moratorium has not been extended, the
consequences of the decision on August 17 and its aftermath remain unclear. The
International Monetary Fund and the G-7 have thus far refused to advance
emergency funds to
 
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<PAGE>   30
 
Russia to address the recent liquidity crisis. For a description of economic
risks relating to our operations in Russia and the CIS face, see "-- Risk
Factors -- Turmoil in Russia and the CIS creates significant uncertainty for our
operations."
 
     Taxes. Generally, taxes payable by Russian companies are substantial. There
is no consolidation provision, and thus, dividends are subject to Russian taxes
at each level that they are paid. 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 us. For a description of tax risks relating to our operations in Russia
and the CIS face, see "-- Risk Factors -- Turmoil in Russia and the CIS creates
significant uncertainty for our operations -- Our Russian tax burden may be
significantly greater than anticipated."
 
  OVERVIEW OF RUSSIAN TELECOMMUNICATIONS MARKET
 
     We believe 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, although recent political and
economic developments have created considerable uncertainty. 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 other
independent republics of the CIS.
 
     Although it remains subject to certain restrictions, significant progress
in privatization of the telecommunications industry in Russia and the other
independent republics of 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.
 
     Despite the recent changes in the Russian telecommunications industry, the
level and quality 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 benefitted from significant capital
investment. Outside Moscow (and to a lesser extent St. Petersburg), most
standard Russian telecommunications equipment is obsolete.
 
  MANAGEMENT, LEGAL AND FINANCIAL CONTROLS IN RUSSIA AND THE CIS
 
     We have a policy worldwide of complying with all applicable laws. However,
emerging market countries often have commercial practices and less developed
legal and regulatory frameworks that differ significantly from practices in the
United States and other Western countries. In addition, some local 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
and other countries.
 
     In light of these circumstances, in the second half of 1996 we increased
our efforts to improve our management and financial controls and business
practices. We recruited a more experienced financial and legal team, including a
new Chief Financial Officer, a senior finance officer overseeing all of the
regions in which we operate, a senior finance officer for the CIS region, and a
senior legal officer for the CIS region and adopted a more rigorous Foreign
Corrupt Practices Act and applicable local laws compliance program.
 
                                       29
<PAGE>   31
 
     In addition, in early 1997, we retained special outside counsel to conduct
a thorough review of certain of our business practices in the emerging markets
in which we operate to determine whether deficiencies existed that needed to be
remedied. In the course of this review, we replaced certain senior employees in
Russia and instituted additional and more stringent management and financial
controls. The review did not identify any violations of law that we believe
would have a material adverse effect on our financial condition. However, if we
were found by government authorities to have violated any law, depending on the
penalties assessed and the timing of any unfavorable resolution, future results
of operations and cash flows could be materially adversely affected in a
particular period.
 
     We believe that the special counsel review was properly conducted and
sufficient in scope and that the actions taken since the review to strengthen
our management, financial controls and legal compliance will be adequate to
address any possible deficiencies. However, we cannot assure you that all
potential deficiencies have been identified or that the control procedures and
compliance programs we have implemented will be effective. The audit committee
of our board recently reviewed our legal compliance procedures. We believe that
this continued oversight will help to ensure that any problems in these
procedures are addressed. For a discussion of the risks we face, see "-- Risk
Factors -- Our management, legal and financial controls may be inadequate to
ensure that we comply with applicable laws.
 
  GTS BUSINESS SERVICES - CIS
 
     OPERATIONS
 
     We provide 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. Dedicated and leased capacity supplements our own
infrastructure, allowing us to bypass the severely congested and poorly
maintained local, domestic and long distance circuits of the Russian and
Ukrainian carriers.
 
     Our business units seek to integrate and co-market their service offerings,
utilizing TeleRoss as the long distance provider, Sovintel as the international
gateway, TeleCommunications of Moscow and Mobile Services for local access, and
Sovam Teleport as the data communications and Internet access network for
business applications and on-line services. This integrated marketing approach
enables us to provide comprehensive telecommunications solutions to
multinational corporations operating throughout Russia and the other independent
countries of the CIS. We have taken preliminary steps to combine
Telecommunications of Moscow, TeleRoss and Sovam. For a discussion of the risks
associated with our joint ventures, see "-- Risk Factors -- Turmoil in Russia
and the CIS creates uncertainty for our operations -- We may be overly dependent
on our joint ventures."
 
     Sovintel. We own 50% of Sovintel, a joint venture with Rostelecom, the
national long distance carrier. Sovintel markets a broad range of high quality
telecommunications services by (i) directly providing international direct dial
access to over 180 countries and private line dedicated voice channels and (ii)
leveraging the infrastructure and services of our other Russian ventures,
including TeleRoss, TeleCommunications of Moscow and Sovam. 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
continues construction of its St. Petersburg network which is interconnected to
Sovintel's Moscow network and is intended to support Sovintel's Moscow clients
which have a presence in St. Petersburg.
 
     Telecommunications of Moscow. During the third quarter of 1998, we
increased our beneficial ownership of Telecommunications of Moscow to 95%.
Telecommunications of Moscow provides a licensed numbering plan and
interconnection to the Moscow city telephone network for carriers needing basic
local access service in Moscow. Telecommunications of Moscow is currently
licensed to provide 100,000 numbers in Moscow, of which over 78,000 have been
leased. Telecommunications of Moscow has completed agreements required to
construct and provide an additional 50,000 numbers. The construction started in
1998 and is expected to be completed by the end of 1999. Telecommunications of
Moscow's switching facilities are
 
                                       30
<PAGE>   32
 
fully integrated with the networks of Rostelecom, Sovintel, and Moscow city
telephone network, allowing it to provide high quality digital service to its
customers.
 
     Telecommunications of Moscow acts as a local gateway by providing numbers
and ports to carriers in Moscow, including Sovintel, VimpelCom 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."
 
     TeleRoss. TeleRoss is a wholly owned subsidiary that operates a domestic
long distance network. In addition, TeleRoss has a 50% ownership interest in 14
joint ventures that originate traffic and provide local termination of calls.
The TeleRoss domestic long distance network serves 15 major Russian cities,
including Moscow and, through satellite technology, 21 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 Telecommunications of Moscow's switching facilities.
Sovam uses the TeleRoss digital channels to provide regional data service and
has co-located its access facilities with TeleRoss.
 
      Sovam. Sovam provides high-speed data communications services, electronic
mail and database access over a high-speed packet/frame relay network to its
customers in a large number of major Russian and CIS cities. Sovam also offers
Russia On Line, the first Russian language Internet service. Russia on Line
(which is our registered trademark) provides direct access to the Internet as
well as access to a wide range of local and international information services
and databases. In addition to serving the Moscow and St. Petersburg markets,
Sovam offers its services in all TeleRoss cities, as well as 32 additional
cities in Russia and the CIS.
 
      Sovam employs a dedicated sales and marketing force. Sovam's sales efforts
are focused primarily on the banking and financial communities and large
multinational companies. We frequently market bundled service packages, which
include Sovam's data and Internet service, Sovintel's international service and
TeleRoss's long distance service in order to offer customers a comprehensive
telecommunications solution.
 
  GTS MOBILE SERVICES - CIS
 
     Our Mobile Services line of business operates cellular businesses in Russia
and the Ukraine. In Russia, we have a wholly owned subsidiary, Vostok Mobile,
which currently operates thirteen AMPS cellular companies in Russian regions
located primarily west of the Urals under the trade name Unicel. Vostok Mobile
owns between 50% and 100% of the Unicel cellular joint ventures in Russia.
Unicel provides analog cellular telephone service based on the Advanced Mobile
Phone System, or AMPS technology. In addition, through Vostok Mobile, we
participate in PrimTelefone, a 50%-owned joint venture that operates an analog
network in Vladivostok and other cities in the Primorsky region of Russia based
on the Nordic Mobile Telephone System, or NMT technology. In April 1998,
PrimTelefone was also awarded a license to operate GSM-1800 in 14 regions of the
Russian Far East. In the Ukraine, we have an approximately 57% beneficial
interest in Golden Telecom, which operates a digital GSM-1800 cellular network
in Kiev, and an international overlay network in the Ukraine. Our Mobile
Services entities hold licenses covering major Russian and the Ukrainian markets
excluding Moscow and St. Petersburg, with an aggregate 1997 population of
approximately 42 million people.
 
COMPETITION FACED BY OUR LINES OF BUSINESS
 
     The European and international telecommunications industries are highly
competitive. Our competitors in these markets include the following entities,
many of which have substantially greater technical, financial, marketing and
other resources:
 
     - established national or regional public telecommunications operators and
       providers;
 
     - private multinational telecommunications carriers;
 
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<PAGE>   33
 
     - other private telecommunications developers and niche providers; and
 
     - consortia of telecommunications providers.
 
     Historically, the European public telecommunications operators monopolized
the provision of telecommunications services in their national or regional home
markets and designed their networks according to national rather than
international considerations. Between 1990 and 1997, however, the European Union
implemented a series of directives designed to open up European
telecommunications markets to competition. These directives required EU member
states to implement legislation liberalizing their respective telecommunications
markets to permit alternative telecommunications companies both to provide
telecommunications services and to access the existing telecommunications
infrastructure controlled by these national and regional providers. In response
to these European regulatory changes, a number of companies, including our
company, have emerged to compete with the European public telecommunications
operators. We believe that competition for telecommunications services in Europe
will continue to increase as a result of continuing liberalization.
 
     Accordingly, we compete primarily with national public telecommunications
operators and other providers which have established market presences,
fully-built networks and financial and other resources which are substantially
greater than ours and, in the case of many public telecommunications operators,
control over the intra-national transmission lines and connections to such
lines. Additionally, the ownership of such infrastructure provides them with
significant cost advantages. Since we utilize many of these networks to provide
our services, the failure to gain cost-oriented access to such networks could
have a material adverse impact on our business, results of operations and
financial condition.
 
     We believe that other competitors in the European markets will include
private multinational consortia such as Unisource, Concert and Global One, as
well as resellers, microwave and satellite carriers, mobile wireless
telecommunications providers, cable television companies, utilities and other
competitive local telecommunications providers. We also compete with other
medium-sized private carriers and resellers in Europe. These companies are
generally more aggressive than the public telecommunications operators and other
dominant providers and sometimes bring experience from more mature marketplaces.
Like ourselves, these providers often target medium-to large-sized business
customers and other big market segments. In addition, the development of new
technologies could give rise to significant new competitors.
 
     Competition in the European telecommunications industry is based upon
price, customer service, type and quality of services and customer
relationships. Our strategy is predicated on our ability to reduce our prices
below the prices charged by the public telecommunications operators or dominant
carriers in each of our markets, yet offer high-quality products and
telecommunications services. However, prices have decreased substantially over
the last few years in most of our markets. Some of our larger competitors may be
able to use their greater financial resources to cause severe price competition
in the countries in which we operate. We expect that prices will continue to
decrease for the foreseeable future and that public telecommunications operators
and other providers will continue to improve their product offerings. For a
discussion of the risks posed by our competitors' operations, see "-- Risk
Factors -- Competitors with greater resources may adversely affect our
business," "-- Risk Factors -- Failure to be competitive with national public
telecommunications operators could adversely affect our business," and "-- Risk
Factors-- Our competitive position may be compromised by our dependence on other
telecommunications service providers."
 
     We have outlined below the competitive environment with respect to each of
our six lines of business.
 
  GTS CARRIER SERVICES
 
     The success of our Carrier Services line of business depends upon our
ability to compete with a variety of other telecommunications providers offering
or seeking to offer cross-border services, including (1) the respective public
telecommunications operator in each country in which Hermes Railtel's network
operates, (2) global alliances among some of the world's largest
telecommunications carriers, and (3) global operators. We expect that some of
these current and future competitors may also become our customers. We also
believe that the ongoing liberalization of the European telecommunications
market will attract additional entrants to
                                       32
<PAGE>   34
 
the carrier's carrier market and increase the intensity of competition.
Competitors in this market compete primarily on the basis of price and quality.
We intend to focus on these factors and on service innovation as well. Our
Carrier Services business plan anticipates substantial direct and indirect
competition. For a discussion of the risks associated with our Carrier Services
line of business, see "-- Risk Factors -- Access Services and Business Services
activities may adversely affect our Carrier Services line of business" and
"-- Risk Factors -- The technology of our Hermes Railtel network could become
obsolete."
 
     Various telecommunications companies, including MCI WorldCom, Inc., Viatel,
Inc., KPN-Qwest, Deutsche Telekom AG, France Telecom S.A., Global Crossing Ltd.,
and British Telecommunications plc, have announced plans to construct, have
begun to construct or are operating fiber optic networks across various European
countries. Some of these networks include, or their promoters have expressed
their intentions to include, transatlantic connectivity.
 
  GTS BUSINESS SERVICES
 
     We have not achieved and we do not expect to achieve a significant market
share for our services in any of Business Services' markets. We expect that
prices for our Business Services line of business will continue to decrease for
the foreseeable future. In addition, certain of our customers, in particular
wholesale carriers, may sometimes use more than one service provider and may
reduce their use of our services and switch to other providers.
 
     In each of our current Business Services markets we compete primarily with
the national public telecommunications providers. Other competitors of Business
Services include private multinational consortia as well as microwave and
satellite carriers, mobile wireless telecommunications providers, cable
television companies, utilities and competing local telecommunications providers
and other medium-sized carriers and resellers in Europe. Some of these carriers
have established their own switch sites and operate their own networks.
Competitors in this segment include MCI/WorldCom, COLT, Viatel and RSL, which
compete in multiple countries, and country-specific competitors such as Energis
(UK), Arcor (Germany), Telfort (The Netherlands), Retevision (Spain), Infostrada
(Italy) and Cegetel (France). These providers are generally more entrepreneurial
than the public telecommunications operators and other dominant providers and
sometimes bring experience from more mature markets. Like us, these providers
often target small, medium and large-sized business customers or other market
niches.
 
  GTS WHOLESALE SERVICES
 
     Our Wholesale Services line of business will face competition from a
consortia of telecommunications operators, large public telecommunications
operators and other international telephone operators with advanced network
infrastructures, access to large quantities of long-haul capacity and
established customer bases. Public telecommunications operators 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 Wholesale Services.
 
     With deregulation of the telecommunications markets, opportunities for the
establishment of international gateways will likely develop and, as a result,
competition in the market for our Wholesale Services will increase. We intend to
relocate and consolidate our Wholesale Services operations in London, which is
served by the Hermes Railtel network. This will allow us to route our Wholesale
Services customers' traffic through the Hermes Railtel network and incur reduced
transmission expenses, thereby enhancing the competitiveness of Wholesale
Services' operations.
 
  GTS ACCESS SERVICES
 
     Public telecommunications operators often offer both local and long
distance services and benefit greatly from their position as sole historic
provider in the markets they serve. We believe that the market for the provision
of local services is sufficiently attractive to cause additional competitive
local exchange carriers, including multi-national carriers, to enter the market
to offer products and services which would compete with ours.
 
                                       33
<PAGE>   35
 
     We will compete with public telecommunications providers and, in certain
markets, competitive local exchange carriers, including, among others, COLT
TeleCom Group plc, which is providing service through networks in London,
Frankfurt, Munich, Hamburg, Berlin, Paris, Zurich, Amsterdam, Brussels, Madrid
and Dusseldorf, and MCI WorldCom, whose pan-European fiber network connects
London, Amsterdam, Brussels, Frankfurt and Paris. We believe, based on our
experience in Western and Central Europe, Russia and the CIS, that we have the
knowledge and ability to develop products and services which will be competitive
with other competitive local exchange carriers in terms of content, quality and
price.
 
  GTS BUSINESS SERVICES - CIS AND MOBILE SERVICES - CIS
 
     We face significant competition in virtually all of our existing
telecommunications businesses in Russia and the other independent countries of
the CIS. We believe that we have certain competitive advantages in each of these
markets because of our operating history, our ability to bundle a broad range of
telecommunications services in the region and our ability to make rapid
decisions in pursuing new business opportunities and addressing customer service
needs. We also believe that our local partnerships and reliance on nationals in
the management of its businesses and joint ventures provide us with better
knowledge of local political and regulatory structures, cultural awareness and
access to customers.
 
LICENSES AND REGULATORY ISSUES
 
  OVERVIEW
 
     The regulation of the European telecommunications industry is in the midst
of significant changes. Starting in 1987, a policy document, the EC Green Paper
on Telecommunications, charted the course for the current changes in the EU
telecommunications industry by advancing principles such as separation of
operators from regulators, transparency of procedures and information, cost
orientation of tariffs, access to monopoly public telephone operator
infrastructure networks and the liberalization of services. The Green Paper
formed the basis of subsequent liberalization and harmonization EU directives.
In 1990, the EU member states approved two directives that established these
principles in EU law: the Open Network Provision Framework Directive and the EU
Services Directive. Combined, these two directives set forth the basic rules for
access to public telephone networks and the liberalization of the provision of
all telecommunications services within the EU except for certain selected
services, including voice telephony.
 
     In 1992, the EU approved the Open Network Provision Leased Line Directive,
which required the incumbent operators to lease lines to competitors and end
users, and to establish cost accounting systems for these products by the end of
1993. The national regulatory authorities were to use this cost information to
set cost-orientated tariffs for leased lines. Even though most EU member states
have established regulatory frameworks requiring public telecommunications
operators to lease lines to competitors and end users, we believe that, in some
EU member states, such lines are not yet being offered at cost-orientated
prices.
 
     In 1996, the EU issued the Full Competition Directive, which requires EU
member states to permit the provision of telecommunications services, other than
certain selected services, including voice telephony, over networks established
by the provider of the services, over network infrastructure provided by third
parties or by means of sharing of networks from July 1996. Since then, there has
been an increasing supply of such capacity offered at attractive prices from
such alternative suppliers. The Full Competition Directive also established
January 1, 1998 as the date by which all EU member states must establish a legal
framework which removes all remaining restrictions on the provision of
telecommunications services, including voice telephony. However, the following
EU member states were granted a delay in implementing this liberalization
directive: (1) Greece, through December 31, 2000; (2) Ireland, through January
1, 2000; (3) Luxembourg, through July 1, 1998; (4) Portugal, through January 1,
2000; and (5) Spain, until November 30, 1998. Ireland implemented the Full
Competition Directive in December 1998. Subject to the foregoing, each EU member
state is obliged, under EU law, to enforce the terms of the Full Competition
Directive in such a manner so as to ensure that its aim and purpose is carried
out. Enforceability of the Full Competition Directive may be challenged at the
EU level or at the EU member state level. Furthermore, in practice,
implementation and enforcement of the directive has been and may also continue
to be delayed on a country by country basis.
 
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<PAGE>   36
 
     As a complement to the Full Competition Directive, the European Parliament
and Council of Ministers in June 1997 adopted a directive which governed the
manner in which public network operators and service providers interconnect with
the public telecommunications operators' public networks. Among other things,
this directive requires EU member states to ensure that public
telecommunications operators with significant market power should provide
interconnection on the basis of cost-oriented charges.
 
     In April 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 be restricted only 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.
 
     In February 1998, the European Parliament and the Council of Ministers
adopted a directive on the application of the Open Network Provision to voice
telephony and on universal service.
 
     Despite these regulatory initiatives supporting the liberalization of the
telecommunications market, most EU member states are still in the initial stages
of liberalizing and harmonizing their telecommunications markets and
establishing competitive regulatory structures to replace the monopolistic
environment in which the public telecommunications operators previously
operated. For example, most EU member states have only recently established a
national regulatory authority. In addition, the implementation, interpretation
and enforcement of these EU directives differs significantly among the EU member
states. While some EU member states have embraced the liberalization process and
achieved a high level of openness, others have delayed the full implementation
of the directives and maintain several levels of restrictions on full
competition.
 
     Member states of the EU are also bound as a matter of international law to
comply with certain multilateral trade rules and regulations. On February 15,
1997, over 60 members of the World Trade Organization committed to open their
telecommunications markets for basic telecommunications services to foreign
competition and ownership and to adopt regulatory measures designed to protect
foreign telecommunications providers against anticompetitive behavior by
domestic public telecommunications operators. For most signatories to this World
Trade Organization Telecommunications Agreement, these commitments took effect
on February 5, 1998 (including the EU member states). We believe that the World
Trade Organization Telecommunications Agreement will primarily impact call
termination charges outside the EU. For a discussion of the regulatory risks
involved, see "-- Risk Factors -- Delays in liberalization of the EU
telecommunications market may adversely affect execution of our business
strategy," and "-- Delays in obtaining regulatory licenses and approvals could
adversely affect our plans to offer services in our targeted markets."
 
     As a multinational telecommunications company, we are subject to varying
degrees of regulation in each of the jurisdictions in which we provide our
services. Local laws and regulations and the interpretation of such laws and
regulations differ significantly among the jurisdictions in which we operate.
For a discussion of the regulatory risks we face, see "-- Risk Factors -- Delays
in obtaining regulatory licenses and approvals could adversely affect our plans
to offer services in our targeted markets."
 
     We are in the process of reviewing the licenses, permits and authorizations
that we obtained through our acquisition of NetSource and Esprit Telecom. It may
be possible for us to use certain of these licenses to provide services through
our Carrier Services, Business Services or Access Services lines of business.
 
  GTS CARRIER SERVICES
 
     HERMES RAILTEL
 
     A summary discussion of the regulatory framework in certain countries where
Hermes Railtel has developed and is developing its 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.
 
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<PAGE>   37
 
     National authorities in individual member states of the EU are responsible
for regulating the construction and operation of telecommunications
infrastructure. We believe 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 construction and operation of telecommunications infrastructure in the
countries of the EU where we currently operate.
 
     Hermes Railtel requires licenses, authorizations or registrations in almost
all countries to operate the network. Licenses, authorizations or registrations
have been obtained in Belgium, France, Germany, Italy, Luxembourg, The
Netherlands, Spain, Sweden, Switzerland, the UK and the United States. No
license or authorization is required to operate a network in Denmark. Hermes
Railtel intends to file applications in other countries in anticipation of
service launch in accordance with the network roll-out plan.
 
     Belgium. Belgium has implemented the "alternative infrastructure" provider
provision of the Full Competition Directive. Most of the EC telecommunications
liberalization package was adopted at the end of December 1997. The implementing
legislation (Royal Decrees) regarding the licensing regimes for the provision of
voice telephony services and the establishment of public network infrastructure
was approved by the Council of Ministers at the end of June 1998. The official
publication and the entry into force of that implementing legislation took place
in July 1998. Until such entry into force, the Belgian Telecommunication
Authority continued to work with the system of provisional licenses. Hermes
Railtel has already obtained, through a wholly owned subsidiary, a license in
February 1997 from the Belgian regulatory authority to build infrastructure
between major Belgian population centers and the relevant border crossings.
Hermes Railtel also has an authorization to provide liberalized services using
alternative infrastructure. The liberalization legislation requires all
previously licenced operators to apply for new licenses or authorizations.
Hermes Railtel applied for a new license in October 1998 and was granted its
license to build and operate its network under the new regulatory framework on
January 26, 1999.
 
     Denmark. With the liberalization of infrastructure as of July 1, 1997,
Denmark has fully liberalized its telecommunications markets in accordance with
the requirements of the relevant EC Directives. According to the Danish rules,
Hermes Railtel will not require any regulatory approval in order to install or
operate the network in Denmark.
 
     France. A new regulatory agency, the Autorite de Regulation des
Telecommunications, 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. In
October 1997, Hermes Railtel obtained authorization to operate its network in
specific regions of France. In August 1998, Hermes Railtel was granted an
extension of its license in order to extend its network in France to reach Italy
and Spain. Such authorization requires prior notification to and approval of the
Autorite de Regulation des Telecommunications of any substantial changes in the
capital of Hermes Railtel or its controlling shareholder.
 
     Germany. Germany has approved legislation to implement the Full Competition
Directive and remove all remaining restrictions on competition from August 1996.
Hermes Railtel was granted a license by the German regulatory authorities on
July 18, 1997. The license permits Hermes Railtel to operate the portions of the
network in Germany connecting Dusseldorf, Frankfurt and Stuttgart; Dusseldorf to
the Dutch border; and Stuttgart to the French border. In 1998, Hermes Railtel
was granted extensions to its license to include operation of routes linking
Hamburg, Hanover, Munich and Berlin and of routes to Denmark.
 
     Italy. Although in the past Italy has been dilatory in implementing EC
liberalization measures, Italy enacted legislation on July 31, 1997 creating an
independent national regulatory authority for the telecommunications and
audiovisual sectors. On September 19, 1997, Italy enacted a regulation
implementing all EC directives in the telecommunications sector and since then
specific laws relating to licensing and interconnection and universal service
have been approved. Hermes Railtel was granted a license by the Italian
authorities in August 1998, enabling the development of its network in the
northwest region of Italy and the offering of services in Milan.
 
     Luxembourg. A new Telecommunication Act entered into force in April 1997,
and a Royal Decree on licensing conditions entered into force in July 1998.
Hermes Railtel applied to the Luxembourg regulatory
 
                                       36
<PAGE>   38
 
authority for a license to build and operate its network in Luxembourg in
October 1998. On February 11, 1999, we were granted a license to build and
operate a public telecommunications network.
 
     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, Hermes Railtel was
granted an authorization for the installation, maintenance and use of a fixed
telecommunications infrastructure.
 
     A new Telecommunications Act came partly into force on December 15, 1998.
The new Act confirms the full liberalization of the telecommunications market
according to European Community standards. When the new Telecommunications Act
entered into force, the authorization held by Hermes Railtel ceased to exist.
Under the new Telecommunications Act, Hermes Railtel has an obligation to
register its activities. A request for registration with the Dutch regulatory
authority ("OPTA") was filed in February 1999 and the OPTA granted Hermes
Railtel its registration as a public telecommunications operator on March 3,
1999.
 
     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. In April 1998, Spain adopted the LGT, its new telecommunications law.
The LGT was implemented through the use of secondary legislation. The LGT and
the secondary legislation resulted in the full liberalization of the Spanish
telecommunications market on December 1, 1998. On December 3, 1998, the Spanish
regulatory authority began to issue licenses under the new regime. Hermes
Railtel was granted a license to install and operate a telecommunications
network in Spain on January 14, 1999.
 
     Sweden. Full liberalization of the Swedish telecommunications market
occurred in 1993. A new Telecommunications Act was passed in 1997 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 certain services. Hermes Railtel registered with
Swedish authorities has been able to provide service in Sweden since July 1998.
 
     Switzerland. The Swiss Parliament has passed a Telecommunications Law which
entered 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. From that date, voice telephony
monopoly was abolished and services fully liberalized. In September 1998, the
Swiss regulatory authority granted Hermes Railtel a definitive concession
(replacing an earlier provisional concession) to build and operate its network
in Switzerland.
 
     United Kingdom. Since the elimination in 1991 of the UK telecommunications
duopoly consisting of British Telecommunications and Mercury, it has been the
stated goal of Oftel, the UK telecommunications regulatory authority, to create
a competitive marketplace from which detailed regulation could eventually be
withdrawn. The UK 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. Hermes Railtel has received a license
from the Secretary of State for Trade and Industry dated December 18, 1996 which
grants it the right to run a telecommunications system or systems in the UK
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 Hermes Railtel
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 to facilitate reforms to the
licensing regime which are expected in 1999. The Department of Trade and
Industry has confirmed that it intends to replace the initial licenses with new
licenses and that it would not revoke an initial license without replacing it
with another license giving an equivalent authorization. The Department of Trade
and Industry is currently discussing with license holders the arrangements to
put these new licenses into effect. Although the Department of Trade and
Industry has indicated that the new licenses are expected to be of 25 years'
duration, we cannot assure you that this will be the case or that the new
licenses will not contain terms or conditions unfavorable to Hermes Railtel.
 
                                       37
<PAGE>   39
 
     United States. Hermes Railtel was granted a license by the FCC pursuant to
section 214 of the Communications Act of 1934 authorizing it to provide limited
global facilities-based and global resale services (subject to the terms and
conditions imposed by the law and authorization), effective October 23, 1998.
The 214 authorization does not allow Hermes Railtel to offer US services to
Hungary, Poland, the Czech Republic, Romania, Monaco, Russia, Ukraine,
Kazakhstan, Uzbekistan, Azerbaijan, China and India.
 
     In addition to the discussion above, Hermes Railtel intends to file
applications in other countries (including Austria, Croatia, Czech Republic,
Hungary, Poland, Portugal, Slovakia and Russia) in anticipation of service
launch in accordance with the Hermes Railtel network roll-out plan. With the
exception of Austria and Portugal, which are members of the EU and whose laws
must comply with EC Directives, these countries have not generally liberalized
their telecommunications sector. We cannot assure you that they will do so in a
timely manner or at all. In addition, the terms and conditions of Hermes
Railtel's licenses, authorizations or registrations may limit or otherwise
affect Hermes Railtel's scope of operations. We cannot assure you that Hermes
Railtel 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 Hermes Railtel. 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 Hermes Railtel.
 
     TRANSOCEANIC SERVICES
 
     A summary of the discussion of the regulatory framework in the United
Kingdom, United States and France that will apply to Transoceanic Services has
already been provided in the section on Hermes Railtel above. Transoceanic
Services, like Hermes Railtel, will require licenses, authorizations or
registrations to the extent that it will operate its own network in the United
Kingdom, United States and France. Since Hermes Railtel has obtained the
necessary licenses, authorizations or registrations in the United Kingdom,
United States and France, Transoceanic Services will endeavor to use the same
(where allowed by national licensing frameworks) in order to build its initial
network, while it obtains its own licenses, authorizations and registrations.
Alternatively, Transoceanic Services may seek to benefit from Hermes Railtel's
licenses to the extent that they may be transferred from Hermes Railtel to GTS
Carrier Services. The transfer of these licenses could be undertaken in the
event that the Hermes Railtel network and Transoceanic Services can be operated
under one license. Such a transfer initially may be envisaged in France where
licenses may be transferred subject to ministerial approval. The regulatory
framework in the United Kingdom and United States, however, would require GTS
Carrier Services to obtain new licenses, authorizations or registrations.
 
     In addition, the terms and conditions of the licenses, authorizations or
registrations may limit or otherwise affect Transoceanic Services' scope of
operations. We cannot assure you that Transoceanic Services will be able to
obtain such licenses, authorizations or registrations or that Transoceanic
Services' operations will not become subject to other regulatory, authorization
or registration requirements in the countries in which it plans to operate. For
a discussion of these risks, see "-- Risk Factors -- Delays in obtaining
regulatory licenses and approvals could adversely affect our plans to offer
services in our targeted markets."
 
     IP SERVICES
 
     At present there is no general consensus on the regulatory position of IP
services in Europe and the United States. At the moment IP services are
generally treated as unregulated or, in some European countries, as a
telecommunications service subject to minimal regulatory requirements. We cannot
assure you that IP Services will not be regulated in the future in Europe or the
United States. We will continue to monitor regulatory developments that may
impact IP Services' operations.
 
                                       38
<PAGE>   40
 
  GTS BUSINESS SERVICES
 
     UNITED KINGDOM
 
     The telecommunications services which we provide through Business Services
are subject to and affected by licenses issued by the United Kingdom's
Department of Trade and Industry and regulations introduced by Oftel, the United
Kingdom telecommunications regulatory authority. Business Services' UK
subsidiary received an international simple resale license from the Department
of Trade and Industry in 1993, which permitted us to provide international
telecommunications services by way of resale of other carriers' facilities. In
December 1996, Business Services' UK subsidiary was among the first recipients
of an international facilities license, which permits us to purchase, lease or
build our own international infrastructure and to interconnect to the public
network. In December 1997, we were granted a domestic public telephone operator
license that will enable us to build out our network and obtain more favorable
interconnect terms from British Telecom.
 
     Business Services' UK subsidiary also holds a Section 214 authorization
license issued by the U.S. Federal Communications Commission under Section 214
of the United States Communications Act of 1934, as amended. Subject to certain
restrictions, the Section 214 authorization permits us to originate and
terminate facilities-based and resold private line and switched
telecommunications services in the United States, including among other things,
reselling international private lines interconnected at both ends to the public
switched telephone network on the United States-United Kingdom route for the
provision of switched services. Under the FCC's rules, such interconnected
private lines may at present be used only for switched traffic that either: (i)
originates in the United Kingdom and terminates in the United States or vice
versa; (ii) originates in the United States, the United Kingdom, Canada, New
Zealand, Australia, Sweden, The Netherlands, France, Germany, Belgium, Denmark,
Norway, or Luxembourg, and terminates in another of those countries, having been
routed through the third country via private lines; or (iii) uses the
interconnected international private lines to reach a switching hub.
 
     This third routing arrangement, termed "switched hubbing," may involve
several configurations: (i) traffic originates in the United States, is carried
via private lines to the United Kingdom and is routed through a switch to points
beyond the United Kingdom; (ii) traffic originates in the United Kingdom, is
carried over private lines to the United States, and is routed through a switch
to points beyond the United States; or (iii) traffic originates in points beyond
the United States or the United Kingdom and is routed via a United States or
United Kingdom switch to terminate in another country (provided that no traffic
originates or terminates in a country that we are not authorized to serve). With
respect to switched hubbing traffic originated or terminated on the Esprit
Network at switches in EU member states other than the United Kingdom, domestic
laws of such EU member states require that the leased lines be interconnected
with the public switched telephone network at one end only. In addition, the FCC
has not made any pronouncement about the legality of switched hubbing
arrangements where the carrier in the destination country does not consent to
receiving traffic indirectly from the originating country and does not realize
the traffic it receives from the "hub" country is actually originating from a
different country.
 
     GERMANY
 
     Our German subsidiaries have authority to provide value-added
telecommunications services throughout Germany. In June 1997, we also received
Type 3 and Type 4 licenses authorizing us to build, acquire and operate
infrastructure and to provide public voice telephony services and to
interconnect with the incumbent public telecommunications operators' network.
These licenses applied initially to restricted areas within Dusseldorf but have
since been expanded to the whole Dusseldorf area and to permit connection to a
cable landing station in northern Germany. In addition, the acquisition of
Plusnet has provided us with a line linked to a national network licensed to
provide point-to-point service on 55 national routes and 300 local routes. We
have also been granted a carrier select code to provide Indirect Access to our
retail services. We entered into an interconnect agreement with Deutsche Telekom
in November 1997. Pursuant to this agreement, we interconnect with Deutsche
Telekom's network in five locations, while Plusnet's network interconnects with
Deutsche Telekom's network in six locations.
 
                                       39
<PAGE>   41
 
     NetSource received a Type 4 license and entered into interconnect
agreements in February 1998.
 
     FRANCE
 
     In March 1998, our French subsidiary was granted public voice telephony and
public network operator licenses permitting us to serve all of France. These
licenses permit us to provide all services, including managed bandwidth on the
London-Paris ring. They also facilitate our building out the fiber optic ring to
Belgium. Our French subsidiary has also applied for a combined public network
and voice telephony license with national coverage and, one digit carrier access
code. In July 1998, our French subsidiary was granted the right to receive one
of the seven available one digit access codes. After a challenge by a
disappointed applicant, the Conseil d'Etat, the French high court, affirmed the
ART's decision. On July 1998, our license was amended to impose certain network
deployment obligations on us. We are now in the process of building out a
national network.
 
     THE NETHERLANDS
 
     For the interim period, two national and several regional infrastructure
licenses have been issued by the Dutch national regulatory authority. An
independent regulatory authority was established in August 1997. We have
obtained an authorization which allows us to build infrastructure, subject to
obtaining rights-of-way, frequency allocations and other authorizations. We have
also registered as a provider of public voice telephony services and have
received a carrier select code to provide indirect access to our retail
services.
 
     NetSource is qualified as a telecommunications provider and obtained a
carrier selection code license in September 1997.
 
     BELGIUM
 
     The Belgian regulator, BIPT, has granted our Belgian subsidiary provisional
national voice telephony and network operator licenses, and our Belgian
subsidiary was the first independent operator to achieve interconnection with
the incumbent public telephone operator, Belgacom. Following the recent adoption
of final legislation, our Belgian subsidiary has filed an application for
definitive national voice telephony and network operator licenses and expects to
receive the same shortly. NetSource plans on using the Esprit Telecom licenses
for its Belgian operations.
 
     SPAIN
 
     The EU granted Spain an eleven month deferment of its obligation to fully
liberalize its telecommunications market. Liberalization of public networks and
voice telephony therefore took place on December 1, 1998. Towards that end, the
Spanish government adopted a framework telecommunications law in April 1998. On
December 3, 1998, Business Services' Spanish subsidiary was granted class B1
licenses for Madrid, Barcelona and Gerona. We were also granted similar licenses
for Bilbao and Valencia. These licenses permit us to provide public telephony
services and operate a network in those cities. A C1 license allowing the
installation of a national network was granted on December 17, 1998.
 
     ITALY
 
     Our Italian subsidiary received a closed user group voice telephony license
in May 1998. We filed an application for authorization to install infrastructure
and provide services on a national basis.
 
     IRELAND
 
     Through NetSource we received a general telecommunication license to
operate in Ireland in December 1998.
 
                                       40
<PAGE>   42
 
     NORWAY
 
     Through NetSource, we are registered as a public telecommunications
provider. We expect to enter into interconnection agreements shortly.
 
     DENMARK
 
     Through a subsidiary of NetSource, we are registered as a public
telecommunications provider. We expect to enter into interconnection agreements
shortly.
 
     SWEDEN
 
     Through NetSource, we were registered as a public telecommunications
provider in October 1998 and we entered into interconnection agreements in
January 1999.
 
     LUXEMBOURG
 
     Through NetSource, we have applied for licenses to operate in Luxembourg.
 
  WHOLESALE SERVICES
 
     Currently, GTS-Monaco Access's telecommunications activities in Monaco
require no telecommunications license. However, GTS-Monaco Access will have to
comply with EU regulation to the extent it does business in EU member states or
its business has an effect on trade between 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. In certain
of our existing and target markets, there are laws and regulations which affect
the number and types of customers which we 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, thereby resulting
in lower overall costs on an end-to-end basis. Re-filing is prevalent in the
industry 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, we cannot assure you 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.
 
  ACCESS SERVICES
 
     Access Services has been granted Class 3 (infrastructure) and Class 4
(voice telephony) licenses authorizing it to serve seven major cities in
Germany. In March 1999, we applied for licenses authorizing us to install local
access networks and to provide voice telephony services in Geneva and Zurich. We
are currently evaluating Access Services' ability to build out fiber loops and
provide access services in its target metropolitan markets under existing
infrastructure licenses and authorizations to provide telephony services held by
our Business Services line of business.
 
     Our determination as to which markets we may enter will depend in part on
our evaluation of the regulatory regime in such market. The detailed regulation
varies from country to country. Delays in receiving required regulatory
approvals and licenses, or the enactment of adverse regulations or regulatory
requirements, may delay or prevent us from entering a particular market or
offering our services in any European market, restrict the types of services
offered by us, constrain our deployment of its networks or otherwise adversely
affect our operations.
 
                                       41
<PAGE>   43
 
     We cannot assure you that Access Services will be able to obtain the
necessary regulatory approvals on a timely basis or that we will not otherwise
be affected by regulatory developments, either of which may have a material
adverse affect on us. These risks are discussed in the section "-- Risk
Factors -- Delays in obtaining regulatory licenses and approvals could adversely
affect our plans to offer services in our target markets."
 
  BUSINESS SERVICES - CIS AND MOBILE SERVICES - CIS
 
     Telecommunications operators in Russia are nominally subject to the
regulations of Goskomsvyaz, the successor of the Russian Ministry of
Communications, and its subordinated bodies, Gossvyaznadzor and the State Radio
Frequency Commission. As a practical matter, these national telecommunications
authorities as well as certain regional and local authorities generally regulate
telecommunications operators in their jurisdictions 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. Separate
legislation implements this institutional framework.
 
     Goskomsvyaz issues licenses to provide telecommunications services on the
basis of a decision by the Licensing Commission at Goskomsvyaz. Goskomsvyaz has
generally issued no new licensing regulations since the enactment of the
Communications Law, and in practice Goskomsvyaz continues to issue licenses
based on the pre-existing licensing regulations, except to the extent such
regulations have been modified by licensing regulations with respect to cellular
services. According to the general licensing regulations, licenses for rendering
telecommunications services may be issued and renewed for periods which range
from 5 to 15 years and several different licenses may be issued to one person.
Under the cellular licensing regulations, licenses for rendering cellular
services may be issued only on the basis of a competitive tender for longer
periods ranging from five to 15 years. 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 Goskomsvyaz and verification by appropriate government
authorities that the licensee has conducted its activities in accordance with
the licenses. Officials of Goskomsvyaz have fairly broad discretion with respect
to both the issuance and renewal procedures. The Communications Law as well as
the general and cellular licensing regulations provide that a license may not be
transferred or assigned to another holder. Regional authorities also exercise
some influence especially in directly influence the issuance of AMPS licenses
because AMPS has been designated a "regional standard." 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. In addition, entities such as Svyazinvest at the federal level, as
well as other entities at the oblast and krai levels (administrative regions
within Russia) and Moscow and St. Petersburg exercise significant control over
their respective local telephone networks and may therefore affect the licensing
process.
 
     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. Our Ukrainian joint venture
agreements provide us with the option of purchasing an additional 1% of the
cellular network if these rules are liberalized. The Ukrainian government has
imposed substantial frequency permit fees in connection with providing GSM
service in Ukraine, and Golden Telecom has paid a $2.9 million frequency license
fee on Golden Telecom's license. We cannot assure you that additional fees will
not be imposed in the future upon the reissuance and/or renewal of such license.
For a comprehensive discussion of these regulatory risks, see also "-- Risk
Factors -- Turmoil in Russia and the CIS creates significant uncertainty for our
operations."
 
                                       42
<PAGE>   44
 
EMPLOYEES
 
     On December 31, 1998, GTS, our consolidated subsidiaries and joint ventures
in which we participate, employed approximately 3,300 persons. We believe our
future success will depend on our continued ability to attract and retain highly
skilled and qualified employees. We believe that our relations with our
employees are good.
 
                                  RISK FACTORS
 
     Set out below is a description of certain risk factors that may adversely
affect our business and results of operations.
 
WE MAY BE UNABLE TO RAISE THE ADDITIONAL CAPITAL NECESSARY TO IMPLEMENT OUR
BUSINESS STRATEGY
 
     We will require additional capital to fund future acquisitions, capital
expenditures and ongoing operations. If we fail to generate sufficient funds in
the future from a combination of operating cash flow and additional debt or
equity financings, we may have to delay or abandon executing significant
elements of our business plan including:
 
     -  our plans to offer local access services in twelve major Western
        European cities by 2001;
 
     -  our plans to further extend our network in Europe;
 
     -  our participation in the FLAG Atlantic Limited joint venture, which
        plans to operate and build a new transatlantic cable; and
 
     -  capital expenditures and other costs necessary to develop and offer IP
        services.
 
Failure to implement elements of our business plan could have a material adverse
effect on our operations and on the market price of our common stock.
 
     In addition, we cannot assure you that any additional financing will be
available to us on favorable terms or at all. If we raise additional funds by
incurring debt, we will likely become subject to additional, more restrictive
financial covenants, which would hinder our ability to pursue business
opportunities. Our cash interest expense obligations would also increase. If we
raise additional funds by issuing equity, your ownership of our stock may be
diluted. For a comprehensive discussion of our liquidity and financing positions
and concerns, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."
 
WE MAY BE UNABLE TO MEET OUR SUBSTANTIAL DEBT OBLIGATIONS
 
     We have incurred substantial debt (including the assumed debt of Esprit
Telecom) and may incur substantial additional debt to implement our business
plans.
 
     As a result of our current high level of debt, we:
 
     -  will need significant cash to service our debt, which will reduce funds
        available for operations, future business opportunities and investments
        in new or developing technologies and make us more vulnerable to adverse
        economic conditions;
 
     -  may not be able to refinance our existing debt or raise additional
        financing to fund future working capital, capital expenditures, debt
        service requirements, acquisitions or other general corporate
        requirements;
 
     -  may be less flexible in planning for, or reacting to, changes in our
        business and in the telecommunications industry that affect how we
        implement our financing, construction or operating plans;
 
     -  will have more debt than some of our competitors, which may place us at
        a competitive disadvantage with respect to such competitors; and
 
                                       43
<PAGE>   45
 
     If we fail to make the required payments or to comply with our debt
covenants we will default on our debt. A default would permit our debtholders to
accelerate the maturity of the debt, which in turn would cause defaults under
our other indebtedness.
 
COVENANTS IN OUR DEBT AGREEMENTS RESTRICT OUR OPERATIONS
 
     The covenants in our currently outstanding debt may materially and
adversely affect our ability to finance our future operations or capital needs
or to engage in other business activities. Among other things, these covenants
limit our ability to:
 
     -  incur additional indebtedness;
 
     -  pay dividends, make distributions on our common stock or make certain
        other restricted payments;
 
     -  limit our ability to use our assets as collateral for loans;
 
     -  dispose of our assets; or
 
     -  enter into transactions with affiliates.
 
WE MAY FAIL TO SUCCESSFULLY INTEGRATE RECENT ACQUISITIONS
 
     We acquired NetSource in November 1998 and Esprit Telecom in March 1999.
Although we expect these acquisitions to result in operating benefits, they may
not provide the expected benefits or such benefits may not be realized within
the time frames that we contemplate. Additionally, the integration of these
acquisitions will divert management's attention from day-to-day matters. If we
are unable to integrate our companies, we may fail to realize the expected cost
savings, increases in revenue and other projected benefits from such
integration, and may suffer material adverse short and long-term effects on our
operating results and financial condition. The integration of these acquisitions
has required and will continue to require additional expenditures which may
offset cost savings and other expected benefits from the acquisitions.
 
     The process of integrating NetSource and Esprit Telecom may disrupt our
respective businesses and may cause an interruption of, or a loss of momentum
in, our respective businesses as a result of a number of obstacles such as:
 
     -  loss of key employees or customers;
 
     -  possible inconsistencies in standards, controls, procedures and policies
       among the companies being combined and the need to implement common
       company-wide financial, accounting, information, billing and other
       systems;
 
     -  failure to maintain the quality of customer service that such companies
       have historically provided;
 
     -  the need to coordinate geographically diverse organizations;
 
     -  incompatible equipment;
 
     -  changes in management may impair relationship with employees and
       customers;
 
     -  limitations under existing Esprit Telecom debt covenants; and
 
     -  the resulting diversion of management's attention from our day-to-day
       business and the need to hire management personnel to address such
       obstacles.
 
     For a comprehensive discussion of the integration of recent acquisitions,
see "-- Business Summary -- GTS Wholesale Services," "-- Recent
Developments -- Esprit Telecom Acquisition" and "-- NetSource Acquisition."
 
WE MAY NOT BE SUCCESSFUL IN IMPLEMENTING OUR ACQUISITION STRATEGY
 
     As part of our business strategy, we expect to make significant
acquisitions in the future. We believe that additional attractive acquisitions
opportunities currently exist in Western and Central Europe and in the
                                       44
<PAGE>   46
 
United States and are continually evaluating these opportunities. Certain of
these transactions, if consummated, may be material to our operations and
financial condition. Such acquisitions may not be successfully integrated or
result in projected benefits. We may not be able to raise the additional capital
necessary to fund such acquisitions and may have to divert resources from other
areas. Although we periodically have discussions with other companies to assess
opportunities on an ongoing basis, we do not have a definitive agreement with
respect to any material acquisition or joint venture. For a comprehensive
discussion of our acquisition strategy, see "-- GTS Carrier Services -- Business
and Marketing Strategy," "-- Business -- GTS Business Services -- Business and
Marketing Strategy," "-- Business -- GTS Wholesale Services -- Business and
Marketing Strategy," and "-- Business -- GTS Access Services -- Business and
Marketing Strategy."
 
WE HAVE A LIMITED OPERATING HISTORY AND HAVE SUSTAINED SUBSTANTIAL NET LOSSES
 
     We have a limited operating history and have historically sustained
substantial operating and net losses. We cannot assure you that our operations
will achieve or sustain profitability or positive cash flow in the future. For
the following periods, we reported net losses of:
 
<TABLE>
<CAPTION>
PERIOD                                                             NET LOSS
------                                                          --------------
<S>                                                             <C>
Year ended December 31, 1996................................    $ 76.2 million
Year ended December 31, 1997................................    $134.8 million
Year ended December 31, 1998................................    $255.8 million
Inception through December 31, 1998.........................    $543.7 million
</TABLE>
 
     These net losses reflect the restatement of our historical financial
statements for 1998 and prior periods to account for the acquisition of Esprit
Telecom as a pooling of interests.
 
     Our operations, infrastructure and customer base have grown significantly
in the last three years as we have expanded into new European markets. In
addition, we intend to enter additional European markets and offer new
telecommunications services. You should evaluate our prospects in light of the
risks, costs and time constraints that we face in establishing operations and
introducing new telecommunications services in newly liberalizing markets.
 
COMPETITORS WITH GREATER RESOURCES MAY ADVERSELY AFFECT OUR BUSINESS
 
     We compete primarily on the basis of price and on the type and quality of
services offered. Competitors may force us to lower our prices or modify our
services offerings to remain competitive. We cannot assure you that we will be
able to effectively market our expanded service offerings, keep prices at a
profitable level or attract and retain customers. Specifically, prices for
international long distance calls have decreased substantially over the last few
years in most of our current and potential markets. We expect our prices for
services to continue to decrease for the foreseeable future. Our competitors
include large established national carriers, alliances among telecommunications
companies, facilities-based competitors, resellers, data providers, Internet
service providers and other providers of bundled services. We may also face
competition from cable television companies, wireless telephone companies,
microwave carriers and satellite companies. Many competitors have established
customer bases and extensive brand name recognition and have greater financial,
management and other resources.
 
     In addition, various telecommunications companies, including MCI WorldCom,
Inc., Viatel, Inc., KPN N.V., Qwest Communications International, Inc., Deutsche
Telekom AG and France Telecom S.A., Global Crossing Ltd. and British
Telecommunications plc, have announced plans to construct, have begun to
construct or are operating fiber optic networks across various European
countries which do or will compete with Hermes Railtel.
 
     For more information on our competitors in Business Services and Access
Services lines of business, see "Business -- Competition Faced by Our Lines of
Business."
 
                                       45
<PAGE>   47
 
FAILURE TO BE COMPETITIVE WITH NATIONAL PUBLIC TELECOMMUNICATIONS OPERATORS
COULD ADVERSELY AFFECT OUR BUSINESS
 
     Our medium- to large-sized business and governmental agency customers and
organizations, may be reluctant to entrust their telecommunications needs to
what they perceive to be a relatively new and unproven operator. Failure to
attract and retain such customers could have a material adverse effect on our
business, results of operations and financial condition.
 
     Hermes Railtel's "point-to-point" transborder service offering also
competes with circuits currently provided by large established national
carriers, through international private leased circuits. The liberalization of
the European telecommunications market has coincided with technological
innovation to create an increasingly competitive market, characterized by
still-dominant public telecommunications operators as well as an increasing
number of new market entrants. In addition, these carriers own and operate fully
built networks and infrastructure which provide them with significant cost
advantages. Since we utilize these networks in part to provide many of our
services, our failure to gain economical access to these networks could have a
material adverse effect on our business, results of operations and financial
condition. For a more comprehensive discussion of our competition, see
"-- Industry Overview -- European Telecommunications Market," and
"Business -- Competition Faced by Our Lines of Business."
 
OUR COMPETITIVE POSITION MAY BE COMPROMISED BY OUR DEPENDENCE ON OTHER
TELECOMMUNICATIONS SERVICE PROVIDERS
 
     We need to enter into interconnection agreements with large established
national carriers and other local service providers operating in our target
markets. We may also need to enter into agreements which permit us to place our
equipment at the facilities of such third parties and/or lease
telecommunications transport capacity from such third parties. We cannot assure
you that we will be able to enter into these interconnection and other
agreements on satisfactory terms.
 
     The terms and conditions of interconnection to the networks operated by
government-run or recently privatized local telecommunications providers will
have a material effect on our competitive position. We can offer no assurance
that such EU members and regulated carriers in those countries will implement
the EU liberalization directive in a timely and consistent manner or that we
will have economical access to and termination on those networks. Accordingly,
customers' ability to access our services may be restricted in some EU
countries.
 
     We will also need to enter into resale agreements with long distance and
international carriers. These agreements often contain minimum volume
commitments. We may be obligated to pay underutilization charges if we
overestimate our need for transmission capacity. If we underestimate our need
for transmission capacity, we may need to pay more for the extra capacity
needed. Under these arrangements, we are subject to the risk of unanticipated
price fluctuations and service restrictions or cancellations. For a
comprehensive discussion on our dependence on other telecommunications service
providers, see "Business -- Competition Faced by Our Lines of Business."
 
OUR ACCESS SERVICES AND BUSINESS SERVICES ACTIVITIES MAY ADVERSELY AFFECT OUR
CARRIER SERVICES LINE OF BUSINESS
 
     Many of the services we plan to offer in our Access Services and Business
Services lines of business could compete with the services offered by customers
or potential customers of our Hermes Railtel network. This development could
negatively impact Hermes Railtel's ability to attract and retain customers,
which could, in turn, have a material adverse effect on us.
 
OUR INFRASTRUCTURE MAY NOT KEEP PACE WITH OUR RAPID GROWTH
 
     Our operating and financial control systems and infrastructure may not be
adequate to maintain and effectively manage future growth. If we fail to
continuously upgrade our administrative, operating and financial control systems
or unexpected expansion difficulties arise, our business, results of operations
and financial
 
                                       46
<PAGE>   48
 
condition could suffer a material adverse effect. We must also purchase
additional telecommunications facilities and expand, train and manage the
employee base. Inaccuracies in our forecasts of market demand could result in
insufficient or excessive telecommunications facilities and fixed expenses that
are not in line with our operations. As we proceed with our development and
expansion, there will be additional demands on our customer support, sales and
marketing and administrative resources and network infrastructure.
 
WE MAY FACE DIFFICULTIES IN INTEGRATING, MANAGING AND OPERATING NEW TECHNOLOGY
 
     Our operations depend on our ability to successfully integrate new and
emerging technologies and equipment. These include the technology and equipment
required for dense wavelength division multiplexing, which allows multiple
signals to be carried simultaneously and IP transmission using dense wavelength
division multiplexing technology. Integrating these new technologies could
increase the risk of system failure and result in further strains. Additionally,
any damage to our network management center in our Carrier Services line of
business and major switching centers in our Business Services line of business
could harm our ability to monitor and manage the network operations and generate
accurate call detail reports from which billing information is derived. See
"-- Business -- GTS Carrier Services" and "-- Business -- GTS Business
Services."
 
THE TECHNOLOGY OF OUR HERMES RAILTEL NETWORK COULD BECOME OBSOLETE
 
     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 cost of implementation
of emerging and future technologies could be significant.
 
     Development and operation of our network are also subject to certain
technological risks. Our network has been designed to utilize dense wavelength
division multiplexing and synchronous digital hierarchy technology and will be
extended to support IP Services in 1999. While the current operational network
segment has performed at or above design specifications since November 1996,
there can be no assurance that our network will achieve the technical
specifications for which we designed it or that we will be able to upgrade our
network as technological improvements in telecommunications equipment are
introduced. For a more comprehensive discussion of the Hermes Railtel network
technology, see "-- Business -- GTS Carrier Services -- Hermes Railtel Network."
 
SYSTEM FAILURES OR INTERRUPTIONS IN OUR NETWORK MAY CAUSE LOSS OF CUSTOMERS
 
     Our success depends on the seamless uninterrupted operation of our network
and on the management of traffic volumes and route preferences over our network.
Furthermore, as we continue to expand our network to increase both its capacity
and reach, and as traffic volume continues to increase, we will face increasing
demands and challenges in managing our circuit capacity and traffic management
systems. Any prolonged failure of our communications network or other systems or
hardware that causes significant interruptions to our operations could seriously
damage our reputation and result in customer attrition and financial losses.
 
WE MAY ENCOUNTER DELAYS IN IMPLEMENTING KEY ELEMENTS OF OUR BUSINESS STRATEGY
 
     Our ability to achieve our strategic objectives will depend in large part
on the successful, timely and cost-effective realization of numerous elements of
our business plan, including:
 
     -  our plan to provide local access services in twelve major Western
        European cities by 2001;
 
     -  our plan to build and operate the FLAG Atlantic-1 transatlantic cable by
        the end of 2000;
 
     -  our plan to develop and offer IP services;
 
     -  the execution of agreements with various parties regarding, among other
        things, rights-of-way and development and maintenance of infrastructure
        and equipment; and
 
     -  the timely performance by third parties of their contractual obligations
        to engineer, design and construct the infrastructure underlying our
        local access strategy, transatlantic services and IP services.
                                       47
<PAGE>   49
 
We cannot assure you that we will execute such actions. In addition, any delays
in concluding such agreements would materially and adversely affect the speed or
successful realization of our business plan.
 
     We believe that our cost estimates and the build-out schedule are
reasonable with respect to these projects. However, the actual construction
costs or time required to complete the plans could substantially exceed current
estimates. Any significant delay or increase in the costs to develop such plans
could have a material adverse effect on our operations. For a comprehensive
discussion of our business strategy, see "-- Business -- Business Strategy,"
"-- Business -- GTS Carrier Services -- Business and Marketing Strategy,"
"-- Business -- GTS Business Services -- Business and Marketing Strategy,"
"-- Business -- GTS Wholesale Services -- Business and Marketing Strategy," and
"-- Business -- GTS Access Services -- Business and Marketing Strategy."
 
DELAYS IN LIBERALIZATION OF THE EU TELECOMMUNICATIONS MARKET MAY ADVERSELY
AFFECT EXECUTION OF OUR BUSINESS STRATEGY
 
     A substantial portion of our strategy depends on the timely implementation
of regulatory liberalization of the EU telecommunications market. We may
implement our business plan and make capital expenditures in a given country in
anticipation of regulatory liberalization which may not occur. This
liberalization is occurring in accordance with existing European Commission
directives. Although EU member states had a legal obligation to liberalize their
markets in accordance with these directives by January 1, 1998, Greece and
Portugal have been granted a delay in implementing the Full Competition
Directive. In addition, Croatia, Czech Republic, Hungary, Poland, Slovakia,
Switzerland and Russia are not members of the EU and are not subject to its
directives, including the liberalization directive. This and similar delays
could limit, constrain or otherwise adversely affect our ability to provide
certain services. Even if an EU member state promptly adopts liberalization
measures in a timely fashion, established national or regional
telecommunications operators, regulators, trade unions and other sources may
resist implementing such measures. Further, our provision of services in Europe
and the implementation of our business plan may be materially adversely affected
if any EU member state imposes greater restrictions on international services
between the EU member state and non-EU countries.
 
DELAYS IN OBTAINING REGULATORY LICENSES AND APPROVALS COULD ADVERSELY AFFECT OUR
PLANS TO OFFER SERVICES IN OUR TARGETED MARKETS
 
     Because we plan to provide, through each of our lines of business, an
expanded array of telecommunications services in Europe, we will become subject
to significant additional regulation at the EU, national and local levels. In
particular, the Hermes Railtel network must obtain additional 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 (known as
infrastructure providers) to build out the network. We cannot assure you that we
will be able to obtain or maintain the necessary lease agreements, regulatory
approvals, rights and permits on a timely basis or that we will not be adversely
affected by regulatory developments, which could have a material adverse effect
on these planned businesses. Delays in receiving regulatory approvals, or the
enactment of adverse regulations or regulatory requirements, may delay or
prevent us from offering one or more of our lines of business in their
applicable targeted markets. See "Business -- Licenses and Regulatory Issues."
 
WE ARE DEPENDENT ON MAJOR SUPPLIERS FOR KEY EQUIPMENT
 
     We are significantly dependent on the technology and products which we
acquire from our main suppliers. Without this equipment, we would face delays,
operational problems and increased expenses. We purchase international and local
equipment from telecommunications equipment manufacturers that may provide
vendor financing for, and maintenance of, this equipment. Our main suppliers are
Alcatel, Nortel, Ericsson and Siemens. We could obtain equipment of comparable
quality from several alternative suppliers. However, we may fail to acquire
compatible equipment from such alternative sources on a timely and cost-
efficient basis.
 
                                       48
<PAGE>   50
 
     In addition, we occasionally enter into turn-key contracts with specific
suppliers as a means of reducing our costs and development risks. If any of our
technologies and products become incompatible with industry standards, or if any
of our turn-key contracts failed to provide the expected benefits, our business,
results of operations and financial condition could be harmed.
 
WE MAY INCUR LOSSES ON THE LEASED PORTIONS OF OUR NETWORK
 
     We currently lease a substantial portion of our network transmission
capacity under agreements which generally have twelve-month or longer fixed
terms. These lease arrangements result in high fixed costs. If our lease
arrangements deteriorate or terminate and we are unable to enter into new
arrangements, our cost structure, service quality, network coverage, results of
operations and financial condition could be adversely affected.
 
     The revenues generated by transporting traffic in these leased fiber routes
may vary with traffic volumes and prices. Accordingly, if we do not carry enough
traffic volume over the particular route or are unable to charge an appropriate
price for such traffic, we could fail to generate revenue sufficient to cover
our lease costs, and would therefore incur operating losses on the particular
route or routes. For a more comprehensive discussion of our network agreements,
see "-- Business -- GTS Carrier Services -- Hermes Railtel Network -- Network
Agreements."
 
WE MAY NOT BE ABLE TO ROUTE SOME TRAFFIC THROUGH THE UNITED STATES
 
     We may be permitted by the U.S. Federal Communications Commission, or FCC,
to use leased private lines between the United States and a country that is a
party to the World Trade Organization's Basic Telecommunications Services
Agreement if that use satisfies a "benchmark" test that became effective on
January 1, 1998. Under the benchmark test, use of international private lines
will be permitted by the FCC if at least half of the settled traffic on a route
in question to a World Trade Organization member is being settled at rates that
are at or below a benchmark set by the FCC. The FCC has sanctioned the use of
interconnected leased private lines from the United States to the United
Kingdom, Canada, New Zealand, Australia, Sweden, The Netherlands, France,
Germany, Belgium, Denmark, Norway, and Luxembourg. However, with respect to
other countries to which we would like to route traffic from the United States,
the FCC may not sanction the use of international private lines to these other
countries. The FCC's refusal to allow international private line resale may
limit our ability to route traffic through the United States in connection with
the provision of our indirect access services outside the United Kingdom. More
generally, the application of these lower benchmarks for international
settlement rates will likely reduce traffic termination costs for calls
originated in or routed through the United States, but may also substantially
decrease profit margins on the routes.
 
OUR REVENUES FROM OUR WHOLESALE AND RESELLER BUSINESSES ARE SUBJECT TO
FLUCTUATION
 
     Wholesale and reseller customers of our Business Services line of business
typically change their routing or providers to take advantage of the lowest cost
alternative, resulting in potentially greater fluctuations in revenue generated
by these customers than for other categories of customers. Due to capacity and
quality constraints on our least-cost routes, we have on occasion been forced to
carry traffic over a higher-cost route, thereby decreasing our revenues. In
response to such constraints, we decided to reduce the volume of wholesale
traffic until the second quarter of fiscal 1998 when sufficient spare capacity
became available to provide services to wholesale customers profitably. Our
credit exposure to resellers may be greater since, unlike wholesale customers,
resellers do not typically furnish any services to us. We may continue to
experience short term fluctuations in usage and revenue as customers change
routing and providers. For a discussion of our wholesale and resale customers,
see "Business -- GTS Wholesale Services -- Customers."
 
UNFAVORABLE TAX TREATMENT MAY ADVERSELY AFFECT OUR RESULTS
 
     The tax rules and regimes which exist in certain emerging markets in which
we operate or plan to operate are, in many cases, new and rapidly changing. If
we repatriate profits from those countries, we may incur
 
                                       49
<PAGE>   51
 
additional taxes. Also, other taxes, such as value added tax, excise taxes and
import duties are changing at an unpredictable pace and could have an adverse
effect on our operations.
 
WE WILL LOSE TAX BENEFITS IF WE ARE UNABLE TO USE OUR NET OPERATING LOSS
CARRYFORWARDS
 
     As of December 31, 1998, we had net operating loss carryforwards for U.S.
federal tax purposes of approximately $251.0 million expiring in 2003 through
2018. We cannot assure you that local tax authorities will allow us to apply
these loss carryforwards, in part or full, to reduce taxes on our future income.
Because of the change in ownership provisions of the Tax Reform Act of 1986, our
ability to use the tax benefits from our net operating loss carryforwards is
subject to an annual limit as a result of the initial public offering and the
follow on stock offering, convertible senior subordinated debenture due 2010
offering carried out in July 1998 and our recent acquisitions of Esprit and
NetSource.
 
FLUCTUATIONS IN FOREIGN CURRENCIES MAY AFFECT OUR ABILITY TO PAY OUR U.S.
DOLLAR-, DEUTSCHMARK- AND EURO-DENOMINATED DEBT
 
     We are exposed to fluctuations in foreign currencies as our revenue, and
some of our costs, assets and liabilities are denominated in multiple local
currencies. We can offer no assurance that exchange rate fluctuations will not
have a material adverse effect on our business, results of operation and
financial condition, particularly on our ability to make principal and interest
payments on our U.S. dollar-denominated, DM-denominated and Euro-denominated
debt. This exposure may increase as our operations expand into additional
countries in Europe, although this risk may be reduced with the adoption of the
Euro in eleven member states of the European Union. We can offer no assurance
that the Euro will maintain its value relative to other currencies. We have
substantial debt denominated in U.S. dollars, Deutschmarks and Euros. However,
most of our revenues are denominated in European currencies. Therefore, our
ability to pay interest and principal on such U.S. dollar-denominated and
DM-denominated and Euro-denominated debt is dependent on the then current
exchange rates between U.S. dollars and the currencies in which our revenues are
denominated. We historically have not used hedging transactions to limit our
exposure to risks from doing business in foreign currencies. In April 1998,
Hermes Europe Railtel B.V. entered into a currency swap contract to limit its
exposure to currency risks from the $265 million of 11.5% senior notes that it
issued in August 1997. For further discussion of our exposure to currency
fluctuations, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Foreign Exchange Rates."
 
     Stage III of the European Economic and Monetary Union commenced on January
1, 1999, in the following member states of the EU: Austria, Belgium, Finland,
France, Germany, Ireland, Italy, Luxembourg, The Netherlands, Portugal and
Spain. Part of Stage III involves the locking of exchange rates and the
introduction of a single Euro currency, which is intended to replace the
national currencies of the EU member states participating in Stage III, and the
transfer of authority for conducting monetary policy for such EU member states
to the European Central Bank. However, we cannot assure you that the Euro will
maintain its value relative to other currencies.
 
RUSSIAN RUBLES AND OTHER SOFT CURRENCIES ARE NOT READILY CONVERTIBLE OR EASILY
REPATRIATED
 
     Through our Business Services - CIS and Mobile Services - CIS lines of
business, we have earned and continue to earn significant revenue in Russia. The
value of the ruble against the U.S. Dollar has steadily declined. As a result of
the August 17, 1998 decision by the Russian Government and the Central Bank of
Russia to devalue the ruble and its aftermath, the value of the ruble against
the U.S. Dollar has fallen even more significantly, negatively affecting our
financial performance. During the quarter ended September 30, 1998, we recorded
a $13.1 million pre-tax charge, the largest portion of which consisted of
foreign currency exchange losses on our net monetary assets that are denominated
in rubles. Since the August 17th decision, the Russian authorities have been
unable to maintain a stable exchange rate. Thus, an additional significant and
sudden decline in the value of the ruble might occur. A significant and sudden
devaluation of the ruble could have a material adverse effect on us and our
results of operations.
 
                                       50
<PAGE>   52
 
     The ruble is generally non-convertible outside Russia. Within Russia, the
market for converting rubles into other currencies is limited and is subject to
rules that restrict the purposes for which conversion and payment are allowed.
This market may become even more restricted as a result of policies the Russian
government may implement. It is uncertain whether such a market in Russia will
continue to exist.
 
WE MAY CONTINUE TO EXPERIENCE LOSSES DUE TO FOREIGN CURRENCY FLUCTUATIONS
 
     We have developed risk management policies that establish guidelines for
managing foreign exchange risk. As part of these policies, we have designed a
reporting process to monitor the potential exposure on an ongoing basis. We use
the output of this process to determine the materiality of foreign currency
exposure and determine whether it is practical and/or economically justified to
execute financial hedges.
 
     For those operating companies that transact their business in currencies
that are not readily convertible, our ability to hedge exposure is limited
because financial hedge instruments for these countries are nonexistent or
limited and also pricing of these instruments is often volatile and not always
efficient. We attempt to minimize our exposure by indexing our 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 we are attempting to match revenues,
costs, borrowing and repayments in terms of their respective currencies, we have
experienced, and may continue to experience, losses and a resulting 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.
 
OUR RISK OF FRAUD AND BAD DEBT MAY GROW AS OUR SMALL TO MEDIUM SIZED CUSTOMERS
INCREASE
 
     We have experienced problems relating to the fraudulent use of our access
codes and the failure of some customers to make full payment for services
rendered. However, we do not believe that such problems are substantially
different from what is generally experienced in the telecommunications industry.
We may have to make provisions for non-payment if we believe that we will not be
able to collect. We expect that the credit risk characteristic of our customer
base may increase as the share of our revenue deriving from small to medium
sized enterprises and service provider/reseller customers increases.
 
DEPENDENCE ON EFFECTIVE BILLING AND MANAGEMENT INFORMATION SYSTEMS
 
     We may encounter difficulties in implementing and enhancing our new billing
and management information systems and in integrating new technology into such
systems. We must record and process millions of call detail records quickly and
accurately in order to efficiently produce customer bills in a timely and
flexible manner. While our existing billing system is sufficient for its current
operations, we have selected a new billing system which we believe will provide
the capability and flexibility to support our anticipated growth. We are also
planning to introduce new management information systems which we believe will
allow us to continuously monitor our operations. We expect that a number of new
systems will be implemented by mid-1999, and that such systems will require
continuous enhancements and ongoing investments, especially as traffic volume
increases and as the Company continues to improve its systems to minimize
problems common to the telecommunications industry, such as call record losses,
and to ensure the timely production of bills. While other lines of business
currently continue to use their own billing systems, we expect that these
systems will be integrated into our new billing process by mid-1999. If we are
unable to implement the new systems or any required system enhancement in a
timely and cost-effective manner, our business could be materially adversely
affected. See "-- Business -- GTS Business Services -- Billing and Management
Information Systems" and "-- Business -- GTS Access Services -- Billing and
Information Systems."
 
FAILURE OF OUR COMPUTER SYSTEMS TO RECOGNIZE THE YEAR 2000 COULD DISRUPT OUR
BUSINESS AND OPERATIONS
 
     The Year 2000 issue is the result of computer programs using two digits
rather than four to define the applicable year. Because of this programming
convention, software, hardware or firmware may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in system failures,
 
                                       51
<PAGE>   53
 
miscalculations or errors causing disruptions of operations or other business
problems, including among others, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
 
     We are undertaking a comprehensive program to address the Year 2000 issue
with respect to the following:
 
     -  our information technology systems;
 
     -  our non-information technology systems;
 
     -  our business partners;
 
     -  the systems of our telecommunications, hardware and software vendors;
        and
 
     -  our customers.
 
     Our Year 2000 program involves four phases:
 
     (1)  a wide ranging assessment of Year 2000 problems that might affect us;
 
     (2)  the development and implementation of remedies to address discovered
          problems;
 
     (3)  preventing future Year 2000 problems from arising; and
 
     (4)  the testing of our system.
 
     We completed the first phase at the end of the fourth quarter of 1998. We
began the last three phases of this program during the first quarter of 1999.
These phases are expected to be completed during the second quarter of 1999.
 
     In addition to the four phases mentioned above, Esprit Telecom's Year 2000
program also involves analyzing Esprit Telecom's most likely worst-case Year
2000 scenario. We expect that this would involve either or both of the
following:
 
     -  a loss of interconnect capacity from one or more major suppliers of
        transmission capacity; and/or
 
     -  Our inability to record, track or invoice billable minutes which could
        ultimately cause it to temporarily stop carrying traffic.
 
     Either scenario would adversely affect our revenue and, if not quickly
remedied, would have a material adverse effect on our business, results of
operations and financial condition.
 
     We are taking steps to determine whether third parties significant to our
business will be Year 2000 compliant are doing the same. We cannot assure you
that our Year 2000 program or the programs of third parties who do business with
us will be effective or that our estimates about the timing and cost of
completing our program will be accurate. See "GTS Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Year 2000
Compliance."
 
     We have spent approximately $4.9 million for our Year 2000 compliance
through December 31, 1998, and expect to spend approximately an additional $5.0
million to $6.0 million through the end of calendar year 1999. We currently
expect to incur $2.0 million to replace identified telecommunications equipment
and software. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Year 2000 Compliance."
 
WE MAY BE ADVERSELY AFFECTED IF WE CANNOT RETAIN KEY PERSONNEL
 
     We believe that our growth and future success will depend in large part
upon a small number of key executive officers, as well as on our ability to
attract and retain highly skilled personnel to work in the emerging markets in
which we operate. Key personnel include our senior management and the heads of
our lines of business. We cannot assure you that we will be able to hire and
retain qualified personnel. The
 
                                       52
<PAGE>   54
 
competition for qualified personnel in the telecommunications industry is
intense, particularly in the emerging markets where we operate.
 
     Key personnel also include senior management personnel formerly employed by
NetSource and Esprit Telecom, which we recently acquired. We cannot assure you
that such persons will not seek employment elsewhere.
 
SIGNIFICANT STOCKHOLDERS MAY INFLUENCE MAJOR DECISIONS IN OUR BUSINESS
 
     At December 31, 1998, the Open Society Institute, Soros Foundation Hungary,
Soros Charitable Foundation, Soros Humanitarian Foundation, Winston Partners II
LLC, Winston Partners II LDC and Chatterjee Fund Management, L.P., which we
collectively refer to as the Soros associates, beneficially owned approximately
11.91% of our common stock and Alan B. Slifka and affiliates beneficially owned
4.60% of our common stock. In addition, two persons who are affiliated with the
Soros associates and one person who is affiliated with the Slifka affiliates
serve on our board. As a result, either of these two stockholder groups may
significantly influence decisions which stockholders must approve, such as the
election of directors and other decisions relating to the management of
business.
 
THE RUSSIAN BANKING CRISIS COULD ADVERSELY AFFECT OUR ABILITY TO CONVERT RUBLES
INTO FOREIGN CURRENCY AND TO RECOVER FUNDS
 
     The banking system in Russia is in crisis as a result of the August 17th
decision and its aftermath. Considerable delays may occur in the transfer of
funds within, and the remittance of funds out of, Russia. The 90-day moratorium
that the August 17th decision imposed on certain foreign exchange payments
delayed transfers of funds. Although the 90-day moratorium has expired, it could
be renewed or established in another form if the Russian government and Central
Bank anticipate further liquidity crises. Any delay in converting rubles into
foreign currency to make a payment or delay in the transfer of such foreign
currency could have a material adverse effect on our operations and on the
market price of Common Stock.
 
     Furthermore, a general Russian banking crisis could have a material adverse
effect on our financial performance and operations, the viability of our
receivables, and our ability to recover funds deposited in Russian banks. For a
more comprehensive discussion of the economic crisis in Russia and the other
independent countries of the CIS, see "-- Business -- GTS Business
Services - CIS and Mobile Services - CIS -- GTS Business
Services - CIS -- Background on the Political, Economic and Tax Environment in
Russia."
 
RUSSIAN EXCHANGE CONTROL LAWS MAY LIMIT OUR ABILITY TO MAKE INTERCOMPANY LOANS
AND CONTRIBUTE TO THE CAPITAL OF OUR RUSSIAN VENTURES
 
     Russia recently tightened currency and capital transfer regulations to
prevent the flight of capital from its borders. These regulations require
licenses for the movement of capital from both the Russian Central Bank and the
Russian government. We are currently working with government agencies to obtain
such licenses for certain intercompany loans and capital contributions. We
believe we will obtain all necessary licenses. It is possible, however, that the
Russian government could deny us the licenses, which could materially affect our
business.
 
TURMOIL IN RUSSIA AND THE CIS CREATES SIGNIFICANT UNCERTAINTY FOR OUR OPERATIONS
 
     To date, we have earned a significant portion of our revenue from
operations in Russia and the other countries of the CIS. All foreign companies
operating in the former Soviet Union, including our company, face significant
political, economic, regulatory, legal and tax risks, as described below.
 
  THE EFFECT OF RUSSIA'S POLITICAL INSTABILITY ON OUR BUSINESS IS UNCERTAIN
 
     Instability in the political systems of Russia and the other independent
countries of the CIS could have a material adverse effect on our operations in
these countries. The political instability results from political
 
                                       53
<PAGE>   55
 
gridlock, dissatisfaction with reform, social and ethnic unrest, economic
difficulties, and changes in government policies, and may grow worse in the
future. Russia's current president continues to institute political reforms, but
the pace of reform is slowing. The dismissal of a significant number of
government leaders by the Russian president over the past year has contributed
to continuing political instability.
 
     The Russian parliament has passed legislation to protect private property
from expropriation and nationalization. However, since the Russian government
lacks experience in enforcing these provisions and since the present political
system is unstable, we do not know if these protections will be enforced in the
future. Expropriation or nationalization of our business would have a material
adverse effect on our operations.
 
  RUSSIA'S UNSTABLE ECONOMY MAY REDUCE DEMAND FOR OUR SERVICES
 
     The Russian economy has experienced severe volatility in both financial and
currency markets. These developments have been accompanied by a substantial
decline in the Russian stock market. Reforms enacted by the Russian government
to create a more market-oriented economy are at risk in this environment and it
is uncertain whether stability will return to the Russian financial markets. If
the Russian economy does not improve, this condition will most likely have an
impact on the demand for our services offered in Russia.
 
  RUSSIAN TELECOMMUNICATIONS REGULATIONS COULD BECOME MORE RESTRICTIVE
 
     Presently, Russian legislation does not restrict foreign investment in the
telecommunications industry, but there have been press reports of renewed
consideration of nationalization and foreign ownership restrictions of certain
strategic industries, such as the telecommunications industry. Any change to
current government regulations or policies could negatively effect our
operations and the market price of our common stock. For a more comprehensive
discussion of regulatory issues in Russia and the other independent countries of
the CIS, see "-- Business -- Licenses and Regulatory Issues -- GTS Business
Services -- CIS and Mobile Services -- CIS".
 
  WE MAY BE UNABLE TO ENFORCE OUR RIGHTS DUE TO CONFUSION IN RUSSIA'S LAWS AND
LEGAL STRUCTURES
 
     The current confusion with the Russian and CIS legal structure makes it
difficult to know if we would be able to enforce our rights in disputes with our
joint venture partners or other parties, or if we are in compliance with all
applicable laws, rules and regulations. The Russian and other CIS governments
have rapidly introduced laws and regulations and have changed their legal
structures in an effort to make their economies more market-oriented, resulting
in considerable legal confusion, especially in areas of the law that directly
affect our operations. There can be no assurance that local laws and regulations
will become stable in the future. Difficulties in protecting and enforcing our
rights in Russia and the CIS and future changes to local laws and regulations
could have a material adverse effect on our operations and the market price of
our common stock.
 
  OUR RUSSIAN TAX BURDEN MAY BE SIGNIFICANTLY GREATER THAN ANTICIPATED
 
     It is possible that our Russian taxes may be greater than the estimated
amount that we have expensed to date and accrued on our balance sheets. The
Russian tax system has many uncertainties and Russian tax authorities have
become increasingly aggressive in their interpretation of the tax law, and in
their enforcement and collection activities. We believe that the resolution of
our Russian tax liability will not have a material adverse effect on our Russian
shareholdings and financial condition. However, the amount and timing of an
unfavorable resolution of our tax liability could have a material adverse effect
on future results of operations or cash flows in a particular period.
 
  OUR MANAGEMENT, LEGAL AND FINANCIAL CONTROLS MAY BE INADEQUATE TO ENSURE THAT
  WE COMPLY WITH APPLICABLE LAWS
 
     As a result of deficient reporting and control standards, we have been
unable to ascertain whether certain practices by our ventures were in compliance
with applicable U.S. and foreign laws. Russia and the other independent
countries of the CIS in which we operate lack corporate management and financial
reporting
                                       54
<PAGE>   56
 
legal requirements, and have underdeveloped banking, computer and other internal
control systems. Additionally, we have had difficulty hiring and retaining
qualified employees in these markets. As a result, we have had difficulty:
 
     -  establishing internal management, legal and financial controls;
 
     -  collecting financial data;
 
     -  preparing financial statements, books of account and corporate records;
       and
 
     -  instituting business practices that meet Western standards.
 
     If we or any of our ventures were found to be involved in unlawful
practices we or our ventures could be exposed, among other things, to
significant fines, the risk of prosecution and the loss of our licenses.
 
     In light of these circumstances, in the second half of 1996 we increased
our efforts to improve our management and financial controls and business
practices. In addition, in early 1997, we retained special outside counsel to
conduct a thorough review of our business practices in the emerging markets in
which we operate. The review did not identify any violations of law that we
believe would have a material adverse effect on our financial condition. We
believe that the special counsel review was properly conducted and was
sufficient in scope, but we cannot assure you that all potential deficiencies
have been identified or that the control procedures and compliance programs
initiated by us will be effective. In addition, if government authorities were
to disagree with our assessment, our future results of operations and cash flows
could be materially adversely affected.
 
  THE REORGANIZATION OF THE RUSSIAN TELECOMMUNICATIONS INDUSTRY MAY CREATE
  STRONGER COMPETITION FOR US AND HURT OUR RELATIONS WITH OUR RUSSIAN PARTNERS
 
     The Russian government has reorganized the Russian telecommunications
industry so that one entity, Svyazinvest, now owns a majority interest in most
of our principal venture partners and other telecommunications service providers
in Russia. This reorganization could have a material adverse effect on our
operations and the price of our common stock because:
 
     -  Svyazinvest is likely to become a stronger competitor; and
 
     -  Our business relationships with our principal venture partners, which
        make up a major component of our business strategy in Russia, may be
        hurt.
 
     For a further discussion of Svyazinvest, see "-- Business -- Licenses and
Regulatory Issues -- GTS Business Services - CIS and Mobile Services - CIS."
 
  WE MAY ENCOUNTER NUMEROUS ADDITIONAL RISKS IN RUSSIA AND THE CIS
 
     Our operations in Russia and the other independent countries of the CIS
also subject us to the following additional risks:
 
     -  corruption;
 
     -  unexpected changes in regulatory requirements, import taxes, customs,
        duties and other trade barriers;
 
     -  potential adverse tax consequences from operating in multiple
        jurisdictions with different tax laws;
 
     -  problems in collecting accounts receivable and devaluation of accounts
        receivable in an inflationary economy;
 
     -  technology export and import restrictions and prohibitions; and
 
     -  delays from customs brokers or government agencies.
 
                                       55
<PAGE>   57
 
     All of the above risks could have a material adverse effect on our
business, results of operations and financial condition.
 
  WE MAY BE OVERLY DEPENDENT ON OUR JOINT VENTURE PARTNERS
 
     MARKETING AND REGULATORY EXPERTISE
 
     We are substantially dependent on our local partners to provide us with
marketing expertise and knowledge of the local regulatory environment. Because
their local knowledge helps facilitate the acquisition of necessary licenses and
permits, any significant disruption in our relationship with these parties could
have a material adverse affect on our Russian and CIS operations.
 
     CORPORATE GOVERNANCE
 
     Under the terms of various joint venture agreements we have the right to
nominate key employees, direct the operations and determine the strategies of
such joint ventures' governance. However, our partners in some ventures have the
ability to frustrate the exercise of such rights. Significant actions by most
ventures, such as approving budgets and business plans, declaring and paying
dividends, and entering into significant corporate transactions effectively
require the approval of our local partners. Further, we would be unlikely as a
practical matter to want to take significant actions without the approval of our
joint venture partners. Accordingly, we are unable to unilaterally control the
operations of our joint ventures. For a discussion of these joint ventures, see
"-- Business -- GTS Business Services - CIS and Mobile Services - CIS -- GTS
Business Services - CIS -- Operations."
 
     COMPETITION WITH OUR PARTNERS
 
     We frequently compete with some joint venture partners in the same markets
which may lead to conflicts of interest. For example, Rostelecom, our partner in
Sovintel, is the dominant international and domestic long distance carrier in
Russia. Similarly, many of our regional telephone company partners in the
TeleRoss Ventures offer cellular services in direct competition with certain of
the operations of Mobile Services - CIS. We cannot assure you that any such
conflicts will be resolved in our favor.
 
WE ARE RESTRICTED FROM ENGAGING IN CERTAIN BUSINESS PRACTICES
 
     Many of our current and potential competitors are not subject to, or
constrained by the prohibitions of, the Foreign Corrupt Practices Act, including
the prohibition against making payments to government officials in order to
obtain commercial benefits. We are subject to, and seek to comply with, the
limitations and prohibitions of such law, and accordingly may be subject to
competitive disadvantages to the extent that our competitors are able to secure
business, licenses or other preferential treatment through the making of such
payments. Accordingly, we cannot assure you that we will be able to compete
effectively against companies free from such limitations in the emerging markets
where such commercial practices are commonplace.
 
ITEM 2. PROPERTIES
 
     We lease 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. We are currently negotiating for
additional office space for our McLean headquarters; however, our growth and
ability to operate have not been constrained by the lack of suitable office
space. We maintain regional headquarters in Moscow and Budapest, as well as
facilities in London.
 
     Esprit Telecom leases its principal executive offices, located in Reading,
United Kingdom, under long-term leases, which expire 2008. The leases contain a
tenant only option to cancel in March 2003. In addition, Esprit Telecom leases
property at each of the locations where it maintains sales offices.
 
     Hermes Railtel leases its executive and principal administrative offices
and its network operations center located just outside Brussels, Belgium, under
two long-term leases, which expire on June 30, 2005. One of the
 
                                       56
<PAGE>   58
 
leases has an option to cancel on January 1, 2002 with a penalty of six months
rent. Hermes Railtel has negotiated leases for two additional buildings, which
are currently under construction and are expected to be ready for occupation in
January 2000. These leases expire in January 2009, but may be terminated after
six years with six-month notice plus six months rental penalty. In addition to
the office in Belgium, Hermes Railtel has leases for office space in Dublin,
Ireland, which expires in 2022, and London, United Kingdom, which expires in
2002.
 
     Hermes Railtel owns substantially all of the telecommunications equipment
required for its business; however, a substantial part of the fiber is on a
long-term basis. The installed fiber optic cable is laid under the various
rights-of-way held by us.
 
ITEM 3. LEGAL PROCEEDINGS
 
     In addition to routine legal proceedings incidental to the conduct of our
business, we have, along with GTS-Hungaro and GTS-Hungary, been 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, we do not believe that the outcome of this litigation will have a
material adverse effect upon our financial condition.
 
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
 
     There were no matters submitted during the fourth quarter of 1998 to a vote
of our security holders.
 
                                    PART II
 
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
     Our common stock has been traded on the Nasdaq National Market since
February 5, 1998, the date of the IPO, under the symbol "GTSG." The following
table sets forth, for the periods indicated, the high and low closing bid prices
per share of our common stock as reported on the Nasdaq National Market.
 
<TABLE>
<CAPTION>
                                                                 HIGH       LOW
                                                                ------    -------
<S>                                                             <C>       <C>
Quarter ending March 31, 1998...............................    $49.00    $ 25.94
Quarter ending June 30, 1998................................    $51.25    $ 35.38
Quarter ending September 30, 1998...........................    $64.25    $ 24.50
Quarter ending December 31, 1998............................    $59.50    $ 21.13
                                                                ------    -------
Quarter ending March 31, 1999 (through March 22, 1999)......    $68.25    $ 47.81
                                                                ======    =======
</TABLE>
 
     As of December 31, 1998, there were approximately 484 holders of record of
our common stock.
 
     We have not paid any dividend on our common stock and do not intend to pay
dividends in the foreseeable future. In addition, the indenture governing our
9 7/8% notes currently prohibits the payment of dividends. This indenture
contains restrictions against making restricted payments (in the form of the
declaration or payment of certain dividends or distributions, the purchase,
redemption or other acquisition of any of our capital stock, 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 exists,
its leverage ratio does not exceed 6.0 to 1.0 and such restricted payments do
not exceed certain amounts.
 
                                       57
<PAGE>   59
 
     During the year ended December 31, 1998 we issued securities which were not
registered under the Securities Act of 1933, as amended (the "Securities Act")
as follows:
 
     In connection with the acquisition of NetSource Europe ASA, during the
fourth quarter of 1998, we issued 3,873,705 shares of our common stock to
holders of NetSource stock who accepted, as of December 15, 1998, our offer to
purchase the NetSource stock owned by such holders. We received the NetSource
shares tendered as consideration for our common shares. No underwriters were
involved in the issuance of the common shares. We issued the common shares
pursuant to Rule 903 under the Securities Act of 1933 and the Company's offer
was made exclusively to non US persons, within the meaning of Rule 902 under the
Securities Act, not in the United States. Up to 163,795 additional shares of our
common stock will be issued pursuant to this transaction. Any additional
issuances also will be effected in accordance with Rule 903 of the Securities
Act and will be disclosed in a subsequent filing with the SEC.
 
     During the second quarter of 1998, we issued 336,630 shares of our common
stock to one of our partners in a business venture ("Seller"), in connection
with fulfilling our obligations under a 1995 purchase agreement, as amended,
with the Seller. During the third quarter of 1998, we issued an additional
126,859 shares of our common stock (and paid $40 million) to the Seller to
purchase their remaining interest in the previously identified business venture.
 
                                       58
<PAGE>   60
 
ITEM 6. SELECTED FINANCIAL DATA
 
     The following is a summary of selected historical financial data as of and
for the five years ended December 31, 1998. The historical financial data as of
December 31, 1998 and 1997 and for the years ended December 31, 1998, 1997 and
1996 have been derived from the historical financial statements of the Company,
which financial statements have been audited by Ernst & Young LLP, independent
public accountants, as indicated in their report included elsewhere herein. 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 document.
 
     The selected financial data presents the restatement of our historical
financial statements for 1998 and prior periods to reflect the business
combination with Esprit Telecom Group plc, which was accounted for as a pooling
of interests.
 
<TABLE>
<CAPTION>
                                                       YEARS ENDED DECEMBER 31,
                                       --------------------------------------------------------
                                          1998         1997        1996       1995       1994
                                       ----------   ----------   --------   --------   --------
                                                (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                    <C>          <C>          <C>        <C>        <C>
Statement of Operations Data:
  Revenues.........................    $  372,392   $  121,461   $ 62,497   $ 30,458   $  8,348
  Gross margin.....................       134,286       24,352     17,902      6,415        256
  Operating loss...................      (145,045)    (105,968)   (65,579)   (52,316)   (18,472)
  Other income (expense)...........       (94,178)     (29,985)    (9,293)    10,683        521
  Loss before extraordinary loss...      (243,052)    (134,761)   (76,205)   (44,196)   (17,951)
  Extraordinary loss...............       (12,704)          --         --         --         --
  Net loss.........................      (255,756)    (134,761)   (76,205)   (44,196)   (17,951)
  Loss per share before
     extraordinary loss............         (3.41)       (2.74)     (2.01)     (1.48)     (0.83)
  Extraordinary loss per share.....         (0.18)          --         --         --         --
  Net loss per share...............         (3.59)       (2.74)     (2.01)     (1.48)     (0.83)
Other Data:
  EBITDA(1)........................    $  (66,222)  $  (87,436)  $(55,866)  $(46,442)  $(16,733)
  Net cash used in operating
     activities....................      (120,852)     (52,268)   (42,763)    (5,637)   (18,506)
  Net cash used in investing
     activities....................      (455,916)    (117,646)   (86,421)   (80,984)   (22,783)
  Net cash provided by financing
     activities....................     1,032,377      468,339    178,998     74,890     67,338
Balance Sheet Data (at end of period):
  Cash and cash equivalents........    $  998,510   $  358,384   $ 67,927   $ 17,767   $ 29,917
  Property and equipment, net......       643,044      259,971     46,992     34,982     12,153
  Total assets.....................     2,614,602      876,647    275,058    136,093     68,640
  Total debt.......................     1,792,314      645,710     89,349     39,379      8,694
  Shareholders' equity.............       349,903       77,649    128,267     63,869     54,825
</TABLE>
 
---------------
 
(1) EBITDA is earnings (loss) from operations before foreign currency gains
    (losses), interest, taxes, depreciation and amortization. In computing
    EBITDA, we have not included our share of the foreign currency gains
    (losses), interest, taxes and depreciation and amortization that we have
    recognized from our respective equity method investees, for the periods
    presented, that is included within our equity in losses of ventures line
    item in our consolidated statements of operations. EBITDA is a measure of a
    company's performance commonly used in the telecommunications industry, but
    should not be construed as an alternative to net income (loss) determined in
    accordance with generally accepted accounting principles ("GAAP") as an
    indicator of operating performance or as an alternative to cash from
    operating activities determined in accordance with GAAP as a measure of
    liquidity.
 
                                       59
<PAGE>   61
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
     The following discussion and analysis relates to our financial condition
and results of operations for the three years ended December 31, 1998. This
information should be read in conjunction with the "Selected Financial Data" and
our Consolidated Financial Statements and the notes related thereto appearing
elsewhere in the document.
 
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
and (iii) changes in our competitive environment, contain forward-looking
statements concerning our 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 our results of operations are the
potential risk of delay in implementing our business plan; the political,
economic and legal aspects of the markets in which we operate; competition; and
our need for additional substantial financing. These and other factors are
discussed herein under "Business -- Risk Factors," "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 of our forward-looking
statements made by or on our behalf, 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 we undertake 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 our 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
 
     We are a leading independent provider of telecommunications services to
businesses, other high usage customers and telecommunications carriers in
Europe. We also provide telecommunications services in Russia and the
Commonwealth of Independent States (CIS).
 
     From our inception until 1998, we focused on (1) providing
telecommunications services in emerging markets, particularly in Russia and (2)
establishing and developing Hermes Europe Railtel B.V., a venture designed to
provide a high speed transmission network across national borders in Western
Europe. We intended to capitalize on the rapidly growing demand for
telecommunications services in countries emerging from totalitarian rule and
state-controlled economies. In addition, in Western Europe, growing
liberalization of regulations governing the provision of telecommunications
services has resulted in a proliferation of new competitors to the incumbent
public telecommunications operators. At the same time, with the trend toward the
increasing globalization of business, there has been substantial growth in
demand for high-quality voice and data telecommunications. We perceived a need
for a fast, efficient and lower cost cross-border network that would carry the
traffic of established public telecommunications operators and other carriers.
Since we
 
                                       60
<PAGE>   62
 
began operating our Hermes Railtel network in late 1996, the demand for its
services has validated our decision to build and develop such a network.
 
     In 1998, we changed our strategy in response to the economic crisis in
emerging markets and the advent on January 1, 1998 of the deregulation of the
provision of telecommunications services in Western Europe. We also sought to
build on the success of our Hermes Railtel network by developing a plan to
provide telecommunications services, including local access services, directly
to businesses and other customers. In October 1998 we realigned our operations
into five lines of business: GTS Carrier Services, GTS Business Services, GTS
Access Services, GTS Business Services - CIS and GTS Mobile Services - CIS. In
March 1999, we added a sixth line of business, GTS Wholesale Services.
 
     Our strategy to develop our businesses is to:
 
     - Continue the buildout of the Hermes Railtel network by extending its
       coverage and by putting in place a cost-efficient transatlantic link
       through our participation in FLAG Atlantic Limited;
 
     - Develop local access infrastructure to facilitate our customers' access
       to our network and to exploit what we believe to be an expanding market;
 
     - Capitalize on growth in data/IP traffic by expanding our IP-based
       capabilities and product offerings;
 
     - Reinforce and extend market penetration of Hermes Railtel's network by
       enhancing the scope, capacity, reliability and efficiency of our
       infrastructure, and by providing our own local access; and
 
     - Increase high usage retail customer base and route traffic over our own
       network.
 
     As part of our business strategy, we expect to continue to expand through
additional significant acquisitions and by entering into additional joint
ventures and other cooperative business relationships. As part of our business
strategy, we expect to make significant acquisitions in the future. We believe
that additional attractive acquisitions opportunities currently exist in Western
and Central Europe and in the United States and are continually evaluating these
opportunities. Certain of these transactions, if consummated, may be material to
our operations and financial condition. Such acquisitions may not be
successfully integrated or result in projected benefits. We may not be able to
raise the additional capital necessary to fund such acquisitions and may have to
divert resources from other areas. Although we periodically have discussions
with other companies to assess opportunities on an ongoing basis, we do not have
a definitive agreement with respect to any material acquisition or joint
venture. For a comprehensive discussion of our acquisition strategy, see "-- GTS
Carrier Services -- Business and Marketing Strategy," "-- GTS Business
Services -- Business and Marketing Strategy," "-- GTS Wholesale
Services -- Business and Marketing Strategy," and "-- GTS Access
Services -- Business and Marketing Strategy." We anticipate that we will
continue to incur substantial additional costs and charges associated with this
strategy in addition to the capital expenditures related to the expansion of our
network and lines of business.
 
ESPRIT TELECOM GROUP -- BUSINESS COMBINATION
 
     The following discussion of our results of operations and liquidity and
capital resource requirements reflect the restatement of our financial results
for 1998 and prior periods as a result of the business combination with Esprit
Telecom, which we accounted for as a pooling of interests.
 
                                       61
<PAGE>   63
 
RESULTS OF OPERATIONS
 
     The following table sets forth our statement of operations as a percentage
of revenues:
 
<TABLE>
<CAPTION>
                                                               FOR THE YEAR ENDED
                                                                  DECEMBER 31,
                                                            -------------------------
                                                            1998      1997      1996
                                                            -----    ------    ------
<S>                                                         <C>      <C>       <C>
Revenues..................................................  100.0%    100.0%    100.0%
Telecommunications services...............................   63.9      80.0      71.4
Selling, general and administrative.......................   53.5      80.0     101.8
Depreciation and amortization.............................   21.1      15.2      15.5
Equity in losses of ventures..............................    0.4      12.0      16.2
                                                            -----    ------    ------
Loss from operations......................................  (38.9)    (87.2)   (104.9)
Interest income...........................................   16.1      10.9       6.1
Interest expense..........................................  (35.2)    (32.8)    (18.7)
Foreign currency losses...................................   (6.2)     (2.8)     (2.3)
                                                            -----    ------    ------
Net loss before income taxes, minority interest and
  extraordinary loss......................................  (64.2)   (111.9)   (119.8)
Income taxes..............................................    2.1       2.1       2.2
                                                            -----    ------    ------
Net loss before minority interest and extraordinary
  loss....................................................  (66.3)   (114.0)   (122.0)
Minority interest.........................................    1.1       3.0        --
                                                            -----    ------    ------
Net loss before extraordinary loss........................  (65.2)   (111.0)    122.0
                                                            -----    ------    ------
Extraordinary loss -- debt refinancing....................   (3.4)       --        --
                                                            -----    ------    ------
Net loss..................................................  (68.6)%  (111.0)%  122.0%
                                                            =====    ======    ======
</TABLE>
 
  YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997
 
     Revenue. Our consolidated revenue increased to $372.4 million for the year
ended December 31, 1998 as compared to $121.5 million for the year ended
December 31, 1997. Significant components of revenue for the year ended December
31, 1998 were Business Services ($180.6 million), Carrier Services ($85.3
million) and Business Services - CIS ($75.4 million). Revenue for the year ended
December 31, 1997 was primarily comprised of Business Services ($74.4 million),
Business Services - CIS ($24.7 million) and Access Services ($13.5 million). The
growth in revenue was primarily attributable to the increase in our customer
base and resulting traffic in all of our operations. An additional contributor
to the revenue growth in 1998 was that we followed the consolidation method of
accounting for certain business ventures, whereas in 1997, these business
ventures were accounted for following the equity method of accounting.
 
     Telecommunications Services. Our costs associated with providing
telecommunications services through our five lines of business in 1998 increased
to $238.1 million or 63.9% of revenues as compared to $97.1 million or 80.0% of
revenues for 1997. The decrease in telecommunication services as a percentage of
revenues in 1998 is attributable to the growth in our customer revenue offset by
increased settlement and interconnect costs paid to third parties and direct
network operating and maintenance costs. Although telecommunications services
costs as a percentage of revenue have decreased, we are incurring substantial
costs related to the implementation of our business strategy.
 
     Selling, General and Administrative. Selling, general and administrative
expenses for 1998 increased to $199.2 million or 53.5% of revenues as compared
to $97.2 million or 80.0% of revenues for 1997. The decrease in selling, general
and administrative expenses as a percentage of revenues in 1998 is attributable
to growth in our customer revenue offset by increases in the number of staff
associated with business growth, as well as administrative and marketing costs
required for our increased customer base. We expect to establish sales offices
in additional European cities, which involves incurring substantial start-up
costs. Accordingly, our consolidated results of operations will fluctuate
depending on the timing of our expansion strategy. During a
 
                                       62
<PAGE>   64
 
period of rapid expansion, selling, general and administrative expenses will be
relatively higher than during more stable periods of growth.
 
     Depreciation and Amortization. Depreciation and amortization increased to
$78.8 million or 21.1% of revenues for the year ended December 31, 1998 as
compared to $18.5 million or 15.2% of revenues for the year ended December 31,
1997. The substantial increase in depreciation and amortization costs is
attributable to the depreciation related to the expansion of our network
infrastructure that we have undertaken over the past several years.
Additionally, we have experienced an increase in amortization expense associated
with goodwill that has arisen from our acquisition activities.
 
     Losses in Ventures. We recognized losses in our investments in
non-consolidated ventures of $1.3 million for the year ended December 31, 1998
as compared to $14.6 million of the year ended December 31, 1997. Included in
these losses was our ownership share of earnings of $1.8 million and losses of
$3.6 million for the years ended December 31, 1998 and 1997, respectively. This
improvement is primarily the result of our 1998 consolidation of certain
business ventures that were previously accounted for following the equity method
of accounting, offset by a $7.7 million charge associated with our business
operations in Russia as a result of the deterioration of the Russian economy.
Included in the 1997 loss was a write-off of approximately $5.4 million, which
represented the net balance of certain investments in, and advances to, business
ventures in Asia and Central Europe that were previously stated in excess of
their net realizable value.
 
     Interest Expense. Interest expense increased to approximately $131.0
million in 1998 from $39.8 million in 1997. This significant increase in
interest expense is attributable to the substantial increase in our outstanding
debt obligations during 1998.
 
     Interest Income. Interest income for 1998 increased to $60.0 million from
$13.2 million in 1997. This increase was due to the interest we earned through
our short-term investments that has grown, due to the proceeds of our financing
activities.
 
     Foreign Currency Loss. We recognized foreign currency losses of $23.2
million in 1998 as compared to $3.4 million in 1997. The losses in 1998 were
attributable to the devaluation of the Russian ruble and losses on several
forward exchange contracts and the weakening of the U.S. dollar versus European
currencies in the third and fourth quarters of 1998.
 
  YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
 
     Revenue. Our consolidated revenue increased to $121.5 million for the year
ended December 31, 1997 as compared to $62.5 million for the year ended December
31, 1996. Revenue for the year ended December 31, 1997 was primarily comprised
of Business Services ($74.4 million), Business Services - CIS ($24.7 million)
and Access Services ($13.5 million). Significant components of revenue for the
year ended December 31, 1996 were Business Services ($38.4 million), Business
Services - CIS ($9.2 million) and Access Services ($9.4 million) and there were
no revenues recognized for Carrier Services during the year ended December 31,
1996. The growth in revenue was primarily attributable to the increase in our
customer base and resulting traffic in all of our operations.
 
     Telecommunications Services. Our costs associated with providing
telecommunications services through our five lines of business in 1997 increased
to $97.1 million or 80.0% of revenues as compared to $44.6 million or 71.4% of
revenues in 1996. The increase in telecommunications services as a percentage of
revenue is attributable to our increased costs related to network operations
without the benefit of a commensurate growth in our customer revenue.
 
     Selling, General and Administrative. Selling, general and administrative
expenses for 1997 increased to $97.2 million or 80.0% of revenues as compared to
$63.6 million or 101.8% of revenues for 1996. The decrease in selling, general
and administrative expenses as a percentage of revenues in 1997 is attributable
to growth in our customer revenue offset by increases in the number of staff
required as a result of business growth as well as administrative and marketing
costs required for our increased customer base.
 
                                       63
<PAGE>   65
 
     Depreciation and Amortization. Depreciation and amortization increased to
$18.5 million or 15.2% of revenues for 1997 as compared to $9.7 million or 15.5%
of revenues for 1996. This increase in depreciation is primarily due to the
expansion of our network offset by a proportional increase in our revenue base.
 
     Losses in Ventures. We recognized losses in our investments in
non-consolidated ventures of $14.6 million for 1997 as compared to $10.2 million
for 1996. Included in these losses was our equity ownership share of losses of
$3.6 million and $5.7 million for 1997 and 1996, respectively. Additionally,
included in the 1997 loss was the write-off of approximately $5.4 million, as
discussed above.
 
     Interest Expense. Interest expense increased to $39.8 million in 1997 from
$11.7 million in 1996. This increase was attributable to the substantial
increase in our outstanding debt obligations during 1997.
 
     Interest Income. Interest income for 1997 increased to $13.2 million from
$3.8 million for 1996. This increase was due to the interest we earned through
our short-term investments that has grown, due to the proceeds generated through
our financing activities.
 
     Foreign Currency Loss. We recognized foreign currency losses of $3.4
million for 1997 as compared to $1.4 million for 1996.
 
                        LIQUIDITY AND CAPITAL RESOURCES
 
CORPORATE
 
     The telecommunications industry is capital intensive. In order for us to
successfully compete, we will require substantial capital to continue to develop
our networks and meet the funding requirements of our operations, including
losses from operations, as well as to provide capital for our acquisition and
business development initiatives. We expect that we will spend over $1.3 billion
in cash over the next three years to meet our capital expenditures and operating
funding requirements to implement our business plan.
 
     Historically, we have raised capital through a combination of public and
private offerings of equity and debt securities. We have received cash proceeds
of $370.1 million, $89.8 million and $141.7 million in 1998, 1997 and 1996,
respectively, net of placement costs, associated with the issuance of our common
stock in connection with these offerings, including issuance of warrants and the
exercise of stock options. In addition, the Company received $812.0 million,
$714.8 million and $60.0 million in gross proceeds in 1998, 1997 and 1996,
respectively, for a total of approximately $1.6 billion under various debt
securities that were issued by Hermes Railtel, Esprit Telecom and ourselves.
 
     We had working capital of $882.3 million and $312.1 million as of December
31, 1998 and 1997, respectively. In addition, we had an accumulated deficit of
$543.7 million as of December 31, 1998, including net losses of approximately
$255.8 million and $134.8 million for the years ended December 31, 1998 and
1997, respectively. During 1997 and 1998, we incurred substantial expenditures
to build out our network, fund the working capital requirements of our
businesses, purchase capital equipment, engage in new development and
acquisitions and increase our ownership interest in Hermes Railtel and in some
of our ventures in Russia and the CIS. We expect to continue to incur
substantial expenditures to fund these requirements.
 
     We believe that our existing cash balances, cash flow received from certain
operating ventures and proceeds from the January 1999 offering of Hermes
Railtel's notes will be sufficient to fund our currently anticipated capital
needs over at least the next 12 months. We expect that we will need to raise
additional capital. In addition, we may decide in the future to initiate a
tender or exchange offer or consent solicitations with respect to Esprit
Telecom's outstanding senior notes, if we determine it is advantageous in order
to enable us to better integrate Esprit Telecom into our overall corporate
structure.
 
     The actual amount and timing of our future capital requirements may differ
materially from our estimates. In particular, the accuracy of our estimates is
subject to changes and fluctuations in our revenues, operating costs and
development expenses, which can be affected by our ability to (1) effectively
and efficiently manage the expansion of the Hermes Railtel network and
operations and the buildout of our local access infrastructure in our targeted
metropolitan markets, (2) effectively and efficiently manage the build-out of
the FLAG Atlantic-1 transatlantic cable, either directly or through our
participation in the FLAG Atlantic
 
                                       64
<PAGE>   66
 
joint venture, (3) obtain infrastructure contracts, rights-of-way, licenses,
interconnection agreements and other regulatory approvals necessary to complete
and operate the Hermes Railtel network, construct our local access
infrastructure and offer telecommunications services to end-users, (4) negotiate
favorable contracts with suppliers, including large volume discounts on
purchases of capital equipment and (5) access markets, attract sufficient
numbers of customers and provide and develop services for which customers will
subscribe. Our revenues and costs are also dependent upon factors that are not
within our control such as political, economic and regulatory changes, changes
in technology, increased competition and various factors such as strikes,
weather, and performance by third parties in connection with our 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 our future capital requirements. In addition, if we expand our
operations at an accelerated rate or consummate acquisitions, our funding needs
will increase, possibly to a significant degree, and we will expend our capital
resources sooner than currently expected. As a result of the foregoing, or if
our capital resources otherwise prove to be insufficient, we will need to raise
additional capital to execute our current business plan and to fund expected
operating losses, as well as to consummate future acquisitions and exploit
opportunities to expand and develop our businesses.
 
     We cannot assure you that we will be able to consummate additional
financing on favorable terms. As a result, we may be subject to additional or
more restrictive financial covenants, our interest obligations may increase
significantly and our 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 us to delay or abandon some or
all of our anticipated expenditures, to sell assets, or both, either of which
could have a material adverse effect on our operations.
 
HERMES RAILTEL NETWORK
 
     Development of Hermes Railtel's fiber optic network has required and will
continue to require substantial capital. Hermes Railtel raised $265.0 million in
gross proceeds from its offering of senior notes in July 1997 (of which $56.6
million was placed in escrow as an interest reserve). We have spent
approximately $192 million in cash on network capital expenditures through
December 31, 1998 and we expect to incur an additional $598 million through 2000
in order to complete the build-out of the network and enhance its capacity
through the implementation of dense wave division multiplexing technology. In
addition, as of December 31, 1998, we had capitalized $271 million in connection
with long-term fiber lease arrangements and an additional $152 million is
expected to be capitalized through 2000. In January 1999, Hermes Railtel issued
$200 million aggregate principal amount of 10.375% senior notes due 2009 and
Euro 85 million (approximately $100 million) aggregate principal amount of
10.375% senior notes due 2006. These new senior notes have substantially the
same terms as the notes Hermes Railtel issued in 1997. We believe that the net
proceeds from the 1997 senior notes and the new senior notes, combined with
projected internally generated funds, should be sufficient to fund expected
capital expenditures as well as payments on the long-term fiber lease
arrangements. However, the actual amount and timing of our future requirements
may differ materially from our estimates. Any failure to obtain necessary
financing may require us to delay or abandon our plans for deploying the
remainder of the network.
 
TRANSOCEANIC SERVICES
 
     We are participating in the construction and operation of the FLAG
Atlantic-1 transoceanic cable through our 50% interest in the Flag Atlantic
Limited joint venture. See "Item 1. Business -- GTS Carrier
Services -- Transoceanic Services." The terms of the joint venture require that
we (1) invest $100 million for our interest in the venture and (2) purchase
capacity on the cable for $150 million. Although these expenditures are payable
over a number of years, we may be required to cover these payments by posting a
fully cash collateralized letter of credit during the second quarter of 1999. We
expect to fund these cash requirements from existing cash balances. We may also
fund or refinance a portion of these cash requirements through the proceeds of
debt or equity financings that we may execute during 1999.
 
     In addition, the terms of the joint venture contemplate that we will be
responsible in part for constructing the European and U.S. backhaul portion of
the FLAG Atlantic project, that is, the terrestrial portion of the
                                       65
<PAGE>   67
 
network connecting the landing points of FLAG Atlantic-1 to Paris, London and
New York. At this time, we estimate that our share of the costs associated with
this portion of the project will be approximately $200 million, of which
approximately $150 million is scheduled to be incurred in 2000. We expect to
meet this cash requirement through a combination of cash on hand and equity or
debt financings. We cannot assure you, however, that we will be able to fund our
expenditures associated with our Transoceanic Services business or that this
business will achieve or sustain profitability or positive cash flow.
 
ACCESS SERVICES BUILDOUT
 
     We plan to provide local access services in up to 12 major European cities
by the end of 2001. See "Item 1 -- Business -- GTS Access Services." We plan to
develop our infrastructure by constructing, purchasing or leasing fiber optic
networks, developing microwave transmission networks or through acquisition or
partnership. We project that approximately $250 million will be required through
the end of 2000 to implement these networks. We expect to be able to fund these
expenditures through a combination of cash on hand and equity and debt
financings.
 
     We cannot estimate with any degree of certainty the amount and timing of
these future capital requirements or other cash requirements for the
implementation of our Access Services plans. These expenditures will be
dependent on many factors, including the rate at which we roll out our Access
Services networks, the types of services we offer, staffing levels, acquisitions
and customer growth, as well as other factors that are not within our control,
including competitive conditions, regulatory developments and capital costs. We
expect that we will have significant operating and net losses and will record
significant net cash outflow, before financing, in coming years in connection
with our Access Services business. We cannot assure you that we will be able to
fund the $250 million in projected expenditures or any additional expenditures
or that our Access Services line of business will achieve or sustain
profitability or positive cash flow in the future.
 
LIQUIDITY ANALYSIS
 
     We had cash and cash equivalents of $998.5 million and $358.4 million as of
December 31, 1998 and 1997, respectively. We had restricted cash of $143.4
million and $66.8 million as of December 31, 1998 and 1997, respectively, that
primarily represent amounts held in escrow for debt interest payments.
 
     In 1998, 1997 and 1996, we used cash of $120.9 million, $52.3 million and
$42.8 million, respectively, for our operating activities. The significant
increase in cash spending for our operations in 1998 as compared to 1997 is
attributable to the growth of our business operations which has resulted in
higher operating cash costs and accounts receivable carrying balances. We also
used cash of $455.9 million, $117.6 million and $86.4 million for our investing
activities in 1998, 1997 and 1996, respectively. Of the $455.9 million of 1998
investing activities, $257.4 million of cash was spent on business acquisitions
(principally the Plusnet and NetSource businesses) and $231.0 million of cash
was spent primarily on building our telecommunications networks. We cannot
assure you that our operations will achieve or sustain profitability or positive
cash flow in the future. If we cannot achieve and sustain operating
profitability or positive cash flow from operations, we may not be able to meet
our debt service obligations or working capital requirements.
 
     Substantially all of our operations are outside the United States and
therefore our consolidated financial results are subject to fluctuations in
currency exchange rates. Our operations transact their business in the following
significant currencies: Deutschmark, French Franc, British Pound Sterling,
Belgian Franc, Dutch Guilder, the Russian Ruble, and, effective January 1, 1999,
the Euro. For those operating companies that transact their business in
currencies that are not readily convertible, we attempt to minimize our exposure
by indexing our invoices and collections to the applicable dollar/foreign
currency exchange rate to the extent our costs (including interest expense,
capital expenditures and equity) are incurred in U.S. Dollars. Although we are
attempting to match revenues, costs, borrowing and repayments in terms of their
respective currencies, we have experienced, and may continue to experience,
losses and a resulting 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
our operations have notes payable and notes receivable which are denominated in
a currency other than their own functional currency or loans linked
 
                                       66
<PAGE>   68
 
to the U.S. Dollar. We may also experience economic loss and a negative impact
on earnings related to these monetary assets and liabilities.
 
     We have developed risk management policies that establish guidelines for
managing foreign exchange risk. We are currently evaluating the materiality of
foreign exchange exposures in different countries and the financial instruments
available to mitigate this exposure. Our ability to hedge our exposure is
limited since certain of our 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. We designed and implemented reporting
processes to monitor the potential exposure on an ongoing basis in 1998. We will
use the output of this process to execute financial hedges to cover foreign
exchange exposure when practical and economically justified.
 
     In April 1998, we consummated a foreign exchange swap transaction to
mitigate the foreign exchange exposure resulting from the issuance of $265
million senior notes issued by Hermes Railtel.
 
     On August 17, 1998 the Russian government and the Russia Central Bank
announced the following measures: a) the repayment of GKO treasury bills and OFZ
federal bonds was suspended; subsequently, secondary trading therein was halted
(since many Russian banks had substantial investments in these securities,
severe liquidity problems resulted for the banks), b) the value of the ruble was
allowed to fluctuate below the ruble/U.S. dollar exchange rate corridor that the
government had committed to support, which effectively devalued the ruble, c) 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 December 31, 1998,
was 20.65 rubles per U.S. dollar, respectively. The last official exchange rate
prior to the suspension of trading on August 17, 1998 was 6.2725 rubles per U.S.
dollar.
 
     As a result of the devaluation of the ruble and the consequences of the
banking and economic crisis within Russia, we recorded a $13.1 million pre-tax
charge within our financial statements in the third quarter 1998, that is mainly
comprised of foreign currency exchange losses for ruble-denominated net monetary
assets. The remainder is associated with estimates for uncollectible accounts
receivable and unrecoverable cash deposits in Russian banks.
 
     Moreover, the Russian government has defaulted on payments, and proposed a
restructuring, of GKO treasury bills and OFZ federal bonds which has been
criticized by Western holders of such obligations. As a result, it is likely
that the Russian government and Russian businesses will have difficulty
accessing Western financial markets for the foreseeable future. The consequences
of the Russian government's decision on August 17th and its aftermath remain
unclear, but we cannot assure you that these emergency measures, coupled with
the policies of Russia's new government, will be sufficient to stabilize the
currency, enhance liquidity or prevent further economic dislocation. In
particular, we cannot assure you that there will not be a further significant
and sudden decline in the value of the ruble and consequent increased
exchange-related losses and increased loss of investor confidence in the Russian
economy. Such consequences coupled with an overall downturn in the Russian
economy and resulting reduced demand for telecommunication services could have a
material adverse effect on us and our financial condition and results of
operations.
 
YEAR 2000 COMPLIANCE
 
     The "Year 2000" issue is the result of computer programs using two digits
rather than four to define the applicable year. Because of this programming
convention, software, hardware or firmware may recognize a date using "00" as
the year 1900 rather than the year 2000. Use of non-Year 2000 compliant programs
could result in system failures, miscalculations or errors causing disruptions
of operations or other business problems, including, among others, a temporary
inability to process transactions and invoices or engage in similar normal
business activities.
 
                                       67
<PAGE>   69
 
     Issues Posed by the Year 2000 Issue. We are exposed to the Year 2000 issue
in a number of ways. Among other things, the Year 2000 issue might affect our:
(1) computer hardware and software; (2) telecommunications equipment and other
systems with embedded logic (among other things, this includes our fire
detection, access control systems, heating, ventilation and air conditioning,
and uninterruptible power supply); (3) operating partners and organizations upon
which we are dependent; (4) local access connections, upon which we are
dependent; and (5) supply chain.
 
     Our Year 2000 Compliance Program. We have initiated a Year 2000 compliance
program to address the aforementioned risks which the Year 2000 issue poses and
to avoid any material loss or impact to us or our customers due to these risks.
The object of this Year 2000 compliance program is to ensure that neither the
performance nor functionality of our operations are affected by dates, prior to,
during and after 2000. The scope of the Year 2000 compliance program includes
all of the business functions, locations and resources which are essential to
us. The resources which are within the scope of the Year 2000 compliance program
are, among other things, our computer systems, software, vendor supplied
software, telecommunications equipment, third party telecommunications partners
and other network service suppliers, environmental and building control systems,
internal communication systems and other interfaces with third party services.
As explained below, our efforts to assess our systems as well as non-system
areas related to Year 2000 compliance involve (1) a wide-ranging assessment of
the Year 2000 problems that may affect us, (2) the development of remedies to
address the problems discovered in the assessment phase and (3) testing of the
remedies.
 
     Assessment Phase. The assessment phase includes internal and third party
review of potential risks associated with the availability, integrity and
reliability of operational systems necessary to conduct business. During the
assessment phase we have identified substantially all of our major hardware and
software platforms, applications, telecommunications equipment and other non-IT
resources that support the business functions. The assessment phase of the Year
2000 compliance program further identified the internal and external technical
interfaces, third party business relationships and internally developed systems
which might be materially impacted by Year 2000 issues. Our observations from
the assessment phase during the third and fourth quarters of 1998 is that most
of our telecommunications equipment and software has been purchased within the
past three years and the majority is already compliant or can be made compliant
with minor upgrades. We completed the assessment phase of our Year 2000
readiness in the fourth quarter of 1998.
 
     Remediation, Prevention and Testing Phases. Based on those resources
identified in the assessment phase, we developed a detailed plan in the fourth
quarter of 1998, that will then be followed by an upgrade, a remediation, a
prevention and a testing phase in early 1999. These phases are expected to be
completed during the second quarter of 1999.
 
     Assessment of Third Party Compliance. As noted above, we have also
undertaken under our Year 2000 compliance program to assess and monitor the
progress of third party vendors in resolving Year 2000 issues. To ensure the
compliance of vendors of hardware and software applications used by us, we are
obtaining confirmations from our primary telecommunication vendors, business
partners and hardware and software vendors as to what plans, if any, are being
developed or are already in place to address their ability to process
transactions in the Year 2000. We intend to continue follow up with any vendors
who indicate any material problems in their replies. We expect to receive
statements of intended compliance by mid-1999.
 
     Our Worst Case Scenario. Our worst case scenario would be the failing of
our telecommunications equipment, power providers and/or interfaces with other
telecommunication vendors and either or both of the following:
 
     - a loss of interconnect capacity from one or more major suppliers of
       transmission capacity; and
 
     - our inability to record, track or invoice billable minutes which could
       ultimately cause us to temporarily stop carrying traffic.
 
     These cases would create business interruption at some of our operations
and would adversely affect our revenues. For example, the Moscow power
authorities have publicly stated that they do not intend to address Year 2000
issues until problems arise. However, we have operations that are geographically
diversified; therefore, it is not anticipated that the worst case scenario would
affect all operations at the same time.
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<PAGE>   70
 
Additionally, if power failures occur, we currently have diesel generators at
certain of our major sites. Based on our assessment during the third and fourth
quarters of 1998, we do not foresee a material loss due to these conditions and
management is hopeful that our remediation and testing efforts will ensure that
we have addressed our Year 2000 readiness. However, we cannot assure you that
Year 2000 non-compliance by our systems or the systems of vendors, customers,
partners or others will not result in a material adverse effect.
 
     Contingency Plans. We are considering a contingency plan to address our
worst case scenario; however, certain of the initiatives are subject to
execution risk. This risk would include the ability to have access to diesel
fuel or large generators should power failures occur, the ability to quickly
replace telecommunications equipment and the ability to contract with
alternative telecommunication and maintenance providers at reasonable terms.
Moreover, we are further limited in resources in certain geographical regions
due to the market volatility and weak economies in which we have business
operations, which is discussed in the section "Business -- Risk
Factors -- Turmoil in Russia and the CIS creates significant uncertainty for our
operations."
 
     Costs Related to the Year 2000 Issue. We expect that we will incur between
$10.0 million to $11.5 million in expenses to complete the assessment, detailed
planning, remediation, prevention and testing phases, exclusive of replacement
costs for telecommunications equipment and software, of which approximately $4.9
million had been incurred during 1998. It is estimated that between $5.0 million
to $6.0 million of the total expenditure will be required to complete the
remediation and testing phase, excluding the replacement of telecommunications
equipment and software. We have currently identified that certain
telecommunications equipment and software will need to be replaced and we
anticipate that we will incur approximately $2.0 million to replace the
identified telecommunications equipment and software. Further, we are currently
unable to quantify the total costs that we may incur for the replacement of all
telecommunications equipment and software due to the stage of our Year 2000
readiness review. These costs will be funded from operating cash flows and
expensed as incurred. In addition, the preceding cost estimate does not include
amounts associated with the accelerated acquisition of replacement systems as
none are included in the initial assessment during the third and fourth quarters
of 1998. We do not expect that the costs of addressing our Year 2000 readiness
will have a material effect on our financial condition or results of operations.
However, we cannot assure you that Year 2000 non-compliance by our systems or
the systems of vendors, customers, partners or others will not result in a
material adverse effect for us.
 
     Risks Related to the Year 2000 Issue. Although our efforts to be Year 2000
compliant are intended to minimize the adverse effects of the Year 2000 issue on
our business and operations, the actual effects of the issue will not be known
until 2000. Difficulties in implementing the remediation or prevention phases or
failure by us to fully implement the planning or remediation phases or the
failure of our major vendors, third party network service providers, and other
material service providers and customers to adequately address their respective
Year 2000 issues in a timely manner would have a material adverse effect on our
business, results of operations, and financial condition. For a comprehensive
discussion of Year 2000 risks, see "Business -- Risk Factors -- Failure of our
computer systems to recognize the Year 2000 could disrupt our business and
operations."
 
IMPACT OF THE EURO
 
  Implementation
 
     In accordance with the Treaty on EU, signed at Maastricht on February 7,
1992, Stage III of the Economic and Monetary Union (EMU) commenced on January 1,
1999, and a single currency, the 'Euro', has been introduced. The Euro exists in
parallel with national currencies, and transactions may be denominated in either
currency until December 31, 2001 (though only notes and coins of the national
currencies will be available for physical exchange). From January 1, 2002, Euro
notes and coins will be introduced and national currencies will be withdrawn by
June 30, 2002. Those participating member states have also transferred authority
for conducting monetary policy to the European Central Bank. Since January 1,
1999, the value of the Euro as against the currencies of each of the
participating member states has been irrevocably fixed.
 
                                       69
<PAGE>   71
 
     Those member states which are currently participating in the third stage of
EMU are: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg,
The Netherlands, Portugal and Spain.
 
     Through certain of our subsidiaries we have significant operations within
the EU, including many of the countries that adopted the Euro. We are currently
evaluating the systems and business issues raised by the adoption of the Euro,
including: preparing business systems for trading in Euros and converting the
accounting systems of companies in the common currency area from their national
currency to Euros; the benefit of the elimination of exchange rate risk in cross
border transactions within the common currency area; the potential impact of
increases in pricing transparency on price differentials between member states;
and training and human resources issues. We are also working actively with key
business suppliers and customers to prepare for EMU. In addition, monetary union
may have a significant impact on macroeconomic factors, including interest and
foreign exchange rates.
 
     Looking forward, key commercial risks, such as pricing transparency, are
being analyzed by each business, with a view to minimizing any impact through
active management in these areas over the EMU transition period and beyond.
However, there can be no assurance that the Euro will not have a negative
impact. The impact of future entry to EMU of other European countries
(particularly the United Kingdom)is being similarly analyzed.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
 
     Our treasury function manages its funding, liquidity, and exposure to
interest rate and foreign exchange rate risks. Our treasury operations are
conducted within a framework of policies and guidelines authorized by our board
of directors. In accordance with our policy, we do not enter into any
transactions of a speculative nature.
 
     We are exposed to market risk from changes in interest rates on long-term
obligations and as a global company, we also face exposure to adverse movements
in foreign currency exchange rates. A portion of our debt obligations are
denominated in currencies which expose us to risks associated with changes in
foreign exchange rates. We have developed risk management policies that
establish guidelines for managing foreign exchange risk and we also periodically
evaluate the materiality of foreign exchange exposures and the financial
instruments available to mitigate this exposure.
 
     Our subsidiary, Hermes Railtel, has entered into a foreign currency swap
agreement in order to mitigate our exposure on US dollar denominated debt. We
also attempt to mitigate this and other exposure from debt obligations
denominated in exposed currencies by maintaining assets in the exposed currency
wherever possible. We find it impractical to hedge all foreign currency exposure
and as a result will continue to experience foreign currency gains and losses.
The introduction of the Euro as a common currency for most members of the
European Union occurred on January 1, 1999. We have not determined what impact,
if any, the Euro will have on our foreign exchange exposure.
 
     The following table provides information about our debt obligations that
are sensitive to changes in interest rates.
 
<TABLE>
<CAPTION>
                                                                                                               FAIR VALUE
                                          1999       2000      2001    2002   2003   THEREAFTER     TOTAL       12/31/98
                                         -------   --------   ------   ----   ----   ----------   ----------   ----------
                                                                          (IN THOUSANDS)
<S>                                      <C>       <C>        <C>      <C>    <C>    <C>          <C>          <C>
Long-term Debt, including current
  portion
Fixed rate.............................  $ 6,275   $121,659.. $3,007   $110   $75    $1,382,095   $1,513,221   $1,806,976
Avg. interest rate.....................      9.4%       8.7%     8.6%   8.1%  7.0%          9.3%
Variable rate..........................  $17,584   $    268       --     --    --            --   $   17,852   $   17,852
Avg. interest rate.....................      9.3%      11.5%      --     --    --            --           --           --
</TABLE>
 
     The following tables provide information about our derivative financial
instruments and other financial instruments by functional currency and where
applicable, presents such information in US dollar equivalents. The tables
summarize information on instruments that are sensitive to foreign currency
exchange rates, including a foreign currency swap agreement and foreign currency
denominated debt obligations.
 
                                       70
<PAGE>   72
 
               OPERATIONS WITH BELGIAN FRANC FUNCTIONAL CURRENCY
 
<TABLE>
<CAPTION>
                                                                                                                       FAIR VALUE
                                            1999      2000      2001       2002       2003     THEREAFTER    TOTAL      12/31/98
                                           -------   -------   -------   --------   --------   ----------   --------   ----------
                                                                               (IN THOUSANDS)
<S>                                        <C>       <C>       <C>       <C>        <C>        <C>          <C>        <C>
Long-term Debt, including current portion
US Dollars
 Fixed rate..............................       --        --        --         --         --    $265,000    $265,000    $285,538
 Avg. interest rate......................       --        --        --         --         --        11.5%         --          --
Currency Swap Agreements Related to
 Long-term Debt
Receipt of USD
 Notional amount.........................       --   $30,475   $30,475.. $295,475         --          --    $356,425    $330,689
 Avg. contract rate......................       --      1.82   1.82...       1.82         --          --          --          --
Receipt of DEM
 Notional amount.........................  $22,000        --        --         --         --          --    $ 22,000    $ 23,882
 Avg. contract rate......................     0.55        --        --         --         --          --          --          --
</TABLE>
 
               OPERATIONS WITH BRITISH POUND FUNCTIONAL CURRENCY
 
<TABLE>
<CAPTION>
                                                                                                                       FAIR VALUE
                                            1999      2000      2001       2002       2003     THEREAFTER    TOTAL      12/31/98
                                           -------   -------   -------   --------   --------   ----------   --------   ----------
                                                                               (IN THOUSANDS)
<S>                                        <C>       <C>       <C>       <C>        <C>        <C>          <C>        <C>
Long-term Debt, including current portion
US Dollars
 Fixed rate..............................       --        --        --         --         --    $380,000    $380,000    $390,000
 Avg. interest rate......................       --        --        --         --         --        11.3%         --          --
German Mark
 Fixed rate..............................       --        --        --         --         --    $165,112    $165,112    $166,613
 Avg. interest rate......................       --        --        --         --         --        11.2%         --          --
</TABLE>
 
                                       71
<PAGE>   73
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
<TABLE>
<CAPTION>
                                                               PAGE
                                                               ----
<S>                                                            <C>
Report of Ernst & Young LLP, Independent Auditors...........    73
Consolidated Balance Sheets as of December 31, 1998 and
  1997 .....................................................    74
Consolidated Statements of Operations for the three years
  ended December 31, 1998...................................    75
Consolidated Statements of Cash Flows for the three years
  ended December 31, 1998...................................    76
Consolidated Statements of Shareholders' Equity for the
  three years ended December 31, 1998.......................    77
Notes to Consolidated Financial Statements..................    78
</TABLE>
 
                                       72
<PAGE>   74
 
               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, 1998 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, 1998. Our audits also
included the financial statement schedules listed in the Index at Item 14(a).
These financial statements and schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedules based on our audits. We did not audit the financial
statements or financial statement schedules of Esprit Telecom Group plc, a
subsidiary, which statements reflect total assets of $632,951,000 and
$96,186,000 as of December 31, 1998 and September 30, 1997, respectively, and
total revenues of $176,826,000, $74,473,000 and $38,380,000 for the years ended
December 31, 1998, September 30, 1997 and September 30, 1996, respectively.
Those financial statements and schedules were audited by other auditors whose
report has been furnished to us, and our opinion insofar as it relates to data
included for Esprit Telecom Group plc, is based solely on the report of the
other auditors.
 
     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, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Global TeleSystems Group, Inc. at
December 31, 1998 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,
1998, in conformity with generally accepted accounting principles. Also, in our
opinion, based on our audits and the report of other auditors, the related
financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
 
                                                  /s/ ERNST & YOUNG LLP
 
Vienna, Virginia
March 8, 1999
 
                                       73
<PAGE>   75
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
                          CONSOLIDATED BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              ---------------------
                                                                 1998        1997
                                                              ----------   --------
<S>                                                           <C>          <C>
Current Assets
  Cash and cash equivalents.................................  $  998,510   $358,384
  Accounts receivable, net..................................     174,430     42,074
  Restricted cash...........................................      82,025     30,486
  Prepaid expenses..........................................      21,640     17,038
  Other assets..............................................      16,752      6,846
                                                              ----------   --------
          Total Current Assets..............................   1,293,357    454,828
Property and equipment, net.................................     643,044    259,971
Investments in and advances to ventures.....................      50,751     76,730
Goodwill and intangible assets, net of accumulated
  amortization of $52,465 and $10,627 at December 31, 1998
  and 1997, respectively....................................     543,524     48,634
Restricted cash and other non-current assets................      83,926     36,484
                                                              ----------   --------
          Total Assets......................................  $2,614,602   $876,647
                                                              ==========   ========
 
                       LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
  Accounts payable and accrued expenses.....................  $  279,509   $101,063
  Debt maturing within one year.............................      23,859      5,350
  Current portion of capital lease obligations..............      43,102     24,313
  Related party debt maturing within one year...............          --      5,708
  Unearned revenue..........................................      36,059      1,435
  Other current liabilities.................................      28,530      4,866
                                                              ----------   --------
          Total Current Liabilities.........................     411,059    142,735
Long-term debt, less current portion........................   1,504,614    407,127
Long-term portion of capital lease obligations..............     218,139    123,416
Related party long-term debt, less current portion..........       2,600     79,796
Unearned revenue, less current portion......................      34,093         --
Taxes and other non-current liabilities.....................      40,784     14,669
                                                              ----------   --------
          Total Liabilities.................................  $2,211,289   $767,743
Commitments and Contingencies
  Minority interest.........................................  $   37,329   $ 18,766
  Common stock, subject to repurchase (288,441 shares and
     797,100 shares outstanding at December 31, 1998 and
     1997, respectively)....................................      16,081     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; 80,733,372 and 53,096,611 shares issued and
     outstanding, net of 195,528 shares of treasury stock at
     December 31, 1997).....................................       8,073      5,310
  Additional paid-in capital................................     885,057    360,015
  Accumulated other comprehensive income (loss).............         488     (7,294)
  Accumulated deficit.......................................    (543,715)  (280,382)
                                                              ----------   --------
          Total Shareholders' Equity........................     349,903     77,649
                                                              ----------   --------
          Total Liabilities and Shareholders' Equity........  $2,614,602   $876,647
                                                              ==========   ========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       74
<PAGE>   76
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31,
                                                             --------------------------------
                                                               1998        1997        1996
                                                             ---------   ---------   --------
<S>                                                          <C>         <C>         <C>
Revenues...................................................  $ 372,392   $ 121,461   $ 62,497
Operating Expenses:
  Telecommunications services..............................    238,106      97,109     44,595
  Selling, general and administrative......................    199,184      97,189     63,618
  Depreciation and amortization............................     78,823      18,532      9,713
  Equity in losses of ventures.............................      1,324      14,599     10,150
                                                             ---------   ---------   --------
                                                               517,437     227,429    128,076
Loss from operations.......................................   (145,045)   (105,968)   (65,579)
Other Income/(Expense):
  Interest income..........................................     60,029      13,248      3,788
  Interest expense.........................................   (131,011)    (39,835)   (11,654)
  Foreign currency losses..................................    (23,196)     (3,398)    (1,427)
                                                             ---------   ---------   --------
                                                               (94,178)    (29,985)    (9,293)
                                                             ---------   ---------   --------
Net loss before income taxes, minority interest and
  extraordinary loss.......................................   (239,223)   (135,953)   (74,872)
Income taxes...............................................      7,752       2,485      1,360
                                                             ---------   ---------   --------
Net loss before minority interest and extraordinary loss...   (246,975)   (138,438)   (76,232)
Minority interest..........................................      3,923       3,677         27
                                                             ---------   ---------   --------
Net loss before extraordinary loss.........................  $(243,052)  $(134,761)  $(76,205)
                                                             ---------   ---------   --------
Extraordinary loss -- debt refinancing.....................    (12,704)         --         --
                                                             ---------   ---------   --------
Net loss...................................................  $(255,756)  $(134,761)  $(76,205)
                                                             =========   =========   ========
Net loss per share before extraordinary loss...............  $   (3.41)  $   (2.74)  $  (2.01)
Net loss per share -- extraordinary loss...................      (0.18)         --         --
                                                             ---------   ---------   --------
Net loss per share.........................................  $   (3.59)  $   (2.74)  $  (2.01)
                                                             =========   =========   ========
Weighted average common shares outstanding.................     71,282      49,166     37,850
                                                             =========   =========   ========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       75
<PAGE>   77
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31,
                                                             --------------------------------
                                                               1998        1997        1996
                                                             ---------   ---------   --------
<S>                                                          <C>         <C>         <C>
Operating Activities
  Net loss.................................................  $(255,756)  $(134,761)  $(76,205)
Adjustments to Reconcile Net Loss to Net Cash Used in
  Operating Activities:
  Extraordinary loss.......................................     12,704          --         --
  Depreciation and amortization............................     79,406      24,511     13,311
  Deferred interest........................................         --      12,970      6,583
  Equity in losses of ventures, net of dividends
     received..............................................      1,324      17,474     11,123
  Fair value adjustment for foreign exchange instrument....     28,650          --         --
  Other....................................................      2,134       7,302      5,139
  Changes in assets and liabilities:
     Accounts receivable...................................   (128,279)    (23,065)   (12,879)
     Accounts payable and accrued expenses.................    115,599      54,058      5,316
     Other changes in assets and liabilities...............     23,366     (10,757)     4,849
                                                             ---------   ---------   --------
          Net Cash Used in Operating Activities............   (120,852)    (52,268)   (42,763)
Investing Activities
  Acquisitions, net of cash acquired.......................   (257,370)     (2,396)      (487)
  Purchases of property and equipment......................   (231,007)    (58,269)   (17,864)
  Restricted cash..........................................     32,000     (62,924)   (13,138)
  Investments in and advances to ventures, net of
     repayments............................................        461       5,943    (54,932)
                                                             ---------   ---------   --------
          Net Cash Used in Investing Activities............   (455,916)   (117,646)   (86,421)
Financing Activities
  Proceeds from debt.......................................    815,868     409,817     63,599
  Net proceeds from issuance of common stock...............    369,990      86,403    119,043
  Repayments of debt.......................................   (116,085)       (149)      (973)
  Payment of debt issue costs..............................    (28,011)    (24,927)    (2,777)
  Other....................................................     (9,385)     (2,805)       106
                                                             ---------   ---------   --------
          Net Cash Provided by Financing Activities........  1,032,377     468,339    178,998
Effect of exchange rate changes on cash and cash
  equivalents..............................................      2,683      (7,968)       209
Net increase in cash and cash equivalents..................    458,292     290,457     50,023
Cash and cash equivalents at beginning of year.............    540,218      67,927     17,904
                                                             ---------   ---------   --------
Cash and Cash Equivalents At End of Year...................  $ 998,510   $ 358,384   $ 67,927
                                                             =========   =========   ========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       76
<PAGE>   78
 
                         GLOBAL TELESYSTEMS GROUP, INC.
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
             FOR THE YEARS ENDED DECEMBER 31, 1996, 1997, AND 1998
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                          ACCUMULATED
                                           COMMON STOCK     ADDITIONAL       OTHER                         TOTAL
                                          ---------------    PAID-IN     COMPREHENSIVE   ACCUMULATED   SHAREHOLDERS'
                                          SHARES   AMOUNT    CAPITAL        INCOME         DEFICIT        EQUITY
                                          ------   ------   ----------   -------------   -----------   -------------
<S>                                       <C>      <C>      <C>          <C>             <C>           <C>
Balance at December 31, 1995............  34,555   $3,456    $130,321       $(1,651)      $ (69,416)     $  62,710
  Proceeds from the sale of common
    stock, net of expenses of $3,567....  10,993   1,099      117,991            --              --        119,090
  Issuance of 7,223 warrants in
    connection with debt financing......      --      --       20,184            --              --         20,184
  Translation adjustment................      --      --           --            35              --             35
  Net loss..............................      --      --           --            --         (76,205)       (76,205)
                                                                                                         ---------
         Total comprehensive income.....                                                                   (76,170)
Other...................................    (613)    (61)       2,514            --              --          2,453
                                          ------   ------    --------       -------       ---------      ---------
Balance at December 31, 1996............  44,935   4,494      271,010        (1,616)       (145,621)       128,267
  Proceeds from the sale of common
    stock, net of expenses of $9,850....   7,647     764       88,426            --              --         89,190
  Translation adjustment................      --      --           --        (5,678)             --         (5,678)
  Net loss..............................      --      --           --            --        (134,761)      (134,761)
                                                                                                         ---------
         Total comprehensive income.....                                                                  (140,439)
Other...................................     515      52          579            --              --            631
                                          ------   ------    --------       -------       ---------      ---------
Balance at December 31, 1997............  53,097   5,310      360,015        (7,294)       (280,382)        77,649
  Changes in shareholders' equity for
    Esprit Telecom Group plc for the
    three months ended December 31,
    1997, not presented elsewhere.......     201      20          750           700          (7,577)        (6,107)
                                          ------   ------    --------       -------       ---------      ---------
Adjusted Balance at December 31, 1997...  53,298   5,330      360,765        (6,594)       (287,959)        71,542
  Proceeds from the sale of common
    stock, net of expenses of $22,805...  15,566   1,557      352,335            --              --        353,892
  Exercise of stock options and other
    transactions........................   2,917     291       15,954            --              --         16,245
  Conversion of notes payable...........   2,072     207       40,580            --              --         40,787
  Exercise of common stock warrants.....   2,543     254         (254)           --              --             --
  Issuance of common stock in connection
    with business combinations..........   4,337     434      115,677            --              --        116,111
  Translation adjustment................      --      --           --         7,082              --          7,082
  Net loss..............................      --      --           --            --        (255,756)      (255,756)
                                                                                                         ---------
         Total comprehensive income.....                                                                  (248,674)
                                          ------   ------    --------       -------       ---------      ---------
Balance at December 31, 1998............  80,733   $8,073    $885,057       $   488       $(543,715)     $ 349,903
                                          ======   ======    ========       =======       =========      =========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       77
<PAGE>   79
 
                         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 Western Europe,
Central Europe and the Commonwealth of Independent States ("CIS"), primarily
Russia.
 
     Effective March 4, 1999, the Company completed its business combination
with Esprit Telecom Group plc ("Esprit") which was accounted for as a pooling of
interests. Accordingly, these financial statements have been restated and are
presented as if the companies have been combined since inception (see Note 3,
"Business Combinations and Venture Transactions").
 
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 inter-company
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 profitable, the Company recognizes 100% of the profits until such time as
the excess losses previously recognized have been recovered.
 
     Results of subsidiaries acquired and accounted for by the purchase method
have been included in operations from the relevant date of acquisition.
 
  Reclassifications
 
     Certain reclassifications have been made to the 1997 and 1996 consolidated
financial statements in order to conform to the 1998 presentation.
 
  Cash and Cash Equivalents
 
     The Company classifies cash on hand and deposits in banks, including
commercial paper, money market accounts, and any other investments with an
original maturity of three months or less, that the Company may hold from time
to time, as cash and cash equivalents. The Company had $143.4 million and $66.8
million of restricted cash at December 31, 1998 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
 
                                       78
<PAGE>   80
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
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 capitalizes material
interest costs associated with the construction of capital assets for business
operations and amortizes the costs over the assets' useful lives. The Company
has capitalized interest costs of $4.9 million during the year ended December
31, 1998. Prior to 1998, the Company had no capitalized interest.
 
  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
fifteen 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 an
event or change in circumstances indicates 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 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
discounted cash flow analysis or other valuation techniques. During the third
quarter of 1997, the Company recorded a write-down of long-lived assets
associated with its investments in the Asia and Central Europe regions (see Note
4, "Investments in and Advances to Ventures"). No impairment expense was
recognized in 1998 or 1996.
 
  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
reinvested in those operations permanently.
 
  Stock Splits
 
     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
                                       79
<PAGE>   81
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
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.
 
  Foreign Currency Translation
 
     The Company follows a translation policy in accordance with SFAS No. 52,
"Foreign Currency Translation," (as amended by SFAS No. 130, "Reporting
Comprehensive Income"). 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 other comprehensive income, 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.
 
     All foreign currency gains and losses recognized in the operations of
consolidated subsidiaries are included in the Company's statement of operations
as "foreign currency gains/losses." The Company's proportionate share of all
foreign currency gains and losses recognized in the operations of ventures
accounted for by the equity method of accounting are recognized in the Company's
statement of operations as "equity in earnings/losses of 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 contracts is accounted for when the services are provided.
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 diluted earnings per share for all
years presented. The Company's net loss per share calculation (basic and
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 6, "Debt Obligations," Note 8,
"Shareholders' Equity" and Note 9, "Stock Option Plans").
 
                                       80
<PAGE>   82
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  Fair Value of Financial Instruments
 
     The carrying amounts for cash, accounts receivable, accounts payable and
accrued liabilities approximate their fair value. The fair value of the
long-term debt is determined based on quoted market prices. At December 31,
1998, the fair value of the Company's fixed rate long-term debt is as follows
(in thousands):
 
<TABLE>
<CAPTION>
                                                                           CARRYING
                                                              FAIR VALUE    VALUE
                                                              ----------   --------
<S>                                                           <C>          <C>
5.75% Senior Subordinated Convertible Debentures Due 2010...   $524,097    $466,902
11.50% Senior Notes Due 2007, USD and DM....................    311,552     305,051
11.50% Senior Notes Due 2007................................    285,538     265,000
10.875% and 11.00% Senior Notes Due 2008, USD and DM........    240,811     240,061
8.75% Senior Subordinated Convertible Bonds Due 2000........    326,931     117,601
9.875% Senior Notes Due 2005................................    100,191     105,000
</TABLE>
 
     The recorded amounts for all other long-term debt of the Company
approximates 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, most of which are
maintained in high-quality financial institutions. 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.
 
     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
was 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 December
31, 1998 was 20.65 rubles 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.
The Company has taken and intends to continue to take actions that may minimize
the unfavorable effect of a continued ruble devaluation.
 
  Derivative Financial Instruments
 
     The Company has developed risk management policies that establish
guidelines for managing foreign exchange risk and periodically evaluates the
materiality of foreign exchange exposures in different countries and the
financial instruments available to mitigate this exposure. The Company finds it
impractical to hedge all foreign currency exposure and as a result, will
continue to experience foreign currency gains and losses.
 
     The Company currently accounts for its existing derivatives under SFAS No.
52, "Foreign Currency Translation." In June 1998, the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which
establishes a reporting standard for derivative instruments which will require
the Company to record all derivatives as either assets or liabilities and
requires that those instruments are recorded at their fair value. The Company
plans to adopt SFAS No. 133 for the fiscal year beginning January 1, 2000. The
Company has not yet determined the impact of the adoption of this statement.
 
                                       81
<PAGE>   83
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The Company enters into foreign currency forward contracts to minimize
foreign exchange risk. The Company utilizes foreign currency agreements that are
short term in duration (generally one week or less). Accordingly, the contract
amount of the forwards at December 31, 1998 approximated fair value.
Additionally, Hermes Railtel maintains one foreign currency swap transaction
agreement (see Note 7, "Foreign Currency Transactions").
 
  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 generally 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 generally 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.
 
NOTE 3: BUSINESS COMBINATIONS AND VENTURE TRANSACTIONS
 
     On March 4, 1999, GTS acquired substantially all of the outstanding
ordinary shares and American Depository Shares of Esprit Telecom Group plc. Upon
the completion of the transaction, the number of shares that will be issued for
the outstanding ordinary shares and American Depository Shares of Esprit is
16,027,512. The Company accounted for this combination as a pooling of
interests. Accordingly, the Company restated the accompanying financial
statements and financial data to represent the combined financial results of the
previously separate entities for all periods presented.
 
     Esprit had a fiscal year-end of September 30. The Esprit statements of
operations for the years ended September 30, 1997 and 1996 were combined with
GTS's statements of operations for the calendar years ended December 31, 1997
and 1996, respectively. The Company's consolidated statement of operations for
the year ended December 31, 1998 includes the twelve months then ended of
Esprit. The three months of operations of Esprit from October 1, 1997 to
December 31, 1997 are not included in any of the statements of operations
presented. Accordingly, an adjustment has been made in the consolidated
statement of shareholders' equity for 1997 to include the net income and other
transactions of Esprit for the three months ended December 31, 1997. In
addition, as reflected in the Company's consolidated statements of cash flows,
the "Cash and cash equivalents at the beginning of the year" for 1998 of $540.2
million and "Cash and cash equivalents at the end of year," of $358.4 million,
for the year ended 1997 do not agree. The $181.8 million difference reflects the
cash flow activity of Esprit for the three month period ended December 31, 1997.
The Company's consolidated balance sheet as of December 31, 1997 represents the
audited historical Esprit balance sheet as of September 30, 1997 combined with
GTS's historical balance sheet as of December 31, 1997.
 
                                       82
<PAGE>   84
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The table below presents pro forma information on the separate results of
operations for GTS and Esprit for the periods prior to the combination:
 
<TABLE>
<CAPTION>
                                                            FISCAL YEAR ENDED
                                                     --------------------------------
                                                       1998        1997        1996
                                                     ---------   ---------   --------
                                                              (IN THOUSANDS)
<S>                                                  <C>         <C>         <C>
Revenue:
  Global TeleSystems Group.........................  $ 197,484   $  47,098   $ 24,117
  Esprit Telecom Group.............................    176,826      74,473     38,380
  Pooling adjustments..............................     (1,918)       (110)        --
                                                     ---------   ---------   --------
          Total Revenue............................  $ 372,392   $ 121,461   $ 62,497
                                                     =========   =========   ========
Net Income (Loss):
  Global TeleSystems Group.........................  $(152,559)  $(116,986)  $(67,991)
  Esprit Telecom Group.............................   (106,507)    (17,775)    (8,214)
  Pooling adjustments..............................      3,310          --         --
                                                     ---------   ---------   --------
          Total Net Loss...........................  $(255,756)  $(134,761)  $(76,205)
                                                     =========   =========   ========
</TABLE>
 
     In conjunction with this business combination, the Company incurred
substantial expenses. The Company may also incur significant charges resulting
from shutdowns due to duplication in the capacity requirements of the combined
network. At the date of the business combination, certain notes were
outstanding. These notes had certain terms and conditions whereas the holders
could put the notes back to Esprit with a premium upon a change in control. As
such, an agreement was reached prior to the business combination to induce the
noteholders to waive their put rights in exchange for a fixed payment of two
percent of the face value of the notes. As such, GTS is obligated to pay and
will incur a one-time charge as payment for the noteholders to negate their
previously existing put rights. This charge will be recorded in conjunction with
the other pooling expenditures discussed herein. The majority of these charges
will be reflected in the quarter ended March 31, 1999.
 
     On November 30, 1998, the Company acquired substantially all of the
outstanding shares of common stock of NetSource Europe ASA, a Norwegian company,
("NetSource") that provides long distance telecommunications services focusing
primarily on small- to medium-sized businesses. The acquisition has been
accounted for under the purchase method of accounting. The initial purchase
price consisted of up to 4,037,500 newly issued shares of the Company's common
stock and $46.1 million in cash for an aggregate initial purchase price of
$145.4 million. The Company has also agreed to make additional payments of up to
$35.0 million in either cash or shares of common stock contingent upon NetSource
achieving certain performance targets during the first two quarters of 1999.
Such payments, if any, will be accounted for as additional purchase price and
will increase the goodwill.
 
     The Company's 1998 financial statements reflect the preliminary allocation
of the purchase price, and as such, the Company has recorded approximately
$137.4 million in goodwill that the Company is amortizing over a 10-year period
using the straight-line method.
 
     On May 1, 1998, the Company acquired all of the outstanding common stock of
Thyssen Festnetz Management GmbH and the whole limited partnership interest in
Thyssen Festnetz GmbH & Co. KG (collectively "Plusnet") for cash consideration
of approximately DM 307.8 million ($173.6 million) before expenses. The
Company's 1998 financial statements reflect the preliminary allocation of the
purchase price, and as such, the Company recorded approximately DM 303.2 million
($171.0 million) of goodwill on that date which the Company is amortizing over a
15-year period using the straight-line method.
 
                                       83
<PAGE>   85
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The following unaudited pro forma combined results of operations for the
Company gives effect to the NetSource and Plusnet business combinations as if
they had occurred at the beginning of each period presented (in thousands,
except per share data). These pro forma amounts are provided for informational
purposes only and do not purport to present the results of operations of the
Company had the transactions assumed therein occurred on or as of the date
indicated, nor is it necessarily indicative of the results of operations which
may be achieved in the future:
 
<TABLE>
<CAPTION>
                                                               FOR THE YEAR ENDED
                                                                  DECEMBER 31,
                                                              ---------------------
                                                                1998        1997
                                                              ---------   ---------
<S>                                                           <C>         <C>
Revenues....................................................  $ 425,452   $ 175,838
Loss before extraordinary item..............................   (313,749)   (190,842)
Net loss....................................................   (326,453)   (190,842)
Loss per common share:
  Loss before extraordinary item............................  $   (4.19)  $   (3.59)
  Net loss..................................................      (4.36)      (3.59)
</TABLE>
 
     During 1998, the Company increased its ownership interest in several of its
previously existing ventures by either buying out or acquiring part of the
minority shareholders' interest in these ventures. These transactions have
enabled the Company to consolidate certain ventures in 1998 that were previously
accounted for following the equity method of accounting. The Company has
executed these transactions by either paying cash or issuing its shares of
common stock. Further, in 1998, the Company has acquired other less significant
telecommunications companies offering similar or complementary services to those
offered by the Company. Such business combinations have been accomplished
through the purchase of the outstanding stock or assets of the acquired entity
for cash. The cash portion of these transactions and acquisitions has generally
been financed through the Company's equity and debt proceeds. The Company has
accounted for these transactions and business combinations following the
purchase method of accounting, and as such, any purchase price paid over net
tangible assets acquired has been reflected primarily as goodwill as is being
amortized over a 5-year period using the straight-line method.
 
NOTE 4: 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 75%. The Company has no investments in ventures
that are accounted for by the cost method.
 
     The components of the Company's investments in and advances to ventures are
as follows:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                               1998      1997
                                                              -------   -------
                                                               (IN THOUSANDS)
<S>                                                           <C>       <C>
Equity in net assets acquired...............................  $14,844   $31,183
Excess of investment cost over equity in net assets acquired
  net of amortization of $3,836 and $4,851 at December 31,
  1998 and 1997, respectively...............................    4,108     7,582
Accumulated earnings recognized.............................   12,790    14,659
Dividends...................................................     (706)   (3,848)
Cash advances and other.....................................   19,715    27,154
                                                              -------   -------
          Total investments in and advances to ventures.....  $50,751   $76,730
                                                              =======   =======
</TABLE>
 
                                       84
<PAGE>   86
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     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. During the third quarter of 1997, the
Company recorded a write-off of approximately $5.4 million ($19.8 million,
including the write-off at the venture level), 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 total charge was classified in the
statement of operations as equity in losses of ventures. The Company recorded no
such write-offs during the years ended December 31, 1998 or 1996.
 
  Hermes Europe Railtel B.V. ("Hermes Railtel") Recapitalization
 
     During the year ended December 31, 1997, Hermes Railtel recapitalized its
equity structure and amended its existing shareholder agreement. In connection
with the Hermes Railtel 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 Hermes Railtel. As
a result of the recapitalization and amended shareholder agreement, the Company
obtained unilateral control over Hermes Railtel.
 
                                       85
<PAGE>   87
                         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,
                                                              -------------------
                                                                1998       1997
                                                              --------   --------
                                                                (IN THOUSANDS)
<S>                                                           <C>        <C>
Balance, at beginning of period.............................  $ 76,730   $104,459
  Equity in net assets acquired.............................    14,701     80,054
  Excess of investment cost over equity in net assets
     acquired...............................................    50,810     10,187
  Dividends.................................................      (706)    (2,875)
  Cash advances (repayments) and other......................       245    (24,171)
  Effect of consolidating equity method companies...........   (89,705)   (76,325)
                                                              --------   --------
                                                               (24,655)   (13,130)
  Equity ownership in earnings/(losses).....................     4,753     (5,552)
  Excess losses recognized over amount attributable to
     ownership interest.....................................    (3,090)   (10,610)
  Amortization of excess of investment cost over equity in
     net assets acquired....................................    (2,987)    (3,313)
  Loss in value that is other than temporary................        --     (5,354)
  Effect of consolidating equity method companies...........        --     10,230
                                                              --------   --------
                                                                (1,324)   (14,599)
                                                              --------   --------
Balance, at end of period...................................  $ 50,751   $ 76,730
                                                              ========   ========
</TABLE>
 
     As of December 31, 1998, 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%
TeleRoss Ventures -- 14 joint ventures in various regions in
  the CIS...................................................      50%
Vostok Ventures -- 13 joint ventures in various regions in
  the CIS...................................................    50-70%
PrimTelefone................................................      50%
Dattel......................................................    51.03%
</TABLE>
 
     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, 1998 and 1997.
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31, 1998
                                            ---------------------------------------------------
                                            MAJORITY OWNED    50% OR LESS       TOTAL EQUITY
EQUITY METHOD ENTITIES                         VENTURES      OWNED VENTURES    METHOD VENTURES
----------------------                      --------------   --------------   -----------------
                                                              (IN THOUSANDS)
<S>                                         <C>              <C>              <C>
Revenue...................................     $ 6,888          $194,184          $201,072
Gross margin..............................       3,918            78,073            81,991
Net income (loss).........................      (2,851)            2,126              (725)
Equity in net losses......................      (2,714)           (1,228)           (3,942)
Current assets............................       4,284            53,723            58,007
Total assets..............................      22,025           156,365           178,390
Current liabilities.......................       7,277            70,765            78,042
Total liabilities.........................      19,943            94,214           114,157
Net assets................................       2,082            62,151            64,233
Ownership interest in equity in net
  assets..................................         689            26,237            26,926
</TABLE>
 
                                       86
<PAGE>   88
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31, 1997
                                            ---------------------------------------------------
                                            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..............................       30,566           79,630           110,196
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................................        7,437           73,359            80,796
Ownership interest in equity in net
  assets..................................        9,541           45,638            55,179
</TABLE>
 
NOTE 5: SUPPLEMENTAL BALANCE SHEET INFORMATION
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              -------------------
                                                                1998       1997
                                                              --------   --------
                                                                (IN THOUSANDS)
<S>                                                           <C>        <C>
Accounts receivable consists of:
  Trade accounts receivable.................................  $153,080   $ 42,689
  Value added taxes receivable..............................    20,873      3,476
  Other receivables.........................................    10,010      2,089
                                                              --------   --------
                                                               183,963     48,254
  Less: allowance for doubtful accounts.....................     9,533      6,180
                                                              --------   --------
          Total accounts receivable, net....................  $174,430   $ 42,074
                                                              ========   ========
Property and equipment consists of:
  Telecommunications equipment..............................  $581,859   $256,552
  Furniture, fixtures and equipment.........................    36,388     14,348
  Other property............................................    13,956      3,470
  Construction in process...................................   104,608      9,412
                                                              --------   --------
                                                               736,811    283,782
Less: accumulated depreciation..............................    93,767     23,811
                                                              --------   --------
          Total property and equipment, net.................  $643,044   $259,971
                                                              ========   ========
Accounts payable and accrued expenses consists of:
  Accounts payable..........................................  $172,921   $ 56,794
  Interest payable..........................................    35,209     17,483
  Professional and consulting expense.......................     4,522      2,825
  Income taxes..............................................     9,713      2,530
  Accrued compensation......................................    14,618      7,170
  Accrued telecommunications expense........................    25,046      2,841
  Other accrued expenses....................................    17,480     11,420
                                                              --------   --------
          Total accounts payable and accrued expenses.......  $279,509   $101,063
                                                              ========   ========
</TABLE>
 
                                       87
<PAGE>   89
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 6: DEBT OBLIGATIONS
 
     Company debt consists of:
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              ---------------------
                                                                 1998        1997
                                                              ----------   --------
                                                                 (IN THOUSANDS)
<S>                                                           <C>          <C>
Senior subordinated convertible debentures, due July 01,
  2010 at 5.75% interest payable semiannually,
  (Debentures)..............................................  $  466,902   $     --
Senior notes of Esprit due December 15, 2007 at 11.5%
  interest payable semiannually, (Senior Notes 2007)........     305,051         --
Senior notes of Hermes Railtel, due August 15, 2007 at 11.5%
  interest payable semiannually, (Senior Notes).............     265,000    265,000
Senior notes of Esprit due June 15, 2008 at 10.875% and
  11.00% interest payable semiannually, (Senior Notes
  2008).....................................................     240,061         --
Senior subordinated convertible bonds, due June 30, 2000 at
  8.75% payable semiannually, (Bonds).......................     117,601    144,787
Senior notes, due February 15, 2005 at 9.875% interest
  payable semiannually, (Notes Offering)....................     105,000         --
Related party debt obligations, with principal payments
  beginning April 1, 1998 and maturing on March 31, 2001 at
  10% interest, net of unamortized discount.................          --     72,233
Other financing agreements..................................      31,458     15,961
                                                              ----------   --------
                                                               1,531,073    497,981
Less: debt maturing within one year.........................      23,859     11,058
                                                              ----------   --------
          Total long-term debt..............................  $1,507,214   $486,923
                                                              ==========   ========
</TABLE>
 
     In July 1998, the Company issued aggregate principal amount of $466.9
million of 5.75% convertible senior subordinated debentures (the "Debentures")
that mature July 1, 2010 and will be redeemable from July 1, 2001 at the option
of the Company, at redemption prices as set forth in the Debentures agreement.
Net proceeds from the Debentures offering were approximately $450.3 million. The
Debentures are convertible into 8.5 million common shares at any time prior to
maturity or redemption at a conversion price of $55.05 per common share.
Interest on the Debentures will be payable semi-annually on January 1 and July
1, commencing January 1, 1999. The Debentures are subordinated to all existing
and future indebtedness of the Company, except for the Bonds, with which they
rank pari passu in right of payment.
 
     On December 12, 1997, Esprit issued US$230.0 million and DM 125.0 million
aggregate principal amount of senior notes due December 15, 2007 (the "Senior
Notes 2007"). The Senior Notes 2007 rank pari-passu with ordinary creditors with
interest payable semi-annually at a rate of 11.5%. Approximately $72.0 million
and DM 36.0 million of the net proceeds of the offering of the Senior Notes 2007
was initially placed in escrow for the first 6 semi-annual payments commencing
June 15, 1998. The Company may redeem the Senior Notes 2007, in whole or in
part, any time on or after December 15, 2002 at specific redemption prices or
prior to that under certain conditions. The Senior Notes 2007 are structurally
senior to the Company's Debentures, Bonds and Notes Offering.
 
     In 1997, Hermes Railtel 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 was initially placed in escrow for the first
four semiannual interest payments commencing in 1998. Hermes Railtel may redeem
the Senior Notes, in whole or in part, any time on or after August 15, 2002
 
                                       88
<PAGE>   90
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
at specific redemption prices. Hermes Railtel 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 Hermes Railtel
with gross proceeds of at least $75.0 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. The Senior Notes are structurally
senior to the Company's Debentures, Bonds and Notes Offering.
 
     On June 19, 1998, Esprit issued US$150.0 million and DM150.0 million
aggregate principal amount of Senior Notes due June 15, 2008 (the "Senior Notes
2008"). The Senior Notes 2008 rank pari-passu with ordinary creditors with
interest payable semi-annually at a rate of 10.875% and 11.00% respectively.
Esprit may redeem the Senior Notes 2008, in whole or in part, any time on or
after 5 years or on June 15, 2001, at specific redemption prices. The Senior
Notes 2008 are structurally senior to any and all obligations of the Company.
The notes will be redeemable at the option of the Company at any time on or
after June 15, 2003 or prior to that under certain conditions.
 
     As a result of the completion of the initial public offering (the "Stock
Offering"), see Note 8, "Shareholders' Equity," the interest rate on the 8.75%
senior subordinated convertible bonds due June 2000, which were issued in July
1997 (the "Bonds") will remain at 8.75% until maturity and the approximately
$5.1 million of the 6.25% additional interest that was previously accrued
through the date of the Stock Offering has been reflected as an increase to
additional paid-in capital. Upon completion of the Stock Offering, the Bonds
became convertible into 7.2 million common shares at a conversion price of
$20.00 per share. During the twelve months ended December 31, 1998, a total of
$27.2 million of the Bonds were converted into approximately 1.4 million common
shares of the Company's common stock. The Bonds are subordinated to all existing
and future indebtedness of the Company, except for the Debentures, with which
they rank pari passu in right of payment.
 
     In February 1998, the Company issued $105.0 million aggregate principal
amount of 9.875% senior notes due February 15, 2005 (the "Notes Offering" and
together with the Stock Offering, the "Offerings"). Net proceeds from the Notes
Offering were approximately $100.5 million. Approximately $19.6 million of the
net proceeds were initially placed in escrow for the first four semi-annual
interest payments, commencing August 15, 1998. The Notes Offering are senior in
rank to both the Debentures and the Bonds.
 
     In 1996, the Company entered into long-term obligations ("Debt
Obligations") totaling $70.0 million with lenders that are affiliated with and
are considered related parties to the Company as a result of their ownership of
the Company's common stock. In February 1998, approximately $85.2 million of the
net proceeds of the Offerings were used to repay the Debt Obligations plus
accrued interest. Accordingly, the Company recognized a $12.7 million
extraordinary charge to earnings resulting from the early extinguishment of the
debt obligations. The nature of the charge is comprised of the write-off of
$11.6 million of unamortized debt discount and $1.1 million of unamortized debt
issuance costs that were deferred as financing costs and were being amortized
over the original maturity of the debt.
 
     Certain of the Company's consolidated ventures maintain credit facilities
for their local operations. Borrowings under such credit facilities bear
interest at the prevailing negotiated market rates. Esprit has two revolving
credit lines that were unused at December 31, 1998. One has an available amount
of GBP 1.0 million $(1.7 million), and the other has an available balance of NLG
1.2 million ($0.6 million), for a total available under these facilities of $2.3
million at December 31, 1998.
 
     Aggregate maturities of long-term debt, as of December 31, 1998, are as
follows: 1999 -- $23.9 million, 2000 -- $121.9 million, 2001 -- $3.0 million,
2002 -- $0.1 million and $1,382.2 million thereafter.
 
     The Company paid interest of $124.2 million, $2.2 million and $0.4 million
in 1998, 1997, and 1996, respectively.
 
                                       89
<PAGE>   91
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 7: FOREIGN CURRENCY TRANSACTIONS
 
     On April 19, 1998, Hermes Railtel entered into a foreign currency swap
transaction agreement (the "Swap") with Rabobank International ("Rabo") in order
to minimize the foreign currency exposure resulting from the issuance in August
1997 of $265.0 million aggregate principal amount 11.5% Senior Notes due 2007
(the "Senior Notes"). Hermes Railtel has marked the Swap to its fair value as of
December 31, 1998 and the resulting adverse change in fair value of $27.8
million has been recorded as a non-current liability on the balance sheet and
recognized as a foreign currency loss in the statement of operations. The
foreign currency loss recognized on marking the Swap to its fair value has been
partially offset in the statement of operations by a $15.3 million foreign
currency gain on the revaluation of the Senior Notes.
 
NOTE 8: SHAREHOLDERS' EQUITY
 
  Common Stock
 
     The following table summarizes the Company's significant issuances of
common stock as a result of its public and private capital raise efforts for the
periods ending:
 
<TABLE>
<CAPTION>
                                                SHARES ISSUED   SHARE PRICE    NET PROCEEDS
                                                -------------   ------------   ------------
                                                     (IN THOUSANDS, EXCEPT SHARE DATA)
<S>                                             <C>             <C>            <C>
December 31, 1998.............................   15,566,000     $20.00-45.50     $353,892
December 31, 1997.............................    6,728,761     13.49-15.67        86,359
December 31, 1996.............................    8,348,532        13.33          107,744
</TABLE>
 
     In February 1998, the Company completed an initial public offering of 12.8
million shares of common stock at $20.00 per common share (the "Stock
Offering"). 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. Net proceeds from the Stock
Offering were $235.2 million. As a result of the Stock Offering, the Company was
no longer obligated to repurchase the 797,100 shares of common stock that were
subject to repurchase at December 31, 1997.
 
     In July 1998, the Company completed a secondary public offering of 2.8
million shares of common stock at $45.50 per common share. Net proceeds from the
offering were $118.7 million. In addition, in conjunction with such offering,
shareholders of the Company sold 11.7 million shares of the Company's common
stock. The Company did not realize any of the proceeds of such sale.
 
     Pursuant to a purchase agreement that the Company has with a venture
partner, the Company issued 463,489 of non-registered shares of common stock to
the partner in 1998. In accordance with the purchase agreement, if such entity
is unable to sell these shares, the Company is obligated to assist the seller in
locating a purchaser for 288,441 of non-registered shares, and if the Company is
unable to do so, to repurchase the 288,441 shares of common stock. The shares of
common stock have been classified as common stock subject to repurchase as of
December 31, 1998.
 
     In June 1998, pursuant to the Debt Obligations described in Note 6 "Debt
Obligations," warrants to purchase 3,333,333 common shares were exercised using
a cashless exercise option at an exercise price of $9.33 per common share. In
addition, warrants to purchase 4,444,444 shares of the Company's common stock
expire in the first and second quarters of 2002.
 
     In February 1997, Esprit completed an initial public offering of 4.75
million American Depositary Shares (ADSs), which represented 33.3 million
ordinary shares of Esprit common stock, at $12.00 per ADS (the "IPO"). The IPO
resulted in Esprit's ADSs being listed on the National Association of Securities
Dealers Automated Quotation Market (NASDAQ) and on the European Association of
Securities Dealers Automated Quotation Market (EASDAQ). Net proceeds from the
IPO were $49.9 million. As a result of the
 
                                       90
<PAGE>   92
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
business combination which occurred on March 4, 1999 (see Note 3, "Business
Combinations and Venture Transactions"), GTS acquired substantially all of the
outstanding ADSs and ordinary shares of Esprit in exchange for new shares of
common stock in GTS. Expressed in terms of the new GTS shares, the February,
1997 offering represented a sale of 4.3 million shares of GTS common stock at
$13.49 per share. Upon completion of the transaction, the Esprit ADSs will be
delisted from NASDAQ and EASDAQ.
 
     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 14,332,970 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, 1998 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, 1998 and 1997, no
shares of preferred stock had been issued.
 
NOTE 9: 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, 1998, 1997 and 1996 would have been
approximately $269.8 million, $142.0 million and $77.2 million, respectively.
 
     The fair value of options granted under GTS plans during 1996 and 1997 are
estimated to be between $2.93 and $7.35 per common share, respectively, on the
date of grant using the minimum value option pricing model during 1996 and the
Black Scholes option pricing model for grants in 1997 with the following
assumptions: dividend yield 0%, risk free interest rate of 6.13% for 1996 and
5.74% for 1997, 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 and the Company's
historic stock performance. The fair value of options granted during 1998 are
estimated to be between $16.51 and $33.72 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 rates between 4.19% and 5.64%, an expected
life of five years, and an expected volatility of .75.
 
     The fair value for the Esprit options (which represent rights to GTS
shares), as expressed as equivalent GTS share options, were estimated at the
date of grant using the Black Scholes option pricing model with the following
assumptions for the years ended September 30, 1996, 1997 and December 31, 1998:
dividend yield of 0%; expected volatility of 1.50 for 1996 and 1997 and 1.00 for
1998; risk-free interest rate of 7.3% for 1996 and 1997 and 4.4% for 1998 and
expected lives from three years to eight and a half years. The weighted average
fair value of options granted was $2.44 for grants during the year ended
September 30, 1996, between $4.72 and $6.22 for options granted during the year
ended September 30, 1997 and $10.23 for options granted during the year ended
December 31, 1998.
 
     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, 1998, the maximum number of shares of common stock
available for grant under the Option Plans was 14,756,954. Except for the
Company's performance based options granted under the 1992 stock option plan,
options granted under the
 
                                       91
<PAGE>   93
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Option Plans generally vest over a four-year period from the date of grant and
expire ten years from the date of grant. In 1996 and 1998, the Company had
granted options with vesting terms that provide for vesting within five and six
years after the date of grant, respectively, unless certain performance goals
are met, in which case vesting could occur over a shorter period of time.
 
     Additional information with respect to stock option activity, excluding the
Esprit options (which represent rights to GTS shares), is summarized as follows:
 
<TABLE>
<CAPTION>
                                                           YEAR ENDED DECEMBER 31,
                                     -------------------------------------------------------------------
                                             1998                    1997                   1996
                                     ---------------------   --------------------   --------------------
                                                  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...   6,562,171    $ 9.75    4,869,360    $ 7.31    3,422,399    $ 5.56
Options granted....................   3,868,565     30.00    2,215,296     14.53    1,612,962     11.10
Options exercised..................  (2,374,947)     6.60      (89,312)     6.34      (56,498)     6.70
Options canceled or expired........    (394,715)    17.88     (433,173)     7.38     (109,503)     8.73
                                     ----------              ---------              ---------
Outstanding at end of year.........   7,661,074     20.53    6,562,171      9.75    4,869,360      7.31
                                     ==========              =========              =========
Options exercisable at year end....   2,097,914    $10.26    2,962,110    $ 6.06    1,992,236    $ 4.65
</TABLE>
 
     The following table summarizes information about stock options outstanding
excluding the Esprit options (which represent rights to GTS shares):
 
<TABLE>
<CAPTION>
                                 OPTIONS OUTSTANDING             OPTIONS EXERCISABLE
                         ------------------------------------   ----------------------
                                        WEIGHTED
                                         AVERAGE
                                        REMAINING    WEIGHTED                 WEIGHTED
                                       CONTRACTUAL   AVERAGE                  AVERAGE
RANGE OF EXERCISE PRICE    NUMBER         LIFE       EXERCISE     NUMBER      EXERCISE
 AT DECEMBER 31, 1998:   OUTSTANDING   (IN YEARS)     PRICE     EXERCISABLE    PRICE
-----------------------  -----------   -----------   --------   -----------   --------
<S>                      <C>           <C>           <C>        <C>           <C>
    $0.00 to $5.73          438,500        5.6        $ 2.50      408,500      $ 2.75
     5.74 to 11.45        1,323,549        6.8          9.45      982,486        9.16
    11.46 to 17.18        2,146,460        8.3         14.44      620,428       14.23
    17.19 to 22.90          120,000        9.2         20.00       40,000       20.00
    22.91 to 28.63        2,580,140        9.8         25.78           --          --
    28.64 to 34.34           85,275        9.3         30.34           --          --
    34.35 to 40.07          280,295        9.4         37.80       46,500       37.94
    40.08 to 45.80          421,855        9.4         43.58           --          --
    48.81 to 51.53          265,000        9.3         46.75           --          --
</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, in 1994, 50,250 options were exercised, during 1998 243,750 were
exercised leaving the remaining 275,250 outstanding and fully exercisable at
December 31, 1998.
 
     In the fourth quarter of 1997, Hermes Railtel implemented a stock option
plan for its key officers and employees (the "Hermes Railtel Plan"). The
ownership dilution caused by the Hermes Railtel Plan is not expected to be
significant. As a result of issuing options under the Hermes Railtel Plan,
Hermes Railtel
 
                                       92
<PAGE>   94
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
incurred a non-cash charge of approximately $3.7 million, of which $2.6 million
was recorded during 1997 and the remaining $1.1 million was recorded in 1998.
 
  Employee Stock Option and Incentive Plans for Esprit
 
     Prior to the March 4, 1999 business combination between GTS and Esprit as
discussed in Note 3, "Business Combinations and Venture Transactions," Esprit
maintained various option plans each with its own terms and conditions.
Effective with the completion of this business combination, all of the options
within these plans will be converted to rights to receive GTS shares of common
stock, based on the business combination exchange ratio, with terms
substantially identical to those of the Esprit plans (except that the "market
price" requirement for vesting of the Management Stock Option Plan, described
below, was omitted). Generally, all options granted under the historical Esprit
stock option plans vest immediately or vest one year after the grant date. Of
the 1,599,066 options converted 928,455 were exercisable on March 4, 1999.
 
     On February 26, 1998, the Esprit Board of Directors approved a new sub plan
under the Esprit Executive and Employee Stock Option Plan, The Management Stock
Option Plan ("MSOP"). Eligibility extended to specified persons who were
employed by an Esprit Telecom Group company before February 26, 1999. These
options vested three years from February 26, 1998 or three years from the date
of employment, whichever was later, on the following two conditions: (i) the
specified employees had to have been employed by Esprit, and (ii) in the case of
those persons already employed on February 26, 1998, the market price of Esprit
common stock had to have been at least fifty percent higher than the exercise
price (which was equal to the market price on the date of grant), or in the case
of those persons employed after February 26, 1998, a market price of at least
fifty percent higher than it was on the date of commencement of their
employment.
 
     A summary of all transactions involving Esprit stock options which
represent rights to GTS shares (expressed as equivalent GTS share options) is as
follows:
 
<TABLE>
<CAPTION>
                                                             YEAR ENDED SEPTEMBER 30,
                                  YEAR ENDED        -------------------------------------------
                              DECEMBER 31, 1998             1997                   1996
                             --------------------   --------------------   --------------------
                                         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.....................  1,162,586    $ 0.47      805,896    $0.08       112,261    $0.08
Options granted............    749,356     10.78      565,482     2.44       701,039     0.08
Options exercised..........   (237,044)     0.94      (90,305)    0.08        (7,404)    0.08
Options canceled or
  expired..................    (75,832)     8.97      (13,619)    0.08            --       --
                             ---------              ---------              ---------
Outstanding at end of
  year.....................  1,599,066    $ 7.71    1,267,454    $0.47       805,896    $0.08
                             =========              =========              =========
</TABLE>
 
NOTE 10: 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
$0.2 million, $0.2 million, and $0.2 million for the years ended December 31,
1998, 1997 and 1996, respectively. The Company made no discretionary
(non-matching) contributions for the years ended December 31, 1998, 1997 or
1996.
 
                                       93
<PAGE>   95
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     With respect to certain Esprit Telecom UK employees, the Company
contributes a fixed percentage, based upon the salary earned, to the employees'
nominated pension insurance policy or other pension arrangements. During the
years ended December 31, 1998, 1997 and 1996, the Company incurred $1.9 million,
$0.3 million and $0.1 million, respectively of expense related to these pension
arrangements. Esprit has no defined benefit pension plan for its employees.
 
     Hermes Railtel established a pension plan in 1995 that covers all Hermes
Railtel employees upon twenty-five years of age and at least one year of
service. Hermes Railtel has entered into an insurance arrangement (an investment
contract) whereby an insurance provider has undertaken a legal obligation to
provide specific benefits to participants in return for a fixed premium. As
such, Hermes Railtel does not bear significant financial risk for its pension
plan. Hermes Railtel's expense under the pension plan was $1.0 million, $0.7
million and $0.04 million for the years ended December 31, 1998, 1997 and 1996,
respectively.
 
NOTE 11: INCOME TAXES
 
     The components of loss before extraordinary loss, income taxes and minority
interest were as follows:
 
<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                                                     --------------------------------
                                                       1998        1997        1996
                                                     ---------   ---------   --------
                                                              (IN THOUSANDS)
<S>                                                  <C>         <C>         <C>
Pretax loss:
  Domestic.........................................  $ (63,943)  $ (64,920)  $(41,554)
  Foreign..........................................   (175,280)    (71,033)   (33,318)
                                                     ---------   ---------   --------
                                                     $(239,223)  $(135,953)  $(74,872)
                                                     =========   =========   ========
</TABLE>
 
     For the years ended December 31, 1998, 1997 and 1996, the Company recorded
$7.8 million, $2.5 million, and $1.4 million respectively, in income tax expense
that related exclusively to its current provision for foreign taxes.
 
     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,
                                                              ------------------------
                                                               1998     1997     1996
                                                              ------   ------   ------
<S>                                                           <C>      <C>      <C>
Taxes at U.S. statutory rates...............................   34.0%    34.0%    34.0%
Foreign income taxes........................................   (3.1)    (1.8)    (1.8)
Foreign operating losses generating no tax benefit..........  (24.9)   (17.8)   (15.1)
Domestic operating losses generating no tax benefit.........   (9.1)   (16.2)   (18.9)
                                                              -----    -----    -----
                                                               (3.1)%   (1.8)%   (1.8)%
                                                              =====    =====    =====
</TABLE>
 
                                       94
<PAGE>   96
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     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,
                                                              -------------------
                                                                1998       1997
                                                              --------   --------
                                                                (IN THOUSANDS)
<S>                                                           <C>        <C>
Deferred Tax Assets:
  Net operating loss carry-forwards.........................  $ 85,337   $ 38,029
  Other deferred tax assets.................................     7,702      3,912
                                                              --------   --------
Total deferred tax asset....................................    93,039     41,941
Deferred Tax Liability......................................     1,186      2,292
                                                              --------   --------
Net deferred tax asset......................................    91,853     39,649
  Less: valuation allowance.................................   (91,853)   (39,649)
                                                              --------   --------
          Total.............................................  $     --   $     --
                                                              ========   ========
</TABLE>
 
     As of December 31, 1998, the Company had net operating loss carry-forwards
for U.S. federal income tax purposes of approximately $251.0 million expiring in
fiscal years 2003 through 2018. 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).
 
NOTE 12: COMMITMENTS AND CONTINGENCIES
 
  Leases
 
     The Company has various lease agreements for fiber and equipment. 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,
                                                              -------------------
                                                                1998       1997
                                                              --------   --------
                                                                (IN THOUSANDS)
<S>                                                           <C>        <C>
Telecommunications equipment................................  $312,962   $158,277
  Less: accumulated amortization............................    16,543      1,209
                                                              --------   --------
                                                              $296,419   $157,068
                                                              ========   ========
</TABLE>
 
     Rental expense for operating leases aggregated $9.9 million, $4.2 million,
and $2.9 million for the years ended December 31, 1998, 1997 and 1996,
respectively.
 
                                       95
<PAGE>   97
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Future minimum payments, by year and in the aggregate, under the capital
leases and non-cancelable operating leases with initial or remaining terms in
excess of one year as of December 31, 1998 were as follows:
 
<TABLE>
<CAPTION>
                                                              CAPITAL    OPERATING
                                                               LEASES     LEASES
                                                              --------   ---------
                                                                 (IN THOUSANDS)
<S>                                                           <C>        <C>
December 31, 1999...........................................  $ 61,712    $15,379
  2000......................................................    34,854      8,347
  2001......................................................    32,940      7,516
  2002......................................................    31,832      6,317
  2003......................................................    31,502      4,361
Thereafter..................................................   246,497     11,181
                                                              --------    -------
          Total minimum lease payments......................   439,337    $53,101
                                                                          =======
Less amount representing interest...........................   178,096
                                                              --------
Present value of net minimum lease payments.................   261,241
Less current portion of capital lease obligations...........    43,102
                                                              --------
Long-term portion of capital lease obligations..............  $218,139
                                                              ========
</TABLE>
 
  Other Commitments and Contingencies
 
     The Company's consolidated and non-consolidated ventures have future
purchase commitments amounting to $66.8 million and $1.2 million, respectively,
as of December 31, 1998.
 
     In the ordinary course of business, the Company has issued financial
guarantees on debt and equities for the benefit of certain of its consolidated
and non-consolidated ventures. The total amounts guaranteed at December 31, 1998
were approximately $2.4 million and $13.7 million, respectively.
 
  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 final Russian Taxes may be in excess of the
estimated amount expensed to date and accrued at December 31, 1998, 1997, and
1996. 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.
 
                                       96
<PAGE>   98
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  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 13: RELATED PARTY TRANSACTIONS
 
     On October 31, 1998, the Company acquired AB Swed Carrier's ownership
interest of 6,551 common shares in Hermes Railtel for approximately $5.8
million. In connection with this purchase, GTS Carrier Services, Inc. paid
approximately $5.3 million to a company, which is affiliated with a board member
of Hermes Railtel, for negotiating with AB Swed Carrier and the remaining
minority shareholder of Hermes Railtel on behalf of GTS Carrier Services, Inc.
to purchase their respective ownership interests in Hermes Railtel.
 
     As discussed within Note 6, "Debt Obligations," the Company issued 8.75%
Senior Subordinated Convertible Bonds due June 30, 2000. An affiliated
shareholder of the Company purchased, on the open market, a portion of the bonds
and as of December 31, 1998 and 1997 held $2.6 million and $3.5 million,
respectively.
 
     Prior to 1998, the Company, in connection with a venture investment,
entered into financing agreements with a shareholder of the Company for a total
of approximately $8.6 million. Subject to certain conditions, the shareholder
had the right to require the repayment of this amount in cash or 0.7 million
shares of the Company's common stock. In June 1998, the Company completed the
restructuring of the capital and ownership of this venture. In conjunction with
this restructuring, the shareholder exercised its right to receive 0.7 million
shares of the Company's common stock. Further, the shareholder contributed an
additional $5.8 million for a 25% interest in the venture (see Note 3, "Business
Combinations and Venture Transactions.")
 
     Prior to October 13, 1997, a shareholder of the Company owned 17% of the
capital stock of Telco Communications Group, Inc. ("Telco"), a long distance
telecommunications company. The Company purchased certain long distance
telecommunications services from, and sells certain services to, Telco. Sales to
and purchases from Telco for 1998, 1997 and 1996 were $1.0 million, $1.0 million
and $3.0 million and $9.6 million, $6.6 million and $3.0 million, respectively.
In addition, the Company engages Tel Labs Inc. ("Tel Labs"), a wholly-owned
subsidiary of Telco, for the final processing of its customer billing records at
Esprit. Purchases from Tel Labs for 1998, 1997 and 1996 were $0.6 million, $0.7
million and $0.5 million, respectively.
 
     As discussed in Note 8, "Shareholders' Equity," the Company issued 463,489
of non-registered shares of common stock to a venture partner in 1998 for their
remaining interest in a business venture within the CIS region. In addition, in
1997, the Company issued 504,600 shares of common stock to the same venture
partner for the Company's original interest in the same business venture.
 
     The Company has entered into certain consulting agreements with directors
of the Company and paid $3.2 million, $0.4 million and $0.2 million in 1998,
1997 and 1996, respectively, pursuant to those agreements.
 
     The Company had notes receivable due from employees approximating $4.1
million, less than $0.1 million, and $0.1 million as of December 31, 1998, 1997
and 1996, respectively, with three employees aggregating more than $4.0 million
in 1998.
 
                                       97
<PAGE>   99
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The Company derived revenue from affiliates of $8.3 million, $4.4 million
and $3.3 million in 1998, 1997 and 1996, respectively. Costs of revenue from
affiliates were $2.3 million, $2.0 million and $0.8 million, respectively for
the years ended December 31, 1998, 1997 and 1996.
 
NOTE 14: SUPPLEMENTAL CASH FLOW INFORMATION
 
     The following table summarizes non-cash investing and financing activities
for the Company:
 
<TABLE>
<CAPTION>
                                                           YEAR ENDED DECEMBER 31,
                                                         ----------------------------
                                                           1998       1997      1996
                                                         --------   --------   ------
                                                                (IN THOUSANDS)
<S>                                                      <C>        <C>        <C>
Capitalization of leases...............................  $149,391   $142,417   $4,003
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       --
Exercise of warrants, resulting in treasury shares.....    31,110
Conversion of bonds and notes into common shares.......    40,580      4,250    4,497
Issuance of common shares or notes for interest in
  business ventures....................................    19,522      4,125    4,500
Net accretion in common stock subject to repurchase....     3,592      8,156       --
</TABLE>
 
     In conjunction with the purchases of NetSource and Plusnet during the year
ended December 31, 1998 (see Note 3, "Business Combinations and Venture
Transactions"), assets acquired, liabilities assumed and common stock issued
were as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                                  1998
                                                                --------
<S>                                                             <C>
Fair value of assets acquired...............................    $ 94,213
Goodwill....................................................     308,410
Fair value of liabilities assumed...........................     (86,009)
Common stock issued.........................................     (92,969)
                                                                --------
Net cash paid...............................................    $223,645
                                                                ========
</TABLE>
 
NOTE 15: SEGMENT INFORMATION AND CERTAIN GEOGRAPHICAL DATA
 
     The Company operates in five segments within 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 Company has adopted the
Financial Accounting Standards Board's Statement of Financial Accounting
Standards No. 131, or SFAS 131, "Disclosures about Segments of an Enterprise and
Related Information." The following tables present consolidated financial
information segmented by the Company's lines of businesses and geographic areas
for 1998, 1997 and 1996.
 
                                       98
<PAGE>   100
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Transfers between geographic areas and lines of businesses were not considered
material for disclosure purposes.
 
GEOGRAPHICAL DATA:
 
  CONSOLIDATED:
 
<TABLE>
<CAPTION>
                                NORTHERN AND                                      CORPORATE
                                  WESTERN                  CENTRAL                 OFFICE &
                                   EUROPE         CIS       EUROPE      ASIA     ELIMINATIONS     TOTAL
                               --------------   --------   --------   --------   ------------   ----------
                                                             (IN THOUSANDS)
<S>                            <C>              <C>        <C>        <C>        <C>            <C>
Year Ended December 31, 1998
  Total revenue..............    $  265,812     $ 85,127   $ 18,911   $  2,614     $    (72)    $  372,392
  Gross margin...............        83,002       42,400      8,404        357          123        134,286
  Operating expenses.........       111,735       43,205      7,683      2,293       34,268        199,184
  Extraordinary items........            --           --         --   -- .....      (12,704)       (12,704)
  Net loss...................      (156,737)     (37,200)    (4,587)    (1,884)     (55,348)      (255,756)
  Identifiable assets........     1,456,108      221,163     44,814      4,856      887,661      2,614,602
  Liabilities................     1,450,968      146,008     28,099      9,384      576,830      2,211,289
  Net (liabilities)/assets...         5,140       75,155     16,715     (4,528)     310,831        403,313
Year Ended December 31, 1997
  Total revenue..............    $   79,736     $ 27,045   $ 13,513   $  1,016     $    151     $  121,461
  Gross margin...............        10,843        6,624      6,747        (14)         152         24,352
  Operating expenses.........        42,623       20,010      5,394      7,507       21,655         97,189
  Net loss...................       (46,839)      (9,505)    (6,882)   (28,043)     (43,492)      (134,761)
  Identifiable assets........       601,779       99,926     23,840     (6,544)     157,646        876,647
  Liabilities................       496,675       62,862     40,465     19,161      148,580        767,743
  Net (liabilities)/assets...       105,104       37,064    (16,625)   (25,705)       9,066        108,904
Year Ended December 31, 1996
  Total revenue..............    $   38,380     $ 12,696   $  9,355   $  1,561     $    505     $   62,497
  Gross margin...............         9,447        2,626      4,756        652          421         17,902
  Operating expenses.........        15,269       17,753      5,131      3,803       21,662         63,618
  Net loss...................       (18,914)     (15,572)    (5,295)    (4,951)     (31,473)       (76,205)
  Identifiable assets........        57,287       96,773     17,339     14,973       88,686        275,058
  Liabilities................        57,756      116,961     33,826     24,753      (93,806)       139,490
  Net (liabilities)/assets...          (469)     (20,188)   (16,487)    (9,780)     182,492        135,568
</TABLE>
 
                                       99
<PAGE>   101
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
LINE OF BUSINESS DATA:
 
  CONSOLIDATED:
 
<TABLE>
<CAPTION>
                                                                   BUSINESS    MOBILE     CORPORATE,
                                 CARRIER    BUSINESS     ACCESS    SERVICES   SERVICES     OTHER &
                                 SERVICES   SERVICES    SERVICES     CIS        CIS      ELIMINATIONS     TOTAL
                                 --------   ---------   --------   --------   --------   ------------   ----------
                                                                  (IN THOUSANDS)
<S>                              <C>        <C>         <C>        <C>        <C>        <C>            <C>
Year Ended December 31, 1998
  Total revenue................  $ 85,251   $ 180,561   $ 18,911   $ 75,394   $  9,818     $  2,457     $  372,392
  Gross margin.................    43,404      39,598      8,404     36,119      6,234          527        134,286
  Operating expenses...........    29,463      83,734      9,237     26,075     11,357       39,318        199,184
  Extraordinary items..........        --          --         --         --         --      (12,704)       (12,704)
  Net loss.....................   (44,302)   (110,878)    (6,144)   (13,839)   (17,595)     (62,998)      (255,756)
  Identifiable assets..........   741,695     713,531     45,696    169,998     51,659      892,023      2,614,602
  Liabilities..................   688,054     761,745     29,268     89,721     47,571      594,930      2,211,289
  Net (liabilities)/assets.....    53,641     (48,214)    16,428     80,277      4,088      297,093        403,313
 
Year Ended December 31, 1997
  Total revenue................  $  5,373   $  74,363   $ 13,513   $ 24,732   $  2,313     $  1,167     $  121,461
  Gross margin.................    (1,470)     12,313      6,747      6,233        351          178         24,352
  Operating expenses...........    17,527      25,096      5,394     11,458      3,290       34,424         97,189
  Net loss.....................   (27,396)    (19,442)    (6,882)     1,085     (5,953)     (76,173)      (134,761)
  Identifiable assets..........   504,478      97,301     23,840     69,388     26,719      154,921        876,647
  Liabilities..................   444,765      51,910     40,465     38,022     19,143      173,438        767,743
  Net (liabilities)/assets.....    59,713      45,391    (16,625)    31,366      7,576      (18,517)       108,904
 
Year Ended December 31, 1996
  Total revenue................  $     --   $  38,380   $  9,355   $  9,211   $  3,485     $  2,066     $   62,497
  Gross margin.................        --       9,447      4,756        817      1,809        1,073         17,902
  Operating expenses...........       257      15,012      5,131      8,278      5,992       28,948         63,618
  Net loss.....................    (9,099)     (9,815)    (5,295)    (3,084)    (9,777)     (39,135)       (76,205)
  Identifiable assets..........    16,492      40,795     17,339     71,138     25,126      104,168        275,058
  Liabilities..................    28,976      28,780     33,826     69,530     41,297      (62,919)       139,490
  Net (liabilities)/assets.....   (12,484)     12,015    (16,487)     1,608    (16,171)     167,087        135,568
</TABLE>
 
NOTE 16: QUARTERLY FINANCIAL DATA (UNAUDITED)
 
     The selected financial data presents the restatement of the Company's
historical financial statements for 1998 and prior periods to reflect the
business combination with Esprit Telecom Group plc, which was accounted for as a
pooling of interests.
 
                                       100
<PAGE>   102
                         GLOBAL TELESYSTEMS GROUP, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Summarized quarterly financial data is as follows:
 
<TABLE>
<CAPTION>
                                          FIRST      SECOND     THIRD      FOURTH      TOTAL
                                         QUARTER    QUARTER    QUARTER    QUARTER      YEAR
                                         --------   --------   --------   --------   ---------
                                               (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                      <C>        <C>        <C>        <C>        <C>
1998
  Revenues.............................  $ 46,248   $ 65,964   $118,335   $141,845   $ 372,392
  Gross Margin.........................    13,069     20,938     45,387     54,892     134,286
  Net loss before extraordinary item...   (37,114)   (47,967)   (63,696)   (94,275)   (243,052)
Extraordinary item.....................   (12,704)        --         --         --     (12,704)
                                         --------   --------   --------   --------   ---------
  Net loss.............................   (49,818)   (47,967)   (63,696)   (94,275)   (255,756)
                                         ========   ========   ========   ========   =========
  Net loss per share before
     extraordinary item................     (0.60)     (0.69)     (0.84)     (1.21)      (3.41)
Extraordinary loss per share...........     (0.21)        --         --         --       (0.18)
                                         --------   --------   --------   --------   ---------
  Net loss per share...................     (0.81)     (0.69)     (0.84)     (1.21)      (3.59)(a)
                                         ========   ========   ========   ========   =========
1997
  Revenues.............................  $ 22,477   $ 26,324   $ 34,778   $ 37,882   $ 121,461
  Gross Margin.........................     5,894      6,478      3,258      8,722      24,352
  Net loss.............................   (20,813)   (25,401)   (52,428)   (36,119)   (134,761)
  Net loss per share...................     (0.46)     (0.54)     (1.02)     (0.68)      (2.74)
</TABLE>
 
---------------
 
(a) The sum of earnings per share for the four quarters will not equal earnings
    per share for the total year due to changes in the average number of common
    shares outstanding.
 
NOTE 17: SUBSEQUENT EVENTS
 
     On January 4, 1999, Hermes Railtel issued in a private placement $200
million principal amount of 10 3/8% Senior Notes due 2009 and Euro 85,000,000
principal amount of 10 3/8% Senior Notes due 2006. The net proceeds of this
offering, approximately $289.7 million, will be used to finance the cost of
Hermes Railtel network assets, to expand the Hermes Railtel network beyond the
currently contemplated scope by adding transatlantic capacity, enhancing the
speed of the Hermes Railtel network and continuing the build-out of the Hermes
Railtel network. The Company filed an S-4 registration statement with the
Securities and Exchange Commission to exchange registered senior notes, with the
same terms and conditions as the New Senior Notes, for the New Senior Notes,
which became effective in February 1999.
 
     On January 13, 1999, GTS, through its subsidiary GTS Transatlantic Holdings
Ltd., entered into an agreement with FLAG Telecom to form a 50/50 joint venture,
to be known as FLAG Atlantic Limited, that will build and operate a transoceanic
fiber optic link, known as FLAG Atlantic-1 between Europe and the United States.
FLAG Atlantic-1 is designed to carry voice, high-speed data and video traffic at
speeds of 1.28 terabits per second, a 25-fold increase over current
transatlantic cable systems. The joint venture will also provide backhaul links
from the European landing points of the transoceanic link to Paris and London.
By interconnecting to FLAG Atlantic-1, GTS Carrier Services and its subsidiary
Hermes Railtel will be able to provide their carrier and Internet service
provider customers with high-capacity cable access from major European cities to
New York City. GTS's investment in FLAG Atlantic Limited is designed to enable
it to participate in the growth opportunity represented by the rapid increase in
demand by business customers for Internet Protocol-based telecommunications
services. The high-capacity fiber optic link will be based on synchronous
digital hierarchy and use dense wave division multiplexing technology. FLAG
Atlantic Limited is expected to offer service by the end of the year 2000. The
project is subject to financing, the execution of related agreements and other
conditions. The Company has committed to a $100 million equity contribution and
an additional purchase commitment for $150 million worth of capacity.
 
                                       101
<PAGE>   103
 
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
 
     The following table sets forth the name, present principal occupation or
employment, and principal occupations and employment and business experience for
the past five years of each director and executive officer of the Company.
Unless otherwise indicated, each such person is a citizen of the United States.
 
MEMBERS OF THE BOARD OF DIRECTORS
 
<TABLE>
<CAPTION>
                   NAME                     AGE
                   ----                     ---
<S>                                         <C>   <C>
Robert J. Amman...........................   61   Mr. Amman was elected to the Company's Board of
                                                  Directors in May 1998. His term expires at the 2000
                                                  annual stockholders meeting. Mr. Amman was elected
                                                  President of the Company in March 1999. Mr. Amman
                                                  was Chairman, President and Chief Executive Officer
                                                  of John H. Harland Company, a printing firm, from
                                                  1995 to 1998. Previously, from 1994 to 1995, he
                                                  served as Vice Chairman of First Financial
                                                  Management Corporation, where he was responsible
                                                  for the merchant services businesses consisting of
                                                  Western Union, NaBanco, Telecheck, Nationwide
                                                  Credit and International Banking Technologies. From
                                                  1988 to 1994, Mr. Amman served as President and
                                                  Chief Executive Officer of Western Union
                                                  Corporation, where he oversaw the transformation of
                                                  the firm from a telecommunications to a financial
                                                  services company. Mr. Amman is a member of the
                                                  Executive and Nominations and Governance Committees
                                                  of the Board of Directors.
David Dey.................................   61   Mr. Dey was elected to the Company's Board of
                                                  Directors in May 1998. His term expires at the 2001
                                                  annual stockholders meeting. Since 1995, Mr. Dey
                                                  has served as an independent consultant,
                                                  particularly to high technology start-up companies
                                                  in Europe. In that capacity, he serves as Chairman
                                                  of World Telecom and as Chairman of STARTECH
                                                  Scotland. From 1992 to 1995, Mr. Dey served as
                                                  Chief Executive Officer of Energis Communications,
                                                  which grew from a start-up company to become the
                                                  United Kingdom's third national telecommunications
                                                  operation during his tenure. Mr. Dey was employed
                                                  by British Telecom plc from 1987 to 1991, most
                                                  recently as Managing Director of its Business
                                                  Communications Division, and he held various
                                                  management positions at IBM Corporation where he
                                                  was employed from 1961 to 1985. Mr. Dey is a member
                                                  of the Audit and Budget, and Compensation
                                                  Committees of the Board of Directors. Mr. Dey is a
                                                  citizen of the United Kingdom.
</TABLE>
 
                                       102
<PAGE>   104
 
<TABLE>
<CAPTION>
                   NAME                     AGE
                   ----                     ---
<S>                                         <C>   <C>
Roger W. Hale.............................   55   Mr. Hale was elected to the Company's Board of
                                                  Directors in May 1998. His term expires at the 2001
                                                  annual stockholders meeting. Mr. Hale is Chairman,
                                                  President and Chief Executive Officer of LG&E
                                                  Energy Corp., a diversified energy services company
                                                  with businesses in retail gas and electric utility
                                                  services, energy marketing and power generation and
                                                  project development. Mr. Hale has served in that
                                                  capacity since August 1990. Previously, Mr. Hale
                                                  served as Executive Vice President of Bell South
                                                  Corp. and Bell South Enterprises, Inc. from 1986 to
                                                  1989 and with AT&T Corporation from 1966 to 1986,
                                                  serving in various management positions including
                                                  Vice President of Marketing, Southern Region. Mr.
                                                  Hale is a Director of H&R Block, Inc. Mr. Hale is
                                                  Chairman of the Nominations and Governance
                                                  Committee and is a member of the Executive
                                                  Committee of the Board of Directors.
Bernard McFadden..........................   65   Mr. McFadden has served as a director of GTS since
                                                  February 1994. His term expires at the 2000 annual
                                                  stockholders meeting. Mr. McFadden currently serves
                                                  as an independent consultant for GTS and is a GTS
                                                  representative on the supervisory board of Hermes
                                                  Railtel. Mr. McFadden's career in international
                                                  telecommunications includes 32 years with ITT
                                                  Corporation, where he served as President and Chief
                                                  Executive Officer of ITT's Telecom International
                                                  Group, and a four and one-half year assignment as
                                                  President and Chief Operating Officer of Alcatel
                                                  Trade International, S.A. Mr. McFadden is a member
                                                  of the Executive, Compensation, and Nominations and
                                                  Governance Committees of the Board of Directors.
Stewart J. Paperin........................   51   Mr. Paperin has served as a director of GTS since
                                                  March 1997. His term expires at the 2000 annual
                                                  stockholders meeting. Mr. Paperin serves as Chief
                                                  Financial Officer of the Soros Foundations. In
                                                  addition, he has served as the President of Capital
                                                  Resource East since October 1993. Prior to that,
                                                  Mr. Paperin was President of Brooke Group
                                                  International from 1990 to 1993 where he was
                                                  responsible for investments in the former Soviet
                                                  Union. Mr. Paperin also served as Chief Financial
                                                  Officer of Western Union Corporation from 1989 to
                                                  1990. Mr. Paperin serves as a director of the Board
                                                  of Penn Octane Corporation. Mr. Paperin is Chairman
                                                  of the Audit and Budget Committee and is a member
                                                  of the Compensation, and Nominations and Governance
                                                  Committees of the Board of Directors.
</TABLE>
 
                                       103
<PAGE>   105
 
<TABLE>
<CAPTION>
                   NAME                     AGE
                   ----                     ---
<S>                                         <C>   <C>
W. James Peet.............................   43   Mr. Peet has served as a director of GTS since
                                                  January 1996. His term expires at the 1999 annual
                                                  stockholders meeting. Mr. Peet was affiliated with
                                                  The Chatterjee Group, an investment firm, from 1991
                                                  until February 1999. Prior to that, Mr. Peet spent
                                                  6 years with McKinsey & Company. Mr. Peet was a
                                                  director of Hainan Airlines and of Phoenix
                                                  Information Systems Corporation. In addition, Mr.
                                                  Peet served as director of Viatel, Inc. from
                                                  November 1995 until June 1998. Mr. Peet is a member
                                                  of the Executive Committee of the Board of
                                                  Directors.
Jean Salmona..............................   63   Mr. Salmona has served as a director of GTS since
                                                  March 1996. His term expires at the 2001 annual
                                                  stockholders meeting. Between December 1989 and
                                                  November 1998, Mr. Salmona was Chairman and C.E.O.
                                                  of CESIA Consulting Group ("CESIA"), of which he is
                                                  now Honorary Chairman and member of the Board. He
                                                  is President and C.E.O. of J&P Partners, a
                                                  consulting concern for high-tech companies which
                                                  invest in Europe, India and China. Mr. Salmona is
                                                  also Chairman and Director General, Data for
                                                  Development International Association, a
                                                  nongovernmental organization with consultative
                                                  status to the United Nations Economic and Social
                                                  Council. Mr. Salmona is a graduate of Ecole
                                                  Polytechnique, Paris, Institut d'Etudes Politiques,
                                                  Paris, and Ecole Nationale de la Statistique et de
                                                  l'Administration Economique, Paris. Mr. Salmona is
                                                  a member of the Audit and Budget Committee of the
                                                  Board of Directors. Mr. Salmona is a citizen of
                                                  France.
Joel Schatz...............................   61   Mr. Schatz has served as a director of GTS since
                                                  the inception of the Company. His term expires at
                                                  the 1999 annual stockholders meeting. Mr. Schatz
                                                  was a founder of the Company and served as its
                                                  President from 1985 to 1991. Mr. Schatz is
                                                  presently the Chairman and Chief Executive Officer
                                                  of Datafusion, Inc., a company developing software
                                                  to accelerate knowledge synthesis. Mr. Schatz is a
                                                  member of the Audit and Budget Committee of the
                                                  Board of Directors.
Frank V. Sica.............................   47   Mr. Sica was elected as a director of GTS in March
                                                  1999. His term expires at the 1999 annual
                                                  stockholders meeting. Mr. Sica is a Managing
                                                  Director of Soros Fund Management LLC and head of
                                                  Soros Fund Management's private equity operations.
                                                  Prior to joining Soros Fund Management, Mr. Sica
                                                  was a Managing Director at Morgan Stanley Dean
                                                  Witter & Co., the investment banking and brokerage
                                                  firm. He is also a director of CSG Systems
                                                  International, Inc., Kohl's Corporation and Emmis
                                                  Broadcasting.
</TABLE>
 
                                       104
<PAGE>   106
 
<TABLE>
<CAPTION>
                   NAME                     AGE
                   ----                     ---
<S>                                         <C>   <C>
Alan B. Slifka............................   69   Mr. Slifka has served as a director of GTS since
                                                  1990, and was Chairman until March 1999 when he was
                                                  elected Executive Vice Chairman. His term expires
                                                  at the 2000 annual stockholders meeting. Mr. Slifka
                                                  is a New York investment banker and the Managing
                                                  Principal of Halcyon/Alan B. Slifka Management
                                                  Company LLC, an equity asset management firm
                                                  specializing in nontraditional investments,
                                                  specifically corporate event investing. Previously,
                                                  Mr. Slifka was a partner of L.F. Rothschild,
                                                  Unterberg, Towbin from 1961 to 1982. He is a
                                                  director of Pall Corporation and is active in other
                                                  business, civic and philanthropic affairs as
                                                  founder, director or officer of numerous for-profit
                                                  and not-for-profit corporations and foundations.
                                                  Mr. Slifka served as acting Chief Executive Officer
                                                  of GTS during most of 1993. Mr. Slifka is a member
                                                  of the Executive and Nominations and Governance
                                                  Committees of the Board of Directors.
Adam Solomon..............................   46   Mr. Solomon has served as a director of the Company
                                                  since June 1995. His term expires at the 2001
                                                  annual stockholders meeting. Mr. Solomon is also
                                                  Chairman of Shaker Investments, Inc., a growth
                                                  equity investment firm and Chairman of Signature
                                                  Properties International, L.P., a
                                                  venture/development firm whose initial focus is
                                                  redeveloping existing residential/golf communities,
                                                  and a member of the board of directors of MetaSolv
                                                  Software, Inc. Prior to that, Mr. Solomon spent
                                                  eleven years with E.M. Warburg, Pincus & Co., Inc.,
                                                  where he was Managing Director from 1988 to 1992.
                                                  While at E.M. Warburg, Pincus & Co., Inc., Mr.
                                                  Solomon served as a member of the board of
                                                  directors of LCI International, Inc., a regional
                                                  long-distance carrier. Mr. Solomon is a member of
                                                  the Executive and Compensation Committees of the
                                                  Board of Directors.
Gerald W. Thames..........................   52   Mr. Thames joined GTS as Chief Executive Officer in
                                                  February 1994, and has served as a director of GTS
                                                  since February 1994. He was elected Vice Chairman
                                                  of the Board of Directors in 1998 and Executive
                                                  Vice Chairman in March 1999. His term expires at
                                                  the 1999 annual stockholders meeting. 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. Mr. Thames is a
                                                  member of the Executive Committee of the Board of
                                                  Directors.
</TABLE>
 
                                       105
<PAGE>   107
 
<TABLE>
<CAPTION>
                   NAME                     AGE
                   ----                     ---
<S>                                         <C>   <C>
H. Brian Thompson.........................   59   Mr. Thompson was elected Chairman of the Board and
                                                  Chief Executive Officer of the Company in March
                                                  1999. From 1991 until June 1998, Mr. Thompson was
                                                  Chairman and Chief Executive Officer of LCI
                                                  International, Inc., a provider of
                                                  telecommunications services in the United States
                                                  and to more than 230 international locations. In
                                                  June 1998, LCI was acquired by Qwest Communications
                                                  International, Inc. and Mr. Thompson became Vice
                                                  Chairman of Qwest. He resigned from the Board of
                                                  Directors of Qwest in December 1998. From 1981 to
                                                  1990, Mr. Thompson served as Executive Vice
                                                  President of MCI Communications Corporation with
                                                  responsibility for eight operating divisions,
                                                  including MCI International. Prior to MCI, Mr.
                                                  Thompson was a management consultant with McKinsey
                                                  & Company. He serves as a member of the board of
                                                  directors of Bell Canada International, Inc. and
                                                  Golden Books Family Entertainment, Inc., and is a
                                                  member of the Listed Company Advisory Committee of
                                                  The New York Stock Exchange board of directors. Mr.
                                                  Thompson is also a trustee of Capitol College in
                                                  Laurel, Maryland and serves as Americas Co-Chairman
                                                  of the Global Information Infrastructure
                                                  Commission, a multinational organization formed in
                                                  1995 to chart the role of the private sector in
                                                  developing global information and
                                                  telecommunications infrastructure.
</TABLE>
 
EXECUTIVE OFFICERS
 
<TABLE>
<CAPTION>
                   NAME                     AGE
                   ----                     ---
<S>                                         <C>   <C>
Robert J. Amman...........................   61   See biographical information under "Directors"
                                                  above.
Bruno d'Avanzo............................   57   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 -- United States, 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. Mr.
                                                  d'Avanzo is a citizen of Italy.
</TABLE>
 
                                       106
<PAGE>   108
 
<TABLE>
<CAPTION>
                   NAME                     AGE
                   ----                     ---
<S>                                         <C>   <C>
Gerard Essing.............................   36   Mr. Essing is the Chief Executive Officer -- GTS
                                                  Mobile Services (CIS). Mr. Essing has been general
                                                  director of Vostok Mobile, a GTS subsidiary, since
                                                  1994. Prior to that, Mr. Essing held a variety of
                                                  management positions with what is now Lucent
                                                  Technologies from 1989 to 1994. Mr. Essing holds a
                                                  Master's Degree in International Management from
                                                  American Graduate School of International
                                                  Management in the United States. He has also
                                                  received post-graduate telecommunications training
                                                  at Technical University Delft in the Netherlands.
Leslie M. Harris..........................   49   Mr. Harris joined GTS in October 1998 as President
                                                  of GTS Access Services, which is based in London.
                                                  Since 1995, he was President and Chief Executive
                                                  Officer of New T&T (Hong Kong) Ltd., the leading
                                                  competitive local exchange carrier in Hong Kong.
                                                  From September 1992 to December 1994, Mr. Harris
                                                  was Joint Managing Director of BT. Australasia Ltd.
                                                  Prior to that, Mr. Harris held a variety of senior
                                                  executive positions with British Telecom in the
                                                  United Kingdom and Australia.
Hans Peter Kohlhammer.....................   51   Mr. Kohlhammer joined GTS as President of GTS
                                                  Business Services -- Western Europe on March 5,
                                                  1999. From October 1998 to March 1999, Mr.
                                                  Kohlhammer was director of sales and marketing of
                                                  Esprit Telecom. Prior to that, Mr. Kohlhammer was
                                                  Chairman of the Board at Thyssen Telecom AG and
                                                  held a Board position with Loewe Opta. Dr.
                                                  Kohlhammer holds a degree in mathematics and
                                                  physics and a doctorate in mathematics from the
                                                  University of Bonn.
Jan Loeber................................   55   Mr. Loeber is President, GTS Carrier Services, and
                                                  Managing Director of Hermes Railtel. 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 UnitelLtd. (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.
</TABLE>
 
                                       107
<PAGE>   109
 
<TABLE>
<CAPTION>
                   NAME                     AGE
                   ----                     ---
<S>                                         <C>   <C>
James M. Newman...........................   49   Mr. Newman joined GTS as Senior Vice President and
                                                  Chief Information Officer in February 1999. Since
                                                  1997, he was Senior Vice President and Chief
                                                  Information Officer of ICG Telecom Group, Inc.,
                                                  which provides competitive local exchange, long
                                                  distance and Internet services. From 1996-1997, Mr.
                                                  Newman was a Director of San Francisco Consulting
                                                  Group, the telecommunications consulting division
                                                  of KPMG Peat Marwick LLP. From 1994-1996, Mr.
                                                  Newman was Vice President -- Information Technology
                                                  of Dial Call Communications, Inc., a
                                                  telecommunications services company.
Kevin Power...............................   45   Mr. Power is President of GTS Wholesale Services
                                                  since March 1999. Prior to that he served as
                                                  Interim Head of GTS Business Services (Western
                                                  Europe). Prior to joining GTS Monaco Access in
                                                  October 1995, Mr. Power was Vice President, Carrier
                                                  Relations for GTS 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 United States Department
                                                  of Commerce.
Grier C. Raclin...........................   46   Mr. Raclin joined GTS as its Senior Vice President
                                                  and General Counsel in September, 1997, and was
                                                  elected Corporate 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..........................   54   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.
</TABLE>
 
                                       108
<PAGE>   110
 
<TABLE>
<CAPTION>
                   NAME                     AGE
                   ----                     ---
<S>                                         <C>   <C>
Jim Reynolds..............................   47   Jim Reynolds, President of Hermes Europe Railtel
                                                  B.V., was formerly chief operating officer of
                                                  Esprit Telecom. His experience and track record
                                                  extends over 26 years in the information technology
                                                  and telecommunications field. Previously director
                                                  of products and services at Mercury Communications,
                                                  Mr. Reynolds was responsible for the
                                                  rationalization and development of the Mercury
                                                  service portfolio during the period when Mercury
                                                  was focusing on making major improvements to
                                                  service delivery and profit. As part of this role
                                                  he managed the Mercury Enterprise businesses
                                                  disposing of a number of these and integrating
                                                  others into the main company. Before joining
                                                  Mercury in 1992 he led the first Digital Equipment
                                                  product group outside the United States and spent
                                                  15 years with ITT Corporation.
Robert A. Schriesheim.....................   39   Mr. Schriesheim joined GTS as Executive Vice
                                                  President and Chief Corporate Development Officer
                                                  in February 1999. Since 1997, he was President,
                                                  Chief Executive Officer and Director of SBC Equity
                                                  Partners, Inc., a private equity firm affiliated
                                                  with Sanwa Business Credit Corporation that invests
                                                  in technology-based service and manufacturing
                                                  companies. From 1996-1997, Mr. Schriesheim was Vice
                                                  President -- Corporate Business Development for
                                                  Ameritech Corp., the regional Bell operating
                                                  company, and Managing Director -- Ameritech
                                                  Development Corporation. From 1993-1996, he was
                                                  Vice President -- Acquisitions and New Business
                                                  Development (1993-1994) and Vice
                                                  President -- Global Corporate Development
                                                  (1995-1996) of A.C. Nielsen Company, a consumer
                                                  marketing research, information and
                                                  decision-support service.
William H. Seippel........................   42   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.
</TABLE>
 
                                       109
<PAGE>   111
 
<TABLE>
<CAPTION>
                   NAME                     AGE
                   ----                     ---
<S>                                         <C>   <C>
Eileen K. Sweeney.........................   47   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.
H. Brian Thompson.........................   60   See biographical information under "Directors"
                                                  above.
Louis T. Toth.............................   56   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.
</TABLE>
 
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
 
     Section 16(a) of the Exchange Act requires the Company's directors and
executive officers, and persons or entities who own more than 10% of the
Company's Common Shares, to file with the SEC and the Nasdaq Stock Market
initial reports of beneficial ownership and changes in beneficial ownership of
the Company's Common Shares. Such persons are also required by SEC regulations
to furnish the Company with copies of all Section 16(a) forms they file. To the
Company's knowledge, based solely on a review of the copies of such reports
furnished to the Company as to transactions for which reports are required, all
Section 16(a) filing requirements applicable to such individuals or entities
were complied with during 1998, except with respect to Messrs. Gerard Essing and
Leslie Harris. The Corporation determined on December 24, 1998 that Messrs.
Essing and Harris were executive officers of the Company. Mr. Essing filed his
"Initial Statement of Beneficial Ownership of Securities" on Form 3 on March 2,
1999 and Mr. Harris filed his "Initial Statement of Beneficial Ownership of
Securities" on Form 3 on February 24, 1999.
 
ITEM 11. EXECUTIVE COMPENSATION
 
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
 
     During 1998, each Director of GTS, except Mr. Thames, receives an annual
directors' fee of $15,000. In addition, the fee paid to each Director, except
for Mr. Thames, for attending any meeting of the Board of Directors is $1,500
per meeting, except for telephonic Board of Directors meetings of two hours or
less, where the fee is $750 for each such meeting. Each Director, except Mr.
Thames, who attends a committee meeting is entitled to a directors' fee of
$1,000 per meeting, except for telephonic committee meetings of a duration of
two hours or less, for which a fee of $500 is paid.
 
     GTS maintains the Global TeleSystems Group, Inc. Non-Employee Directors'
Stock Option Plan that permits directors to share in the growth of the value of
GTS through the grant and exercise of nonqualified stock options. See "-- Global
TeleSystems Group, Inc. Non-Employee Directors' Stock Option Plan." In addition,
on February 27, 1998 the Board of Directors granted to each of certain of its
then incumbent members options to purchase 15,000 shares of Common Stock at an
exercise price of $20 per share.
 
                                       110
<PAGE>   112
 
GLOBAL TELESYSTEMS GROUP, INC. NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
 
     The purpose of the Global TeleSystems Group, Inc. non-employee directors'
stock option plan, which we refer to as the Directors' Plan, is to permit
eligible non-employee directors of GTS to share in the growth of the value of
GTS through the grant and exercise of nonqualified stock options.
 
     The total number of shares of GTS common stock presently reserved and
available for delivery under the Directors' Plan is 1,275,000. The Directors'
Plan is administered by the compensation committee of the Board of Directors,
which we refer to as the Committee. Only directors of GTS who are not employees
of GTS or any subsidiary of GTS on the date on which an option is to be granted
are eligible to participate in the Directors' Plan on such date.
 
     An option to purchase shares of GTS common stock was granted to each
non-employee director on the effective date of the Directors' Plan and a
director's option is granted to each new non-employee director when he or she is
first elected or appointed to serve as a director of GTS. One-half of the
directors' options vests six months after the date of grant. An additional one
quarter become exercisable on the date six months following the first annual
meeting of GTS's shareholders to occur after such date of grant, and the
remaining one quarter shares become exercisable on the date six months following
the second annual meeting of GTS's shareholders to occur after such date of
grant. An initial directors' option represents 22,250 shares of GTS common
stock. On the date of each annual meeting of GTS's shareholders, an additional
directors' option to purchase 9,000 shares will be granted each year on the date
of GTS' annual meeting to the individuals who will serve as elected non-employee
directors of GTS during the next year.
 
     Directors' options are nonqualified stock options which are subject to
certain terms and conditions including those summarized below. The exercise
price per share of GTS common stock purchasable under a directors' option will
be equal to 100% of the fair market value of GTS common stock on the date of
grant. Each directors' option will expire upon the earliest of (a) the tenth
anniversary of the date of grant, (b) one year after the non-employee director
ceases to serve as a director of GTS due to death or disability (except that, in
the case of disability, if the non-employee director dies within that one-year
period, the directors' option is exercisable for a period of one year from the
date of death), (c) three months after the non-employee director ceases to serve
as a director of GTS for any reason other than death or disability (except that,
if the non-employee director dies within that three-month period, his or her
directors' options are exercisable for a period of one year from the date of
such death), and (d) three months after the non-employee director ceases to be
employed by GTS if such non-employee director had become an employee of GTS
(except that, if the non-employee director dies within that three-month period,
his or her directors' options are exercisable for a period of one year from the
date of such death). Each directors' option may be exercised in whole or in part
by giving written notice of exercise to GTS specifying the directors' option to
be exercised and the number of shares to be purchased. Such notice must be
accompanied by payment in full of the exercise price in cash or by surrender of
shares of GTS common stock or a combination thereof. Directors' options granted
under the Directors' Plan may not be sold, pledged, assigned or otherwise
disposed of in any manner other than by will or by the laws of descent and
distribution.
 
     At the time of grant, the Board of Directors may provide in connection with
any grant made under the Directors' Plan that the shares of GTS common stock
received as a result of such grant are subject to a right of first refusal by
GTS.
 
     The Board of Directors may amend, alter, suspend, discontinue or terminate
the Directors' Plan at any time, except that any such action will be subject to
the approval of GTS shareholders at the next annual meeting following such Board
of Directors' action if such shareholder approval is required by any federal or
state law or regulation or the rules of any stock exchange or automated
quotation system on which GTS common stock may then be listed or quoted, or if
the Board of Directors determines in its discretion to seek such shareholder
approval.
 
                                       111
<PAGE>   113
 
     The following table sets forth each component of compensation paid or
awarded to, or earned by, the Chief Executive Officer and the four other most
highly compensated executive officers serving as of December 31, 1998, for the
years indicated.
 
                           SUMMARY COMPENSATION TABLE
 
<TABLE>
<CAPTION>
                                                                          LONG-TERM COMPENSATION
                                                                         ------------------------
                                                                                  AWARDS
                                           ANNUAL COMPENSATION           ------------------------
                                    ----------------------------------   RESTRICTED   SECURITIES
                                                          OTHER ANNUAL     STOCK      UNDERLYING     ALL OTHER
                                     SALARY    BONUS(1)   COMPENSATION    AWARD(S)    OPTIONS/SAR   COMPENSATION
NAME AND PRINCIPAL POSITION  YEAR     ($)        ($)          ($)           ($)           (#)         ($)(11)
---------------------------  ----   --------   --------   ------------   ----------   -----------   ------------
<S>                          <C>    <C>        <C>        <C>            <C>          <C>           <C>
Gerald W. Thames.........    1998   $395,000   $330,000             (2)         0       350,000(6)    $ 19,065
  Vice Chairman,             1997    375,417    140,000             (2)         0       141,195(6)      19,850
  President and              1996    325,000    113,750             (2)         0       112,500(6)       9,954
  Chief Executive Officer
Bruno d'Avanzo(12).......    1998   $340,000   $173,333(3)          0           0       175,000(6)    $ 18,105
  Executive Vice             1997    340,000     83,313(3)          0           0       104,475(6)      21,675
  President and              1996    141,667     33,333(3)          0           0        83,025(6)       5,650
  Chief Operating Officer
Jan Loeber...............    1998   $310,000   $119,400     $101,840(4)         0       150,000(6)    $178,565
  Senior Vice                1997    235,000    177,308       46,598(4)         0         4,812(7)     179,450
  President -- Hermes;       1996    235,000          0       42,806(4)    30,000(5)        3.5(8)      12,986
  President -- GTS
  Carrier Services
William H. Seippel(13)...    1998   $245,833   $120,000             (2)         0       150,000(6)    $  9,650
  Executive Vice             1997    200,000     11,469     $ 25,225(9)         0        97,500(6)      52,215
  President --               1996     43,205          0             (2)         0       285,000(6)         943
  Chief Financial Officer
Stewart P. Reich(14).....    1998   $243,750   $ 98,300     $187,008(10)        0       150,000(6)    $  5,197
  President -- GTS           1997     78,333     75,000       59,772(10)        0       112,500(6)         384
  Business
  Services -- CIS
</TABLE>
 
---------------
 
 (1) Represents cash bonus paid in the year indicated for services rendered in
     the immediately preceding year, except in the case of Mr. Loeber, whose
     bonus paid in 1997 was for services rendered in 1996 and 1995.
 
 (2) Perquisites and other personal benefits paid to the named executive officer
     were less than the lesser of $50,000 and 10 percent of the total of salary
     and bonus report for the named executive officer.
 
 (3) Mr. D'Avanzo's bonuses in 1998, 1997 and 1996 include the three equal
     installments of a $100,000 sign-on bonus that GTS agreed to pay in three
     equal annual installments when he was hired in 1996.
 
 (4) For 1998, the amount disclosed includes an overseas living allowance of
     $21,700 and a tax equalization payment of $58,613 that compensated Mr.
     Loeber for the higher taxes he pays because he resides in Belgium instead
     of the United States. For 1997, the amount disclosed includes an overseas
     living allowance of $16,450, a tax equalization payment of $13,953 and a
     gross-up payment of $11,648 for certain tax liabilities. For 1996, the
     amount disclosed includes an overseas living allowance of $16,450 and a
     gross-up payment of $12,778 for certain tax liabilities.
 
 (5) Shares of restricted stock that vest in an amount of one-third each year on
     the three anniversary dates of grant, beginning on January 2, 1997.
 
 (6) Shares of common stock underlying stock options awarded under the Stock
     Option Plan.
 
 (7) Stock options awarded under The Key Employee Stock Option Plan of Hermes
     Europe Railtel B.V. which we refer to as the Hermes Stock Option Plan.
 
                                       112
<PAGE>   114
 
 (8) Stock options awarded under the GTS-Hermes, Inc. Stock Option Plan, which
     will be terminated. The stock options granted to Mr. Loeber in 1997 and
     described in footnote (6) are in substitution for the 3.5 stock options
     granted to Mr. Loeber in 1996, which have been cancelled.
 
 (9) Amount disclosed represents a gross-up payment of $25,225 associated with
     certain tax liabilities.
 
(10) For 1998, the amount disclosed includes an overseas living allowance of
     $72,000, rent on a residence in Moscow of $90,000, and a tax equalization
     payment of $19,844 that compensated Mr. Reich for the higher taxes he pays
     because he resides in Russia instead of United States. For 1997, the amount
     disclosed includes an overseas living allowance of $24,000 and rent on a
     residence in Moscow of $30,300.
 
(11) Amounts disclosed hereunder represent the sum of premiums paid by GTS for
     $1 million in term life insurance for each named executive officer and
     contributions by GTS under the 401(k) Plan, as defined below, to each named
     executive officer's account, except Mr. D'Avanzo who does not participate
     in the 401(k) Plan because of his foreign citizenship and Mr. Seippel in
     1996 and Mr. Reich in 1997 because their tenure with GTS did not qualify
     them for participation in the 401(k) Plan in those years. In each case in
     which GTS paid 401(k) Plan contributions, $4,000 was paid in each of 1997
     and 1996 and $3,750 was paid in 1996 to the named executive officers. In
     addition, for 1998 and 1997, the amounts disclosed for Mr. Loeber include
     $156,700 in each year, which represents the value as of December 31, 1997
     and December 31, 1998 of 10,000 shares of restricted stock which vested in
     each of 1997 and 1998.
 
(12) Mr. D'Avanzo commenced his employment with GTS in August 1996.
 
(13) Mr. Seippel commenced his employment with GTS in October 1996.
 
(14) Mr. Reich commenced his employment with GTS in September 1997.
 
                     OPTION/SAR GRANTS IN LAST FISCAL YEAR
 
     The following table provides information on stock option grants to the five
most highly compensated officers in 1998 under the Stock Option Plan
 
<TABLE>
<CAPTION>
                                                    % OF TOTAL
                                       NUMBER OF      OPTIONS
                                       SECURITIES   GRANTED TO      EXERCISE
                                       UNDERLYING    EMPLOYEES         OR                     GRANT DATE
                                        OPTIONS         IN            BASE       EXPIRATION     PRESENT
NAME                                   GRANTED(#)   FISCAL YEAR   PRICE($/SH.)      DATE      VALUE($)(2)
----                                   ----------   -----------   ------------   ----------   -----------
<S>                                    <C>          <C>           <C>            <C>          <C>
Gerald W. Thames....................    350,000(1)      9.4          $25.75       10-14-08    $5,779,445
Bruno d'Avanzo......................    175,000(1)      4.7           25.75       10-14-08     2,889,723
Jan Loeber..........................    150,000(1)      4.0           25.75       10-14-08     2,476,905
William H. Seippel..................    150,000(1)      4.0           25.75       10-14-08     2,476,905
Stewart P. Reich....................    150,000(1)      4.0           25.75       10-14-08     2,476,905
</TABLE>
 
---------------
 
(1) All these options would vest in February 2005, when financial results for
    2004 are expected to be publicly announced. If certain performance targets
    are met or exceeded, these options could be fully exercisable in February
    2002, when financial results for 2001 are expected to be publicly announced.
 
(2) The present value of each grant is estimated on the date of grant using the
    Black-Scholes option pricing model with the following weighted-average
    assumptions: dividend yield 0%, expected volatility of 0.75, risk-free
    interest rate of 4.23% and expected life of five years.
 
                                       113
<PAGE>   115
 
  AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
 
     The following table provides information on the number and value of GTS
stock options exercised by the five most highly compensated officers during
1998, the number of options under the Stock Option Plan held by such persons at
December 31, 1998, and the value of all unexercised options held by such persons
as of that date.
 
<TABLE>
<CAPTION>
                                                       NUMBER OF SECURITIES        VALUE OF UNEXERCISED
                           SHARES                     UNDERLYING UNEXERCISED           IN-THE-MONEY
                         ACQUIRED ON      VALUE        OPTIONS AT FY-END(#)       OPTIONS AT FY-END($)(1)
NAME                     EXERCISE(#)   REALIZED($)   EXERCISABLE/UNEXERCISABLE   EXERCISABLE/UNEXERCISABLE
----                     -----------   -----------   -------------------------   -------------------------
<S>                      <C>           <C>           <C>                         <C>
Gerald W. Thames.......    487,500     $20,048,438        354,048/512,147         $16,296,754/$17,458,263
Bruno d'Avanzo.........     50,000       2,085,000         31,468/281,032             1,312,935/9,682,065
Jan Loeber.............        -0-             -0-              0/150,000                   -0-/4,500,000
William H. Seippel.....     50,000       2,064,750        169,375/313,125            7,162,950/11,353,950
Stewart P. Reich.......        -0-             -0-         28,125/234,375             1,127,250/7,881,750
</TABLE>
 
---------------
 
(1) Based on the closing price of $55.75 on the Nasdaq Stock Market of the
    Common Stock on December 31, 1998.
 
   AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR
                        VALUES-HERMES STOCK OPTION PLAN
 
     The following table provides information on the number and value of options
exercised by one of the five most highly compensated officers, Jan Loeber,
during 1998 under the Hermes Stock Option Plan, and the number and value of
unexercised options held by Mr. Loeber as of December 31, 1998 under such Plan.
Mr. Loeber was not granted any options in the Hermes Stock Option Plan in 1998.
 
<TABLE>
<CAPTION>
                               SHARES                      NUMBER OF SECURITIES        VALUE OF UNEXERCISED
                              ACQUIRED                    UNDERLYING UNEXERCISED      IN-THE-MONEY OPTIONS AT
                             ON EXERCISE      VALUE        OPTIONS AT FY-END(#)            FY-END($)(2)
NAME                           (1)(#)      REALIZED($)   EXERCISABLE/UNEXERCISABLE   EXERCISABLE/UNEXERCISABLE
----                         -----------   -----------   -------------------------   -------------------------
<S>                          <C>           <C>           <C>                         <C>
Jan Loeber.................     3,209      $2,129,793             1,603/0                  $1,292,928/$0
</TABLE>
 
---------------
 
(1) The shares are beneficially owned by Mr. Loeber and are held in trust by
    Stichting Administratiekantoor Hermes Foundation, which in turn has issued
    depositary receipts to him representing beneficial ownership in the shares.
 
(2) Based on a valuation price of $889.61 per share of Hermes common stock at
    December 31, 1998. This valuation was determined by the valuation per common
    share that a wholly owned subsidiary of GTS paid to AB Swed Carrier for
    acquiring all of its minority interest in Hermes on October 31, 1998.
 
THE GTS 401(K) PLAN
 
     The GTS 401(k) Plan is a defined contribution retirement benefit plan that
is qualified for favorable tax treatment under Section 401 of the Code. All
employees of GTS, subject to certain regulatory qualifications, including the
five most highly compensated officers, who are at least 21 years of age and have
completed the minimum service requirement are eligible to participate in the
401(k) Plan. The 401(k) Plan participants may defer pre-tax income by
contributing to the plan up to the maximum amount permitted by law. After-tax
contributions are also permitted under the 401(k) Plan. GTS matches 50% of each
participant's pre-tax contribution to the 401(k) Plan up to 5% of the
participant's total compensation. In addition, GTS may, in its sole discretion
and in a nondiscriminatory manner, contribute additional amounts as profit
sharing to each participant's account. The amounts that are deposited into each
participant's account are invested among various investment options according to
the direction of the participant. Each participant's pre-tax and after-tax
contributions are immediately vested and nonforfeitable. GTS's matching
contribution and profit sharing allocations to each participant's account do not
vest until the participant has completed three years of service with GTS, at
which time the matching contribution and profit sharing allocations become 100%
vested. Each
 
                                       114
<PAGE>   116
 
participant is eligible to begin receiving benefits under the 401(k) Plan on the
first day of the month coincident with or following the attainment of normal
retirement age. There is no provision for early retirement benefits under the
401(k) Plan.
 
THE GLOBAL TELESYSTEMS GROUP, INC. EQUITY COMPENSATION PLAN
 
     The purpose of the Global TeleSystems Group, Inc. Equity Compensation Plan
is to attract, retain and motivate key employees, officers and eligible
independent contractors of GTS and to enable such individuals to own shares of
GTS common stock and to have a mutuality of interest with other shareholders of
GTS through the grant of restricted stock and other equity-based awards.
 
     The total number of shares of common stock that may be issued or
transferred under the Equity Compensation Plan is four percent of the total
number of shares of common stock outstanding at the beginning of the calendar
year, subject to certain adjustments, which are described below. This threshold
number may be increased by the number of shares (a) that were issued under the
Equity Compensation Plan with respect to which no dividends were paid and (b)
that were subsequently forfeited, in accordance with the terms of the Equity
Compensation Plan.
 
     The Equity Compensation Plan is administered by the Committee. The chief
executive officer of GTS has the authority to recommend the individuals to whom
awards will be granted, subject to approval by the Committee. The Committee has
full and binding authority to determine the fair market value of the GTS common
stock and the number of shares included in any awards, to establish terms and
conditions of any award, to interpret the Equity Compensation Plan, to prescribe
rules relating to the Equity Compensation Plan and to make all other
determinations necessary to administer the Equity Compensation Plan. The
Committee may condition the vesting of restricted stock upon the attainment of
specified performance goals or such other factors as the Committee may determine
in its sole discretion. In the event that the Committee determines, in its sole
discretion, that an award of restricted stock would not be appropriate with
respect to any individual who has been recommended for an award by the chief
executive officer, the Committee has the authority to grant to any such
individual any other variety of equity-based compensation award, including, but
not limited to, phantom stock, phantom units, stock appreciation rights,
performance shares and performance units. The Committee does not, however, have
the authority to grant stock options pursuant to the Equity Compensation Plan.
 
     Grants under the Equity Compensation Plan are determined by the Committee
in its sole discretion. For this reason, it is not possible to determine the
benefits or amounts that will be received by any individual employee or group of
employees in the future. The Equity Compensation Plan will remain effective
until November 14, 2004, unless earlier terminated by GTS. No restricted stock
may be granted under the Equity Compensation Plan on or after November 14, 2000.
 
     During a specified period set by the Committee commencing with the date of
any restricted stock award, the participant is not permitted to sell, transfer,
pledge or otherwise encumber shares of restricted stock. Within these limits,
the Committee, in its sole discretion, may provide for the lapse of such
restrictions or may accelerate or waive such restrictions in whole or in part,
based on service, performance and such other factors. Unless the Committee
specifically determines otherwise, a restricted stock award granted under the
Equity Compensation Plan vests one-third on the second anniversary of the date
of grant, one-third on the third anniversary of the date of grant and one-third
on the fourth anniversary of the date of grant.
 
     The Committee may impose such other restrictions on shares of Common Stock
issued under the Equity Compensation Plan, including a right of first refusal by
GTS that requires the participant to offer GTS any shares that the participant
wishes to sell.
 
     The Equity Compensation Plan provides that, in the event of a change to the
GTS common stock (whether by reason of merger, consolidation, reorganization,
recapitalization, stock dividend, stock split, combination or exchange of
shares, or other change in the capital structure made without receipt of
consideration), the Board of Directors will preserve the value of outstanding
awards by making certain equitable adjustments in its discretion.
 
                                       115
<PAGE>   117
 
     The Board of Directors may amend, alter, suspend, discontinue or terminate
the Equity Compensation Plan at any time, except that any such action will be
subject to the approval of GTS shareholders at the first annual meeting
following such action if such shareholder approval is required by any federal or
state law or regulation or the rules of any stock exchange or automated
quotation system on which Common Stock may then be listed or quoted, or if the
Board of Directors determines in its discretion to seek such shareholder
approval.
 
THE FOURTH AMENDED AND RESTATED 1992 STOCK OPTION PLAN OF GLOBAL TELESYSTEMS
GROUP, INC.
 
     The 1992 Stock Option Plan of Global TeleSystems Group, Inc. was adopted by
the Board of Directors of GTS and approved by stockholders in 1992 and has been
subsequently amended, among other things, to increase the number of shares
available for grant. The Board of Directors of GTS adopted the Fourth Amended
and Restated Plan on April 9, 1998, and it received stockholder approval at the
May 20, 1998 annual shareholders meeting: (i) to modify the provisions relating
to the number of shares with respect to which options to purchase shares of
Common Stock may be granted under the 1992 Stock Option Plan; (ii) to extend
eligibility under the 1992 Stock Option Plan to nonemployee directors and
independent contractors of the Company (as defined in the 1992 Stock Option
Plan), its subsidiaries and affiliates; (iii) to provide the Stock Option
Committee (as defined in the 1992 Stock Option Plan) with more flexibility to
specify the terms of options granted under the 1992 Stock Option Plan; (iv) to
specify that the options covering not more than 1.5 million shares of common
stock may be granted to any employee during any calendar year; (v) to extend the
term of the 1992 Stock Option Plan, as amended, to April 9, 2008 and (vi) to
eliminate certain provisions that are not necessary or desirable in an option
plan of a public company.
 
     This summary does not purport to be complete and is qualified in its
entirety by the terms of the Fourth Amended and Restated Plan.
 
     The Fourth Amended and Restated Plan provides for the grant of options to
employees, non-employee directors, and independent contractors of GTS and any
subsidiary or affiliate of GTS. A total of approximately 12.0 million shares of
common stock are reserved for issuance to employees, non-employee directors and
independent contractors under the Amended 1992 Stock Option Plan representing
18.5% of the outstanding shares of common stock on December 31, 1998. A total of
1 million shares of common stock may be issued pursuant to options qualifying
for tax purposes as incentive options under the Fourth Amended and Restated
Plan.
 
     The Fourth Amended and Restated Plan is administered by the stock option
committee, which consists of not less than two directors appointed by the Board
of Directors. The stock option committee selects the employees, independent
contractors and directors of GTS and its subsidiaries and affiliates to whom
options will be granted. Options covering not more than 1.5 million shares of
common stock may be granted to any employee during any calendar year.
 
     The option exercise price under the Fourth Amended and Restated Plan may
not be less than the exercise price determined by the stock option committee (or
110% of the fair market value of the GTS common stock on the date of grant of
the option in the case of an incentive option granted to an optionee
beneficially owning more than 10% of the outstanding common stock). The maximum
option term is 10 years and one day (or five years in the case of an incentive
option granted to an optionee beneficially owning more than 10% of the
outstanding common stock). Options become vested and exercisable at the time and
to the extent provided in the option agreement related to such option. The Stock
Option Committee has the discretion to accelerate the vesting and exercisability
of options.
 
     There is a $100,000 limit on the value of stock (determined at the time of
grant) covered by incentive options that first become exercisable by an optionee
in any calendar year. No option may be granted more than 10 years after the
effective date of the Fourth Amended and Restated Plan. Generally, during an
optionee's lifetime, only the optionee (or a guardian or committee if the
optionee is incapacitated) may exercise an option except that, upon approval by
the Stock Option Committee, nonqualified options may be transferred to the
spouse of the optionee and certain nonqualified options may be granted or
transferred to the GTS
 
                                       116
<PAGE>   118
 
Employee Stock Option Plan Trust for the benefit of one or more designated
foreign employees, independent contractors or directors. Incentive stock options
are non-transferable except at death.
 
     Payment for shares purchased under options granted pursuant to the Fourth
Amended and Restated Plan may be made either in cash or by exchanging shares of
GTS common stock (which shares have been held by the optionee for at least six
months) with a fair market value of up to the total option exercise price and
cash for any difference. Options may be exercised by directing that certificates
for the shares purchased be delivered to a licensed broker-dealer as agent for
the optionee, provided that the broker-dealer tenders to GTS cash or cash
equivalents equal to the option exercise price plus the amount of any taxes that
GTS may be required to withhold in connection with the exercise of the option.
 
     If an optionee's employment or service with GTS or a subsidiary or
affiliate terminates by reason of death, retirement or permanent and total
disability, his or her vested options may be exercised within one year after
such death, retirement or disability, unless otherwise provided with respect to
a particular option (but not later than the date the option would otherwise
expire). If the optionee's employment or service with GTS or a subsidiary or
affiliate terminates for any reason other than death, retirement or disability,
options held by such optionee terminate 90 days after such termination, unless
otherwise provided with respect to a particular option (but not later than the
date the options would otherwise expire), except that options terminate
immediately upon termination of an employee or independent contractor for
"cause" (as defined), unless the stock option committee determines otherwise.
Each option would be exercisable to the extent it had become vested before the
termination of employment or service (unless otherwise provided in the option
agreement).
 
     If the outstanding shares of common stock are increased or decreased or
changed into or exchanged for a different number or kind of shares or securities
of GTS, by reason of merger, consolidation, reorganization, recapitalization,
reclassification, stock split-up, combination of shares, exchange of shares,
stock dividend, spin-off or other distribution payable in capital stock, or
other increase or decrease in such shares without receipt of consideration by
GTS, an appropriate and proportionate adjustment will be made in the number and
kinds of shares subject to the Fourth Amended and Restated Plan, and in the
number, kinds and per share exercise price of shares subject to the unexercised
portion of options granted prior to any such change, in order to preserve the
value of any granted options. Any such adjustment in an outstanding option,
however, will be made without a change in the total price applicable to the
unexercised portion of the option, but with a corresponding adjustment in the
per share option price.
 
     Upon any dissolution or liquidation of GTS, or upon a reorganization,
merger or consolidation in which GTS is not the surviving corporation, or upon
the sale of substantially all of the assets of GTS to another corporation, or
upon any transaction (including, without limitation, a merger or reorganization
in which GTS is the surviving corporation) approved by the board of directors
which results in any person or entity owning 80% or more of the total combined
voting power of all classes of stock of GTS, the Fourth Amended and Restated
Plan and the options issued thereunder will terminate, unless provision is made
in connection with such transaction for the continuation of the Fourth Amended
and Restated Plan, the assumption of such options or for the substitution for
such options of new options covering the stock of a successor corporation or a
parent or subsidiary thereof, with appropriate adjustments as to the number and
kinds of shares and the per share exercise price. In the event of such
termination, all outstanding options shall be exercisable in full during such
period immediately prior to the occurrence of such termination as the Board of
Directors in its discretion shall determine.
 
     The board of directors may further amend the Fourth Amended and Restated
Plan with respect to shares of the common stock as to which options have not
been granted. However, GTS's stockholders must approve any amendment that would
(1) change the requirements as to eligibility to receive incentive options; or
(2) increase the maximum number of shares in the aggregate for which incentive
options may be granted (except for adjustments upon changes in capitalization);
or (3) otherwise to the extent required by applicable law, rule or regulation.
 
     The board of directors at any time may terminate or suspend the Fourth
Amended and Restated Plan. Unless previously terminated, the Fourth Amended and
Restated Plan will terminate automatically on April 9, 2008. No termination,
suspension or amendment of the Fourth Amended and Restated Plan may, without the
                                       117
<PAGE>   119
 
consent of the person to whom an option has been granted, adversely affect the
rights of the holder of the option.
 
HERMES RAILTEL STOCK OPTION PLAN
 
     In the fourth quarter of 1997, Hermes Railtel established a stock option
plan to replace the GTS-Hermes Plan for the purpose of incentivizing Hermes
Railtel key employees. The aggregate number of shares of Hermes Railtel stock
subject to this new plan is approximately 13% of the total shares of Hermes
stock issued and outstanding including options. During 1997, Hermes Railtel
issued 10,166 options in replacement of those outstanding under a stock option
plan maintained by Hermes Railtel's parent, GTS-Hermes, Inc., a wholly owned
subsidiary of GTS, as well as additional options to certain employees. The
issuance of these options resulted in a non-cash charge of $3.7 million of which
$2.6 million was recorded during the fourth quarter of 1997 and the remaining
$1.1 million was recognized in 1998. The GTS-Hermes Plan is intended to be
terminated. GTS is considering whether to eliminate, and alternative ways of
eliminating, share option plans in subsidiaries, such as the Hermes Railtel
Stock Option Plan. GTS may eliminate such plans in the future while
incorporating such beneficiaries into GTS' employee stock option plan or
providing them with alternative equivalent value.
 
EMPLOYMENT AGREEMENTS
 
     GTS has employment agreements with each of the five most highly compensated
officers during 1998. The agreement with Mr. Thames includes a three-year term
of employment commencing on April 1, 1998. Mr. D'Avanzo's employment agreement
has a three-year term commencing on March 1, 1997. The agreements with Messrs.
Loeber, Seippel and Reich include a two-year term of employment commencing on
January 3, 1995, February 1, 1998 and September 1, 1997, respectively. The
employment agreements with Messrs. Loeber and Seippel provide for the automatic
renewal of the term for additional one-year periods, and the agreement with Mr.
Reich provides for the automatic renewal of the term for additional two-year
periods, after the initial term, unless written notice of intent to terminate is
provided by either party within a stated period of between 120 days and six
months prior to the renewal date. Mr. Thames' agreement provides for an
automatic renewal each year for a new three-year period. Mr. D'Avanzo's
agreement terminates on March 1, 2000, unless either GTS or Mr. D'Avanzo
requests an extension 180 days prior to such termination and the parties agree
upon an extension. The salary of each of the five most highly compensated
officers is reviewed yearly and may be increased at the sole discretion of the
Board of Directors. In addition to salary, each of the five most highly
compensated officers is eligible for a performance-based annual bonus, to
participate in the stock option plan, to receive standard health and insurance
benefits that are provided to executives of GTS, to receive certain other fringe
benefits and to be reimbursed for all reasonable expenditures incurred in the
execution of each named executive officer's respective duties.
 
     The employment agreements provide for severance payments in the event of
(a) termination without cause, as defined, or (b) resignation for good reason,
as defined, following a change of control event, as defined. Mr. Thames would be
eligible for severance payments of base salary for the greater of 24 months or
the remaining term of his agreement. Severance arrangements with other named
officers are for a period of six to eighteen months of base salary. If the named
executive officer is terminated for cause or if he voluntarily terminates his
employment other than for good reason after a change of control event, he shall
not be entitled to any salary, bonus or severance payments (other than accrued
salary).
 
     Each employment agreement includes noncompetition and nonsolicitation
clauses that are effective during the term of employment and for a period of
from four months to one year thereafter. In addition, the employment agreements
include an unlimited covenant of confidentiality and nondisclosure. Any dispute
arising under an employment agreement must be resolved through arbitration,
except that each agreement also provides for specific performance and for a
court injunction in the event of a breach by the named executive officer.
 
                                       118
<PAGE>   120
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
     Bernard McFadden, a Director and Chairman of the Compensation Committee,
has a consulting agreement with GTS pursuant to which he is paid $100,000 in
consulting fees each year.
 
REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS
 
     The role of the Compensation Committee involves overseeing and directing
the development of executive compensation policies and programs which are
consistent with, explicitly linked to, and supportive of the strategic
objectives of growing the Company's businesses and maximizing shareholder value.
The Committee's specific responsibilities include determining the appropriate
levels of compensation for members of the Company's senior management, including
salaries, annual bonuses, long-term incentives and employee benefits. The
Company believes that a strong link should exist between executive compensation
and management's ability to maximize shareholder value. This belief is adhered
to by developing both short-term and long-term incentive compensation programs
that provide competitive compensation and reflect Company performance.
 
  Compensation Philosophy
 
     The four fundamental principles to which the Committee adheres in
discharging its responsibilities are as follows. First, the majority of the
annual and long-term compensation for the Company's senior executive officers
should be at risk, with actual compensation levels correlating with the
Company's actual performance in certain key areas determined by the Committee.
Second, over time, incentive compensation of the Company's senior executive
officers should focus more heavily on long-term rather than short-term
accomplishments and results. Third, equity-based compensation should be used on
an increasing basis so as to provide executive officers with clear and direct
links to the shareholders' interests. Fourth, the overall executive compensation
program should be competitive, equitable and structured so as to ensure the
Company's ability to attract, retain, motivate and reward the talented
executives who are essential to the Company's continuing success. Total
compensation, rather than individual compensation elements, is the focus of the
Company's intent to provide competitive compensation opportunities.
 
     The Committee believes that continued revenue growth as well as continued
improvement in other key financial and operating measures should be recognized
in considering compensation levels along with improvements in overall
effectiveness, productivity, return on investment and success of strategic
alliances and business acquisitions and combinations.
 
     The Committee meets with an outside compensation consultant at least
annually to evaluate how well the Company's executive compensation program
adheres to this philosophy and to evaluate the level and mix of salary, annual
bonuses and long-term incentives.
 
  Compensation Elements
 
     The Company's compensation program for executives consists of four
principal elements, each of which is vitally important in meeting the Company's
need to attract, retain, motivate and reward highly-qualified executives.
 
     The four principal compensation elements are:
 
  Base Salaries
 
     Base salaries for executives are generally set at levels which reflect the
competitive marketplace for companies that are of comparable size and complexity
and would be considered competitors of the Company in attracting and retaining
quality executives. The salaries of the named officers are reviewed and approved
by the Compensation Committee based on its assessment of each executive's
experience and performance and a comparison of salaries of peers in other
companies.
 
                                       119
<PAGE>   121
 
  Annual Incentives
 
     Annual incentive awards have been made to selected executives on the basis
of the Company, business unit and individual performance relative to budget in
such areas as revenue, cash flow, operating income, operating margin and the
like. The Company intends to continue providing annual incentives in concert
with other compensation elements in order to maintain a competitive total
compensation program for its executives. The Committee reviews and approves all
performance measures and goals established under the annual and long-term
incentive plans and reviews and approves all annual incentive payments to senior
executives.
 
  Long-Term Incentives
 
     The Company relies on stock options as the principal means of providing
long-term incentive compensation. Stock options have been, and will continue to
be, granted under the Fourth Amended and Restated 1992 Stock Option Plan.
 
  Benefits
 
     Benefits offered to executives serve a different purpose than do other
elements of the total compensation program. In general, they provide for
retirement income and serve as a safety net against problems which can arise
from illness, disability or death. Benefits offered to senior executive officers
are basically those offered to other employees of the Company.
 
  Evaluation Procedure
 
     In determining matters regarding executive officer compensation (other than
the Chief Executive Officer), the Committee reviews with the President and Chief
Executive Officer, the Executive Vice President and Chief Operating Officer,
other key senior executives and the independent compensation consultant the
respective areas of authority and responsibility of the various executive
officers and the performance and contribution of each to the efforts of the
Company in meeting its goals.
 
     The Company's independent compensation consultant has confirmed that
compensation paid in 1998 to the named officers is consistent with the Company's
compensation philosophy and objectives.
 
  Compensation of Chief Executive Officer
 
     Decisions regarding the compensation of the President and Chief Executive
Officer, Gerald W. Thames, are the responsibility of the Committee. Gerald
Thames's base salary for 1998 was $395,000. Mr. Thames was awarded a bonus for
1998 of $330,000 for performance during 1997, which was greater than his target
bonus level. This bonus reflected the Company's performance in meeting revenue
and exceeding corporate development targets for the year, completing several
transactions that greatly enhanced the Company's asset values, and achieving
significant improvement in the Company's stock price and shareholder returns. In
evaluating and determining Mr. Thames's compensation, the Committee and its
compensation consultant compared the Company's compensation practices and levels
to those of other companies involved in similar businesses, including but not
limited to, the companies included in the NASDAQ Telecom Index contained in the
Stock Price Performance Graph. Based on this review, a subcommittee composed of
Messrs. Greeley, Paperin, Solomon, and Dey determined that the compensation paid
to Mr. Thames for 1998 was appropriate.
 
  Deductibility of Certain Executive Compensation
 
     Beginning in 1994, the Omnibus Reconciliation Act of 1993 (the Act) limits
to $1 million the amount that may be deducted by a publicly held corporation for
compensation paid to each of its named executives in a taxable year, unless the
compensation in excess of $1 million is "qualified performance-based
compensation." The Committee and the Company have determined that the Company's
practice is to design its short-term and long-term compensation plans to qualify
for the exemption from the deduction limitations of Section 162(m) of the
Internal Revenue Code and to be consistent with providing appropriate
compensation to executives. Shareholder approval of incentive compensation plans
and various provisions thereunder has
 
                                       120
<PAGE>   122
 
been sought and obtained and will be sought in the future to continue to qualify
performance-based compensation for the exemption. Although it is the Company's
intent to qualify compensation for the exemption from the deduction limitations,
the Company's compensation practices have been and, will continue to be,
designed to serve the best interests of shareholders regardless of whether
specific compensation qualifies for the exemption.
 
Compensation Committee Members during 1998:
 
Bernard McFadden, Chairman
David Dey (elected to the Committee in May, 1998)
Michael Greeley
Stewart J. Paperin
Alan B. Slifka (resigned from the Committee in May, 1998)
Adam Solomon
 
                                       121
<PAGE>   123
 
                               PERFORMANCE GRAPH
 
     The following performance graph compares the percentage change in the
Company's cumulative total shareholder return on our common stock from February
5, 1998 (the date on which the common stock began trading on the Nasdaq National
Market) and ending on December 31, 1998 with the cumulative total return,
assuming reinvestment of dividends, of the Standard & Poor's 500 Stock Index and
the Nasdaq Telecom Index.
                              [PERFORMANCE GRAPH]
 
<TABLE>
<CAPTION>
MEASUREMENT  GTS INDEX     S&P INDEX        NASDAQ
  PERIOD                                 TELECOM INDEX
<S>          <C>         <C>             <C>
2/5/98        100.00%       100.00%         100.0%
3/2/98         133.6         104.5           108.3
4/1/98         173.9         110.4           117.8
5/1/98         173.9         111.7           116.6
6/1/98         139.1         108.7           113.3
7/1/98         172.1         114.5           126.4
8/3/98         195.9         110.9           127.2
9/1/98         114.7          99.1           103.1
10/1/98        104.6          98.3           104.5
11/2/98        149.0         110.8           122.1
12/1/98        152.9         117.1           131.4
12/31/98       204.1         122.5           151.4
</TABLE>
 
                                       122
<PAGE>   124
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     The following table sets forth certain information ownership of our common
stock and rights to acquire common stock, which reflects the business
combination of Esprit Telecom Group plc, by (i) GTS stockholders that manage or
own, either beneficially or of record, five percent or more of the common stock,
(ii) each of the directors and executive officers of GTS and (iii) the directors
and officers of GTS as a group as of December 31, 1998. For the purposes of this
table, a person or group of persons is deemed to have "beneficial ownership" of
any shares which such person or group has the right to acquire within 60 days
after such date, but such shares are not deemed to be outstanding for the
purpose of computing the percentage ownership of any other person.
 
<TABLE>
<CAPTION>
                                                               NUMBER OF
                                                                 SHARES       PERCENTAGE
                                                              BENEFICIALLY   BENEFICIALLY
NAME OF BENEFICIAL OWNER                                      OWNED(1)(2)      OWNED(1)
------------------------                                      ------------   ------------
<S>                                                           <C>            <C>
Mutuelles AXA/AXA-UAP/......................................    9,261,880(3)    11.47
  The Equitable Companies Incorporated
  9 Place Vendome
  75001 Paris France
Fidelity Management and Research Corporation................    6,857,252(4)     8.49
  82 Devonshire Street
  Boston, MA 02109
Putnam Investments..........................................    5,806,779(5)     7.19
  One Post Office Square
  Boston, MA 02109
Invesco Inc.................................................    4,373,078(6)     5.41
  1315 Peachtree Street, N.E.
  Atlanta, GA 30309
The Open Society Institute..................................    4,330,281(7)     5.15
  c/o Soros Fund Management LLC
  888 Seventh Avenue, 31st Floor
  New York, NY 10106
Apax Funds Nominees Limited.................................    4,265,171        5.28
  62 Green Street
  London WIY 4BA
Gold & Appel Transfer.......................................    4,148,277        5.14
  Omar Hodge Building
  Wickam's Cay
  Road Tour
  Tortola
  British Virgin Islands
Alan B. Slifka and affiliates...............................    3,732,112(8)     4.60
  c/o Halcyon/Alan B. Slifka Management Company, LLC
  477 Madison Avenue, 8th Floor
  New York, NY 10022
Soros Foundation Hungary....................................    3,074,199        3.81
Warburg Pincus Ventures, L.P................................    1,962,697        2.43
Winston Partners II LDC.....................................      760,764(9)    *
Soros Charitable Foundation.................................      656,849       *
Chatterjee Fund Management, L.P.............................      555,555(10)    *
Winston Partners II LLC.....................................      378,881(11)    *
Soros Humanitarian Foundation...............................       37,718       *
Robert Amman................................................       10,500       *
David Dey...................................................        7,900       *
Roger Hale..................................................        7,109       *
</TABLE>
 
                                       123
<PAGE>   125
 
<TABLE>
<CAPTION>
                                                               NUMBER OF
                                                                 SHARES       PERCENTAGE
                                                              BENEFICIALLY   BENEFICIALLY
NAME OF BENEFICIAL OWNER                                      OWNED(1)(2)      OWNED(1)
------------------------                                      ------------   ------------
<S>                                                           <C>            <C>
Bernard McFadden............................................       50,000       *
Stewart J. Paperin..........................................       21,500       *
W. James Peet...............................................        8,000       *
Jean Salmona................................................       26,000       *
Joel Schatz.................................................      512,750       *
Frank V. Sica(12)...........................................           --       *
Adam Solomon................................................       65,414       *
Gerald W. Thames............................................      863,722        1.06
H. Brian Thompson(12).......................................           --       *
Bruno d'Avanzo..............................................       48,212       *
Jan Loeber..................................................       20,000       *
William H. Seippel..........................................      189,375       *
Stewart Reich...............................................       28,125       *
Other officers..............................................      316,462       *
  All Directors and Executive Officers as a group (27
     persons)...............................................    5,907,181
Total of above..............................................   53,139,968
</TABLE>
 
---------------
 
  *  Less than 1%
 
 (1) The percentage of ownership for each beneficial owner is based upon
     80,771,733 shares of GTS common stock issued and outstanding at December
     31, 1998 and the number of warrants and stock options in common stock held
     by such beneficial owner. Excluded from the calculation are: 8,127,380
     shares of common stock issued under the GTS' option plans; and an
     additional 163,795 shares of common stock that will be issued in exchange
     for NetSource shares that will be tendered in connection with such
     acquisition. Subject to NetSource meeting certain performance targets
     during the first two quarters of 1999. An additional 1.4 million shares of
     common stock may be issued. See "Shares Eligible for Future Sale."
 
 (2) Includes shares of common stock issuable upon the exercise of stock options
     and stock warrants within 60 days of December 31, 1998.
 
 (3) Ownership information, that represents holdings of several separately
     managed funds, is based on a Schedule 13G filed in February 1999 with the
     SEC. Number of shares as to which such holder has: sole voting
     power -- 3,078,108 shares; shared voting power -- 6,168,273 shares; sole
     dispositive power -- 9,252,376 shares; and shared dispositive
     power -- 9,505 shares.
 
 (4) Ownership information, that represents holdings of several separately
     managed funds, is based on a Schedule 13 G/A dated as of December 31, 1998,
     disclosing their ownership interest in us, that was filed in February 1999
     with the SEC and a Schedule 13 F-E dated as of December 31, 1998,
     disclosing their ownership interest in Esprit Telecom Group plc, that was
     filed with the SEC in February 1999.
 
 (5) Ownership information is based on a Schedule 13G filed in February 1999
     with the SEC. Number of shares with sole voting power -- none; shared
     voting power -- 42,400; shared dispositive power -- 5,806,779.
 
 (6) Ownership information is based on a Schedule 13G filed in February 1999
     with the SEC. Number of shares with shared voting power -- 4,373,078;
     shared dispositive power -- 4,373,078.
 
 (7) Comprised of 996,948 shares and warrants to purchase 3,333,333 shares of
     common stock held by The Open Society Institute. See "Shares Eligible for
     Future Sale."
 
 (8) Includes 2,530,562 shares of common stock owned by Mr. Slifka, 644,072
     shares of common stock held in various trusts, options to purchase 8,000
     shares of common stock owned by Mr. Slifka, 214,478 shares of common stock
     held by various Halcyon partnerships which are managed by Halcyon/Alan B.
     Slifka Management Company (over which Mr. Slifka disclaims beneficial
     ownership), 130,000 shares of
 
                                       124
<PAGE>   126
 
     common stock issuable upon the conversion of GTS' 8.75% Convertible Bonds
     held by various Halcyon partnerships which are managed by Halcyon/Allan B.
     Slifka Management Company (over which Mr. Slifka disclaims beneficial
     ownership), and options to purchase 205,000 shares of common stock held by
     Halcyon/Alan B. Slifka Management Company (over which Mr. Slifka disclaims
     beneficial ownership). GTS has filed a shelf registration statement
     covering such shares not previously registered by GTS.
 
 (9) Comprised of 390,393 shares of common stock and warrants to purchase
     370,371 shares of Common Stock. Information in the above entry excludes
     21,500 and 8,000 shares of, and options for the purchase of, Common Stock
     held by Stewart J. Paperin and W. James Peet, respectively, over which
     Winston Partners II LDC disclaims ownership. GTS has filed a shelf
     registration statement covering such shares. See "Shares Eligible for
     Future Sale."
 
 (10) Comprised of warrants to purchase 555,555 shares of common stock.
      Information in the above entry excludes 21,500 and 8,000 shares of, and
      options for the purchase of, common stock held by Stewart J. Paperin and
      W. James Peet, respectively, over which Chatterjee Fund Management, L.P.,
      disclaims ownership. GTS has filed a shelf registration statement covering
      such shares. See "Shares Eligible for Future Sale."
 
 (11) Comprised of 193,697 shares of common stock and warrants to purchase
      185,184 shares of common stock. Information in the above entry excludes
      21,500 and 8,000 shares of, and options for the purchase of, Common Stock
      held by Stewart J. Paperin and W. James Peet, respectively, over which
      Winston Partners II LLC disclaims ownership. See "Shares Eligible for
      Future Sale."
 
 (12) Messrs. Sica and Thompson were elected to the Board and as Chairman and
      Chief Executive Officer, respectively, in March 1999.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     Alan B. Slifka, the Executive Vice Chairman of the board of directors, and
Bernard McFadden, a director of GTS, each have a consulting agreement with us
pursuant to which they are paid $100,000 in consulting fees each year.
 
     Halcyon/Alan B. Slifka Management Company LLC (formerly Alan B. Slifka and
Company), a company principally owned by Mr. Slifka, holds 225,000 stock options
to purchase shares of our common stock that were granted in 1991 pursuant to a
stock option agreement that is not subject to any stock option plan. The options
have an exercise price of $0.533 per share and are fully vested. Any of the
stock options that remain unexercised after November 30, 2001 shall lapse and
become void. Generally, in the event that Mr. Slifka ceases to be an employee or
nonemployee director of GTS, any of such unexercised stock options shall lapse
thirty days after such termination. The shares of common stock underlying such
options have been registered under a registration statement that has been
declared effective by the SEC.
 
     In addition, Joel Schatz, a director of GTS, was granted in 1991 stock
options to purchase our common stock pursuant to stock option agreements that
are not subject to any stock option plan. Mr. Schatz holds 50,250 of such stock
options to purchase shares of common stock with an exercise price of $0.533 per
share. Mr. Schatz's options are fully vested and any unexercised options he
holds after November 4, 2001 shall lapse and become void. Generally, in the
event that Mr. Schatz ceases to be an employee or nonemployee director of GTS
any of his unexercised stock options shall lapse thirty days after such
termination. The shares of common stock underlying such options have been
registered under a registration statement that has been declared effective by
the SEC.
 
     In August and September 1997, the Soros associates and Mr. Slifka purchased
319,149 and 57,015 shares of our common stock, respectively, at a price of
$15.67 per share in a private stock offering. In addition, affiliates of Mr.
Slifka purchased $2.9 million of 8.75% Senior Subordinated Convertible Bonds due
2000 in September 1997. Pursuant to the terms of the indenture related to the
8.75% convertible bonds, these bonds are convertible into such shares of our
common stock as is equal to the principal amount of such bonds due
 
                                       125
<PAGE>   127
 
2000 divided by the applicable conversion price, which conversion price shall be
equal to the public offering price of our common stock in our initial public
offering in February 1998.
 
     The Soros associates purchased $40 million of notes from us in 1996, which
notes bore interest at 10% per annum, in partial consideration of which (1) the
Soros associates received the right to designate, from time to time, one person
for nomination to the Board of Directors and (2) the affiliates received
warrants to purchase 4,444,443 shares of our common stock. Together with their
prior equity interests in GTS, these affiliates currently hold, on a fully
diluted basis (excluding shares underlying stock options), approximately 14% of
our common stock. 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. In
February 1998, we repaid the $40 million of notes, plus accrued interest, using
part of the proceeds of an offering of senior notes and the initial public
offering completed at that time. In addition, these affiliates collect a
monitoring fee of $40,000 per month. Under certain agreements, these affiliates
have the right to co-invest with us in all of our new ventures throughout Asia,
excluding countries in the former Soviet Union, and pursuant to this right, one
of these affiliates holds a 25% interest in GTS China Investments LLC.
 
     On January 20, 1999, we filed a shelf registration statement covering all
of the affiliate shares owned by the affiliates of Mr. Slifka and the Soros
associates that were not sold in the July 1998 offering. As of the date of this
report, the SEC has not declared this registration statement effective. We
agreed to file the shelf registration statement in exchange for such
shareholders' undertaking to be bound by certain restrictions on their ability
to resell their shares. Under the restrictions, holders of affiliate shares will
be prevented from selling any such shares during the first six months after the
closing date of the offerings and will be able to sell (1) 50% of such shares
after the six month anniversary of the closing date of the July 1998 offerings,
(2) 75% of such shares after the nine month anniversary of the closing date of
the July 1998 offerings and (3) 100% of such shares after the twelve month
anniversary of the closing date of the July 1998 offerings. The Soros associates
have expressed to us that because the shelf registration statement is not yet
effective, the above contractual restrictions may no longer apply and that they
are free to enter into transactions in respect of their shares subject to
applicable provisions of U.S. securities law. We have expressed to them our view
that such restrictions continue to apply. Some limited partners of partnerships
affiliated with Alan B. Slifka and currently in dissolution may, upon advance
notice to us, withdraw some or all of their shares of our common stock from
registration under the shelf registration statement and from the restrictions.
The number of shares of our common stock subject to this withdrawal may not
exceed the total of 726,953 shares of GTS common stock minus the number of
shares sold by such limited partners in the July 1998 stock offerings. See "Risk
Factors -- Substantial resales of our common stock may depress our stock price
and dilute your ownership interest," "-- A substantial amount of our common
stock may be resold under this prospectus, which may depress our stock price and
dilute your ownership interest."
 
     Jean Salmona, a director of GTS, is the former Chairman and Chief Executive
Officer of CESIA. CESIA also provides consultancy services for our venture in
India and for Hermes Railtel. We paid $37,500 in 1998 to CESIA for consulting
services related to our Indian venture. In addition, Hermes Railtel paid
$270,017 in 1998 to CESIA for consulting services.
 
     On March 26, 1998, Gerald W. Thames, Executive Vice Chairman, exercised
non-qualified options to purchase 487,500 shares of our common stock at an
exercise price of $2.75 per share. Mr. Thames borrowed funds from a brokerage
firm in order to pay the exercise price and the tax liabilities resulting from
such exercise. The shares of our common stock resulting from such exercise
served as collateral for his margin loan. Subsequently, the market price of the
our common stock declined and consequently the brokerage firm required Mr.
Thames to reduce the size of the loan or increase the collateral securing it.
Mr. Thames was unable to sell any of the shares of our common stock
collateralizing the margin loan (and thereby reduce it) because of lock-up
arrangements with the underwriters of the July 1998 stock offerings. As a
result, we loaned Mr. Thames $3.5 million in September and October 1998, so he
could use the proceeds of such loans to repay a corresponding portion of the
loan. These loans from GTS bear interest at a rate of 7% per annum. Mr. Thames
repaid the loan in January 1999.
 
                                       126
<PAGE>   128
 
                                    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:
 
     - Report of Ernst & Young LLP, Independent Auditors
 
     - Consolidated Balance Sheets as of December 31, 1998 and 1997
 
     - Consolidated Statements of Operations for each of the Three Years Ended
       December 31, 1998
 
     - Consolidated Statements of Cash Flows for each of the Three Years Ended
       December 31, 1998
 
     - Consolidated Statements of Changes in Stockholders' Equity for each of
       the Three Years Ended December 31, 1998
 
     - Notes to Consolidated Financial Statements
 
     2 Consolidated Financial Statement Schedules
 
     We have furnished Schedule II -- Valuation and Qualifying Accounts on Page
137.
 
     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>
November 30, 1998....................  Acquisition of NetSource Europe ASA
November 30, 1998, Amended on
  December 16, 1998..................  Acquisition of NetSource Europe ASA
</TABLE>
 
(c) Exhibits
 
     The following is a list of exhibits filed as a part of this report.
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
      2.1***             -- Offer Agreement dated as of December 8, 1998 between the
                            Registrant and Esprit Telecom Telecom Group plc
      2.2***             -- Irrevocable Undertaking by Walter Anderson dated as of
                            December 8, 1998
      2.3***             -- Irrevocable Undertaking by Apax Funds Nominees Limited
                            dated as of December 8, 1998
      2.3(a)***          -- Amendment to the Irrevocable Undertaking by Apax Funds
                            Nominees Limited dated as of December 8, 1998, dated
                            December 12, 1998
      2.4***             -- Irrevocable Undertaking by Gold & Appel Transfer S.A.
                            dated as of December 8, 1998
      2.5***             -- Irrevocable Undertaking by Warburg, Pincus Ventures, L.P.
                            dated as of December 8, 1998
      2.6***             -- Irrevocable Undertaking by Sir Robin Biggam dated as of
                            December 8, 1998
      2.7***             -- Irrevocable Undertaking by John McMonigall dated as of
                            December 8, 1998
</TABLE>
 
                                       127
<PAGE>   129
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
      2.8***             -- Irrevocable Undertaking by Roy Merritt dated as of
                            December 8, 1998
      2.9***             -- Irrevocable Undertaking by David Oertle dated as of
                            December 8, 1998
      2.10***            -- Irrevocable Undertaking by Michael Potter dated as of
                            December 8, 1998
      2.11***            -- Irrevocable Undertaking by Dominic Shorthouse dated as of
                            December 8, 1998
      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
      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
</TABLE>
 
                                       128
<PAGE>   130
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
      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)
      4.8++              -- Indenture dated as of July 8, 1998 between Global
                            TeleSystems Group, Inc. and The Bank of New York relating
                            to the Company's 5 3/4% Convertible Senior Debentures due
                            2010
      4.9***             -- Registration Rights Agreement dated as of December 8,
                            1998 by and among the Registrant, Apax Funds Nominees
                            Limited and Warburg, Pincus Ventures, L.P.
     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
     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.,
                            dated September 29, 1997
     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
</TABLE>
 
                                       129
<PAGE>   131
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
     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
     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
</TABLE>
 
                                       130
<PAGE>   132
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
     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+              -- Restated and Amended 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
     10.24+              -- Third Amended and Restated 1992 Stock Option Plan of
                            Global TeleSystems Group Inc. dated as of 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 Maatschappij 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 incorporated by reference 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
</TABLE>
 
                                       131
<PAGE>   133
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
     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
     10.42**             -- Consulting Agreement between CESIA S.A. and Hermes Europe
                            Railtel B.V., dated June 20, 1997
     10.43++             -- Master Agreement, dated June   , 1998 between Ebone
                            Holding Association, Ebone A/S, Hermes Europe Railtel
                            Holdings B.V. and Hermes Europe Railtel (Ireland) Limited
     10.44+++            -- Plusnet Acquisition Agreement between Esprit Telecom
                            Group plc and Plusnet Gesellschaft fur Netzwerk Services
                            GmbH
     10.45****           -- Press Announcement of Esprit Telecom Group plc, dated
                            December 8, 1998, announcing the signing of a definitive
                            offer agreement with Global TeleSystems Group, Inc.
     10.46++++           -- Form of Undertaking of shareholders of NetSource ASA made
                            in connection with the acquisition of NetSource ASA by
                            Global TeleSystems Group, Inc.
     10.47++++           -- Form of Amendment Agreement to the Undertaking of
                            shareholders of NetSource ASA made in connection with the
                            acquisition of NetSource ASA by Global TeleSystems Group,
                            Inc.
     10.48++++           -- Form of Waiver Agreement in made connection with the
                            acquisition of NetSource ASA by Global TeleSystems Group,
                            Inc.
     10.49++++           -- Form of Waiver Agreement with certain shareholders of
                            NetSource ASA made in connection with the acquisition of
                            NetSource ASA by Global TeleSystems Group, Inc.
     10.50+++++          -- Indenture dated as of December 18, 1997 between Esprit
                            Telecom Group plc, as Issuer, and The Bank of New York,
                            as Trustee, Registrar and Paying Agent, relating to the
                            Esprit Telecom Group plc 11 1/2% Dollar Senior Notes due
                            2007 and 11 1/2% DM Senior Notes due 2007
</TABLE>
 
                                       132
<PAGE>   134
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
     10.51+++            -- Indenture dated as of June 24, 1998 between Esprit
                            Telecom Group plc, as Issuer, and The Bank of New York,
                            as Trustee, Registrar and Paying Agent, relating to the
                            Esprit Telecom Group plc 10 7/8% Dollar Senior Notes due
                            2008 and 11% DM Senior Notes due 2008
     10.52***            -- Supplemental Indenture, dated December 23, 1998 of
                            $230,000,000 11 1/2% Senior Notes due 2007, supplementing
                            the indenture dated as of December 18, 1997, between
                            Esprit Telecom Group plc, as issuer, and The Bank of New
                            York, as Trustee, Registrar and Paying Agent
     10.53***            -- Supplemental Indenture, dated December 23, 1998 of DM
                            125,000,000 11 1/2% Senior Notes due 2007, supplementing
                            the indenture dated as of December 18, 1997, between
                            Esprit Telecom Group plc, as issuer, and The Bank of New
                            York, as Trustee, Registrar and Paying Agent
     10.54***            -- Supplemental Indenture, dated December 23, 1998 of DM
                            150,000,000 11% Senior Notes due 2008, supplementing the
                            indenture dated as of June 24, 1998, between Esprit
                            Telecom Group plc, as issuer and The Bank of New York, as
                            Trustee, Registrar and Paying Agent
     10.55***            -- Supplemental Indenture, dated December 23, 1998 of
                            $150,000,000 10 7/8% Senior Notes due 2008, supplementing
                            the indenture dated as of June 24, 1998, between Esprit
                            Telecom Group plc, as issuer, and The Bank of New York,
                            as Trustee, Registrar and Paying Agent
     21.1*               -- List of Subsidiaries of the Registrant
     23.1*               -- Consent of Ernst & Young LLP, Independent Auditors
     23.2*               -- Consent of PricewaterhouseCoopers, Independent Auditors
     23.3*               -- Report of PricewaterhouseCoopers, Independent Auditors
     24.1*               -- Powers of Attorney (included on signature page to this
                            report)
     27.1*               -- Financial Data Schedule extracted from our December 31,
                            1998 audited financial statements
</TABLE>
 
---------------
 
     * Filed herewith.
 
   ** Incorporated by reference to the corresponding exhibit to our Registration
      Statement on Form S-1 (File No. 333-36555), filed on September 26, 1997.
 
  *** Incorporated by reference to the corresponding exhibit to our Registration
      Statement on Form S-4 (File No. 333-68511), filed on December 8, 1998.
 
 **** Incorporated by reference to the corresponding exhibit to the Esprit
      Telecom Group plc Annual Report on Form 20-F for the year ended September
      30, 1998, filed on December 24, 1998.
 
     + Incorporated by reference to the corresponding exhibit to our Annual
       Report on Form 10-K for the year ended December 31, 1997, filed on March
       30, 1998.
 
   ++ Incorporated by reference to the corresponding exhibit to our Registration
      Statement on Form S-1 (File No. 333-52733) filed on May 14, 1998.
 
  +++ Incorporated by reference to the corresponding exhibit to the Esprit
      Telecom Group plc Registration Statement on Form F-4 (File No. 333-9292),
      filed on August 13, 1998.
 
 ++++ Incorporated by reference to the corresponding exhibit to the Global
      TeleSystems Group, Inc. Form 8-K, filed on November 30, 1998.
 
+++++ Incorporated by reference to the corresponding exhibit to the Esprit
      Telecom Group plc Registration Statement on Form F-1 (File No. 333-8012)
      filed on December 10, 1997.
 
                                       133
<PAGE>   135
 
(d) Schedules
 
          Schedule II -- Valuation and Qualifying Accounts. Our other financial
     statement schedules 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.
 
                                       134
<PAGE>   136
 
                                   SIGNATURES
 
     Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act 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 22nd day of March, 1999.
 
                                            GLOBAL TELESYSTEMS GROUP, INC.
 
                                            By:    /s/ H. BRIAN THOMPSON
 
                                              ----------------------------------
                                              Name: H. Brian Thompson
                                              Title: Chairman and Chief
                                                     Executive Officer
 
     Each person whose signature appears below constitutes and appoints Gerald
W. Thames, William H. Seippel, Grier Raclin and Arnold Y. Dean and each of them
singly, as his true and lawful attorney-in-fact and agents with full power of
substitution and resubstitution, for him, and in his name, place and stead, in
any and all capacities to sign any and all amendments and supplements to this
annual report on Form 10-K and to file the same, with all exhibits thereto, and
all other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents full power and
authority to do and perform each and every act and thing requisite and necessary
to be done, as full to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents or their substitute or substitutes may lawfully do or cause to be done by
virtue thereof.
 
     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 22nd day of March, 1999.
 
<TABLE>
<CAPTION>
                      SIGNATURE                                             TITLE
                      ---------                                             -----
<C>                                                     <S>
 
                /s/ H. BRIAN THOMPSON                   Chairman and Chief Executive Officer
-----------------------------------------------------     (principal executive officer)
                  H. Brian Thompson
 
                 /s/ ROBERT J. AMMAN                    President and Director
-----------------------------------------------------
                   Robert J. Amman
 
               /s/ WILLIAM H. SEIPPEL                   Executive Vice President -- Finance and Chief
-----------------------------------------------------     Financial Officer (principal financial and
                 William H. Seippel                       accounting officer)
 
                /s/ GERALD W. THAMES                    Executive Vice Chairman of the Board of
-----------------------------------------------------     Directors, President, Chief Executive
                  Gerald W. Thames                        Officer (principal executive officer)
 
                 /s/ ALAN B. SLIFKA                     Executive Vice Chairman of the Board of
-----------------------------------------------------     Directors
                   Alan B. Slifka
 
                    /s/ DAVID DEY                                          Director
-----------------------------------------------------
                      David Dey
</TABLE>
 
                                       135
<PAGE>   137
 
<TABLE>
<CAPTION>
                      SIGNATURE                                             TITLE
                      ---------                                             -----
<C>                                                     <S>
                   /s/ ROGER HALE                                          Director
-----------------------------------------------------
                     Roger Hale
 
                /s/ BERNARD MCFADDEN                                       Director
-----------------------------------------------------
                  Bernard McFadden
 
               /s/ STEWART J. PAPERIN                                      Director
-----------------------------------------------------
                 Stewart J. Paperin
 
                  /s/ W. JAMES PEET                                        Director
-----------------------------------------------------
                    W. James Peet
 
                  /s/ JEAN SALMONA                                         Director
-----------------------------------------------------
                    Jean Salmona
 
                   /s/ JOEL SCHATZ                                         Director
-----------------------------------------------------
                     Joel Schatz
 
                                                                           Director
-----------------------------------------------------
                    Frank V. Sica
 
                  /s/ ADAM SOLOMON                                         Director
-----------------------------------------------------
                    Adam Solomon
</TABLE>
 
                                       136
<PAGE>   138
 
                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
  12/31/98..................................    $6,474       $7,474            --     $(4,415)      $9,533
Allowance for doubtful accounts at
  12/31/97..................................     1,040        5,318            --        (178)       6,180
Allowance for doubtful accounts at
  12/31/96..................................       100          960            --         (20)       1,040
</TABLE>
 
     The beginning balance for 1998 does not match the ending balance for 1997;
the difference reflects the activity of Esprit for the three month period ended
December 31, 1997. The Company's consolidated balance sheet as of December 31,
1997 represents the audited historical balance sheet of Esprit as of September
30, 1997 combined with GTS's historical balance sheet as of December 31, 1997.
 
                                       137
<PAGE>   139
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
      2.1***             -- Offer Agreement dated as of December 8, 1998 between the
                            Registrant and Esprit Telecom Telecom Group plc
      2.2***             -- Irrevocable Undertaking by Walter Anderson dated as of
                            December 8, 1998
      2.3***             -- Irrevocable Undertaking by Apax Funds Nominees Limited
                            dated as of December 8, 1998
      2.3(a)***          -- Amendment to the Irrevocable Undertaking by Apax Funds
                            Nominees Limited dated as of December 8, 1998, dated
                            December 12, 1998
      2.4***             -- Irrevocable Undertaking by Gold & Appel Transfer S.A.
                            dated as of December 8, 1998
      2.5***             -- Irrevocable Undertaking by Warburg, Pincus Ventures, L.P.
                            dated as of December 8, 1998
      2.6***             -- Irrevocable Undertaking by Sir Robin Biggam dated as of
                            December 8, 1998
      2.7***             -- Irrevocable Undertaking by John McMonigall dated as of
                            December 8, 1998
      2.8***             -- Irrevocable Undertaking by Roy Merritt dated as of
                            December 8, 1998
      2.9***             -- Irrevocable Undertaking by David Oertle dated as of
                            December 8, 1998
      2.10***            -- Irrevocable Undertaking by Michael Potter dated as of
                            December 8, 1998
      2.11***            -- Irrevocable Undertaking by Dominic Shorthouse dated as of
                            December 8, 1998
      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
      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
</TABLE>
<PAGE>   140
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
      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)
      4.8++              -- Indenture dated as of July 8, 1998 between Global
                            TeleSystems Group, Inc. and The Bank of New York relating
                            to the Company's 5 3/4% Convertible Senior Debentures due
                            2010
      4.9***             -- Registration Rights Agreement dated as of December 8,
                            1998 by and among the Registrant, Apax Funds Nominees
                            Limited and Warburg, Pincus Ventures, L.P.
     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
     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.,
                            dated September 29, 1997
</TABLE>
<PAGE>   141
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
     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
     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
</TABLE>
<PAGE>   142
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
     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+              -- Restated and Amended 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
     10.24+              -- Third Amended and Restated 1992 Stock Option Plan of
                            Global TeleSystems Group Inc. dated as of 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
</TABLE>
<PAGE>   143
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
     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 Maatschappij 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 incorporated by reference 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
     10.42**             -- Consulting Agreement between CESIA S.A. and Hermes Europe
                            Railtel B.V., dated June 20, 1997
     10.43++             -- Master Agreement, dated June   , 1998 between Ebone
                            Holding Association, Ebone A/S, Hermes Europe Railtel
                            Holdings B.V. and Hermes Europe Railtel (Ireland) Limited
     10.44+++            -- Plusnet Acquisition Agreement between Esprit Telecom
                            Group plc and Plusnet Gesellschaft fur Netzwerk Services
                            GmbH
     10.45****           -- Press Announcement of Esprit Telecom Group plc, dated
                            December 8, 1998, announcing the signing of a definitive
                            offer agreement with Global TeleSystems Group, Inc.
</TABLE>
<PAGE>   144
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
     10.46++++           -- Form of Undertaking of shareholders of NetSource ASA made
                            in connection with the acquisition of NetSource ASA by
                            Global TeleSystems Group, Inc.
     10.47++++           -- Form of Amendment Agreement to the Undertaking of
                            shareholders of NetSource ASA made in connection with the
                            acquisition of NetSource ASA by Global TeleSystems Group,
                            Inc.
     10.48++++           -- Form of Waiver Agreement in made connection with the
                            acquisition of NetSource ASA by Global TeleSystems Group,
                            Inc.
     10.49++++           -- Form of Waiver Agreement with certain shareholders of
                            NetSource ASA made in connection with the acquisition of
                            NetSource ASA by Global TeleSystems Group, Inc.
     10.50+++++          -- Indenture dated as of December 18, 1997 between Esprit
                            Telecom Group plc, as Issuer, and The Bank of New York,
                            as Trustee, Registrar and Paying Agent, relating to the
                            Esprit Telecom Group plc 11 1/2% Dollar Senior Notes due
                            2007 and 11 1/2% DM Senior Notes due 2007
     10.51+++            -- Indenture dated as of June 24, 1998 between Esprit
                            Telecom Group plc, as Issuer, and The Bank of New York,
                            as Trustee, Registrar and Paying Agent, relating to the
                            Esprit Telecom Group plc 10 7/8% Dollar Senior Notes due
                            2008 and 11% DM Senior Notes due 2008
     10.52***            -- Supplemental Indenture, dated December 23, 1998 of
                            $230,000,000 11 1/2% Senior Notes due 2007, supplementing
                            the indenture dated as of December 18, 1997, between
                            Esprit Telecom Group plc, as issuer, and The Bank of New
                            York, as Trustee, Registrar and Paying Agent
     10.53***            -- Supplemental Indenture, dated December 23, 1998 of DM
                            125,000,000 11 1/2% Senior Notes due 2007, supplementing
                            the indenture dated as of December 18, 1997, between
                            Esprit Telecom Group plc, as issuer, and The Bank of New
                            York, as Trustee, Registrar and Paying Agent
     10.54***            -- Supplemental Indenture, dated December 23, 1998 of DM
                            150,000,000 11% Senior Notes due 2008, supplementing the
                            indenture dated as of June 24, 1998, between Esprit
                            Telecom Group plc, as issuer and The Bank of New York, as
                            Trustee, Registrar and Paying Agent
     10.55***            -- Supplemental Indenture, dated December 23, 1998 of
                            $150,000,000 10 7/8% Senior Notes due 2008, supplementing
                            the indenture dated as of June 24, 1998, between Esprit
                            Telecom Group plc, as issuer, and The Bank of New York,
                            as Trustee, Registrar and Paying Agent
     21.1*               -- List of Subsidiaries of the Registrant
     23.1*               -- Consent of Ernst & Young LLP, Independent Auditors
     23.2*               -- Consent of PricewaterhouseCoopers, Independent Auditors
     23.3*               -- Report of PricewaterhouseCoopers, Independent Auditors
     24.1*               -- Powers of Attorney (included on signature page to this
                            report)
     27.1*               -- Financial Data Schedule extracted from our December 31,
                            1998 audited financial statements
</TABLE>
 
---------------
 
     * Filed herewith.
 
   ** Incorporated by reference to the corresponding exhibit to our Registration
      Statement on Form S-1 (File No. 333-36555), filed on September 26, 1997.
 
  *** Incorporated by reference to the corresponding exhibit to our Registration
      Statement on Form S-4 (File No. 333-68511), filed on December 8, 1998.
<PAGE>   145
 
 **** Incorporated by reference to the corresponding exhibit to the Esprit
      Telecom Group plc Annual Report on Form 20-F for the year ended September
      30, 1998, filed on December 24, 1998.
 
     + Incorporated by reference to the corresponding exhibit to our Annual
       Report on Form 10-K for the year ended December 31, 1997, filed on March
       30, 1998.
 
   ++ Incorporated by reference to the corresponding exhibit to our Registration
      Statement on Form S-1 (File No. 333-52733) filed on May 14, 1998.
 
  +++ Incorporated by reference to the corresponding exhibit to the Esprit
      Telecom Group plc Registration Statement on Form F-4 (File No. 333-9292),
      filed on August 13, 1998.
 
 ++++ Incorporated by reference to the corresponding exhibit to the Global
      TeleSystems Group, Inc. Form 8-K, filed on November 30, 1998.
 
+++++ Incorporated by reference to the corresponding exhibit to the Esprit
      Telecom Group plc Registration Statement on Form F-1 (File No. 333-8012)
      filed on December 10, 1997.