UNITED STATES
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 __________ to _________
Commission file number: 0-28668
________________________________________________________________
TELCO COMMUNICATIONS GROUP, INC.
(Exact name of registrant as specified in its charter)
________________________________________________________________
Virginia 54-1674283
(State or other jurisdiction of I.R.S. Employer Identification No.)
incorporation or organization)
4219 Lafayette Center Drive, Chantilly, Virginia 20151-1209
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (703) 631-5600
Indicate by check mark whether the registrant (1) had 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 ___
The number of outstanding shares of the registrant' Common Stock, no par value,
was 33,130,942 on August 1, 1997.
Exhibit Index on Page 17
<PAGE>
TELCO COMMUNICATIONS GROUP, INC.
FORM 10-Q
For the Quarter Ended June 30, 1997
Table of Contents
Page
PART I - FINANCIAL INFORMATION Number
Item 1. Financial Statements
Consolidated Balance Sheets as of
December 31, 1996 and June 30, 1997 3
Consolidated Statements of Income
for the three months and six months
ended June 30, 1997 and 1996 4
Consolidated Statement of Shareholders'
Equity for the six months ended
June 30, 1997 and the year ended 5
December 31, 1996
Consolidated Statements of Cash Flows
for the six months ended
June 30, 1997 and 1996 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II - OTHER INFORMATION
Item 1-6. 16
Signatures 19
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
<TABLE>
<CAPTION>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except share data)
December 31, June 30,
1996 1997
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 25,373 13,233
Accounts receivable, trade(net of 89,114 107,640
allowances of $7,972 and
$5,807, respectively)
Prepaid income taxes 2,394 --
Deferred tax asset 357 898
Other 8,947 10,242
--------------- ----------------
Total current assets 126,185 132,013
--------------- ----------------
PROPERTY, PLANT AND EQUIPMENT
Leasehold improvements 2,189 2,405
Network equipment 34,749 178,924
Office furniture and equipment 5,474 7,858
Network facilities under
development 7,375 19,097
Less accumulated depreciation (10,121) (15,516)
--------------- ----------------
39,666 192,768
--------------- ----------------
OTHER ASSETS
Goodwill 43,663 42,803
Deferred tax asset -- 2,383
Other assets 1,082 3,756
--------------- ----------------
44,745 48,942
=============== ================
Total assets $ 210,596 $ 373,723
=============== ================
LIABILITES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Capital lease obligation,
current portion $ 681 681
Current portion of
long-term debt --- 6,250
Excise taxes payable 3,103 3,342
Accounts payable 21,062 23,772
Accrued network access 21,450 28,211
and transmission expense
Other accrued expenses 12,670 14,235
Income taxes payable -- 5,584
Deferred revenue -- 3,916
Deferred taxes payable current 1,225 1,225
--------------- ---------------
Total current liabilities 60,191 87,216
--------------- ---------------
LONG TERM LIABILITIES
Long-term debt -- 112,750
Capital lease obligations, 2,620 2,371
less current portion
Deferred revenue -- 6,522
Deferred taxes 2,065 2,977
--------------- ----------------
Total long term liabilities 4,685 124,620
--------------- ----------------
<PAGE>
COMMITMENTS AND CONTINGENCIES (NOTE 7)
SHAREHOLDERS' EQUITY
Common stock (no par, 150,000,000
shares authorized 32,754,869 and
33,130,942 shares outstanding) 111,309 111,985
Preferred stock (15,000,000 shares -- --
authorized, unissued)
Accumulated deficit (1,247) (1,247)
Unrealized gain on marketable 10 61
securities, net of tax
Retained earnings 35,648 51,088
--------------- ----------------
Total Shareholders' Equity 145,720 161,887
--------------- ----------------
Total Liabilities and
Shareholders' Equity $ 210,596 373,723
=============== ================
</TABLE>
See accompanying notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share data)
Three months ended June 30, Six months ended June 30,
1996 1997 1996 1997
<S> <C> <C> <C> <C>
Revenues, net $ 104,078 $ 138,774 $ 196,006 $ 261,627
Cost of services 60,802 79,649 115,532 152,068
----------- ---------- ------------ -------------
Gross margin 43,276 59,125 80,474 109,559
----------- ---------- ------------ -------------
Operating expenses:
Selling, general
and administrative 31,539 39,396 59,402 76,566
Depreciation and
amortization 1,872 3,649 3,305 6,263
----------- ----------- ----------- --------------
Total operating
expenses 33,411 43,045 62,707 82,829
----------- ----------- ----------- -------------
Operating income
9,865 16,080 17,767 26,730
----------- ----------- ----------- -------------
Interest expense 1,122 2,910 2,188 3,073
Other income 105 548 117 1,168
Income taxes 3,542 5,138 6,676 9,385
Minority interest 120 -- 554 --
=========== =========== ============ ============
Net income $ 5,186 $ 8,580 $ 8,466 $ 15,440
=========== =========== ============ ============
Net income per $ 0.18 $ 0.25 $ 0.30 $ 0.45
common and common
equivalent share
Average common and
common equivalent
shares 28,345 34,550 28,345 34,392
See accompanying notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the six months ended June 30, 1997 and the year ended December 31, 1996
(unaudited)
(in thousands)
Accumulated
Deficit
Remaining Upon Unrealized
Termination of Gain on
Common S-Corporation Retained Securities
Stock Election Earnings Held for Sale
--------- -------------- ---------- -------------
<S> <C> <C> <C> <C>
BALANCE DECEMBER 31, 1995 $ 896 $ (1,247) $12,771 --
Issuance of common shares 59,912 -- -- --
Loans to option holders (584) -- -- --
Purchase of subsidiary 47,725 -- -- --
Proceeds from exercise
of options 840 -- -- --
Tax benefit from net 2,520 -- -- --
warrant activity
Change in unrealized gain on -- -- -- 10
securities available for sale
Net income -- -- 22,877 --
-------- --------- ---------- ----------
BALANCE DECEMBER 31, 1996 111,309 (1,247) 35,648 10
Proceeds from exercise
of options 676 -- -- --
Change in unrealized gain
on securities available -- -- -- 51
for sale
Net income -- -- 15,440 --
========== ========== ========= ==========
$ 111,985 $ (1,247) $ 51,088 $ 61
========== ========== ========= ==========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
For the six months ended June 30,
1996 1997
<S> <C> <C>
Cash Flows From (Used For) Operations:
Net income $ 8,466 $ 15,440
Adjustments to reconcile net income to net
cash from (used for) operating activities:
Depreciation and amortization 3,294 6,263
Minority interest 554 --
Loss on disposal of fixed assets -- 8
Deferred income taxes 604 (2,012)
Changes in current assets and liabilities:
Trade accounts receivable (26,601) (18,526)
Prepaid and other assets (2,944) (1,524)
Accounts payable 1,100 2,710
Accrued expenses 10,122 8,565
Deferred income -- 10,438
Income taxes payable 230 5,584
------------ --------------
Net cash from (used for) operating
activities (5,175) 26,946
------------ --------------
Cash Flows From (Used For)
Investing Activities:
Purchase of equipment (2,776) (187,539)
Proceeds from sale of equipment -- 29,026
Investments, net of cash acquired (344) --
------------ --------------
Net cash used for (3,120) (158,513)
investing activities ------------ --------------
Cash Flows From (Used For)
Financing Activities:
Proceeds from the line of credit 16,374 161,000
Payments on line of credit -- (42,000)
Payments on capital leases (1,516) (249)
Proceeds from exercise of options -- 676
------------ ----------------
Net cash from financing activities 14,858 119,427
------------ ----------------
Increase (decrease) in cash 6,563 (12,140)
Cash, beginning of the period 937 25,373
------------ ----------------
Cash, end of the period $ 7,500 $ 13,233
============ ================
</TABLE>
See accompanying notes to Consolidated Financial Statements.
<PAGE>
TELCO COMMUNICATIONS GROUP, INC.
Notes to Consolidated Financial Statements
(unaudited)
NOTE 1. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The interim consolidated financial statements included herein have been prepared
by Telco Communications Group, Inc. (the "Company"), without audit, pursuant to
the rules and regulations of the Securities and Exchange Commission ("SEC"). All
adjustments have been made to the accompanying interim consolidated financial
statements which are, in the opinion of the Company's management, necessary for
a fair presentation of the Company's financial position, operating results and
cash flows for the periods presented. All adjustments are of a normal recurring
nature. Certain information footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted pursuant to the SEC's rules and regulations. It is recommended
that these interim consolidated financial statements be read in conjunction with
the consolidated financial statements and the notes thereto contained in the
Company's Annual Report on Form 10-K for the year ended December 31, 1996.
The results of operations for the three months and six months ended June 30,
1997 are not necessarily indicative of the results to be expected for the full
year.
NOTE 2. STATEMENT OF CASH FLOWS
Cash payments and non-cash activities for the six months ended June 30, were as
follows:
1996 1997
Cash payments for income taxes $ 5,919,814 $ 5,786,423
Cash payments for interest $ 2,177,545 $ 2,928,601
Non cash investing and financing activities:
Assets acquired in connection
with acquisitions $ 16,640,421
Liabilities assumed in connection
with acquisitions $ 15,697,563
Common stock issued in connection
with acquisitions $ 120
Capital lease obligations incurred $ 3,083,516
NOTE 3. CHANGE IN ACCOUNTING STANDARD
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 "Earnings Per Share". This new standard
requires dual presentation of basic and diluted earnings per share ("EPS") on
the face of the earnings statement and requires a reconciliation of the
numerators and denominators of basic and diluted EPS calculations. This
statement will be effective for the Company's 1997 fiscal year. The Company's
current EPS calculation conforms to the diluted EPS. Basic EPS is not expected
to be materially different from diluted EPS since potential common shares in the
form of stock options are not materially dilutive.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income". This
statement establishes standards for the reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
The effect of adopting the new standard is not expected to be significant as the
Company does not currently have material items of other comprehensive income
disclosed outside of the statement of operations. The standard will be adopted
for the Company's 1998 fiscal year.
Also in June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information". The statement requires enterprises to
report financial and descriptive information about its reportable operating
segments, products and services, countries and major customers, as well as
reconciliations of segment financial information to corresponding amounts in the
general purpose financial statements. The Company anticipates that its pending
transaction with Excel Communications, Inc. may ultimately affect its decisions
regarding the nature of reportable operating segments, products and customer
classes when the statement is adopted in the 1998 fiscal year (see Note 6).
NOTE 4. LONG-TERM AND OTHER DEBT
On April 15, 1997, the Company's existing credit facility was amended to
increase the maximum amount available for borrowing to $200 million, in
conjunction with the Company's acquisition of certain voice network assets (the
"New Credit Facility"). Borrowings under the New Credit Facility are subject to
various financial convenants and ratios.
NOTE 5. NETWORK AND PROPERTY ACQUISITIONS
On April 15, 1997, the Company purchased the voice network assets of Advantis, a
data and voice network partnership of International Business Machines
Corporation and Sears, Roebuck and Co., for $170 million. The purchase includes
long-term service rights to approximately 100,000 network miles of DS-3 fiber
optic capacity (under a long-term right to use agreement), Nortel DMS 250
switches and other ancillary network equipment in five switch locations and 17
other locations. The Company borrowed $146 million under its New Credit Facility
(see Note 4) to finance the transaction. On June 24, 1997, the Company sold for
$38 million the Nortel DMS 250 switches and associated equipment acquired in the
Advantis transaction located in the five switch sites, including a multi-year
lease for a portion of its fiber optic capacity.
On June 10, 1997, the Company acquired real property for $6.4 million. The
property will be used for expansion purposes.
NOTE 6. PROPOSED MERGER
On June 5, 1997, the Company entered into a merger agreement with Excel
Communications, Inc. ("Excel"). Under the terms of the agreement, each share of
Telco's common stock will be exchanged for $15.00 of cash and 0.7595 shares of
common stock in a newly formed holding company, and each share of Excel's common
stock will be exchanged for one share of the new holding company. The merger
will be accounted for as a purchase of Telco by Excel and is expected to be
completed by year-end, subject to the approval by the shareholders of each
company, the approval of the Federal Communications Commission and various state
authorities and other customary conditions.
NOTE 7. COMMITMENTS AND CONTINGENCIES
The Company is a party from time to time to litigation in the ordinary course of
business including employment related litigation. No provision has been
reflected in the accompanying financial statements for any litigation. Based
upon information presently available, management believes the final deposition
of these items will not have an adverse material effect on operations or the
financial position of the Company. For additional discussion, see Part II Other
Information, Item 1. Legal Proceedings.
During 1996, the Company entered into employment and consulting agreements with
certain members of management. The agreements provide for the employees to
receive amounts not less than specified base annual salaries through the terms
of the agreements, which have terms of one to five years. Certain of the
contracts also include non-competition covenants and options to purchase shares
of the Company's common stock.
<PAGE>
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
FORWARD LOOKING INFORMATION
Statements in this report concerning future results, performance, achievements,
expectations or trends, if any, are forward-looking statements. Actual results,
performance, achievements, events or trends could differ materially from those
expressed or implied by such forward-looking statements as a result of known and
unknown risks, uncertainties and other factors including those described below
and those identified in the Company's other filings with the Securities and
Exchange Commission.
INTRODUCTION
Telco Communications Group, Inc. and its wholly owned subsidiaries (collectively
"Telco" or the "Company") is a rapidly growing facilities-based provider of
domestic and international long distance telecommunication services to
residential, commercial and wholesale customers in the United States. The
majority of the Company's current revenues are generated by customers accessing
the Telco network by dialing a unique five digit Carrier Identification Code
("CIC") before dialing the number they are calling. Using a CIC Code to access
the Company's network is known as "dial around" or "casual calling" because
customers can use the Company's services at any time without changing their
existing presubscribed long distance carrier. The Company markets its
residential long distance services through marketing subsidiaries under two
brands, each with a unique CIC Code: Dial & Save (CIC Code 10457) and the Long
Distance Wholesale Club ("LDWC") (CIC Code 10297), and prices its services
primarily at a discount to the basic "1 plus" rates offered by the three major
long distance carriers: AT&T, MCI and Sprint. During June 1997, the Company
provided long distance services to approximately 2.0 million customers (switched
access lines) in 48 states and the District of Columbia. All dial around
operations are conducted through marketing subsidiaries that are referred to
collectively as the Consumer Division. Consumer Division revenues were $99.2
million for the three months ended June 30, 1997, and accounted for
approximately 71.5% of total revenues.
To increase its volume of call traffic, Telco has been marketing long distance
telecommunications products utilizing its daytime network capacity to commercial
and carrier customers through its Commercial Sales Division ("CSD"). Because the
Company's existing customer base is primarily residential, the majority of calls
are handled during off-peak evening and weekend periods. As of June 30, 1997,
CSD had opened 31 sales offices and employed approximately 400 sales personnel.
For the three months ended June 30, 1997, CSD revenues, which includes both
switched and private line revenues from commercial and wholesale customers, were
$38.9 million, or approximately 28.0% of total revenues.
The Company bills its Consumer Division customers through local exchange carrier
("LEC") billing and collection agreements which enable the Company to place its
charges on the monthly local phone bills of its casual calling customers. The
Company has agreements with LECs, including all of the regional Bell-operating
companies, that cover the vast majority of the switched access lines in the
United States. The Company believes that these billing arrangements are the most
effective mechanism for billing the Company's residential customers, because of
the convenience to its customers of receiving one bill for both local and long
distance service and the benefits derived from the LECs' extensive collections
infrastructure. The Company's billing information systems and services are
provided by Tel Labs, Inc. ("Tel Labs"), a telecommunications billing company
started in 1991 by Telco's Chairman of the Board and acquired by the Company in
August 1996. Tel Labs revenues from third parties were $0.7 million, or 0.5% of
total revenues, for the three months ended June 30, 1997.
The Company's switch-based network currently consists of six DSC DEX 600S, 600
and 600E switches located in Washington, D.C.; Fort Lauderdale, Florida;
Davenport, Iowa; Chattanooga, Tennessee; Austin, Texas; and Las Vegas, Nevada.
Additionally, the Company is currently installing a DEX 600E switch in the New
York City metropolitan area and has taken receipt of an eighth switch to be
installed later in 1997 in a yet undetermined location.
On April 15, 1997, the Company completed its acquisition of the voice network
assets of Advantis for $170 million. The Advantis assets include approximately
100,000 network miles of DS-3 fiber optic capacity (under a long term right to
use agreement), Nortel DMS 250 switches and other ancillary network equipment in
22 locations (including five switch site locations). The Company has received
commitments to lease portions of the network to third party customers under long
term agreements ("private line revenue"). The remaining capacity will either be
leased to third parties or be integrated into the Company's existing network
consisting of leased fiber optic capacity and owned switches. On June 24, 1997,
the Company sold for $38 million, the Nortel DMS 250 switches and associated
equipment acquired in the Advantis transaction located in the five switch sites
and a multi-year lease for a portion of its fiber optic capacity.
On June 5, 1997, the Company entered into a merger agreement with Excel
Communications, Inc. ("Excel"). Under the terms of the agreement, each share of
Telco's common stock will be exchanged for $15.00 of cash and 0.7595 shares of
common stock in a newly formed holding company, and each share of Excel's common
stock will be exchanged for one share of the new holding company. The merger
will be accounted for as a purchase of Telco by Excel and is expected to be
completed by year-end, subject to the approval by the shareholders of each
company, the approval of the Federal Communications Commission and various state
authorities and other customary conditions.
Future issues affecting the Company's operations for 1997 and beyond are as
follows:
Competitive Factors. The Company has observed new entrants and increased
competition in the Company's dial around segment as well as an increase in the
number of promotional, discounted calling plans available to all long distance
consumers. Additionally, AT&T has recently reduced its basic rates to its
residential customers which will likely result in a decline in the Company's per
minute revenue from its Consumer Division customer base.
Regulatory Changes. The operations of the Company will continue to be affected
by the ongoing events associated with the 1996 Telecommunications Act. Such
events include access charge reform which could change existing transmission
costs for both the Company and other long distance companies, the entry by the
Regional Bell Operating Companies into the long distance marketplace and the
ability of long distance companies like Telco to begin marketing local telephone
services.
In conjunction with upcoming local competition, incumbent local phone companies
are not likely to provide billing services for customers presubscribed to
competitive local phone companies. This would force the Company to either bill
the customer directly, enter into a billing and collection agreement with new
local phone companies or seek other alternatives.
Additionally, the Federal Communications Commission has mandated that by January
1, 1998, all telecommunications companies must migrate from their existing five
digit CIC codes (10+XXX) to seven digit CIC codes (10+10+XXX). This will require
a change in the dialing patterns of the Consumer Division customers in order to
utilize the Company's services, and the Company intends to integrate
re-education materials into its marketing activities for the remainder of the
year.
Availability of Transmission Facilities. The Company has observed a tightening
market in the availability of leased fiber optic facilities connecting the
Company's switches. The Company leases these facilities under multi-year
contracts primarily from three major vendors, and to date, has been able to
secure the necessary facilities. Although the Advantis voice network asset
acquisition has provided the Company with a significant amount of captive fiber
optic capacity, the Company will continue to lease additional capacity from
third party providers.
Expansion of the Commercial Sales Division. The costs associated with the
Company's Commercial Sales Division are expected to reduce the Company's net
income at least through 1997. The Company expects that the revenue growth
associated with this division will represent a material portion of the overall
growth of the Company.
Consummation of the Excel Transaction. The Company recently executed a
definitive merger agreement with Excel and the transaction is expected to close
by year-end. There can be no assurance that this transaction will eventually be
completed or that the anticipated benefits of the merger will be realized.
<PAGE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1997 COMPARED TO THREE MONTHS ENDED
JUNE 30, 1996
Revenues. Revenues increased 33%, or $34.7 million, from $104.1 million, for the
three months ended June 30, 1996 to $138.8 million for the three months ended
June 30, 1997. The increase in revenue was due to an increase in per minute and
other revenues generated by the Company's Commercial Sales Division offset by a
slight decline in the revenues from the Consumer Division. Revenues for the
Consumer Division for the three months ended June 30, 1997 were $99.2 million, a
decrease of $1.0 million, or 1%, versus $100.2 million for the three months
ended June 30, 1996. Consumer Division revenues, primarily attributable to dial
around customers, were largely the result of Consumer Division marketing
activities for the three months ended June 30, 1997 combined with the carryover
customer base from March 31, 1997 and prior periods. The decline in the Consumer
Division revenues resulted from LDWC products which generated approximately $2.9
million less in revenue for the three months ended June 30, 1997 than for the
three months ended June 30, 1996. In early 1997, the Consumer Division
reformulated the base LDWC dial around offering into a fee-based, flat rate per
minute product, and the results to date have been less than anticipated.
CSD generated revenues of $38.9 million for the three months ended June 30,
1997, which includes per minute and private line revenue from direct, dealer and
wholesale customers. Prior to the formation of CSD in June 1996, the Company
generated wholesale carrier revenues which totaled $3.9 million for the three
months ended June 30, 1996. The Company generated $17.0 million in CSD revenue
during the three months ended March 31, 1997. Revenues for CSD for the three
months ended June 30, 1997 represent an 897% and 129% increase versus the three
month periods ended June 30, 1996 and March 31, 1997, respectively. This growth
is attributable to the significant increase in the number of sales personnel and
other marketing efforts of CSD since its formation. This total also includes
approximately $8.3 million in private line and other revenue as a result of the
Advantis voice network acquisition. Also included in revenues for the three
months ended June 30, 1997 was $0.7 million from Tel Labs, which the Company
acquired concurrently with the completion of the Company's initial public
offering ("IPO") in August 1996.
Overall, billed minutes of use ("MOUs") increased 43% from 703.1 million for the
three months ended June 30, 1996 to 1,007.4 million for the three months ended
June 30, 1997. The Company's revenue per MOU was $0.129 for the three months
ended June 30, 1997 (excluding private line and Tel Labs revenue), a decrease
from $0.148 for the three months ended June 30, 1996. This decrease is due to an
increasing contribution of lower revenue per minute products including carrier
products and commercial products such as 800/888 service and dedicated T-1
service. During the three months ended June 30, 1997 compared to the three
months ended June 30, 1996, the Company's offsets to revenues declined as a
percentage of revenue due to both increased carrier revenue which has a lower
corresponding bad debt accrual percentage, and favorable trends in LEC holdback
percentages for the Consumer Division, while the overall aggregate amount of
revenue offsets increased due to the increased revenues.
Cost of Services. Cost of services increased 31%, or $18.9 million, from $60.8
million for the three months ended June 30, 1996 to $79.7 million for the three
months ended June 30, 1997. Approximately $19.1 million of the cost of services
increase was due to the recurring costs related to increased MOUs, $1.2 million
of the increase was the result of increased facilities lease expense as a result
of the Company's expansion of its transmission network, and $0.3 million of the
increase was the result of the inclusion of Tel Labs' cost of services, all of
which was offset by a $1.7 million reduction in installation expenses. The
reduction in the cost of services per MOU from $0.086 for the three months ended
June 30, 1996 to $0.079 for the three months ended June 30, 1997 was largely the
result of an increased percentage of on-net traffic, other network efficiencies
and an increasing percentage of dedicated products that have lower LEC access
costs per MOU.
Gross Margin. Gross margin increased 37%, or $15.8 million, from $43.3 million
for the three months ended June 30, 1996 to $59.1 million for the three months
ended June 30, 1997 due to the reasons discussed above. As a percentage of
revenues, gross margin increased from 41.6% for the three months ended June 30,
1996 to 42.6% for the three months ended June 30, 1997.
Selling, General and Administrative Expense. Selling, general and administrative
expense increased 25%, or $7.9 million, from $31.5 million for the three months
ended June 30, 1996 to $39.4 million for the three months ended June 30, 1997.
Approximately $10.3 million of this increase was attributable to the direct
expenses of CSD which generated negligible expenses during the three months
ended June 30, 1996. The offsetting decrease of approximately $2.4 million for
the three months ended June 30, 1997 consisted of increased general and
administrative expense, and reduced costs associated with Consumer Division
marketing expenses, LEC billing expenses and customer service costs. As a
percentage of revenues, selling, general and administrative expense decreased
from 30.3% for the three months ended June 30, 1996 to 28.4% for the three
months ended June 30, 1997.
Depreciation and Amortization Expense. Depreciation and amortization expense
increased by $1.7 million from $1.9 million for the three months ended June 30,
1996 to $3.6 million for the three months ended June 30, 1997. Depreciation
expense increases were primarily related to the expansion of the Company's
switch network, and goodwill and other amortization expense increases were
associated with the acquisition of the Advantis assets and the acquisition of
the remaining 44.4% of LDWC and Tel Labs.
Interest Expense. Interest expense, net of other income, primarily interest
income, increased $1.4 million from $1.0 million for the three months ended June
30, 1996 to $2.4 million in interest expense for the three months ended June 30,
1997. This increase was due to the increased leverage resulting from the
acquisition of the Advantis assets partially offset by the proceeds from the
Company's August 1996 IPO which were used to repay substantially all of the
Company's indebtedness combined with free cash flow generated since that time.
Net income. Net income increased $3.4 million from $5.2 million for the three
months ended June 30, 1996 to $8.6 million for the three months ended June 30,
1997.
SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED
JUNE 30, 1996
Revenues. Revenues increased 33%, or $65.6 million, from $196.0 million, for the
six months ended June 30, 1996 to $261.6 million for the six months ended June
30, 1997. The increase in revenue was due to an increase in per minute and other
revenues generated by both the Company's Consumer and Commercial Sales
Divisions. Revenues for the Consumer Division for the six months ended June 30,
1997 were $204.6 million, an increase of $15.5 million, or 8.2%, versus $189.1
million for the six months ended June 30, 1996. Consumer Division growth,
primarily attributable to dial around revenues, was largely the result of
Consumer Division marketing activities for the six months ended June 30, 1997
combined with the carryover customer base from December 31, 1996 and prior
periods.
CSD generated revenues of $55.9 million for the six months ended June 30, 1997,
which includes per minute and private line revenue from direct, dealer and
wholesale customers. Prior to the formation of CSD in June 1996, the Company
generated wholesale carrier revenues which totaled $6.9 million for the six
months ended June 30, 1996. The Company generated $26.3 million in CSD revenues
during the six months ended March 31, 1997. The revenue for CSD for the six
months ended June 30, 1997 represents a 709% and 112% increase versus the six
month periods ended June 30, 1996 and March 31, 1997, respectively. This growth
is attributable to the significant increase in the number of sales personnel and
other marketing efforts of CSD since its formation. Also included in revenues
for the six months ended June 30, 1997 was $1.1 million from Tel Labs, which the
Company acquired concurrently with the completion of the Company's IPO in August
1996.
Overall, billed minutes of use ("MOUs") increased 42% from 1,356.2 million for
the six months ended June 30, 1996 to 1,929.6 million for the six months ended
June 30, 1997. The Company's revenue per MOU was $0.131 for the six months ended
June 30, 1997 (excluding private line revenue), a decrease from $0.145 for the
six months ended June 30, 1996. This decrease is due to an increasing percentage
of lower revenue per minute products including carrier products and commercial
products such as 800/888 service and dedicated T-1 service. During the six
months ended June 30, 1997 compared to the six months ended June 30, 1996, the
Company's offsets to revenues declined both in the aggregate and as a percentage
of revenue due to both increased carrier revenue which has a lower corresponding
bad debt accrual percentage, and favorable trends in LEC holdback percentages
for the Consumer Division.
Cost of Services. Cost of services increased 32%, or $36.6 million, from $115.5
million for the six months ended June 30, 1996 to $152.1 million for the six
months ended June 30, 1997. Approximately $34.5 million of the cost of services
increase was due to the recurring costs related to increased MOUs, $3.8 million
of the increase was the result of increased facilities lease expense as a result
of the Company's expansion of its transmission network, and $0.6 million of the
increase was the result of the inclusion of Tel Labs' cost of services, all of
which was offset by a $2.3 million reduction in installation expenses. The
reduction in the cost of services per MOU from $0.085 for the six months ended
June 30, 1996 to $0.079 for the six months ended June 30, 1997 was largely the
result of an increased percentage of on-net traffic, other network efficiencies
and an increasing percentage of dedicated products that have lower LEC access
costs per MOU.
Gross Margin. Gross margin increased 36%, or $29.1 million, from $80.5 million
for the six months ended June 30, 1997 to $109.6 million for the six months
ended June 30, 1997 due to the reasons discussed above. As a percentage of
revenues, gross margin increased from 41.1% for the six months ended June 30,
1996 to 41.9% for the six months ended June 30, 1997.
Selling, General and Administrative Expense. Selling, general and administrative
expense increased 29%, or $17.2 million, from $59.4 million for the six months
ended June 30, 1996 to $76.6 million for the six months ended June 30, 1997.
Approximately $19.2 million of this increase was attributable to the direct
expenses of CSD which generated negligible expenses during the six months ended
June 30, 1996. The offsetting decrease of approximately $2.0 million for the six
months ended June 30, 1997 consisted of increased general and administrative
expense, and reduced costs associated with Consumer Division marketing expenses,
LEC billing expenses and customer service costs. As a percentage of revenues,
selling, general and administrative expense decreased from 30.3% for the six
months ended June 30, 1996 to 29.3% for the six months ended June 30, 1997.
Depreciation and Amortization Expense. Depreciation and amortization expense
increased by $3.0 million from $3.3 million for the six months ended June 30,
1996 to $6.3 million for the six months ended June 30, 1997. Depreciation
expense increases were primarily related to the expansion of the Company's
switch network, and goodwill and other amortization expense increases were
associated with the acquisition of the Advantis assets and the acquisition of
the remaining 44.4% of LDWC and Tel Labs.
Interest Expense. Interest expense, net of other income, primarily interest
income, decreased $0.1 million from $2.0 million for the six months ended June
30, 1996 to $1.9 million in interest expense for the six months ended June 30,
1997. This slight decrease was due to the use of proceeds from the Company's
August 1996 IPO which were used to repay substantially all of the Company's
indebtedness combined with free cash flow generated since that time, offset by
the increased leverage resulting from the April 1997 acquisition of the Advantis
assets.
Net income. Net income increased $6.9 million from $8.5 million for the six
months ended June 30, 1996 to $15.4 million for the six months ended June 30,
1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company conducts its operations through its direct and indirect wholly owned
subsidiaries. There are no restrictions on the movement of cash within the
consolidated group and the Company's discussion of its liquidity is based on the
consolidated group. The Company measures its liquidity based on cash flow as
reported in its Consolidated Statements of Cash Flows.
On August 9, 1996 the Company sold 4,681,000 Common Shares (of which 825,000
shares were sold on August 26, 1996 in conjunction with the underwriters'
exercise of the over-allotment option) in its IPO. The net proceeds to the
Company (after expenses) of approximately $60.0 million were used to repay
existing indebtedness, including capital lease obligations and the outstanding
balance on the Company's existing credit facility. The remaining proceeds
coupled with the Company's cash and borrowing capacity under the credit facility
were used to fund working capital and capital expenditures and for general
corporate purposes.
Since commencing operations in 1993, the Company has experienced rapid growth
requiring substantial investments in working capital, capital expenditures and
mail marketing expenses. Additionally, start-up costs associated with the
formation of CSD are expected to reduce the Company's consolidated net income at
least through 1997.
In December 1996, the Company entered into a credit facility for borrowings up
to $100 million, which was later amended in April 1997 to $200 million in
connection with the Company's acquisition of certain voice network assets from
Advantis ("the New Credit Facility"). Borrowings under the New Credit Facility
are subject to various financial covenants and ratios including a Total Leverage
Ratio, Interest Coverage Ratio, Current Ratio, Pro Forma Debt Service Ratio and
Fixed Charge Ratio. The interest rate on the New Credit Facility is based on the
prevailing Total Leverage Ratio and ranges on a Eurodollar (LIBOR) option from a
spread of 0.75% to 2.00%, and on a Base (Prime) Rate option from a spread of 0%
to 1.00%. No scheduled principal payments on the New Credit Facility are due
until June 30, 1998 and the New Credit Facility expires on March 31, 2002.
Borrowings under the New Credit Facility on the April 15, 1997 closing date of
the Advantis voice network acquisition totaled approximately $146 million which
resulted in an initial spread of 1.75% for LIBOR and 0.75% for Prime. The
remaining purchase price and other transaction-related expenses were funded
using a portion of the Company's existing cash. On June 24, 1997, the Company
sold the Nortel switches and associated equipment acquired in the Advantis
transaction located in the five switch sites for $38 million. Also included in
the sale was a multi-year lease for certain portions of the Company's fiber
optic capacity. The proceeds from the sale were used to reduce existing
indebtedness.
Net cash from operating activities increased $32.1 million from $5.2 million in
cash used for operating activities for the six months ended June 30, 1996 to
$26.9 million in cash provided by operating activities for the six months ended
June 30, 1997. The increase was largely the result of increases in net income
and depreciation and amortization expense combined with a smaller increase in
working capital accounts primarily attributable to an increase in deferred
income. Net cash used for investing activities increased $155.4 million, from
$3.1 million for the six months ended June 30, 1997 to $158.5 million for the
six months ended June 30, 1997. Net cash from financing activities increased
$104.5 million from $14.9 million for the six months ended June 30, 1996 to
$119.4 million for the six months ended June 30, 1997. Both increases were
primarily the result of the acquisition and related funding of the line of
credit to finance the purchase of the Advantis assets partially offset by the
cash proceeds generated by the sale of the equipment in the five Advantis switch
sites.
Management believes that cash flow from operations and existing facilities will
provide sufficient liquidity to enable it to meet its currently forseeable
working capital and capital expenditure requirements.
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In December 1996, Telco and LDWC became involved in a civil action, AT&T Corp.
v. Telco Communications Group, Inc. and Long Distance Wholesale Club, pending in
the United States District Court for the District of New Jersey. In this
litigation, AT&T claims that certain LDWC advertisements stating that consumers
can save up to 50% off AT&T's basic rates are false and misleading under federal
and state law. AT&T seeks treble damages, statutory attorneys' fees and costs,
and an injunction. The Company denies the allegations in this litigation and is
vigorously defending against them, including that all disclosures are contained
clearly in LDWC's advertisements and that it is possible for consumers in the
United States to place calls that will achieve up to a 50% savings. Further the
Company filed a separate complaint against AT&T (which has now been consolidated
with this litigation) and also asserted additional counterclaims against AT&T
based on AT&T's advertising which the Company believes contains a variety of
misleading and deceptive statements. If AT&T prevails, the Company could be
found liable for damages and an injunction might be issued against future use of
specific LDWC advertisements.
On December 31, 1996, An Apple A Day, Inc. ("Apple") filed suit against the
Company in the United States District Court for the Eastern District of Missouri
alleging trademark and tradename infringement, unfair competition, false
designation of origin, federal trademark dilution, trade dress dilution and
violations of Missouri common law. According to the complaint, Apple holds a
Dial and Save service mark for telephone order services in the field of
electronic equipment and uses that mark in the State of Missouri. Apple alleges
that the Company's use of a Dial & Save logo and tradename in connection with
its sale to consumers of long distance service infringes Apple's mark. Apple
seeks an injunction against the Company's further use of the Dial & Save logo
and name, disgorgement of all profits made from use of the Dial & Save logo and
name, damages for preparation and distribution of corrective advertising,
damages for loss of sales, loss of goodwill and damage to reputation, trebling
of damages and payment of attorney's fees and costs. The Company denies the
allegations and is vigorously defending against them, including on the grounds,
among others, that there is no competitive proximity of the electronic equipment
that Apple sells and the long distance service that the Company offers and no
likelihood of, or actual, confusion regarding the seller, and therefore the
source, of each. If the Company is found to have infringed Apple's mark, and/or
to have liability for Apple's other claims, then it may be found liable to Apple
in whole, or in part, for damages of the nature sought by Apple and may be
enjoined from using a Dial & Save service mark.
In related litigation, on April 15, 1997, the Company filed suit against Apple
and two (2) individuals in the United States District Court for the Eastern
District of Virginia. The suit includes claims for defamation, and conspiracy to
harm the Company's business, in violation of the statutory and common laws of
Virginia, and for tortious interference with contractual relationships and with
reasonable business expectations, in violation of the common laws of Virginia.
The Company seeks an injunction barring the defendants from making or causing
others to make further false and defamatory statements about the Company and
seeks compensatory and exemplary damages for wrongful diminution of the
Company's reputation and goodwill, for tortious interference with the Company's
business and for defamation, as well as payment of the Company's litigation
costs and expenses. The court has entered a preliminary injunction prohibiting
the defendants from directly or indirectly making defamatory statements about
the Company. The defendants have not yet filed their respective answers to the
Company's complaint in this litigation.
On May 8, 1995, the Company, and its subsidiary, Dial & Save of Nevada, Inc.,
filed suit against Central Telephone Company-Nevada, d/b/a Sprint/Central
Telephone Company-Nevada, a division of the Central Telephone Company ("CTC"),
Sprint, Inc., et al, in the District Court of Clark County, Nevada. The suit
includes claims for breach of contract, promissory and equitable estoppel,
unfair trade practices and breach of the duty of good faith and fair dealing,
all in violation of the laws of Nevada. The Company and its subsidiary seek an
order for temporary injunctive relief preventing the defendant from denying
possession of certain commercial real property in Las Vegas to the Company and
its subsidiary and compelling the defendant to execute and honor a commercial
real property lease with the Company, as well as compensatory and punitive
damages, attorneys fees and costs.
In related litigation, on May 5, 1995, CTC filed suit against the Company in the
United States District Court for the District of Nevada. The suit includes
claims for negligent and/or malicious omission or concealment of material facts,
conversion of personal property and trespass to chattel in violation of the
common laws of Nevada, in connection with certain commercial real property and
telecommunications facilities owned by the plaintiff in Las Vegas, Nevada. The
plaintiff seeks damages and a declaratory judgment specifying the respective
rights of the plaintiff and the Company regarding occupancy of the commercial
real property and use of the telecommunications facilities in Las Vegas, and
requiring the Company to present any complaint against the plaintiff to the FCC
prior to bringing any court action. The Company denies the allegations, intends
to defend vigorously against them and has filed the suit described above against
the plaintiff.
On March 14, 1997, Frontier Corporation and Frontier Communication Services,
Inc. filed suit against the Company, and three (3) of the Company's employees,
in the United States District Court for the Southern District of Indiana,
alleging breach of contract, tortious interference with contractual relations
and tortious interference with prospective economic relations. The plaintiffs
allege that three (3) of the Company's employees, who formerly were employed by
the plaintiffs, left the employ of plaintiffs, joined the Company, and
thereafter solicited on behalf of the Company plaintiffs' employees and
customers, in breach of written agreements between the plaintiffs and the
employees, and in violation of the common laws. The plaintiffs also allege that
the Company breached a written agreement between the Company and the plaintiffs
in which the Company agreed not to allow solicitation of plaintiffs' employees
or customers by the Company's employees who were formerly employed by the
plaintiffs. The plaintiffs seek an injunction preventing the Company and the
three (3) employees from breaching their respective written agreements with
plaintiffs and preventing the Company from aiding or abetting the employees in
breach of the employees' written agreements with the plaintiffs; an accounting
and disgorgement of all profits made by the Company and the employees arising
from the breach of the written agreements with the plaintiffs; a declaratory
judgment that the Company and the employees have breached their respective
written agreements with the plaintiffs and have tortiously interfered with the
plaintiffs' existing contractual and prospective economic relations; damages for
breach of contract and interference with plaintiffs' existing contractual and
prospective economic relations; and payment of attorneys' fees and costs. The
court has entered a preliminary injunction prohibiting one of the employee
defendants from performing certain limited acts in violation of her agreement
with Frontier, and requiring the other defendants to take certain actions to
enable and ensure her compliance. The Company has filed an answer denying the
allegations against it, and is vigorously defending the action.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
See Exhibit Index on page 20.
B. Reports on Form 8-K
Form 8-K dated April 15, 1997 announcing the Company's completion of the
transaction to acquire the voice network assets of Advantis ("Advantis"), a
partnership formed by International Business Machines Corp. and Sears,
Roebuck and Co., for approximately $170 million.
Form 8-K dated June 5, 1997, announcing that the Company had entered into
an Agreement and Plan of Merger dated as of June 5, 1997 pursuant to which
the Company and EXCEL Communications, Inc. ("EXCEL") would merge into
separate newly formed wholly owned subsidiaries of New RES, Inc., itself a
newly formed corporation wholly owned by EXCEL, with each of the Company
and EXCEL as the surviving corporations.
Form 8-K dated June 24, 1997, announcing the Company's sale to Intermedia
Communications, Inc. of certain switch assets and associated equipment
acquired by the Company in connection with the purchase of the Advantis
voice network assets in April of 1997.
<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 by the
undersigned, thereunto duly authorized, in the City of Chantilly, State of
Virginia, on August 13, 1997.
Telco Communications Group, Inc.
By: /s/ Donald A. Burns
------------------------------------------------------
Donald A. Burns, President & Chief Executive Officer
By: /s/ Nicholas A. Merrick
------------------------------------------------------
Nicholas A. Merrick, Chief Financial Officer
By: /s/ Janet D. Anastasi
------------------------------------------------------
Janet D. Anastasi, Chief Accounting Officer
<PAGE>
TELCO COMMUNICATIONS GROUP, INC.
EXHIBIT INDEX
Exhibit
No. Description
- -------- --------------------------------------------
11.1 Computation of Earnings Per Common and
Common Equivalent Share
27.1 Financial Data Schedule
<PAGE>
<TABLE>
TELCO COMMUNICATIONS GROUP, INC.
SCHEDULE OF COMPUTATION OF EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE
WEIGHTED AVERAGE NUMBER OF SHARES
The weighted average number of shares of common stock and common stock
equivalents, after adjusting for the 425-to-1 stock split, was determined
as follows:
For all periods presented prior to the initial public offering, outstanding
options for common stock granted within 12 months of the initial filing
date of the initial public offering have been included in the calculations
of common and common equivalent shares outstanding using the treasury stock
method based on the initial public offering price of $14 per share as the
market price.
Three months ended June 30, Six months ended June 30,
(in thousands, except per (in thousands, except per
share data) share data)
------------------------- -----------------------
1996 1997 1996 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Common Stock:
Shares outstanding
beginning of period 20,864 33,062 20,864 32,755
Shares issued during
period, net (1) 0 41 0 246
SEC SAB 83 shares (2)
5,889 0 5,889 0
26,753 33,103 26,753 33,001
Common Stock Equivalents:
Options (3) 956 1,447 956 1,391
Warrants (4)
636 0 636 0
1,592 1,447 1,592 1,391
Weighted average number
of shares 28,345 34,550 28,345 34,392
Net income (loss) $5,186 $8,580 $8,466 $15,440
Net income (loss) per share $ 0.18 $ 0.25 $ 0.30 $ 0.45
- ---------------------------------------------
(1) Weighted average shares issued
(2) Shares and employee options issued from 7,094
June 14, 1997 through June 13, 1996
Less shares reacquired under treasury
stock method 1,205
-------
Net SAB 83 shares 5,889
=======
(3) Options granted, less shares acquired under treasury
stock method, on a weighted average basis.
(4) Represents warrant held by Signet Media Capital Group to purchase
636,158 shares of common stock at a nominal exercise price.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1997
<PERIOD-START> JAN-01-1996 JAN-01-1997
<PERIOD-END> DEC-31-1996 JUN-30-1997
<CASH> 25,372,575 13,233,404
<SECURITIES> 0 0
<RECEIVABLES> 97,086,496 113,446,844
<ALLOWANCES> 7,972,104 5,807,133
<INVENTORY> 0 0
<CURRENT-ASSETS> 126,184,771 132,012,880
<PP&E> 49,786,683 208,213,967
<DEPRECIATION> 10,121,057 15,446,065
<TOTAL-ASSETS> 210,595,919 373,723,202
<CURRENT-LIABILITIES> 60,190,531 87,215,944
<BONDS> 0 0
0 0
0 0
<COMMON> 111,309,316 111,985,279
<OTHER-SE> 0 0
<TOTAL-LIABILITY-AND-EQUITY> 210,595,919 373,723,202
<SALES> 428,552,436 261,626,752
<TOTAL-REVENUES> 428,552,436 261,626,752
<CGS> 252,035,525 152,067,925
<TOTAL-COSTS> 252,035,525 152,067,925
<OTHER-EXPENSES> 133,542,536 82,828,601
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 3,514,903 3,073,268
<INCOME-PRETAX> 39,960,233 24,824,746
<INCOME-TAX> 16,394,046 9,384,743
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 22,876,735 15,440,003
<EPS-PRIMARY> 0.75 0.45
<EPS-DILUTED> 0 0
</TABLE>
