<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
-------------------------------------------------
Commission file number 0-20913
---------------------------------------------------------
TELEPORT COMMUNICATIONS GROUP INC.
- --------------------------------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-3173139
- --------------------------------------------------------------------------------
(STATE OF OTHER JURISDICTION OF (I.R.S. EMPLOYER
OR ORGANIZATION) IDENTIFICATION NO.)
437 RIDGE ROAD, EXECUTIVE BUILDING 3, DAYTON, NEW JERSEY 08810
- --------------------------------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(908) 392-2000
- --------------------------------------------------------------------------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- -----
Number of outstanding shares of Registrant's Common Stock as of August 7,
1997: 40,204,109 shares of Class A Common Stock and 125,274,632 shares of Class
B Common Stock.
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
(Unaudited) ----
-----------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 107,750 $ 277,540
----------- -----------
Marketable securities 361,930 440,806
----------- -----------
Accounts receivable:
Trade-net of allowance for doubtful accounts ($7,336 in
1997 and $5,989 in 1996) 71,158 46,325
Related parties 4,690 4,191
Miscellaneous-net of allowance for doubtful accounts
($185 in 1997 and $1,406 in 1996) 8,087 6,795
----------- -----------
Accounts receivable-net 83,935 57,311
----------- -----------
Subscription receivable (subsequently received) 3,080 --
----------- -----------
Prepaid expenses 10,648 9,531
----------- -----------
Other current assets 4,838 2,373
----------- -----------
Total current assets 572,181 787,561
----------- -----------
Fixed assets-at cost:
Communications network 1,465,209 1,211,922
Other 120,851 92,307
----------- -----------
1,586,060 1,304,229
Less accumulated depreciation and amortization (299,164) (236,967)
----------- -----------
Fixed assets-net 1,286,896 1,067,262
----------- -----------
Investment in and advances to unconsolidated affiliates 13,676 126,561
----------- -----------
Goodwill-net of accumulated amortization 266,383 57,764
----------- -----------
Other assets 21,021 10,949
----------- -----------
Total assets $ 2,160,157 $ 2,050,097
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities ($1,714 in 1997
and $1,079 in 1996 with related parties) 225,935 215,808
Current portion of capital lease obligations ($25,569 in
1997 and $21,139 in 1996 with related parties) 29,069 24,063
Other current liabilities 5,879 2,365
----------- -----------
Total current liabilities 260,883 242,236
Capital lease obligations ($21,601 in 1997 and $28,716 in 1996
with related parties) 27,355 34,489
TCI note-subordinated (including accrued interest of $2,029 in
1997 and $1,007 in 1996) 28,029 27,007
Long-term bank debt 52,575 --
Senior Notes 300,000 300,000
Senior Discount Notes 696,255 659,567
Unamortized notes costs (24,410) (25,761)
Other liabilities 15,274 15,689
----------- -----------
Total liabilities 1,355,961 1,253,227
----------- -----------
Stockholders' equity:
Common Stock, Class A $.01 par value: 450,000,000 shares
authorized, 40,188,368 shares issued and outstanding at
June 30, 1997; and 28,668,400 shares issued
and outstanding at December 31, 1996 402 287
Common Stock, Class B $.01 par value: 300,000,000 shares
authorized, 133,250,370 shares issued and outstanding at
June 30, 1997 and 139,250,370 shares issued and
outstanding at December 31, 1996 1,333 1,393
Additional paid-in capital 1,300,563 1,197,252
Unrealized gain (loss) on marketable securities 295 (25)
Accumulated deficit (377,372) (281,012)
----------- -----------
925,221 917,895
Less cost of Class B Common Stock held in treasury, 7,975,738
shares at June 30, 1997 and December 31, 1996 (121,025) (121,025)
----------- -----------
Total stockholders' equity 804,196 796,870
----------- -----------
Total liabilities and stockholders' equity $ 2,160,157 $ 2,050,097
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- -----------------------------
CONSOLIDATED COMBINED CONSOLIDATED COMBINED
1997 1996 1997 1996
------------ -------- ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Telecommunications services ($2,556
and $104 for the three months ended
June 30, 1997 and 1996 and $4,498 and $191
for the six months ended June 30, 1997
and 1996, respectively with related
parties) $ 115,664 $ 45,164 $ 212,508 $ 84,717
Management and royalty fees from affiliates - 11,923 - 22,805
----------- ---------- ----------- ----------
Total revenues 115,664 57,087 212,508 107,522
----------- ---------- ----------- ----------
Expenses:
Operating 67,627 33,421 124,964 62,336
Selling, general and administrative 39,363 15,578 72,734 29,380
Depreciation and amortization 37,255 14,110 67,011 26,959
----------- ---------- ----------- ----------
Total expenses 144,245 63,109 264,709 118,675
----------- ---------- ----------- ----------
Operating loss (28,581) (6,022) (52,201) (11,153)
----------- ---------- ----------- ----------
Interest:
Interest income 6,751 1,480 18,041 2,670
Interest expense ($1,700 and $5,498
for the three months ended June 30, 1997
and 1996, and $3,174 and $10,851 for the
six months ended June 30, 1997 and 1996
respectively with related parties) (28,743) (9,474) (58,251) (17,622)
----------- ---------- ----------- ----------
Total interest (21,992) (7,994) (40,210) (14,952)
----------- ---------- ----------- ----------
Loss before minority interest, equity in
losses of unconsolidated affiliates and income
tax provision (50,573) (14,016) (92,411) (26,105)
Minority interest - 706 - 856
Equity in losses of unconsolidated affiliates (243) (5,866) (2,833) (12,394)
----------- ---------- ----------- ----------
Loss before income tax provision (50,816) (19,176) (95,244) (37,643)
Income tax provision (516) (567) (1,116) (792)
----------- ---------- ----------- ----------
Net loss $ (51,332) $ (19,743) $ (96,360) $ (38,435)
=========== ========== =========== ==========
Loss per share $ (.31) $ (.27) $ (.59) $ ( .54)
=========== =========== ============ ==========
Weighted average number of shares
outstanding 164,860,699 72,930,110 163,271,950 71,465,125
=========== ========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
UNREALIZED
GAIN/(LOSS)
CLASS A CLASS B ADDITIONAL ON TOTAL
COMMON COMMON PAID-IN MARKETABLE ACCUMULATED TREASURY STOCKHOLDERS'
STOCK STOCK CAPITAL SECURITIES DEFICIT STOCK EQUITY
------- ------- --------- ---------- ----------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997 $ 287 $ 1,393 $1,197,252 $ (25) $ (281,012) $ (121,025) $ 796,870
Issuance of 662,885 shares of
Class A Common Stock upon
exercise of options 6 -- 9,875 -- -- -- 9,881
Issuance of 2,100,000 shares of
Class A Common Stock to purchase
CERFnet Services, Inc. 21 -- 47,386 -- -- -- 47,407
Issuance of 2,757,083 shares of
Class A Common Stock to purchase
controlling interest in Eastern
TeleLogic Corporation 28 -- 46,050 -- -- -- 46,078
Conversion of 6,000,000 shares of
Class B Common Stock to Class A
Common Stock 60 (60) -- -- -- -- --
Unrealized gain on marketable
securities -- -- -- 320 -- -- 320
Net loss -- -- -- -- (96,360) -- (96,360)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at June 30, 1997 $ 402 $ 1,333 $1,300,563 $ 295 $ (377,372) $ (121,025) $ 804,196
========== ========== ========== ========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
-----------------------------
CONSOLIDATED COMBINED
1997 1996
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (96,360) $ (38,435)
Adjustments to reconcile net loss to net cash
(used for) provided by operating activities, net of
effects of acquisitions:
Depreciation and amortization 67,011 26,959
Amortization of notes costs 1,351 -
Equity in losses of unconsolidated affiliates 2,833 12,394
Amortization of deferred credits (3,607) (1,183)
Provision for losses on accounts receivable 3,018 1,143
Accretion of discount on Senior Discount Notes 36,688 -
Accretion of TCI note 1,022 -
Minority interest - (856)
(Increase) decrease in operating assets and increase
(decrease) in operating liabilities:
Accounts receivable (25,633) (5,314)
Other assets (12,659) 434
Accounts payable and accrued liabilities (4,137) 14,004
Deferred credits 8,877 931
--------- --------
Net cash (used for) provided by
operating activities (21,596) 10,077
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (211,146) (75,436)
Investment in unconsolidated affiliates (5,116) (10,057)
Due from related parties - (23,037)
Purchase of a Local Market Partnership interest - (11,618)
Capital contributions to Local Market Partnerships
prior to Reorganization - (16,435)
Proceeds from sales and maturities of marketable
securities, net of purchases 79,196 -
Cash paid for acquisitions, net of cash acquired (6,258) -
--------- ---------
Net cash used for investing activities (143,324) (136,583)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt - 162,500
Principal payments on capital leases (10,273) (1,796)
Proceeds from the exercise of employee stock options 5,403 -
--------- ---------
Net cash (used for) provided by
financing activities (4,870) 160,704
--------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (169,790) 34,198
CASH AND CASH EQUIVALENTS, JANUARY 1 277,540 11,862
--------- ---------
CASH AND CASH EQUIVALENTS, JUNE 30 $ 107,750 $ 46,060
========== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION -
Cash paid during the period for interest $ 2,301 $ 4,508
========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
STATEMENTS OF CASH FLOWS - CONTINUED
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
CONSOLIDATED COMBINED
1997 1996
------------ ------------
<S> <C> <C>
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:
In February 1997, TCG purchased all of the assets and
liabilities of CERFnet Services, Inc. for TCG's
Class A Common Stock:
Fair value of 2,100,000 Class A Common Stock 47,407 $ --
Fair value of net assets acquired (2,980) --
--------- ---------
Goodwill recorded from non-cash transactions $ 44,427 $ --
========= =========
In March 1997, TCG purchased all of the assets and
liabilities of Eastern TeleLogic Corporation for TCG's
Class A Common Stock:
Fair value of 2,757,083 Class A Common Stock $ 46,078 $ --
Fair value of net liabilities acquired 121,232 --
--------- ---------
Goodwill recorded from non-cash transactions $ 167,310 $ --
========= =========
Fixed assets acquired under capital leases $ 6,725 $ 60
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(UNAUDITED)
1. BASIS OF PRESENTATION
In the opinion of the management of Teleport Communications Group Inc.
(together with its wholly-owned subsidiaries "TCG" or the "Company"), the
accompanying consolidated financial statements contain all adjustments,
consisting of only normal recurring adjustments, necessary to present fairly the
Company's financial position as of June 30, 1997 and the Company's results of
operations and cash flows for the six months then ended.
The results of operations for the six months ended June 30, 1997 are not
necessarily indicative of the results expected for the full year.
2. SIGNIFICANT ACCOUNTING POLICIES
Consolidation
The consolidated financial statements include the accounts of TCG's
wholly-owned subsidiaries at June 30, 1997. The 1997 consolidated statements of
operations and cash flows include equity in the losses of BizTel Communications,
Inc. for six months (See Note 6 - Acquisitions) and of Eastern TeleLogic
Corporation for two months. As of December 31, 1996, the consolidated balance
sheet includes the accounts of TCG and all wholly-owned subsidiaries. The 1996
combined statements of operations and of cash flows include equity in losses of
unconsolidated affiliates for all of the Local Market Partnerships except for
TCG St. Louis which was consolidated. (See Note 4 -Reorganization).
All material intercompany transactions and balances have been eliminated
in consolidation. Certain information and footnote disclosure normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. These financial statements
and notes should be read in conjunction with the financial statements of
Teleport Communications Group Inc. and Subsidiaries included as part of TCG's
Form 10-K for the year ended December 31, 1996 and TCG's Registration Statements
on Form S-1 (File Nos. 333-3850 and 333-3984).
Earnings Per Share
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings
per Share". This statement is effective for financial statements issued for
periods ending after December 15, 1997. Management has evaluated the effect on
its financial reporting from the adoption of this statement and does not believe
it to be significant.
Capital Structure
In February 1997, the FASB also issued SFAS No. 129 "Disclosure of
Information about Capital Structure". This statement is effective for financial
statements issued for periods ending after December 15, 1997. Management has
evaluated the effect on its financial reporting and as it contains no change in
disclosure requirements for entities that were previously subject to the
requirements of Accounting Principles Board Opinions 10 and 15 and SFAS 47, no
further disclosures are needed.
Comprehensive Income
In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive
Income". This statement is effective for financial statements issued for periods
ending after December 15, 1997. Management has evaluated the effect on its
financial reporting from the adoption of this statement and has found the
majority of required disclosures to be not applicable and the remainder to be
not significant.
7
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(UNAUDITED)
3. OFFERINGS
On June 27, 1996, TCG issued 27,025,000 shares of Class A Common Stock
which resulted in gross proceeds of approximately $432.4 million as part of an
initial public offering (the "Stock Offering"), and $300 million aggregate
amount of 9 7/8% Senior Notes and $1,073 million aggregate amount at maturity of
Senior Discount Notes (the "Notes Offerings" and collectively, with the Stock
Offering, the "Offerings"). The Notes Offerings resulted in aggregate gross
proceeds of $925 million. The gross proceeds of the Offerings (approximately
$1.3 billion) were received by TCG on July 2, 1996. TCG also recognized a
liability of approximately $46.8 million which was paid to the Underwriters on
July 2, 1996. In July 1996, the Company utilized a portion of the net proceeds
of the Offerings to (i) repay $250 million of bank indebtedness plus accrued
interest and (ii) purchase 7,975,738 shares of Class B Common Stock owned by
Continental Cablevision, Inc. for $16.00 per share, less related expenses, for a
net cost of $121 million. In addition, on October 25, 1996, TCG loaned
approximately $115 million to its affiliate Comcast CAP of Philadelphia, Inc.
("Comcast CAP"), as part of the first step in TCG's acquisition of Eastern
TeleLogic Corporation. The remaining funds will be used to expand and develop
existing and new networks, to make acquisitions and for general corporate and
working capital purposes.
4. REORGANIZATION
Prior to the Offerings, the Company was owned by subsidiaries of
Cox Communications, Inc. ("Cox") (approximately 30%), TCI Communications, Inc.
("TCI") (approximately 30%), Comcast Corporation ("Comcast") (approximately 20%)
and Continental Cablevision, Inc. ("Continental") (approximately 20%)
(collectively the "Cable Stockholders"). The business was operated through TCG,
and beginning in 1992, TCG Partners, which is a New York general partnership
owned prior to the Reorganization by the Cable Stockholders in the same
percentages as TCG. TCG Partners was formed to invest, with TCG, the Cable
Stockholders and other cable operators, in 14 partnerships (the "Local Market
Partnerships") to develop and operate local telecommunications networks. The
Local Market Partnerships were owned by TCG, and/or TCG Partners, and certain of
the Cable Stockholders which have cable operations in the particular markets
addressed by the Local Market Partnerships and, in some cases, other cable
operators in such markets. To simplify this complex ownership structure, TCG and
the Cable Stockholders agreed to consolidate the ownership of TCG Partners and
of the Local Market Partnerships as wholly-owned subsidiaries of TCG. As part of
this process, certain of the other cable operators agreed to sell their
interests in the Local Market Partnerships to TCG directly or through a Cable
Stockholder.
On May 13, 1996, in connection with the Reorganization, TCG purchased
the partnership interest of Hyperion Telecommunications, Inc. of Florida in TCG
South Florida for 11.6 million.
In consideration of the transfer by each of the Cable Stockholders of
its respective interests in TCG Partners and the Local Market Partnerships and
the contribution to TCG of $269 million of indebtedness plus accrued interest
from the Cable Stockholders (except that TCI retained $26 million subordinated
note of TCG), the Company issued, immediately prior to the Offerings, 69,250,230
additional shares of Class B Common Stock to the Cable Stockholders.
On July 2, 1996, TCG issued 576,263 shares of Class A Common Stock to
the unaffiliated minority partners of TCG Detroit in consideration for the
transfer to TCG of the remaining partnership interests in TCG Detroit.
In addition, on December 26, 1996, TCI was issued (i) 638,862 shares of
Class A Common Stock in consideration for the transfer on such date to TCG of
the partnership interests which TCI had acquired from
8
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(UNAUDITED)
MicroNet, Inc. in TCG San Francisco and (ii) 372,666 shares of Class A Common
Stock in consideration for the transfer on such date to TCG of the partnership
interests which TCI had acquired from Intermedia Partners in TCG San Francisco.
As a result, as of December 26, 1996, all of the Local Market Partnerships had
become wholly-owned subsidiaries of TCG.
As of June 30, 1997, TCI, Cox, Comcast and Continental owned 38.9%,
31.2%, 20.5% and 9.4%, respectively, of the Company's Class B Common Stock,
representing 37.8%, 30.2%, 19.8% and 9.1%, respectively, of the combined voting
power of the Company's Common Stock. As of June 30, 1997, TCG was owned 30.1%,
23.6%, 15.5%, 7.1% and 23.7% by TCI, Cox, Comcast, Continental and public
shareholders, respectively.
Unaudited financial information for the three and six months ended June
30, 1997 and unaudited pro forma financial information for the three and six
months ended June 30, 1996, as if the Reorganization had occurred January 1,
1996, is as follows (in thousands, except share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
ACTUAL PRO FORMA ACTUAL PRO FORMA
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues $ 115,664 $ 65,114 $ 212,508 $ 123,236
------------ ------------ ----------- -----------
Expenses:
Operating 67,627 40,647 124,964 77,117
Selling, general and administrative 39,363 22,119 72,734 42,792
Depreciation and amortization 37,255 22,872 67,011 44,154
------------ ------------ ----------- -----------
Total expenses 144,245 85,638 264,709 164,063
------------ ------------ ----------- -----------
Operating loss (28,581) (20,524) (52,201) (40,827)
------------ ------------ ----------- -----------
Interest:
Interest income 6,751 633 18,041 1,614
Interest expense (28,743) (5,446) (58,251) (10,935)
------------ ------------ ----------- -----------
Total interest (21,992) (4,813) (40,210) (9,321)
------------ ------------ ----------- -----------
Loss before minority interest, equity in
losses of unconsolidated affiliates and
income tax provision (50,573) (25,337) (92,411) (50,148)
Minority interest - 1,034 - 2,049
Equity in losses of unconsolidated
affiliates (243) (340) (2,833) (645)
------------ ------------ ----------- -----------
Loss before provision for income taxes (50,816) (24,643) (95,244) (48,744)
Income tax provision (516) (567) (1,116) (792)
------------ ------------ ----------- -----------
Net loss $ (51,332) $ (25,210) $ (96,360) $ (49,536)
============ ============ =========== ===========
Loss per share $ (.31) $ (.19) $ (.59) $ (.37)
============ ============ =========== ===========
Weighted average number of shares
outstanding 164,860,699 131,850,895 163,271,950 131,850,895
============ ============ =========== ===========
</TABLE>
Pro forma adjustments include the reversal of TCG's equity in the losses
of 13 Local Market Partnerships for the three and six months ended June 30,
1996, as well as amortization of the goodwill which was recorded upon closing of
the transactions and the reduction of interest expense from the conversion of
subordinated debt to parents to equity. The pro forma financial information
presented above is not necessarily indicative of the operating results which
would have been achieved had the transactions occurred at the beginning of the
periods presented or of the results to be achieved in the future.
9
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(UNAUDITED)
5. EMPLOYEE BENEFIT PLANS
TCG adopted the Teleport Communications Group Inc. Employee Stock
Purchase Plan (the "Stock Purchase Plan"), effective June 27, 1996. The Stock
Purchase Plan is administered by the Compensation Committee. Each eligible
employee was given an option to purchase 10% of such employee's compensation
plus bonus paid for the calendar year preceding the year the option is awarded,
divided by the purchase price per share under the option. No employee can
receive options for more than $25,000 worth of shares in any calendar year. The
purchase price for one share of Class A Common Stock is 15% below the initial
offering price of $16 or $13.60. The Board of Directors authorized the issuance
of 745,000 shares under the Stock Purchase Plan with the unused options expiring
on June 27, 1997. TCG issued shares of 584,686 shares of Class A Common Stock
pursuant to the exercise of options under the Stock Purchase Plan. Gross
proceeds of $4.9 million from the exercise of options under the Stock Purchase
Plan were received by TCG prior to June 30, 1997 and $3.1 million was received
during July 1997. The amounts received in July are classified as a subscription
receivable on the June 30, 1997 balance sheet.
6. ACQUISITIONS
BizTel Communications, Inc.
On July 28, 1997, the Company exercised an option to acquire the
remaining 50.1% equity interest in BizTel Communications Inc. ("BizTel") not
owned by it in exchange for the issuance of 1,667,631 shares of the Company's
Class A Common Stock. The Company had previously acquired a 49.9% interest in
BizTel in February 1996. On July 31, 1997, the Company and BizTel filed an
application with the Federal Communications Commission (the "FCC") seeking
approval of the acquisition of the remaining interest in BizTel. The closing of
this purchase is subject to regulatory approvals, including the approval of the
FCC. BizTel holds FCC licenses to provide telecommunications services utilizing
38 Ghz digital milliwave transmission in 206 geographic areas, which include
more than 95 of the 100 largest metropolitan markets and all markets where TCG
operates. BizTel's 38 Ghz milliwave services can be used by TCG to economically
connect customers to the Company's fiber optic networks, to provide network
redundancy, diverse routing or quick temporary installations and to provide
stand-alone facilities where the Company does not have fiber optic networks.
The goodwill recorded with this investment, which represented the excess
of the Company's investment over the underlying net assets of BizTel, was
approximately $7.4 million. Such amount is being amortized over 20 years
beginning March 1996 and is reported in the statement of operations in equity in
losses of unconsolidated affiliates. Amortization expense related to such
goodwill for the six months ended June 30, 1997 was $.2 million.
CERFnet Services, Inc.
On February 4, 1997, the Company acquired from General Atomics all the
outstanding capital stock of CERFnet Services, Inc. ("CERFnet"), a leading
regional provider of Internet-related services to businesses, including dial-up
and dedicated Internet access, World Wide Web hosting, and colocation services
and Internet training. TCG issued to CERFnet's former controlling stockholder
2,100,000 shares of its Class A Common Stock and granted to it certain
registration rights with respect to such shares of Class A Common Stock.
10
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(UNAUDITED)
The goodwill recorded with this investment, which represented the excess
of the Company's investment over the underlying net assets of CERFnet, was
approximately $44.4 million. Such amount is being amortized over 20 years and is
reported in the statement of operations in depreciation and amortization
expense. Amortization of the CERFnet goodwill for the six months ended June 30,
1997 was approximately $.9 million.
It is TCG's intention to more fully evaluate the acquired assets and
liabilities, and as a result, the allocation of the acquisition costs among the
tangible and intangible assets acquired with CERFnet may change.
Eastern TeleLogic Corporation
Effective as of March 1, 1997, TCG completed its previously announced
acquisition of Eastern TeleLogic Corporation ("ETC"). In the first of two steps,
on October 25, 1996, employees of ETC exercised their stock options and then ETC
redeemed the shares of its stock, (approximately 47%) not held by Comcast CAP of
Philadelphia Inc. ("Comcast CAP"), a corporation owned 51% by Comcast and 49% by
TCG. Comcast CAP borrowed at a market interest rate approximately $115 million
from TCG as a short-term loan and, in turn, loaned this amount to ETC to effect
the redemption. In the second step, TCG acquired Comcast's 51% stock interest in
Comcast CAP in exchange for 2,757,083 shares of the Company's Class A Common
Stock, resulting in ETC becoming a wholly-owned subsidiary of TCG. After the
acquisition, the name of ETC was changed to TCG Delaware Valley, Inc. TCG
assumed $53 million of long-term debt in this acquisition.
The goodwill recorded with this investment, which represented the excess
of the Company's investment over the underlying net assets of ETC, was
approximately $167.3 million. Such amount is being amortized over 20 years and
is reported in the statement of operations. Amortization expense related to such
goodwill for the six months ended June 30, 1997 was $3.9 million.
It is TCG's intention to more fully evaluate the acquired assets and
liabilities, and as a result, the allocation of the acquisition costs among the
tangible and intangible assets acquired with ETC may change.
Unaudited pro forma financial information for the six months ended June
30, 1997 and 1996, as if the Reorganization and the acquisitions of ETC and
CERFnet had occurred at the beginning of each of the respective periods, is as
follows (in thousands, except share amounts):
1997 1996
----------- ---------
Revenue $ 218,697 $ 137,954
Net loss $ (96,528) $ (49,202)
Loss per share $ (.59) $ (.36)
Weighted average number of shares
outstanding 164,847,226 136,707,978
Pro forma adjustments include (i) the reversal of TCG's equity in the
losses of ETC for the six months ended June 30, 1997 and the reversal of TCG's
equity in the losses of the 13 Local Market Partnerships and ETC for the six
months ended June 30, 1996, (ii) as well as amortization of the goodwill
recorded upon close of the transactions and (iii) the reduction of interest
expense from the conversion of subordinated debt to parents to equity. The pro
forma financial information presented above is not necessarily indicative of the
operating results which would have been achieved had the transactions occurred
at the beginning of the periods presented or of the results to be achieved in
the future.
11
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(UNAUDITED)
7. COMMITMENTS AND CONTINGENCIES
In April 1997, a complaint was filed against the Company in the Circuit
Court of Cook County, Illinois by two former customers of the Company and an
alleged class purporting to consist of investors in one of the customers,
alleging fraud, breach of contract and misappropriation of property. The Company
believes that the allegations are without merit and that it possesses
meritorious counterclaims for damages arising from breach of contract. The
Company additionally believes that any costs arising from this lawsuit will not
have a material adverse effect on its financial condition, results of operations
or cash flows.
8. SUBSEQUENT EVENTS
On June 2, 1997, pursuant to the Amended and Restated Stockholders'
Agreement of the Company (the "Stockholders' Agreement"), Continental converted
an additional 2,000,000 shares of Class B Common Stock into Class A Common Stock
and sold such shares in a private transaction pursuant to Rule 144 of the
Securities Act of 1933, as amended.
Pursuant to the Stockholders' Agreement, on July 2, 1997, Continental
delivered to the Company a request that the Company effect the registration of
10,285,592 shares of Class A Common Stock. As required by the Stockholders'
Agreement, Continental gave notice to the other Cable Stockholders of its
intention to convert 10,285,592 shares of Class B Common Stock into shares of
Class A Common Stock, and has given the remaining Cable Stockholders the right,
pursuant to the Stockholders' Agreement, to purchase these shares in lieu of
conversion. The remaining Cable Stockholders have not yet responded to this
offer. The Company has exercised its right under the Stockholders' Agreement to
defer such registration for three months.
On July 28, 1997, TCG, through a wholly-owned subsidiary, amended its
$250 million Revolving Credit Agreement to a $400 million Revolving Credit
Agreement (the "Revolving Credit Agreement"). TCG may, subject to the approval
of the lenders, incur up to $100 million of incremental facility with a maturity
date no earlier than March 31, 2006. The Revolving Credit Agreement is secured
by (i) the stock of the following wholly-owned subsidiaries of TCG: TC New York
Holdings I, Inc., TC New York Holdings II, Inc., TC Systems, Inc., TCG
Payphones, Inc. and the partnership interests in Teleport Communications
(collectively "TCGNY"), (ii) a negative pledge with respect to the assets and a
pledge of the stock of each existing and future subsidiary of TCGNY, (iii) a
negative pledge with respect to the TCGNY contracts that relate to TCGNY
operations, (iv) upstream guarantees from any existing and future subsidiaries
of TCGNY and (v) a lien on all present and future intercompany indebtedness
owned to TCGNY from TCG and all of its subsidiaries. The Revolving Credit
Agreement provides for interest based upon either the base rate or London
Interbank Offered Rate ("LIBOR"), adjusted. There is no outstanding balance as
of June 30, 1997.
The commitment will be reduced in equal quarterly installments according
to the following schedule:
YEAR AMOUNT
(in millions)
2000 $ 12.5
2001 35.0
2002 55.0
2003 70.0
2004 90.0
2005 100.0
2006 37.5
---------
$400.0
=========
12
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
- ---------------------
Revenue
Total revenues increased to $115.7 million and $212.5 million for the
three months and six months ended June 30, 1997 from $57.1 million and $107.5
million for the similar periods in 1996, representing increases of $58.6 million
and $105.0 million, or 103% and 98%, respectively. Pursuant to the
Reorganization, TCG consolidated the financial statements of the Local Market
Partnerships, which accounted for 37% and 38% of total revenue for the three and
six months ended June 30, 1997. Telecommunications services revenue increased to
$115.7 million and $212.5 million for the three months and six months ended June
30, 1997, from $45.2 million and $84.7 million for the three months and six
months ended June 30, 1996, representing increases of $70.5 million and $127.8
million, or 156% and 151%, respectively. The increases in revenue occurred in
every revenue category, most significantly switched services. These increases in
revenues are also a result of increased market penetration primarily in TCG's
existing markets as well as expansion into new markets. Total revenues for the
three months and six months ended June 30, 1997 include $11.9 and $17.0 million,
respectively, attributable to Eastern TeleLogic Corporation ("ETC") and CERFnet
Services, Inc. ("CERFnet"), which were acquired by TCG during the first quarter
of 1997 and consolidated with TCG from the dates of acquisition.
On a pro forma basis, had telecommunications services revenue generated
by unconsolidated Local Market Partnerships been included in the prior period's
financial statements, total revenues would have increased to $115.7 million and
$212.5 million for the three months and six months ended June 30, 1997 from
$65.1 million and $123.2 million for the three months and six months ended June
30, 1996, reflecting increases of $50.6 million and $89.3 million, or 78% and
72%, respectively. This revenue growth is a direct result of increased market
penetration of all telecommunications service offerings in existing markets and
the addition of new markets. Annualized monthly recurring revenue increased to
approximately $444.8 million for the month of June 30, 1997, from $245.9 million
on a pro forma basis for the comparable period in 1996, an increase of $198.9
million, or 81%. Monthly recurring revenue represents monthly service charges
billable to telecommunications services customers for the month indicated, but
excludes non-recurring revenues for certain one-time services, such as
installation fees or equipment charges.
Switched services revenue increased 91% and 87% for the three months and
six months ended June 30, 1997 from pro forma switched services revenue for the
similar periods in 1996. Switched services revenue represented 43% and 40% of
total pro forma revenue for the six months ended June 30, 1997 and 1996,
respectively. Increased monthly dedicated services revenue, as well as sales
growth in enhanced switched services products to new customers, also contributed
to overall revenue growth. Dedicated services revenue increased 61% and 56% for
the three months and six months ended June 30, 1997, from pro forma dedicated
services revenue for the similar periods in 1996.
Management fees were directly related to operating and administrative
support services provided by TCG to the Local Market Partnerships. Royalty fees
were charged to the Local Market Partnerships based on revenue. As a result of
the Reorganization, management and royalty fees from the Local Market
Partnerships are no longer reflected as revenue for the three months and six
months ended June 30, 1997, due to the consolidation of the Local Market
Partnerships.
Operating Expenses
TCG, in order to be consistent with industry standards, has reclassified
certain compensation and overhead expenses, related to engineering, customer
service and new technology, from selling, general and administrative to
operating expenses. Operating expenses increased to $67.6 million and $125.0
million for the three months and six months ended June 30, 1997, from $33.4
million and $62.3 million for the three months and six months ended June 30,
1996, increases of $34.2 million and $62.7 million, or 102% and 101%,
respectively. Pursuant to the Reorganization, TCG has consolidated the financial
statements of the Local Market Partnerships, the operating expenses of which
accounted for 38% of the total operating expenses for both the three months and
six months
13
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ended June 30, 1997. The remaining increases are directly related to
the costs associated with the expansion of TCG's networks. These expenses
include costs specifically associated with network operations, including
compensation costs for technical personnel, access, rights-of-way, node, rent
and maintenance expenses. Offsetting these expense increases are reductions in
expenses due to renegotiation of interconnection agreements with incumbent local
exchange carriers. Operating expenses increased to $67.6 million and $125.0
million for the three months and six months ended June 30, 1997, from $40.6
million and $77.1 million on a pro forma basis for the three months and six
months ended June 30, 1996, increases of $27.0 million and $47.9 million, or 67%
and 62%, respectively. Operating expenses were approximately 58% and 59% of
revenue for the three months and six months ended June 30, 1997, and 62% and 63%
of revenue on a pro forma basis for the three months and six months ended June
30, 1996.
Selling, General and Administrative Expenses
TCG, in order to be consistent with industry standards, has reclassified
certain compensation and overhead expenses related to engineering, customer
service and new technology, from selling, general and administrative to
operating expenses. Selling, general and administrative expenses increased to
$39.4 million and $72.7 million for the three months and six months ended June
30, 1997, from $15.6 million and $29.4 million for the three months and six
months ended June 30, 1996, increases of $23.8 million and $43.3 million, or
153% and 147%, respectively. Pursuant to the Reorganization, TCG has
consolidated the financial statements of the Local Market Partnerships, the
selling, general and administrative expenses of which accounted for 51% and 52%
of the total selling, general and administrative expenses for the three months
and six months ended June 30, 1997. The remaining increase is attributable to
the costs required to maintain an infrastructure which supports the continued
expansion of the Company's networks and the introduction of new services. These
costs include compensation, occupancy, insurance, professional fees, and sales
and marketing expenses. Selling, general and administrative expenses increased
to $39.4 million and $72.7 million for the three months and six months ended
June 30, 1997, from $22.1 million and $42.8 million on a pro forma basis for the
three months and six months ended June 30, 1996, increases of $17.3 million and
$29.9 million, or 78% and 70%, respectively. Selling, general and administrative
expenses were approximately 34% of revenue for both the three months and six
months ended June 30, 1997 and 34% and 35% of revenue on a pro forma basis for
the three months and six months ended June 30, 1996.
EBITDA
EBITDA (earnings before interest, taxes, depreciation, amortization,
minority interest and equity in losses of unconsolidated affiliates) increased
to $8.7 million and decreased to $14.8 million for the three months and six
months ended June 30, 1997, from $8.1 million and $15.8 million for the three
months and six months ended June 30, 1996, an increase of $.6 million and a
decrease of $1.0 million, respectively. Pursuant to the Reorganization, TCG has
consolidated the financial statements of the Local Market Partnerships, the
EBITDA of which accounted for 21% and 22% of total EBITDA for the three months
and six months ended June 30, 1997. EBITDA increased to $8.7 million and $14.8
million for the three months and six months ended June 30, 1997, from $2.3
million and $3.3 million on a pro forma basis for the three months and six
months ended June 30, 1996, increases of $6.4 million and $11.5 million,
respectively. The Local Market Partnerships, which are included in the pro forma
financial data to reflect the Reorganization, had negative EBITDA due to the
start-up or rapid expansion of the networks of such Local Market Partnerships.
Depreciation and Amortization Expense
Depreciation and amortization expense increased to $37.3 million and
$67.0 million for the three months and six months ended June 30, 1997, from
$14.1 million and $27.0 million for the three months and six months ended June
30, 1996, increases of $23.2 million and $40.0 million, or 165% and 148%,
respectively. These increases are primarily attributable to increased
depreciation related to the expansion of the Company's local telecommunications
networks throughout the country and increased amortization of goodwill related
to various 1996 and 1997 acquisitions. Depreciation and amortization expense
increased to $37.3 million and $67.0 million for the three months and six months
ended June 30, 1997, from $22.9 million and $44.2 million on a pro forma basis
for the three months and six months ended June 30, 1996, increases of $14.4
million and $22.8 million, or 63% and 52%.
14
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Interest Income
Interest income increased to $6.8 million and $18.0 million for the
three months and six months ended June 30, 1997, from $1.5 million and $2.7
million for the three months and six months ended June 30, 1996, increases of
$5.3 million and $15.3 million, respectively. These increases are attributable
to interest earned on the cash and cash equivalents and marketable securities
that resulted from the proceeds of the Offerings.
Interest Expense
Interest expense increased to $28.7 million and $58.3 million for the
three months and six months ended June 30, 1997, from $9.5 million and $17.6
million for the three months and six months ended June 30, 1996, increases of
$19.2 million and $40.7 million, respectively. These increases resulted from
interest on the Company's Senior Notes, Senior Discount Notes, the subordinated
note to TCI issued on June 27, 1996, and interest on the long-term bank debt
which TCG assumed in the acquisition of ETC, partially offset by the absence of
interest for the three and six months ended June 30, 1997 on the Revolving
Credit Agreement and borrowings under a loan facility with the Cable
Stockholders.
Equity in Losses of Unconsolidated Affiliates
Equity in losses of unconsolidated affiliates decreased to $.2 million
and $2.8 million for the three months and six months ended June 30, 1997 from
$5.9 million and $12.4 million for the three months and six months ended June
30, 1996, decreases of $5.7 million and $9.6 million, respectively. These
decreases resulted from the consolidation of the Local Market Partnerships and
ETC.
Net Loss
The Company's results for the three months and six months ended June 30,
1997, reflected a net loss of $51.3 million and $96.4 million, compared to a net
loss of $19.7 million and $38.4 million for the three months and six months
ended June 30, 1996, or increases of $31.6 million and $58.0 million,
respectively. These increases in net loss are attributable to the factors
discussed above. Net loss increased to $51.3 million and $96.4 million for the
three months and six months ended June 30, 1997 from $25.2 million and $49.5
million on a pro forma basis for the three months and six months ended June 30,
1996, or increases of $26.1 million and $46.9 million, respectively.
LIQUIDITY AND CAPITAL RESOURCES
TCG had total assets of approximately $2.2 billion and $2.1 billion as
of June 30, 1997 and December 31, 1996, respectively. At June 30, 1997 the
Company's current assets of approximately $572.2 million exceeded current
liabilities of $260.9 million, providing working capital of approximately $311.3
million. Network and equipment, net of depreciation, as of June 30, 1997,
aggregated approximately $1.3 billion.
TCG has invested the net proceeds from the Offerings in marketable
securities such as Treasury bills and commercial paper. TCG will utilize the
remaining net proceeds to expand its networks, for acquisitions and to provide
funds for working capital.
Effective as of March 1, 1997, TCG completed its previously announced
acquisition of ETC for 2,757,083 shares of its Class A Common Stock. The Company
loaned $115 million to ETC, the proceeds of which were used by ETC to redeem
shares of its stock held by certain minority stockholders. After the acquisition
the name of ETC was changed to TCG Delaware Valley, Inc.
In addition, as part of the acquisition of ETC, TCG assumed the related
credit facility. This facility, which ETC entered into in October 1995, is a $60
million credit facility (the "Facility") with certain banks. Initial borrowings
under the Facility of $37 million were principally used to repay existing
long-term debt, leases and certain subordinated convertible demand promissory
notes. The Facility provides for interest based upon either the
15
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
base rate, as defined, or London Interbank Offered Rate ("LIBOR"), adjusted
as defined in the Facility (7.4375% at June 30, 1997), which is payable
quarterly. The balance outstanding under the Facility was $52.6 million as of
June 30, 1997, and that amount, together with any additional balance, is due on
September 30, 1998.
Borrowings under the Facility are collateralized by substantially all of
the assets and outstanding common stock of TCG Delaware Valley, Inc. In
addition, the Facility contains certain restrictive covenants which, among other
things, require TCG Delaware Valley, Inc. to maintain certain debt service
coverage ratios and limit the payment of dividends and capital expenditures. In
addition, TCG Delaware Valley, Inc. is required to pay .375% per year on the
available portion of the Facility.
To finance TCG's capital expenditures, acquisitions, investments,
working capital and for other general corporate purpose, TCG's wholly-owned
subsidiary, TCG New York, Inc., amended its $250 million Revolving Credit
Agreement to a $400 million Revolving Credit Agreement on July 28, 1997. TCG
may, subject to the approval of the lenders, incur up to $100 million of
incremental facility with a maturity date no earlier than March 31, 2006. The
Revolving Credit Agreement is secured by (i) the stock of the following TCG
wholly-owned subsidiaries: TC New York Holdings I, Inc., TC New York Holdings
II, Inc., TC Systems, Inc., TCG Payphones, Inc. and the partnership interest in
Teleport Communications (collectively "TCGNY"), (ii) a negative pledge on the
assets and a pledge of the stock of each existing and future subsidiary of TCGNY
(iii) a negative pledge on the TCGNY contracts that relate to TCGNY operations
(iv) upstream guarantees from any existing and future subsidiaries of TCGNY and
(v) a lien on all present and future intercompany indebtedness owned to TCGNY
from TCG and all its subsidiaries. As of June 30, 1997, $250 million was
available to the Company.
The Revolving Credit Agreement contains various covenants and
conditions, including restrictions on additional indebtedness, maintenance of
certain financial ratios and limitations on capital expenditures. None of these
covenants negatively impact TCG's liquidity or capital resources at this time.
In addition, TCG is required to pay .375% per year on the available portion of
the Revolving Credit Agreement.
On July 28, 1997, the Company exercised an option to acquire the
remaining 50.1% equity interest in BizTel Communications Inc. ("BizTel") not
owned by it in exchange for the issuance of 1,667,631 shares of the Company's
Class A Common Stock. The Company had previously acquired a 49.9% interest in
BizTel in February 1996. On July 31, 1997, the Company and BizTel filed an
application with the Federal Communications Commission (the "FCC") seeking
approval of the acquisition of the remaining interest in BizTel. The closing of
this purchase is subject to regulatory approvals, including the approval of the
FCC.
The Company has incurred significant net operating losses resulting from
the development and operation of new networks which TCG expects will continue as
it expands its networks. Persistent demands from TCG's customers for capital
intensive local services drives the development, construction and expansion of
its networks. While cash provided by operations may be sufficient to fund modest
incremental growth it may not be sufficient to fund the extensive expansion and
development of networks as currently planned.
Net cash (used for) provided by financing activities for the six months
ended June 30, 1997 and 1996, was ($4.9) million and $160.7 million,
respectively, comprised primarily of principal payments on capital leases
partially offset by proceeds from the exercise of employee stock options for the
six months ended June 30, 1997, and borrowings under the Revolving Credit
Agreement for the six months ended June 30, 1996. Net cash (used for) provided
by operating activities was ($21.6) million and $10.1 million for the six months
ended June 30, 1997 and 1996, respectively. Net cash used for investing
activities was $143.3 million and $136.6 million for the six months ended June
30, 1997 and 1996, respectively. As of June 30, 1997, cash and cash equivalents
were $107.8 million and marketable securities were $361.9 million.
16
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TCG made capital expenditures (excluding acquisitions) of $217.6 million
and $127.0 million for the six months ended June 30, 1997 and June 30, 1996, on
a pro forma basis, respectively. The Company anticipates that capital
expenditures (excluding acquisitions) will be approximately $500 million in the
aggregate in 1997, primarily for the expansion, development and construction of
its networks, the acquisition and deployment of switches and the expansion of
operating support systems.
The Company believes that the net proceeds from the Offerings and the
amount of credit available under the Revolving Credit Agreement and the Facility
will be adequate for its 1997 funding requirements. The Company intends to
preserve financial flexibility in order to respond to the rapidly evolving
telecommunications marketplace. TCG will continue to take advantage of favorable
financing arrangements, including the sale of debt or equity securities in the
public markets, private placements, increasing the amount available under the
existing credit facilities or adding additional lines of credits.
The Company from time to time evaluates acquisitions and investments in
light of the Company's long range plans. The Company may have future
opportunities with certain of its Cable Stockholders to invest in additional
markets as a minority partner or shareholder as well as opportunities as a
managing partner or controlling shareholder in new or existing
telecommunications ventures which are consistent with the Company's business
plans. The Company expects to continue to build on its existing relationships
with cable television providers and other strategic customers, suppliers and
telecommunications carriers. Such acquisitions, investments and strategic
arrangements, if available, could use a material portion of the Company's
financial resources and may accelerate the need for raising additional capital
in the future.
Earnings before fixed charges were insufficient to cover fixed charges
for the six months ended June 30, 1997 and 1996, by $95.2 million and $38.5
million, respectively. On a pro forma basis, the Company's earnings would have
been insufficient to cover fixed charges by $50.5 million for the six months
ended June 30, 1996.
REGULATORY MATTERS
TCG is subject to extensive federal and state regulation. In most
states, the Company is subject to certification and tariff filing requirements
with respect to intrastate services. TCG is required to file tariffs for
interstate access services with the FCC, although such tariff requirements are
generally less restrictive than those imposed on incumbent local exchange
carriers ("ILECs") which offer similar services. An October 1996 FCC ruling
required federal tariffs for domestic interstate, interexchange services to be
canceled by September 22, 1997. The FCC's order has been temporarily stayed and
a number of parties have filed petitions with the FCC seeking reconsideration of
the FCC's decision. On June 19, 1997, the FCC adopted an Order that permits
competitive local exchange carriers ("CLECs") like the Company to voluntarily
withdraw their FCC tariffs for most interstate services. The Company has not
decided whether to withdraw its FCC tariff. On the same day, the FCC initiated a
further inquiry to determine whether to require that competitive local exchange
carriers like the Company withdraw their tariffs. While it is impossible to
predict what the FCC will do with this further inquiry, were the FCC to require
the withdrawal of the Company's tariffs and replacement of those tariffs with
contractual arrangements, TCG could incur substantial legal and administrative
expense.
Under the Telecommunications Act of 1996 (the "1996 Act") all local
exchange carriers, including TCG, must interconnect with other carriers, make
their services available for resale by other carriers, provide
non-discriminatory access to rights of way, offer reciprocal compensation for
termination of traffic and provide dialing parity and telephone number
portability. The Company, ILECs, other CLECs and long distance carriers, will
also be required to contribute some portion of their gross revenues (subject to
adjustments) to the support of universal service programs under the FCC's rules
implementing the universal service provisions of the 1996 Act, which were
adopted on May 7, 1997. TCG may also be eligible to receive funds from universal
service programs if the Company provides services to schools and libraries.
Several parties have sought judicial review of the FCC's universal service
rules.
On August 8, 1996, the FCC released both a First Report and Order and a
Second Report and Order and a Memorandum Opinion and Order in its CC Docket No.
96-98 (collectively, the "Interconnection Orders"). The Interconnection Orders
established a framework of minimum national standards and procedures to enable
State
17
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Public Utility Commissions and the FCC to begin implementing many of the
local competition provisions of the 1996 Act. On September 27, 1996, the FCC
issued an Order on Reconsideration of the First Report and Order in CC Docket
No. 96-98, in which it added a non-usage-sensitive charge to the rate for
unbundled switching and clarified that, as a practical matter, an Interexchange
Carrier may not lease unbundled switching for the provision of exchange access
service only. The new rules were scheduled to become effective on September 30,
1996. On October 15, 1996, however, the U.S. Court of Appeals for the Eighth
Circuit issued a stay of certain provisions of the rules pending its resolution
of numerous petitions for review filed by ILECs and others. Specifically, the
Court stayed the FCC's pricing rules and its "pick and choose" rule, which would
have allowed CLECs to receive the benefit of the most favorable provisions
contained in an ILEC's agreements with other carriers. On July 18, 1997, the
Court of Appeals held that the pricing rules and the "pick and choose" rule
exceeded the FCC's authority and were inconsistent with the terms of the 1996
Act. The Court also invalidated the FCC's rule requiring that interconnection
agreements negotiated prior to enactment of the 1996 Act be submitted to state
commissions for approval, and it held that the FCC had no authority to review or
enforce agreements approved by state regulators. The FCC has indicated that it
will ask the United States Supreme Court to review this decision of the Court of
Appeals. The Supreme Court previously rejected applications to vacate the stay
that had been imposed by the Court of Appeals, and it is impossible to predict
whether the Court will agree to review the decision or what the outcome of such
review would be.
On June 13, 1997 the FCC ordered certain ILECs to refund to certain
CLECs, including the Company, various overcharges by the ILECs for colocation
arrangements retroactive to December 1994. TCG is unable to estimate the
probable amount of this refund but the amount of any refund will not be material
to the Company's financial condition.
The matters discussed or incorporated by reference in this Form 10-Q
contain forward-looking statements, within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended, which are inherently uncertain.
Actual results and events may differ significantly from those discussed in such
forward-looking statements. In addition to other information discussed herein,
factors that might cause or contribute to such differences include the risks and
uncertainties set forth under the caption "Risk Factors" in the Prospectuses,
dated as of June 27, 1996, relating to the Stock Offering and to the Notes
Offerings, respectively, included in the Company's Registration Statements on
Form S-1 (File Nos. 333-3850 and 333-3984) and the matters set forth in the
Company's 1996 Annual Report on Form 10-K.
EFFECTS OF RECENT ISSUED ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings
per Share". This statement is effective for financial statements issued for
periods ending after December 15, 1997. Management has evaluated the effect on
its financial reporting from the adoption of this statement and does not believe
it to be significant.
In February 1997, the FASB also issued SFAS No. 129 "Disclosure of
Information about Capital Structure". This statement is effective for financial
statements issued for periods ending after December 15, 1997. Management has
evaluated the effect on its financial reporting and as it contains no change in
disclosure requirements for entities that were previously subject to the
requirements of Accounting Principles Board Opinions 10 and 15 and Statement 47,
no further disclosures are needed.
In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive
Income". This statement is effective for financial statements issued for periods
ending after December 15, 1997. Management has evaluated the effect on its
financial reporting from the adoption of this statement and has found the
majority of required disclosures to be not applicable and the remainder to be
not significant.
18
<PAGE>
PART II
OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
In April 1997, a complaint was filed against the Company in the Circuit
Court of Cook County, Illinois, (Case No. 97L001928) by two former customers of
the Company and an alleged class purporting to consist of investors in one of
the customers, alleging fraud, breach of contract and misappropriation of
property. The Company believes that the allegations are without merit and that
it possesses meritorious counterclaims for damages arising from breach of
contract. The Company additionally believes that any costs arising from this
lawsuit will not have a material adverse effect on its financial condition,
results of operations or cash flows.
ITEM 2: CHANGES IN SECURITIES
There were no reportable events during the quarter ended June 30, 1997.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
There were no reportable events during the quarter ended June 30, 1997.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 14, 1997, TCG held its Annual Meeting of Stockholders. In
addition to the election of Directors to serve for the ensuing year, the
shareholders (i) approved the appointment of Deloitte & Touche LLP as
independent auditors for TCG, (ii) approved the 1997 Employee Stock Purchase
Plan and (iii) approved the Restricted Stock and Bonus Plan.
Each share of Class A Common Stock entitles the holder to one vote and
each share of Class B Common Stock entitles the holder to 10 votes on each
matter to be voted upon by the holders of the Common Stock.
The following votes were cast for each of the following nominees for
Director or were withheld with respect to such nominees:
Class A Class B
------------------------ -------------------------
For Withheld For Withheld
--- -------- --- --------
Robert Annunziata 32,827,129 220,076 1,272,746,320 0
Brendan R. Clouston 32,702,329 344,876 1,272,746,320 0
John R. Dillon 32,820,329 226,876 1,272,746,320 0
Gerald W. Gaines 32,819,629 227,576 1,272,746,320 0
Jimmy W. Hayes 32,822,629 224,576 1,272,746,320 0
James Bruce Llewellyn 32,866,166 181,039 1,272,746,320 0
James O. Robbins 32,822,429 224,776 1,272,746,320 0
Brian L. Roberts 32,704,529 342,676 1,272,746,320 0
C.B. Rogers, Jr. 32,865,266 181,939 1,272,746,320 0
Larry E. Romrell 32,702,929 344,276 1,272,746,320 0
Lawrence Smith 32,874,029 173,176 1,272,746,320 0
Bernard W. Schotters 32,822,729 224,476 1,272,746,320 0
David M. Woodrow 32,822,329 224,876 1,272,746,320 0
19
<PAGE>
The following votes were cast with respect to the proposal to approve
the appointment of Deloitte & Touche LLP as independent auditors of TCG for
1997:
Class A Class B
------- -------
For 32,750,237 1,134,890,400
Against 262,646 0
Abstain 34,322 137,855,920
The following votes were cast with respect to the proposal to approve
the 1997 Employee Stock Purchase Plan:
Class A Class B
------- -------
For 26,790,435 1,134,890,400
Against 844,142 0
Abstain 53,563 137,855,920
Broker no votes 5,359,065 0
The following votes were cast with respect to the proposal to approve
the Restricted Stock and Bonus Plan:
Class A Class B
------- -------
For 19,055,930 1,134,890,400
Against 8,561,977 0
Abstain 70,233 137,855,920
Broker no votes 5,359,065 0
ITEM 5: OTHER INFORMATION
There were no reportable events during the quarter ended June 30, 1997.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits:
Exhibit No.
- -----------
*2.1 Reorganization Agreement, dated as of April 18, 1996
*3.6 Amended and Restated Certificates of Incorporation of TCG, as revised
*3.7 Amended and Restated By-laws of TCG, as revised
*4.2 Form of Amended and Restated Stockholders' Agreement (incorporated
by reference to Exhibit E of Exhibit 2.1 hereof)
*4.3 Form of Indenture between TCG and United States Trust Company of New
York, as Trustee, relating to the 11 1/8% Senior Discount Notes
due 2007 of TCG
*4.4 Form of Indenture between TCG and United States Trust Company of New
York, as Trustee, relating to 9 7/8% Senior Notes due 2006 of TCG
*4.5 From of Stock Certificate for Teleport Communications Group, Inc.
*10.1 New York Franchise Agreement, dated May 2, 1994, as amended
*10.2 Participation Agreement, dated May 15, 1984
*10.3 Agreement of Lease, dated May 15, 1984, as amended
*10.4 Keepwell Agreement, dated June 7, 1984, as amended
*10.5 Agreement of Lease with Teleport Associates, dated November
10, 1987
*10.6 Agreement of Sublease between Merrill Lynch/WFC/L, Inc. and TC
Systems, Inc. dated January 30, 1990
*10.7 Loan Agreement, dated May 5, 1993
20
<PAGE>
*10.8 Amendment No. 1 to Loan Agreement, dated March 1, 1994
*10.9 Amendment No. 2 to Loan Agreement, dated October 23, 1994
*10.10 Amendment No. 3 to Loan Agreement, dated February 15, 1995
*10.11 Loan Agreement, dated May 22, 1995 and related documents
*10.12 Amendment No. 1 to Loan Agreement, dated May 31, 1996
*10.13 Teleport Communications Group Inc. 1992 Unit Appreciation Plan
*10.14 Teleport Communications Group Inc. 1993 Unit Appreciation Plan
*10.15 Teleport Communications Group Inc. 1993 Stock Option Plan, as amended
*10.16 Form of Teleport Communications Group Inc. Employee Stock Purchase
Plan
*10.17 Deferred Compensation Plan of Teleport Communications Group Inc.
*10.18 Make-up Plan of Teleport Communications Group Inc. for the Retirement
Savings Plan
*10.19 Teleport Communications Group Inc. 1996 Equity Incentive Plan
*10.20 Robert Annunziata Employment Agreement, dated December 18, 1992, as
amended
*10.21 John A. Scarpati Employment Agreement, dated July 12, 1994, as
amended
*10.22 Robert C. Atkinson Employment Agreement, dated July 12, 1994, as
amended
*10.23 Stuart A. Mencher Employment Agreement, dated July 12, 1994, as
amended
*10.24 Alf T. Hansen Employment Agreement, dated July 12, 1994, as amended
*10.25 Partnership Agreement of TCG Detroit, dated as of November 1, 1993
*10.26 Amended and Restated Partnership Agreement of TCG Los Angeles, dated
as of March 1, 1994
*10.27 Partnership Agreement of TCG Pittsburgh, dated as of March 1, 1994
*10.28 Partnership Agreement of TCG San Diego, dated as of June 1, 1994
*10.29 Partnership Agreement of TCG San Francisco, dated as of January 1,
1994, as amended
*10.30 Partnership Agreement of TCG Seattle, dated as of January 1, 1994,
as amended
*10.31 Agreement among Teleport Communications Group Inc. and Comcast
Corporation, dated April 18, 1996
*10.32 First Amendment to the Teleport Communications Group Inc. 1993 Stock
Option Plan
*10.33 Second Amendment to the Teleport Communications Group Inc. 1993 Stock
Option Plan
*10.34 Letter of Intent between Viacom Telecom, Inc. and Teleport
Communications Group Inc., dated as of May 30, 1996.
*10.35 Letter of Intent between Viacom Telecom, Inc. and Teleport
Communications Group Inc., dated as of May 30, 1996
*10.36 First Amendment to the Teleport Communications Group Inc. 1996 Equity
Incentive Plan
*10.37 Stockholders' Agreement of Comcast CAP of Philadelphia, Inc. dated as
of June 30, 1993
**10.38 Teleport Communications Group Inc. 1997 Employee Stock Purchase Plan
***10.39 Teleport Communications Group Inc. Restricted Stock and Bonus Plan
11.00 Computation of Loss Per Common Share
27.00 Financial Data Schedule
*Incorporated by reference to the corresponding exhibit of TCG's Registration
Statements on Form S-1 (File Nos. 333-3850 and 333-3984).
**Incorporated by reference to the corresponding exhibit of TCG's Registration
Statement on Form S-8 (File No. 333-30571).
***Incorporated by reference to the corresponding exhibit of TCG's Registration
Statement on Form S-8 (File No. 333-30569).
B. Reports on Form 8-K:
The following report on Form 8-K was filed during the Company's quarter
ended June 30, 1997.
An Item 7, report on Form 8-K/A was filed on May 22, 1997, to amend the
previously filed Item 2 report on Form 8-K, dated March 20, 1997, to report that
based on analysis of ETC's audited financial statements for 1996, the Company,
after discussion with its independent auditors, determined that ETC's audited
financial statements and unaudited pro forma financial statements reflecting the
acquisition of ETC were not required.
An Item 5 report on Form 8-K, dated August 6, 1997, was filed reporting
the Company's financial results for the fiscal quarter ended June 30, 1997.
21
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf of the
undersigned, thereunto duly authorized.
TELEPORT COMMUNICATIONS GROUP INC.
Dated: August 12, 1997
By: /s/ John A. Scarpati
----------------------------
Name: John A. Scarpati
Title: Senior Vice President and
Chief Financial Officer
Dated: August 12, 1997 By: /s/ Maria Terranova-Evans
---------------------------------
Name: Maria Terranova-Evans
Title: Vice President and Controller
(Principal Accounting Officer)
22
<PAGE>
EXHIBIT 11
TELEPORT COMMUNICATIONS GROUP INC.
COMPUTATION OF LOSS PER SHARE
THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
CONSOLIDATED COMBINED CONSOLIDATED COMBINED
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss $(51,332,000) $(19,743,000) $96,360,000 $(38,435,000)
============= ============= =========== =============
Primary loss per common share:
Weighted average number of shares
outstanding 164,860,699 72,930,110 163,271,950 71,465,125
============= ============= =========== =============
Loss per share $ (.31) $ (0.27) $ (.59) $ (0.54)
============= ============= =========== =============
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
Financial Statement Data
As of and For the Period Ended June 30, 1997
(In Thousands, Except Share Data)
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997
<CASH> 107,750
<SECURITIES> 361,930
<RECEIVABLES> 73,868
<ALLOWANCES> 7,336
<INVENTORY> 0
<CURRENT-ASSETS> 572,181
<PP&E> 1,586,060
<DEPRECIATION> 299,164
<TOTAL-ASSETS> 2,160,157
<CURRENT-LIABILITIES> 260,883
<BONDS> 1,108,873
0
0
<COMMON> 1,735
<OTHER-SE> 923,191
<TOTAL-LIABILITY-AND-EQUITY> 2,160,157
<SALES> 0
<TOTAL-REVENUES> 115,664
<CGS> 0
<TOTAL-COSTS> 67,627
<OTHER-EXPENSES> 37,255
<LOSS-PROVISION> 2,049
<INTEREST-EXPENSE> 28,743
<INCOME-PRETAX> (50,816)
<INCOME-TAX> 516
<INCOME-CONTINUING> (51,332)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (51,332)
<EPS-PRIMARY> (.31)
<EPS-DILUTED> (.31)
</TABLE>
