SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to ___________________
Commission File No. 000-29284
TELEGROUP, INC.
(Exact name of Registrant as Specified in Its Charter)
Iowa 42-1344121
- ------------------------------ ----------------------------
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
2098 Nutmeg Avenue, Fairfield, IA 52556
- --------------------------------- -----------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: 515-472-5000
------------------------
- -----------------------------------------------------------------------------
Former Name, Former Address and Former Fiscal Year, if Changed Since Last
Report
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securites under a plan
confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of Common Stock, as of the latest practicable date: There are 33,003,903
----------------------
shares of Common stock outstanding as of March 31, 1998 and 33,124,205 as
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of the close of business on May 13, 1998.
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TELEGROUP, INC.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
- ------------------------------ ----
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 1997
and March 31, 1998 (unaudited).................................. 3
Consolidated Statements of Operations for the Three
Months Ended March 31, 1997 (unaudited) and
March 31, 1998 (unaudited)...................................... 4
Consolidated Statements of Comprehensive Earnings for
the Three Months Ended March 31, 1997 (unaudited) and
March 31, 1998 (unaudited)....................................... 5
Consolidated Statement of Shareholders' Equity for the
Three Months Ended March 31, 1998 (unaudited)................... 6
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 1997 (unaudited) and March 31, 1998 (unaudited)....... 7
Notes to Consolidated Financial Statements (unaudited).......... 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................... 13
PART II - OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings.................................................17
Item 2. Changes in Securities and Use of Proceeds.........................17
Item 3. Defaults Upon Senior Securities...................................17
Item 4. Submission of Matters to a Vote of Security Holders...............17
Item 5. Other Information.................................................17
Item 6. Exhibits and Reports on Form 8-K..................................19
Exhibit Index.............................................................20
Signatures................................................................21
PART I - FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND MARCH 31,1998 (UNAUDITED)
December 31, March 31,
------------------------
ASSETS 1997 1998
------ ------------ ----------
Current assets:
Cash and cash equivalents $ 74,213,856 73,094,622
Securities available-for-sale 21,103,030 11,894,458
Accounts receivable and unbilled services, less
allowance for credit losses of $6,173,846 and
$5,351,555 at December 31, 1997 and March 31,
1998, respectively 54,188,757 47,358,655
Income tax recoverable 2,693,679 2,516,440
Prepaid expenses and other assets 1,384,886 1,170,070
Receivables from shareholders 39,376 34,430
Receivables from employees 152,259 115,206
----------- ----------
Total current assets 153,775,843 136,183,881
----------- ----------
Net property and equipment 27,912,978 31,890,499
----------- ----------
Other assets:
Deposits and other assets 3,594,101 7,610,375
Goodwill, net of amortization of $142,203 and
$248,807 at December 31, 1997 and
March 31,1998, respectively 3,102,707 8,142,916
Capitalized software, net of amortization 1,724,758 1,959,225
Debt issuance costs, net of amortization 3,648,026 3,674,568
----------- ----------
12,069,592 21,387,084
----------- ----------
Total assets $193,758,413 189,461,464
----------- ----------
----------- ----------
December 31, March 31,
------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY 1997 1998
------------------------------------ ------------ ---------
Current liabilities:
Accounts payable 48,434,985 46,953,993
Commissions payable 7,691,401 6,695,034
Accrued expenses 4,479,515 6,364,338
Customer deposits 778,024 1,079,614
Unearned revenue 186,779 95,826
Current portion of capital lease obligations 158,706 150,262
Current portion of long-term debt (note 2) 93,788 162,970
----------- ----------
Total current liabilities 61,823,198 61,502,037
----------- ----------
Capital lease obligations, excluding current portion 221,179 189,569
Long-term debt, excluding current portion(note 2) 101,450,951 103,415,166
Minority interest - -
Shareholders' equity:
Common stock, no par or stated value;
150,000,000 shares authorized, 30,889,945
and 33,003,903 shares issued and outstanding
at December 31, 1997 and March 31,1998,
respectively - -
Additional paid-in capital 51,649,660 56,967,668
Retained deficit
(21,125,080)(32,365,300)
Accumulated comprehensive earnings (261,495) (
247,676)
----------- -----------
Total shareholders' equity 30,263,085 24,354,692
----------- -----------
Commitments and contingencies (notes)
Total liabilities and
shareholders' equity $193,758,413 189,461,464
----------- -----------
----------- -----------
See accompanying notes to consolidated financial statements.
3
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31,1997 AND 1998
Three months
ended March 31,
------------------
1997 1998
------ ------
Revenues:
Retail $ 56,909,405 57,018,648
Wholesale 17,186,372 28,846,014
---------- ----------
Total revenues 74,095,777 85,864,662
Cost of revenues 53,282,940 69,002,388
---------- ----------
Gross profit 20,812,837 16,862,274
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Operating expenses:
Selling, general and administrative expenses 19,454,755 24,281,908
Depreciation and amortization 806,539 2,181,791
Stock option based compensation 85,595 85,595
---------- -----------
Total operating expenses 20,346,889 26,549,294
---------- ---------- ---------- -----------
Operating income (loss) 465,948 (9,687,020)
Other income (expense):
Interest expense (729,450) (2,490,005)
Interest income 184,359 1,123,833
Foreign currency transaction loss (367,564) (152,055)
Other 31,048 52,907
---------- ----------
Earnings (loss) before income taxes (415,659) (11,152,340)
Income tax benefit (expense) 138,647 (87,880)
Minority interest in share of loss - -
--------- ----------
Net earnings (loss) $ (277,012) (11,240,220)
--------- ----------
--------- ----------
Basic and diluted net earnings (loss)
per common share (0.01) (0.35)
--------- ----------
--------- ----------
Weighted-average common shares outstanding
basic and diluted 24,651,989 32,082,975
---------- ----------
---------- ----------
See accompanying notes to consolidated financial statements.
4
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (UNAUDITED)
THREE MONTHS ENDED MARCH 31,1997 AND 1998
Three months
ended March 31,
------------------
1997 1998
-------- ------
Net earnings (loss) $ (277,012) (11,240,220)
Foreign currency translation adjustment,
net of tax (41,679) 13,819
----------- ----------
Comprehensive earnings (loss) $ (318,691) (11,226,401)
----------- ----------
----------- ----------
See accompanying notes to consolidated financial statements.
5
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
THREE MONTHS ENDED MARCH 31,1998
Foreign Total
Additional currency share-
Common stock paid-in Retained translation holders'
Shares Amount capital deficit adjustment equity
------ ------ ----------- --------- ------------- ---------
Balances at
December 31,
1997 30,889,945 $ - 51,649,660 (21,125,080) (261,495) 30,263,085
Net loss - - - (11,240,220) - (11,240,220)
Shares issued
in connection
with business
combinations
(note 3) 304,267 - 4,056,504 - - 4,056,504
Compensation
expense in
connection
with stock
option plan - - 85,595 - - 85,595
Shares issued
in-lieu of
future sales
commissions
(note 3) 40,000 - 565,000 - - 565,000
Payment received
on note
receivable from
shareholder - - 31,420 - - 31,420
Issuance of shares
for options
exercised
(note 3) 442,358 - 579,489 - - 579,489
Issuance of shares
for warrants
exercised 1,327,333 - - - - -
Change in
foreign
currency
translation - - - - 13,819 13,819
---------- ---- --------- ---------- ------- ----------
Balances at
March 31,
1998 33,003,903 $ - 56,967,668 (32,365,300) (247,676) 24,354,692
---------- ---- ---------- ---------- ------- ----------
---------- ---- ---------- ---------- ------- ----------
See accompanying notes to consolidated financial statements.
6
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31,1997 AND 1998
Three months
ended March 31,
-------------------------
1997 1998
---------- --------
Cash flows from operating activities:
Net loss $ (277,012) (11,240,220)
Adjustments to reconcile net loss
to net cash provided by (used in)
operating activities:
Depreciation and amortization 806,539 2,181,791
Deferred income taxes (61,595) -
Loss on sale of equipment - 378
Provision for credit losses on
accounts receivable 2,473,265 1,420,901
Accretion of debt discounts 127,263 1,969,473
Stock option based compensation expense 85,595 85,595
Changes in operating assets and liabilities,
excluding the effects of business
combinations:
Accounts receivable and unbilled services (5,294,238) 5,472,099
Prepaid expenses and other assets 90,185 282,999
Deposits and other assets (680,009) (3,443,067)
Accounts payable, commissions payable and
accrued expenses 8,990,423 (740,067)
Income taxes (77,915) 177,239
Unearned revenue (24,286) (90,953)
Customer deposits 35,490 301,590
---------- ---------
Net cash provided by (used in)
operating activities 6,193,705 (3,622,242)
---------- ---------
Cash flows from investing activities:
Purchases of equipment (3,285,409) (5,708,070)
Sales of securities available-for-sale - 9,208,572
Proceeds from sale of equipment - 250
Capitalization of software (201,590) (394,068)
Business combinations,
net of cash acquired - (988,290)
Net change in receivables from
shareholders and employees (41,641) 41,999
--------- ---------
Net cash (used in) provided by
investing activities (3,528,640) 2,160,393
--------- ---------
Cash flows from financing activities:
Debt issuance costs - (164,194)
Net proceeds from options exercised - 579,489
Principal payments from other
long-term borrowings (378,649) (77,865)
Principal payments under capital
lease obligations (51,232) (40,054)
Proceeds received on note due from
shareholder - 31,420
--------- ---------
Net cash (used in) provided by
financing activities (429,881) 328,796
--------- ---------
Effect of exchange rate changes on cash (63,150) 13,819
--------- ---------
Net increase in cash and
cash equivalents $ 2,172,034 (1,119,234)
Cash and cash equivalents at beginning
of period 14,155,013 74,213,856
---------- ----------
Cash and cash equivalents at end of period $16,327,047 73,094,622
---------- ----------
---------- ----------
Supplemental disclosures of cash flow
information:
Interest paid $ 4,417 1,990,005
---------- ----------
---------- ----------
Income taxes paid $ 975 10,370
---------- ----------
---------- ----------
Supplemental disclosures of noncash
investing and financing activities:
Common stock issued in-lieu of
future sales commissions $ - 565,000
---------- ----------
---------- ----------
Common stock issued in connection
with business combinations $ - 4,056,504
---------- ----------
---------- ----------
See accompanying notes to consolidated financial statements.
7
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) PREPARATION OF INTERIM FINANCIAL STATEMENTS
The consolidated financial statements of Telegroup, Inc. and subsidiaries
(the Company or Telegroup) have been prepared in accordance with the
rules and regulations of the Securities and Exchange Commission (SEC).
These consolidated financial statements include estimates and assumptions
that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities and the amounts of revenues and
expenses. Actual results could differ from those estimates. The
consolidated balance sheet at December 31, 1997, was derived from the
Company's audited consolidated balance sheet as of that date. The
consolidated financial statements as of March 31,1998 and for the
three month period then ended are unaudited. In the opinion of the
Company, such interim financial statements include all adjustments
necessary for a fair presentation of the results of all interim periods
reported herein. All adjustments are of a normal recurring nature
unless otherwise disclosed. Certain information and footnote
disclosures prepared in accordance with generally accepted accounting
principles have been either condensed or omitted pursuant to SEC
rules and regulations. However, the Company believes that the disclosures
made are adequate for a fair presentation of results of operations,
financial position and cash flows. These consolidated financial
statements should be read in conjunction with the consolidated
financial statements and accompanying notes included in the Company's
Annual Report on Form 10-K.
8
(2) DEBT
Long-term debt at December 31, 1997 and March 31,1998 is shown
below:
December 31, March 31,
------------------------------
1997 1998
------------- -----------
8.0% convertible subordinated
notes, due April 15, 2005,
unsecured 25,000,000 25,000,000
10.5% senior discount notes,
net of discount, due
November 1, 2004, unsecured 76,442,135 78,411,608
8.5% note payable, due monthly
through fiscal 2000, secured by
vehicle 11,082 6,235
10.8% note payable, due monthly
through fiscal 1998, secured by
equipment financed 80,955 59,662
8.00% note payable, due fiscal
1998, unsecured - 93,395
6.85% note payable, due monthly
through fiscal 1999, unsecured 8,204 6,639
8.00% note payable, due monthly
through fiscal 1998, unsecured 2,363 597
----------- -----------
101,544,739 103,578,136
Less current portion (93,788) (162,970)
----------- -----------
$101,450,951 103,415,166
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------------ ----------
(3) SHAREHOLDERS' EQUITY
ACQUISITIONS
On January 15, 1998, the Company acquired the operations of its
Australian country coordinator. Consideration for the Australian country
coordinator was $97,151 and 119,036 shares of unregistered common stock of
the Company valued at $1,581,982, for total consideration of $1,679,133.
The acquisition has been accounted for using the purchase method of
accounting and, accordingly, the net assets and results of operations are
included in the consolidated financial statements from the date of
9
acquisition. The aggregate purchase price of the acquisition was allocated
based on fair values as follows:
Property and equipment $ 18,104
Goodwill 1,661,029
Total $ 1,679,133
Also on January 15, 1998, the Company acquired the operations of its New
Zealand country coordinator. Consideration for the New Zealand country
coordinator was $90,000 and 178,554 shares of unregistered common stock of
the Company valued at $2,374,768, for total consideration of $2,464,768.
The acquisition has been accounted for using the purchase method of
accounting and, accordingly, the net assets and results of operations are
included in the consolidated financial statements from the date of
acquisition. The aggregate purchase price of the acquisition was
allocated based on fair values as follows:
Property and equipment $ 18,122
Goodwill 2,446,646
Total $ 2,464,768
On January 21, 1998, the Company acquired 60 percent of the common stock
of, and controlling interest in, Redicall Pty Limited (Redicall) for
$504,375 and 6,677 shares of unregistered common stock valued at $99,754,
for total consideration of $604,129. Redicall is engaged in the wholesale
distribution of prepaid telephone calling cards. The acquisition has been
accounted for using the purchase method of accounting and, accordingly, the
net assets and results of operations are included in the consolidated
financial statements from the date of acquisition. The aggregate purchase
price of the acquisition was allocated based on fair values as follows:
Current assets $ 156,337
Property and equipment 1,672
Deposits 8,207
Goodwill 727,234
Current liabilities (147,532)
Non-current liabilities (141,789)
Total $ 604,129
The minority interest deficit of 40% was included in the calculation of
goodwill due to the Company absorbing all of Redicall's net earnings and
losses until Redicall's net asset becomes positive. Until Redicall's net
asset deficit becomes positive, no minority interest is reflected in the
accompanying financial statements. Pro forma operating results of the
companies described above, assuming these acquisitions were consummated on
January 1, 1997, do not significantly differ from reported amounts.
10
WARRRANTS
During the quarter ended March 31, 1998, all of the Company's outstanding
warrants were exercised in a cashless transaction. Total warrants
exercised were 1,327,333, which represented the total warrants outstanding
of 1,327,500 less 167 warrants which were canceled. The canceled warrants
represent the value of the consideration (exercise price) due from the
warrant holder at the time of exercise.
SHARES ISSUED IN-LIEU OF FUTURE SALES COMMISSIONS
On January 15, 1998, the Company prepai d sales commissions owed to certain
independent sales agents. Total consideration was $700,000 and 40,000
shares of unregistered common stock valued at $565,000. The total
consideration of $1,265,000 is being amortized using an accelerated method
over the estimated life of the agent's customers or three years, whichever
is shorter.
(4) COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board issued Statement
No. 130, "Reporting Comprehensive Income" ("SFAS 130"), which establishes
standards for the presentation of comprehensive income in the financial
statements. Comprehensive income includes income and loss components
which are otherwise recorded directly to stockholders' equity under
generally accepted accounting principles. The Company adopted SFAS 130
effective January 1, 1998 and has included a separate statement entitled
"Consolidated Statement of Comprehensive Earnings" which reports the
components of other comprehensive income.
(5) COMMITMENTS AND CONTINGENCIES
COMMITMENTS WITH TELECOMMUNICATIONS COMPANIES
The Company has an agreement with Sprint Communications Company L.P.
(Sprint) to use Sprint's fiber-optic network in its delivery of
telecommunication services. This agreement requires net quarterly usage
commitments of $6,000,000. In the event such quarterly commitments are
not met, the Company is required to remit to Sprint 25% of the difference
between the $6,000,000 quarterly commitment and actual usage. This
agreement extends through December 1998. When total usage exceeds
$24,000,000 during 1998, the Company has no further commitment.
The Company has a one year $3,000,000 usage commitment with MFS/WorldCom
in Frankfurt, Germany, to use MFS/WorldCom's fiber-optic network in its
delivery of telecommunication services. This agreement began on
September 5, 1997.
11
The Company has an agreement with Meyer Group Limited (Meyer) with a
usage commitment to terminate $3,000,000 in Hong Kong call traffic on
Meyer's network by December 31, 1998. The Company's commitment on this
agreement is contingent upon the Company's network remaining operational
in the Hong Kong market.
Shortfalls in usage commitments, if any, are recorded as cost of revenues
in the period identified.
LITIGATION
The Company is a party to certain litigation which has arisen in the
ordinary course of business. In the opinion of management, the ultimate
resolution of these matters will not have a significant effect on the
financial statements of the Company.
TENDER OFFER
On February 3, 1998, Telegroup acquired 9.9 percent (2,350,000 shares)
of Newsnet ITN LTD (Newsnet), a publicly traded Australian company.
Total consideration given was $963,171. In addition, Telegroup
commenced a tender offer for all of the shares of Newsnet at a price of
$0.60 (AUD) per share. This tender offer is pending approval of
existing Newsnet shareholders. Newsnet provides enhanced fax services,
including LAN-based fax and fax forwarding.
SUBSEQUENT EVENTS
On April 23, 1998, the Company entered into a 25 year indefeasible right
of use agreement with Cable and Wireless Communications Services Limited
(Cable and Wireless) for the right to use network capacity in an
under-sea fiber cable system. The agreement calls for a $975,000
payment upon the execution of the agreement and a remaining payment of
$8,775,000 upon the activation of service or 90 days from the date of
the agreement, whichever is sooner. In addition, the Company will be
responsible for its pro rata share of the costs and fees in relation to
the operation and maintenance of the cable system.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, INCLUDING STATEMENTS
REGARDING THE COMPANY'S ABILITY TO SEIZE OPPORTUNITIES FROM CONTINUING
DEREGULATION OF THE TELECOMMUNICATIONS MARKETS, THE NUMBER OF SWITCHES/NODES
AND FACILITIES THE COMPANY PLANS TO INSTALL, TECHNOLOGICAL DEVELOPMENT OF THE
COMPANY'S NETWORK, THE ANTICIPATED EXPANSION OF REGIONAL CARRIER SALES, THE
PREPAYMENT OF EXISTING NOTES, AND THE INCREASE IN THE COMPANY'S INTERNAL AND
EXTERNAL SALES FORCES. THE COMPANY'S REVENUES AND ABILITY TO CONTINUE ITS
EXPANSION ARE DIFFICULT TO FORECAST AND COULD DIFFER MATERIALLY FROM THOSE
PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF NUMEROUS FACTORS,
INCLUDING WITHOUT LIMITATION, OPERATING AND TECHNICAL PROBLEMS, REGULATORY
UNCERTAINTIES, POSSIBLE DELAYS IN THE FULL IMPLEMENTATION OF LIBERALIZATION
INITIATIVES, COMPETITION, AVAILABILITY OF CAPITAL, FOREIGN CURRENCY
FLUCTUATIONS, AND CHANGES IN THE US AND FOREIGN TAX LAWS.
The following discussion of the financial condition and performance of
the Company should be read in conjunction with the consolidated financial
statements and related notes and other detailed information regarding the
Company included in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1997 and other reports filed by the Company with the
SEC.
SUMMARY
Telegroup is a leading emerging multinational carrier of long distance
telecommunications services to over 200 countries. Telegroup offers services
to small and medium-sized businesses and residential customers. The Company
also provides value-added wholesale services to over 40 domestic and
international telecommunications carriers. Telegroup believes that it has one
of the most comprehensive global sales, marketing, and customer service
organizations of the emerging multinational carriers. The Company operates a
digital, facilities-based network, the Telegroup Intelligent Global Network ,
which consists of a central operating center, twenty-one switches, five
enhanced service platforms, owned or leased capacity on ten digital
fiber-optic cable links, and leased parallel data transmission capacity.
THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH
31, 1997
Revenues. Revenues increased 15.9%, or $11.8 million, from $74.1 million
in the three months ended March 31,1997 to $85.9 million in the three months
ended March 31,1998. This increase was primarily due to growth in
international and domestic wholesale revenues. Wholesale revenues increased
from $17.2 million, or 23.2% of total revenues in the three months ended March
31,1997, to $28.8 million, or 33.6% of revenues for the three months ended
March 31,1998.
13
Cost of Revenues. Cost of revenues increased 29.5%, or $15.7 million,
from $53.3 million in the three months ended March 31, 1997 to $69.0 million
in the three months ended March 31, 1998. As a percentage of revenues, cost of
revenues increased from 71.9% to 80.4%, primarily as a result of a larger
percentage of lower margin wholesale revenues and retail price declines in
certain deregulating markets.
Operating Expenses. Operating expenses increased 30.5%, or $6.2 million,
from $20.3 million in the three months ended March 31,1997 to $26.5 million in
the three months ended March 31,1998, primarily as a result of an increase in
the number of employees necessary to provide customer service, billing and
collection and accounting support. Other contributing factors were
depreciation and amortization, as discussed below. As a percentage of
revenues, operating expenses increased 3.4% from 27.5% in the three months
ended March 31,1997 to 30.9% in the three months ended March 31,1998. The
number of full and part-time employees grew from 472 in the three months ended
March 31,1997, to 702 in the three months ended March 31, 1998, representing a
48.7% increase.
Bad Debt. Bad debt expense decreased from $2.5 million, or 3.4% of
revenues in the three months ended March 31,1997 to $1.4 million, or 1.6% of
revenues, in the three months ended March 31,1998. The decrease in bad debt
expense as a percentage of revenues in the three months ended March 31, 1998
was due to continued vigilance in assessing the credit worthiness of new
subscribers to Company services and improved fraud control procedures.
Depreciation and Amortization. Depreciation and amortization increased
from $0.8 million in the three months ended March 31,1997, to $2.2 million in
the three months ended March 31,1998, primarily due to increased capital
expenditures incurred in connection with the development and expansion of the
TIGN, as well as amortization expenses associated with intangible assets.
Operating Income. Operating income decreased by $10.2 million, from $0.5
million in the three months ended March 31,1997, to $(9.7) million in the
three months ended March 31,1998, as a result of the preceding factors.
Net Loss. Net loss increased approximately $10.9 million, from $(0.3)
million in the three months ended March 31,1997, to $(11.2) million in the
three months ended March 31,1998. The increase is attributable to lower
operating income, a $0.8 million increase in net interest expense, partly
offset by a $0.2 million decrease in foreign currency transaction losses.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company's capital requirements have consisted of capital
expenditures in connection with the acquisition and maintenance of switching
capacity and funding of accounts receivable and other working capital
requirements. The Company's capital requirements have been funded primarily by
funds provided by operations, the Company's Initial Public Offering,
convertible debentures, long-term debt, additional equity issuances, and by
capital leases. The Company may require additional capital to develop and
14
expand the TIGN, open new offices, introduce new telecommunications services,
upgrade and/or replace its management information systems, fund its
acquisition plans, and fund its anticipated operating losses and net cash
outflows in the near term. In addition, the implementation of the Company's
strategy to develop an ATM-based network is dependent on, among other things,
the ability of the Company to obtain additional financing. The Company may
seek to raise such additional capital from public or private equity and/or
debt sources. There can be no assurance that the Company will be able to
obtain the additional financings or if obtained, that it will be able to do so
on a timely basis or on terms favorable to the Company.
Net cash provided by (used in) operating activities was $6.2 million
in the three months ended March 31, 1997 and $(3.6) million in the three
months ended March 31, 1998. The net cash provided by operating activities in
the three months ended March 31, 1997 was primarily due to a greater increase
in accounts payable to carriers relative to the increase in accounts
receivable from customers and an increase in the provision for credit losses
on accounts receivable. The net cash used in operating activities in the
three months ended March 31, 1998 was primarily due to the net loss, partly
offset by a decrease in accounts receivable, an increase in depreciation and
amortization expense, and an increase in accretion of the debt discount. The
$3.4 million increase in deposits and other assets in the three months ended
March 31, 1998, was due primarily to deposits on major accounting and billing
software systems not yet in service at period end.
Net cash (used in) provided by investing activities was $(3.5)
million in the three months ended March 31, 1997, and $2.2 million in the
three months ended March 31, 1998. The net cash used in the three months
ended March 31, 1997 was primarily due to increases in equipment purchases.
The net cash provided in the three months ended March 31, 1998 was primarily
due to sales of securities available-for-sale, partly offset by equipment
purchases.
Net cash (used in) provided by financing activities was $(.4)
million in the three months ended March 31, 1997, and $.3 million in the three
months ended March 31, 1998. The net cash used in the three months ended
March 31, 1997, was primarily due to principal payments on long-term
borrowings. The net cash provided in the three months ended March 31, 1998,
was primarily due to proceeds from options exercised.
The continued development and expansion of the TIGN, the upgrade or
replacement of the Company's management information systems, the opening of
new offices, and the introduction of new telecommunications services, as well
as the funding of anticipated operating losses and net cash outflows, will
require additional capital. The Company has identified an additional $57
million of capital expenditures, including acquisitions, which the Company
intends to undertake for the remainder of 1998. The Company currently
anticipates that the cash on hand will allow the Company to fund capital
expenditures as planned and to fund anticipated operating losses and net cash
outflows for the remainder of the year. The amount of the Company's actual
future capital requirements will depend upon many factors, including the
15
performance of the Company's business, the rate and manner in which it expands
the TIGN, increases staffing levels and customer growth, upgrades or replaces
management information systems and opens new offices, as well as other factors
that are not within the Company's control, including competitive conditions
and regulatory or other government actions. In the event that the Company's
plans or assumptions change or prove to be inaccurate, or if internally
generated funds and funds from other financings if entered into, prove to be
insufficient to fund the Company's growth and operations, then some or all of
the Company's development and expansion plans could be delayed or abandoned,
or the Company may be required to seek additional funds earlier than currently
anticipated. There can be no assurance that any additional financing will be
available to the Company in the future or, if available, that it could be
obtained on terms acceptable to the Company.
YEAR 2000 COMPLIANCE
While the Company believes that its software applications are year 2000
compliant, there can be no assurance until the year 2000 occurs that all of
its systems will then function adequately. All software systems which the
Company purchases are required by the Company to be year 2000 compliant. In
addition, the Company is developing year 2000 compliancy tests for year 2000
compliancy end-to-end across all systems. At this time, the Company believes
that neither the risks nor the costs incurred to be year 2000 compliant are
material to the Company. However, if the software applications of local
exchange carriers, long distance carriers or others on whose services the
Company depends are not year 2000 compliant, the non-compliance of those
applications could have a material adverse effect on the Company's financial
condition and results of operations.
EFFECTS OF INFLATION
Inflation is not a material factor affecting the Company's business and
has not had a significant effect on the Company's operations to date.
SEASONAL FLUCTUATIONS
The Company has historically experienced, and expects to continue to
experience, reduced growth rates in revenues in the months of August and
December due to extended vacation time typically taken by Americans and
Europeans during these months.
16
PART II. OTHER INFORMATION
TELEGROUP, INC.
Item 1. Legal Proceedings.
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The Company makes routine filings and is a party to customary
regulatory proceedings with the FCC relating to its operations. The Company is
not a party to any lawsuit or proceeding which, in the opinion of management,
is likely to have a material adverse effect on the Company's business,
financial condition, and results of operations.
Item 2. Changes in Securities and Use of Proceeds.
- ------ -----------------------------------------
On January 15, 1998, to acquire business assets of the LeHeron
Corporation Limited in Australia and New Zealand, the Company issued 297,590
shares of common stock. Also on January 15, 1998, the Company issued 40,000
shares of common stock in lieu of future sales commissions to Katz &
Associates in Brazil. On February 27, 1998, the Company issued 6,677 shares
of common stock to purchase 60% of the common stock of RediCall Pty. Limited
in Australia.
Each issuance of securities described above was made in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act as
a transaction by an issuer not involving any public offering. The recipients
of securities in each such transaction represented their intention to acquire
the securities for investment only and not with a view to or for sale in
connection with any distribution thereof and appropriate legends were affixed
to the share certificates in such transactions. All recipients had adequate
access, through their relationships with the Company, to information about the
Company.
Item 3. Defaults Upon Senior Securities.
- ------ -------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders.
- ------ ---------------------------------------------------
None.
Item 5. Other Information.
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Forward-Looking Statements. Item 2 of Part I of this report
--------------------------
includes, and future oral or written statements of the Company and its
management may include, certain forward-looking statements, including without
limitation statements with respect to the Company's anticipated future
17
operating and financial performance, financial position and liquidity, growth
opportunities and growth rates, business and competitive outlook, investment
and expenditure plans, pricing plans, strategic alternatives, business
strategies, and other similar statements of expectations or objectives that
are highlighted by words such as "expects," "anticipates," "intends," "plans,"
"believes," "projects," "seeks," "estimates," "should" or "may," and
variations thereof and similar expressions. Such forward-looking statements
are subject to uncertainties that could cause the Company's actual results to
differ materially from such statements. These uncertainties include but are
not limited to those set forth below:
(i) the effects of ongoing deregulation in the telecommunications industry
as a result of the World Trade Organization agreement on basic
telecomunications services and the Telecommunications Act of 1996
(the "1996 Act") and other similar federal and state legislation and
federal and state regulations enacted thereunder, including without
limitation (a) greater than anticipated competition in the Company's
telephone markets resulting therefrom, (b) the final outcome of the
FCC rulemakings with respect to interconnection agreements and access
charge reforms, and of foreign regulatory proceedings affecting the
Company's ability to compete in foreign markets, and (c) future state
regulatory actions taken in response to the 1996 Act.
(ii) the effects of greater than anticipated competition from other
telecommunications companies, including without limitation competition
requiring new pricing or marketing strategies or new product
offerings, and the attendant risk that the Company will not be able to
respond on a timely or profitable basis.
(iii) possible changes in the demand for the Company's products and
services, including without limitation lower than anticipated demand
for premium telephone services.
(iv) the Company's ability to successfully introduce new service offerings
on a timely and cost-effective basis, including without limitation the
Company's ability to (a) expand successfully its long distance and
enhanced service offerings to new markets, and (b) offer bundled
service packages on terms attractive to its customers.
(v) the risks inherent in rapid technological change, including without
limitation (a) the lack of assurance that the Company's ongoing TIGN
improvements will be sufficient to meet or exceed the capabilities and
quality of competing networks, and (b) the risk that technologies
will not be developed on a timely or cost-effective basis or perform
according to expectations.
(vi) regulatory limits on the Company's ability to change its prices for
telephone services in response to competitive pressures.
(vii) the Company's ability to effectively manage its growth, including
without limitation the Company's ability to (a) achieve projected
18
economies of scale and cost savings, (b) meet pro forma cash flow
projections developed by management in valuing newly-acquired
businesses, and (c) implement necessary internal controls, and
retain and attract key personnel.
(viii) any difficulties in the Company's ability to expand through additional
acquisitions, whether caused by financing constraints, regulatory
limitations, a decrease in the pool of attractive target companies,
or competition for acquisitions from other interested buyers.
(ix) higher than anticipated operating costs due to churn or fraudulent
uses of the Company's networks.
(x) the lack of assurance that the Company can compete effectively
against better capitalized competitors.
(xi) the effects of more general factors, including without limitation:
(a) changes in general industry and market conditions and growth
rates
(b) changes in interest rates or other general national, regional
or local economic conditions
(c) changes in legislation, regulation or public policy
(d) unanticipated increases in capital, operating or
administrative costs, or the impact of new business
opportunities requiring significant up-front investments
(e) the continued availability of financing in amounts, and on
terms and conditions, necessary to support the Company's
operations
(f) changes in the Company's relationships with vendors
(g) changes in accounting systems, policies or practices adopted
voluntarily or as required by generally accepted accounting
principles
(h) changes in VAT policies of the EU.
For a more detailed description of these and other uncertainties, see
Risk Factors in the Company's Prospectus dated July 8, 1997. Due to these
uncertainties, you are cautioned not to place undue reliance upon the
Company's forward-looking statements, which speak only as of the date hereof.
The Company undertakes no obligation to update or revise any of its forward-
looking statements for any reason.
Item 6. Exhibits and Reports on Form 8-K.
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A. Exhibits
The exhibits filed as part of this report are set forth in the
Exhibit Index on page 24 of this report.
B. Reports on Form 8-K
None 19
EXHIBIT INDEX
The following exhibits are included in this Quarterly Report on Form 10-Q:
Exhibit Number Exhibit Description
- -------------- -------------------
3.1 Form of Second Restated Articles of Incorporation of
Telegroup, Inc. (incorporated by reference to Exhibit 3.2
to the Company's Registration Statement on Form S-1,
File No. 333-25065)
3.2 Form of Amended and Restated Bylaws of Telegroup, Inc.
(incorporated by reference to Exhibit 3.4 to the
Company's Registration Statement on Form S-1, File No.
333-25065)
3.1 Form of Indenture for 8.0% Convertible Notes dated
September 30, 1997 (incorporated by reference to Exhibit
4.1 to the Company's Form 10-Q for the quarter-ended
September 30, 1997, SEC File No. 0-29284)
3.2 Form of Indenture for 10.5% Senior Discount Notes dated
October 23, 1997 (incorporated by reference to Exhibit 4.2
to the Company's Form 10-Q for the quarter-ended September
30, 1997, SEC File No. 0-29284)
27 Financial Data Schedule
20
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Telegroup, Inc.
Date: May 14, 1998 By: /s/ Douglas Neish
-----------------------
Douglas Neish
Vice President and
Chief Financial Officer
Date: May 14, 1998 By: /s/ Gary Korf
-----------------------
Gary Korf
Controller
21