SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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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 September 30, 1997
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
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(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
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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 30,768,542
----------------------
shares of Common stock outstanding as of September 30, 1997 and 30,880,522 as
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of the date of filing this report.
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02
TELEGROUP, INC.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
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Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 1996
and September 30, 1997 (unaudited).................................3
Consolidated Statements of Operations for the Three
and Nine Months Ended September 30, 1996 (unaudited) and
September 30, 1997 (unaudited).....................................5
Consolidated Statement of Shareholders' Equity for the
Nine Months Ended September 30,1997 (unaudited)....................6
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1996 (unaudited) and September 30, 1997 (unaudited)..7
Notes to Consolidated Financial Statements (unaudited).............8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................11
PART II - OTHER INFORMATION
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Item 1. Legal Proceedings.................................................20
Item 2. Changes in Securities and Use of Proceeds.........................20
Item 3. Defaults Upon Senior Securities...................................20
Item 4. Submission of Matters to a Vote of Security Holders...............20
Item 5. Other Information.................................................21
Item 6. Exhibits and Reports on Form 8-K..................................23
Exhibit Index.............................................................24
Signatures................................................................25
03
PART I - FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997 (UNAUDITED)
December September
ASSETS 1996 1997
Current assets:
Cash and cash equivalents $ 14,155,013 58,215,248
Accounts receivable and unbilled services, less
allowance for credit losses of $3,321,119 and
$4,639,183 at December 31, 1996 and September 30,
1997, respectively 32,288,507 48,007,389
Income tax recoverable 1,796,792 2,924,478
Deferred taxes 1,392,058 1,639,066
Prepaid expenses and other assets 245,271 757,508
Receivables from shareholders 14,974 45,880
Receivables from employees 85,539 189,070
----------- ----------
Total current assets 49,978,154 111,778,639
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Net property and equipment 11,256,139 21,596,980
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Other assets:
Deposits and other assets 376,614 688,665
Goodwill, net of amortization of $22,768 and
$96,520 at December 31, 1996 and
September 30, 1997, respectively 1,001,841 2,969,347
Capitalized software, net of amortization 1,906,655 1,873,946
Debt issuance costs, net of amortization 1,437,004 750,000
----------- ----------
4,722,114 6,281,958
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Total assets $ 65,956,407 139,657,577
----------- ----------
----------- ----------
December September
31, 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1997
Current liabilities:
Accounts payable 30,719,562 44,413,669
Accrued expenses 8,561,041 12,233,538
Note payable - 15,000,000
Unearned revenue 64,276 160,222
Customer deposits 602,940 717,224
Current portion of long-term debt (note 2) 232,596 92,194
Current portion of capital lease obligations 138,309 127,099
----------- ----------
Total current liabilities 40,318,724 72,743,946
----------- ----------
Deferred taxes 756,891 730,847
Capital lease obligations 301,393 218,320
Long-term debt (note 2) 11,216,896 25,042,057
Minority interest (note 3) - -
Commitments and contingencies (note 5) - -
Shareholders' equity:
Common stock, no par or stated value;
150,000,000 shares authorized, 26,211,578
and 30,768,542 shares issued and outstanding
at December 31, 1996 and September 30, 1997,
respectively - -
Additional paid-in capital 10,765,176 51,405,027
Retained earnings 2,599,530 (10,220,143)
Foreign currency translation adjustment (2,203) ( 262,477)
----------- -----------
Total shareholders' equity 13,362,503 40,922,407
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Total liabilities and
shareholders' equity $ 65,956,407 139,657,577
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----------- -----------
See accompanying notes to consolidated financial statements.
04
TELEGROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
Three Months Ended September 30, 1996 and 1997
and Nine Months Ended September 30, 1996 and 1997
Three months Nine months
ended September 30, ended September 30
1996 1997 1996 1997
Revenues:
Retail $ 44,463,875 56,192,571 128,827,926 169,720,131
Wholesale 12,687,810 28,128,733 18,950,715 68,757,955
---------- ---------- ---------- -----------
Total revenues 57,151,685 84,321,304 147,778,641 238,478,086
Cost of revenues 40,853,396 61,876,405 100,794,086 174,273,208
---------- ---------- ---------- -----------
Gross profit 16,298,289 22,444,899 46,984,555 64,204,878
---------- ---------- ---------- -----------
Operating expenses:
Selling, general and
administrative
expenses 15,246,635 23,114,929 42,648,269 63,174,487
Depreciation and
amortization 513,167 1,264,523 1,158,124 3,208,063
Stock option based
compensation - 85,595 - 256,785
---------- ---------- ---------- -----------
Total operating
expenses 15,759,802 24,465,047 43,806,393 66,639,335
---------- ---------- ---------- -----------
Operating income
(loss) 538,487 (2,020,148) 3,178,162 (2,434,457)
Other income (expense):
Interest expense (151,383) (645,311) (200,209) (2,134,691)
Interest income 84,209 427,677 210,859 782,299
Foreign currency trans-
action gain(loss) 33,958 (130,522) (56,688) (587,291)
Other (18,821) 79,556 60,966 159,228
---------- ---------- ---------- ----------
Earnings (loss) before
income taxes and
extraordinary item 486,450 (2,288,748) 3,193,090 (4,214,912)
Income tax benefit
(expense) (183,076) 727,588 (1,143,538) 1,366,054
Minority interest in share
of earnings (loss) - - - -
--------- --------- --------- ---------
Earnings (loss) before
extraordinary item 303,374 (1,561,160) 2,049,552 (2,848,858)
Extraordinary item, loss on
extinguishment of debt,
net of income taxes of
$1,469,486 (note 2) - (9,970,815) - (9,970,815)
-------- --------- --------- ---------
Net earnings (loss) $ 303,374 (11,531,975) 2,049,552 (12,819,673)
--------- --------- --------- ---------
--------- --------- --------- ---------
Per share amounts (note 4):
Earnings (loss) before
extraordinary loss $ 0.01 (0.05) 0.07 (0.10)
----- ---- ---- ----
Net earnings (loss) $ 0.01 (0.39) 0.07 (0.47)
----- ---- ---- ----
Weighted-average
shares 28,784,635 29,923,051 28,784,635 27,462,331
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
See accompanying notes to consolidated financial statements.
05
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 1997
Foreign Total
Additional Retained currency share-
paid-in earnings translation holders'
Shares Amount capital (deficit) adjustment equity
Balances at
December 31,
1996 26,211,578 $ - 10,765,176 2,599,530 (2,203) 13,362,503
Net loss - - - (12,819,673) - (12,819,673)
Issuance of
shares, net
of offering
expenses
(note 3) 4,450,000 - 39,825,343 - - 39,825,343
Shares issued
in connection
with business
combination
(note 3) 40,000 - 470,000 - - 470,000
Compensation
expense in
connection
with stock
option plan - - 256,785 - - 256,785
Issuance of shares
for options
exercised 66,964 - 87,723 - - 87,723
Change in
foreign
currency
translation - - - - (260,274) (260,274)
--------- ----- ---------- --------- -------- ----------
Balances at
September 30,
1997 30,768,542 $ - 51,405,027 (10,220,143) (262,477) 40,922,407
--------- ----- ---------- ---------- --------- ----------
--------- ----- ---------- ---------- --------- ----------
See accompanying notes to consolidated financial statements.
06
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
Nine months
ended September 30,
-------------------------
1996 1997
Cash flows from operating activities:
Net earnings (loss) $ 2,049,552 (12,819,673)
Adjustments to reconcile net earnings
(loss) to net cash provided by
operating activities:
Depreciation and amortization 1,158,124 3,208,063
Deferred income taxes 362,790 (273,052)
Loss on extinguishment of debt - 10,040,301
Provision for credit losses on
accounts receivable 3,730,892 6,384,001
Accretion of debt discount - 364 455
Stock option based compensation expense,
excluding the effects of
business combinations: - 256,785
Changes in operating assets and liabilities:
Accounts receivable (9,753,315) (21,791,926)
Prepaid expenses and other assets (86,267) (462,267)
Deposits and other assets 187,565 (1,650,196)
Accounts payable and accrued expenses 10,510,992 16,826,408
Income taxes (4,202,227) (1,295,174)
Unearned revenue 41,986 95,946
Customer deposits 82,978 114,284
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Net cash provided by (used in)
operating activities 4,083,070 (1,002,045)
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Cash flows from investing activities:
Purchases of equipment (6,263,952) (12,463,348)
Capitalization of software (1,326,858) (306,373)
Cash paid in business combinations,
net of cash acquired
Net change in receivables from (468,187) (420,956)
shareholders and employees (202,003) (134,437)
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Net cash used in investing
activities (8,261,000) (13,325,114)
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Cash flows from financing activities:
Net payments on notes payable (2,000,000) -
Net proceeds from line of credit 4,800,000 15,000,000
Net proceeds from
long-term borrowings 1,254,596 24,578,885
Debt issuance costs - (750,000)
Prepayment of senior subordinated notes - (20,000,000)
Net proceeds from issuance of stock - 39,825,343
Net proceeds from options exercised 87,723
Payments on capital lease obligations (151,948) (94,283)
Net change in due to shareholders (25,881) -
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Net cash provided by
financing activities 3,876,767 58,647,668
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Effect of exchange rate changes on cash (730) (260,274)
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Net increase (decrease) in cash and
cash equivalents (301,893) 44,060,235
Cash and cash equivalents at beginning
of period 4,591,399 14,155,013
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Cash and cash equivalents at end of period $ 4,289,506 58,215,248
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Supplemental cash flow disclosures:
Dividends declared $ 425,000 -
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Common stock issued in connection
with business combinations 573,984 470,000
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Common stock issued in consideration
for notes receivable 52,366 -
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Interest paid 200,209 2,356,921
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------------ -----------
Taxes paid 5,040,634 2,622
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See accompanying notes to consolidated financial statements.
07
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, 1996, was derived from the
Company's audited consolidated balance sheet as of that date. The
consolidated financial statements as of September 30, 1997 and for the
three month and nine month periods 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
Registration Statement on Form S-1.
(2) Debt
Long-term debt at December 31, 1996 and September 30, 1997 is shown
below:
December 31, September 30,
1996 1997
12% senior subordinated notes,
net of discount, paid in
September 1997 $ 10,894,126 -
8.0% convertible subordinated
notes, due April 15, 2005,
unsecured - 25,000,000
8.5% note payable, due monthly
through fiscal 2000, secured by
vehicle 19,003 12,493
10.8% note payable, due monthly
through fiscal 1998, secured by
equipment financed 160,628 108,327
12.0% note payable, paid in
February 1997 74,319 -
12.0% note payable, paid in
February 1997 276,853 -
6.85% note payable, due monthly
through fiscal 1999, unsecured 14,138 9,291
8.00% note payable, due monthly
through fiscal 1998, unsecured 10,425 4,140
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11,449,492 25,134,251
Less current portion (232,596) (92,194)
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$ 11,216,896 25,042,057
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08
(2) DEBT (CONTINUED)
On September 5, 1997, the Company prepaid in full all of its
outstanding senior subordinated notes. The Company paid $21,400,000,
which included $20,000,000 in principal and $1,400,000 for a prepayment
penalty. In addition, the Company recognized a loss of $8,741,419 and
$1,298,882 for the write-off of the unamortized original issue discount
and debt issuance costs, respectively. The early extinguishment of the
senior subordinated notes is reflected on the statement of operations
as an extraordinary item, net of income taxes.
On September 30, 1997, the Company issued $25 million in aggregate
principal amount of convertible subordinated notes due April 15, 2005.
The net proceeds from the issuance of the convertible notes were
approximately $24.3 million.
The convertible notes are unsecured obligations of the Company and are
subordinated to all existing and future senior indebtedness of the
Company. The convertible notes bear interest at 8% per annum, payable
in cash, on each April 15 and October 15, commencing April 15, 1998;
provided that, until the earlier of (x) April 15, 1999 or (y) the
Final Note Interest Time (as defined in the Convertible Note Indenture),
at the option of the Company, interest may be paid by the issuance of
additional convertible notes. The convertible notes are convertible into
shares of common stock of the Company at any time on or before the
business day next preceding April 15, 2005, unless previously
redeemed, at a conversion price of $12.00 per share, subject to
adjustment upon the occurrence of certain events.
The convertible notes are redeemable, in whole or in part, at the
option of the Company, at any time on or after October 15, 2000 at
redemption prices (expressed as a percentage of the principal amount)
declining annually from 104.0% beginning October 15, 2000 to 100.0%
beginning on October 15, 2003 and thereafter, together with accrued
interest to the redemption date and subject to certain conditions.
The convertible note Indenture places certain restrictions on the
ability of the Company and its subsidiaries to (i) incur additional
indebtedness, (ii) make restricted payments (dividends, redemptions
and certain other payments), (iii) incur liens, (iv) enter into
mergers, consolidations or acquisitions, (v) sell or otherwise dispose
of property, business or assets, (vi) issue and sell preferred stock
of a subsidiary and (vii) engage in transactions with affiliates. For
details, see the convertible note Indenture attached as Exhibit 4.1 to
this report.
The Company had a credit agreement with a bank which provided for up to
$5,000,000 in committed credit at December 31, 1996. On September 12,
1997, the Company entered into a $15 million revolving credit facility
(the Facility) which replaced the previous credit facility. The
Facility expires October 31, 1997 and is secured by the Company's
accounts receivable and other assets. Amounts outstanding under the
Facility bear interest at a fluctuating rate which was 8.75% at
September 30, 1997. There were no borrowings under the credit at
December 31, 1996 and $15,000,000 borrowed under the Facility at
September 30, 1997.
On October 23, 1997, the Company issued $97 million in aggregate
principal amount of 10.5% senior discount notes. The notes will mature
on November 1, 2004, and each note will have a principal amount at
maturity of $1,000 and an accreted value of $772.50. The notes are
unsecured obligations of the Company and are subordinated to all
existing and future Senior Indebtedness, as defined in the indenture
governing the notes.
Cash interest on the senior discount notes will neither accrue nor be
payable prior to May 1, 2000. The notes bear interest at 10.5% per
annum, payable in cash, on each May 1 and November 1. The notes are
redeemable, in whole or in part, at the option of the Company, at any
time on or after November 1, 2001 at redemption prices (expressed as a
percentage of the principal amount) declining annually from 105.25%
beginning November 1, 2001 to 100.0% beginning on November 1, 2004 and
thereafter, together with accrued interest to the redemption date and
subject to certain conditions.
The senior discount Indenture places certain restrictions on the ability
of the Company and its subsidiaries to (i) incur additional indebtedness,
(ii) make restricted payments (dividends, redemptions and certain other
payments), (iii) incur liens, (iv) enter into mergers, consolidations or
acquisitions, (v) sell or otherwise dispose of property, business or
assets, (vi) issue and sell preferred stock of a subsidiary and (vii)
engage in transactions with affiliates. (For details, see the Senior
Discount Note Indenture attached as Exhibit 4.2 to this report.)
(3) SHAREHOLDERS' EQUITY
IPO
On July 14, 1997, the Company consummated an IPO. The Company sold
4,000,000 shares of common stock at a price to public of $10 per share
for net proceeds of approximately $35.6 million. On August 12, 1997,
the underwriters exercised their over-allotment option and purchased an
additional 450,000 shares at $10 per share which yielded net proceeds
to the Company of approximately $4.2 million.
ACQUISITIONS
On August 14, 1997, the Company acquired 60 percent of the common stock
of, and a controlling interest in, PCS Telecom, Inc. (PCS Telecom) for
$1,340,000 in cash and 40,000 shares of unregistered common stock
valued at $470,000, for total consideration of $1,810,000. PCS Telecom
is a developer and manufacturer of state of the art, feature-rich,
calling card platforms used by Telegroup and numerous other companies.
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 $ 1,281,826
Property and equipment 534,600
Goodwill 2,041,258
Current liabilities (2,047,684)
-----------
Total $ 1,810,000
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-----------
09
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(4) EARNINGS PER SHARE
For the three month and nine month periods ended September 30, 1996,
earnings per common and common equivalent share have been computed
using the weighted-average number of shares of common stock outstanding
during each period as adjusted for the effects of Securities and
Exchange Commission Staff Accounting Bulletin No. 83. Accordingly,
options and warrants to purchase common stock granted within one year
of the Company's initial public offering, which had exercise prices
below the initial public offering price per share, have been included
in the calculation of common equivalent shares, using the treasury
stock method, as if they were outstanding for all periods presented.
For the three and nine month periods ended September 30, 1997, earnings
per common share have been computed under the provisions of Accounting
Principles Board Opinion No. 15, "Earnings Per Share."
(5) COMMITMENTS AND CONTINGENCIES
COMMITMENTS WITH TELECOMMUNICATIONS COMPANIES
The Company has an agreement with Sprint Communications Company L.P.
(Sprint) with net monthly usage commitments of $1,500,000. In the
event such monthly commitments are not met, the Company is required to
remit to Sprint 25 percent of the difference between the $1,500,000
monthly commitment and actual usage. Such amount, if necessary, would
be recorded as cost of revenue in the period incurred. The Company has
exceeded the monthly usage commitments since the inception of this
agreement. This agreement extends through December 1997.
The Company has a one year $3,000,000 usage commitment with
MFS/WorldCom in Frankfurt, Germany, which began on September 5, 1997.
The Company is obligated to remit any shortfall under this agreement to
MFS/WorldCom in October, 1998. Such remittance, if necessary, will be
recorded as cost of revenue in the period incurred.
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 this matter will not have a significant effect
on the financial statements of the Company.
NETWORK
At September 30, 1997, the Company had $4.5 million in commitments for
capital expenditures. The Company has identified a total of $60.1
million of capital expenditures which the Company intends to undertake
in 1997 and 1998 and approximately $75.0 million of additional
capital expenditures during the period from 1999 through 2001.
10
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, 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 Prospectus filed with the SEC on July 8, 1997 and other
reports filed by the Company with the SEC.
OVERVIEW
Telegroup is a leading global alternative provider of international
telecommunications services. The Company offers a broad range of discounted
international and enhanced telecommunications services to 268,000 small and
medium-sized business and residential customers in over 180 countries
worldwide. Telegroup has achieved its significant international market
penetration by developing what it believes to be one of the most comprehensive
global sales, marketing and customer service organizations in the
international telecommunications industry. The Company operates a digital,
switched-based telecommunications network, the Telegroup Intelligent Global
Network or the TIGN, to deliver its services in a reliable, flexible and
cost-effective manner. According to FCC statistics, Telegroup was the
thirteenth largest US carrier of long distance traffic in 1996. Telegroup's
revenues have increased from $29.8 million in fiscal 1993 to $303.9 million
for the 12 months ended September 30,1997.
As of September 30, 1997, the Company had 44,190 active retail customers
within the United States and 167,444 active retail customers outside the
United States. This only includes retail customers who were sent an invoice
in September and excludes active international customers with an outstanding
balance of less than $50. The Company's network currently includes switches
located in Australia, Denmark, France, Germany, Hong Kong, Japan, the
Netherlands, Switzerland, the UK, and the US and leased and owned
transmission facilities, enabling the Company to offer a variety of enhanced
telecommunications services. In August 1997, the Company installed a switch
in Frankfurt, Germany that has been tested and is in service as of the date
of this report. The Company also installed switches in Copenhagen, Denmark
and Zurich, Switzerland during the third quarter of 1997.
In the fourth quarter of 1997, the Company intends to install two
switches in New York and one additional switch in Hong Kong. Also in the
fourth quarter of 1997 or the first quarter of 1998, the Company plans to
sign interconnect agreements in the Netherlands, Denmark and Sweden, and
contracts for IPLS between Rome and Milan, and between Tokyo and Osaka.
The Company plans to have 30 switches installed worldwide by the end of 1998.
11
The Company has attained positive net earnings in only two of the last
five years--1992 and 1995, and positive EBITDA in 1992, 1995 and 1996. EBITDA
represents net earnings (loss) plus net interest expense (income), income
taxes, depreciation and amortization and non-cash stock option based
compensation. The Company expects to incur lower gross margins, negative
EBITDA and significant operating losses and net losses for the near term as it
incurs additional costs associated with the development and expansion of the
TIGN, the expansion of its marketing and sales organization, and the
introduction of new telecommunications services. As the development and
expansion of the TIGN continues and the Company's customers migrate from
Global Access CallBack to Global Access Direct service, the Company expects
that its gross margins, EBITDA, and operating and net income will improve.
However, there can be no assurance that this will be the case.
Telegroup's revenues are derived from the sale of telecommunications
services to retail customers, typically residential users and small to
medium-sized businesses in over 180 countries worldwide and to wholesale
customers, typically other US and non-US telecommunications carriers. The
Company's revenues from retail and wholesale customers represented 84% and
16%, respectively, of the Company's total revenues for the year ended December
31, 1996 and 71% and 29%, respectively, for the nine months ended September
30, 1997. The Company's retail customer base is diversified both
geographically and by customer type. No single retail customer accounted for
more than 1% of the Company's total revenues for the year ended December 31,
1996 nor for the nine months ended September 30, 1997. For the nine months
ended September 30, 1997, one wholesale customer accounted for approximately
12% of the Company's total revenues. The Company expects that wholesale
revenues will continue to grow as a percentage of total telecommunications
revenue in the near term.
During the nine months ended September 30, 1997, the geographic origin of
the Company's revenues was as follows: United States-34.2%; Europe-29.4%;
Pacific Rim--24.5%; Other-11.9%, compared to fiscal year 1996 in which such
geographic origin was as follows: United States--28.3%; Europe--38.1%; Pacific
Rim--19.8%; Other--13.8%. The most significant shift in composition of revenue
was the increase in revenue derived from carrier services both in the US and
internationally. The Company continues to increase its wholesale carrier
business, which accounted for 29% of revenues for the nine months ended
September 30, 1997 compared to 10% for the nine months ended September 30,
1996, primarily by serving wholesale customers in the US and the Pacific Rim.
The Company has expanded its Country Coordinator offices and retail marketing
activities primarily in its core markets, six of which are located in Western
Europe, and three in the Pacific Rim. The Company believes that, because its
core markets comprise approximately 64% of the total global long distance
telecommunications market, according to TeleGeography, the US, Europe, and
Pacific Rim regions will continue to comprise the bulk of the Company's
revenues.
12
The Company believes that, typically, its retail services are
competitively priced below those of the Incumbent Telecommunications Operators
(ITOs) in each country in which the Company offers its services. Prices for
telecommunications services in many of the Company's core markets have
declined in recent years as a result of deregulation and increased
competition. The Company believes that worldwide deregulation and increased
competition are likely to continue to reduce the Company's retail revenues per
billable minute. The Company believes, however, that any decrease in retail
revenues per minute will be at least partially offset by an increase in
billable minutes by the Company's customers, and by a decreased cost per
billable minute as a result of the expansion of the TIGN and the Company's
ability to use least cost routing in additional markets.
For the year ended December 31, 1996, and the nine months ended September
30, 1997, 83.8% and 75.5%, respectively, of the Company's retail revenues were
derived from Telegroup's Global Access CallBack services. For the year ended
December 31, 1996 and the nine months ended September 30, 1997, 68.9% and
53.7%, respectively, of the Company's total revenues were derived from
Telegroup's Global Access CallBack services. As the Company's Global Access
Direct service is provided to customers currently using traditional call-
reorigination services, the Company anticipates that revenue derived from
Global Access Direct will increase as a percentage of retail revenues.
However, the Company expects to continue to aggressively market its Global
Access CallBack service in markets not served by the TIGN and to use
transparent call-reorigination as a possible routing methodology for its
Global Access Direct customers where appropriate. Accordingly, the Company
believes that call-reorigination will continue to be a significant source of
revenue.
Historically, the Company has not been required to collect Value Added
Tax (VAT), which is typically 15% to 25% of the sales price, on call-
reorigination services provided to customers in the EU because prior laws
deemed such services to be provided from the US. However, Germany and France
have adopted rules whereby, as of January 1, 1997, telecommunications services
provided by non-EU based firms are deemed to be provided where the customer is
located. Since April 1, 1997, Austria, Belgium, Denmark, Finland, Greece,
Ireland, Italy, Luxembourg, Spain, Norway, Portugal, Sweden and the United
Kingdom have begun to impose VAT on telecommunications services provided by
non-EU companies. The Company is currently analyzing the effect of this
legislation on its service offerings. The Company may have no alternative but
to reduce prices of particular services offered to certain customer segments
in order to remain competitive in light of the imposition of VAT on its
services in certain EU member states. Such price reduction could have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company believes that whatever negative impact the
imposition of VAT will have on its operations, such impact will be partially
mitigated by the migration of customers to, and the higher gross margins
associated with, call-through services.
13
Cost of retail and wholesale revenues is comprised of (i) variable costs
associated with the origination, transmission and termination of voice and
data telecommunications services by other carriers, and (ii) costs associated
with owning or leasing and maintaining switching facilities and circuits.
The Company also includes as a cost of revenues payments resulting from
traffic imbalances under its operating agreement with AT&T Canada. Currently,
a significant portion of the Company's cost of revenues is variable, based on
the number of minutes of use transmitted and terminated over other carriers'
facilities. The Company's gross profitability is driven mainly by the
difference between revenues and the cost of transmission and termination
capacity.
The Company seeks to lower the variable portion of its cost of services
by originating, transporting and terminating a higher portion of its traffic
over the TIGN. However, in the near term, the Company expects that its cost of
revenues as a percentage of revenues will increase as the Company continues
the development and expansion of the TIGN and introduces new
telecommunications services. Subsequently, as the Company increases the volume
and percentage of traffic transmitted over the TIGN, cost of revenues will
increasingly consist of fixed costs associated with leased and owned lines and
the ownership and maintenance of the TIGN, and the Company expects that the
cost of revenues as a percentage of revenues will decline. The Company seeks
to lower its cost of revenues by: (i) expanding and upgrading the TIGN by
acquiring owned and leased facilities and increasing volume on these
facilities, thereby replacing a variable cost with a fixed cost and spreading
fixed costs over a larger number of minutes; (ii) negotiating lower cost of
transmission over the facilities owned by other national and international
carriers; and (iii) expanding the Company's least cost routing choices and
capabilities.
The Company generally realizes higher gross margins from its retail
services than from its wholesale services. Wholesale services, however,
provide a source of additional revenue and add significant minutes originating
and terminating on the TIGN, thus enhancing the Company's purchasing power for
leased lines and switched minutes and enabling it to take advantage of volume
discounts. The Company also generally realizes higher gross margins from
direct access services than from call-reorigination. The Company expects its
gross margins to continue to decline in the near term as a result of increased
wholesale revenues as a percentage of total revenues. In addition, the Company
intends to reduce prices in advance of corresponding reductions in
transmission costs in order to maintain market share while migrating customers
from traditional call-reorigination to Global Access Direct. The Company then
expects gross margins to improve as the volume and percentage of traffic
originated, transmitted and terminated on the TIGN increases and cost of
revenues is reduced. The Company's overall gross margins may fluctuate in the
future based on its mix of wholesale and retail long distance services and the
percentage of calls using direct access as compared to call-reorigination, any
significant long distance rate reductions imposed by ITOs to counter external
competition, and any risks associated with the Company agreeing to minimum
volume contracts and not achieving the volume necessary to meet the
commitments.
14
The Company's general and administrative expenses include salaries and
benefits, other corporate overhead costs and costs associated with the
operation and maintenance of the TIGN. These costs have increased due to the
development and expansion of the TIGN and corporate infrastructure. The
Company expects that general and administrative expenses may increase as a
percentage of revenues in the near term as the Company incurs additional costs
associated with the development and expansion of the TIGN, the expansion of
its marketing and sales organization, and the introduction of new
telecommunications services.
The Company spends considerable resources to collect receivables from
customers who fail to make payment in a timely manner. While the Company
continually seeks to minimize bad debt, the Company's experience indicates
that a certain portion of past due receivables will never be collected, and
that such bad debt is a necessary cost of conducting business in the
telecommunications industry. In addition to uncollectible receivables, the
telecommunications industry historically has been exposed to a variety of
forms of customer fraud. The TIGN and the Company's billing systems are
designed to detect and minimize fraud, where practicable, and the Company
continuously seeks to enhance and upgrade its systems in an effort to minimize
losses as it expands into new markets.
As the Company begins to integrate its distribution network in selected
strategic locations by acquiring Country Coordinators and independent agents
or by establishing internal sales organizations, it may incur added selling,
general and administrative expenses associated with the transition which may
result, initially, in an increase in selling, general and administrative
expenses as a percentage of revenues. The Company anticipates, however, that
as sales networks become fully integrated, new service offerings are
implemented, and economies of scale are realized, selling, general and
administrative expenses will decline as a percentage of revenue.
15
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1996
Revenues. Revenues increased 47.4%, or $27.1 million, from $57.2 million
in the three months ended September 30, 1996 to $84.3 million in the three
months ended September 30, 1997. This increase was primarily due to growth in
international and domestic retail sales and international and domestic
wholesale revenues. Wholesale revenues increased from $12.7 million, or 22.2%
of total revenues in the three months ended September 30, 1996, to $28.1
million, or 33.3% of revenues for the three months ended September 30, 1997.
Cost of Revenues. Cost of revenues increased 51.3%, or $21.0 million,
from approximately $40.9 million to approximately $61.9 million. As a
percentage of revenues, cost of revenues increased from 71.5% to 73.4%,
primarily as a result of a larger percentage of lower margin wholesale
revenues.
Operating Expenses. Operating expenses increased 55.1%, or $8.7 million,
from $15.8 million in the three months ended September 30, 1996 to $24.5
million in the three months ended September 30, 1997, primarily as a result of
increased sales commissions related to revenue growth, as well as an increase
in the number of employees necessary to provide customer service, billing and
collection and accounting support. Other contributing factors were bad debt,
depreciation, and amortization, as discussed below. As a percentage of
revenues, operating expenses increased 1.4% from 27.6% in the three months
ended September 30, 1996 to 29.0% in the three months ended September 30,
1997. The number of full and part-time employees grew from 402 in the three
months ended September 30, 1996, to 586 in the three months ended September
30, 1997, representing a 45.8% increase.
Bad Debt. Bad debt expense increased from $1.4 million, or 2.4% of
revenues in the three months ended September 30, 1996 to $1.9 million, or 2.3%
of revenues, in the three months ended September 30, 1997. The decrease in bad
debt expense as a percentage of revenues in the three months ended September
30, 1997 was due to continued vigilance in assessing the credit worthiness of
new subscribers to Company services.
Depreciation and Amortization. Depreciation and amortization increased
from $0.5 million in the three months ended September 30, 1996, to $1.3
million in the three months ended September 30, 1997, 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 $2.5 million, from $0.5
million in the three months ended September 30, 1996, to $(2.0) million in the
three months ended September 30, 1997, as a result of the foregoing factors.
Net Earnings (Loss). Net earnings (loss) decreased approximately $11.8
million, from $0.3 million in the three months ended September 30, 1996, to
$(11.5) million in the three months ended September 30, 1997. The decrease is
attributable to lower operating income, a $0.2 million increase in net
interest expense, a $0.1 million increase in foreign currency transaction
losses, and extraordinary charge of $10.0 million for loss on early
extinguishment of debt. The foreign currency transaction losses resulted
primarily from a strengthening of the US Dollar in such period versus foreign
currencies in which the Company had unhedged positions.
16
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1996
Revenues. Revenues increased 61.4%, or $90.7 million, from $147.8 million
in the nine months ended September 30, 1996, to $238.5 million in the nine
months ended September 30, 1997. This increase was primarily due to growth in
international and domestic retail sales and international and domestic
wholesale revenues. Wholesale revenues increased from $19.0 million, or 12.9%
of total revenues in the nine months ended September 30, 1996, to $68.8
million or 28.8% of revenues for the nine months ended September 30, 1997.
Cost of Revenues. Cost of revenues increased 72.9%, or $73.5 million,
from approximately $100.8 million to approximately $174.3 million. As a
percentage of revenues, cost of revenues increased from 68.2% to 73.1%,
primarily as a result of a larger percentage of lower margin wholesale
revenues.
Operating Expenses. Operating expenses increased 52.1%, or $22.8 million,
from $43.8 million in the nine months ended September 30, 1996, to $66.6
million in the nine months ended September 30, 1997, primarily as a result of
increased sales commissions related to revenue growth, as well as an increase
in the number of employees necessary to provide network and systems
development and support, customer service, billing and collection and
accounting support. Other contributing factors were bad debt, depreciation,
and amortization, as discussed below. As a percentage of revenues,
operating expenses decreased 1.7% from 29.6% in the nine months ended
September 30, 1996, to 27.9% in the nine months ended September 30, 1997.
Bad Debt. Bad debt expense increased from $3.8 million, or 2.6% of
revenues in the nine months ended September 30, 1996, to $6.4 million, or 2.7%
of revenues, in the nine months ended September 30, 1997. The increase in bad
debt expense as a percentage of revenues in the nine months ended September 30,
1997, was due primarily to the write-off of accounts receivable for services
rendered to a single domestic customer during the first third of the period.
Services to this customer have been discontinued.
Depreciation and Amortization. Depreciation and amortization increased
from $1.2 million in the nine months ended September 30, 1996, to $3.2 million
in the nine months ended September 30, 1997, primarily due to increased
capital expenditures incurred in connection with the development and expansion
of the TIGN during the nine months ended September 30, 1997, as well as
amortization expenses associated with intangible assets.
Operating Income. Operating income decreased by $5.6 million, from $3.2
million in the nine months ended September 30, 1996, to $(2.4) million in the
nine months ended September 30, 1997, primarily as a result of the foregoing
factors.
Net Earnings (Loss). Net earnings (loss) decreased approximately $14.8
million, from $2.0 million in the nine months ended September 30, 1996, to
$(12.8) million in the nine months ended September 30, 1997. The decrease
was attributable to lower operating income, a $1.4 million increase in net
interest expense, a $0.5 million increase in foreign currency transaction
losses, and an extraordinary charge of $10.0 million for loss on early
extinguishment of debt. The foreign currency transaction losses resulted
primarily from a strengthening of the US Dollar in such period versus foreign
currencies in which the Company had unhedged positions.
17
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, term loans and revolving credit
facilities from commercial banks, and by capital leases. Due to the recent
funding described below, the Company is fully funded but may require
additional capital to develop and 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 July, the Company completed an IPO, issuing 4 million shares at a
price to public of $10 per share, yielding $40 million of gross proceeds. In
August, an additional 450,000 shares were issued pursuant to the exercise of
the underwriters' over-allotment option, yielding an additional $4.5 million
of gross proceeds. The net proceeds to the Company from the IPO (including
the over-allotment issue), after fees and other expenses, were approximately
$39.8 million. Approximately $4.1 million has been used as of September 30,
1997 to expand the TIGN, including the purchase of 60% of the stock of PCS
Telecom, Inc; approximately $9.8 million was used for prepayment of the
outstanding $20 million in Senior Subordinated Notes, and $1.5 million for
working capital. The Company expects that an additional $21.7 million will be
used to further expand the TIGN and the balance will be used for working
capital.
The Company had a credit agreement with a bank which provided for up to
$5,000,000 in committed credit at December 31, 1996. The credit line was
amended to provide up to $7,500,000 effective March 28, 1997, and
terminating June 30, 1998. On September 5, 1997, the Company entered into a
$15 million Revolving Credit Facility to replace the $7.5 million credit
facility. The Revolving Credit Facility, secured by the Company's accounts
receivable and other assets, expired on October 31, 1997. There were no
borrowings under the credit at December 31, 1996, $15,000,00 borrowings under
the Revolving Credit Facility on September 30, 1997, and there were no
borrowings under the Revolving Credit Facility at October 31, 1997.
The Company currently anticipates entering into a New Credit Facility with a
bank or other financial institution for available borrowings in an amount not
expected to exceed $20 million. There can be no assurance that the Company
will enter into the New Credit Facility.
On September 5, 1997, the Company prepaid in full all of its outstanding
Senior Subordinated Notes. The Company paid $21,400,000, which included
$20,000,000 in principal and $1,400,000 for a prepayment penalty. In
addition, the Company recognized a loss of $8,741,419 and $1,298,882 for the
write-off of the unamortized original issue discount and debt issuance costs,
respectively. The early extinguishment of the Senior Subordinated Notes is
reflected on the statement of operations as an extraordinary item, net of
income taxes. The Company financed the prepayment of the Senior Subordinated
Notes with $12.9 million of the net proceeds from the IPO and $8.5 million of
borrowings under the Revolving Credit Facility.
On September 30, 1997, the Company issued $25 million aggregate principal
amount of Convertible Notes. The net proceeds from the issuance of the
Convertible Notes were approximately $24.3 million and approximately $15.0
million of such net proceeds were used to repay all amounts outstanding under
the Revolving Credit Facility. Unless redeemed by the Company previously, the
Notes are convertible into common stock of the Company at the conversion price
of $12 per share.
On October 23, 1997, the Company sold $97,000,000 aggregate principal
amount at maturity of its 10.5% Senior Discount Notes due 2004 ("Sr. Notes"),
with net proceeds of approximately $72,300,000. The Sr. Notes will accrete
in value from the date of issuance to May 1, 2000, at a rate of 10.5% per
annum, compounded semi-annually. Cash interest on the Sr. Notes will neither
accrue nor be payable prior to May 1, 2000. Commencing May 1, 2000, interest
will be payable in cash on the Sr. Notes semi-annually in arrears on each May
1, and November 1, at a rate of 10.5% per annum. The Sr. Notes will mature on
November 1, 2004.
Net cash provided by (used in) operating activities was $4.1 million in
the nine months ended September 30, 1996 and $(1.0) million in the nine
months ended September 30, 1997. The net cash provided by operating
activities in the nine months ended September 30, 1996 was primarily due to
net earnings and an increase in the provision for credit losses on accounts
receivable. The net cash used in operating activities in the nine months
ended September 30, 1997 was due to the increase in depreciation and
amortization expense, an increase in the provision for credit losses on
accounts receivable, and an increase in accounts payable. These increases
18
were partially offset by an increase in accounts receivable. The $1.8
million increase in deposits and other assets in the nine months ended
September 30, 1997, was due primarily to a deposit to one vendor for card
platform switch equipment.
Net cash used in investing activities was $(8.3) million in the nine
months ended September 30, 1996, and $(13.3) million in the nine months ended
September 30, 1997. The net cash used in the nine months ended September
30, 1996, and September 30, 1997, was primarily due to increases in
equipment purchases.
Net cash provided by financing activities was $3.9 million in the nine
months ended September 30, 1996, and $58.6 million in the nine months ended
September 30, 1997. The net cash provided in the nine months ended September
30, 1996, was primarily due to proceeds from long-term borrowings and the
operating line of credit. The net cash provided in the nine months ended
September 30, 1997, was primarily due to proceeds from the IPO and long-term
borrowings.
The development and expansion of the TIGN, the upgrade and/or replacement
of the Company's management information systems, the opening of new offices,
the introduction of new telecommunications services, funding future
acquisitions, as well as the funding of anticipated losses and net cash
outflows, may require additional capital. At September 30, 1997, the
Company had $4.5 million in commitments for capital expenditures. The
Company has identified a total of $60.1 million of capital expenditures which
the Company intends to undertake in 1997 and 1998.
The Company expects that the net proceeds from the IPO, the Convertible
Notes, and the Sr. Notes will provide the Company with sufficient capital to
fund planned capital expenditures and anticipated operating losses through
December 1998. The net proceeds from the IPO, the Convertible Notes,
and the Sr. Notes are expected to provide sufficient funds for the Company to
expand its business as planned and to fund anticipated operating losses and
net cash outflows for the next 18 to 24 months. There can be no assurance
that the Company will be able to obtain the New Credit Facility or,
if obtained, that it will be able to do so on a timely basis or on terms
favorable to the Company. The amount of the Company's actual future capital
requirements will depend upon many factors, including the performance of the
Company's business, the rate and manner in which it expands the TIGN,
increases in staffing levels and customer growth, upgrades or replacements to
management information systems and opening of new offices, as well as other
factors that are not within the Company's control, including competitive
conditions, general economic conditions, and regulatory or other government
actions. In the event that the Company's plans or assumptions change or prove
to be inaccurate or internally generated funds and funds from other
financings, if obtained, 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.
FOREIGN CURRENCY
Although the Company's functional currency is the US Dollar, the Company
derives a substantial percentage of its telecommunications revenues from
international sales. In countries where the local currency is freely
exchangeable and the Company is able to hedge its exposure, the Company bills
for its services in the local currency. In cases where the Company bills in a
local currency, the Company is exposed to the risk that the local currency
will depreciate between the date of billing and the date payment is received.
In certain countries in Europe, the Company purchases foreign exchange
19
contracts through its fiscal agent to hedge against this foreign exchange
risk. For the nine months ended September 30, 1997, approximately $56.3 million
(US Dollar equivalent) or 23.6% of the Company's billings for
telecommunications services were billed in currencies other than the US
dollar with a significant percentage of these billings covered by foreign
forward exchange contracts or similar hedging strategies.
The Company's financial position and results of operations for the year
ended September 30, 1997, were not significantly affected by foreign currency
exchange rate fluctuation. As the Company continues to expand the TIGN and
increase its customer base in its targeted markets, an increasing proportion of
costs associated with operating and maintaining the TIGN, as well as local
selling expenses, will be billed in foreign currencies. Although the Company
attempts to match costs and revenues and borrowings and repayments in terms of
local currencies, there will be many instances in which costs and revenues and
borrowings and repayments will not be matched with respect to currency
denominations. The Company may choose to limit any additional exposure to
foreign exchange rate fluctuations by the purchase of foreign forward exchange
contracts or similar hedging strategies. There can be no assurance that any
currency hedging strategy would be successful in avoiding exchange-related
losses.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard (SFAS) 128, "Earnings Per Share"
which revises the calculation and presentation provisions of Accounting
Principles Board Opinion 15 and related interpretations. SFAS 128 is effective
for the Company's fiscal year ending December 31, 1997. Retroactive
application will be required. The Company believes the adoption of SFAS 128
will not have a significant effect on its reported earnings per share.
SFAS 130, "Reporting Comprehensive Income", was issued in June 1997. It
establishes standards for reporting and display of comprehensive income and
its components in a full set of general-purpose financial statements. SFAS
131, "Disclosures about Segments of an Enterprise and Related Information",
was issued in June 1997. It establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. The Company
does not believe that adoption of any of these standards will have a
significant effect on its consolidated financial statements.
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.
20
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.
In June 1996, Macrophone Worldwide (PTY) Ltd. (the "Plaintiff"), a
former Country Coordinator for South Africa, filed a complaint (the
"Complaint") against the Company in the United States District Court for the
Southern District of Iowa (the "Action") alleging, among other things, breach
of contract, wrongful termination and intentional interference with
contractual relations. The Complaint requests unspecified damages. On
September 2, 1997, the United States District Court granted summary judgment
for the Company on all seven tort-based claims. The only remaining claim is
a contract claim in which there is no pending claim for exemplary damages.
The Company is vigorously defending the Action.
Item 2. Changes in Securities and Use of Proceeds.
- ------ -----------------------------------------
Amended and Restated 1996 Stock Option Plan. On August 20, 1997, the
Company's Board of Directors authorized the filing of an S-8 with the
Securities and Exchange Commission (SEC), registering stock issued pursuant to
the Company's Amended and Restated 1996 Stock Option Plan (Stock Option Plan).
The S-8 was filed with the SEC on August 28, 1997. During the first nine months
of 1997, options for a total of 361,925 shares were issued under the Amended
Stock Option Plan to Company employees. The options have an exercise price of
$10.00 per share (the IPO price to public), vest from April 10, 1997 through
September 1, 2000, depending on date of grant, and have expiration dates of
April 1, 2007.
As of September 30, 1997, the Company has used $18.5 million of
net proceeds from the IPO. Of those expenditures, $4.1 million was used for
expansion of the TIGN, including $1.3 million for the cash portion of the
acquisition cost of PCS Telecom, Inc., $12.9 million for the prepayment of the
$20 million Senior Subordinated Notes issued to Greenwich Partners, Ltd., and
$1.5 million for general corporate purposes, including upgrading of internal
billing and accounting systems.
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.
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None.
Item 4. Submission of Matters to a Vote of Security Holders.
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None.
21
Item 5. Other Information.
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On September 27, 1997, Telegroup's existing Board of Directors
increased the number of directorships from six to seven and appointed three
outside directors who joined its seven-member Board of Directors on October
1, 1997, filling all Board vacancies. The new outside directors are: Steve J.
Baumgartner, Executive Vice President and Sector President Global Commercial
Print, for R.R. Donnelley & Sons Company; J. Sherman Henderson III, President
and CEO of Louisville-based UniDial Communications; and, Rashi Glazer,
currently on the faculty of the Walter A. Haas School of Business, University
of California, Berkeley and Co-Director of the Berkeley Center for Marketing
and Technology. Messrs. Baumgartner and Henderson will serve on the
Compensation and Audit Committees, and Mr. Glazer will serve as a marketing
consultant to Telegroup.
On October 28, 1997, the Company entered into a contract
with PeopleSoft, Inc. to provide the Company an integrated accounting system.
Additionally, the Company has contracted with KPMG to implement the new
software. The implementation of the software is expected to be completed by
the second quarter of 1998.
On November 10, 1997, the Company entered into a contract with
Saville Systems Inc. to provide the Company a complete billing and customer
support system. Although the Company believes that its current system is
adequate through 1998, the Company anticipates that the new system by Saville
will enhance the Company's billing and customer support capabilities.
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
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 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.
22
(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
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.
23
Item 6. Exhibits and Reports on Form 8-K.
- ------ --------------------------------
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
24
TELEGROUP, INC.
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)
4.1 Indenture for 8.0% Convertible Notes dated September 30,
1997
4.2 Indenture for 10.5% Senior Discount Notes dated October
23, 1997
27 Financial Data Schedule
25
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: November 14, 1997 By: /s/ Douglas Neish
-----------------------
Douglas Neish
Vice President and
Chief Financial Officer
Date: November 14, 1997 By: /s/ Gary Korf
-----------------------
Gary Korf
Controller