<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 22, 1997
REGISTRATION NO. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
TELEGROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
IOWA 4813 42-1344121
(STATE OR OTHER JURISDICTION (PRIMARY STANDARD (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) INDUSTRIAL IDENTIFICATION NUMBER)
CLASSIFICATION CODE
NUMBER)
---------------
2098 NUTMEG AVENUE
FAIRFIELD, IOWA 52556
(515) 472-5000
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE PRINCIPAL OFFICES)
DOUGLAS A. NEISH
CHIEF FINANCIAL OFFICER
TELEGROUP, INC.
2098 NUTMEG AVENUE
FAIRFIELD, IOWA 52556
(515) 472-5000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
---------------
COPIES TO:
MORRIS F. DEFEO, JR., ESQ.
EDSEL J. GUYDON, ESQ.
SWIDLER & BERLIN, CHARTERED
3000 K STREET, N.W., SUITE 300
WASHINGTON, D.C. 20007
(202) 424-7500; FACSIMILE (202) 424-7647
---------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: [_]
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
================================================================================
PROPOSED
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT MAXIMUM AGGREGATE
SECURITIES TO BE TO BE OFFERING PRICE OFFERING AMOUNT OF
REGISTERED REGISTERED PER SHARE(1) PRICE(1) REGISTERED FEE
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, No par
value(2)(3) .......... 234,889 $12.9375 $3,038,876.44 $920.87
- -------------------------------------------------------------------------------
Warrants(3)............ 5 $0.01 $0.05 $0.01
- -------------------------------------------------------------------------------
TOTAL.................. $920.88
================================================================================
</TABLE>
(1) Estimated solely for purposes of calculating the registration fee. In
accordance with Rule 457(c) of Regulation C, the estimated price for such
shares was based on the average of the high and low reported prices on the
Nasdaq National Market System on December 17, 1997.
(2) Includes: (i) 23,188 shares which are reserved for issuance pursuant to
currently issued and outstanding Convertible Subordinated Notes which will
be offered for resale by certain Selling Shareholders, and (ii) 211,701
shares of Common Stock issuable upon exercise of the Warrants (the
"Warrants").
(3) Pursuant to Rule 416, this Registration Statement also covers such
indeterminate number of shares of Common Stock as may be issuable upon
exercise of the referenced Warrants pursuant to antidilution provisions.
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION
STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE
COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF
ANY SUCH STATE.
================================================================================
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED DECEMBER 22, 1997
PROSPECTUS
234,899 SHARES
[LOGO OF TELEGROUP APPEARS HERE]
COMMON STOCK
THE DATE OF THIS PROSPECTUS IS , 1998.
The 234,899 shares of Common Stock, no par value (the "Common Stock"), are
offered hereby, of Telegroup, Inc. (the "Company") subject to issuance upon
conversion of certain Convertible Subordinated Notes (the "Notes") of the
Company owned by certain selling securityholders (the "Selling Shareholders"),
which may be sold from time to time, by the Selling Shareholders for their own
accounts. The Company has been advised that the Selling Shareholders may from
time to time sell the shares to or through brokers or dealers in one or more
transactions, on the Nasdaq National Market System (the "Nasdaq NMS") or
otherwise, at market prices prevailing at the time of sale, at prices relating
to such prevailing market prices, or at negotiated prices. The Warrants offered
hereby are exercisable at any time prior to November 28, 2003. The Warrants are
entitled to certain antidilution protection in the event of additional
issuances of Common Stock, stock splits, stock dividends, reorganizations and
other similar events. The shares of Common Stock issued pursuant to the
exercise of the Warrants are entitled to certain registration rights described
herein.
The Company's Common Stock is listed on the Nasdaq NMS under the symbol TGRP.
On December 17, 1997, the last reported sale price of Common Stock, as reported
on the Nasdaq NMS, was $12.9375 per share.
------------
SEE "RISK FACTORS" BEGINNING ON PAGE 10 OF THIS PROSPECTUS FOR A DISCUSSION
OF RISK FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF
THE SHARES OF COMMON STOCK OFFERED HEREBY.
------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Since the Common Stock registered hereunder is being offered on a delayed or
continuous basis pursuant to Rule 415 under the Securities Act of 1933, as
amended (the "Act"), the Company cannot include herein information about the
price to the public of the Common Stock or the proceeds to the Selling
Shareholders. The Company will receive no proceeds from any sales of Common
Stock by the Selling Shareholders, and the Company is obligated to pay the
expenses of this offering, which are estimated at $ . The Selling
Shareholders will pay their own expenses in connection with sales of the Common
Stock. The Selling Shareholders and any brokers or dealers executing selling
orders on their behalf may be deemed "underwriters" within the meaning of the
Act, in which event the usual and customary selling commissions which may be
paid to the brokers or dealers may be deemed to be underwriting commissions
under the Act. There can be no assurance that any or all of the Shares
registered hereunder will be sold. See "Plan of Distribution."
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-4 (the "Exchange Offer Registration Statement") under the Securities Act
with respect to the Exchange Notes being offered by this Prospectus. This
Prospectus does not contain all the information set forth in the Exchange
Offer Registration Statement and the exhibits and schedule thereto, certain
portions of which have been omitted pursuant to the rules and regulations of
the Commission. Statements made in this Prospectus as to the contents of any
contract, agreement or other document are not necessarily complete. With
respect to each such contract, agreement or other document filed or
incorporated by reference as an exhibit to the Exchange Offer Registration
Statement, reference is made to such exhibit for a more complete description
of the matter involved, and each such statement is qualified in its entirety
by such reference.
The Company is subject to the periodic reporting and other informational
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and in accordance therewith files reports and other information with
the Commission. The Exchange Offer Registration Statement and reports, and
other information filed by the Company can be inspected and copied at the
public reference facilities maintained by the Commission at Room 1024, 450
Fifth Street, N.W., Washington, D.C. 20549; Suite 1400, 500 West Madison
Street, Chicago, Illinois 60661; and Seven World Trade Center, 13th Floor, New
York, New York 10048. Copies of such material can be obtained by mail from the
Public Reference Section of the Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed fees. The Commission also maintains a
website that contains reports, proxy and information statements and other
information. The website address is http://www.sec.gov. Under the terms of the
Indenture (as defined herein) pursuant to which the Old Notes were, and the
Exchange Notes will be, issued, the Company will be required to file with the
Commission, and to furnish holders of the Notes with, the information,
documents and other reports specified in Sections 13 and 15(d) of the Exchange
Act, including reports on Forms 10-K, 10-Q and 8-K.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus contains certain forward-looking statements (as such term is
defined in the Private Securities Litigation Reform Act of 1995) and
information relating to the Company that is based on the beliefs of the
Management of the Company, as well as assumptions made by and information
currently available to the Management of the Company. When used in this
Prospectus, the words "estimate," "project," "believe," "anticipate,"
"intend," "expect" and similar expressions are intended to identify forward-
looking statements. Such statements reflect the current views of the Company
with respect to future events and are subject to risks an uncertainties that
could cause actual results to differ materially from those contemplated in
such forward-looking statements, including those discussed under "Risk
Factors." Readers are cautioned not to place undue reliance on these forward-
looking statements, which speak only as of the date hereof. The Company does
not undertake any obligation to publicly release any revisions to these
forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
2
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information, including risk factors, the Company's consolidated financial
statements and other financial data, appearing elsewhere in this Prospectus.
References in this Prospectus to the "Company" and "Telegroup" refer to
Telegroup, Inc. and its Subsidiaries (as defined), except where the context
otherwise requires. See "Glossary of Terms" for definitions of certain
technical and other terms used in this Prospectus.
THE COMPANY
Telegroup is a leading global provider of long distance telecommunications
services. The Company offers a broad range of discounted international,
national, value-added wholesale and enhanced telecommunications services to
approximately 268,000 small and medium-sized business, residential and
wholesale customers in over 180 countries worldwide. Telegroup has achieved its
significant international market penetration by developing what it believes to
be one of the most comprehensive global sales, marketing and customer service
organizations in the global telecommunications industry. The Company operates a
reliable, flexible, cost-effective, digital, facilities-based network (the
"Telegroup Intelligent Global Network" or "TIGN") consisting of 19 Excel,
NorTel or Harris switches, five enhanced services platforms, owned and leased
capacity on seven digital fiber-optic cable links, leased parallel data
capacity and the Company's Network Operations Center in Fairfield, Iowa.
According to Federal Communications Commission ("FCC") statistics based on 1996
revenue, Telegroup was the thirteenth largest U.S. long distance carrier in
1996.
Telegroup provides an extensive range of telecommunications services on a
global basis under the Spectra, Global Access and other brand names. The
Company's services are typically priced competitively with other alternative
telecommunications providers and below the prices offered by the incumbent
telecommunications operators ("ITOs"), which are often government-owned or
protected telephone companies. While the Company offers a broad range of
telecommunications services, the services offered in a particular market vary
depending upon regulatory constraints and local market demands. Telegroup
historically has offered traditional call-reorigination service (also known as
"callback") to penetrate international markets having regulatory constraints.
As major markets continue to deregulate, the Company continues to migrate an
increasing portion of its customer base to "call-through" service, which
includes conventional international long distance service and a "transparent"
form of call-reorigination. The Company markets its call-through service under
the brand name Global Access Direct and its traditional call-reorigination
service under the brand name Global Access CallBack. Currently, the Company
offers both international and national long distance service, prepaid and
postpaid calling cards, toll-free service and enhanced services such as fax
store and forward, fax-mail, voice-mail and call conferencing. The Company
believes its broad array of basic and enhanced services enables the Company to
offer a comprehensive bundled solution to its customers' telecommunications
needs. The Company also resells switched minutes and enhanced service platforms
on a wholesale basis to other telecommunications providers and carriers. See
"Business--Services."
Telegroup's extensive sales, marketing and customer service organization
consists of a worldwide network of independent agents and an internal sales
force who market Telegroup's services and provide customer service, typically
in local languages and in accordance with the cultural norms of the countries
and regions in which they operate. The Company's local sales, marketing and
customer service organization permits the Company to continually monitor
changes in each market and quickly modify service and sales strategies in
response to changes in particular markets. In addition, the Company believes
that it can leverage its global sales and marketing organization to quickly and
efficiently market new and innovative service offerings. As of November 30,
1997, the Company had approximately 1,375 independent agents worldwide. Twenty-
eight country coordinators ("Country Coordinators") are responsible for
coordinating Telegroup's operations, including sales, marketing, customer
service and independent agent support, in 72 countries. In addition, the
Company has 31 internal sales personnel in the United States and one each in
France, Germany and the United Kingdom, and
3
<PAGE>
intends to establish additional internal sales departments in selected core
markets. The Company believes that its comprehensive global sales, marketing
and customer service organization will enable the Company to increase its
market share and position itself as the leading alternative international long
distance provider in each of its target markets. The Company believes that it
is the largest alternative international long distance provider in three of the
largest international telecommunications markets in the world--France, the
Netherlands and Switzerland. See "Business--Sales, Marketing and Customer
Service."
The Telegroup Intelligent Global Network includes a central Network
Operations Center ("Network Operations Center") in Iowa City, Iowa, as well as
switches, owned and leased transmission capacity and a proprietary distributed
intelligent network architecture. The TIGN is designed to allow customer-
specific information, such as credit limits, language selection, waiting voice-
mail and faxes, and speed dial numbers to be distributed efficiently over a
parallel data network wherever Telegroup has installed a TIGN switch. In
addition, the open, programmable architecture of the TIGN allows the Company to
rapidly deploy new features, improve service quality, and reduce costs through
least cost routing. As of September 30, 1997, the TIGN consisted of (i) the
Network Operations Center, (ii) 19 Excel, NorTel or Harris switches in New York
City, Jersey City, New Jersey, London, Paris, Amsterdam, Zurich, Copenhagen,
Frankfurt, Hong Kong, Sydney, Tokyo and Milan (iii) five enhanced services
platforms in New York, Hong Kong, London, Paris and Sydney, (iv) owned and
leased fiber-optic cable links connecting its New York and New Jersey switches
to its switches in London, Amsterdam, Sydney and Los Angeles, and its London
switches to its switches in Paris and Amsterdam, and (v) leased parallel data
transmission capacity connecting Telegroup's switches to each other and to the
networks of other international and national carriers. The Company intends to
further develop the TIGN by upgrading existing facilities and by adding
switches and transmission capacity principally in and between major markets
where the Company has established a substantial customer base. See "Business--
Network and Operations."
MARKET OPPORTUNITY
The global market for national and international telecommunications equipment
and services is undergoing significant deregulation and reform. The industry is
being shaped by the following trends: (i) deregulation and privatization of
telecommunications markets worldwide; (ii) diversification of services through
technological innovation; and (iii) globalization of major carriers through
market expansion, consolidation and strategic alliances. As a result of these
factors, it is anticipated that the industry will experience considerable
growth in the foreseeable future, both in terms of traffic volume and revenue.
According to the International Telecommunications Union ("ITU"), a worldwide
telecommunications organization under the auspices of the United Nations, the
1998 revenues of the global telecommunications industry is projected to exceed
$1 trillion. The international telecommunications industry accounted for $52.8
billion in revenues and 60.3 billion minutes of use in 1995, increasing from
$21.7 billion in revenues and 16.7 billion minutes of use in 1986, which
represents compound annual growth rates of 10% and 15%, respectively. The ITU
projects that global telecommunications services revenues will approach $900
billion by the year 2000. See "The Global Telecommunications Industry."
BUSINESS STRATEGY
Telegroup's objective is to become the leading provider of telecommunications
services to small and medium-sized business and high-volume residential
customers in its existing core markets and in selected target markets.
Telegroup's strategy for achieving this objective is to deliver additional
services to customers in its markets through the continued deployment of the
TIGN and to expand its sales and marketing organization into new target
markets. The Company's business strategy includes the following key elements:
Expand the Telegroup Intelligent Global Network. Telegroup is currently
expanding the TIGN by installing additional switches, purchasing ownership in
additional fiber-optic cable and leasing additional dedicated transmission
capacity in strategically located areas of customer concentration in Western
Europe and
4
<PAGE>
the Pacific Rim. Through September 30, 1997, the Company has invested over
$16.2 million in network facilities, and the Company anticipates the investment
of an additional $40.3 million in network facilities over the next 15 months.
During the next 15 months, the Company has scheduled the installation of
additional switches in the United States, Spain, New Zealand, Korea, El
Salvador and Brazil, and nodes in the United States, Sweden, Norway, Belgium,
Greece and Austria. Telegroup will continue to purchase ownership in additional
fiber-optic cables and lease additional dedicated transmission capacity to
reduce the Company's per minute transmission costs. The Company's ability to
achieve these goals is dependent upon, among other things, its ability to raise
additional capital. The Company believes that the expansion of the TIGN will
enable Telegroup to continue to migrate customers from traditional call-
reorigination services to Global Access Direct. In order to maximize the
Company's return on invested capital, the Company employs a success-based
approach to capital expenditures, locating new switching facilities in markets
where the Company has established a customer base by marketing its call-
reorigination services.
Maximize Operating Efficiencies. Telegroup intends to reduce its costs of
providing telecommunications services by strategically deploying switching
facilities, adding leased and owned fiber-optic capacity and entering into
additional alternative "transit/termination agreements." This expansion of the
TIGN will enable the Company to originate, transport and terminate a larger
portion of its traffic over its own network, thereby reducing its overall
telecommunications costs. The Company believes that through least cost routing
and its cost effective Excel LNX switches and its other facilities, Telegroup
will be able to further reduce the overall cost of its services.
Expand Global Sales, Marketing and Customer Service Organization. The Company
believes that its experience in establishing one of the most comprehensive
global sales, marketing and customer service organizations in the global
telecommunications industry provides it with a competitive advantage. The
Company intends to expand its global sales, marketing and customer service
organization in new and existing markets. In new target markets, the Company
relies primarily on independent agents to develop a customer base while
minimizing its capital investment and management requirements. As the customer
base in a particular market develops, the Company intends to selectively
acquire the operations of its Country Coordinator serving such market and
recruit and train additional internal sales personnel and independent agents.
The Company believes that a direct sales and marketing organization complements
its existing independent agents by enabling Telegroup to conduct test marketing
and quickly implement new marketing strategies. In addition to its sales
offices in France, Germany and the United Kingdom, the Company intends to open
or acquire additional offices in target markets in Europe and the Pacific Rim
during 1998.
Position Telegroup as a Local Provider of Global Telecommunications
Services. Telegroup is one of the only alternative telecommunications providers
that offers in-country and regional customer service offices in major markets
on a global basis. At November 30, 1997, the Company had 28 Country
Coordinators providing customer service in 72 countries. Telegroup believes
this local presence provides an important competitive advantage, allowing the
Company to tailor customer service and marketing to meet the specific needs of
its customers in a particular market. Customer service representatives speak
the local languages and are aware of the cultural norms in the countries in
which they operate. The Company continually monitors changes in the local
market and seeks to quickly modify service and sales strategies in response to
such changes. In many instances, this type of dedicated customer service and
marketing is not available to the Company's target customer base from the ITOs.
Target Small and Medium-Sized Business Customers. The Company believes that
small and medium-sized business customers focus principally on obtaining
quality and breadth of service at low prices and have historically been
underserved by the ITOs and the major global telecommunications carriers.
Through the deployment of the TIGN, the Company will continue to migrate
existing customers from traditional call-reorigination services to Global
Access Direct, and to address the telecommunications needs of a wider base of
5
<PAGE>
small and medium-sized business customers. Telegroup believes that, with its
direct, face-to-face sales force and dedicated customer service, it can more
effectively attract and serve these business customers.
Pursue Acquisitions, Joint Ventures and Strategic Alliances. The Company
intends to expand its global sales, marketing and customer service
organizations, increase its customer base, add network and circuit capacity,
enter additional markets and develop new products and services through
acquisitions, joint ventures and strategic alliances. The Company seeks to
acquire controlling interests in companies that have established marketing
organizations, existing customer bases, complementary network facilities, new
services or technologies and experienced management teams. In addition, the
Company intends to make selective acquisitions of its Country Coordinators'
operations, in order to lower its selling, general and administrative expense
and increase control over this distribution channel. The Company also expects
to acquire the operations of other agents and marketing groups. The Company
also intends to enter into joint ventures and strategic alliances with selected
business partners to enable the Company to enter additional markets and to
complement the Company's current operations and service offerings. The Company
is continuously reviewing opportunities and believes that such acquisitions,
joint ventures and strategic alliances are an important means of expanding its
network and increasing network traffic volume, both of which are expected to
lower its overall cost of telecommunications services.
Broaden Market Penetration through Enhanced Service Offerings. The Company
believes that offering a broad array of enhanced services is essential to
retain existing customers and to attract new customers. The TIGN's enhanced
services platform and its distributed intelligent network architecture permit
the Company to provide a broad array of voice, data and enhanced services and
to efficiently distribute customer information, such as language selection,
waiting voice-mail and faxes and speed dial numbers throughout the TIGN. The
Company offers a comprehensive solution to its customers' telecommunications
needs by providing enhanced services, including fax store and forward, fax-
mail, voice-mail and call conferencing and intends to introduce e-mail-to-
voice-mail translation and voice recognition services. Telegroup believes that
its provision of such enhanced services will enable it to increase its revenue
from existing customers and to attract a broader base of small and medium-sized
business customers.
The Company was incorporated in Iowa in 1989. The address of the Company's
principal place of business is 2098 Nutmeg Avenue, Fairfield, Iowa 52556, and
its telephone number is (515) 472-5000.
RECENT DEVELOPMENTS
On July 14, 1997, the Company completed the initial public offering (the
"IPO") of 4,000,000 shares of Common Stock, no par value (the "Common Stock"),
at a price of $10.00 per share. The net proceeds to the Company from the sale
of the 4,000,000 shares was approximately $35.6 million after deducting
expenses and underwriting discounts. In addition, on August 12, 1997, the
Company completed the sale of an additional 450,000 shares of Common Stock
pursuant to the exercise of the underwriters' overallotment option, yielding
net proceeds to the Company of approximately $4.2 million after deducting
underwriting discounts.
On August 14, 1997, the Company acquired 60% of the common stock of, and a
controlling interest in, PCS Telecom, Inc. ("PCS Telecom") for approximately
$1.3 million in cash and 40,000 shares of unregistered Common Stock. PCS
Telecom is a developer and manufacturer of state of the art, feature-rich,
calling card platforms used by Telegroup and numerous other companies. PCS
Telecom, which currently has 25 employees, has installed its products both in
international and domestic markets. Telegroup has purchased these platforms as
part of its global strategy of providing enhanced services for the TIGN, and
considers this acquisition to be a strategic purchase which is intended to
ensure stability of supply of platforms to establish expeditiously an
international facilities network for enhanced services.
On September 5, 1997, the Company prepaid in full all of its outstanding $20
million in aggregate principal amount of 12% Senior Subordinated Notes due 2003
(the "Senior Subordinated Notes") at a redemption price
6
<PAGE>
equal to 107% of the principal amount thereof, plus accrued interest. The
Company financed the prepayment of the Senior Subordinated Notes with a portion
of the net proceeds from the IPO and $8.5 million of borrowings under a $15
million revolving credit facility with First Chicago NBD, Inc. (the "Revolving
Credit Facility"). The Revolving Credit Facility expired on October 31, 1997.
The Company currently anticipates entering into a new credit facility for
available borrowings in an amount not expected to exceed $20 million with a
bank or other financial institution (the "New Credit Facility"). There can be
no assurance that the Company will enter into the New Credit Facility.
On September 30, 1997, the Company issued $25 million aggregate principal
amount of 8% Convertible Subordinated Notes due 2005 (the "Convertible Notes").
The net proceeds to the Company from the issuance of the Convertible Notes was
approximately $24.3 million and approximately $15.0 million of such net
proceeds were used to repay all amounts outstanding under the Revolving Credit
Facility. See "Description of Other Indebtedness."
On October 23, 1997, the Company consummated a private placement under Rule
144A of the Securities Act, pursuant to which the Company issued and sold $97
million aggregate principal amount at maturity of Senior Discount Notes (the
"Senior Discount Notes"), receiving gross proceeds of approximately $72.3
million. The Senior Discount Notes were issued pursuant to the terms of an
indenture dated October 23, 1997 (the "Indenture") between the Company and
State Street Bank and Trust Company, as trustee (the "Trustee").
On November 25, 1997, the Company acquired certain property and equipment
from Fastnet UK Limited ("Fastnet") for approximately $240,000. Fastnet has an
agency agreement with the Company in which it coordinated retail sales and
provided customer service and other services to the Company's customers in the
United Kingdom. The Company intends to utilize the assets acquired to enhance
the operations of Telegroup UK Limited, a wholly-owned subsidiary of the
Company.
THE OFFERING
Common Stock offered by
the Selling Shareholders Up to 234,889 shares of Common Stock. See
......................... "Description of Common Stock."
Common Stock outstanding
before offering (1) ..... 30,768,542 shares
Common Stock to be
outstanding after the 31,003,431 shares
Offering (2) ............
Use of proceeds .......... The Company will not receive any of the proceeds
from the sale of Common Stock by the Selling
Shareholders.
Dividend policy .......... The Company does not expect to pay dividends on the
Common Stock in the foreseeable future. See
"Dividend Policy."
Nasdaq National Market TRGP
Symbol ..................
- --------
(1) As of September 30, 1997, excludes (i) 1,677,153 shares of Common Stock
issuable upon the exercise of options granted under the Stock Option Plan
(as defined); (ii) 2,322,847 shares of Common Stock issuable upon the
exercise of options available for grant under the Stock Option Plan; and
(iii) 1,160,107 shares of Common Stock issuable upon the exercise of the
Warrants (as defined). See "Management--Amended and Restated Stock Option
Plan" and "Description of Capital Stock--Warrants."
(2) Assumes that all of the Convertible Subordinated Notes are converted at a
conversion rate of $12 per share. See "Description of Securities."
7
<PAGE>
SUMMARY FINANCIAL DATA
The following table sets forth certain consolidated financial information for
the Company for (i) the years ended December 31, 1994, 1995 and 1996, which
have been derived from the Company's audited consolidated financial statements
and notes thereto included elsewhere in this Prospectus, (ii) the year ended
December 31, 1993, which has been derived from audited consolidated financial
statements of the Company which are not included herein, and (iii) the year
ended December 31, 1992, which has been derived from unaudited consolidated
financial statements which are not included herein. The summary financial data
as of September 30, 1997 and for the nine months ended September 30, 1996 and
1997 has been derived from the unaudited consolidated financial statements for
the Company included elsewhere in this Prospectus. In the opinion of
management, the unaudited consolidated financial statements have been prepared
on the same basis as the audited consolidated financial statements and include
all adjustments, which consist only of normal recurring adjustments, necessary
for a fair presentation of the financial position and the results of operations
for these periods. The "As Adjusted" financial information is not necessarily
indicative of the Company's financial position or the results of operations
that actually would have occurred if the transactions described herein had
occurred on the dates indicated or for any future period or date. The
adjustments give effect to available information and assumptions that the
Company believes are reasonable. The following financial information should be
read in conjunction with "Selected Financial Data" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the
Company's consolidated financial statements and notes thereto appearing
elsewhere herein.
<TABLE>
<CAPTION>
YEAR NINE MONTHS
ENDED NINE MONTHS ENDED
DECEMBER 31, ENDED SEPTEMBER 30,
YEAR ENDED DECEMBER 31, AS ADJUSTED SEPTEMBER 30, AS ADJUSTED
----------------------------------------------- ------------ ----------------- -------------
1992 1993 1994 1995 1996 1996(1) 1996 1997 1997(2)
----------- ------- ------- -------- -------- ------------ -------- -------- -------------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT RATIOS AND OTHER OPERATING DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Retail................. $23,846 $29,790 $68,714 $128,139 $179,147 $179,147 $128,828 $169,720 $169,720
Wholesale.............. -- -- -- 980 34,061 34,061 18,951 68,758 68,758
------- ------- ------- -------- -------- -------- -------- -------- --------
Total revenues......... 23,846 29,790 68,714 129,119 213,208 213,208 147,779 238,478 238,478
Cost of revenues........ 18,411 22,727 49,513 83,101 150,537 150,537 100,794 174,273 174,273
------- ------- ------- -------- -------- -------- -------- -------- --------
Gross profit........... 5,435 7,063 19,201 46,018 62,671 62,671 46,985 64,205 64,205
------- ------- ------- -------- -------- -------- -------- -------- --------
Operating expenses:
Selling, general and
administrative........ 3,935 7,341 19,914 39,222 59,652 59,652 42,648 63,174 63,174
Depreciation and
amortization.......... 61 172 301 655 1,882 2,415 1,158 3,208 3,480
Stock option based
compensation.......... -- -- -- -- 1,032 1,032 -- 257 257
------- ------- ------- -------- -------- -------- -------- -------- --------
Total operating
expenses.............. 3,996 7,513 20,215 39,877 62,566 63,099 43,806 66,639 66,911
------- ------- ------- -------- -------- -------- -------- -------- --------
Operating income
(loss)................ 1,439 (450) (1,014) 6,141 105 (428) 3,179 (2,434) (2,706)
Interest expense....... 88 47 112 121 579 10,178 200 2,135 7,540
Extraordinary item,
loss on extinguishment
of debt, net of income
taxes................. -- -- -- -- -- -- -- 9,971 10,473
------- ------- ------- -------- -------- -------- -------- -------- --------
Net earnings (loss).... 1,386 (707) (538) 3,821 (118) (7,661) 2,050 (12,820) (17,633)
======= ======= ======= ======== ======== ======== ======== ======== ========
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
YEAR NINE MONTHS
ENDED NINE MONTHS ENDED
DECEMBER 31, ENDED SEPTEMBER 30,
YEAR ENDED DECEMBER 31, AS ADJUSTED SEPTEMBER 30, AS ADJUSTED
------------------------------------------- ------------ --------------- -------------
1992 1993 1994 1995 1996 1996(1) 1996 1997 1997(2)
----------- ------ ------ ------ ------- ------------ ------ ------- -------------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT RATIOS AND OTHER OPERATING DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Per share amounts(8):
Earnings (loss) before
extraordinary item.... $ .05 (.02) (.02) .13 (.00) (.23) .07 (.10) (.26)
Net earnings (loss).... $ .05 (.02) (.02) .13 (.00) (.23) .07 (.47) (.64)
Weighted-average
shares................ 28,785 28,785 28,785 28,785 28,785 33,235 28,785 27,462 27,462
OTHER FINANCIAL DATA:
EBITDA(3)............... $1,510 $ (278) $ (577) $6,994 $ 2,990 $4,341 $ 602
Net cash provided by
(used in) operating
activities............. 820 924 1,364 5,561 4,904 4,083 (1,002)
Net cash (used in)
investing activities... (667) (765) (700) (2,818) (11,262) (8,261) (13,325)
Net cash (used in)
provided by financing
activities............. 21 (10) 957 (115) 15,924 3,877 58,648
Ratio of earnings to
fixed charges(4)....... 15.18 -- -- 29.76 .84 .26 10.44 -- --
Capital expenditures.... 291 449 1,056 2,652 9,068 6,264 12,463
Dividends declared per
common share........... -- -- -- .02 .02 .02 --
OTHER OPERATING DATA (AT
PERIOD END):
Retail customers(5):
Domestic (US).......... 8,261 7,021 16,733 17,464 34,294 48,785
International.......... 0 5,301 28,325 56,156 109,922 167,444
Wholesale customers(6).. 0 0 0 4 18 26
Number of employees..... 54 97 217 296 444 576
Number of switches...... 0 1 2 3 7 19
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1997
------------------------
ACTUAL AS ADJUSTED (7)
-------- ---------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.............................. $ 58,215 $130,025
Working capital........................................ 39,035 110,845
Property & equipment, net.............................. 21,597 21,597
Total assets........................................... 139,658 214,590
Long term debt, less current portion................... 25,042 99,975
Total shareholders' equity............................. 40,922 40,922
</TABLE>
- -------
(1) Adjusted to give effect to the issuance of the Convertible Notes, the
offering of Senior Discount Notes and the elimination of interest and
amortization expense for the Senior Subordinated Notes as if such
transactions had occurred on January 1, 1996. As adjusted interest expense
reflects (i) approximately $2.0 million on the Convertible Notes for the
year ended December 31, 1996, and approximately $7.9 million on the Senior
Discount Notes for the year ended December 31, 1996 (ii) the elimination of
$0.3 million with respect to the Senior Subordinated Notes, for the year
ended December 31, 1996 (iii) amortization of fees and costs totaling $0.5
million relating to the Convertible Notes and the offering of Senior
Discount Notes for the year ended December 31, 1996 using amortization
periods equal to the term of the respective issuances (iv) the elimination
of $0.01 million of amortization of fees and costs relating to the Senior
Subordinated Notes for the year ended December 31, 1996 and (v) the
4,450,00 shares issued in connection with the initial public offering and
the underwriters' overallotment option. Interest income has not been
adjusted to reflect interest earned on additional available cash.
(2) Adjusted to give effect to the issuance of the Convertible Notes, the
offering of Senior Discount Notes and the elimination of interest and
amortization expense for the Senior Subordinated Notes as if such
transactions had occurred on January 1, 1997. As adjusted interest expense
reflects (i) approximately $1.5 million on the Convertible Notes for the
nine-months ended September 30, 1997, and approximately $5.9 million on the
Senior Discount Notes for the nine-months ended September 30, 1997, (ii)
the elimination of $2.0 million with respect to the Senior Subordinated
Notes, for the nine-months ended September 30, 1997, (iii) amortization of
fees and
9
<PAGE>
costs totaling $0.4 million relating to the Convertible Notes and the
offering of Senior Discount Notes for the nine-months ended September 30,
1997 using amortization periods equal to the term of the respective
issuances and (iv) the elimination of $0.1 million of amortization of fees
and costs relating to the Senior Subordinated Notes for the nine-months
ended September 30, 1997. Interest income has not been adjusted to reflect
interest earned on additional available cash. Adjusted also reflects the
additional loss of $0.5 million (net of tax) on the extinguishment of debt
as if such transaction had occurred on January 1, 1997.
(3) EBITDA represents net earnings (loss) plus net interest expense (income),
income taxes, depreciation and amortization, non-cash stock option based
compensation and the extraordinary item, loss on extinguishment of debt.
While EBITDA is not a measurement of financial performance under generally
accepted accounting principles and should not be construed as a substitute
for net earnings (loss) as a measure of performance, or cash flow as a
measure of liquidity, it is included herein because it is a measure
commonly used in the telecommunications industry.
(4) The ratio of earnings to fixed charges was computed by dividing earnings
by fixed charges. For this purpose, earnings consist of income from
continuing operations, before income taxes and fixed charges of the
Company and its subsidiaries. Fixed charges consist of the Company's and
its subsidiaries' interest expense and the portion of rent expense
representative of an interest factor. For the years ended December 31,
1993, 1994, 1996, 1996 as adjusted, and for the nine months ended
September 30, 1997, and September 30, 1997 as adjusted, earnings were
inadequate to cover fixed charges. The dollar amount of the coverage
deficiency was $436,891, $886,700, $125,770, $10,258,419, $4,214,912 and
$9,892,150, respectively.
(5) Consists of retail customers who received invoices for the last month of
the period indicated. Does not include active international customers who
incurred charges in such month but who had outstanding balances as of the
last day of such month of less than $50, as the Company does not render
invoices in such instances.
(6) Consists of wholesale customers who received invoices for the last month
of the period indicated.
(7) Adjusted to give effect to the offering of the Senior Discount Notes as if
such transaction had occurred on September 30, 1997.
(8) Earnings per common and common equivalent share have been computed using
the weighted-average number of shares of common stock outstanding during
each period as adjusted for the effects of Securities and Exchange
Commission Staff Accounting Bulletin No. 83. Accordingly, options and
warrants to purchase common stock granted within one year of the Company's
initial public offering, which had exercise prices below the initial
public offering price per share, have been included in the calculation of
common equivalent shares, using the treasury stock method, as if they were
outstanding for all periods presented. For the nine-month period ended
September 30, 1997 and as adjusted, earnings per common share have been
computed under the provisions of Accounting Principles Board Opinion No.
15, "Earnings Per Share." Common stock equivalents, which includes options
and convertible subordinated notes, are not included in the loss per share
calculation as their effect is anti-dilutive.
9--1
<PAGE>
RISK FACTORS
In addition to the other information in this Prospectus, including "Selected
Financial Data," "Management's Discussion and Analysis of Financial Condition
and Results of Operations," and the Company's consolidated financial
statements and notes thereto included elsewhere herein, the following risk
factors should be considered carefully by prospective investors prior to
making an investment in the Notes.
SIGNIFICANT LEVERAGE AND DEBT SERVICE
The Company has indebtedness which is substantial in relation to its
stockholders' equity, as well as interest and debt service requirements which
are significant compared to its cash flow from operations. As of September 30,
1997, on a pro forma basis after giving effect to the offering of the Senior
Discount Notes and the application of the net proceeds therefrom, the Company
would have had approximately $100.2 million of indebtedness outstanding,
including the Notes and the Convertible Notes, which would have represented
71% of total capitalization. See "Capitalization." In addition, the Company
was permitted to incur up to $15.0 million of indebtedness under the Revolving
Credit Facility. The Company anticipates entering into the New Credit Facility
with a bank or other financial institution for available borrowings in an
amount not expected to exceed $20 million. There can be no assurance that the
Company will enter into the New Credit Facility.
The degree to which the Company is leveraged could have important
consequences to holders of the Notes, including, but not limited to the
following: (i) a substantial portion of the Company's cash flow from
operations must be dedicated to debt service and will not be available for
operations and other purposes; (ii) the Company's ability to obtain additional
financing in the future for working capital, capital expenditures,
acquisitions or general corporate purposes may be impaired; and (iii) certain
of the Company's borrowings are and will continue to be at variable rates of
interest, which exposes the Company to the risk of increased interest rates.
The Company's ability to pay interest on the Notes and to satisfy its other
obligations will depend upon the Company's future operating performance, which
will be affected by prevailing economic conditions and financial, business and
other factors, many of which are beyond the Company's control. Although the
Company's cash flow from operations has been sufficient to meet its debt
service obligations in the past, there can be no assurance that the Company's
operating results will continue to be sufficient for the Company to meet its
obligations. The Company may be required to refinance the Notes at maturity.
No assurance can be given that, if required, the Company will be able to
refinance the Notes on terms acceptable to it, if at all. If the Company is
unable to service its indebtedness, it will be forced to adopt an alternative
strategy that may include actions such as reducing or delaying capital
expenditures or the expansion of the TIGN, selling assets, restructuring or
refinancing its indebtedness or seeking additional equity capital. There can
be no assurance that any of these strategies could be effected on terms
acceptable to the Company, if at all. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
LIMITATIONS IMPOSED BY CERTAIN INDEBTEDNESS
The Indenture and the indenture governing the Convertible Notes contain
certain restrictive covenants which affect, and in many respects significantly
limit or prohibit, among other things, the ability of the Company to incur
indebtedness, make prepayments of certain indebtedness, make investments,
engage in transactions with affiliates, create liens, sell assets and engage
in mergers and consolidations. The collateral securing borrowings under the
Revolving Credit Facility consisted of substantially all the assets of the
Company. It is currently anticipated that the New Credit Facility will provide
for similar collateral arrangements. If the Company were unable to repay
borrowings under the New Credit Facility, if entered into, the lender
thereunder could proceed against the collateral securing the New Credit
Facility. If the indebtedness under the New Credit Facility or, if entered
into, the New Credit Facility, were to be accelerated, there can be no
assurance that the assets of the Company would be sufficient to repay such
indebtedness and the Notes. See "Description of Other Indebtedness--New Credit
Facility."
10
<PAGE>
OPERATION THROUGH SUBSIDIARIES; STRUCTURAL SUBORDINATION
The Company conducts part of its operations through its Subsidiaries. As a
result, the Company is required to rely, in part, upon payment from its
Subsidiaries for the funds necessary to meet its obligations, including the
payment of interest on and principal of the Notes. The ability of the
Subsidiaries to make such payments will be subject to, among other things,
applicable state laws. Claims of creditors of the Company's Subsidiaries will
generally have priority as to the assets of such Subsidiaries over the claims
of the Company. At September 30, 1997, holders of the Notes would have been
structurally subordinated to approximately $3.8 million of indebtedness and
other liabilities (including trade payables) of the Company's Subsidiaries.
The markets in which the Company's Subsidiaries now conduct business, except
for South Africa, generally do not restrict the removal or conversion of the
local or foreign currency; however, there can be no assurance that this
situation will continue. The Company has formed a Subsidiary in South Africa
which is authorized to handle such repatriation functions on the Company's
behalf in accordance with applicable laws.
EXPANSION AND OPERATION OF THE TIGN
Historically, a significant portion of the Company's revenue has been
derived from the provision of traditional call-reorigination services to
retail customers on a global basis. The Company believes that as deregulation
occurs and competition increases in various markets around the world, the
pricing advantage of traditional call-reorigination relative to conventional
international long distance service will diminish or disappear in those
markets. The Company believes that, in general, in order to maintain its
existing customer base and to attract new customers in such markets, it will
need to be able to offer call-through services at prices at or below the
current prices charged for traditional call-reorigination. The Company seeks
to achieve this objective by continuing to expand the TIGN in core and
selected target markets, thereby enabling it to offer call-through
international long distance services in deregulated markets. The Company will
continue to migrate its existing call-reorigination customers and to attract
new customers in core and selected target markets to the Global Access Direct
service. There can be no assurance that the Company will be successful in its
efforts to expand the TIGN or in its efforts to continue to migrate existing
customers and attract new customers to Global Access Direct service. Failure
to accomplish this objective could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company has only recently begun operating the TIGN. The long-term
success of the Company is dependent upon its ability to operate, expand,
manage and maintain the TIGN, activities in which the Company has limited
experience. The continued expansion, operation and development of the TIGN
will depend on, among other factors, the Company's ability to raise additional
capital through debt and/or equity financing and to accomplish the following:
(i) acquire switching hardware and peripheral equipment; (ii) program the
switches with proprietary TIGN software; (iii) transport the hardware and
peripherals to the switch installation sites; (iv) obtain a switch co-location
site in each country; (v) obtain access and egress circuit capacity connecting
the switches to the Public Switched Telephone Network ("PSTN") and/or other
carriers; (vi) obtain necessary licenses permitting termination and
origination of traffic; (vii) load switches with customer data; and (viii)
obtain access to or ownership of transmission facilities linking a switch to
other TIGN switches. The failure to raise such additional capital or to
accomplish any of these tasks could cause a significant delay in the
deployment of the TIGN. Moreover, there can be no assurance that the Company
has obtained all licenses or approvals necessary to import equipment for use
in its telecommunications network. Significant delays in the deployment of the
TIGN could have a material adverse effect on the Company's business, financial
condition and results of operations.
The successful implementation of the Company's expansion strategy will be
subject to a variety of risks, including operating and technical problems,
regulatory uncertainties, possible delays in the full implementation of
liberalization initiatives, competition and the availability of capital. In
expanding the TIGN, the Company may encounter technical difficulties because
of the existence of multiple local technical standards. These difficulties
could involve a delay in programming new switches with proprietary TIGN
software or otherwise integrating
11
<PAGE>
such switches into the TIGN. In addition, in expanding the TIGN, the Company
may incur substantial capital expenditures and additional fixed operating
costs. There can be no assurance that the TIGN will grow and develop as
planned or, if developed, that such growth or development will be completed on
schedule, at a commercially reasonable cost or within the Company's
specifications.
In deploying the TIGN, the Company must obtain reasonably priced access to
transmission facilities and interconnection with one or more carriers that
provide access and egress into and from the PSTN. Although the Company has
been successful to date in this regard, there can be no assurance that this
will be the case in the future. See "--Dependence on Telecommunications
Facilities Providers," "--Intense International and National Competition" and
"Business--Competition."
In addition, concurrently with its anticipated expansion, the Company may
from time to time experience general problems affecting the quality of the
voice and data transmission of some calls transmitted over the TIGN, which
could result in poor quality transmission and interruptions in service. To
provide redundancy in the event of technical difficulties with the TIGN and to
the extent the Company resells transit and termination capacity from other
carriers, the Company relies upon other carriers' networks. Whenever the
Company is required to route traffic over a non-primary choice carrier due to
technical difficulties or capacity shortages with the TIGN or the primary
choice carrier, these calls will be more costly to the Company. Any failure by
the Company to properly operate, expand, manage or maintain the TIGN could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations" and "Business."
NEED FOR ADDITIONAL FINANCING
The continued development and expansion of the TIGN, the upgrade or
replacement of the Company's management information systems, the opening of
new offices, and the introduction of new telecommunications services, as well
as the funding of anticipated operating losses and net cash outflows, may
require additional capital. The Company expects that the net proceeds from the
offering of the Senior Discount Notes will provide the Company with sufficient
capital to fund planned capital expenditures and anticipated operating losses
through December 1998. The Company currently anticipates that the net proceeds
from the offering of the Senior Discount Notes as well as borrowings under the
New Credit Facility, if entered into, will allow the Company to expand its
business as planned and to fund anticipated operating losses and net cash
outflows for the next 18 to 24 months. The amount of the Company's actual
future capital requirements will depend upon many factors, including the
performance of the Company's business, the rate and manner in which it expands
the TIGN, increases staffing levels and customer growth, upgrades or replaces
management information systems and opens new offices, as well as other factors
that are not within the Company's control, including competitive conditions
and regulatory or other government actions. In the event that the Company's
plans or assumptions change or prove to be inaccurate, the Company does not
enter into the New Credit Facility, or the net proceeds of the offering of the
Senior Discount Notes, together with internally generated funds and funds from
other financings, including the New Credit Facility, if entered into, prove to
be insufficient to fund the Company's growth and operations, then some or all
of the Company's development and expansion plans could be delayed or
abandoned, or the Company may be required to seek additional funds earlier
than currently anticipated.
HISTORICAL AND ANTICIPATED LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY
For the nine months ended September 30, 1997, the Company had an operating
loss of $2.4 million and a net loss of $12.8 million, compared to operating
income and net earnings of $3.2 million and $2.0 million, respectively, for
the nine months ended September 30, 1996. For the year ended December 31,
1996, the Company had operating income of $0.1 million and a net loss of $0.1
million, compared to operating income and net income of $6.1 million and $3.8
million for the year ended December 31, 1995. The Company expects to incur
lower gross margins, negative EBITDA and significant operating losses and net
losses for the near term as it incurs additional costs associated with the
development and expansion of the TIGN, the expansion of its marketing and
sales organization, and the introduction of new telecommunications services.
Furthermore, the
12
<PAGE>
Company expects that operations in new target markets will sustain negative
cash flows until an adequate customer base and related revenue stream have
been established. There can be no assurance that the Company will achieve or,
if achieved, will sustain profitability or positive cash flow from operating
activities in the future. If the Company cannot achieve and sustain
profitability or positive cash flow, it is likely that it will not be able to
meet its working capital requirements without additional financing. See "--
Need for Additional Financing" and "--Potential Fluctuations in Quarterly
Operating Results."
In addition, the Company intends to expand its operations in or enter
markets where it has limited or no operating experience. Furthermore, in many
of the Company's target markets, the Company intends to offer new services or
services that have previously been provided only by the local ITOs.
Accordingly, there can be no assurance that such operations will generate
operating or net income, and the Company's prospects must therefore be
considered in light of the risks, expenses, problems and delays inherent in
establishing a new business in a rapidly changing industry.
DEPENDENCE ON EFFECTIVE MANAGEMENT INFORMATION SYSTEMS
The Company believes that, based on its current business plan, its
management information systems will be sufficient for the next 9 to 15 months,
but will require substantial enhancements, replacements and additional
investments to continue their effectiveness after such time as the Company
continues to expand the TIGN and process a higher volume of calls. Contracts
have been concluded by the Company with both PeopleSoft and Saville Systems
and for the purchase of key replacement applications. Implementation planning
for replacement Order Entry, Customer Care, Billing, and Financial systems
from these two vendors is funded and underway. These activities are being
pursued by industry-experienced Company staff in cooperation with an approved
PeopleSoft Implementation Partner (KPMG), and Saville Systems. The failure to
successfully implement these and other such enhancements, replacements and
investments in a timely fashion could result in a material adverse effect on
the Company's business, financial condition and results of operations. Even if
the Company is successful in implementing these enhancements, replacements and
investments in a timely fashion there can be no assurance that the Company's
management information systems will not require further enhancements,
replacements or investments.
Historically, the Company has experienced some difficulties in reconciling
certain carrier accounts or, in some cases, accurately estimating monthly
carrier costs on a timely basis. These difficulties have affected the
Company's ability to complete its financial statements on a timely basis. To
address these issues, the Company has substantially upgraded and continues to
improve its accounting and billing systems. In addition, the Company has
developed a call costing and reconciliation system, which was substantially
implemented in June 1997. While there can be no assurance, the Company
believes that such improved and newly developed systems will enable the
Company to prepare its financial statements on a timely basis. Notwithstanding
such recent developments and upgrades, the Company anticipates that its Small
Business Technologies ("SBT") accounting, commissions, billing and possibly
other systems will be required to be further upgraded or replaced in the next
9 to 15 months. Therefore, the Company has purchased Enterprise Accounting
Management software from PeopleSoft, and Order Entry, Customer Care, Billing,
and Accounts Receivable software from Saville Systems. Implementation planning
for these replacement systems is fully funded and under way. Failure to
successfully operate existing systems, or successfully replace such SBT
accounting, commissions, billing and possibly other systems, all in a timely
fashion, could affect the Company's ability to meet required financial
reporting deadlines and management's ability to manage the Company efficiently
and, therefore, could result in a material adverse effect on the Company's
business, financial condition or results of operations. See "Business--Network
and Operations."
RECENT RAPID GROWTH; ABILITY TO MANAGE GROWTH
The Company's ability to continue to grow may be affected by various
factors, many of which are not within the Company's control, including
governmental regulation of the telecommunications industry in the United
States and in other countries, competition, and the transmission capacity.
Although the Company has
13
<PAGE>
experienced significant growth in a relatively short period of time and
intends to continue to grow rapidly, there can be no assurance that the growth
experienced by the Company will continue or that the Company will be able to
achieve the growth contemplated by its business strategy. The Company has
experienced significant revenue growth and has expanded the number of its
employees and the geographic scope of its operations. These factors have
resulted in increased responsibilities for management personnel. The Company's
ability to continue to manage its growth successfully will require it to
further expand its network and infrastructure, enhance its management,
financial and information systems and controls and to effectively expand,
train and manage its employee base. In addition, as the Company increases its
service offerings and expands its target markets, there will be additional
demands on its customer service support and sales, marketing and
administrative resources. There can be no assurance that the Company will be
able to successfully manage its expanding operations. If the Company's
management is unable to manage growth effectively, the Company's business,
financial condition and results of operations could be materially and
adversely affected. See "--Dependence on Effective Management Information
Systems" and "Business."
SUBSTANTIAL GOVERNMENT REGULATION
General. The global telecommunications industry is subject to international
treaties and agreements, and to laws and regulations which vary from country
to country. Enforcement and interpretation of these treaties, agreements, laws
and regulations can be unpredictable and are often subject to informal views
of government officials and ministries that regulate telecommunications in
each country. In certain countries, such government officials and ministries
are subject to influence by the local ITO.
The Company has pursued and expects to continue to pursue a strategy of
providing its services to the maximum extent it believes, upon consultation
with counsel, to be permissible under applicable laws and regulations. To the
extent that the interpretation or enforcement of applicable laws and
regulations is uncertain or unclear, the Company's aggressive strategy may
result in the Company (i) providing services or using transmission methods
that are found to violate local laws or regulations or (ii) failing to obtain
approvals or make filings subsequently found to be required under such laws or
regulations. Where the Company is found to be or otherwise discovers that it
is in violation of local laws and regulations and believes that it is subject
to enforcement actions by the FCC or the local authority, it typically seeks
to modify its operations or discontinue operations so as to comply with such
laws and regulations. There can be no assurance, however, that the Company
will not be subject to fines, penalties or other sanctions as a result of
violations regardless of whether such violations are corrected. If the
Company's interpretation of applicable laws and regulations proves incorrect,
it could lose, or be unable to obtain, regulatory approvals necessary to
provide certain of its services or to use certain of its transmission methods.
The Company also could have substantial monetary fines and penalties imposed
against it. Except as set forth in this "Substantial Government Regulation"
and in "Business--Government Regulation," the Company believes that it is
currently in compliance with all applicable material domestic and
international regulatory requirements. To the Company's knowledge, it is not
currently subject to any material regulatory inquiry or investigation.
In numerous countries where the Company operates or plans to operate, local
laws or regulations limit the ability of telecommunication companies to
provide basic international telecommunications service in competition with
state-owned or state-sanctioned monopoly carriers. There can be no assurance
that future regulatory, judicial, legislative or political considerations will
permit the Company to offer to residents of such countries all or any of its
services, that regulators or third parties will not raise material issues
regarding the Company's compliance with applicable laws or regulations, or
that such regulatory, judicial, legislative or political decisions will not
have a material adverse effect on the Company. If the Company is unable to
provide the services which it presently provides or intends to provide or to
use its existing or contemplated transmission methods due to its inability to
obtain or retain the requisite governmental approvals for such services or
transmission methods, or for any other reason related to regulatory compliance
or lack thereof, such developments could have a material adverse effect on the
Company's business, financial condition and results of operations.
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The Company provides a substantial portion of its customers with access to
its services through the use of call-reorigination. Revenues attributable to
call-reorigination represented 76.6% of the Company's revenues in fiscal year
1996 and 75.5% of the Company's revenues for the nine-month period ended
September 30, 1997, and are expected to continue to represent a significant
but decreasing portion of the Company's revenues. A substantial number of
countries have prohibited certain forms of call-reorigination as a mechanism
to access telecommunications services. This has caused the Company to cease
providing call-reorigination services to customers in Bermuda, the Bahamas,
the Philippines, and the Cayman Islands, and may require it to do so with
respect to customers in other jurisdictions in the future. As of November 20,
1997, reports had been filed with the ITU and/or the FCC claiming that the
laws in 79 countries prohibit call-reorigination. While the Company provides
call-reorigination services in substantially all of these countries, no single
country within this group accounted for more than 2% of the total revenues of
the Company for the nine months ended September 30, 1997. There can be no
assurance that other countries where the Company derives material revenue will
not prohibit call-reorigination in the future. To the extent that a country
with an express prohibition against call-reorigination is unable to enforce
its laws against a provider of such services, it can request that the FCC
enforce such laws in the United States by, for example, requiring a provider
of such services to cease providing call-reorigination services to such
country or, in extreme circumstances, by revoking such provider's FCC
authorizations. Twenty-nine countries have formally notified the FCC that they
expressly prohibit call-reorigination. See "--United States--The FCC's
Policies on Call-reorigination." There can be no assurance that the Company's
call-reorigination services will not continue to be, or will not become,
prohibited in certain jurisdictions, including jurisdictions in which the
Company currently provides call-reorigination services, and, depending on the
jurisdictions, services and transmission methods affected, there could be a
material adverse effect on the Company's business, financial condition and
results of operations.
On February 15, 1997, the United States and more than 60 members of the
World Trade Organization ("WTO") agreed to open their respective
telecommunications markets to competition and foreign ownership and to adopt
regulatory measures to protect market entrants against anticompetitive
behavior by dominant telephone companies (the "WTO Agreement"). Although the
Company believes that the WTO Agreement could provide the Company with
significant opportunities to compete in markets that were not previously
accessible, reduce its costs and provide more reliable services, it could also
provide similar opportunities to the Company's competitors. There can be no
assurance that the pro-competitive effects of the WTO Agreement will not have
a material adverse effect on the Company's business, financial condition and
results of operations or that members of the WTO will implement the terms of
the WTO Agreement.
United States. In the United States, the provision of the Company's services
is subject to the provisions of the Communications Act of 1934, as amended
(the "Communications Act"), the 1996 Telecommunications Act (the "1996
Telecommunications Act") and the FCC regulations thereunder. While the recent
trend in federal regulation of nondominant telecommunication service
providers, such as the Company, has been in the direction of reduced
regulation, this trend has also given AT&T Corp. ("AT&T"), the largest long
distance carrier in the U.S., increased pricing flexibility that has permitted
it to compete more effectively with smaller long distance carriers such as
Telegroup. In addition, the 1996 Telecommunications Act has opened the U.S.
market to increased competition by allowing the Regional Bell Operating
Companies ("RBOCs") to provide
interexchange service for the first time. There can be no assurance that
future regulatory, judicial and legislative changes will not have a material
adverse effect on the Company's business, financial condition and results of
operations.
U.S. International Long Distance Services. The Company is subject to FCC
rules requiring authorization from the FCC prior to leasing international
capacity, acquiring international facilities, and/or purchasing switched
minutes, and initiating international service between the United States and
foreign points, as well as to FCC rules which also regulate the manner in
which the Company's international services may be provided, including the
circumstances under which the Company may provide international switched
services by using private lines or route traffic through third countries. FCC
rules also require prior authorization before transferring control of or
assigning FCC authorizations, and impose various reporting and filing
requirements on companies providing
15
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international services under an FCC authorization. Failure to comply with the
FCC's rules could result in fines, penalties or forfeiture of the Company's
FCC authorizations, each of which could have a material adverse effect on the
Company business, financial condition and results of operations.
The FCC's Policies on Call-reorigination. The Company offers service by
means of call-reorigination pursuant to an FCC authorization ("Section 214
Switched Voice Authorization") under Section 214 of the Communications Act and
certain relevant FCC decisions. The FCC has determined that call-reorigination
service using uncompleted call signaling does not violate United States or
international law, but has held that United States companies providing such
services must comply with the laws of the countries in which they provide
service to customers as a condition of such companies' Section 214 Switched
Voice Authorizations. The FCC reserves the right to condition, modify or, in
extreme circumstances, revoke any Section 214 Authorizations and impose fines
for violations of the Communications Act or the FCC's regulations, rules or
policies promulgated thereunder or for a company's Section 214 Authorization.
FCC policy provides that foreign governments that satisfy certain conditions
may request FCC assistance in enforcing their laws against call-reorigination
providers based in the United States that are violating the laws of these
jurisdictions. Twenty-nine countries have formally notified the FCC that call-
reorigination services violate their laws. The Company provides call-
reorigination in 28 of these countries, which accounted for 7.9% of the
Company's total revenues for the nine months ended September 30, 1997. Two of
the 29 countries have requested assistance from the FCC in enforcing their
prohibitions on call-reorigination within their respective jurisdictions.
Neither of these two countries accounted for more than 2% of the Company's
total revenues for the nine months ended September 30, 1997. The FCC has held
that it would consider enforcement action against companies based in the
United States engaged in call-reorigination by means of uncompleted call
signaling in countries where this activity is expressly prohibited. There can
be no assurance that the FCC will not take action to limit the provision of
call-reorigination services. Enforcement action could include an order to
cease providing call-reorigination services in such country, the imposition of
one or more restrictions on the Company, monetary fines or, in extreme
circumstances the revocation of the Company's Section 214 Switched Voice
Authorization, and could have a material adverse effect on the Company's
business, financial condition and results of operations.
The FCC's Private Line Resale Policy. The FCC's private line resale policy
currently prohibits a carrier from reselling international private leased
circuits to provide switched services (known as "ISR") to or from a country
unless the FCC has found that the country affords U.S. carriers equivalent
opportunities to engage in similar activities in that country. Thus far, the
FCC has found that Canada, the United Kingdom, Sweden, New Zealand and
Australia afford such opportunities to U.S. carriers. In separate proceedings,
the FCC is considering equivalency determinations for the Netherlands, Chile,
Denmark, Finland and Mexico. The FCC has decided to modify its policy on
private line resale to allow such resale to countries that are members of the
WTO and where the local ITO generally charges U.S. carriers at or below an FCC
determined rate for terminating the U.S. carriers' traffic. As a result, the
Company may be allowed to engage in private line resale to a larger number
countries. The Company has entered into an arrangement with a wholly owned
Subsidiary in Australia that involves the transmission over private lines of
switched services to or from Australia. Although the FCC has made a
determination that resale opportunities in Australia are deemed equivalent
pursuant to the FCC's rules and policies, the Company cannot take advantage of
this finding because the local ITO does not charge U.S. carriers at or below
an FCC determined rate for terminating the U.S. carriers' traffic. The Company
anticipates
being able to take advantage of Australia's "equivalency" designation around
February 1998, when new FCC rules permit carriers to engage in ISR if they
meet either the FCC's "equivalency" rules or its new rules. The FCC has
granted the Company's request for a waiver allowing the Company to deviate
from the existing FCC approved $0.22 per minute settlement rate and to
contract at $0.05 per minute, pursuant to an agreement with its Subsidiary in
Australia. The Company has recently initiated service pursuant to this
agreement. There can be no assurance, however, that the FCC or any other
country's regulatory authority will change their policies in a way that would
have a beneficial impact on the Company or that would not have a material
adverse effect on the Company's business, financial condition and results of
operations.
The FCC's Policies on Transit and Refile. The FCC is currently considering a
1995 request (the "1995 Request") to limit or prohibit the practice whereby a
carrier routes, through its facilities in a third country, traffic
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<PAGE>
originating from one country and destined for another country. The FCC has
permitted third country calling where all countries involved consent to the
routing arrangements (referred to as "transiting"). Under certain arrangements
referred to as "refiling," the carrier in the destination country does not
consent to receiving traffic from the originating country and does not realize
the traffic it receives from the third country is actually originating from a
different country. While the Company's revenues attributable to refiling
arrangements are minimal, refiling may constitute a larger portion of the
Company's operations in the future. The FCC to date has made no pronouncement
as to whether refiling arrangements are inconsistent with U.S. or ITU
regulations, although it is considering these issues in connection with the
1995 Request. It is possible that the FCC will determine that refiling
violates U.S. and/or international law, which could have a material adverse
effect on the Company's business, financial condition and results of
operations.
The FCC's International Settlements Policy. The Company is also required to
conduct its facilities-based international business in compliance with the
FCC's international settlements policy (the "ISP"). The ISP establishes the
permissible arrangements for U.S. based facilities-based carriers and their
foreign counterparts to settle the cost of terminating each other's traffic
over their respective networks. One of the Company's arrangements with foreign
carriers is subject to the ISP and it is possible that the FCC could take the
view that this arrangement does not comply with the existing ISP rules. See
"The Global Telecommunications Industry--International Switched Long Distance
Services--Operating Agreements." If the FCC, on its own motion or in response
to a challenge filed by a third party, determines that the Company's foreign
carrier arrangements do not comply with FCC rules, among other measures, it
may issue a cease and desist order, impose fines on the Company or, in extreme
circumstances, revoke or suspend its FCC authorizations. See "--Recent and
Potential FCC Actions." Such action could have a material adverse effect on
the Company's business, financial condition and results of operations.
The FCC's Tariff Requirements for International Long Distance Services. The
Company is also required to file and has filed with the FCC a tariff
containing the rates, terms and conditions applicable to its international
telecommunications services. The Company is also required to file with the FCC
any agreements with customers containing rates, terms, and conditions for
international telecommunications services, if those rates, terms, or
conditions are different than those contained in the Company's tariff.
Notwithstanding the foregoing requirements, to date, the Company has not filed
with the FCC certain commercially sensitive carrier-to-carrier customer
contracts. If the Company charges rates other than those set forth in, or
otherwise violates, its tariff or a customer agreement filed with the FCC, or
fails to file with the FCC carrier-to-carrier agreements, the FCC or a third
party could bring an action against the Company, which could result in a fine,
a judgment or other penalties against the Company. Such action could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Recent and Potential FCC Actions. Regulatory action that has been and may be
taken in the future by the FCC may enhance the intense competition faced by
the Company. The FCC recently enacted certain changes in its rules designed to
permit alternative arrangements outside of its ISP as a means of encouraging
competition and achieving lower, cost-based accounting and collection rates as
more facilities-based competition is permitted in foreign markets.
Specifically, the FCC has decided to allow U.S. carriers, subject to certain
competitive safeguards, to propose methods to pay for international call
termination that deviate from traditional bilateral
accounting rates and the ISP. The FCC has also established lower ceilings
("benchmarks") for the rates that U.S. carriers will pay foreign carriers for
the termination of international services. Moreover, the FCC recently changed
its rules to implement the WTO Agreement, in part by allowing U.S. carriers to
accept certain exclusive arrangements with certain foreign carriers. While
these rule changes may provide the Company with more flexibility to respond
more rapidly to changes in the global telecommunications market, it will also
provide similar flexibility to the Company's competitors. The implementation
of these changes could have a material adverse effect on the Company's
business, financial condition and results of operations.
U.S. Domestic Long Distance Services. The Company's ability to provide
domestic long distance service in the United States is subject to regulation
by the FCC and relevant state Public Service Commissions ("PSCs")
17
<PAGE>
which regulate interstate and intrastate rates, respectively, ownership of
transmission facilities, and the terms and conditions under which the
Company's domestic U.S. services are provided. In general, neither the FCC nor
the relevant state PSCs exercise direct oversight over prices charged for the
Company's services or the Company's profit levels, but either or both may do
so in the future. The Company, however, is required by federal and state law
and regulations to file tariffs listing the rates, terms and conditions of
services provided. The Company has filed domestic long distance tariffs with
the FCC. The FCC adopted an order on October 29, 1996 (the "October 29, 1996
Order") eliminating the requirement that non-dominant interstate carriers,
such as the Company, maintain FCC tariffs. However, on February 13, 1997, the
United States Court of Appeals for the DC Circuit stayed the October 29, 1996
Order, pending judicial review of the Order. Elimination of tariffs will
require that the Company secure contractual agreements with its customers
regarding many of the terms of its existing tariffs or face possible claims
over the respective rights of the parties once these rights are no longer
clearly defined in tariffs. The Company generally is also required to obtain
certification from the relevant state PSC prior to the initiation of
intrastate service. Telegroup has the authorizations required or is not
required to obtain authorization to provide service in 47 states, and has
filed or is in the process of filing required tariffs in each state that
requires such tariffs to be filed. The Company has complied, or is in the
process of complying, with reporting requirements imposed by state PSCs in
each state in which it conducts business. Any failure to maintain proper
federal and state tariffing or certification or file required reports, or any
difficulties or delays in obtaining required authorizations, could have a
material adverse effect on the Company's business, financial condition and
results of operations. The FCC also imposes some requirements for marketing of
telephone services and for obtaining customer authorization for changes in the
customer's primary long distance carrier. If these requirements are not met,
the Company may be subject to fines and penalties.
To originate and terminate calls in connection with providing their
services, long distance carriers such as the Company must purchase "access
services" from local exchange carriers ("LECs") or competitive local exchange
carriers ("CLECs"). Access charges represent a significant portion of the
Company's cost of U.S. domestic long distance services and, generally, such
access charges are regulated by the FCC for interstate services and by PSCs
for intrastate services. The FCC has undertaken a comprehensive review of its
regulation of LEC access charges to better account for increasing levels of
local competition. On May 16, 1997, the FCC released an order making
significant changes in the access service rate structure. Some of the changes
may result in increased costs to the Company for the "transport" component of
access services, although other revisions of the order likely will reduce
other access costs. Some issues in the FCC proceeding have not yet been
resolved, including a proposal under which LECs would be permitted to allow
volume discounts in the pricing of access charges. While the resolution of
these issues is uncertain, if these rate structures are adopted, many long
distance carriers, including the Company, could be placed at a significant
cost disadvantage to larger competitors. In addition, the FCC has adopted
certain measures to implement the 1996 Telecommunications Act that will impose
new regulatory requirements, including the requirement that the Company
contribute some portion of its telecommunications revenues to a "universal
service fund" designated to fund affordable telephone service for consumers,
schools, libraries and rural healthcare providers. These contributions will
become payable beginning in 1998 for all interexchange carriers. Although the
FCC has not determined the precise amount of the contribution, the Company
estimates at this time that it will constitute approximately 4% of its gross
revenues from domestic end-user customers.
In some instances, the Company may be responsible for city sales taxes on
calls made within the jurisdiction of certain U.S. cities. The Company is
implementing software to track and bill for this tax liability. However, the
Company may be subject to sales tax liability for calls transmitted prior to
the implementation of such tax software and against which it has no
corresponding customer compensation. While the Company believes that any such
liability will not be significant, there can be no assurance that such tax
liability, if any, will not have a material adverse effect on the Company's
business, financial condition and results of operations.
In November 1996, the FCC adopted rules that would require that
interexchange companies offering toll-free access through payphones compensate
certain payphone operators for customers' use of the payphone. On July 1,
1997, the United States Court of Appeals for the District of Columbia Circuit
issued an opinion reversing
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<PAGE>
in part the FCC's payphone orders. The Court of Appeals ruled that the rate of
$.35 per call was arbitrary and capricious and remanded the case to the FCC
for further proceedings. The FCC issued a Second Report and Order on October
9, 1997, including that interexchange carriers must compensate payphone owners
at a rate of $.284 per call for all calls using their payphones. This
compensation method will be effective from October 7, 1997 through October 7,
1999. After this time period, interexchange carriers will be required to
compensate payphone owners at a market-based rate minus $0.066 per call. A
number of carriers have appealed the Second Report and Order to the U.S. Court
of Appeals for the D.C. Circuit or have sought FCC reconsideration of this
order. Although the Company cannot predict the outcome of the FCC's
proceedings on the Company's business, it is possible that such proceedings
could have a material adverse effect on the Company's business, financial
condition and results of operations.
The FCC and certain state agencies also impose prior approval requirements
on transfers of control, including pro forma transfers of control (without
public notice), and corporate reorganizations, and assignments of regulatory
authorizations. Such requirements may delay, prevent or deter a change in
control of the Company.
European Union. Historically, European countries have prohibited the direct
transport and switching of speech in real-time between switched network
termination points ("Voice Telephony") except by the ITO. Although the
regulation of the telecommunications industry is governed at a supra-national
level by the European Union ("EU"), the Company's provision of services in the
EU is subject to the laws and regulations of each EU member state in which it
provides services. The Full Competition Directive 96/19 (which together with
its subsidiary directives is hereinafter called the "Full Competition
Directive") was adopted on March 13, 1996 and requires the liberalization of
Voice Telephony and the freedom to create alternative telecommunications
infrastructures within EU member states (Austria, Belgium, Denmark, Finland,
France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands,
Portugal, Spain, Sweden, and the United Kingdom). While the Full Competition
Directive sets January 1, 1998 as the deadline for each EU member state to
enact its own laws to implement such directive, subject to extensions granted
to Spain (December 1998), Ireland (January 1, 2000), Greece (2000), Luxembourg
(July 1, 1998) and Portugal (2000), there can be no assurance that each EU
member state will enact laws that implement the Full Competition Directive
within the allotted time frame or at all. The European Commission has
announced plans to initiate legal action against Belgium, Denmark, Germany,
Greece, Italy, Luxembourg and Portugal for not implementing this legislation
adequately. If the Commission is not satisfied with the explanations given by
these countries for their delay, the Commission may take action that
ultimately could result in a decision by the European Court of Justice
concerning whether these countries have violated the Full Competition
Directive. To the extent the Full Competition Directive is not implemented, or
not properly or fully implemented, in a particular member state, the Company
will not be able to offer its full range of services or utilize certain
transmission or access methods in that country.
Each EU member state in which the Company currently conducts business has a
different national regulatory scheme and regulatory variations among the
member states are expected to continue for the foreseeable future. In the EU,
the Company currently owns and operates switching facilities in the United
Kingdom, the Netherlands and France and provides other telecommunications
services in certain other member countries. The requirements for the Company
to obtain necessary approvals to offer the full range of telecommunications
services, including Voice Telephony, vary considerably from country to
country. In the U.K., the Company provides Voice Telephony pursuant to a class
license and holds a license under Section 7 of
the Telecommunications Act of 1984 to engage in ISR. The U.K. government is
considering replacing the ISR license with a new license applicable to a
narrower scope of activities. The Company may have to apply for a new license
if the U.K. government replaces the ISR license and if the Company's
activities fall within the scope of activities covered by the new license.
Other than in the U.K., the Company has not obtained approvals necessary to
provide Voice Telephony in any EU member country. There can be no assurance
that the Company has received all necessary approvals, filed applications for
such approvals, received comfort letters or obtained all necessary licenses
from the applicable regulatory authorities to offer telecommunications
services in the EU, or that it will do so in the future. The Company's failure
to obtain, or retain necessary approvals could have a material adverse effect
on the Company's business, financial condition and results of operations.
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<PAGE>
Liberalization in EU member states and Switzerland is proceeding rapidly and
the Company is seeking to keep pace with competition even where ITOs retain a
legally mandated monopoly on Voice Telephony. In France, Germany and
Switzerland, the Company is currently providing traditional or transparent
call-reorigination services, but anticipates that it will migrate CUGs and
other customers to forms of call-through other than transparent call-
reorigination prior to January 1, 1998, the date on which full competition
with the ITOs will be permitted. The Company anticipates providing a range of
enhanced telecommunications services and switched voice services in France,
Germany and Switzerland to business users, including to CUGs, prior to January
1, 1998, by routing traffic via the international switched networks of
competitors to the French, German or Swiss ITOs, respectively. While the
Company believes that it will not be found to be offering Voice Telephony in
these countries prior to the expiration of the ITO's monopoly on such
services, the Company has received no assurance from the respective ITOs or
from the respective regulating authorities that this will be the case. It is
possible that the Company could be fined, or that the Company would not be
allowed to provide specific services in these countries, if the Company were
found to be providing Voice Telephony before January 1, 1998, or after that
date without obtaining a proper license. Such actions could have a material
adverse impact on the Company's business, financial condition and results of
operations.
Moreover, the Company may be incorrect in its assumption that (i) each EU
member state will abolish, on a timely basis, the respective ITO's monopoly to
provide Voice Telephony within and between member states and other countries,
as required by the Full Competition Directive, (ii) deregulation will continue
to occur and (iii) the Company will be allowed to continue to provide and to
expand its services in the EU member countries. There can be no assurance that
an EU member state will not adopt laws or regulatory requirements that will
adversely affect the Company. Additionally, there can be no assurance that
future EU regulatory, judicial or legislative changes will not have a material
adverse effect on the Company or that regulators or third parties will not
raise material issues with regard to the Company's compliance with applicable
laws or regulations. If the Company is unable to provide the services it is
presently providing or intends to provide or to use its existing or
contemplated transmission methods due to its inability to receive or retain
formal or informal approvals for such services or transmission methods, or for
any other reason related to regulatory compliance or the lack thereof, such
events could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business--Government
Regulation."
The Pacific Rim. Regulation of the Company's activities varies in the
Pacific Rim depending upon the particular country involved. The Company's
ability to provide voice telephony services is restricted in all countries
where the Company provides services except Australia and New Zealand, although
service between Australia or New Zealand and other countries may be
constrained by restrictions in the other countries. In Australia and New
Zealand, regulation of the Company's provision of telecommunications services
is relatively permissive, although registration in New Zealand with the
regulator is required for ISR. The Company's Australian Subsidiary was
enrolled in Australia as a "Supplier of Eligible International Services" under
the Telecommunications Act 1991, and now has the right to supply equivalent
services under the Telecommunications Act 1997. Additionally, in Japan, the
Company provides call-reorigination services but may not provide basic
switched voice services to the public. The Company may, with a license,
provide a broad array of value-added services, as well as limited switched
voice services to CUGs. The Japanese government has indicated that it will
permit carriers such as the Company to apply for ISR authority some time in
1997. There can be no assurance that the Company will be permitted to apply
for ISR authority, or (if it is permitted to apply) that ISR authority will be
granted, and the failure to obtain such authority could have an adverse effect
on the Company's plans to expand its services in Japan.
Call-reorigination services have been expressly permitted by the regulator
in Hong Kong. In Hong Kong, the Company has been issued a Public Non-Exclusive
Telecommunications Services ("PNETS") license which permits the provision of
personal identification number validation and call routing service and
facsimile communication service, and which, in general, has been interpreted
to permit the provision of call-reorigination services. A range of
international telephone services, including the operation of an international
gateway for all incoming and outgoing international calls, is provided in Hong
Kong solely by Hong Kong Telecommunications
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<PAGE>
International Limited ("HKTI"), the Hong Kong ITO, pursuant to an exclusive
license which will expire on October 1, 2006. The regulator in Hong Kong has
sought to encourage competition in international services consistent with
HKTI's exclusivities. For example, the Company may, with a license, provide a
broad array of value-added services, as well as limited basic switched voice
services to CUGs. In addition, the Hong Kong government has entered into
discussions with HKTI concerning a possible early termination of its exclusive
license and it has been reported that HKTI's exclusive license may be
terminated as early as 1999. In developing a competitive position in Hong
Kong, the Company has sought to provide international services to and from
Hong Kong to the maximum extent permitted under the current Hong Kong
regulatory regime, through, for example, agreements with providers within Hong
Kong. There can be no guarantee that the Hong Kong regulator will not change
its regulations or policy or, where the Company has interpreted laws and/or
regulations that are unclear, not find that the Company is in violation of
existing laws or that such change or finding will not require the Company to
cease providing certain services to and from Hong Kong.
There can be no assurance that the People's Republic of China ("China") will
continue the existing licensing regime with respect to the Hong Kong
telecommunications industry. There is also no assurance that China will
continue to implement the existing policies of the Hong Kong government with
respect to promoting the liberalization of the Hong Kong telecommunications
industry in general, including the policy allowing call-reorigination, which
is currently prohibited in China. For the nine months ended September 30,
1997, one wholesale customer in Hong Kong, New T&T Hong Kong Limited (the
"Hong Kong Customer"), accounted for approximately 12% of the Company's total
revenues. Substantially all of the services provided by the Company to this
customer consists of call-reorigination services. The initial term of the
Company's agreement with the Hong Kong Customer expires in October 1998,
automatically renews for one-year periods, and may be terminated by the Hong
Kong Customer if it determines in good faith that the services provided
pursuant to the agreement are no longer commercially viable in Hong Kong. If
the Company loses its rights under its PNETS license and/or if it is unable to
provide call-reorigination services in Hong Kong on either a retail or
wholesale basis, such action could have a material adverse effect on the
Company's business, financial condition and results of operations. In
addition, a material reduction in the level of services provided by the
Company to the Hong Kong Customer or a termination of the Company's agreement
with the Hong Kong Customer could have a material adverse effect on the
Company's business, financial condition and results of operations.
In all other Pacific Rim countries, the Company is strictly limited in its
provision of public voice and value added services. While some countries in
the Pacific Rim oppose call-reorigination, the Company generally has not faced
significant regulatory impediments. China has specifically informed the FCC
that call-reorigination is illegal in that country. Australia, New Zealand,
Japan and Hong Kong do not prohibit call-reorigination. If the Company is
unable to provide the services it is presently providing or intends to provide
or to use its existing or contemplated transmission methods due to its
inability to receive or retain formal or informal approvals for such services
or transmission methods, or for any other reason related to regulatory
compliance or the lack thereof, such events could have a material adverse
effect on the Company's business, financial condition and results of
operations. See "Business--Government Regulation."
Other Non-U.S. Markets. To the extent that it seeks to provide
telecommunications services in other non-U.S. markets, the Company will be
subject to the developing laws and regulations governing the competitive
provision of telecommunications services in those markets. The Company
currently plans to provide a limited range of services in South Africa and
certain Latin American countries, as permitted by regulatory conditions in
those markets, and to expand its operations as these markets implement
liberalization to permit competition in the full range of telecommunications
services. The nature, extent and timing of the opportunity for the Company to
compete in these markets will be determined, in part, by the actions taken by
the governments in these countries to implement competition and the response
of incumbent carriers to these efforts. There can be no
assurance that any of these countries will implement competition in the near
future or at all, that the Company will be able to take advantage of any such
liberalization in a timely manner, or that the Company's operations in any
such country will be successful. See "Business--Government Regulation."
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DEPENDENCE ON INDEPENDENT AGENTS; CONCENTRATION OF MARKETING RESOURCES
The Company's success depends in significant part on its ability to recruit,
maintain and motivate a network of independent agents, including its Country
Coordinators. Telegroup's international market penetration has resulted
primarily from the sales activities of independent agents compensated on a
commission basis. As of November 30, 1997, Telegroup had approximately 1,375
independent agents worldwide. The Company is subject to competition in the
recruitment of independent agents from other organizations that use
independent agents to market their products and services, including those that
market telecommunications services. The motivation of the independent agents,
which can be affected by general economic conditions and a number of
intangible factors, may impact the effectiveness of the independent agents'
ability to recruit customers for the Company's services. Because of the number
of factors that affect the recruiting of independent agents, the Company
cannot predict when or to what extent such increases or decreases in the level
of independent agent activity will occur. There can be no assurance that the
Company will be able to continue to effectively recruit, maintain and motivate
independent agents and, to the extent the Company is not able to do so, the
Company's business, results of operations and financial condition could be
materially and adversely affected.
As of September 30, 1997, approximately one-third of the Company's retail
revenues were derived from customers enrolled by agents who are contractually
prohibited from offering telecommunications services of the Company's
competitors to their customers during the term of their contract and typically
for a period of two years thereafter. Contracts with independent agents
entered into by the Company after July 1996 typically provide for such
exclusivity. As earlier agreements expire, the Company has generally required
its independent agents to enter into such new agreements. In the past, certain
independent agents have elected to terminate their relationship with the
Company in lieu of entering into new independent agent agreements. In the
event that independent agents transfer a significant number of customers to
other service providers or that a significant number of agents decline to
renew their contracts under the new terms and move their customers to another
carrier, this would have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business--Business
Strategy" and "Business--Sales, Marketing and Customer Service."
While the Company has an extensive marketing and sales organization
consisting of a worldwide network of independent agents and an internal sales
force, a significant portion of the Company's revenues are generated from a
limited number of these individuals. For the nine months ended September 30,
1997, the Company's internal sales force was responsible for approximately
41.3% of the Company's U.S. domestic long distance retail service revenues,
and approximately 7.7% of the Company's total revenues. For the nine months
ended September 30, 1997, 10 independent agents and/or Country Coordinators
were responsible for generating 33.6% of the Company's international long
distance service billings and 50 independent agents and/or Country
Coordinators were responsible for generating 58.9% of the Company's
international long distance service billings. Any loss of the Company's
internal sales force or certain of the Company's more productive independent
agents or Country Coordinators could have a material adverse effect on the
Company's business, financial condition and results of operations.
In connection with the Company's efforts to market its Global Access Direct
service, the Company anticipates that commission rates paid to its independent
agents for customer usage of Global Access Direct service may in some cases be
lower than those paid for marketing call-reorigination services. While the
Company does not believe that a lower commission rate will have a material
adverse effect on the Company's ability to market its Global Access Direct
service or to retain its independent agents, there can be no assurance that
this will be the case. In the event that the Company is unable to effectively
market its Global Access Direct service or retain its independent agents, such
events would have a material adverse effect on the Company's business,
financial condition and results of operations.
INTENSE INTERNATIONAL AND NATIONAL COMPETITION
The international and national telecommunications industry is highly
competitive. The Company's success depends upon its ability to compete with a
variety of other telecommunications providers in each of its markets,
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including the respective ITO in each country in which the Company operates and
global alliances among some of the world's largest telecommunications
carriers. Other potential competitors include cable television companies,
wireless telephone companies, Internet access providers, electric and other
utilities with rights of way, railways, microwave carriers and large end users
which have private networks. The intensity of such competition has recently
increased and the Company believes that such competition will continue to
intensify as the number of new entrants increases. If the Company's
competitors devote significant additional resources to the provision of
international or national long distance telecommunications services to the
Company's target customer base of high-volume residential consumers and small
and medium-sized businesses, such action could have a material adverse effect
on the Company's business, financial condition and results of operations, and
there can be no assurance that the Company will be able to compete
successfully against such new or existing competitors.
Many of the Company's competitors are significantly larger, have
substantially greater financial, technical and marketing resources, larger
networks and a broader portfolio of services than the Company. Additionally,
many competitors have strong name recognition and "brand" loyalty, long-
standing relationships with the Company's target customers, and economies of
scale which can result in a lower relative cost structure for transmission and
related costs. These competitors include, among others, AT&T, MCI
Telecommunications Corporation ("MCI"), Sprint Communications, Inc.
("Sprint"), WorldCom, Inc. ("WorldCom"), Cable & Wireless, Inc., Frontier
Corp. ("Frontier") and LCI International, Inc. ("LCI") and RBOCs outside their
exchange territories providing long distance services in the United States;
France Telecom in France, PTT Telecom B.V. in the Netherlands, Cable &
Wireless plc, British Telecommunications plc ("BT"), Mercury Communications
Ltd. ("Mercury"), AT&T, WorldCom, Sprint and ACC Corp. in the United Kingdom;
Deutsche Telecom AG ("Deutsche Telecom") in Germany; Swisscom in Switzerland;
Telia AB and Tele-2 in Sweden; HKTI in Hong Kong, Telstra and Optus in
Australia; and Kokusan Denshin, Denwa ("KDD"), NTT Worldwide
Telecommunications, International Telecom Japan ("ITJ") and International
Digital Communications ("IDC") in Japan. The Company competes with numerous
other long distance providers, some of which focus their efforts on the same
customers targeted by the Company. In addition to these competitors, recent
and pending deregulation in various countries may encourage new entrants. For
example, as a result of the recently enacted 1996 Telecommunication Act in the
United States, once certain conditions are met, RBOCs will be allowed to enter
the domestic long distance market, AT&T, MCI and other long distance carriers
will be allowed to enter the local telephone services market, and any entity
(including cable television companies and utilities) will be allowed to enter
both the local service and long distance telecommunications markets. Moreover,
while the recently completed WTO Agreement could create opportunities for the
Company to enter new foreign markets, implementation of the accord by the
United States and other countries could result in new competition from ITOs
previously banned or limited from providing services in the United States.
Increased competition in such countries as a result of the foregoing, and
other competitive developments, including entry by Internet service providers
into the long-distance market, could have an adverse effect on the Company's
business, financial condition and results of operations. In addition, many
smaller carriers have emerged, most of which specialize in offering
international telephone services utilizing dial-up access methods, some of
which have begun to build networks similar to the TIGN. See "The Global
Telecommunications Industry."
The Company believes that ITOs generally have certain competitive advantages
due to their control over local connectivity and close ties with national
regulatory authorities. The Company also believes that, in certain instances,
some regulators have shown a reluctance to adopt policies and grant regulatory
approvals that would result in increased competition for the local ITO. If an
ITO were to successfully pressure national regulators to prevent the Company
from providing its services, the Company could be denied regulatory approval
in certain jurisdictions in which its services would otherwise be permitted,
thereby requiring the Company to seek judicial or other legal enforcement of
its right to provide services. Any delay in obtaining approval, or failure to
obtain approval, could have a material adverse effect on the Company's
business, financial condition and results of
operations. If the Company encounters anti-competitive behavior in countries
in which it operates or if the ITO in any country in which the Company
operates uses its competitive advantages to the fullest extent, the Company's
business, financial condition and results of operations could be materially
adversely affected. See "Business--Competition" and "Business--Government
Regulation."
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The long distance telecommunications industry is intensely competitive and
is significantly influenced by the pricing and marketing decisions of the
larger industry participants. In the United States, the industry has
relatively limited barriers to entry with numerous entities competing for the
same customers. Customers frequently change long distance providers in
response to the offering of lower rates or promotional incentives by
competitors. Generally, the Company's domestic customers can switch carriers
at any time. The Company believes that competition in all of its markets is
likely to increase and that competition in non-United States markets is likely
to become more similar to competition in the United States market over time as
such non-United States markets continue to experience deregulatory influences.
In each of the countries where the Company markets its services, the Company
competes primarily on the basis of price (particularly with respect to its
sales to other carriers), and also on the basis of customer service and its
ability to provide a variety of telecommunications products and services.
There can be no assurance that the Company will be able to compete
successfully in the future. The Company anticipates that deregulation and
increased competition will result in decreasing customer prices for
telecommunications services. The Company believes that the effects of such
decreases will be at least partially offset by increased telecommunications
usage and decreased costs as the percentage of its traffic transmitted over
the TIGN increases. There can be no assurance that this will be the case. To
the extent this is not the case, there could be an adverse effect on the
Company's margins and financial profits, and the Company's business, financial
condition and results of operations could be materially and adversely
effected.
The telecommunications industry is in a period of rapid technological
evolution, marked by the introduction of new product and service offerings and
increasing satellite transmission capacity for services similar to those
provided by the Company. Such technologies include satellite-based systems,
such as the proposed Iridium and GlobalStar systems, utilization of the
Internet for international voice and data communications and digital wireless
communication systems such as personal communications services ("PCS"). The
Company is unable to predict which of many possible future product and service
offerings will be important to maintain its competitive position or what
expenditures will be required to develop and provide such products and
services.
RISK OF NETWORK FAILURE
The success of the Company is largely dependent upon its ability to deliver
high quality, uninterrupted telecommunication services and on its ability to
protect its software and hardware against damage from fire, earthquake, power
loss, telecommunications failure, natural disaster and similar events. Any
failure of the TIGN or other systems or hardware that causes interruptions in
the Company's operations could have a material adverse effect on the Company.
As the Company expands the TIGN and call traffic grows, there will be
increased stress on hardware, circuit capacity and traffic management systems.
There can be no assurance that the Company will not experience system
failures. The Company's operations are also dependent on its ability to
successfully expand the TIGN and integrate new and emerging technologies and
equipment into the TIGN, which could increase the risk of system failure and
result in further strains upon the TIGN. The Company attempts to minimize
customer inconvenience in the event of a system disruption by routing traffic
to other circuits and switches which may be owned by other carriers. However,
significant or prolonged system failures, or difficulties for customers in
accessing, and maintaining connection with, the TIGN could damage the
reputation of the Company and result in customer attrition and financial
losses. Additionally, any damage to the Company's Network Operations Center
could have a negative impact on the Company's ability to monitor the
operations of the TIGN and generate accurate call detail reports.
DEPENDENCE ON TELECOMMUNICATIONS FACILITIES PROVIDERS
The Company's success will continue to depend, in part, on its ability to
obtain and utilize transmission capacity on a cost-effective basis. The
Company currently owns only a limited amount of telecommunications
transmission infrastructure. Telephone calls made by the Company's customers
may be transmitted via one or
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more of the following types of circuit capacity: (i) capacity purchased from
another carrier on a per minute basis under a simple resale agreement; (ii)
capacity leased from another carrier; or (iii) capacity owned by Telegroup on
an IRU basis. In addition, the Company requires leased circuit capacity to
provide access and egress between its switches and the local PSTN in each
country.
The Company obtains most of its transmission capacity under a variety of
volume-based resale arrangements with facilities-based and other carriers
including ITOs. The Company has entered into resale agreements with more than
20 carriers in the U.S., U.K., Canada, the Netherlands, Denmark, Australia,
Hong Kong and Switzerland. Under these arrangements, the Company is subject to
the risk of unanticipated price fluctuations and service restrictions or
cancellations. The Company generally has not experienced sudden or
unanticipated price fluctuations, service restrictions or cancellations
imposed by such facilities-based carriers but there can be no assurance that
this will be the case in the future. The Company has entered into a resale
agreement with Sprint which contains a net monthly usage commitment of
$1,500,000, with the Company liable for 25% of any shortfall below such
commitment level. The Sprint agreement terminates in December 1997 and is
cancelable by the Company or Sprint on 90 days' notice, subject to the payment
of an early termination fee. The failure of the Company to meet the net
monthly usage commitments contained in this agreement could have a material
adverse effect on the Company's business, financial condition and results of
operations. Although the Company believes that its arrangements and
relationships with such carriers generally are satisfactory, the deterioration
or termination of the Company's arrangements and relationships, or the
Company's inability to enter into new arrangements and relationships with one
or more of such carriers could have a material adverse effect upon the
Company's cost structure, service quality, network coverage, results of
operations and financial condition.
In addition, the Company leases circuit capacity at fixed terms ranging up
to 12 months under arrangements with facilities-based long distance carriers.
As a result, the Company depends upon facilities-based carriers such as the
ITOs in each of the countries in which the Company operates to supply the
Company with high capacity transmission links. Some of these carriers are or
may become competitors of the Company. The Company has periodically
experienced difficulties with the quality of the services provided by such
carriers. In addition, the Company has experienced delays in obtaining access
and egress transmission lines supplied by ITOs and other facilities-based
carriers. While the Company seeks to minimize the impact of such difficulties,
there can be no assurance that difficulties with circuit access and quality of
service will not arise in the future and constitute a material adverse effect.
See "--Intense International and National Competition," "Business Competition"
and "Business--Regulation." Moreover, minimum volume contracts may result in
relatively high fixed costs to the extent that the Company does not generate
the requisite traffic volume over the particular route. See "Business--Network
and Operations."
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
A key component of the Company's strategy is its expansion in international
markets. In many international markets, the ITO controls access to the local
networks, enjoys better brand recognition and brand and customer loyalty, and
possesses significant operational economies, including a larger backbone
network and operating agreements with other ITOs. Moreover, an ITO may take
many months before allowing competitors, including the Company, to
interconnect to its switches within the target market. Pursuit of
international growth opportunities may require significant investments for
extended periods of time before returns, if any, on such investments are
realized. In addition, there can be no assurance that the Company will be able
to obtain the permits and operating licenses required for it to operate,
obtain access to local transmission facilities or market, sell and deliver
competitive services in these markets.
In addition to the uncertainty as to the Company's ability to expand its
international presence, there are certain risks in conducting business
internationally, which could have a material adverse effect on the Company's
international operations, including its strategy to open additional offices in
foreign countries and its ability to repatriate net income from foreign
markets. Such risks may include unexpected changes in regulatory
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requirements, VAT, tariffs, customs, duties and other trade barriers,
difficulties in staffing and managing foreign operations, problems in
collecting accounts receivable, political risks, fluctuations in currency
exchange rates, foreign exchange controls which restrict or prohibit
repatriation of funds, technology export and import restrictions or
prohibitions, delays from customs brokers or government agencies, seasonal
reductions in business activity during the summer months in Europe and certain
other parts of the world, and potentially adverse tax consequences resulting
from operating in multiple jurisdictions with different tax laws. In addition,
the Company's business could be adversely affected by a reversal in the
current trend toward deregulation of telecommunications carriers. In certain
countries into which the Company may choose to expand in the future, the
Company may need to enter into a joint venture or other strategic relationship
with one or more third parties in order to successfully conduct its operations
(possibly with an ITO or other dominant carrier). There can be no assurance
that such factors will not have a material adverse effect on the Company's
future operations and, consequently, on the Company's business, results of
operations and financial condition, or that the Company will not have to
modify its current business practices. In addition, there can be no assurance
that laws or administrative practices relating to taxation, foreign exchange
or other matters of countries within which the Company operates will not
change. Any such change could have a material adverse effect on the Company's
business, financial condition, and results of operations.
As a result of the Offering, the Company will become subject to the Foreign
Corrupt Practices Act ("FCPA"), which generally prohibits U.S. companies and
their intermediaries from bribing foreign officials for the purpose of
obtaining or keeping business. The Company may be exposed to liability under
the FCPA as a result of past or future actions taken without the Company's
knowledge by agents, strategic partners and other intermediaries. Such
liability could have a material adverse effect on the Company's business,
financial condition and results of operations.
FOREIGN EXCHANGE RATE RISKS; REPATRIATION RISKS
Although the Company and its Subsidiaries attempt to match costs and
revenues in terms of local currencies, the Company anticipates that as it
continues its expansion of the TIGN on a global basis, there will be many
instances in which costs and revenues will not be matched with respect to
currency denomination. As a result, the Company anticipates that increasing
portions of its revenues, costs, assets and liabilities will be subject to
fluctuations in foreign currency valuations, and that such changes in exchange
rates may have a material adverse effect on the Company's business, financial
condition and results of operations. While the Company may utilize foreign
currency forward contracts or other currency hedging mechanisms to minimize
exposure to currency fluctuation, there can be no assurance that such hedges
will be implemented, or if implemented, will achieve the desired effect. The
Company may experience economic loss and a negative impact on earnings solely
as a result of foreign currency exchange rate fluctuations. The markets in
which the Company's Subsidiaries now conduct business, except for South
Africa, generally do not restrict the removal or conversion of the local or
foreign currency; however, there can be no assurance that this situation will
continue. The Company has formed a Subsidiary in South Africa which is
authorized to handle such repatriation functions on the Company's behalf in
accordance with applicable laws. See "--Risks Associated with International
Operations."
FAILURE TO COLLECT RECEIVABLES (BAD DEBT RISK)
Many of the countries in which the Company operates do not have established
credit bureaus, thereby making it more difficult for the Company to ascertain
the creditworthiness of potential customers. In addition, the Company expends
considerable resources to collect receivables from customers who fail to make
payment in a timely manner. While the Company continually seeks to minimize
bad debt, the Company's experience indicates that a certain portion of past
due receivables will never be collected and that such bad debt is a necessary
cost of conducting business in the telecommunications industry. Expenses
attributable to the write-off of bad debt, including an estimate of accounts
receivable expected to be written off, represented approximately 1.5%, 3.1%
and 2.4% of revenues for the years ended December 31, 1994, 1995 and 1996,
respectively, and 2.7% for the nine months ended September 30, 1997. There can
be no assurance, however, that, with regard to
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any particular time period or periods or a particular geographic location or
locations, bad debt expense will not rise significantly above historical or
anticipated levels. Any significant increase in bad debt levels could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The telecommunications industry has historically been a victim of fraud.
Although the Company has implemented anti-fraud measures to minimize losses
relating to fraudulent practices, there can be no assurance that the Company
can effectively control fraud when operating in the international or national
telecommunications arena. The Company's failure to effectively control fraud
could have a material adverse effect on the Company's business, financial
condition and results of operations.
RISKS ASSOCIATED WITH IMPOSITION OF VAT ON COMPANY'S SERVICES
The EU imposes value-added taxes ("VAT") upon the sale of goods and services
within the EU. The rate of VAT varies among EU members, but ranges from 15% to
25% of the sales price of goods and services. Under basic VAT rules,
businesses are required to collect VAT from their customers upon the sale to
such customers of goods and services and remit such amounts to the VAT
authorities.
In the case of services, VAT is imposed only where services are deemed to
have been provided within an EU member state. Pursuant to the Sixth VAT
Directive adopted in 1977 (the "Sixth Directive"), telecommunications services
were deemed to be provided where the supplier of such services is located.
Under the Sixth Directive, therefore, telecommunications services provided by
U.S. telecommunications companies in the United States were deemed to be
performed outside the EU and were exempt from VAT. Because telecommunications
providers based in the EU had to charge VAT on telecommunications services
they provided, U.S.-based and other non-EU based telecommunications providers
historically enjoyed a competitive advantage over their EU counterparts under
the Sixth Directive.
Derogation to the Sixth Directive. In March 1997, the EU issued a derogation
to the Sixth Directive (the "Derogations") that, as of January 1, 1997,
authorized individual EU states to amend their laws so as to change the locus
of telecommunications services provided by non-EU based firms, treating such
services as being provided where the customer is located rather than where the
telecommunications provider is established. In the case of sales by non-EU
based telecommunications companies to non-VAT-registered (usually residential)
customers in EU member states, the Derogation provides that the non-EU based
companies will be required to collect, charge, and remit VAT.
Germany and France have adopted rules that, as of January 1, 1997, deem
telecommunications services provided by non-EU based firms to be provided
where the customer is located, thereby subjecting telecommunications services
provided to customers in the EU by non-EU based companies to VAT. The German
and French rules impose VAT on both individual and business customers of non-
EU based telecommunications companies. In the case of sales to individuals (as
opposed to business), German and French rules require that the non-EU based
telecommunications carriers collect and remit the VAT. In the case of sales by
such providers to German business customers, the German rules generally
require that such customers collect and remit the VAT. Under the so-called
"Nullregelung" doctrine, however, certain German business customers that are
required to charge VAT on goods and services provided to their customers
(generally, companies other than banks and insurance companies) are exempt
from the aforesaid obligation with regard to certain services. The exemption
only applies if the provider has not invoiced VAT and the respective customer
would be entitled to be fully reimbursed for VAT paid if such VAT had been
invoiced. In the case of sales by such providers to French VAT-registered
customers, the French rules require that such business customers collect and
remit the VAT.
Since April 1, 1997, Austria, Belgium, Denmark, Finland, Greece, Ireland,
Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden and the United
Kingdom have begun to impose VAT on telecommunications services provided by
non-EU based companies. The rules adopted by these countries are generally
similar to those adopted by France and Germany in that they impose VAT on both
individuals and businesses, with non-EU based telecommunications providers
required to collect and remit the VAT in the case
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of sales to non-VAT-registered customers and the customer required to collect
and remit VAT in the case of sales to VAT-registered customers.
Proposed Amendment to the Sixth Directive. The EU has adopted a proposed
amendment to the Sixth Directive (the "Amendment") that, if adopted in present
form, would require all EU members to adopt legislation to impose VAT on non-
EU based telecommunications services provided to customers in the EU by non-EU
based companies, beginning as early as December 31, 1998. Under the Amendment,
non-EU based telecommunications companies would be required to collect and
remit VAT on telecommunications services provided to EU businesses as well as
to individuals.
To the extent that the Company's services are, and in the future become,
subject to VAT, the Company's competitive price advantage with respect to
those EU businesses and other customers required to pay VAT will be reduced.
Such reduction could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company historically has
collected, and will continue to collect, VAT on Global Access Direct services
where it is offered in a VAT country. In addition, the Company's U.K.
Subsidiary acts as the provider of call-reorigination services throughout much
of Europe and collects U.K. VAT, where applicable, on such services. The
Company believes that whatever negative impact the Derogations and the
Amendment will have on its operations as a result of the imposition of VAT on
traditional call-reorigination, such impact will be partially mitigated by the
customer migration towards and the higher gross margins associated with call-
through services and by the fact that call-reorigination services offered by
the Company's U.K. Subsidiary are imposed at the relatively low U.K. rate of
17.5%.
DEPENDENCE ON KEY PERSONNEL
The Company's success depends to a significant degree upon the continued
contributions of its management team, as well as its technical, marketing and
sales personnel. While certain of the Company's employees have entered into
employment agreements with the Company, the Company's employees may
voluntarily terminate their employment with the Company at any time. The
Company has obtained a $5 million key man life insurance policy covering Mr.
Cliff Rees, the Company's Chief Executive Officer and President, but there can
be no assurance that the coverage provided by such policy will be sufficient
to compensate the Company for the loss of Mr. Rees' services. The Company's
success also will depend on its ability to continue to attract and retain
qualified management, marketing, technical and sales personnel. The process of
locating such personnel with the combination of skills and attributes required
to carry out the Company's strategies is often lengthy. Competition for
qualified employees and personnel in the telecommunications industry is
intense. There can be no assurance that the Company will be successful in
attracting and retaining such executives and personnel. The loss of the
services of key personnel, including Mr. Rees, or the inability to attract
additional qualified personnel, could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management."
PROTECTION OF PROPRIETARY TECHNOLOGY AND INFORMATION
The Company relies on trade secrets, know-how and continuing technological
advancements to maintain its competitive position. The Company also relies on
unpatented proprietary technology and there can be no assurance that third
parties may not independently develop the same or similar technology or
otherwise obtain access to the Company's unpatented technology, trade-secrets
and know-how. Although the Company has entered into confidentiality and
invention agreements with certain of its employees and consultants, no
assurance can be given that such agreements will be honored or that the
Company will be able to protect effectively its rights to its unpatented
technology, trade secrets and know-how. Moreover, no assurance can be given
that others will not independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to the
Company's trade secrets and know-how. If the Company is unable to maintain the
proprietary nature of its technologies, the Company could be materially
adversely affected.
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Competitors in both the United States and foreign countries, many of which
have substantially greater resources and have made substantial investments in
competing technologies, may have applied for or obtained, or may in the future
apply for and obtain, patents that will prevent, limit or otherwise interfere
with the Company's ability to sell its services. The Company has not conducted
an independent review of patents issued to third parties. Although the Company
believes that its products do not infringe on the patents or other proprietary
rights of third parties, there can be no assurance that other parties will not
assert infringement claims against the Company or that such claims will not be
successful. An adverse outcome in the defense of a patent suit could subject
the Company to significant liabilities to third parties, require disputed
rights to be licensed from third parties or require the Company to cease
selling its services.
CONTROL OF COMPANY BY PRINCIPAL SHAREHOLDERS
As of September 30, 1997, Fred Gratzon, the Chairman of the Board, and
Clifford Rees, the Chief Executive Officer, collectively beneficially owned in
the aggregate approximately 76.5% of the then outstanding Common Stock.
Accordingly, if they choose to do so, Messrs. Gratzon and Rees acting together
will have the power to amend the Company's Second Restated Articles of
Incorporation, elect all of the directors, effect fundamental corporate
transactions such as mergers, asset sales and the sale of the Company and
otherwise direct the Company's business and affairs, without the approval of
any other shareholder. See "Management" and "Principal Shareholders."
RISKS ASSOCIATED WITH ACQUISITIONS, INVESTMENTS AND STRATEGIC ALLIANCES
In furtherance of its business strategy, the Company may enter into
strategic alliances with, acquire assets or businesses from, or make
investments in, companies that are complementary to its current operations.
While the Company is currently engaged in negotiations to acquire the
operations and customer base of its Country Coordinators in Australia, the
Netherlands and New Zealand, the Company has no present agreements with
respect to any such strategic alliance, investment or acquisition. Any such
future strategic alliances, investments or acquisitions would be accompanied
by the risks commonly encountered in such transactions. Such risks include,
among other things, the difficulty of assimilating the operations and
personnel of the companies, the potential disruption of the Company's ongoing
business, costs associated with the development and integration of such
operations, the inability of management to maximize the financial and
strategic position of the Company by the successful incorporation of licensed
or acquired technology into the Company's service offerings, the maintenance
of uniform standards, controls, procedures and policies, the impairment of
relationships with employees and customers as a result of changes in
management, and higher customer attrition with respect to customers obtained
through acquisitions.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Prospectus, including, without
limitation, statements containing the words "believes," "anticipates,"
"intends," "expects" and words of similar import, constitute "forward-looking
statements." Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company or the global long distance telecommunications
industry to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. Such
factors include, among others, the following: general economic and business
conditions; prospects for the global long distance telecommunications
industry; competition; changes in business strategy or development plans; the
loss of key personnel; the availability of capital; regulatory developments
and other factors referenced in this Prospectus, including, without
limitation, under the captions "Prospectus Summary," "Recent Developments,"
"Risk Factors," "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Business." Given these uncertainties,
prospective investors are cautioned not to place undue reliance on such
forward-looking statements. The Company disclaims any obligation to update any
such factors or to publicly announce the results of any revisions to any of
the forward-looking statements contained herein to reflect future events or
developments.
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<PAGE>
USE OF PROCEEDS
The Company will not receive any of the proceeds from the sale of Common
Stock by the Selling Shareholders.
DIVIDEND POLICY
The Company declared a $525,000 cash dividend in December 1995 and a
$425,000 cash dividend in March 1996, both of which were paid in November 1996
to the Company's shareholders. The Company currently intended to retain all
future earnings for use in the operation of its business and, therefore, does
not anticipate paying any cash dividends in the foreseeable future. The
declaration and payment in the future of any cash dividends will be at the
discretion of the Company's Board of Directors and will depend upon among
other things, the earnings, capital requirements and financial position of the
Company, exisiting and/or future loan covenants and general economic
conditions. Under the terms of the Credit Facility, the Company is restricted
from declaring, making or paying any distributions unless certain financial
covenants are met. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
MARKET FOR THE COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Common Stock was initially offered to the public on July 9, 1997 at a
price of $10.00 per share and commenced trading on the Nasdaq National Market
on that date under the symbol "TGRP." The following table sets forth, for the
calendar period indicated, the high and low sale prices per share for the
Common Stock, as reported on the Nasdaq National Market. These prices do not
include retail markups, markdowns or commissions.
<TABLE>
<CAPTION>
CALENDAR YEAR 1997 HIGH LOW
------------------ ------- ------
<S> <C> <C>
Third Quarter, July 9-September 30, 1997.................. $ 13 3/4 $ 8 7/8
Fourth Quarter, November 1-December 17, 1997.............. $13.125 $9 3/4
</TABLE>
On December 17, 1997, the last sale price of the Common Stock as reported by
Nasdaq NMS was $12.9375 per share. As of December , 1997, there were
approximately shareholders of record.
30
<PAGE>
CAPITALIZATION
The following table sets forth the cash and cash equivalents and
capitalization of the Company (i) as of September 30, 1997, and (ii) as
adjusted to give effect to the offering of the Senior Discount Notes as if
such transaction had occurred on September 30, 1997. See "Selected Financial
Data," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the Company's consolidated financial statements and
notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1997
--------------------------------
ACTUAL AS ADJUSTED
-------- ----------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents..................... $ 58,215 $130,025
======== ========
Current portion of long term debt and capital
lease obligations............................ 219 219
======== ========
Long-term debt, net of current portion:
10 1/2% Senior Discount Notes due 2004...... -- 74,933
Convertible Notes........................... 25,000 25,000
Other long term debt........................ 42 42
Capital lease obligations................... 218 218
-------- --------
Total long-term debt...................... 25,260 100,193
Shareholders' equity:
Preferred Stock, no par value; 10,000,000
shares authorized; no shares issued or out-
standing................................... -- --
Common Stock, no par value; 150,000,000
shares authorized; 30,768,542 shares issued
and outstanding(1)......................... -- --
Additional paid-in capital.................... 51,405 51,405
Retained earnings (deficit)................... (10,483) (10,483)
-------- --------
Total shareholders' equity.................. 40,922 40,922
======== ========
Total capitalization...................... $ 66,182 $141,115
======== ========
</TABLE>
- --------
(1) Excludes (i) 1,677,153 shares of Common Stock issuable upon the exercise
of options granted under the Stock Option Plan as of September 30, 1997;
(ii) 2,322,847 shares of Common Stock issuable upon the exercise of
options available for grant under the Stock Option Plan as of September
30, 1997; and (iii) 1,160,107 shares of Common Stock issuable upon the
exercise of the Warrants as of September 30, 1997. See "Management--
Amended and Restated Stock Option Plan" and "Description of Capital
Stock--Warrants."
31
<PAGE>
SUMMARY FINANCIAL DATA
The following table sets forth certain consolidated financial information
for the Company for (i) the years ended December 31, 1994, 1995 and 1996,
which have been derived from the Company's audited consolidated financial
statements and notes thereto included elsewhere in this Prospectus, (ii) the
year ended December 31, 1993, which has been derived from audited consolidated
financial statements of the Company which are not included herein, and (iii)
the year ended December 31, 1992, which has been derived from unaudited
consolidated financial statements which are not included herein. The summary
financial data as of September 30, 1997 and for the nine months ended
September 30, 1996 and 1997 has been derived from the unaudited consolidated
financial statements for the Company included elsewhere in this Prospectus. In
the opinion of management, the unaudited consolidated financial statements
have been prepared on the same basis as the audited consolidated financial
statements and include all adjustments, which consist only of normal recurring
adjustments, necessary for a fair presentation of the financial position and
the results of operations for these periods. The "As Adjusted" financial
information is not necessarily indicative of the Company's financial position
or the results of operations that actually would have occurred if the
transactions described herein had occurred on the dates indicated or for any
future period or date. The adjustments give effect to available information
and assumptions that the Company believes are reasonable. The following
financial information should be read in conjunction with "Selected Financial
Data" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the Company's consolidated financial statements and
notes thereto appearing elsewhere herein.
<TABLE>
<CAPTION>
YEAR NINE MONTHS
ENDED NINE MONTHS ENDED
DECEMBER 31, ENDED SEPTEMBER 30,
YEAR ENDED DECEMBER 31, AS ADJUSTED SEPTEMBER 30, AS ADJUSTED
----------------------------------------------- ------------ ----------------- -------------
1992 1993 1994 1995 1996 1996(1) 1996 1997 1997(2)
----------- ------- ------- -------- -------- ------------ -------- -------- -------------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT RATIOS AND OTHER OPERATING DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Retail................. $23,846 $29,790 $68,714 $128,139 $179,147 $179,147 $128,828 $169,720 $169,720
Wholesale.............. -- -- -- 980 34,061 34,061 18,951 68,758 68,758
------- ------- ------- -------- -------- -------- -------- -------- --------
Total revenues......... 23,846 29,790 68,714 129,119 213,208 213,208 147,779 238,478 238,478
Cost of revenues........ 18,411 22,727 49,513 83,101 150,537 150,537 100,794 174,273 174,273
------- ------- ------- -------- -------- -------- -------- -------- --------
Gross profit........... 5,435 7,063 19,201 46,018 62,671 62,671 46,985 64,205 64,205
------- ------- ------- -------- -------- -------- -------- -------- --------
Operating expenses:
Selling, general and
administrative........ 3,935 7,341 19,914 39,222 59,652 59,652 42,648 63,174 63,174
Depreciation and
amortization.......... 61 172 301 655 1,882 2,415 1,158 3,208 3,480
Stock option based
compensation.......... -- -- -- -- 1,032 1,032 -- 257 257
------- ------- ------- -------- -------- -------- -------- -------- --------
Total operating
expenses.............. 3,996 7,513 20,215 39,877 62,566 63,099 43,806 66,639 66,911
------- ------- ------- -------- -------- -------- -------- -------- --------
Operating income
(loss)................ 1,439 (450) (1,014) 6,141 105 (428) 3,179 (2,434) (2,706)
Interest expense....... 88 47 112 121 579 10,178 200 2,135 7,540
Extraordinary item,
loss on extinguishment
of debt, net of income
taxes................. -- -- -- -- -- -- -- 9,971 10,473
------- ------- ------- -------- -------- -------- -------- -------- --------
Net earnings (loss).... 1,386 (707) (538) 3,821 (118) (7,661) 2,050 (12,820) (17,633)
======= ======= ======= ======== ======== ======== ======== ======== ========
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
YEAR NINE MONTHS
ENDED NINE MONTHS ENDED
DECEMBER 31, ENDED SEPTEMBER 30,
YEAR ENDED DECEMBER 31, AS ADJUSTED SEPTEMBER 30, AS ADJUSTED
------------------------------------------- ------------ --------------- -------------
1992 1993 1994 1995 1996 1996(1) 1996 1997 1997(2)
----------- ------ ------ ------ ------- ------------ ------ ------- -------------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT RATIOS AND OTHER OPERATING DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Per share amounts(8):
Earnings (loss) before
extraordinary item.... $ .05 (.02) (.02) .13 (.00) (.23) .07 (.10) (.26)
Net earnings (loss).... $ .05 (.02) (.02) .13 (.00) (.23) .07 (.47) (.64)
Weighted-average
shares................ 28,785 28,785 28,785 28,785 28,785 33,235 28,785 27,462 27,462
OTHER FINANCIAL DATA:
EBITDA(3)............... $1,510 $ (278) $ (577) $6,994 $ 2,990 $4,341 $ 602
Net cash provided by
(used in) operating
activities............. 820 924 1,364 5,561 4,904 4,083 (1,002)
Net cash (used in)
investing activities... (667) (765) (700) (2,818) (11,262) (8,261) (13,325)
Net cash (used in)
provided by financing
activities............. 21 (10) 957 (115) 15,924 3,877 58,648
Ratio of earnings to
fixed charges(4)....... 15.18 -- -- 29.76 .84 .26 10.44 -- --
Capital expenditures.... 291 449 1,056 2,652 9,068 6,264 12,463
Dividends declared per
common share........... -- -- -- .02 .02 .02 --
OTHER OPERATING DATA (AT
PERIOD END):
Retail customers(5):
Domestic (US).......... 8,261 7,021 16,733 17,464 34,294 48,785
International.......... 0 5,301 28,325 56,156 109,922 167,444
Wholesale customers(6).. 0 0 0 4 18 26
Number of employees..... 54 97 217 296 444 576
Number of switches...... 0 1 2 3 7 19
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1997
------------------------
ACTUAL AS ADJUSTED (7)
-------- ---------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.............................. $ 58,215 $130,025
Working capital........................................ 39,035 110,845
Property & equipment, net.............................. 21,597 21,597
Total assets........................................... 139,658 214,590
Long term debt, less current portion................... 25,042 99,975
Total shareholders' equity............................. 40,922 40,922
</TABLE>
- -------
(1) Adjusted to give effect to the issuance of the Convertible Notes, the
offering of Senior Discount Notes and the elimination of interest and
amortization expense for the Senior Subordinated Notes as if such
transactions had occurred on January 1, 1996. As adjusted interest expense
reflects (i) approximately $2.0 million on the Convertible Notes for the
year ended December 31, 1996, and approximately $7.9 million on the Senior
Discount Notes for the year ended December 31, 1996 (ii) the elimination of
$0.3 million with respect to the Senior Subordinated Notes, for the year
ended December 31, 1996 (iii) amortization of fees and costs totaling $0.5
million relating to the Convertible Notes and the offering of Senior
Discount Notes for the year ended December 31, 1996 using amortization
periods equal to the term of the respective issuances (iv) the elimination
of $0.01 million of amortization of fees and costs relating to the Senior
Subordinated Notes for the year ended December 31, 1996 and (v) the
4,450,00 shares issued in connection with the initial public offering and
the underwriters' overallotment option. Interest income has not been
adjusted to reflect interest earned on additional available cash.
(2) Adjusted to give effect to the issuance of the Convertible Notes, the
offering of Senior Discount Notes and the elimination of interest and
amortization expense for the Senior Subordinated Notes as if such
transactions had occurred on January 1, 1997. As adjusted interest expense
reflects (i) approximately $1.5 million on the Convertible Notes for the
nine-months ended September 30, 1997, and approximately $5.9 million on the
Senior Discount Notes for the nine-months ended September 30, 1997, (ii)
the elimination of $2.0 million with respect to the Senior Subordinated
Notes, for the nine-months ended September 30, 1997, (iii) amortization of
fees and
33
<PAGE>
costs totaling $0.4 million relating to the Convertible Notes and the
offering of Senior Discount Notes for the nine-months ended September 30,
1997 using amortization periods equal to the term of the respective
issuances and (iv) the elimination of $0.1 million of amortization of fees
and costs relating to the Senior Subordinated Notes for the nine-months
ended September 30, 1997. Interest income has not been adjusted to reflect
interest earned on additional available cash. Adjusted also reflects the
additional loss of $0.5 million (net of tax) on the extinguishment of debt
as if such transaction had occurred on January 1, 1997.
(3) EBITDA represents net earnings (loss) plus net interest expense (income),
income taxes, depreciation and amortization, non-cash stock option based
compensation and the extraordinary item, loss on extinguishment of debt.
While EBITDA is not a measurement of financial performance under generally
accepted accounting principles and should not be construed as a substitute
for net earnings (loss) as a measure of performance, or cash flow as a
measure of liquidity, it is included herein because it is a measure
commonly used in the telecommunications industry.
(4) The ratio of earnings to fixed charges was computed by dividing earnings
by fixed charges. For this purpose, earnings consist of income from
continuing operations, before income taxes and fixed charges of the
Company and its subsidiaries. Fixed charges consist of the Company's and
its subsidiaries' interest expense and the portion of rent expense
representative of an interest factor. For the years ended December 31,
1993, 1994, 1996, 1996 as adjusted, and for the nine months ended
September 30, 1997, and September 30, 1997 as adjusted, earnings were
inadequate to cover fixed charges. The dollar amount of the coverage
deficiency was $436,891, $886,700, $125,770, $10,258,419, $4,214,912 and
$9,892,150, respectively.
(5) Consists of retail customers who received invoices for the last month of
the period indicated. Does not include active international customers who
incurred charges in such month but who had outstanding balances as of the
last day of such month of less than $50, as the Company does not render
invoices in such instances.
(6) Consists of wholesale customers who received invoices for the last month
of the period indicated.
(7) Adjusted to give effect to the offering of the Senior Discount Notes as if
such transaction had occurred on September 30, 1997.
(8) Earnings per common and common equivalent share have been computed using
the weighted-average number of shares of common stock outstanding during
each period as adjusted for the effects of Securities and Exchange
Commission Staff Accounting Bulletin No. 83. Accordingly, options and
warrants to purchase common stock granted within one year of the Company's
initial public offering, which had exercise prices below the initial
public offering price per share, have been included in the calculation of
common equivalent shares, using the treasury stock method, as if they were
outstanding for all periods presented. For the nine-month period ended
September 30, 1997 and as adjusted, earnings per common share have been
computed under the provisions of Accounting Principles Board Opinion No.
15, "Earnings Per Share." Common stock equivalents, which includes options
and convertible subordinated notes, are not included in the loss per share
calculation as their effect is anti-dilutive.
33--1
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and performance of the
Company should be read in conjunction with the consolidated financial
statements and related notes and other detailed information regarding the
Company included elsewhere in this Prospectus. Certain information contained
below and elsewhere in this Prospectus, including information with respect to
the Company's plans and strategy for its business, are forward-looking
statements. See "Risk Factors" for a discussion of important factors which
could cause actual results to differ materially from the forward-looking
statements contained herein.
OVERVIEW
Telegroup is a leading global provider of long distance telecommunications
services. The Company offers a broad range of discounted international,
national, value-added wholesale and enhanced telecommunications services to
approximately 268,000 small and medium-sized business and residential
customers in over 180 countries worldwide. Telegroup has achieved its
significant international market penetration by developing what it believes to
be one of the most comprehensive global sales, marketing and customer service
organizations in the global telecommunications industry. The Company operates
a reliable, flexible, cost-effective, digital, switched-based network, the
Telegroup Intelligent Global Network or the TIGN, consisting of 19 Excel,
NorTel or Harris switches, five enhanced service platforms, owned and leased
capacity on seven digital fiber-optic cable links, leased parallel data
capacity and the Company's Network Operations Center in Fairfield, Iowa.
According to FCC statistics based on 1996 revenue, Telegroup was the
thirteenth largest U.S. long distance carrier in 1996. Telegroup's revenues
have increased from $29.8 million in 1993 to $303.9 million for the 12 months
ended September 30, 1997. In 1993, the Company had an operating loss of $0.5
million and a net loss of $0.7 million, compared to operating income of $0.1
million and a net loss of $0.1 million in 1996.
Incorporated in 1989, Telegroup was one of the first resellers of AT&T's
Software Defined Network and Distributed Network Service long distance
services. The Company derived its initial growth by aggregating long distance
services to individuals and small businesses in the U.S. in order to fulfill
large volume commitments to AT&T. In early 1993, Telegroup initiated call
reorigination service in certain countries in Western Europe and the Pacific
Rim. By 1994, more than one half of Telegroup's retail customers were located
outside the United States. At September 30, 1997, the Company had
approximately 49,000 active retail customers within the United States and
approximately 167,000 active retail customers outside the United States. The
Company's network currently includes switches located in Australia, Denmark,
France, Germany, Hong Kong, Italy, Japan, the Netherlands, Switzerland the
U.K. and the U.S. and leased and owned transmission facilities, and enables
the Company to offer a variety of enhanced telecommunications services.
The Company has attained positive EBITDA (as defined in "Selected Financial
Data") and net earnings in only two of the last five years--1992 and 1995. The
Company expects to incur lower gross margins, negative EBITDA and significant
operating losses and net losses for the near term as it incurs additional
costs associated with the development and expansion of the TIGN, the expansion
of its marketing and sales organization, and the introduction of new
telecommunications services. As the development and expansion of the TIGN
continues and the Company's customers migrate from Global Access CallBack to
Global Access Direct service, the Company expects that its gross margins,
EBITDA, and operating and net income will improve. However there can be no
assurance that this will be the case. See "Risk Factors--Historical and
Anticipated Losses; Uncertainty of Future Profitability."
Telegroup's revenues are derived from the sale of telecommunications
services to retail customers, typically residential users and small to medium-
sized businesses in over 180 countries worldwide and to wholesale customers,
typically other U.S. and non-U.S. telecommunications carriers. The Company's
revenues from retail and wholesale customers represented 84% and 16%,
respectively, of the Company's total revenues for the year ended December 31,
1996 and 71% and 29%, respectively, for the nine months ended September 30,
1997. The
34
<PAGE>
Company's retail customer base is diversified both geographically and by
customer type. No single retail customer accounted for more than 1% of the
Company's total revenues for the year ended December 31, 1996 and for the nine
months ended September 30, 1997. Revenues from the Company's wholesale
customers have grown from $1.0 million in 1995, the first year in which the
Company derived revenues from wholesale customers, to $34.1 million for the
year ended December 31, 1996. For the nine months ended September 30, 1997,
one wholesale customer in Hong Kong, New T&T Hong Kong Limited, accounted for
approximately 12% of the Company's total revenues. See "Business--Customers."
The Company expects that wholesale revenues will continue to grow as a
percentage of total telecommunications revenue in the near term.
The FCC has adopted certain measures to implement the 1996
Telecommunications Act that will impose new regulatory requirements, including
the requirement that the Company contribute some portion of its
telecommunications revenues to a "universal service fund" designated to fund
affordable telephone service for consumers, schools, libraries and rural
healthcare providers. These contributions will become payable beginning in
1998 for all interexchange carriers. Although the FCC has not determined the
precise amount of the contribution, the Company estimates at this time that it
will constitute approximately 4% of its gross revenues from domestic end-user
customers. It is currently anticipated that the Company will increase its
rates to offset such contribution.
The following chart sets forth the Company's combined retail and wholesale
revenues for the nine months ended September 30, 1997 for each of the
Company's ten largest markets, determined by customers' billing addresses:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30,
1997
REVENUES PERCENTAGE OF
COUNTRY (MILLIONS) TOTAL REVENUES
------- ------------- --------------
<S> <C> <C>
United States................................... $81.5 34.2%
Hong Kong....................................... 35.0 14.7
Netherlands..................................... 18.2 7.6
Australia....................................... 11.8 4.9
France.......................................... 11.1 4.7
Switzerland..................................... 9.8 4.1
Germany......................................... 8.1 3.4
Sweden.......................................... 6.5 2.7
Japan........................................... 5.1 2.1
Denmark......................................... 4.5 1.9
</TABLE>
During the nine months ended September 30, 1997, the geographic origin of
the Company's revenues was as follows: United States--34.2%; Europe--31.3%;
Pacific Rim--24.5%; Other--10.0%
During fiscal year 1996, the geographic origin of the Company's revenues was
as follows: United States--28.3%; Europe--38.1%; Pacific Rim--19.8%; Other--
13.8%. The Company has developed its wholesale carrier business, which
accounted for 28.8% of revenues for the nine months ended September 30, 1997
compared to 12.8% for the nine months ended September 30, 1996, primarily by
serving wholesale customers in the U.S. and the Pacific Rim. In addition, the
Company has expanded its Country Coordinator offices and retail marketing
activities primarily in its core markets, six of which are located in Western
Europe, and three in the Pacific Rim. The Company believes that, because its
core markets comprised approximately 64% of the total global long distance
telecommunications market in 1996, according to TeleGeography, the U.S.,
Europe, and Pacific Rim regions will continue to comprise the bulk of the
Company's revenues.
The Company believes its retail services are typically competitively priced
below those of the ITO in each country in which the Company offers its
services. Prices for telecommunications services in many of the
35
<PAGE>
Company's core markets have declined in recent years as a result of
deregulation and increased competition. The Company believes that worldwide
deregulation and increased competition are likely to continue to reduce the
Company's retail revenues per billable minute. The Company believes, however,
that any decrease in retail revenues per minute will be at least partially
offset by an increase in billable minutes by the Company's customers, and by a
decreased cost per billable minute as a result of the expansion of the TIGN
and the Company's ability to use least cost routing in additional markets. See
"Risk Factors--Expansion and Operation of the TIGN."
For the year ended December 31, 1996 and the nine months ended September 30,
1997, 83.8% and 75.5%, respectively, of the Company's retail revenues were
derived from Telegroup's Global Access CallBack services. As the Company's
Global Access Direct service is provided to customers currently using
traditional call-reorigination services, the Company anticipates that revenue
derived from Global Access Direct will increase as a percentage of retail
revenues. However, the Company expects to continue to aggressively market its
Global Access CallBack service in markets not served by the TIGN and to use
transparent call-reorigination as an alternative routing methodology for its
Global Access Direct customers where appropriate. Accordingly, the Company
believes that call-reorigination will continue to be a significant source of
revenue.
Historically, the Company has not been required to collect VAT (typically
15% to 25% of the sales price) on call-reorigination services provided to
customers in the EU because prior laws deemed such services to be provided
from the U.S. However, Germany and France have adopted rules whereby, as of
January 1, 1997, telecommunications services provided by non-EU based firms
are deemed to be provided where the customer is located. Since April 1, 1997,
Austria, Belgium, Denmark, Finland, Greece, Ireland, Italy, Luxembourg, Spain,
the Netherlands, Portugal, Sweden and the United Kingdom have begun to impose
VAT on telecommunications services provided by non-EU based companies. The
Company is currently analyzing the effect of this legislation on its service
offerings. The Company may have no alternative but to reduce prices of
particular services offered to certain customer segments in order to remain
competitive in light of the imposition of VAT on its services in certain EU
member states. Such price reduction could have a material adverse effect on
the Company's business, financial condition and results of operations. The
Company believes that whatever negative impact the imposition of VAT will have
on its operations, such impact will be partially mitigated by the migration of
customers towards and the higher gross margins associated with call-through
services. See "Risk Factors--Risks Associated With Imposition of VAT on
Company's Services."
Cost of retail and wholesale revenues is comprised of (i) variable costs
associated with the origination, transmission and termination of voice and
data telecommunications services by other carriers, and (ii) costs associated
with owning or leasing and maintaining switching facilities and circuits. The
Company also includes as a cost of revenues payments resulting from traffic
imbalances under its operating agreement with AT&T Canada. Currently, a
significant portion of the Company's cost of revenues is variable, based on
the number of minutes of use transmitted and terminated over other carriers'
facilities. The Company's gross profitability is driven mainly by the
difference between revenues and the cost of transmission and termination
capacity.
The Company seeks to lower the variable portion of its cost of services by
originating, transporting and terminating a higher portion of its traffic over
the TIGN. However, in the near term, the Company expects that its cost of
revenues as a percentage of revenues will increase as the Company continues
the development and expansion of the TIGN and introduces new
telecommunications services. Subsequently, as the Company increases the volume
and percentage of traffic transmitted over the TIGN, cost of revenues will
increasingly consist of fixed costs associated with leased and owned lines and
the ownership and maintenance of the TIGN, and the Company expects that the
cost of revenues as a percentage of revenues will decline. The Company seeks
to lower its cost of revenues by: (i) expanding and upgrading the TIGN by
acquiring owned and leased facilities and increasing volume on these
facilities, thereby replacing a variable cost with a fixed cost and spreading
fixed costs over a larger number of minutes; (ii) negotiating lower cost of
transmission over the facilities owned by other national and international
carriers; and (iii) expanding the Company's least cost routing choices and
capabilities.
36
<PAGE>
The Company generally realizes higher gross margins from its retail services
than from its wholesale services. Wholesale services, however, provide a
source of additional revenue and add significant minutes originating and
terminating on the TIGN, thus enhancing the Company's purchasing power for
leased lines and switched minutes and enabling it to take advantage of volume
discounts. The Company also generally realizes higher gross margins from
direct access services than from call-reorigination. The Company expects its
gross margins to continue to decline in the near term as a result of increased
wholesale revenues as a percentage of total revenues. In addition, the Company
intends to reduce prices in advance of corresponding reductions in
transmission costs in order to maintain market share while migrating customers
from traditional call-reorigination to Global Access Direct. The Company then
expects gross margins to improve as the volume and percentage of traffic
originated, transmitted and terminated on the TIGN increases and cost of
revenues is reduced. The Company's overall gross margins may fluctuate in the
future based on its mix of wholesale and retail long distance services and the
percentage of calls using direct access as compared to call-reorigination, any
significant long distance rate reductions imposed by ITOs to counter external
competition, and any risks associated with the Company agreeing to minimum
volume contracts and not achieving the volume necessary to meet the
commitments.
Operating expenses include: (i) selling, general and administrative; (ii)
depreciation and amortization; and (iii) stock option based compensation.
Selling, general and administrative expenses include: (i) selling expenses;
(ii) general and administrative expenses; and (iii) bad debt expense. Selling
expenses are primarily sales commissions paid to internal salespersons and
independent agents, the primary cost associated with the acquisition of
customers by the Company. The Company's decision to use independent agents to
date has been primarily driven by the low initial fixed costs associated with
this distribution channel, and the agents' familiarity with local business and
marketing practices. The Company strives to reduce its customer acquisition
costs where possible by acquiring successful independent agents and by
developing its internal sales and customer service operations in countries
where there is sufficient market penetration. Sales commissions have increased
over the past three years as the Company's business has expanded. The Company
anticipates that, as revenues from the Company's Global Access Direct,
Spectra, and wholesale carrier services increase relative to its existing
services, selling expense will decline as a percentage of revenue, because of
the generally lower commission structure associated with these services. See
"Risk Factors--Dependence on Independent Agents; Concentration of Marketing
Resources."
The general and administrative expense component includes salaries and
benefits, other corporate overhead costs and costs associated with the
operation and maintenance of the TIGN. These costs have increased due to the
development and expansion of the TIGN and corporate infrastructure. The
Company expects that general and administrative expenses may increase as a
percentage of revenues in the near term as the Company incurs additional costs
associated with the development and expansion of the TIGN, the expansion of
its marketing and sales organization, and the introduction of new
telecommunications services.
The Company spends considerable resources to collect receivables from
customers who fail to make payment in a timely manner. While the Company
continually seeks to minimize bad debt, the Company's experience indicates
that a certain portion of past due receivables will never be collected, and
that such bad debt is a necessary cost of conducting business in the
telecommunications industry. Expenses attributable to the write-off of bad
debt represented approximately 1.5%, 3.1% and 2.4% of revenues for the years
ended December 31, 1994, 1995 and 1996, respectively, and 2.7% for the nine
months ended September 30, 1997. See "Risk Factors--Failure to Collect
Receivables (Bad Debt Risk)." In addition to uncollectible receivables, the
telecommunications industry has historically been exposed to a variety of
forms of customer fraud. The TIGN and the Company's billing systems are
designed to detect and minimize fraud, where practicable, and the Company
continuously seeks to enhance and upgrade its systems in an effort to minimize
losses as it expands into new markets. See "Risk Factors--Dependence on
Effective Management Information Systems."
As the Company begins to integrate its distribution network in selected
strategic locations by acquiring Country Coordinators and independent agents
or by establishing internal sales organizations, it may incur added
37
<PAGE>
selling, general and administrative expenses associated with the transition
which may result, initially, in an increase in selling, general and
administrative expenses as a percentage of revenues. The Company anticipates,
however, that as sales networks become fully integrated, new service offerings
are implemented, and economies of scale are realized, selling, general and
administrative expenses will decline as a percentage of revenue. See
"Business--Market Opportunity" and "--Business Strategy."
Depreciation and amortization expense primarily consists of expenses
associated with the depreciation of assets, amortization of goodwill derived
from business combinations and the amortization of debt issuance costs
associated with the private placement of the Company's Senior Subordinated
Notes in November 1996.
Stock option based compensation expense results from the granting of certain
unqualified and performance based options to employees at exercise prices
below that of fair market value at the date of grant or when specified
performance criteria have been met. As a result of certain non-qualified stock
option grants during 1996, the Company will incur stock option based
compensation expense of $342,000 in 1997 and 1998, and $283,000 in 1999.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial
data as a percentage of revenues.
PERCENTAGE OF REVENUES
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------- ------------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues....................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues............... 72.0 64.4 70.6 68.2 73.1
Gross profit................... 28.0 35.6 29.4 31.8 26.9
Operating expenses:
Selling, general and
administrative.............. 29.0 30.4 28.0 28.9 26.5
Depreciation and
amortization................ 0.5 0.5 0.8 0.7 1.3
Stock option based
compensation................ -- -- 0.5 -- 0.1
Total operating expenses... 29.5 30.9 29.3 29.6 27.9
Operating income (loss)........ (1.5) 4.7 0.1 2.2 (1.0)
Income tax benefit (expense)... 0.5 (2.0) 0.0 (0.8) 0.6
Extraordinary item, loss on
extinguishment of debt, net of
income taxes.................. -- -- -- -- 4.2
Net earnings (loss)............ (0.8) 3.0 (0.1) 1.4 (5.4)
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1996
Revenues. Revenues increased 61.4%, or $90.7 million, from $147.8 million in
the nine months ended September 30, 1996, to $238.5 in the nine months ended
September 30, 1997. This increase was primarily due to growth in international
and domestic retail sales and international and domestic wholesale revenues.
Wholesale revenues increased from $19.0 million, or 12.9% of total revenues in
the nine months ended September 30, 1996, to $68.8 million or 28.8% of
revenues for the nine months ended September 30, 1997.
Cost of Revenues. Cost of revenues increased 72.9%, or $73.5, million, from
approximately $100.8 million to approximately $174.3 million. As a percentage
of revenues, cost of revenues increased from 68.2% to 73.1%, primarily as a
result of a larger percentage of lower margin wholesale revenues.
Operating Expenses. Operating expenses increased 52.1%, or $22.8 million,
from $43.8 million in the nine months ended September 30, 1996, to $66.6
million in the nine months ended September 30, 1997, primarily as
38
<PAGE>
a result of increased sales commissions related to revenue growth, as well as
an increase in the number of employees necessary to provide customer service,
billing and collection and accounting support. Other contributing factors were
bad debt, depreciation, and amortization, as discussed below. As a percentage
of revenues, operating expenses decreased 1.7% from 29.6% in the nine months
ended September 30, 1996, to 27.9% in the nine months ended September 30,
1997.
Bad Debt. Bad debt expense increased from $3.8 million, or 2.6% of revenues
in the nine months ended September 30, 1996, to $6.4 million, or 2.7% of
revenues, in the nine months ended September 30, 1997. The increase in bad
debt expense as a percentage of revenues in the nine months ended September
30, 1997, was due primarily to the write-off of accounts receivable for
services rendered to a single domestic customer during the first quarter in
the nine month period. Services to this customer have been discontinued.
Depreciation and Amortization. Depreciation and amortization increased from
$1.2 million in the nine months ended September 30, 1996, to $3.2 million in
the nine months ended September 30, 1997, primarily due to increased capital
expenditures incurred in connection with the development and expansion of the
TIGN during the nine months ended September 30, 1997, as well as amortization
expenses associated with intangible assets.
Operating Income. Operating income decreased by $5.6 million, from $3.2
million in the nine months ended September 30, 1996, to $(2.4) million in the
nine months ended September 30, 1997, primarily as a result of the foregoing
factors.
Extraordinary Item. The Company recorded an extraordinary item, loss on
extinguishment of debt, of approximately $10.0 million dollars, net of tax, in
the third quarter of 1997 resulting from the prepayment of the Senior
Subordinated Notes.
Net Earnings (Loss). Net earnings (loss) decreased approximately $14.8
million, from $2.0 million in the nine months ended September 30, 1996, to
$(12.8) million in the nine months ended September 30, 1997. The decrease was
attributable to lower operating income, a $1.4 million increase in interest
expense, a $0.5 million increase in foreign currency transaction losses and an
extraordinary charge of $10.0 million for loss on early extinguishment of
debt. The foreign currency transaction losses resulted primarily from a
strengthening of the US Dollar in such period versus foreign currencies in
which the Company had unhedged positions.
EBITDA. EBITDA decreased from 4.3 million in the nine months ended September
30, 1996, to 0.6 million in the nine months ended September 30, 1997.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Revenues. Revenues increased 65.1%, or $84.1 million, from $129.1 million in
1995 to $213.2 million in 1996. The increase in revenues was due primarily to
an increase in billed customer minutes from the domestic and international
call-reorigination distribution channels and the first full year of wholesale
carrier operations. Revenues from international and domestic retail call
service usage increased by 39.8%, or $51.0 million, from $128.1 million in
1995 to $179.1 million in 1996. Revenues from wholesale carrier service usage
increased by $33.1 million, from $1.0 million in 1995 to $34.1 million in
1996. The wholesale revenue growth is largely the result of a significant
increase in traffic utilization from one international carrier, using bulk
call-reorigination to service its market more competitively.
Cost of Revenues. Cost of revenues increased 81.1%, or $67.4 million, from
$83.1 million in 1995, to $150.5 million in 1996. The increase in cost of
revenues was attributable primarily to increased traffic being handled by the
Company and increased costs associated with the expansion of the TIGN. The
increase in cost of revenues as a percent of revenues was attributable
primarily to the greater increase in the wholesale business as a percentage of
revenues. Other factors contributing to the increase in cost of revenues as a
percent of revenues included volume discounts to one large wholesale customer
in the fourth quarter of 1996, traffic rerouting penalties associated with
certain wholesale carrier traffic that exceeded the capacity of the Company's
network
39
<PAGE>
in the first two months of the fourth quarter; certain rate reductions to
customers in the U.S., Japan and France ahead of corresponding carrier cost
declines and the addition of fixed access costs associated with the expansion
of the TIGN.
The cost of revenues as a percentage of total revenues increased from 64.4%
in 1995 to 70.6% in 1996. Of the contributing factors identified above,
increases in wholesale business accounted for 3.0%, volume discounts being
offered accounted for 1.0% and rate reductions to customers in advance of
corresponding rate decreases from carriers and other factors accounted for the
additional 2.2% of the difference.
Gross Profit. Gross profit increased 36.3%, or $16.7 million, from $46.0
million in 1995 to $62.7 million in 1996. As a percentage of revenues, gross
profit decreased from 35.6% in 1995 to 29.4% in 1996.
Operating Expenses. Operating expenses increased 56.9%, or $22.7 million,
from $39.9 million in 1995 to $62.6 million in 1996. This increase was
primarily due to greater employee and contract employee costs, professional
fees for network and operating systems developers and legal, financial and
accounting costs associated with the development of the TIGN and the
supporting information and financial systems. From 1995 to 1996, the Company's
staff levels grew from 296 full and part time positions to 444 full and part
time positions, representing a 50.0% increase in the number of employees.
Growth was mainly in the professional category, with the hiring of additional
telecommunications technicians and programmers, and finance and accounting
professionals.
Bad debt expense increased $1.1 million, from $4.0 million in 1995, to $5.1
million in 1996. As a percentage of revenues, bad debt expense decreased from
3.1% in 1995 to 2.4% in 1996, primarily as a result of improvements in the
Company's collections systems and procedures.
Depreciation and amortization increased $1.2 million, from $0.7 million in
1995, to $1.9 million in 1996. The increase in depreciation and amortization
is primarily attributable to increased capital expenditures incurred in
connection with the development and expansion of the TIGN and amortization of
goodwill associated with: (i) the acquisition of the operations of the
Company's Country Coordinator in France in August 1996; and (ii) expenses
incurred by the Company in connection with the private placement of its Senior
Subordinated Notes in November 1996.
The Company also incurred a non-cash stock option based compensation expense
of $1.0 million in the fourth quarter of 1996, resulting from the grant of
non-qualified and performance base stock options to certain employees.
As a percentage of revenues, operating expenses decreased from 30.9% in 1995
to 29.3% in 1996, as the additional costs and expenses were more than offset
by increased revenues during the period.
Operating Income. Operating income decreased by $6.0 million, from $6.1
million in 1995 to $0.1 million in 1996. As a percentage of revenues,
operating income decreased from 4.7% in 1995 to 0.1% in 1996, for the reasons
discussed above.
Interest Expense. Interest expense increased from $0.1 million for 1995 to
$0.6 million for 1996, an increase of $0.5 million. The increase is directly
attributable to the increase in long-term indebtedness during 1996.
Net Earnings (Loss). Net earnings decreased $3.9 million from $3.8 million
in 1995 to $(0.1) million in 1996.
EBITDA. EBITDA decreased from $7.0 million in 1995, to $3.0 million in 1996.
40
<PAGE>
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
Revenues. Revenues increased 87.9%, or $60.4 million, from $68.7 million in
1994 to $129.1 million in 1995. This increase was due primarily to an increase
in billed customer minutes of use from call-reorigination customers in Western
Europe, especially in France and the Netherlands.
Cost of Revenues. Cost of revenues increased 67.9%, or $33.6 million, from
approximately $49.5 million in 1994 to approximately $83.1 million in 1995. As
a percentage of revenues, cost of revenues declined from 72.0% to 64.4%,
primarily as a result of volume discounts under fixed-price lease agreements
and a reduction in rates charged by the Company's carrier suppliers.
Gross Profits. Gross profit increased 139.6%, or $26.8 million, from $19.2
million in 1994 to $46.0 million in 1995. As a percentage of revenues, gross
profit increased from 28.0% in 1994 to 35.6% in 1995, due to the decline in
the relative cost of revenues as a percentage of overall revenues.
Operating Expenses. Operating expenses increased 97.5%, or $19.7 million,
from $20.2 million in 1994 to $39.9 million in 1995, primarily as a result of
increases in commissions to independent agents and Country Coordinators
directly relating to the Company's increased revenues and to growth in sales,
customer service, billing, collections and accounting staff required to
support this growth. As a percentage of revenues, operating expenses increased
1.4% from 29.5% in 1994 to 30.9% in 1995, primarily due to the growth in staff
needed to accommodate the Company's growth in business volume and complexity.
Staff levels grew from 217 full and part time employees in 1994 to 296 in
1995, representing a 36.4% increase in the staff compliment.
Bad debt expense increased from $1.1 million, or 1.5% of revenues in 1994,
to $4.0 million, or 3.1% of revenues, in 1995, due to a rapid increase in
international sales, which outpaced the Company's collection abilities.
Depreciation and amortization increased from $0.3 million in 1994, to $0.7
million in 1995, primarily due to increased capital expenditures incurred in
connection with the development and expansion of the Company's network.
Operating Income. Operating income increased by $7.1 million, from $(1.0)
million in 1994 to $6.1 million in 1995, as a result of increased sales and
gross profit with commensurate costs and expenses.
Net Earnings (Loss). Net earnings increased $4.3 million from $(0.5) million
in 1994 to $3.8 million in 1995, as a result of improved operating income.
EBITDA. EBITDA increased from $(0.6) million in 1994, to $7.0 million in
1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital investments consist of capital expenditures in
connection with the acquisition and maintenance of switching capacity and
funding of accounts receivable and other working capital requirements.
Historically, the Company's capital requirements have been funded primarily by
funds provided by operations, term loans and revolving credit facilities from
commercial banks, and by capital leases. The Company expects to require
substantial additional capital to develop and expand the TIGN, open new
offices, introduce new telecommunications services, upgrade and/or replace its
management information systems, and fund its anticipated operating losses and
net cash outflows in the near term.
Net cash provided by (used in) operating activities was $4.1 million in the
nine months ended September 30, 1996 and $(1.0) million in the nine months
ended September 30, 1997. The net cash provided by operating activities in the
nine months ended September 30, 1996 was primarily due to net earnings and an
increase in the provision for credit losses on accounts receivable. The net
cash used in operating activities in the nine months ended September 30, 1997
was primarily due to the net loss, an increase in depreciation and
amortization
41
<PAGE>
expense, an increase in provision for credit losses on accounts receivable,
and an increase in accounts payable. These increases were partially offset by
an increase in accounts receivable. The $1.7 million increase in deposits and
other assets in the nine months ended September 30, 1997 was due primarily to
an increase in goodwill arising from business combinations net of
amortization.
Net cash provided by operating activities was $1.4 million in 1994, $5.6
million in 1995 and $4.9 million in 1996. The net cash provided by operating
activities in 1996 and 1995 was mainly a result of a greater increase in
accounts payable to carriers relative to the increase in accounts receivable
from customers. In 1995, net cash provided by operating activities was mainly
due to net earnings, changes in operating activities and off-setting increases
in current assets and liabilities for the year.
Net cash used in investing activities was $(8.3) million in the nine months
ended September 30, 1996 and $(13.3) million in the nine months ended
September 30, 1997. The net cash used in the nine months ended September 30,
1996 and September 30, 1997, was primarily due to increases in equipment
purchases.
Net cash used in investing activities was $0.7 million in 1994, $2.8 million
in 1995 and $11.3 million in 1996. The net cash used in investing activities
in 1996, 1995 and 1994 was mainly due to an increase in equipment purchases,
and in 1996, the expenditure of $1.8 million in capitalized software
development costs.
Net cash provided by financing activities was $3.9 million in the nine
months ended September 30, 1996, and $58.6 million in the nine months ended
September 30, 1997. The net cash provided in the nine months ended September
30, 1996 was primarily due to proceeds from long-term borrowings and the
operating line of credit. The net cash provided in the nine months ended
September 30, 1997 was primarily due to proceeds from the IPO and long-term
borrowings.
Net cash provided by (used in) financing activities was $1.0 million in
1994, $(0.1 million) in 1995 and $15.9 million in 1996. In November 1996, the
Company completed a private placement of its Senior Subordinated Notes for net
proceeds of $18.5 million.
On July 14, 1997, the Company completed the IPO yielding net proceeds of
approximately $35.6 million after deducting expenses and underwriting
discounts. In addition, on August 12, 1997, the Company completed the sale of
an additional 450,000 shares of Common Stock pursuant to the exercise of the
underwriters' over allotment option, yielding net proceeds to the Company of
approximately $4.2 million after deducting underwriting discounts.
In September, 1997, the Company entered into its $15 million Revolving
Credit Facility. On September 5, 1997, the Company prepaid in full all of its
outstanding $20 million in aggregate principal amount of the Senior
Subordinated Notes at a redemption price equal to 107% of the principal amount
thereof, plus accrued interest. The Company financed the prepayment of the
Senior Subordinated Notes with a portion of the net proceeds from the IPO and
$8.5 million of borrowings under the Revolving Credit Facility. The Revolving
Credit Facility expired on October 31, 1997. The Company currently anticipates
entering into the New Credit Facility with a bank or other financial
institution for available borrowings in an amount not expected to exceed $20
million. There can be no assurance that the Company will enter into the New
Credit Facility.
On September 30, 1997, the Company issued $25 million aggregate principal
amount of Convertible Notes. The net proceeds from the issuance of the
Convertible Notes were approximately $24.3 million and approximately $15.0
million of such net proceeds were used to repay all amounts outstanding under
the Revolving Credit Facility.
On October 23, 1997, the Company sold $97.0 million aggregate principal
amount at maturity of its Senior Discount Notes, with net proceeds of
approximately $72.3 million. The Senior Discount Notes will accrete in value
from the date of issuance to May 1, 2000, at a rate of 10 1/2% per annum,
compounded semi-annually.
42
<PAGE>
Cash interest on the Senior Discount Notes will neither accrue nor be payable
prior to May 1, 2000. Commencing May 1, 2000, interest will be payable in cash
on the Senior Discount Notes semi-annually in arrears on each May 1, and
November 1, at a rate of 10 1/2% per annum. The Senior Discount Notes will
mature on November 1, 2004.
The development and expansion of the TIGN, the upgrade and/or replacement of
the Company's management information systems, the opening of new offices and
the introduction of new telecommunications services, as well as the funding of
anticipated losses and net cash outflows, will require substantial additional
capital. At September 30, 1997, the Company had $4.5 million in commitments
for capital expenditures. The Company has identified an additional $60.1
million of capital expenditures which the Company intends to undertake in 1997
and 1998 and approximately $75.0 million of additional capital expenditures
during the period from 1999 through 2001, subject to the ability to obtain
additional financing.
The Company expects that the net proceeds from the IPO, the Convertible
Notes and the Senior Discount Notes will provide the Company with sufficient
capital to fund planned capital expenditures and anticipated operating losses
through December 1998. The net proceeds from the IPO, the Convertible Notes
and the Senior Discount Notes are expected to provide sufficient funds for the
Company to expand its business as planned and to fund anticipated operating
losses and net cash outflows for the next 18 to 24 months. There can be no
assurance that the Company will be able to obtain the New Credit Facility or
if obtained, that it will be able to do so on a timely basis or on terms
favorable to the Company. The amount of the Company's actual future capital
requirements will depend upon many factors, including the performance of the
Company's business, the rate and manner in which it expands the TIGN,
increases staffing levels and customer growth, upgrades or replaces management
information systems and opens new offices, as well as other factors that are
not within the Company's control, including competitive conditions and
regulatory or other government actions. In the event that the Company's plans
or assumptions change or prove to be inaccurate, the Company does not enter
into the New Credit Facility, or the net proceeds of the Offering, together
with internally generated funds and funds from other financings, including the
Revolving Credit Facility or the New Credit Facility, if entered into, prove
to be insufficient to fund the Company's growth and operations, then some or
all of the Company's development and expansion plans could be delayed or
abandoned, or the Company may be required to seek additional funds earlier
than currently anticipated.
The Company continuously reviews opportunities to further its strategy
through strategic alliances with, investments in, or acquisitions of companies
that are complementary to the Company's operations. The Company may finance
such a venture with cash flow from operations or through additional bank debt
or one or more public offerings or private placements of securities.
FOREIGN CURRENCY
Although the Company's functional currency is the U.S. Dollar, the Company
derives a substantial percentage of its telecommunications revenues from
international sales. In countries where the local currency is freely
exchangeable and the Company is able to hedge its exposure, the Company bills
for its services in the local currency. In cases where the Company bills in a
local currency, the Company is exposed to the risk that the local currency
will depreciate between the date of billing and the date payment is received.
In certain countries in Europe, the Company purchases foreign exchange
contracts through its fiscal agent to hedge against this foreign exchange
risk. For the twelve months ended December 31, 1996, approximately $54.0
million (U.S. Dollar equivalent) or 25.3% of the Company's billings for
telecommunications services were billed in non-U.S. Dollar local currencies.
For the nine months ended September 30, 1997, approximately $56.3 million
(U.S. Dollar equivalent) or 23.6% of the Company's billings for
telecommunications services were billed in non-U.S. Dollar local currencies.
The Company's financial position and results of operations for the year
ended December 31, 1996 and the nine months ended September 30, 1997 were not
significantly affected by foreign currency exchange rate fluctuation. As the
Company continues to expand the TIGN and increase its customer base in its
targeted markets, an increasing proportion of costs associated with operating
and maintaining the TIGN, as well as local selling
43
<PAGE>
expenses, will be billed in foreign currencies. Although the Company and its
Subsidiaries attempt to match costs and revenues and borrowings and repayments
in terms of local currencies, there will be many instances in which costs and
revenues and borrowings and repayments will not be matched with respect to
currency denominations. The Company may choose to limit any additional
exposure to foreign exchange rate fluctuations by the purchase of foreign
forward exchange contracts or similar hedging strategies. There can be no
assurance that any currency hedging strategy would be successful in avoiding
exchange-related losses. See "Risk Factors--Foreign Exchange Rate Risks;
Repatriation Risks."
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, "Earnings Per Share" which revises the calculation and presentation
provisions of Accounting Principles Board Opinion 15 and related
interpretations. Statement No. 128 is effective for the Company's fiscal year
ending December 31, 1997. Retroactive application will be required.
SFAS 130, "Reporting Comprehensive Income," was issued in June 1997. It
establishes standards for reporting and display of comprehensive income and
its components in a full set of general-purpose financial statements.
SFAS 131, "Disclosures about Segments of an Enterprise and Related
Information," was issued in June 1997. It establishes standards for the way
that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas, and major customers.
The Company does not believe that adoption of any of these standards will
have a significant effect on its reported earnings per share or consolidated
financial statements.
EFFECTS OF INFLATION
Inflation is not a material factor affecting the Company's business and has
not had a significant effect on the Company's operations to date.
SEASONAL FLUCTUATIONS
The Company has historically experienced, and expects to continue to
experience, reduced growth rates in revenues in the months of August and
December due to extended vacation time typically taken by Americans and
Europeans during these months.
44
<PAGE>
THE GLOBAL TELECOMMUNICATIONS INDUSTRY
OVERVIEW
According to the World Telecommunication Development Report 1996/97
published by the ITU on February 20, 1997 (the "ITU Report"), the 1998 revenue
of the global telecommunications industry is projected to exceed $1 trillion.
In terms of market capitalization, the industry already ranks third behind
banking and health care. The industry can be divided into two sectors,
equipment, which accounts for almost one-fourth of the revenue, and services,
which accounts for the remainder. These two sectors can be further divided
into the national and international segments. The national telecommunication
services provide voice and data transmission within the borders of a nation,
whereas, the international telecommunication services provide voice and data
transmission across national borders from one national telephone network to
another. The entire industry has experienced dramatic changes during the past
decade as a result of significant growth in the use of services and
enhancements to technology. The industry is expecting similar growth in
revenue and traffic volume in the foreseeable future. In 1995, cross-border
telecommunication services accounted for $52.8 billion in revenues and 60.3
billion minutes of use, increasing from $21.7 billion in revenues and 16.7
billion minutes of use in 1986. This represents compound annual growth rates
of 10% and 15%, respectively. The ITU estimates that the 1996 sales exceeded
$100 billion for total cross-border telecommunications services. The ITU
Report estimates sales of equipment and services in the global
telecommunications industry will exceed $1 trillion in 1998, three-quarters of
which will be from services. The ITU projects that revenues from global
telecommunications services will exceed $900 billion in the year 2000.
The market for telecommunications services is highly concentrated. In 1995,
40 countries accounted for 83.8% of the global revenue, with the EU, Japan,
and the United States accounting for almost 75% of global revenue. The
Company's top ten targeted markets accounted for over 78% of all
telecommunication services revenue in 1995. Each market contributed as
follows: U.S. (30.3%), Japan (15.9%), Italy (9.5%), Germany (8.1%), the United
Kingdom (4.7%), France (4.6%), Switzerland (1.5%), Australia/New Zealand
(2.3%), the Netherlands (1.4%), and Hong Kong (0.9%).
Growth and change in the international telecommunications industry have been
fueled by a number of factors, including greater consumer demand,
globalization of the industry, increases in international business travel,
privatization of ITOs, and growth of computerized transmission of voice and
data information. These trends have sharply increased the use of, and reliance
upon, telecommunications services throughout the world. The Company believes
that despite these trends, a high percentage of the world's businesses and
residential consumers continue to be subject to high prices with poor quality
of service which have been characteristic of many ITOs. Demand for improved
service and lower prices has created opportunities for private industry to
compete in the international telecommunications market. Increased competition,
in turn, has spurred a broadening of products and services, and new
technologies have contributed to improved quality and increased transmission
capacity and speed.
Consumer demand and competitive initiatives have also acted as catalysts for
government deregulation, especially in developed countries. Deregulation
accelerated in the United States in 1984 with the divestiture by AT&T of the
RBOCs. Today, there are over 500 U.S. long distance companies, most of which
are small or medium-sized companies. In order to be successful, these small
and medium-sized companies have to offer their customers a full range of
services, including international long distance. However, most of these
carriers do not have the critical mass of customers to receive volume
discounts on international traffic from the larger facilities-based carriers
such as AT&T, MCI and Sprint. In addition, these small and medium-sized
companies have only a limited ability to invest in international facilities.
Alternative international carriers such as the Company have capitalized on
this demand for less expensive international transmission facilities. These
emerging international carriers are able to take advantage of larger traffic
volumes to obtain volume discounts on international routes (resale traffic)
and/or invest in facilities when volume on particular routes justify such
investments. As these emerging international carriers have become established,
they have also begun to carry overflow traffic from the larger long distance
providers that own overseas transmission facilities.
45
<PAGE>
Deregulation in the United Kingdom began in 1981 when Mercury, a subsidiary
of Cable & Wireless plc, was granted a license to operate a facilities-based
network and compete with BT. Deregulation and privatization have also allowed
new long distance providers to emerge in other foreign markets. Deregulation
spread to Europe with the adoption of the "Directive on Competition in the
Markets for Telecommunication Services" in 1990. A series of subsequent EU
Directives, reports and actions are expected to result in substantial
deregulation of the telecommunications industries in most EU member states by
1998. A similar movement toward deregulation has already taken place in
Australia and New Zealand and is taking place in Japan, Mexico, Hong Kong and
other markets. Other governments have begun to allow competition for value-
added and other selected telecommunications services and features, including
data and facsimile services and certain restricted voice services. Many
governments also permit or tolerate the provision of international call-
reorigination services to customers in their territories. In many countries,
however, the rate of change and emergence of competition remain slow and the
timing and extent of future deregulation is uncertain.
On February 15, 1997, pursuant to the WTO Agreement, the United States and
more than 60 members of the WTO agreed to open their respective
telecommunications markets to competition and foreign ownership and adopted
regulatory measures to protect market entrants against anticompetitive
behavior by dominant telephone companies. Although the Company believes that
the WTO Agreement could provide the Company with significant opportunities to
compete in markets that were not previously accessible, reduce its costs and
provide more reliable services, the WTO Agreement could also provide similar
opportunities to the Company's competitors. In some countries, for example,
the Company will be allowed to own facilities or to interconnect to the public
switched network on reasonable and non-discriminatory terms. There can be no
assurance, however, that the pro-competitive effects of the WTO Agreement will
not have a material adverse effect on the Company's business, financial
condition and results of operations or that members of the WTO will implement
the terms of the WTO Agreement.
By eroding the traditional monopolies held by ITOs, many of which are or
were wholly or partially government owned, deregulation is providing U.S.-
based providers the opportunity to negotiate more favorable agreements with
both the traditional ITOs and emerging foreign providers. In addition,
deregulation in certain foreign countries is enabling U.S.-based providers to
establish local switching and transmission facilities in order to terminate
their own traffic and begin to carry international long distance traffic
originated in those countries.
INTERNATIONAL SWITCHED LONG DISTANCE SERVICES
International switched long distance services are provided through switching
and transmission facilities that automatically route calls to circuits based
upon a predetermined set of routing criteria. In the U.S., an international
long distance call typically originates on a LEC's network and is switched to
the caller's domestic long distance carrier. The domestic long distance
provider then carries the call to its own or another carrier's international
gateway switch. From there it is carried to a corresponding gateway switch
operated in the country of destination by the ITO of that country and then is
routed to the party being called though that country's domestic telephone
network.
International long distance providers can generally be categorized by the
extent, if any, of their ownership and use of their own switches and
transmission facilities. The largest U.S. carriers, AT&T, MCI, Sprint, and
WorldCom primarily utilize owned U.S. transmission facilities and generally
use other long distance providers to carry their overflow traffic. Only the
largest U.S. carriers have operating agreements with, and own transmission
facilities that carry traffic to, the over 200 countries to which major long
distance providers generally offer service. A significantly larger group of
long distance providers own and operate their own switches but either rely
solely on resale agreements with other long distance carriers to terminate
their traffic or use a combination of resale agreements and leased or owned
facilities in order to terminate their traffic, as discussed below.
Switched Resale Arrangements. A switched resale arrangement typically
involves the wholesale purchase of termination services by one long distance
provider from another on a variable, per minute basis. Such resale,
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which was first permitted with the deregulation of the U.S. market, enables
the emergence of alternative international providers that rely at least in
part on transmission services acquired on a wholesale basis from other long
distance providers. A single international call may pass through the
facilities of multiple long distance resellers before it reaches the foreign
facilities-based carrier that ultimately terminates the call. Resale
arrangements set per minute prices for different routes, which may be
guaranteed for a set time period or subject to fluctuation following notice.
The resale market for international transmission is constantly changing, as
new long distance resellers emerge and existing providers respond to
fluctuating costs and competitive pressures. In order to effectively manage
costs when utilizing resale arrangements, long distance providers need timely
access to changing market data and must quickly react to changes in costs
through pricing adjustments or routing decisions. The Company has entered into
resale agreements with more than 20 carriers in the U.S., U.K., Canada, the
Netherlands, Denmark, Australia, Hong Kong and Switzerland, four of which
accounted for approximately 60% of the Company's cost of revenues for the year
ended December 31, 1996 and 61% for the nine months ended September 30, 1997.
Transit Arrangements. In addition to utilizing an operating agreement to
terminate traffic delivered from one country directly to another, an
international long distance provider may enter into transit arrangements
pursuant to which a long distance provider in an intermediate country carries
the traffic to the country of destination.
Alternative Transit/Termination Arrangements. As the international long
distance market began to deregulate, long distance providers developed
alternative transit/termination arrangements in an effort to decrease their
costs of terminating international traffic. Some of the more significant of
these arrangements include refiling, ISR and ownership of switching facilities
in foreign countries. Refiling of traffic, which takes advantage of
disparities in settlement rates between different countries, allows traffic to
a destination country to be treated as if it originated in another country
that enjoys lower settlement rates with the destination country, thereby
resulting in a lower overall termination cost. The difference between transit
and refiling is that, with respect to transit, the long distance provider in
the destination country has a direct relationship with the originating long
distance provider and is aware of the arrangement, while with refiling, it is
likely that the long distance provider in the destination country is not aware
of the country in which the traffic originated or of the originating carrier.
To date, the FCC has made no pronouncement as to whether refiling complies
with either U.S. or ITU regulations, although it is considering such issues in
an existing proceeding. While the Company's revenues attributable to refiling
arrangements are minimal, refiling may constitute a larger portion of the
Company's operations in the future.
With ISR, a long distance provider completely bypasses the accounting rates
system by connecting an international leased private line (i) to the PSTN of
two countries or (ii) directly to the premises of a customer or partner in one
country and the PSTN in the other country (except in the U.K., where only the
activity described in (i) is considered to be "ISR"). While ISR currently is
only sanctioned by applicable regulatory authorities on a limited number of
routes, including U.S.-U.K., U.S.-Canada, U.S.-Sweden, U.S.-New Zealand, U.K.-
worldwide and Canada-U.K., it is increasing in use and is expected to expand
significantly as deregulation of the international telecommunications market
continues and makes it possible for long distance providers to establish their
own switching facilities in certain foreign countries, enabling them to
directly terminate traffic. See "Business--Government Regulation." The Company
has been granted a license by the FCC to engage in ISR in the U.S. The Company
anticipates that the FCC will soon approve ISR with Denmark, the Netherlands,
Norway, France, Germany, and Finland with Japan and Hong Kong possibly to
follow in the near future. The Company is either using or prepared to use
direct leased capacity among countries where such use is either authorized or
about to be authorized. In the U.K., ISR is permitted with any country,
provided the U.K. based carrier has been granted the appropriate license. The
Company's wholly owned U.K. Subsidiary, Telegroup UK Limited, has been granted
its U.K. ISR license.
Operating Agreements. Under traditional operating agreements, international
long distance traffic is exchanged under bilateral agreements between
international long distance providers that have rights in facilities
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in different countries. Operating agreements provide for the termination of
traffic in, and return traffic from, the international long distance
providers' respective countries at a negotiated "accounting rate." Under a
traditional operating agreement, the international long distance provider that
originates more traffic compensates the long distance provider in the other
country by paying an amount determined by multiplying the net traffic
imbalance by the latter's share of the accounting rate.
The Company currently has an operating agreement with AT&T Canada (formerly
Unitel), Canada's second largest carrier. This agreement is used primarily to
transit/terminate traffic between the U.S. and Canada. Also, the Company has
purchased capacity on the CANTAT-3 cable system as a means of linking its
switching facilities in the U.S. and the U.K. In addition, the Company both
leases transmission facilities and resells switched minutes from carriers that
have operating agreements. By aggressively negotiating resale agreements with
carriers who have entered into operating agreements, the Company takes
advantage of such carrier's economic incentive to increase outgoing traffic to
a particular country. The resold call volume increases the market share for
that carrier to a particular country, thereby increasing such carrier's
proportionate return traffic from the correspondent under the accounting rate
process. The Company may in the future enter into additional operating
agreements if such agreements would improve the Company's profitability over
these routes.
Under a typical operating agreement each carrier has a right in its portion
of the transmission facilities between two countries. A carrier gains
ownership rights in a digital fiber-optic cable by purchasing direct ownership
in a particular cable (usually prior to the time the cable is placed in
service), by acquiring an "Indefeasible Right of Use" ("IRU") in a previously
installed cable, or by leasing or obtaining capacity from another long
distance provider that either has direct ownership or IRU rights in the cable.
In situations where a long distance provider has sufficiently high traffic
volume, routing calls across leased, IRU, or directly-owned cable capacity is
generally more cost-effective on a per call basis than the use of resale
arrangements with other long distance providers. However, leased capacity,
acquisition of IRU rights, and direct ownership require a company to make a
substantial initial investment of its capital based on the amount of capacity
being acquired. Telegroup's interest in the CANTAT-3 Trans-Atlantic cable
between New York and the U.K. is 50% IRU and 50% leased. The Company intends
to acquire 100% IRU ownership.
The rapidly changing international telecommunications market has created a
significant opportunity for carriers that can offer high quality, low cost
international long distance service. Deregulation, privatization, the
expansion of the resale market and other trends influencing the international
telecommunications market are resulting in decreased termination costs, a
proliferation of routing options, and increased competition. To be successful,
both the alternative and established international long distance companies
will need to aggregate enough traffic to maximize the use of both facilities-
based and resale opportunities, maintain systems which enable analysis of
multiple routing options, invest in facilities and switches and remain
flexible enough to locate and route traffic through the most advantageous
routes.
COMPETITIVE OPPORTUNITIES AND ADVANCES IN TECHNOLOGY
The combination of a continually expanding global telecommunications market,
consumer demand for lower prices with improved quality and service, and
ongoing deregulation has created competitive opportunities in many countries.
Further, as more small and medium-sized businesses and residential customers
have come to rely on international telecommunications services for their
business and personal needs, an increasingly diverse and sophisticated
customer base has generated demand for a greater variety of services.
Increased competition has also resulted in improved quality of service at
lower prices. Similarly, new technologies, including fiber-optic cable and
improvements in digital compression, have improved quality and increased
transmission capacities and speed, with transmission costs decreasing as a
result.
Advances in technology have created multiple ways for telecommunications
carriers to provide customer access to their networks and services. These
include customer-paid local access, international and national toll-free
access, direct digital access through a dedicated line, equal access through
automated routing from the PSTN and call-reorigination. The type of access
offered depends on the proximity of switching facilities to the customer, the
needs of the customer, and the regulatory environment in which the carrier
competes. Overall,
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these changes have resulted in a trend towards bypassing traditional
international long distance operating agreements as international long
distance companies seek to operate more efficiently.
In a deregulated country such as the United States, carriers can establish
switching facilities, own or lease fiber-optic cable, enter into operating
agreements with foreign carriers and, accordingly, provide direct access
service. In markets that have not deregulated or are slow in implementing
deregulation, such as South Africa, international long distance carriers have
used advances in technology to develop innovative alternative access methods,
such as call-reorigination. In other countries, such as Japan and most EU
member states, where deregulation is imminent but not complete, carriers are
permitted to offer facilities-based data and facsimile services, as well as
limited voice services including those to CUGs, but are as yet precluded from
offering full voice telephony. As countries deregulate, the demand for
alternative access methods typically decreases as carriers are permitted to
offer a wider range of facilities-based services on a transparent basis.
The most common form of alternative international access, traditional call-
reorigination, avoids the high international rates offered by the ITO in a
particular regulated country by providing customers with dial tone from a
deregulated country, typically the United States. To place a call using
traditional call-reorigination, a user dials a unique phone number to an
international carrier's switching center and then hangs up after it rings. The
user then receives an automated callback providing dial tone from the U.S.
which enables the user to complete the call. Technical innovations, ranging
from inexpensive dialers to sophisticated in-country switching platforms, have
enabled telecommunications carriers to offer a "transparent" form of call-
reorigination. The customer dials into the local switch, and then dials the
international number in the usual fashion, without experiencing the "hang-up"
and "callback," and the international call is automatically and swiftly
processed.
Historically, a significant portion of the Company's revenue and operating
income has been derived from the provision of traditional international call-
reorigination services to retail customers on a global basis. The Company
believes that as deregulation occurs and competition increases in various
markets around the world, the pricing advantage of traditional call-
reorigination to most destinations relative to conventional call-through
international long distance service will diminish in those markets. The
Company believes that, in order to maintain its existing customer base and to
attract new customers in such markets, it will need to be able to offer call-
through services at prices significantly below the current prices charged for
call-reorigination. See "Risk Factors--Expansion and Operation of the TIGN."
The worldwide telecommunications market is increasingly served by a wide
range of telecommunications providers, many of which seek to focus on only a
limited segment of the overall market. ITOs and major global carriers
typically concentrate their efforts on multinational companies and other high
volume long distance telephone users that demand high quality and customized
services. Many alternative carriers, such as the Company, concentrate on
serving the international long distance needs of small and medium-sized
business and high-volume residential customers who in the aggregate have
significant international long distance traffic.
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The following table provides an overview of the Company's core international
telecommunications markets:
<TABLE>
<CAPTION>
1995 ORIGINATED
MINUTES OF
INT'L TRAFFIC
COUNTRY TOTAL MINUTES (IN BILLIONS)(1) DEREGULATION DATE ITO(S)
- ------- ------------- ---------------- ----------------- ------
<S> <C> <C> <C> <C>
United States........... 15.6 1984(2) AT&T, MCI, Sprint, WorldCom
Germany................. 5.2 1/1/1998(3) Deutsche Telecom
United Kingdom.......... 4.0 1981(4) BT, Mercury
France.................. 2.8 1/1/1998(3) France Telecom
Switzerland............. 1.8 1/1/1998(3) Swisscom
Hong Kong............... 1.7 1995(6) HKTI
Japan................... 1.6 1998 KDD, IDC, ITJ
Netherlands............. 1.5 7/1/1997 KPN
Australia............... 1.0 1991(7) Telstra, OPTUS
Sweden.................. 0.9 1980(5) Telia AB, Tele-2
</TABLE>
- --------
(1) Source: TeleGeography 1996/97.
(2) Deregulation accelerated in the United States in 1984 with the divestiture
by AT&T of the RBOCs.
(3) Date set for complete liberalization of the telecommunications market
established by the EU Full Competition Directive.
(4) The deregulation of the United Kingdom telecommunications market began in
1981, when a second national carrier, Mercury, was first licensed.
(5) Although Sweden is subject to the EU deadline for complete liberalization,
it began permitting competition in 1980.
(6) To date, Hong Kong has not officially deregulated its telecommunications
market. However, in 1995, the Hong Kong regulator granted local FTNS
licenses to three carriers, and has since permitted the provision of
value-added, data and, virtual private network services. China assumed
sovereignty of Hong Kong on July 1, 1997. See "Risk Factors--Substantial
Government Regulation--The Pacific Rim."
(7) Liberalization began in Australia in 1991, when a second facilities-based
carrier, OPTUS, was authorized to begin operation. Under Australian law,
competitors to the ITO may own international facilities.
United States. The U.S. long distance market, with 1995 revenue of
approximately $70.0 billion, is the largest and most competitive in the world.
The international segment of this market was 15.6 billion minutes of usage in
1995. According to TeleGeography, a leading industry publication, five of the
top six international calling routes originate or terminate in the U.S. The
U.S. domestic long distance market is largely dominated by the four major
carriers: AT&T (54.3%), MCI (28.5%), Sprint (11.3%), and WorldCom (3.5%),
which collectively control approximately 97% of the market. MCI and WorldCom
have recently announced plans to merge. Several second and third tier
carriers, such as Frontier, LCI, Excel Communications, Inc., Tel-Save
Holdings, Inc. and Telco Communications Group, Inc., have made inroads in both
the high-volume residential and small and medium-sized business sectors. The
second and third tier providers have largely employed a strategy of switched
resale targeted at the national long distance market. The international long
distance market for small and medium-sized businesses, which is the Company's
primary focus, has been largely ignored by the major carriers as well as the
second and third tier national long distance providers.
The Company believes that the U.S. long distance market will become more
competitive in the near future as the 1996 Telecommunications Act permits RBOC
entry into long distance. The Company believes that the RBOCs will focus their
marketing efforts on the high-end of the long distance market, where they will
be able to offer the greatest savings on local access charges to large
business customers, and on the low-end of the market, where they will be able
to provide small residential users with the convenience of a single bill.
Netherlands. The market for international telecommunications in the
Netherlands has historically been dominated by the Dutch ITO, KPN. The Dutch
market was completely liberalized on July 1, 1997. The Company believes it is
the largest provider of international telecommunications services in this
market. Two alternative
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carriers, Telfort and Enertel, are currently building out networks and
starting to provide competitive national and international services. The
Company believes that new entrants will drive down transmission costs and
potentially open up opportunities in the national long distance and wholesale
sectors of the market.
France. The market for international telecommunications in France has
historically been dominated by the French ITO, France Telecom. The Company
believes it is the largest provider of international telecommunications
services in this market. Telecom Development, a consortium led by SNCF, the
French National Railways Company, and Compagnie Generale des Eaux, the leading
French telecommunications group, has commenced construction of a facilities-
based, digital long distance network to offer a broad range of voice and data
services. In addition, other competitors have entered the market, including
WorldCom which has begun a build-out of local fiber loops in the Paris region
and Unisource which has installed switches connected by leased lines
throughout France.
United Kingdom. The deregulation of the U.K. telecommunications industry
began in 1981 when Mercury, a subsidiary of Cable & Wireless plc, was granted
a license to operate a facilities-based network and compete with BT. This
duopoly over all public voice telecommunication services continued until 1991
when the government further liberated the U.K. national telecommunications
market by stating it would license new national and regional public
telecommunications operators.
The U.K. international telecommunications market was not fully liberalized
until 1996. Competition was introduced into this market from 1993 onwards
through licensing of international simple resellers and other public operators
which were allowed to buy international private leased circuits by means of
which they could provide services to the public. In addition to BT and Mercury
there are over 40 other companies in the U.K. which presently hold licenses
authorizing the operation of systems which may be connected to foreign
systems. Some of these other new international licensees such as Energis and
WorldCom have commenced installing new international cables. The Company
believes that new market entrants will drive down costs and potentially extend
opportunities not only in the U.K. national long distance and wholesale
sectors but also in the U.K. international markets.
Germany. The market for international telecommunications in Germany has
historically been dominated by the German ITO, Deutsche Telecom. Mannesmann
Arcor, Viag Interkom, as well as o.tel.o GmbH a consortium of German utilities
companies, have commenced construction of a facilities-based digital long
distance networks that are expected to offer a broad range of voice and data
services in competition with Deutsche Telecom. In addition, other competitors
have entered the market, including WorldCom/MFS which is operating local fiber
loops in various metropolitan areas in Germany such as Frankfurt/Main in the
Frankfurt region.
Switzerland. The international telecommunications market in Switzerland has
been historically dominated by the ITO, Swisscom. Although Switzerland is not
a member of the EU, its government has announced that it will voluntarily
conform to the EU objective of deregulating telecommunications markets and
allowing cross border competition. Swisscom is a member of the Unisource
consortium. Global One has established a presence in Switzerland and is
currently offering private network services to large, corporate and
institutional customers. The Company believes that it is the primary
competitor to Swisscom for international voice services in Switzerland.
Sweden. The telecommunications market in Sweden is among the most
deregulated in the world. Sweden has liberalized its telecommunications market
so that competitors, led by Tele-2, accounted for approximately 30% of the
market in 1995. Telia is a member of the Unisource consortium and is also
authorized to provide facilities-based and resold services between the United
States and Sweden. The Company believes it will have opportunities to enter
into resale agreements with one or more companies in Sweden which will allow
it to offer fully transparent access to the TIGN and possibly national long
distance service as well.
Hong Kong. HKTI currently holds an exclusive license until September 30,
2006 to provide a variety of international services including the right to
operate an international gateway for the handling of all outgoing and
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incoming international calls. There are four local fixed telephone network
operators, including the former monopoly, Hong Kong Telephone Company, that
have been licensed by the Office of the Telecommunications Authority ("OFTA"),
the Hong Kong regulator. Despite the fact that HKTI has the exclusive right
under its license to provide international telephone services, all three of
the new local fixed network operators have in recent years gained a
significant share of the international long distance call market by utilizing
U.S. and Canada-based call-reorigination services. Effective July 1, 1997,
control of Hong Kong reverted to China, and it is unclear what effect, if any,
this will have on the Company's operations in Hong Kong. See "Risk Factors--
Substantial Government Regulation" and "Business--Government Regulation."
Australia. The market for international telecommunications services in
Australia has historically been dominated by Telstra. A smaller share of the
market is held by a new carrier, OPTUS. In the last two years, switched and
switchless service providers have increased their market share of
international telecommunications in Australia from 3.4% to 14%, largely at the
expense of Telstra. Recently, AAPT and Axicorp, a division of Primus, have
leased nationwide network capacity to compete with the two ITOs. Legislation
in effect until June 30, 1997 prohibited service providers from installing and
maintaining line links between specific locations in Australia. Open
competition commenced on July 1, 1997, under the Australian Telecommunication
Act, subject to certain conditions.
Japan. The market for international long distance telecommunications
services in Japan has historically been dominated by the Japanese ITO, KDD. In
recent years, IDC and ITJ have grown rapidly and each have captured
approximately 17% of the market. Recently, it was announced that NTT, the
dominant provider of local and long distance services in Japan that was
prohibited from entering the international market, would be split into three
companies, including one international service provider. It was also announced
that ITJ will merge with a domestic Japanese carrier, Japan Telecom, Inc., and
that KDD will operate a joint venture with DDI, another domestic Japanese
carrier. Additionally, several smaller companies have entered the Japanese
market in the last few years offering call-reorigination services.
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BUSINESS
OVERVIEW
Telegroup is a leading global provider of long distance telecommunications
services. The Company offers a broad range of discounted international,
national, value-added wholesale and enhanced telecommunications services to
approximately 268,000 small and medium-sized business, residential and
wholesale customers in over 180 countries worldwide. Telegroup has achieved
its significant international market penetration by developing what it
believes to be one of the most comprehensive global sales, marketing and
customer service organizations in the global telecommunications industry. The
Company operates a reliable, flexible, cost-effective, digital, facilities-
based network, the Telegroup Intelligent Global Network, consisting of 19
Excel, NorTel or Harris switches, five enhanced services platforms, owned and
leased capacity on seven digital fiber-optic cable links, leased parallel data
capacity and the Company's Network Operations Centers in Fairfield, Iowa.
According to FCC statistics based on 1996 revenue, Telegroup was the
thirteenth largest U.S. long distance carrier in 1996. Telegroup's revenues
have increased from $29.8 million in 1993 to $213.2 million in 1996 and $303.9
million for the twelve months ended September 30, 1997. In 1993, the Company
had an operating loss of $0.4 million and a net loss of $0.7 million, compared
to operating income of $0.1 million and a net loss of $0.1 million in 1996.
Telegroup provides an extensive range of telecommunications services on a
global basis under the Spectra, Global Access and other brand names. The
Company's services are typically priced competitively with the services of
other alternative telecommunications providers and below the prices offered by
the ITOs, which are often government-owned or protected telephone companies.
While the Company offers a broad range of telecommunications services, the
services offered in a particular market vary depending upon regulatory
constraints and local market demands. Telegroup historically has offered
traditional call-reorigination service (also known as callback) to penetrate
international markets having regulatory constraints. As major markets continue
to deregulate, the Company continues to migrate an increasing portion of its
customer base to "call-through" service, which includes conventional
international long distance service and a "transparent" form of call-
reorigination. The Company markets its call-through service under the brand
name Global Access Direct and its traditional call-reorigination service under
the brand name Global Access CallBack. Currently, the Company offers both
international and national long distance service, prepaid and postpaid calling
cards, toll-free service and enhanced services such as fax store and forward,
fax-mail, voice-mail and call conferencing. The Company believes its broad
array of basic and enhanced services enables the Company to offer a
comprehensive bundled solution to its customers' telecommunications needs. The
Company also resells switched minutes and enhanced service platforms on a
wholesale basis to other telecommunications providers and carriers. See "--
Services."
Telegroup's extensive sales, marketing and customer service organization
consists of a worldwide network of independent agents and an internal sales
force who market Telegroup's services and provide customer service, typically
in local languages and in accordance with the cultural norms of the countries
and regions in which they operate. The Company's local sales, marketing and
customer service organization permits the Company to continually monitor
changes in each market and quickly modify service and sales strategies in
response to changes in particular markets. In addition, the Company believes
that it can leverage its global sales and marketing organization to quickly
and efficiently market new and innovative service offerings. As of November
30, 1997, the Company had approximately 1,375 independent agents worldwide.
Twenty-eight Country Coordinators are responsible for coordinating Telegroup's
operations, including sales, marketing, customer service and independent agent
support, in 72 countries. In addition, the Company has 31 internal sales
personnel in the United States and one each in France, Germany and the United
Kingdom, and intends to establish additional internal sales departments in
selected core markets. The Company believes that its comprehensive global
sales, marketing and customer service organization will enable the Company to
increase its market share and position itself as the leading international
long distance provider in each of its target markets. The Company believes
that it is the largest alternative international long distance provider in
three of the largest
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international telecommunications markets in the world--France, the Netherlands
and Switzerland. See "--Sales, Marketing and Customer Service."
The Telegroup Intelligent Global Network includes a central Network
Operations Center in Iowa City, Iowa, as well as switches, owned and leased
transmission capacity and a proprietary distributed intelligent network
architecture. The TIGN is designed to allow customer-specific information,
such as credit limits, language selection, waiting voice-mail and faxes, and
speed dial numbers to be distributed efficiently over a parallel data network
wherever Telegroup has installed a TIGN switch. In addition, the open,
programmable architecture of the TIGN allows the Company to rapidly deploy new
features, improve service quality, and reduce costs through least cost
routing. As of December 15, 1997, the TIGN consisted of (i) the Network
Operations Center, (ii) 19 Excel, NorTel or Harris switches in New York City,
Jersey City, New Jersey, London, Paris, Amsterdam, Zurich, Copenhagen,
Frankfurt, Hong Kong, Sydney, Tokyo and Milan, (iii) five enhanced services
platforms in New York, Hong Kong, London, Paris and Sydney, (iv) owned and
leased fiber-optic cable links connecting its New York and New Jersey switches
to its switches in London, Amsterdam, Sydney and Los Angeles, and its London
switches to its switches in Paris and Amsterdam, and (v) leased parallel data
transmission capacity connecting Telegroup's switches to each other and to the
networks of other international and national carriers. The Company intends to
further develop the TIGN by upgrading existing facilities and by adding
switches and transmission capacity principally in and between major markets
where the Company has established a substantial customer base. See "--Network
and Operations."
MARKET OPPORTUNITY
The global market for international telecommunications equipment and
services is undergoing significant deregulation and reform. The industry,
which provides voice and data communication world wide, is being shaped by the
following trends: (i) deregulation and privatization of telecommunications
markets worldwide; (ii) diversification of services through technological
innovation; and (iii) globalization of major carriers through market
expansion, consolidation and strategic alliances. As a result of these
factors, it is anticipated that the industry will experience considerable
growth in the foreseeable future, both in terms of traffic volume and revenue.
According to the ITU Report, trade in the international telecommunications
industry, including sales of equipment and services, is projected to exceed $1
trillion in 1998. International telecommunications services, defined as sales
of services across national borders, accounted for $52.8 billion in revenues
and 60.3 billion minutes of use in 1995, increasing from $21.7 billion in
revenues and 16.7 billion minutes of use in 1986, which represents compound
annual growth rates of 10% and 15%, respectively. The ITU estimates for total
cross-border telecommunications trade in 1996 are in excess of $100 billion.
The ITU projects that revenues from global telecommunications services will
exceed $900 million in the year 2000.
Deregulation and Privatization of Telecommunications Markets
Worldwide. Significant legislation and agreements have been adopted since the
beginning of 1996 which are expected to lead to the liberalization of the
majority of the world's telecommunication markets, including:
The U.S. Telecommunications Act, signed in February 1996, establishes
parameters for the implementation of full competition in the U.S. national
long distance market.
The EU Full Competition Directive, adopted in March 1996, abolishes
exclusive rights for the provision of Voice Telephony services throughout
the EU and the PSTNs of any member country of the EU by January 1, 1998,
subject to extension by certain EU member countries.
The World Trade Organization Agreement, signed in February 1997, creates
a framework under which more than 60 countries have committed to liberalize
their telecommunications laws in order to permit increased competition and,
in most cases, foreign ownership in their telecommunications markets,
beginning in 1998. The 69 governments participating in the WTO
telecommunications negotiations on basic telecommunications services
account for over 90% of global market telecommunications services,
according to the ITU Report.
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The 1997 Australian Telecommunications Act, adopted in March 1997, opens
the Australian market up to greater competition in the provision of
telecommunications services over a company's own telephone lines.
The Company believes that the foregoing initiatives, as well as other
proposed legislation and agreements, will result in reduced restrictions on
the ability of alternative carriers such as Telegroup to provide
telecommunications services in the subject markets. In many markets, Telegroup
believes that long distance callers have been charged relatively high,
uncompetitive prices by the ITOs in exchange for limited services. The ITU's
projections for substantially increased international minutes of use and
revenue by the year 2000 are based in part on the belief that reduced pricing
as a result of deregulation and competition will result in a substantial
increase in the demand for telecommunications services in most markets.
Telegroup believes that its comprehensive global sales, marketing and customer
service organization uniquely positions it among alternative
telecommunications providers to capitalize on the opportunities presented by
these reduced restrictions. Telegroup also believes that such global
regulatory reform will expand the availability of transmission capacity,
enabling Telegroup to strategically add transmission capacity to its network
in order to reduce its cost of sales through least cost routing.
Diversification of Services through Technological Innovation. The
deregulation of telecommunications markets throughout the world has coincided
with substantial technological innovation. The proliferation of digital fiber-
optic cable in and between major markets has significantly increased
transmission capacity, speed and flexibility. Improvements in computer
software and processing technology have enabled telecommunications providers
to offer a broad range of enhanced voice and data services. Unlike many
established telecommunications providers, the Company is not encumbered by
large, inflexible legacy switching systems. The TIGN uses primarily open-
architecture Excel switches which can be programmed to meet the specifications
of new enhanced service platforms. The Company believes that expansion of the
TIGN will enable it to deliver a flexible, comprehensive set of enhanced
telecommunications services to meet the evolving needs of its global customer
base.
Globalization of Major Carriers through Market Expansion, Consolidation and
Strategic Alliances. Faced with the prospect of declining market share in
their respective markets, AT&T and several of the European ITOs have sought
out alternative sources of revenue by expanding into new markets.
Additionally, certain ITOs have pursued mergers, acquisitions and other
strategic alliances, such as the proposed BT/MCI merger and the formation of
the Global One and Unisource consortia, to provide telecommunications services
in additional markets. Telegroup believes that it is uniquely positioned to
take advantage of these trends in the global telecommunications marketplace.
As telecommunications markets are deregulated, the Company believes that its
global sales, marketing and customer service organization and the design of
the TIGN will enable the Company to expand its customer base and its service
offerings in existing and new markets, and to reduce its cost of transmission
service obtained from other carriers. The Company believes that it will be
better able to negotiate favorable alternative transit/termination agreements
with facilities-based carriers or consortia in multiple markets because of its
large, globally distributed customer base and substantial traffic volumes.
BUSINESS STRATEGY
Telegroup's objective is to become the leading provider of
telecommunications services to small and medium-sized business and high-volume
residential customers in its existing core markets and in selected target
markets. Telegroup's strategy for achieving this objective is to deliver
additional services to customers in its markets through the continued
deployment of the TIGN and to expand its sales and marketing organization into
new target markets. The Company's business strategy includes the following key
elements:
Expand the Telegroup Intelligent Global Network. Telegroup is currently
expanding the TIGN by installing additional switches, purchasing ownership in
additional fiber-optic cable and leasing additional dedicated transmission
capacity in strategically located areas of customer concentration in Western
Europe and the Pacific Rim. Through September 30, 1997, the Company has
invested over $16.2 million in network facilities,
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and the Company anticipates the investment of an additional $40.3 million in
network facilities with the net proceeds of the IPO, the Convertible Notes,
and the Old Notes. During the next 15 months, the Company has scheduled the
installation of additional switches in the United States, Spain, New Zealand,
Korea, El Salvador and Brazil, and nodes in the United States, Sweden, Norway,
Belgium, Greece and Austria. Telegroup will continue to purchase ownership in
additional fiber-optic cables and lease additional dedicated transmission
capacity to reduce the Company's per minute transmission costs. The Company's
ability to achieve these goals is dependent upon, among other things, its
ability to raise additional financing. See "Risk Factors--Need for Additional
Financing." The Company believes the expansion of the TIGN will enable
Telegroup to continue to migrate customers from traditional call-reorigination
services to Global Access Direct. In order to maximize the Company's return on
invested capital, the Company employs a success-based approach to capital
expenditures, locating new switching facilities in markets where the Company
has established a customer base by marketing its call-reorigination services.
Maximize Operating Efficiencies. Telegroup intends to reduce its costs of
providing telecommunications services by strategically deploying switching
facilities, adding leased and owned fiber-optic capacity and entering into
additional alternative "transit/termination agreements." This expansion of the
TIGN will enable the Company to originate, transport and terminate a larger
portion of its traffic over its own network, thereby reducing its overall
telecommunications costs. The Company believes that through least cost
routing, its cost effective Excel LNX switches and its other facilities,
Telegroup will be able to further reduce the overall cost of its services.
Expand Global Sales, Marketing and Customer Service Organization. The
Company believes that its experience in establishing one of the most
comprehensive global sales, marketing and customer service organizations in
the global telecommunications industry provides it with a competitive
advantage. The Company intends to expand its global sales, marketing and
customer service organization in new and existing markets. In new target
markets, the Company relies primarily on independent agents to develop a
customer base while minimizing its capital investment and management
requirements. As the customer base in a particular market develops, the
Company intends to selectively acquire the operations of its Country
Coordinator serving such market and recruit and train additional internal
sales personnel and independent agents. The Company believes that a direct
sales and marketing organization complements its existing independent agents
by enabling Telegroup to conduct test marketing and quickly implement new
marketing strategies. In addition to its sales offices in France, Germany and
the United Kingdom, the Company intends to open or acquire additional offices
in target markets in Europe and the Pacific Rim during 1997 or 1998.
Position Telegroup as a Local Provider of Global Telecommunications
Services. Telegroup is one of the only alternative telecommunications
providers that offers in-country and regional customer service offices in
major markets on a global basis. At November 30, 1997, the Company had 28
Country Coordinators providing customer service in 72 countries. Telegroup
believes this local presence provides an important competitive advantage,
allowing the Company to tailor customer service and marketing to meet the
specific needs of its customers in a particular market. Customer service
representatives speak the local languages and are aware of the cultural norms
in the countries in which they operate. The Company continually monitors
changes in the local market and seeks to quickly modify service and sales
strategies in response to such changes. In many instances, this type of
dedicated customer service and marketing is not available to the Company's
target customer base from the ITOs.
Target Small and Medium-Sized Business Customers. The Company believes that
small and medium-sized business customers focus principally on obtaining
quality and breadth of service at low prices and have historically been
underserved by the ITOs and the major global telecommunications carriers.
Through the deployment of the TIGN, the Company will continue to migrate
existing customers from traditional call-reorigination services to Global
Access Direct, thereby addressing the telecommunications needs of a wider base
of small and medium-sized business customers. Telegroup believes that, with
its direct, face-to-face sales force and dedicated customer service, it can
more effectively attract and serve these business customers.
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Pursue Acquisitions, Joint Ventures and Strategic Alliances. The Company
intends to expand its global sales, marketing and customer service
organizations, increase its customer base, add network and circuit capacity,
enter additional markets and develop new products and services through
acquisitions, joint ventures and strategic alliances. The Company seeks to
acquire controlling interests in companies that have established marketing
organizations, existing customer bases, complementary network facilities, new
services or technologies and experienced management teams. In addition, the
Company intends to make selective acquisitions of its Country Coordinators'
operations in order to lower its selling, general and administrative expense
and increase control over this distribution channel. The Company also expects
to acquire the operations of other agents and marketing groups. The Company
also intends to enter into joint ventures and strategic alliances with
selected business partners to enable the Company to enter additional markets
and to complement the Company's current operations and service offerings. The
Company is continuously reviewing opportunities and believes that such
acquisitions, joint ventures and strategic alliances are an important means of
expanding its network and increasing network traffic volume, both of which are
expected to lower its overall cost of telecommunications services.
Broaden Market Penetration through Enhanced Service Offerings. The Company
believes that offering a broad array of enhanced services is essential to
retain existing customers and to attract new customers. The TIGN's enhanced
services platform and its distributed intelligent network architecture permit
the Company to provide a broad array of voice, data and enhanced services and
to efficiently distribute customer information, such as language selection,
waiting voice-mail and faxes and speed dial numbers throughout the TIGN. The
Company offers a comprehensive solution to its customers' telecommunications
needs by providing enhanced services, including fax store and forward, fax-
mail, voice-mail and call conferencing and intends to introduce e-mail-to-
voice-mail translation and voice recognition services. Telegroup believes that
its provision of such enhanced services will enable it to increase its revenue
from existing customers and to attract a broader base of small and medium-
sized business customers. The Company's investment in PCS is expected to serve
as the basis for providing enhanced services for the TIGN.
CUSTOMERS
Telegroup's worldwide retail customer base is comprised of residential
customers and small to medium-sized businesses with monthly bills averaging
between $50 and $5,000. At September 30, 1997, Telegroup had approximately
216,000 active retail customers (those that incurred charges during September
1997), consisting of approximately 49,000 U.S. domestic and approximately
167,000 international customers. In addition, Telegroup markets its wholesale
services to both facilities-based carriers and switched-based long distance
providers that purchase the Company's service for resale to their own
customers. As of September 30, 1997, Telegroup had 26 active wholesale carrier
customers.
The following chart sets forth the Company's combined retail and wholesale
revenues for the nine months ended September 30, 1997 for each of the
Company's ten largest markets, determined by customers' billing addresses:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, 1997 PERCENTAGE OF
COUNTRY REVENUES TOTAL REVENUES
------- ------------------ --------------
(MILLIONS)
<S> <C> <C>
United States.............................. $81.5 34.2%
Hong Kong.................................. 35.0 14.7
Netherlands................................ 18.2 7.6
Australia.................................. 11.8 4.9
France..................................... 11.1 4.7
Switzerland................................ 9.8 4.1
Germany.................................... 8.1 3.4
Sweden..................................... 6.5 2.7
Japan...................................... 5.1 2.1
Denmark.................................... 4.5 1.9
</TABLE>
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For the nine months ended September 30, 1997, the Company's revenues from
retail and wholesale customers represented 71% and 29%, respectively, of the
Company's total revenues. This compared with 84% and 16%, respectively, for
the year ended December 31, 1996.
Retail Customers. The Company's retail customer base is diversified both
geographically and by customer type. No single retail customer accounted for
more than 1% of the Company's total revenues for the year ended December 31,
1996 or for the nine months ended September 30, 1997. The Company's sales and
marketing efforts target high-volume residential consumers and small and
medium-sized businesses. The Company believes that high-volume residential
consumers are attracted to Telegroup's services because of its significant
price savings as compared to first-tier carriers, its simplified price
structure and its variety of service offerings. The Company believes that
small and medium-sized businesses are attracted to Telegroup's services
because of significant price savings compared to first-tier carriers, and
because of its personalized approach to customer service and support,
including its local presence, customized billing and enhanced service
offerings.
Wholesale Customers. Telegroup's wholesale marketing targets second- and
third-tier international and telecommunications providers. The Company
currently provides wholesale services to a total of 26 customers, of which 24
are U.S.-based providers and two are international providers. The Company
believes that long distance services, when sold to telecommunications carriers
and other resellers, are generally a commodity product with the purchase
decision based primarily on price. Sales to these other carriers and resellers
help the Company maximize the use of its network and thereby minimize fixed
costs per minute of use.
For the nine months ended September 30, 1997, one wholesale customer in Hong
Kong accounted for approximately 12% of the Company's total revenues.
Substantially all of the services provided by the Company to this customer
consist of call-reorigination services. The initial term of the Company's
agreement with the Hong Kong Customer expires in October 1998, automatically
renews for one year periods, and may be terminated by the Hong Kong Customer
if it determines in good faith that the services provided pursuant to the
agreement are no longer commercially viable in Hong Kong. If the Company loses
its rights under its PNETS license and/or if it is unable to provide call-
reorigination services in Hong Kong on either a retail or wholesale basis,
such action could have a material adverse effect on the Company's business,
financial condition and results of operations. Similarly, a material reduction
in the level of services provided by the Company to the Hong Kong Customer or
a termination of the Company's agreement with the Hong Kong Customer could
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, China resumed sovereignty over Hong
Kong as of July 1, 1997. See "Risk Factors--Substantial Government
Regulation--The Pacific Rim."
SALES, MARKETING AND CUSTOMER SERVICE
Telegroup's global sales, marketing and customer service organization
consists of Country Coordinators, independent agents and an internal sales
force who market Telegroup's services and provide customer service in local
languages and in accordance with the cultural norms of the countries in which
they operate. The Company's local sales, marketing and customer service
organization allows the Company to continually monitor changes in each market
and quickly modify service and sales procedures in response to market changes.
Since its inception, Telegroup's sales, marketing and customer service
strategy has been based on providing its network of agents and salespeople
with the systems, technology and infrastructure to attract and support
customers as efficiently as possible.
Global Independent Agent Network. Telegroup's international market
penetration has resulted primarily from the sales activities of independent
agents compensated on a commission-only basis. As of November 30, 1997,
Telegroup had approximately 1,375 independent agents located worldwide. The
use of independent agents has allowed the Company to limit marketing expenses
and customer acquisition costs. See "Risk Factors--Dependence on Independent
Agents; Concentration of Marketing Resources."
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The Company's agreements with its independent agents typically provide for a
two-year term and require the agents to offer the Company's services at rates
prescribed by the Company and to abide by the Company's marketing and sales
policies and rules. Independent agent compensation is paid directly by the
Company and is based exclusively upon payment for the Company's services by
customers obtained for Telegroup by the independent agents. The commission
paid to independent agents ranges between five to twelve percent of revenues
received by the Company and varies depending on individual contracts, the
exclusivity of the agent and the type of service sold. Independent agents are
responsible for up to 40% of bad debt attributable to customers they enroll.
The Company's agreements with its independent agents typically provide that
the agents have no authority to bind Telegroup or to enter into any contract
on the Company's behalf.
Country Coordinators. In significant international markets, Telegroup
appoints Country Coordinators. Country Coordinators are typically self-
financed, independent agents, with contracts that bind them exclusively to
Telegroup. Country Coordinators also have additional duties beyond marketing
Telegroup services, including the responsibility in a country or region to
coordinate the activities of Telegroup independent agents, including training
and recruitment, customer service and collections. As of November 30, 1997,
Telegroup had 28 Country Coordinators who were responsible for sales,
marketing, customer service and collections in 72 countries. Telegroup has
begun to vertically integrate its sales, marketing and customer service
operations by opening offices in Germany and the U.K. which provide the
services of a Country Coordinator and, in August 1996, acquired the business
operations of its Country Coordinator in France.
Country Coordinators offer the Company's services at rates prescribed by the
Company, and enforce standards for all advertising, promotional, and customer
training materials relating to Telegroup's services that are used or
distributed in the applicable country or region. Country Coordinators review
all proposed marketing or advertising material submitted to them by the
independent agents operating in their country or region and ensure such
agents' compliance with the Company's standards and policies. The Company's
agreements with its independent Country Coordinators typically have a two-year
term and include an exclusivity provision restricting the Country
Coordinator's ability to offer competing telecommunication services. Such
agreements typically entitle the Country Coordinator to an override based on a
percentage of revenues collected by Telegroup from customers within the
Country Coordinator's country or region, as well as a commission similar to
the commission paid to independent agents with respect to customers obtained
directly by the Country Coordinator. The Company's agreements with its Country
Coordinators typically provide that the agents have no right to enter into any
contract on Telegroup's behalf or to bind Telegroup in any manner not
expressly authorized in writing. See "Risk Factors--Dependence on Independent
Agents" and "--Agreements with Independent Agents."
Internal Sales Department. In early 1993, Telegroup began the development of
an internal sales force which, as of September 30, 1997, numbered 34 persons,
including 31 in the U.S. and one each in Germany, France and the United
Kingdom. The internal sales department, which is fully dedicated to marketing
Telegroup's services, provides increased control over existing customers and
enables the Company to quickly test new products and implement special
marketing campaigns. For the nine months ended September 30, 1997, Telegroup's
internal sales department was responsible for generating approximately 41.0%
of the Company's revenues from U.S. retail customers, with the balance being
generated by independent agents in the U.S. Internal sales representatives are
compensated by means of a base salary and a commission which varies depending
upon the type of services sold.
The Internet. In March 1995, Telegroup implemented an aggressive program to
use the World Wide Web as a marketing, order entry, and information
distribution tool. The Company currently processes approximately 90% of orders
submitted by its independent agents through its Web-based RepLink order entry
system. RepLink allows for customer provisioning in approximately 30 minutes
and provides agents with real-time access to customer information. In
addition, the Company's World Wide Web site provides a central source of
information about Telegroup, easily accessible to Telegroup's agents and
prospective customers around the world.
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Customer Service. Telegroup is committed to providing its customers with
high-quality customer service, provided in the local language and in
accordance with local cultural norms. As of September 30, 1997, Telegroup
directly provided customer service to customers in 107 countries, 24 hours a
day, 365 days a year, from its headquarters in Fairfield, Iowa. In addition,
Telegroup currently has 28 Country Coordinators, each of whom maintains a
customer service office. These offices provide customer support to Telegroup's
customers in 72 countries.
Customer service offices are equipped with Telegroup customer service and
sales support systems for use in the country or region. Customer service
representatives can access the Company's "RepLink" order entry system and
Integrated Databases ("IDB"), a customer information database. See "Management
Information Systems." These systems facilitate and expedite customer
provisioning and changes to customer account information. In addition,
selected customer service offices are connected to Telegroup's Fairfield, Iowa
headquarters by high-speed frame relay data links which provide real-time
access to the Company's central databases.
SERVICES
Telegroup offers a broad array of telecommunications services through the
TIGN and through interconnections with the networks of other carriers. While
the Company offers a broad range of telecommunications services in each of its
markets, the services offered in a particular market vary depending upon
regulatory constraints and local market demands. In order to create a global
brand identity, the Company markets its products primarily under the Spectra
or Global Access brands in virtually all of its markets. The Company currently
offers the following services:
International Long Distance. The Company provides international voice
services to its customers in over 180 countries. On a market-by-market
basis, access methods required to originate a call vary according to
regulatory requirements and the existing national telecommunications
infrastructure. The Company's call-reorigination services are available in
all of its markets, generally under the brand name Global Access CallBack.
Telegroup is actively migrating customers to Global Access Direct service,
which is currently available through TIGN switches located in Hong Kong,
France, the U.K. and the Netherlands. Global Access Direct provides
Telegroup customers call-through service, which includes the provision of
long distance service through conventional international long distance or
through a "transparent" form of call-reorigination.
National Long Distance. The Company currently provides national long
distance service in the United States and Australia. The Company also
expects to provide national long distance service in New Zealand and the
U.K. by the end of 1997.
Prepaid (Debit) and Postpaid Calling Cards. The Company's prepaid (debit)
and postpaid Global Access Telecard may be used by customers for
international telephone calls from more than 60 countries to substantially
all other countries in the world. These calling cards also enable the
Company's customers to access Telegroup's enhanced services.
Toll-free Services. The Company currently provides domestic toll-free
services within the United States under its Spectra 800 brand, and toll-
free services for calls to overseas businesses which are originated in the
United States and Canada, under its Global Access 800 brand.
Enhanced Services. Telegroup's enhanced services include fax store and
forward, fax-mail, voice-mail, and call conferencing.
Wholesale Services. In addition to retail services, the Company provides
international and national call termination services and enhanced services
on a wholesale basis to switch-based telecommunications carriers in the
United States, the Pacific Rim and Europe. Such wholesale arrangements
typically involve the purchase of transmission services on a per-minute
basis, with rates varying according to the destination country and the time
of day the call is placed.
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Telegroup constantly evaluates potential new service offerings in order to
increase customer retention and loyalty, and increase usage of the Company's
services. New services the Company expects to introduce in selected markets in
1998 include:
Internet Access Services. The Company intends to offer switched and
dedicated access to the Internet for use by commercial and residential
customers. These services may be offered on a direct connection to the
Internet or on a resale basis. Once connected to the Internet, customers
will be able to access services provided by others, such as World Wide Web
browsing, electronic mail, news feeds and bulletin boards.
Resold Local Switched and Switchless Service. The Company intends to
provide local service on a resale basis in the United States, subject to
commercial feasibility and regulatory limitations.
Mobile Resale. The Company intends to offer its customers resold mobile
telecommunications services in the United States and other selected
markets.
Integrated Voice-Mail, E-Mail and Fax-Mail. Integrated services enable
customers to convert e-mail and facsimile data to audio text and to receive
voice-mail messages in writing. The Company intends to offer its customers
integrated voice-mail, e-mail and fax-mail through the TIGN in all
countries where the Company's international telecommunications services are
available.
There can be no assurance that the Company will be able to launch such
services or that, if launched, such services will be successful.
NETWORK AND OPERATIONS
The TIGN employs digital switching and fiber-optic technologies, runs on
proprietary software developed by Telegroup and is supported by comprehensive
monitoring and technical services at the Company's Network Operations Center
in Iowa City, Iowa. The TIGN also employs Telegroup's proprietary distributed
intelligent network architecture, enabling Telegroup to transmit customer-
specific information among its switches almost instantaneously over redundant
high-speed frame relay data networks.
Through the TIGN, Telegroup is able to deliver an expanded set of enhanced
services which may not be available from the ITO in a particular country. The
availability of these enhanced services enables Telegroup to attract a wider
base of small to medium-sized business customers. In addition, the network
provides the Company with more efficient call routing and cost savings by
means of reduced circuit charges.
History of the TIGN. In 1992, the Company installed its first Harris switch
at its main office in Fairfield, Iowa primarily to serve as a PBX for internal
Company purposes. Since 1992, Telegroup has invested substantial resources in
developing the TIGN and related business operations. In 1993, the Company
installed a switch in New York City to handle call-reorigination service for
retail customers. In 1994, the Company installed a Harris switch in London to
provide call-reorigination services for intra-European calls and leased a
private data line for call setup and to transfer call detail reports from the
U.K. switch to the New York switch. In February 1995, Telegroup entered into
an operating agreement with AT&T-Canada (formerly Unitel) providing for
correspondent traffic termination rights.
In July 1995, the Company installed its first enhanced services switch at
the New York switch site to provide post-paid card services for domestic and
international customers in 40 countries. Also in 1995, Telegroup opened a new
office in Iowa City, Iowa to house the Network Operations Center and switch
development and deployment teams.
In February 1996, the Company installed its first Excel switch in Hong Kong
in addition to an identical mated switch in New York to provide Global Access
Direct service to Hong Kong customers using transparent call-reorigination. In
May 1996, Telegroup began to utilize the existing Harris switch at the main
office to receive incoming call-reorigination calls from international
customers. In September 1996, the Company installed a DMS-250 switch in New
York. The DMS-250 switch was connected via T-1 lines to other carriers whereby
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wholesale traffic was brought in to the DMS-250 switch and then routed to
other carriers for international termination. In August 1996, the Company
installed a Harris switch in Amsterdam incorporating proprietary software
developed by the Telegroup Intelligent Network Department to provide Global
Access Direct service to international customers.
In January 1997, the Company installed another pair of Excel switches in
Hong Kong and New York, linked by the existing data network. Shortly
thereafter, TIGN switches were installed in France and Australia, opening
those markets to Global Access Direct services. At the same time, the Company
acquired an interest in the CANTAT-3 Trans-Atlantic circuit between New York
and London.
Current Network Architecture. As of December 15, 1997, the TIGN consisted of
(i) the central NOC, (ii) 19 operational Excel, NorTel or Harris switches in
New York City, Jersey City, New Jersey, London, Paris, Amsterdam, Zurich,
Copenhagen, Frankfurt, Hong Kong, Sydney, Tokyo and Milan, (iii) five enhanced
services platforms in New York, Hong Kong, London, Paris and Sydney, (iv)
owned and leased fiber-optic cable links connecting its New York and New
Jersey switches to its switches in London, Amsterdam, Sydney and Los Angeles,
and its London switches to its switches in Paris and Amsterdam, and (v) leased
parallel data transmission capacity connecting Telegroup's switches to each
other and to the networks of other international and national carriers. The
Company intends to further develop the TIGN by upgrading existing facilities
and by adding switches and transmission capacity principally in and between
major markets where the Company has already established a substantial customer
base. See "--Business Strategy."
In markets in which the Company believes it is not optimal to own or lease
network facilities, the Company typically enters into agreements to resell the
facilities of other carriers. The Company purchases switched minute capacity
from various carriers and depends on such agreements for termination of
traffic from the TIGN. The Company is also a reseller of other carriers'
national long distance services. As a result of the Company's strategic
relationship with AAPT in 1997, the Company is a reseller of Australian
national long distance services. In other markets, the Company works with
multiple national long distance carriers in an effort to ensure that the
pricing and service on each route are the best available and that the Company
can provide an integrated long distance service to its customers. The Company
believes that the opportunities for resale will become increasingly attractive
as countries deregulate and grant additional carrier licenses, and competitive
pressures force carriers to find alternative sources of distribution. See
"Risk Factors--Dependence on Telecommunications Facilities Providers."
In general, the Company relies upon other carriers' networks to provide
redundancy in the event of technical difficulties on the TIGN. The Company
believes that the strategy of using other carriers' networks for redundancy is
currently more cost-effective than purchasing or leasing its own redundant
capacity. To the extent that the traffic over the TIGN exceeds the Company's
transmission capacity, the Company typically routes overflow traffic over
other carriers' networks, which may result in reduced margins on such calls.
The TIGN's Distributed Intelligent Network Architecture. Most
telecommunications companies operate their networks using software developed
by switch manufacturers. Consequently, switch software typically cannot be
modified or improved except by the switch manufacturer, which can result in
significant expense and delay. Through its Intelligent Network Department,
consisting of approximately 80 full-time employees, Telegroup develops and
continuously refines its proprietary TIGN software, enabling the Company to
purchase flexible, open-architecture switching hardware into which it
incorporates such software.
TIGN Competitive Advantages. The TIGN platform is designed to provide a
highly reliable, flexible and cost-effective network for processing calls and
delivering enhanced services. The design of the TIGN achieves the principles
established for Advanced Intelligent Networks ("AIN") specified by the ITU.
The TIGN platform provides significant competitive advantages over voice
networks of other providers. These advantages include:
. Distributed intelligence. The TIGN voice network is configured in
parallel with a frame relay data network for call setup and the sharing
of customer data among the TIGN switches. All customer
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information such as current usage, credit limits, language selections,
waiting voice-mail and faxes, and speed numbers are distributed and
available throughout the TIGN.
. Rapid deployment of new services and features. The TIGN software allows
enhancements to existing services and new services to be quickly
developed and tested with minimal impact to existing software.
Enhancements to existing services can be added in days rather than
months and new services can be developed and tested in a few weeks
rather than many months or even years required by other network designs.
. Cost benefits versus conventional switching platforms. The switching
matrix employed within the TIGN platform consists of two redundant Excel
LNX switches, each with 2000 voice ports--one actively controlling call
processing and one in hot standby mode. This latest generation in
switching equipment from Excel provides a cost-per-port which is less
expensive than that found on larger, traditional switching equipment
used by conventional voice service providers.
. Flexible and adaptive signaling. Because of the many national and
carrier-specific variants on the international signaling protocol such
as ISDN and CCS7, one of the largest problems faced by international
carriers and voice service providers has been interconnecting to the
national ITOs. The TIGN software has been designed to take advantage of
the open architecture on the Excel LNX switches to facilitate
compatibility with various international signaling protocols.
MANAGEMENT INFORMATION SYSTEMS
Telegroup believes that reliable, sophisticated and flexible billing and
information systems are essential to remain competitive in the global
telecommunications market. Accordingly, the Company has invested substantial
resources to develop and implement information systems. As the Company
continues to grow, it will need to invest additional capital to enhance and
upgrade its operating systems in order to meet its provisioning, billing,
costing and collection requirements. See "Risk Factors--Dependence on
Effective Management Information Systems."
The Company's information systems include (i) RepLink, an Internet Web-based
global order entry system; (ii) the IDB which stores client information using
client server architecture; (iii) a Small Business Technologies ("SBT")
accounting system; (iv) a proprietary customer billing system; and (v) a
proprietary call costing and reconciliation system which was substantially
implemented in June 1997. The Company has initiated activity to replace its
SBT accounting, IDB, and billing systems using commercially available software
provided by Saville Systems, and PeopleSoft with completion planned for the
next 12 months. The Company anticipates that it will also enhance, upgrade or
replace its commissions and possibly other systems in the next 9 to 15 months.
RepLink Order Entry System. The Company has developed RepLink, a unique
World Wide Web interface, primarily for its independent agents to send
customer information to the Company for fully automated provisioning. First
implemented in 1995, RepLink has reduced the average interval required to
provision a new customer from most countries to an average of 30 minutes or
less. Customer information is entered by the agent and screened during the
provisioning process to ensure data quality and accuracy. Agents can also
receive monthly usage reports, commission reports, and reports on new products
and features through RepLink.
IDB Customer Database. The IDB is the Company's integrated database for all
customer and service information. The IDB can be accessed through the IDB
custom user interface, which allows the Company's customer service and sales
support staff to maintain customer records and provide customer service. The
IDB interface also allows limited access to a customer's financial information
which is stored in the Company's SBT accounting system. Customer order
information is transferred directly from RepLink into the IDB. After final
data is reviewed, the customer is provisioned for the services requested by
the agent. Each hour, all provisioning information for Global Access services
flows automatically to the Company's switches. Several times each day,
provisioning information for Spectra services is transferred electronically to
the Company's underlying carriers.
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SBT Accounting System. SBT, a modifiable, multi-user database accounting
software, provides the Company with the flexibility to create custom
accounting modules to support various accounting needs. All of SBT's
accounting products perform real-time posting and provide custom file
browsers. The IDB and SBT systems are linked by use of an open server through
which information is freely exchanged. Since the Company's new billing system
software is compatible with SBT, financial information is able to flow easily
between the two systems without manual intervention.
Billing System. The Company's new billing system streamlines and automates a
number of billing processes, including worldwide call detail data collection.
A call detail report ("CDR"), an itemized record of the activity which occurs
at a particular switch location, is downloaded and used in the generation of
customer invoices. The entire process of CDR import, matching and rating is
now combined into a single process, eliminating manual intervention. The
Company is able to review and analyze the CDR to ensure the accuracy of
customer bills and detect errors. Monthly customer invoices are created,
printed and mailed from the Company's facilities in Fairfield, Iowa.
Call Costing and Reconciliation System. To ensure that costs charged to the
Company by its carriers are accurate, the Company has developed a call costing
and reconciliation system which was substantially implemented in June 1997.
This system is designed to reconcile the Company's CDRs against invoices that
the Company receives from its underlying carriers. Each carrier invoice will
be compared for total calls, total duration, total cost, and the Telegroup
rated cost. All discrepancies will be logged and an audit for the carrier/day
combinations that show discrepancies will be scheduled to examine the details
of the discrepancies between the Company's data and the carrier's data. See
"Risk Factors--Dependence on Effective Management Information Systems."
The Company believes that this suite of management information systems,
coupled with continued enhancements and additions, will enable the Company to
effectively provision and bill customers, produce accurate financial reports
and control costs.
COMPETITION
The international and national telecommunications industry , estimated to
reach $1 trillion in 1998, is highly competitive. The Company's success
depends upon its ability to compete with a variety of other telecommunications
providers in each of its markets, including the respective ITO in each country
in which the Company operates and global alliances among some of the world's
largest telecommunications carriers. Other potential competitors include cable
television companies, wireless telephone companies, Internet access providers,
electric and other utilities with rights of way, railways, microwave carriers
and large end users which have private networks. The intensity of such
competition has recently increased and the Company believes that such
competition will continue to intensify as the number of new entrants
increases. If the Company's competitors devote significant additional
resources to the provision of international or national long distance
telecommunications services to the Company's target customer base of high-
volume residential consumers and small and medium-sized businesses, such
action could have a material adverse effect on the Company's business,
financial condition and results of operations, and there can be no assurance
that the Company will be able to compete successfully against such new or
existing competitors.
The Company's larger competitors include AT&T, MCI, Sprint, WorldCom,
Frontier and LCI in the United States; France Telecom in France; PTT Telecom
B.V. in the Netherlands; Cable & Wireless plc, BT, AT&T, WorldCom, Sprint and
ACC Corp. in the United Kingdom; Deutsche Telecom in Germany; Swiss PTT in
Switzerland; Telia AB and Tele-2 in Sweden; HKTI in Hong Kong, Telstra and
Optus in Australia; and KDD, IDC and ITJ in Japan. The Company competes with
numerous other long distance providers, some of which focus their efforts on
the same customers targeted by the Company. In addition to these competitors,
recent and pending deregulation in various countries may encourage new
entrants. For example, as a result of the recently enacted 1996
Telecommunication Act in the United States, once certain conditions are met,
RBOCs will be allowed to enter the domestic long distance market in their
exchange territories, AT&T, MCI and other long
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distance carriers will be allowed to enter the local telephone services
market, and any entity (including cable television companies and utilities)
will be allowed to enter both the local service and long distance
telecommunications markets. Moreover, while the recently completed WTO
Agreement could create opportunities for the Company to enter new foreign
markets, implementation of the accord by the United States could result in new
competition from ITOs previously banned or limited from providing services in
the United States. Increased competition in the United States as a result of
the foregoing, and other competitive developments, including entry by Internet
service providers into the long-distance market, could have an adverse effect
on the Company's business, financial condition and results of operations. In
addition, many smaller carriers have emerged, most of which specialize in
offering international telephone services utilizing dial up access methods,
some of which have begun to build networks similar to the TIGN. See "The
Global Telecommunications Industry."
The long distance telecommunications industry is intensely competitive and
is significantly influenced by the pricing and marketing decisions of the
larger industry participants. In the United States, the industry has
relatively limited barriers to entry with numerous entities competing for the
same customers. Customers frequently change long distance providers in
response to the offering of lower rates or promotional incentives by
competitors. Generally, the Company's domestic customers can switch carriers
at any time. The Company believes that competition in all of its markets is
likely to increase and that competition in non-United States markets is likely
to become more similar to competition in the United States market over time as
such non-United States markets continue to experience deregulatory influences.
In each of the countries where the Company markets its services, the Company
competes primarily on the basis of price (particularly with respect to its
sales to other carriers), and also on the basis of customer service and its
ability to provide a variety of telecommunications products and services.
There can be no assurance that the Company will be able to compete
successfully in the future. The Company anticipates that deregulation and
increased competition will result in decreasing customer prices for
telecommunications services. The Company believes that the effects of such
decreases will be at least partially offset by increased telecommunications
usage and decreased costs as the percentage of its traffic transmitted over
the TIGN increases. There can be no assurance that this will be the case. To
the extent this is not the case, there could be an adverse effect on the
Company's margins and financial profits, and the Company's business, financial
condition and results of operations could be materially and adversely
effected.
The telecommunications industry is in a period of rapid technological
evolution, marked by the introduction of new product and service offerings and
increasing satellite transmission capacity for services similar to those
provided by the Company. Such technologies include satellite-based systems,
such as the proposed Iridium and GlobalStar systems, utilization of the
Internet for international voice and data communications and digital wireless
communication systems such as PCS. The Company is unable to predict which of
many possible future product and service offerings will be important to
maintain its competitive position or what expenditures will be required to
develop and provide such products and services.
GOVERNMENT REGULATION
Overview. The Company's provision of international and national long
distance telecommunications services is heavily regulated. Many of the
countries in which the Company provides, or intends to provide, services
prohibit or limit the services which the Company can provide, or will be able
to provide and the transmission methods by which it can provide such services.
For example, in the United States, the Company plans to engage in the resale
of international private lines for the provision of switched communications
services pursuant to an authorization ("Section 214 Private Line
Authorization") under Section 214 of the Communications Act. Certain rules of
the FCC currently prohibit the Company from (i) transmitting calls routed over
the Company's leased line between the United States and the United Kingdom
onward over international leased lines to certain foreign locations or (ii)
transmitting calls from certain European countries over international leased
lines and then onward over its leased line between the United States and the
United Kingdom. If a violation of FCC rules concerning resale of international
private line service were found to exist,
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the FCC could impose sanctions and penalties, including revocation of the
Section 214 Private Line Authorization. FCC restrictions thus materially limit
the optimal and most profitable use of the Company's leased line between the
United States and the United Kingdom.
In addition, the Company provides a substantial portion of its customers
with access to its services through the use of call-reorigination. Revenues
attributable to call-reorigination represented 76.6% of the Company's revenues
in fiscal year 1996 and 75.5% of the Company's revenues for the nine months
ended September 30, 1997, and are expected to continue to represent a
significant but decreasing portion of the Company's revenues. A substantial
number of countries have prohibited certain forms of call-reorigination as a
mechanism to access telecommunications services. This has caused the Company
to cease providing call-reorigination services to customers in Bermuda, the
Bahamas, the Philippines, and the Cayman Islands, and may require it to do so
with respect to customers in other jurisdictions in the future. As of November
20, 1997, reports had been filed with the ITU and/or the FCC claiming that the
laws in 79 countries prohibit call-reorigination. While the Company provides
call-reorigination services in substantially all of these countries, no single
country within this group accounts for more than [2%] of the total revenues of
the Company for the nine months ended September 30, 1997. There can be no
assurance that other countries where the Company derives material revenue will
not prohibit call-reorigination in the future. To the extent that a country
with an express prohibition against the provision of call-reorigination using
uncompleted call signaling is unable to enforce its laws against a provider of
such services, it can request that the FCC enforce such laws in the United
States by, for example, requiring a provider of such services to cease
providing call-reorigination services using uncompleted call signaling to such
country or by revoking such provider's FCC authorizations. Twenty-nine
countries have formally notified the FCC that call-reorigination services
violate their laws. The Company provides call-reorigination in 28 of these
countries, which accounted for 7.9% of the Company's total revenues for the
nine months ended September 30, 1997. Two of the 29 countries have requested
assistance from the FCC in enforcing their prohibition on call-reorigination.
Neither of these two countries accounted for more than 2% of the Company's
consolidated revenues for the nine months ended September 30, 1997. The FCC
has held that it would consider enforcement action against companies based in
the United States engaged in call-reorigination by means of uncompleted call
signaling to customers in countries where this activity is expressly
prohibited. The FCC recently ordered several U.S. carriers to cease providing
call-reorigination services using uncompleted call signalling to customers in
the Philippines and allowed the complaining party to seek damages. The FCC has
been asked to reconsider its decision. There can be no assurance that the FCC
will not take additional action to limit the provision of call-reorganization
services. Enforcement action could include an order to cease providing call-
reorigination services in such country, the imposition of one or more
restrictions on the Company, monetary fines or, in extreme circumstances, the
revocation of the Company's Section 214 Switched Voice Authorization, and
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Risk Factors--Substantial Government
Regulation--United States."
Local laws and regulations differ significantly among the jurisdictions in
which the Company operates, and, within such jurisdictions, the interpretation
and enforcement of such laws and regulations can be unpredictable. For
example, EU member states have inconsistently and, in some instances,
unclearly implemented the Full Competition Directive under which the Company
provides certain voice services in Western Europe. As a result, some EU member
states may limit, constrain or otherwise adversely affect the Company's
ability to provide certain services. There can be no assurance that certain EU
member states will implement, or will implement consistently, the Full
Competition Directive, and either the failure to implement or inconsistent
implementation of such directives could have a material adverse effect on the
Company's business, financial condition and results of operations.
Additionally, there can be no assurance that future United States or foreign
regulatory, judicial or legislative changes will not have a material adverse
effect on the Company or that regulators or third parties will not raise
material issues with regard to the Company's compliance with applicable laws
or regulations. If the Company is unable to provide the services it is
presently providing or intends to provide or to use its existing or
contemplated transmission methods due to its inability to receive or retain
formal or informal approvals for such services or
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transmission methods, or for any other reason related to regulatory compliance
or the lack thereof, such events could have a material adverse effect on the
Company's business, financial condition and results of operations. See "Risk
Factors--Substantial Government Regulation."
The Company has pursued and expects to continue to pursue a strategy of
providing its services to the maximum extent it believes, upon consultation
with counsel, to be permissible under applicable laws and regulations. To the
extent that the interpretation or enforcement of applicable laws and
regulations is uncertain or unclear, the Company's strategy may result in the
Company's (i) providing services or using transmission methods that are found
to violate local laws or regulations or (ii) failing to obtain approvals or
make filings subsequently found to be required under such laws or regulations.
Where the Company is found to be or otherwise discovers that it is in
violation of local laws and regulations and believes that it is subject to
enforcement actions by the FCC or the local authority, it typically seeks to
modify its operations or discontinue operation so as to comply with such laws
and regulations. There can be no assurance, however, that the Company will not
be subject to fines, penalties or other sanctions as a result of violations
regardless of whether such violations are corrected. If the Company's
interpretation of applicable laws and regulations proves incorrect, it could
lose, or be unable to obtain, regulatory approvals necessary to provide
certain of its services or to use certain of its transmission methods. The
Company also could have substantial monetary fines and penalties imposed
against it.
A summary discussion of the regulatory frameworks in certain geographic
regions in which the Company operates or has targeted for penetration is set
forth below. This discussion is intended to provide a general outline of the
more relevant regulations and current regulatory posture of the various
jurisdictions and is not intended as a comprehensive discussion of such
regulations or regulatory posture.
United States. The Company's provision of international service to, from,
and through the United States is subject to regulation by the FCC. Section 214
of the Communications Act requires a company to make application to, and
receive authorization from, the FCC to, among other things, resell
telecommunications services of other U.S. carriers with regard to
international calls. In May 1994, the FCC authorized the Company, pursuant to
the Section 214 Switched Voice Authorization, to resell public switched
telecommunications services of other U.S. carriers. The Section 214 Switched
Voice Authorization requires, among other things, that services be provided in
a manner that is consistent with the laws of countries in which the Company
operates. As described above, the Company's aggressive regulatory strategy
could result in the Company's providing services that ultimately may be
considered to be provided in a manner that is inconsistent with local law. If
the FCC finds that the Company has violated the terms of the Section 214
Switched Voice Authorization, it could impose a variety of sanctions on the
Company, including fines, additional conditions on the Section 214 Switched
Voice Authorization, cease and desist or show cause orders, or the revocation
of the Section 214 Switched Voice Authorization, the latter of which is
usually imposed only in the case of serious violations. Depending upon the
sanction imposed, such sanction could have a material adverse effect on the
Company's business, financial condition and results of operations. See "Risk
Factors--Substantial Government Regulation."
In order to conduct a portion of its business involving the origination and
termination of calls in the United States, the Company uses leased lines. The
Company's Section 214 Private Line Authorization permits the Company to resell
international private lines interconnected to the PSTNs in the United States
and the United Kingdom, for the purpose of providing switched
telecommunications services. However, the FCC imposes certain restrictions
upon the use of the Company's private line between the United States and the
United Kingdom. The Company may route over the private line switched traffic
originating in the United States or in the United Kingdom and terminating in
the United States or the United Kingdom. The Company may also route over the
private line switched traffic originating in the United States or the United
Kingdom and sent to third countries via the switched services of a carrier in
the United States or the United Kingdom by taking such services at published
rates. Similarly, the Company may route over the private line calls that
originate in a third country over an ITO's tariffed switched services and
terminate in the United States or the United Kingdom. The Company may not
route traffic to or from the United States over the private line between the
United States and the United Kingdom if such traffic originates or terminates
in a third country over a private line between the
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United Kingdom and such third country, if the third country has not been found
by the FCC to offer "equivalent" resale opportunities. The Company is
currently not routing U.S.-originated traffic to or U.S. terminated traffic
from non-"equivalent" countries via private lines. To date, the FCC has found
that only Canada, the United Kingdom, Sweden, New Zealand and Australia offer
such opportunities. Recently, the FCC held that carriers will be permitted to
route switched traffic over private lines between the United States and any
country that is a member of the WTO and also where the local ITO generally
charges U.S. carriers at or below an FCC-determined rate for terminating the
U.S. carriers' traffic. The FCC also held that carriers may route over private
lines between such countries switched traffic originating in the United States
and sent to third countries via the switched services of a carrier in these
countries by taking such services at published rates. Similarly, the Company
may route over the private lines traffic that originates in a third country
over an ITO's switched services and terminate in the United States. The
Company believes that, when the FCC's decision becomes effective, the Company
will also be permitted to route switched traffic over international private
lines initially between the United States and Denmark, Germany, France,
Luxembourg, the Netherlands, and Norway. Following implementation of the Full
Competition Directive by EU member states, the FCC may authorize the Company
to originate and terminate traffic over its private line between the United
States and such carriers and over an additional private line pursuant to ISR
authority to additional member states. However, there can be no assurance that
the FCC will take such action.
The Company also owns capacity in international facilities to provide some
services, and may in the future acquire additional interests in international
facilities. The Company has a Section 214 facilities authorization to provide
services over international facilities between the United States and all
countries other than Cuba. The Company is also required to conduct its
facilities-based international business in compliance with the FCC's ISP. The
ISP establishes the permissible arrangements for U.S. based facilities-based
carriers and their foreign counterparts to settle the cost of terminating each
other's traffic over their respective networks. One of the Company's
arrangements with foreign carriers is subject to the ISP and it is possible
that the FCC could take the view that this arrangement does not comply with
the existing ISP rules. See "The Global Telecommunications Industry--
International Switched Long Distance Services--Operating Agreements." If the
FCC, on its own motion or in response to a challenge filed by a third party,
determines that the Company's foreign carrier arrangements do not comply with
FCC rules, among other measures, it may issue a cease and desist order, impose
fines on the Company or revoke or suspend its FCC authorizations. See "Risk
Factors--Recent and Potential FCC Actions." Such action could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company is required to file and has filed with the FCC a tariff
containing the rates, terms and conditions applicable to its international
telecommunications services. The Company is also required to file with the FCC
any agreements with customers containing rates, terms, and conditions for
international telecommunications services, if those rates, terms, or
conditions are different than those contained in the Company's tariff.
Notwithstanding the foregoing requirements, to date, the Company has not filed
with the FCC certain commercially sensitive carrier-to-carrier customer
contracts. If the Company charges rates other than those set forth in, or
otherwise violates, its tariff or a customer agreement filed with the FCC, or
fails to file with the FCC carrier-to-carrier agreements, the FCC or a third
party could bring an action against the Company, which could result in a fine,
a judgment or other penalties against the Company. Such action could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company's provision of domestic long distance service in the United
States is subject to regulation by the FCC and relevant state PSCs, which
regulate interstate and intrastate rates, respectively, ownership of
transmission facilities, and the terms and conditions under which the
Company's domestic services are provided. In general, neither the FCC nor the
relevant state PSCs exercise direct oversight over cost justification for the
Company's services or the Company's profit levels, but either or both may do
so in the future. The Company, however, is required by federal and state law
and regulations to file tariffs listing the rates, terms and conditions of
services provided. The Company has filed domestic long distance tariffs with
the FCC. The October 29, 1996 Order eliminated the requirement that non-
dominant interstate carriers, such as the Company, maintain FCC
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tariffs. However, on February 13, 1997, the DC Circuit ruled that the FCC's
order will be stayed pending judicial review of the appeals. Should the
appeals fail and the FCC's order become effective, the Company may benefit
from the elimination of FCC tariffs by gaining more flexibility and speed in
dealing with marketplace changes. However, the absence of tariffs will also
require that the Company secure contractual agreements with its customers
regarding many of the terms of its existing tariffs or face possible claims
arising because the rights of the parties are no longer clearly defined. The
Company generally is also required to obtain certification from the relevant
state PSC prior to the initiation of intrastate service. Telegroup has the
authorizations required or is not required to obtain authorization to provide
service in 47 states, and has filed or is in the process of filing required
tariffs in each state that requires such tariffs to be filed. The Company has
complied or is in the process of complying with certain reporting requirements
imposed by state PSCs in each state in which it conducts business. Any failure
to maintain proper federal and state tariffing or certification or to file
required reports or otherwise to comply with FCC or state requirements could
have a material adverse effect on the Company's business, financial condition
and results of operations. The FCC also imposes some requirements for
marketing of telephone services and for obtaining customer authorization for
changes in the customer's primary long distance carrier.
To originate and terminate calls in connection with providing their
services, long distance carriers such as the Company must purchase "access
services" from LECs or CLECs. Access charges represent a significant portion
of the Company's cost of U.S. domestic long distance services and, generally,
such access charges are regulated by the FCC for interstate services and by
PSCs for intrastate services. The FCC has undertaken a comprehensive review of
its regulation of LEC access charges to better account for increasing levels
of local competition. On May 16, 1997, the FCC released an order making
significant changes in the access service rate structure. Some of the changes
may result in increased costs to the Company for the "transport" component of
access services, although other revisions of the order likely will reduce
other access costs. Some issues in the FCC proceeding have not yet been
resolved, including a proposal under which LECs would be permitted to allow
volume discounts in the pricing of access charges. While the outcome of these
proceedings is uncertain, if these rate structures are adopted many long
distance carriers, including the Company, could be placed at a significant
cost disadvantage to larger competitors. In addition, the FCC has recently
announced actions to implement the 1996 Telecommunications Act that will
impose new regulatory requirements including the requirement that all
telecommunications service providers, including the Company, contribute some
portion of their telecommunications revenues to a "universal service fund"
designated to fund affordable telephone service for consumers, schools,
libraries and rural health care providers. These contributions will become
payable beginning in 1998 for all interexchange carriers. Although the FCC has
not determined the precise amount of the contribution, the Company estimates
at this time that it will constitute approximately 4% of its gross revenues
from domestic end-user customers.
In some instances, the Company may be responsible for city sales taxes on
calls made within the jurisdiction of certain U.S. cities. The Company is
implementing software to track and bill for this tax liability. However, the
Company may be subject to sales tax liability for calls transmitted prior to
the implementation of such tax software and not be able to collect
reimbursement for such liability from its customers. While the Company
believes that any such liability will not be significant, there can be no
assurance that such tax liability, if any, will not have a material adverse
effect on the Company's business, financial condition or results of
operations.
In November 1996, the FCC adopted rules that would require that
interexchange companies offering toll-free access through payphones compensate
certain payphone operators for customers' use of the payphone. On July 1, 1997
the United States Court of Appeals for the District of Columbia Circuit issued
an opinion reversing in part the FCC's payphone orders. The Court ruled that
the rate of $.35 per call was arbitrary and capricious and remanded the case
to the FCC for further proceedings. The FCC issued a Second Report and Order
on October 9, 1997, holding that interexchange carriers must compensate
payphone owners at a rate of $.284 per call for all calls using their
payphones. This compensation method will be effective from October 7, 1997
through October 7, 1999. After this time period, interexchange carriers will
be required to compensate payphone owners at a market-based rate minus $0.066
per call. A number of carriers have appealed the Second Report and Order
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to the U.S. Court of Appeals for the D.C. Circuit or have sought FCC
reconsideration of this order. Although the Company cannot predict the outcome
of the FCC's proceedings on the Company's business, it is possible that such
proceedings could have a material adverse effect on the Company's business,
financial condition and results of operations.
The FCC and certain state agencies also impose prior approval requirements
on transfers of control, including pro forma transfers of control and
corporate reorganizations, and assignments of regulatory authorizations. Such
requirements may delay, prevent or deter a change in control of the Company.
Europe. In Europe, the regulation of the telecommunications industry is
governed at a supra-national level by the EU (consisting of the following
member states: Austria, Belgium, Denmark, Finland, France, Germany, Greece,
Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden and the
United Kingdom), which is responsible for creating pan-European policies and,
through legislation, has developed a regulatory framework to ensure an open,
competitive telecommunications market. The EU was established by the Treaty of
Rome and subsequent conventions and is authorized by such treaties to issue
"directives." EU member states are required to implement these directives
through national legislation. If an EU member state fails to adopt such
directives, the European Commission may take action, including referral to the
European Court of Justice, to enforce the directives.
In 1990, the EU issued the Services Directive requiring each EU member state
to abolish existing monopolies in telecommunications services, with the
exception of Voice Telephony. The intended effect of the Services Directive
was to permit the competitive provision of all services other than Voice
Telephony, including value-added services and voice services to CUGs. However,
as a consequence of local implementation of the Services Directive through the
adoption of national legislation, there are differing interpretations of the
definition of prohibited Voice Telephony and permitted value-added and CUG
services. Voice services accessed by customers through leased lines are
permissible in all EU member states. The European Commission has generally
taken a narrow view of the services classified as Voice Telephony, declaring
that voice services may not be reserved to the ITOs if (i) dedicated customer
access is used to provide the service, (ii) the service confers new value-
added benefits on users (such as alternative billing methods) or (iii) calling
is limited by a service provider to a group having legal, economic or
professional ties.
In March 1996, the EU adopted the Full Competition Directive containing two
provisions which required EU member states to allow the creation of
alternative telecommunications infrastructures by July 1, 1996, and which
reaffirmed the obligation of EU member states to abolish the ITOs' monopolies
in Voice Telephony by 1998. The Full Competition Directive encouraged EU
member states to accelerate liberalization of Voice Telephony. To date,
Sweden, Finland, Denmark, the Netherlands and the United Kingdom have
liberalized facilities-based services to all routes. Certain EU countries may
delay the abolition of the Voice Telephony monopoly based on exemptions
established in the Full Competition Directive. These countries include Spain
(1998), Portugal (2000), Ireland (January 1, 2000), Luxembourg (July 1, 1998)
and Greece (2000).
Each EU member state in which the Company currently conducts its business
has a different regulatory regime and such differences are expected to
continue beyond January 1998. The requirements for the Company to obtain
necessary approvals vary considerably from country to country and are likely
to change as competition is permitted in new service sectors. Except with
respect to Voice Telephony and call-reorigination, the Company believes that,
to the extent required, it has filed or will file applications, received
comfort letters or obtained licenses from the applicable regulatory
authorities.
The Company may be incorrect in its assumptions that (i) each EU member
state will abolish, on a timely basis, the respective ITO's monopoly to
provide Voice Telephony within and between member states and other countries,
as required by the Services Directive and the Full Competition Directive, (ii)
deregulation will continue to occur and (iii) the Company will be allowed to
continue to provide and to expand its services in the EU member countries. The
European Commission has announced plans to initiate legal action against
Belgium, Denmark, Germany, Greece, Italy, Luxembourg and Portugal for not
implementing the Full Competition
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Directive adequately. If the European Commission is not satisfied with the
explanation given by these countries for their delay it may take action that
ultimately could result in a decision by the European Court of Justice
concerning whether these countries have violated the Full Competition
Directive. The Company's provision of services in Western Europe may also be
affected if any EU member state imposes greater restrictions on non-EU
international service than on such service within the EU. There can be no
assurance that EU member states will not adopt laws or regulatory requirements
that will adversely affect the Company.
United Kingdom. The Company owns and operates a switching facility in London
that is connected to the UK international gateway by private line circuits
leased by the Company from third parties. In the United Kingdom, the Company
offers direct access and call-reorigination, as well as customized calling
card and prepaid debit calling card services, and provides international call
termination services to other telecommunications carriers and resellers on a
wholesale switched minute basis. The Company's services are subject to the
Telecommunications Act of 1984 (the "UK Telecommunications Act"). The
Secretary of State for Trade and Industry (the "TI Secretary") is responsible
for granting telecommunications licenses and the Director General of
Telecommunications ("DGT") and his staff, known as the Office of
Telecommunications ("Oftel"), the United Kingdom's telecommunications
regulatory authority, are responsible for enforcing the conditions of such
licenses. On May 6, 1997, the TI Secretary granted the Company an ISR license,
which allows the Company to offer certain international and national long
distance services utilizing international private leased circuits. The TI
Secretary is considering replacing the ISR license with a new license
applicable to a narrower scope of activities. The Company may have to apply
for a new license if the TI Secretary replaces the ISR license and if the
Company's activities fall within the scope of activities covered by the new
license. The loss of the Company's license or the placement of significant
restrictions thereon could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Risk Factors--
Substantial Government Regulation."
To reduce transmission costs associated with leasing IPLCs owned by third
parties and to provide additional capacity between the United States and
United Kingdom, the Company has the option to acquire capacity on an IRU basis
in a digital undersea fiber-optic cable for the transmission of traffic
between its London switching facility and its international gateway switching
center in New York. Before providing service over this capacity, the Company
is required to apply to the TI Secretary to obtain an International Facilities
License ("IF License") that would permit it to run international voice
services over submarine cables in which it has an IRU interest. The British
government has not placed any limit on the number of IF Licenses it will
issue, but there can be no assurance that the Company will be granted an IF
License. The Company's failure to obtain an IF License would prevent the
Company from providing facilities-based services to and from the United
Kingdom through its own facilities (e.g., by IRU), would adversely affect the
Company's plans and ability to expand its operations, and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Netherlands. The regulation of telecommunications is currently
controlled by the Onafhankelijke post-en telecommunicatie autoriteit ("OPTA"),
an independent administrative authority. The Company presently owns and
operates a switching facility in Amsterdam, which the Company intends in the
future to connect by leased lines to its international gateway switching
center in New York, subject to Dutch and FCC rules. To keep pace with
competitors, the Company presently offers call-through services in the
Netherlands. In particular, the Company has begun to provide a range of
enhanced telecommunications services and switched voice services to business
users, including to CUGs, by routing traffic via the switched networks of a
competitor of the ITO.
Germany. The regulation of the telecommunications industry in Germany is
governed by Telekommunikations-gesetz, the Telecommunications Act of 1996
("TKG"), which, with respect to most of its provisions, became effective in
August 1996. Under the TKG, a license ("TKG License") is generally required by
any person that: (i) operates transmission facilities for the provision of
telecommunications services to the public; or (ii) offers Voice Telephony
services to the public through telecommunications networks operated by such
provider. While the TKG represents the final phase of the reform of the German
telecommunications industry, the law will continue to protect the monopoly
rights of Deutsche Telecom over the provision of Voice Telephony until January
1, 1998.
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In Germany, the Company is currently providing calling card services as well
as traditional call-reorigination services (through answered or unanswered
call signaling), and is migrating CUGs and other customers to call-
reorigination services provided through Internet/X.25 data link signaling, to
transparent call-reorigination and/or to forms of call-through other than
transparent call-reorigination. The Company anticipates providing a range of
enhanced telecommunications services and switched voice services to business
users, including to CUGs, by routing traffic via the international switched
networks of competitors to the ITO. While the Company believes that it will
not be found to be offering Voice Telephony prior to the expiration of the
ITO's monopoly on such services, the Company has received no assurance from
the ITO or from the respective regulatory authorities that this will be the
case. It is possible that the Company could be fined, or that the Company
would not be allowed to provide specific services, if the Company were found
to be providing Voice Telephony before January 1, 1998, or after that date
without obtaining a proper license, such actions could have a material adverse
effect on the Company's business, financial condition and results of
operations.
In order to provide the Voice Telephony services to the public that the
Company intends to provide after January 1, 1998, and expand its network
switching facilities in Germany, the Company will be required to obtain a TKG
License. Under the TKG, an applicant is entitled to the grant of a license
subject to certain public policy considerations set forth in the statute. A
license may be revoked if, among other things, continued effectiveness would
be contrary to statutory public policy considerations. There can be no
assurance that the Company will be able to obtain, or, if granted, thereafter
maintain, a TKG License. The failure to obtain, or the loss of, a TKG License
or the placement of significant restrictions thereon could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, there can be no assurance that any future changes in,
or additions to, any existing or future German laws, regulations, government
policy, court or administrative rulings regarding telecommunications will not
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Risk Factors--Substantial Government
Regulation--European Union."
France. The Company currently provides call-reorigination services,
including transparent call-reorigination. The Company is permitted to provide
call-reorigination over the ITO's network in France without a license.
Although it does not currently provide such services, under current law, the
Company may lease circuits and provide switched voice services to CUGs in
France without a license. Until January 1, 1998, the Company may not provide
Voice Telephony to the public in France. The Company anticipates that it will
migrate CUGs and other customers to forms of call-through other than call-
reorigination prior to January 1, 1998. The Company anticipates providing a
range of enhanced telecommunications services and switched voice services to
business users, including to CUGs, by routing traffic via the international
switched networks of competitors to the ITO. While the Company believes that
it will not be found to be offering Voice Telephony prior to the expiration of
the ITO's monopoly on such services, the Company has received no assurance
from the ITO or from the respective regulatory authorities that this will be
the case. It is possible that the Company could be fined, or that the Company
would not be allowed to provide certain services, if the Company were found to
be providing Voice Telephony before January 1, 1998, or after that date
without obtaining a proper license. Such actions could have a material adverse
effect on the Company's business, financial condition and results of
operations.
A new telecommunications law, passed in 1996 to implement the Full
Competition Directive, establishes a licensing regime and an independent
regulator and imposes various interconnection and other requirements designed
to facilitate competition. Depending on the establishment of rules to
implement this new law, the Company expects to be in a position to expand its
services to include, for example, all forms of call-through services in France
which the Company expects to provide on a facilities-based or on a resale
basis. After January 1, 1998, if it decides to provide switched voice services
to the public, including call-through services, or to own facilities, the
Company will have to apply for a license from the Minister of
Telecommunications. There can be no guarantee, however, that the Company will
be able to obtain necessary licenses, permits, or interconnection arrangements
to fully take advantage of such liberalization. The lack of timely
liberalization or the Company's inability to take advantage of such
liberalization could have a material adverse impact on the Company's ability
to expand its services as planned.
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Switzerland. In Switzerland, the Company is currently providing call-
reorigination services, but anticipates that it will migrate CUGs and other
customers to forms of call-through other than call-reorigination prior to
January 1, 1998, the date on which full competition with the ITO will be
permitted. The Company anticipates providing a range of enhanced
telecommunications services and switched voice services to business users,
including to CUGs, by routing traffic via the international switched networks
of competitors to the ITO. While the Company believes that it will not be
found to be offering Voice Telephony prior to the expiration of the ITO's
monopoly on such services, the Company has received no assurance from the ITO
or from the respective regulatory authorities that this will be the case. It
is possible that the Company could be fined, or that the Company would not be
allowed to provide specific services, if the Company were found to be
providing Voice Telephony before January 1, 1998, or after that date without
obtaining a proper license, such actions could have a material adverse effect
on the Company's business, financial condition and results of operations. The
Company's existing services are subject to the Federal Law on
Telecommunications of June 21, 1991 ("LTC"). Although Switzerland is not an EU
member state, the Swiss government has expressed its intention to maintain
Swiss telecommunications regulations in line with EU directed liberalization.
Towards that end, on October 1, 1996, the Swiss federal government published a
draft law designed to increase competition in the telecommunications industry
and to guarantee "universal" services for the entire Swiss population at
reasonable prices. This draft law was approved by the Swiss Parliament on
April 30, 1997 ("New LTC"). Upon deregulation of the Swiss telecommunications
market and subject to FCC rules, the Company plans to expand operations in
Switzerland through the installation of additional switching facilities in
Zurich and other metropolitan areas of Switzerland connected via international
private leased circuits ("IPLCs") to its international gateway switching
center to provide international and national long distance services with
switched and dedicated access. Under the New LTC, the Company would not be
required to obtain a license unless it controls the infrastructure over which
its services are carried. The new Federal decree adopted by the Swiss
government on October 6, 1997 confirms this regulation; nevertheless, the
government has indicated that a telecommunication provider using switchboard
facilities may be required to obtain a license if the turnover achieved in
Switzerland is more than CHF 10 million. Accordingly, the Company's provision
of its existing or increased services may require the Company to obtain such a
license. Furthermore, there can be no guarantee that the Company will be able
to obtain any necessary license. See "Risk Factors--Substantial Government
Regulation."
Pacific Rim. Regulation of the Company varies in the Pacific Rim, depending
upon the particular country involved. The Company's ability to provide voice
telephony services is restricted in all countries where the Company provides
service except Australia and New Zealand, although service between Australia
or New Zealand and other countries may be constrained by restrictions in the
other countries. In Australia and New Zealand, regulation of the Company's
provision of telecommunications services is relatively permissive, although
enrollment (in Australia) or registration (in New Zealand) with the regulator
is required for ISR. The Company's Australian Subsidiary was enrolled in
Australia as a Supplier of Eligible International Services under the
Telecommunications Act 1991 (and now has the right to provide equivalent
services under the Telecommunications Act 1997) and its Subsidiary in New
Zealand has registered with the Ministry of Commerce as an International
Service Operator under the Telecommunications International Services
Regulations of 1995. Additionally, in Japan, the Company provides call-
reorigination services but may not provide basic switched voice services to
the public. The Company may, with a license, provide a broad array of value-
added services, as well as limited switched voice services to CUGs. The
Japanese government has indicated that it will permit carriers such as the
Company to apply for ISR authority some time in 1997. In Hong Kong, the
Company may provide call-reorigination under its existing license. A range of
international telephone services, including the operation of an international
gateway for all incoming and outgoing international calls, is provided in Hong
Kong solely by HKTI, the ITO, pursuant to an exclusive license which will
expire on October 1, 2006. However, the Hong Kong government has entered into
discussions with HKTI concerning a possible early termination of its exclusive
license. In all other Pacific Rim countries, the Company is strictly limited
in its provision of public voice and value added services.
While some countries in the Pacific Rim oppose call-reorigination, the
Company generally has not faced significant regulatory impediments. China,
Indonesia, and the Philippines have specifically informed the FCC
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that call-reorigination using uncompleted call signaling is illegal in those
countries. Australia, New Zealand, Japan and Hong Kong permit call-
reorigination.
Australia. In Australia, the provision of the Company's services was subject
to federal regulation pursuant to the Telecommunications Act 1991 of Australia
(the "1991 Act") until June 30, 1997, and is now subject to federal
legislation pursuant to the Telecommunications Act 1997 (the "1997 Act") and
federal regulation of anticompetitive practices pursuant to the Trade
Practices Act 1974. In addition, other federal legislation, various
regulations pursuant to delegated authority and legislation, ministerial
declarations, codes, directions, licenses, statements of Commonwealth
Government policy and court decisions affecting telecommunications carriers
also apply to the Company. There can be no assurance that future declarations,
codes, directions, licenses, regulations, and judicial and legislative changes
will not have a material adverse effect on the Company's business, financial
condition and results of operations.
The Australian Telecommunications Authority ("AUSTEL"), Australia's federal
telecommunications regulatory authority, had control until June 30, 1997 over
a broad range of issues affecting the operation of the Australian
telecommunications industry, including the licensing of carriers, the
promotion of competition, consumer protection and technical matters. Under the
1997 Act, AUSTEL's authority is now divided between the Australian
Communications Authority and the Australian Competition and Consumer
Commission.
The Company owns and operates a switch in Sydney that is connected to the
New York international gateway switch via leased lines. On December 9, 1996,
the Company's Subsidiary, Telegroup Network Services pty Limited, was enrolled
as a Supplier of Eligible International Services ("Class License") under
Section 226 of the 1991 Act, which allowed the Company to resell national,
local and long distance service, cellular service, and international service,
including to engage an ISR. Under the 1991 Act, the Company's Australian
Subsidiary was required to comply with the conditions of the Class License
until the 1997 Act came into effect on July 1, 1997. Under the 1997 Act, the
Company's Subsidiary is subject to certain service provider rules, including
an obligation to provide certain operator services, directory assistance
services and itemized billing for customers of the Subsidiary. It is currently
expected that the Australian Government will allow additional carriers,
including the Company, to own transmission facilities in July 1997. The
Company is a carriage service provider under the 1997 Act, which entitles the
Company to purchase IRUs for the Australian portion of the underseas fiber-
optic cable between Sydney and New York, as well as Auckland, New Zealand. The
Company will be required to comply with the rules applicable to carriage
service providers. If the Company or its affiliate purchases or constructs a
link between places in Australia (e.g., to provide an extension to its
international services), it will be required to apply for a carrier license.
It would then be subject to the terms of its own license and would be subject
to greater regulatory controls such as in areas of regulation of connectivity,
provision of access to service providers, land access and contributions to the
net cost of universal service throughout Australia (to provide
telecommunications services at reasonable prices to remote sections of that
country) applicable to licensed facilities-based carriers.
Although Australia is recognized by the FCC as an "equivalent" country, the
Company is not authorized by the FCC to use the Australian ISR license between
the U.S. and Australia, as is allowed in the United Kingdom, because the ITO
does not currently charge U.S. carriers at or below an FCC-determined rate for
terminating U.S. carrier's traffic. The Company anticipates receiving this
authorization in February 1998. The FCC has granted the Company's request for
a waiver allowing the Company to deviate from the existing FCC approved $0.22
per minute settlement rate and to contract at $0.05 per minute using leased
lines, pursuant to an agreement with its Subsidiary in Australia. The Company
has initiated service pursuant to this agreement.
There can be no assurance that a change in government policy in relation to
telecommunications or competition, or in the enforcement of the 1997 Act, will
not have a material adverse effect on the Company's business, financial
condition and results of operations. For example, there can be no assurance
that the deregulatory process will proceed in accordance with the government's
announced timetable. Any delay in such
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deregulatory process or in the granting of licenses to other entities
interested in developing their own transmission facilities in Australia could
delay potential price reductions anticipated in a more competitive
marketplace, thereby delaying the Company's access to potentially less
expensive transmission and access facilities.
Hong Kong. The Company acts as a wholesale carrier in Hong Kong, utilizing
its switch colocated at the business premises of one or more of the local
carriers licensed at Fixed Telecommunications Network Service ("FTNS")
operators in Hong Kong to provide international services to such FTNS
providers. The Company carries a substantial amount of such FTNS operators'
international traffic on a transparent call-reorigination basis. The Company
operates under a PNETS license granted in 1995 and renewable on an annual
basis. The Company's PNETS license was most recently renewed in March 1997.
The Company's PNETS license will likely be renewed unless there has been a
material breach of one of the license conditions.
The telecommunications market in Hong Kong for the provision of public
telephone services can be categorized into two primary areas: international
long distance services and local telephone services. HKTI currently holds an
exclusive license until September 30, 2006 to provide a variety of
international services including the right to operate an international gateway
for the handling of all outgoing and incoming international calls. However,
there have been reports in the Hong Kong press in recent months of talks
between the Hong Kong Government and HKTI over the possibility of HKTI
relinquishing its monopoly on a range of international telecommunications
services (including public international long distance calls) by terminating
its existing exclusive license, as early as 1999, which is not due to expire
until October 1, 2006.
Prior to June 1995, the Hong Kong Telephone Company Limited was the sole
operator of local fixed network telephone services. Subsequently, the market
was liberalized and the Hong Kong government granted licenses to Hutchison,
New World and New T&T Hong Kong Limited to provide fixed local telephone
network services. Each of the four fixed local telephone network operators
each currently hold a FTNS license issued by the Hong Kong government. The
Company plans to apply for a FTNS license if and when the Hong Kong government
decides to grant additional FTNS licenses, which, the Hong Kong government has
indicated, will be no earlier than 1998. Despite the fact that HKTI has the
exclusive right under its license to provide international telephone services,
all three of the other local fixed network operators have in recent years
gained a significant share of the international long distance call market
(approximately 30% to 40% according to the Company's estimates) by utilizing
U.S. and Canada-based call-reorigination services. See "Risk Factors--
Substantial Government Regulation" and "The Global Telecommunications
Industry--Competitive Opportunities and Advances in Technology."
There can be no assurance that China will continue the existing licensing
regime with respect to the Hong Kong telecommunications industry. There is
also no assurance that China will continue to implement the existing policies
of the Hong Kong government with respect to promoting the liberalization of
the Hong Kong telecommunications industry in general, including the policy
allowing call-reorigination, which is currently prohibited in China. For the
nine months ended September 30, 1997, one wholesale customer in Hong Kong
accounted for approximately 12% of the Company's total revenues. Substantially
all of the services provided by the Company to this customer consist of call-
reorigination services. The initial term of the Company's agreement with the
Hong Kong Customer expires in October 1998, automatically renews for one-year
periods, and may be terminated by the Hong Kong Customer if it determines in
good faith that the services provided pursuant to the agreement are no longer
commercially viable in Hong Kong. If the Company loses its rights under its
PNETS license and/or if it is unable to provide international
telecommunications services in Hong Kong on a wholesale basis, such action
could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, a material reduction in the
level of services provided by the Company to the Hong Kong Customer, or a
termination of the Company's agreement with the Hong Kong Customer, could have
a material adverse effect on the Company's business, financial condition and
results of operations.
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Japan. The Company owns and operates a switch in Tokyo. In Japan, the
Company offers traditional call-reorigination services, and anticipates
offering call-through as well as customized calling card and debit calling
card services. The Company's services in Japan are subject to regulation by
the Ministry of Post and Telecommunications (the "Japanese Ministry") under
the Telecommunications Business Law (the "Japanese Law"). The Company has
filed notice with the Japanese Ministry as a General Type II carrier. The
Company is in the process of seeking a Special Type II registration which will
permit the Company to provide additional services in Japan. There can be no
assurance that the Company will be able to register with the Japanese Ministry
as a Special Type II carrier. The Company's failure to obtain rights as a
Special Type II carrier, could have a material adverse effect on the Company's
ability to expand its operations in Japan and could materially adversely
effect the Company's business, financial condition and results of operations.
75--1
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EMPLOYEES
As of September 30, 1997, the Company had 510 full-time and 66 part-time
employees. None of the Company's employees are covered by a collective
bargaining agreement. Management believes that the Company's relationship with
its employees is satisfactory.
AGREEMENTS WITH INDEPENDENT AGENTS
Independent Agents. The Company's agreements with its independent agents
(other than Country Coordinators) typically provide for a two-year term and
require the agents to offer the Company's services at rates prescribed by the
Company and to abide by the Company's marketing and sales policies and rules.
Independent agent compensation is paid directly by the Company and is based
exclusively upon payment for the Company's services by customers obtained for
Telegroup by the independent agents. The commission paid to independent agents
ranges between five to twelve percent of revenues received by the Company and
varies depending on individual contracts, the exclusivity of the agent and the
type of service sold. Commissions are paid each month based on payments
received during the prior month from customers obtained by independent agents.
Independent agents are held accountable for customer collections and are
responsible for up to 40% of bad debt attributable to customers they enroll.
The Company may change commissions on any of its services with 30 days written
notice to the independent agent.
As of September 30, 1997, approximately [one-third] of the Company's retail
revenues was derived from customers enrolled by agents who are contractually
prohibited from offering competitive telecommunications services to their
customers during the term of their contract and typically for a period of two
years thereafter. Contracts with independent agents entered into by the
Company after July 1996 typically provide for such exclusivity. As earlier
agreements expire, the Company has generally required its independent agents
to enter into such new agreements. In the past, certain independent agents
have elected to terminate their relationships with the Company in lieu of
entering into new independent agent agreements. In the event that independent
agents transfer a significant number of customers to other service providers
or that a significant number of agents decline to renew their contracts under
the new terms and move their customers to another carrier, either of such
events may have a material adverse effect on the Company's business, financial
condition and results of operations. The Company's agreements with its
independent agents typically provide that the agents have no authority to bind
Telegroup or to enter into any contract on the Company's behalf.
Country Coordinators. In significant international markets, Telegroup
appoints Country Coordinators. Country Coordinators are typically self-
financed, independent agents, with contracts that bind them exclusively to
Telegroup. Country Coordinators also have additional duties beyond marketing
Telegroup services, including the responsibility in a country or region to
coordinate the activities of Telegroup independent agents including training
and recruitment, customer service and collections. As of November 30, 1997,
Telegroup had 28 Country Coordinators who were responsible for sales,
marketing, customer service and collections in 72 countries. Telegroup has
begun to vertically integrate its operations by opening offices in Germany and
the U.K. which provide Country Coordinator services and, in August 1996,
acquired the business operations of its Country Coordinator in France.
Country Coordinators offer the Company's services at rates prescribed by the
Company, and enforce standards for all advertising, promotional, and customer
training materials relating to Telegroup's services that are used or
distributed in the applicable country or region. Country Coordinators review
all proposed marketing or advertising material submitted to them by the
independent agents operating in their country or region and ensure such
agents' compliance with the Company's standards and policies. The Company's
agreements with its independent Country Coordinators typically have a two-year
term and include an exclusivity provision restricting the County Coordinator's
ability to offer competing telecommunication services. Such agreements
typically entitle the Country Coordinator to an override based on a percentage
of revenues collected by Telegroup from customers within the Country
Coordinator's country or region, as well as a commission similar to the
commission paid to independent agents with respect to customers obtained
directly by the Country Coordinator.
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The Company's agreements with its Country Coordinators typically provide that
the agents have no right to enter into any contract on Telegroup's behalf or
to bind Telegroup in any manner not expressly authorized in writing. See "Risk
Factors--Dependence on Independent Agents; Concentration of Marketing
Resources."
LEGAL MATTERS
The Company makes routine filings and is a party to customary regulatory
proceedings with the FCC relating to its operations. The Company is not a
party to any lawsuit or proceeding which, in the opinion of management, is
likely to have a material adverse effect on the Company's business, financial
condition and results of operations.
In June 1996, Macrophone Worldwide (PTY) Ltd. (the "Plaintiff"), a former
Country Coordinator for South Africa, filed a complaint (the "Complaint")
against the Company in the United States District Court for the Southern
District of Iowa (the "Action") alleging, among other things, breach of
contract, wrongful termination and intentional interference with contractual
relations. The Complaint requests compensatory and exemplary damages. On
September 2, 1997, the United States District Court granted summary judgment
for the Company on all seven tort-based claims. The only remaining claim is a
contract claim in which there is no pending claim for exemplary damages.
Although the Company is vigorously defending the Action, management believes
that the Company will ultimately prevail and does not believe the outcome of
the Action, if unfavorable, will have a material adverse effect on the
Company's business, financial condition or results of operations, there can be
no assurance that this will be the case.
On June 19, 1997, the Company received notice of a threatened lawsuit from
counsel to Richard DeAngelis, a former Vice President--Sales and Marketing of
the Company employed from 1993 until May 30, 1997. The notice alleges claims
for breach of contract, wrongful termination, wrongful discharge and
defamation. The Company believes that the threatened claims are without merit.
If an action is filed, the Company intends to vigorously contest any of such
claims. Although management believes that if an action were filed the Company
would ultimately prevail and does not believe that the outcome of such action,
if unfavorable, would have a material adverse effect on the Company's
business, financial condition or results of operations, there can be no
assurance that this will be the case. To date, no action has been filed
against the Company by Mr. DeAngelis.
INTELLECTUAL PROPERTY AND PROPRIETARY INFORMATION
Intellectual Property. The Company owns U.S. registration number 1,922,458,
for the mark TELEGROUP GLOBAL ACCESS(R) for international long distance
telecommunications services, U.S. registration number 2,048,650 for the mark
TELEGROUP(R), for domestic and international long distance telephone
telecommunications services and electronic transmission of messages and data,
a U.S. application for registration of its trademark TELEGROUP(R) INTELLIGENT
GLOBAL NETWORK SM Number 75-106,214 for domestic and international long
distance telephone telecommunications services and electronic transmission of
messages and data, and U.S. application for registration of its Logo, Number
75-384,655. In addition, the Company owns several foreign applications and
registrations for the marks TELEGROUP, TELEGROUP TECHNOLOGIES, INTELLIGENT
GLOBAL NETWORK, TELEGROUP INTELLIGENT GLOBAL NETWORK, SPECTRA, GLOBAL ACCESS,
TELEGROUP GLOBAL ACCESS, TELECARD, and the TELEGROUP logo. The Company relies
primarily on common law rights to establish and protect its intellectual
property, its name, products, and long distance services. There can be no
assurance that the Company's measures to protect its intellectual property
will deter or prevent the unauthorized use of the Company's intellectual
property. If the Company is unable to protect its intellectual property
rights, including existing trademarks and service marks, it could have a
material adverse effect upon the Company's business, financial condition and
results of operations.
Proprietary Information. To protect rights to its proprietary know-how and
technology, the Company requires certain of its employees and consultants to
execute confidentiality and invention agreements that prohibit the disclosure
of confidential information to anyone outside the Company. These agreements
also require disclosure and assignment to the Company of discoveries and
inventions made by such persons while employed
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by the Company. There can be no assurance that these agreements will not be
breached, that the Company will have adequate remedies for any such breach, or
that the Company's confidential information will not otherwise become known or
be independently developed by competitors or others.
PROPERTY
The Company leases certain office space under operating leases and subleases
that expire at various dates through October 31, 2001, including the Company's
principal headquarters in Fairfield, Iowa. The principal offices currently
leased or subleased by the Company are as follows:
<TABLE>
<CAPTION>
LOCATION SQUARE FOOTAGE LEASE EXPIRATION
-------- -------------- ----------------
<S> <C> <C>
Fairfield, Iowa (Corporate Headquarters)...... 31,632 January 2001
Fairfield, Iowa (Various Offices)............. 35,000 Various
Coralville, Iowa (Network Operations Center).. 7,200 October 2001
Dusseldorf, Germany (Sales and Customer
Service Office).............................. 2,100 April 1999
London, England (Sales and Customer Service
Office)...................................... 1,200 April 2001
Paris, France (Sales and Customer Service
Office)...................................... 1,600 September 1999
</TABLE>
The Company's switches in New York City, Australia, France, Japan, Hong
Kong, the Netherlands and the U.K. are located in various facilities pursuant
to separate colocation agreements. The Company's aggregate rent expense for
its domestic and international operations, excluding costs relating to
colocation agreements, was $682,630 in 1996.
The Company recently purchased 65 acres in Fairfield, Iowa, on which it
intends to build its new corporate headquarters.
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MANAGEMENT
The following table sets forth certain information regarding the Company's
directors, executive officers and certain other officers as of November 30,
1997.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Fred Gratzon............ 51 Chairman of the Board and Director
Clifford Rees........... 46 President, Chief Executive Officer and Director
John P. Lass............ 47 Senior Vice President and Chief Operating Officer
Ronald B. Stakland...... 44 Senior Vice President--International Marketing and
Operations and Director
Douglas A. Neish........ 42 Vice President--Finance, Chief Financial Officer, Treasurer
and Director
Stanley Crowe........... 52 Vice President--North America
Michael Lackman......... 46 Vice President--Intelligent Networks
Eric E. Stakland........ 45 Vice President--Global Carrier Services
Ronald L. Jackenthal.... 33 Vice President--North American Carrier Sales
Robert E. Steinberg..... 43 Vice President and General Counsel
Ellen Akst Jones........ 47 Vice President--Administration
Andrew Munro............ 37 Vice President--Revenue Systems
Steven W. Hathaway...... 49 Vice President--Enhanced Services
J. Sherman Henderson
III.................... 54 Director
Steven J. Baumgartner... 46 Director
Rashi Glazer............ 49 Director
</TABLE>
Fred Gratzon, a co-founder of the Company, has served as Chairman of the
Company's Board of Directors and a Director since its formation in 1989. Mr.
Gratzon founded The Great Midwestern Ice Cream Company in Fairfield, Iowa, in
1979 and served as its Chairman from 1979 to 1988. Mr. Gratzon received a BA
in fine arts from Rutgers University in 1968.
Clifford Rees, a co-founder of the Company, has served as President, Chief
Executive Officer and a Director of the Company since its formation in 1989.
Prior to co-founding Telegroup, Mr. Rees was a co-founder of Amerex Petroleum
Corporation, a multinational oil brokerage company. Mr. Rees has been a member
of the Board of Directors of the Telecommunications Resellers Association
("TRA") since its inception, and was the founding chairman of the TRA's
International Resale Council, which advises the TRA Board of Directors on
issues concerning the expansion of telecommunications resale throughout the
world. Mr. Rees received a BA, summa cum laude, in biochemistry from Michigan
State University in 1974.
John P. Lass has served as Senior Vice President and Chief Operating Officer
of the Company since January 1, 1997. Prior to joining the Company, from
November 1987 through December 1996, Mr. Lass served as Director and President
of Capital Management Partners, Inc., an NASD-registered broker-dealer firm.
During the same period, Mr. Lass was also Director and President of Everest
Asset Management, Inc., an investment management firm. From 1983 to 1987, Mr.
Lass served as Investment Manager for the Zimmerman Capital Group and from
1982 to 1983, Mr. Lass was a consultant with the Boston Consulting Group. Mr.
Lass received an MBA from Harvard Business School in 1982, where he graduated
as a Baker Scholar. Mr. Lass received a BA from the University of Washington
in 1972.
Ronald B. Stakland has served as Senior Vice President of International
Marketing and Operations of the Company since 1992 and as a Director since
April 1997. Prior to joining the Company, Mr. Stakland was a broker for Prime
Energy, Inc., an oil brokerage company from January 1988 to August 1992. Mr.
Stakland received a BFA from the University of Minnesota in 1975.
Douglas A. Neish has served as Vice President of Finance of the Company
since November 1995, Treasurer since October 1996 and Chief Financial Officer
and a Director since April 1997. From 1990 to 1995, Mr. Neish
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served as Deputy Treasurer for Canada Mortgage and Housing Corporation and
from 1988 to 1990 as Vice President of Canada Development Investment
Corporation ("CDIC"). Prior to his position with CDIC, from 1979 to 1988, Mr.
Neish was employed by Export Development Corporation where he served in a
number of positions including Senior Treasury Officer and Manager of
Marketing. Mr. Neish received a BA from Acadia University, Nova Scotia, Canada
in 1976 and an MBA from Dalhousie University, Nova Scotia, Canada in 1979.
Stanley Crowe has served as Vice President of North America of the Company
since 1993. Prior to joining the Company, Mr. Crowe was a manager for Mall
Network Services, a telecommunications consulting and management firm from
1990 to 1993. Prior to his position with Mall Network Services, Mr. Crowe
served as Vice President of Marketing of Guild Investment Management, a
national investment management firm, from 1988 to 1990 and President of
Stanley Crowe & Associates (predecessor to Oakwood Corp.), a real estate
development and brokerage firm, from 1979 to 1986. Mr. Crowe received a BA
from the University of California in 1968.
Michael Lackman has served as Vice President of Intelligent Networks of the
Company since 1994. Mr. Lackman served as Senior Manager at MCI from 1991 to
1994, where he was responsible for managing global development projects for
MCI and its alliance partners. From 1988 to 1991, Mr. Lackman was development
manager for Computer Associates, Inc. From 1980 to 1988, Mr. Lackman was a
consultant with the Resource Consulting Group. From 1978 to 1980, he served as
a system administrator with the California Institute of Technology. He
received his BS in Computer Science from the University of Oregon in 1975.
Eric E. Stakland has served as Vice President of Global Carrier Services
since 1995. Prior to joining the Company, Mr. Stakland was Chief Executive
Officer of Impact Solutions, Inc. (also known as Fiberflex, Inc.), a golf club
manufacturing and marketing company based in Fairfield, Iowa, from July 1993
to October 1994. Prior to May 1993, Mr. Stakland was Chief Operating Officer
of USA Global Link, a telecommunications company. Mr. Stakland received a BSCI
from Maharishi European Research University in 1983 and an MBA from Maharishi
University of Management in 1985.
Ronald L. Jackenthal has served as Vice President of North American Carrier
Sales since May 1997. Prior to joining the Company, Mr. Jackenthal served as
National Director, Carrier Sales for Cable & Wireless, Inc., the U.S.
subsidiary of Cable & Wireless, PLC. Beginning in 1987, Mr. Jackenthal held
various positions at Cable & Wireless, including Manager Carrier Sales from
1993 to 1995 and National Manager, Major Accounts, from 1990 to 1993. Mr.
Jackenthal received a B.A. from the University of Florida in 1987.
Robert E. Steinberg has served as Vice President and General Counsel of the
Company since June 9, 1997. Prior to joining the Company, Mr. Steinberg served
from 1988 to May 1997 as Managing Partner of the Washington, D.C. office of
Porter, Wright, Morris & Arthur (a 250 attorney law firm based in Ohio). Mr.
Steinberg served from 1983 to 1986 as Special Assistant to U.S. Attorney
General William French Smith and as Special Litigation Counsel at the U.S.
Department of Justice. Mr. Steinberg is the author of five books and thirty
articles on regulatory and litigation topics, including in law journals at
Yale and Columbia law schools. Mr. Steinberg received a B.A. in 1976 and J.D.
in 1979 from Washington University.
Ellen Akst Jones has served as the Company's Vice President of
Administration and Director of Human Resources since August 1997. Prior to
joining the Company, Ms. Jones ran a private law practice in Fairfield, Iowa
from 1992 to 1997. Prior to that time, Ms. Jones served as an Associate
Professor of Law and Government and Dean of Maharishi International University
College of Natural Law in Washington, DC, an Associate Counsel to the United
States Senate for the Senate Committee on Human Resources and an Assistant
General Counsel for the United States Conference of Mayors and Assistant
Attorney General of Texas. Ms. Jones received a B.A. and a J.D. from the
University of Pennsylvania in 1970 and 1974, respectively. Ms. Jones is
admitted to practice in Iowa and before the United States Supreme Court.
Andrew Munro has served as the Company's Vice President of Revenue Systems
since September 1997. Prior to joining the Company, Mr. Munro held positions
with MCI in its Engineering and Information
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Technologies divisions, where he was responsible for architectural
definitions, design, and implementation of multiple custom billing
applications. Mr. Munro received a B.S. in Political Science from Charter Oak
College in 1988.
Steven W. Hathaway has served as the Company's Vice President of Enhanced
Services since August 1997 and, previously, as the Company's Director of
Enhanced Services from September 1994 to July 1997. Prior to joining the
Company, Mr. Hathaway co-founded and served as Vice President of Marketing for
Keyboard Advancements. Prior to that time, Mr. Hathaway served as Vice
President of Sales and Marketing for Laser's Edge and as a Product and
Marketing Manager for Computer Associates. Mr. Hathaway received a BA from
Rutgers University in 1971.
J. Sherman Henderson III has served as a director of the Company since
October 1997 and has served as President and CEO of UniDial Communications
from 1993 to the present. Prior to that, Mr. Henderson was employed by US
Network where he served as a regional telecommunications distributor for
American Centrex beginning in 1989. Mr. Henderson currently serves as Chairman
of the Telecommunications Resellers Association's Board of Directors. Mr.
Henderson has over 35 years of business experience in sales, marketing,
management and company ownership.
Steven J. Baumgartner has served as a director of the Company since October
1997 and has served as Executive Vice President and Sector President Global
Commercial Print for R.R. Donnelley & Sons Company ("R.R. Donnelley") from
1995 to the present. At R.R. Donnelley Mr. Baumgartner is responsible for all
printing business outside the United States and is a member of R.R.
Donnelley's five-person executive committee. Prior to that time, Mr.
Baumgartner served as Executive Vice President of R.R. Donnelley responsible
for strategy, communication, technology and human resources from 1993 to 1995.
Prior to working at R.R. Donnelley, Mr. Baumgartner was co-founder and chief
executive officer of FRC Management, Inc., a retirement concepts corporation,
from 1991 to 1993.
Rashi Glazer has served as a director of the Company since October 1997 and
has served on the faculty of the Walter A. Haas School of Business, University
of California, Berkeley and Co-Director of the Berkeley Center for Marketing
and Technology from 1992 to the present. Prior to that time, Mr. Glazer served
on the faculty of the Columbia University Graduate School of Business.
All directors of the Company currently hold office until the next annual
meeting of the Company's shareholders or until their successors are elected
and qualified. The Company's Board of Directors have been divided into three
classes serving staggered three-year terms. See "Risk Factors--Antitakeover
Considerations." At each annual meeting of the Company's shareholders,
successors to the class of directors whose term expires at such meeting will
be elected to serve for three-year terms and until their successors are
elected and qualified. Officers are elected by, and serve at the discretion
of, the Board of Directors. See "Description of Capital Stock--Certain
Provisions of the Company's Articles and Bylaws."
Except for Eric E. Stakland and Ronald B. Stakland, who are brothers, there
are no family relationships among any of the directors and executive officers
of the Company.
COMMITTEES OF THE BOARD OF DIRECTORS
Audit Committee. The Board of Directors has established an Audit Committee.
The Audit Committee currently consists of Messrs. Henderson and Baumgartner,
and is charged with recommending the engagement of independent accountants to
audit the Company's financial statements, discussing the scope and results of
the audit with the independent accountants, reviewing the functions of the
Company's management and independent accountants pertaining to the Company's
financial statements and performing such other related duties and functions as
are deemed appropriate by the Audit Committee and the Board of Directors.
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<PAGE>
Compensation Committee. The Board of Directors has established a
Compensation Committee. The Compensation Committee is comprised solely of
"disinterested persons" or "Non-Employee Directors" as such term is used in
Rule 16b-3 promulgated under the Exchange Act, and "outside directors" as such
term is used in Treasury Regulation Section 1.162-27(c)(3) promulgated under
the Internal Revenue Code of 1986, as amended (the "Code"). Messrs. Henderson
and Baumgartner currently serve on the Compensation Committee, which is
responsible for reviewing general policy matters relating to compensation and
benefits of employees and officers, determining the total compensation of the
officers and directors of the Company and administering the Company's Stock
Option Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Board of Directors did not have a Compensation Committee during fiscal
year 1996. As a result, Messrs. Gratzon and Rees, executive officers and the
only members of the Board of Directors in 1996, participated in deliberations
concerning executive officer compensation, including their own compensation.
The Board of Directors has established a Compensation Committee comprised of
directors who are not executive officers or employees of the Company.
DIRECTOR REMUNERATION
Directors who are not employees of the Company receive an annual fee in the
form of options exercisable for 10,000 shares of the Company's Common Stock,
but will not receive a meeting fee for their participation at board meetings
and committee meetings. All directors will be reimbursed for out-of-pocket
expenses incurred in connection with attendance at board and committee
meetings. The Company may, from time to time and in the sole discretion of the
Company's Board of Directors, grant options to directors under the Company's
Stock Option Plan.
EXECUTIVE COMPENSATION
The following table sets forth certain summary information concerning
compensation for services in all capacities awarded to, earned by or paid to,
the Company's Chief Executive Officer and each of the four other most highly
compensated executive officers of the Company, whose aggregate cash and cash
equivalent compensation exceeded $100,000 (collectively, the "Named
Officers"), with respect to the year ended December 31, 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
-------------------- ------------
SECURITIES
NAME OF INDIVIDUAL AND OTHER ANNUAL UNDERLYING ALL OTHER
PRINCIPAL POSITION SALARY ($) BONUS ($) COMPENSATION ($) OPTIONS (#) COMPENSATION ($)
---------------------- ---------- --------- ---------------- ------------ ----------------
<S> <C> <C> <C> <C> <C>
Clifford Rees........... $690,000 $250,000 -- -- --
Chief Executive Officer
Fred Gratzon............ 600,000 250,000 -- -- --
Chairman of the Board
Ronald B. Stakland...... 250,000 71,417 -- -- --
Senior Vice President--
International Services
Michael Lackman......... 111,000 38,000 -- -- --
Vice President--
Intelligent Networks
Richard P. 44,418 85,147 7 147,958 $183,732(2)
DeAngelis(1)...........
Vice President--Sales &
Marketing
</TABLE>
- --------
(1) Mr. DeAngelis was employed by the Company from 1993 until May 30, 1997.
(2) Represents payments by the Company for earned commissions.
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<PAGE>
STOCK OPTION GRANTS
The following table sets forth certain information regarding grants of
options to purchase Common Stock made by the Company during the fiscal year
ended December 31, 1996 to each of the Named Officers. No stock appreciation
rights were granted during 1996.
OPTION GRANTS IN 1996 INDIVIDUAL GRANTS
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE
AT ASSUMED ANNUAL RATES
NUMBER OF PERCENT OF OF
SECURITIES TOTAL OPTIONS STOCK PRICE APPRECIATION
UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM ($)(2)
OPTIONS EMPLOYEES IN PRICE/ EXPIRATION ---------------------------
NAME GRANTED 1996 (%)(1) (SHARE) DATE (5%) (10%)
---- ---------- ------------- -------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Richard P.
DeAngelis(3)........... 147,958(4) 9.07% $1.31 1/1/06 $ 122,257 $ 309,823
</TABLE>
- --------
(1) The Company granted options to purchase a total of 1,631,031 shares of
Common Stock in 1996.
(2) Represents amounts that may be realized upon exercise of options
immediately prior to the expiration of their term assuming the specified
compounded rates of appreciation (5% and 10%) on the Common Stock over
the terms of the options. These assumptions do not reflect the Company's
estimate of future stock price appreciation. Actual gains, if any, on the
stock option exercises and Common Stock holdings are dependent on the
timing of such exercise and the future performance of the Common Stock.
There can be no assurance that the rates of appreciation assumed in this
table can be achieved or that the amounts reflected will be received by
the option holder.
(3) Mr. DeAngelis was employed by the Company from 1993 until May 30, 1997.
(4) One half, or 73,979 shares, are performance based options conditioned
upon reaching certain sales objectives. Such sales objectives were met
during the fourth quarter of 1996.
OPTION EXERCISES AND HOLDINGS
The following table sets forth certain information as of December 31, 1996,
regarding options to purchase Common Stock held by each of the Named Officers.
None of the Named Officers exercised any stock options or stock appreciation
rights during fiscal year 1996.
FISCAL 1996 YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED "IN-THE-MONEY" OPTIONS AT
OPTIONS AT FISCAL YEAR-END (#) FISCAL YEAR-END ($) (1)
------------------------------------ -------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------------- ---------------- ----------- -------------
<S> <C> <C> <C> <C>
Richard P.
DeAngelis(2)........... 147,958 -- 973,078 --
</TABLE>
- --------
(1) Options are in the money if the fair market value of the underlying
securities exceeds the exercise price of the options. The amounts set
forth represent the difference between $7.89 per share, the market value
of the Common Stock issuable upon exercise of options at December 31,
1996 (as determined by the Board of Directors), and the exercise price of
the option, multiplied by the applicable number of shares underlying the
options.
(2) Mr. DeAngelis was employed by the Company from 1993 until May 30, 1997.
EMPLOYMENT AGREEMENTS
On April 7, 1997, the Company entered into employment agreements (the
"Employment Agreements") with each of Mr. Gratzon and Mr. Rees pursuant to
which Mr. Gratzon has agreed to serve as Chairman of the Board and Mr. Rees
has agreed to serve as President and Chief Executive Officer of the Company.
The Employment Agreements provide for an annual base salary for each of Mr.
Gratzon and Mr. Rees of $500,000
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<PAGE>
and incentive compensation of up to $500,000. The incentive compensation
component of the Employment Agreements will be calculated and shared equally
between Mr. Gratzon and Mr. Rees as follows: (i) a total of $1 million if EBT
(as defined below) for the immediately preceding year is $2 million or more
and; (ii) the excess of EBT over $1 million if EBT for the immediately
preceding year is between $1 million and $2 million. As defined more
particularly in the Employment Agreements "EBT" is equal to the sum of net
income of the Company and its Subsidiaries, plus any provision for income
taxes deducted in computing net income. The Employment Agreements provide that
any additional annual base salary and incentive compensation will be at the
discretion of the Compensation Committee, will be commensurate with bonuses
paid to other employees of the Company and will take into account total
compensation paid to executives of competitors of the Company.
The Employment Agreements expire on December 31, 2000, unless earlier
terminated in accordance with their terms. In addition, the Employment
Agreements contain a non-competition covenant which prohibits Mr. Rees and Mr.
Gratzon from, during the term of their employment with the Company and for a
period of one year following the termination of the Employment Agreements in
most circumstances, working for any company that competes with the Company as
of the date of termination, without the written consent of the Company.
INDEMNIFICATION AGREEMENTS
The Company has entered into indemnification agreements with certain of its
executive officers and directors (collectively, the "Indemnification
Agreements"). Pursuant to the terms of the Indemnification Agreements, each of
the executive officers and directors who are parties thereto will be
indemnified by the Company to the full extent provided by law in the event
such officer or director is made or threatened to be made a party to a claim
arising out of such person acting in his capacity as an officer or director of
the Company. The Company has further agreed that, upon a change in control, as
defined in the Indemnification Agreements, the rights of such officers and
directors to indemnification payments and expense advances will be determined
in accordance with the provisions of the Iowa Business Corporation Act and
that, upon a potential change of control, as defined in the Indemnification
Agreements, it will create a trust in an amount sufficient to satisfy all
indemnity expenses reasonably anticipated at the time a written request to
create such a trust is submitted by an officer or director.
AMENDED AND RESTATED STOCK OPTION PLAN
On April 9, 1997, the Board of Directors of the Company adopted and the
shareholders of the Company approved the Amended and Restated 1996 Stock
Option Plan (the "Stock Option Plan"), which provides for the grant to
officers, key employees and directors of the Company and its Subsidiaries of
both "incentive stock options" within the meaning of Section 422 of the Code,
and stock options that are non-qualified for federal income tax purposes. The
total number of shares for which options may be granted pursuant to the Stock
Option Plan is 4,000,000 and the maximum number of shares for which options
may be granted to any person is 1,875,000 shares, subject to certain
adjustments to reflect changes in the Company's capitalization. The Stock
Option Plan is currently administered by the Company's Board of Directors.
Upon the completion of the Offering, the Stock Option Plan will be
administered by the Compensation Committee. The Compensation Committee will
determine, among other things, which officers, employees and directors will
receive options under the plan, the time when options will be granted, the
type of option (incentive stock options, non-qualified stock options, or both)
to be granted, the number of shares subject to each option, the time or times
when the options will become exercisable, and, subject to certain conditions
discussed below, the option price and duration of the options. Members of the
Compensation Committee are not eligible to receive options under the Stock
Option Plan, but are entitled to receive options as directors.
The exercise price of incentive stock options are determined by the
Compensation Committee, but may not be less than the initial public offering
price if granted prior to the Offering or the fair market value of the Common
Stock on the date of grant if granted after the Offering and the term of any
such option may not exceed ten years from the date of grant. With respect to
any participant in the Stock Option Plan who owns stock representing more than
10% of the voting power of all classes of the outstanding capital stock of the
Company
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<PAGE>
or of its Subsidiaries, the exercise price of any incentive stock option may
not be less than 110% of the fair market value of such shares on the date of
grant and the term of such option may not exceed five years from the date of
grant.
The exercise price of non-qualified stock options are determined by the
Compensation Committee on the date of grant. In the case of non-qualified
stock options granted on or before the earliest of (i) the expiration or
termination of the Stock Option Plan; (ii) the material modification of the
Stock Option Plan; (iii) the issuance of all options under the Stock Option
Plan; or (iv) the first meeting of shareholders at which Directors are elected
occurring after the year 2000 (the "Reliance Period"), the exercise price of
such options may not be less than the initial public offering price if granted
prior to the Offering or the fair market value of the Common Stock on the date
of grant if granted after the Offering. In the case of non-qualified stock
options granted after the Reliance Period, the exercise price of such options
may not be less than the fair market value of the Common Stock on the date of
grant. In either case, the term of such options may not exceed ten years from
the date of grant.
Payment of the option price may be made in cash or, with the approval of the
Compensation Committee, in shares of Common Stock having a fair market value
in the aggregate equal to the option price. Options granted pursuant to the
Stock Option Plan are not transferable, except by will or the laws of descent
and distribution. During an optionee's lifetime, the option is exercisable
only by the optionee.
The Compensation Committee has the right at any time and from time to time
to amend or modify the Stock Option Plan, without the consent of the Company's
shareholders or optionees; provided, that no such action may adversely affect
options previously granted without the optionee=s consent, and provided
further that no such action, without the approval of a majority of the
shareholders of the Company, may increase the total number of shares of Common
Stock which may be purchased pursuant to options under the Stock Option Plan,
increase the total number of shares of Common Stock which may be purchased
pursuant to options under the Stock Option Plan by any person, expand the
class of persons eligible to receive grants of options under the Stock Option
Plan, decrease the minimum option price, extend the maximum term of options
granted under the Stock Option Plan, extend the term of the Stock Option Plan
or change the performance criteria on which the granting of options is based.
The expiration date of the Stock Option Plan after which no option may be
granted thereunder, is April 1, 2007.
The Company has filed with the Commission a registration statement on Form
S-8 covering the shares of Common Stock underlying options granted under the
Stock Option Plan.
As of December 31, 1996, options to purchase an aggregate of 1,631,031
shares of Common Stock were granted under the original 1996 Stock Option Plan.
The outstanding options were held by 320 individuals and were exercisable at
$1.31 per share. During 1996, certain stock options were granted with exercise
prices below the estimated fair market value of such shares. As a result, the
Company recognized stock option based compensation of $1,032,646 during the
year ended December 31, 1996. Shares subject to options granted under the plan
that have lapsed or terminated may again be subject to options granted under
the plan.
Certain Federal Income Tax Consequences. The following discussion is a
summary of the principal United States federal income tax consequences under
current federal income tax laws relating to option grants to employees under
the Stock Option Plan. This summary is not intended to be exhaustive and,
among other things, does not describe state, local or foreign income and other
tax consequences.
An optionee will not recognize any taxable income upon the grant of a non-
qualified option and the Company will not be entitled to a tax deduction with
respect to such grant. Generally, upon exercise of a non-qualified option, the
excess of the fair market value of the Common Stock on the exercise date over
the exercise price will be taxable as compensation income to the optionee.
Subject to the discussion below with respect to Section 162(m) of the Code and
the optionee including such compensation in income or the Company satisfying
applicable reporting requirements, the Company will be entitled to a tax
deduction in the amount of such compensation income. The optionee=s tax basis
for the Common Stock received pursuant to such exercise will
85
<PAGE>
equal the sum of the compensation income recognized and the exercise price.
Special rules may apply in the case of an optionee who is subject to Section
16 of the Exchange Act.
In the event of a sale of Common Stock received upon the exercise of a non-
qualified option, any appreciation or depreciation after the exercise date
generally will be taxed to the optionee as capital gain or loss and will be
long-term capital gain or loss if the holding period for such Common Stock was
more than one year.
Subject to the discussion below, an optionee will not recognize taxable
income at the time of grant or exercise of an "incentive stock option" and the
Company will not be entitled to a tax deduction with respect to such grant or
exercise. The exercise of an "incentive stock option" generally will give rise
to an item of tax preference that may result in alternative minimum tax
liability for the optionee.
Generally, a sale or other disposition by an optionee of shares acquired
upon the exercise of an "incentive stock option" more than one year after the
transfer of the shares to such optionee and more than two years after the date
of grant of the "incentive stock option" will result in any difference between
the amount realized and the exercise price being treated as long-term capital
gain or loss to the optionee, with no deduction being allowed to the Company.
Generally, upon a sale or other disposition of shares acquired upon the
exercise of an "incentive stock option" within one year after the transfer of
the shares to the optionee or within two years after the date of grant of the
"incentive stock option," any excess of (i) the lesser of (a) the fair market
value of the shares at the time of exercise of the option and (b) the amount
realized on such sale or other disposition over (ii) the exercise price of
such option will constitute compensation income to the optionee. Subject to
the discussion below with respect to Section 162(m) of the Code and the
optionee including such compensation in income or the Company satisfying
applicable reporting requirements, the Company will be entitled to a deduction
in the amount of such compensation income. The excess of the amount realized
on such sale or disposition over the fair market value of the shares at the
time of the exercise of the option generally will constitute short-term or
long-term capital gain and will not be deductible by the Company.
Section 162(m) of the Code disallows a federal income tax deduction to any
publicly held corporation for compensation paid in excess of $1,000,000 in any
taxable year to the chief executive officer or any of the four other most
highly compensated executive officers who are employed by the corporation on
the last day of the taxable year. Under regulations promulgated under Section
162(m), the deduction limitation of Section 162(m) does not apply to any
compensation paid pursuant to a plan that existed during the period in which
the corporation was not publicly held, to the extent the prospectus
accompanying the initial public offering disclosed information concerning such
plan that satisfied all applicable securities laws. However, the foregoing
exception may be relied upon only for awards made before the earliest of (i)
the expiration of the plan; (ii) the material modification of the plan; (iii)
the issuance of all stock allocated under the plan; or (iv) the first meeting
of shareholders at which directors are elected occurring after the close of
the third calendar year following the calendar year in which the initial
public offering occurs (the "Reliance Period"). The compensation attributable
to awards granted under the Company's Stock Option Plan during the Reliance
Period is not subject to the deduction limitation of Section 162(m). The
Company has structured and implemented the Stock Option Plan in a manner so
that compensation attributable to awards made after the Reliance Period will
not be subject to the deduction limitation.
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<PAGE>
CERTAIN TRANSACTIONS
PRINCIPAL SHAREHOLDERS REGISTRATION RIGHTS AGREEMENT
In connection with the IPO, the Company and each of Clifford Rees, Fred
Gratzon, Shelley Levin-Gratzon and Ronald Stakland (the "Principal
Shareholders") entered into a registration rights agreement (the "Principal
Shareholders Registration Rights Agreement") granting the Principal
Shareholders and certain other shareholders demand and incidental registration
rights in connection with their ownership of shares of Common Stock. See
"Description of Capital Stock--Registration Rights--Principal Shareholders."
ACQUISITION OF COUNTRY COORDINATOR'S OPERATIONS
The Company acquired substantially all of the assets of Telegroup South
Europe, Inc., a Pennsylvania corporation ("TGSE") and Telecontinent, S.A., a
French company ("Telecontinent"). George Apple, the Company's Country
Coordinator in France, owned all of the issued and outstanding shares of TGSE
and substantially all of the shares of Telecontinent. Pursuant to separate
agreements, the Company paid Mr. Apple aggregate consideration of $1,031,547
in cash and 262,116 shares of the Company's Common Stock for TGSE and
Telecontinent.
LOANS TO CERTAIN EXECUTIVE OFFICERS
The Company has from time to time made various personal loans to Messrs.
Gratzon and Rees, the Chairman of the Board and President, respectively. Mr.
Gratzon received loans from the Company, during 1996, in the aggregate amount
of $162,318, at an interest rate equal to 12% per annum, all of which were
repaid in full by Mr. Gratzon in November 1996. The largest aggregate amount
of indebtedness owed by Mr. Gratzon to the Company at any time during 1996 was
$162,318.
Mr. Rees received loans from the Company during 1994 and 1995, and in
October 1996 in the aggregate amount of $135,878, at interest rates equal to
12% per annum. These loans were repaid in full by Mr. Rees in November 1996.
The largest aggregate amount of indebtedness owed by Mr. Rees to the Company
at any time during 1996 was $135,878.
MANAGEMENT AGREEMENT
During 1994, 1995 and a portion of 1996, the Company had a management
agreement with an affiliate of the Company owned by Messrs. Gratzon and Rees
pursuant to which it paid a management fee, determined annually, plus an
incentive fee based upon performance, to Messrs. Gratzon and Rees. Amounts
paid to Messrs. Gratzon and Rees under this agreement totaled $1,155,000,
$1,334,000 and $415,000 during 1994, 1995 and 1996, respectively. The
management agreement was terminated on May 15, 1996.
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PRINCIPAL SHAREHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of September 30, 1997, by (i) each
person known by the Company to beneficially own five percent or more of any
class of the Company's capital stock, (ii) each director of the Company, (iii)
each executive officer of the Company that is a Named Officer and (iv) all
directors and executive officers of the Company as a group. All information
with respect to beneficial ownership has been furnished to the Company by the
respective shareholders of the Company.
<TABLE>
<CAPTION>
NUMBER OF SHARES OF
COMMON STOCK PERCENTAGES AS OF
BENEFICIAL OWNER BENEFICIALLY OWNED(1) SEPTEMBER 30, 1997
- ---------------- --------------------- ------------------
<S> <C> <C>
Fred Gratzon and Shelley Levin-
Gratzon............................. 11,836,653(2) 38.5%
Clifford Rees........................ 11,683,215(3) 38.0%
Ronald B. Stakland................... 773,004(4) 2.5%
Michael Lackman...................... 518,988 1.7%
Douglas A. Neish..................... 120,559 *
J. Sherman Henderson III............. 0 *
Steven J. Baumgartner................ 0 *
Rashi Glazer......................... 0 *
All directors and executive officers
as a group (17 persons)............. 25,162,577 80.9%
</TABLE>
- --------
* Represents beneficial ownership of less than 1% of the outstanding shares
of Common Stock.
(1) Beneficial ownership is determined in accordance with the rules of the
Commission. In computing the number of shares beneficially owned by a
person and the percentage of ownership of that person, shares of Common
Stock subject to options and warrants held by that person that are
currently exercisable or exercisable within 60 days of October 8, 1997 are
deemed outstanding. Such shares, however, are not deemed outstanding for
the purposes of computing the percentage of ownership of any other person.
Except as otherwise indicated, and subject to community property laws
where applicable, the persons named in the table above have sole voting
and investment power with respect to all shares of Common Stock shown as
owned by them. The address of each of the persons in this table is as
follows: c/o Telegroup, Inc., 2098 Nutmeg Avenue, Fairfield, Iowa 52556.
(2) Represents (i) 5,918,326 shares of Common Stock owned by Fred Gratzon and
Shelley Levin-Gratzon as joint tenants, (ii) 2,239,580 shares of Common
Stock held by the Fred Gratzon Revocable Trust, (iii) 2,239,580 shares of
Common Stock held by the Shelley L. Levin-Gratzon Revocable Trust, (iv)
1,265,201 shares of Common Stock owned by the Gratzon Family Partnership
II, L.P., a Georgia limited partnership, and (v) 173,966 shares of Common
Stock owned by the Gratzon Family Partnership I, L.P., a Georgia limited
partnership. Fred Gratzon and Shelley Levin-Gratzon are husband and wife,
and together they (i) serve as trustees of the two trusts referenced in
the prior sentence and (ii) own and/or control the general partners of the
two partnerships referenced in the prior sentence. Fred Gratzon is the
sole beneficiary of the Fred Gratzon Revocable Trust and Shelley Levin-
Gratzon is the sole beneficiary of the Shelley L. Levin-Gratzon Revocable
Trust.
(3) Represents (i) 4,804,629 shares of Common Stock owned by Lakshmi Partners,
L.P., a Georgia limited partnership, of which a corporation owned and/or
controlled by Mr. Rees serves as the general partner, and (ii) 6,878,586
shares of Common Stock are held by a revocable trust of which Mr. Rees is
the trustee and sole beneficiary.
(4) Represents (i) 663,406 shares of Common Stock owned by Ronald Stakland and
(ii) 109,598 shares of Common Stock held by the Stakland Family Trust,
Ernst & Young Trustees Limited.
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SELLING SHAREHOLDERS
The following table sets forth the number of shares of the Company's Common
Stock to be offered by the Selling Shareholders named herein, and, as of
December 15, 1997, the number and percentage of shares beneficially owned
prior to the offering made hereby and number of shares offered pursuant to
this Prospectus.
<TABLE>
<CAPTION>
SHARES OWNED
PRIOR TO OFFERING SHARES OFFERED
------------------ PURSUANT TO THIS
NAME NUMBER PERCENTAGE PROSPECTUS
---- ------- ---------- ----------------
<S> <C> <C> <C>
Smith Barney Inc. ........................ 20,406
Hare and Co. ............................. 2,782
Greenwich Street Capital Partners, L.P. .. 153,310
Greenwich Street Capital Offshore Fund,
Ltd. .................................... 9,343
TRV Employees Fund, L.P. ................. 37,458
The Travelers Insurance Company........... 7,765
The Travelers Life and Annuity Company.... 3,825
</TABLE>
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DESCRIPTION OF CAPITAL STOCK
GENERAL
The authorized capital stock of the Company consists of 150,000,000 shares
of Common Stock, no par value, and 10,000,000 shares of Preferred Stock, no
par value. The statements under this caption are summaries of all material
provisions of the Company's Second Restated Articles of Incorporation (the
"Second Restated Articles of Incorporation") and Amended and Restated Bylaws
(the "Bylaws"), relating to the Company's capital stock which are filed as
exhibits to the Registration Statement of which this Prospectus is a part.
Such summaries do not purport to be complete and are subject to, and are
qualified in their entirety by reference to, such documents.
THE RECAPITALIZATION
In July 1996, the Company adopted amended Articles and Bylaws. The Articles
provide for the reclassification of the Company's Class A Common Stock, no par
value, and its nonvoting Class B Common Stock, no par value, into a single
class of voting Common Stock, no par value, (the "Reclassification"). The
Articles also provide for "blank check" preferred stock. See "--Preferred
Stock." In addition, the Company effected an approximately 5.48-for-one stock
split of its then existing Common Stock (the "Stock Split"). The
Reclassification and the Stock Split are referred to collectively herein as
the "Recapitalization."
COMMON STOCK
As of December 15, 1997, there were shares of Common Stock outstanding
and held of record by approximately holders of record. Holders of shares
of Common Stock are entitled to one vote per share on all matters on which the
holders of Common Stock are entitled to vote and do not have any cumulative
voting rights. This means that the holders of more than 50% of the shares
voting for the election of directors can elect all of the directors if they
choose to do so; and, in such event, the holders of the remaining shares of
Common Stock will not be able to elect any person to the Board of Directors.
Subject to the rights of the holders of shares of any series of Preferred
Stock, holders of Common Stock are entitled to receive such dividends as may
from time to time be declared by the Board of Directors of the Company out of
funds legally available therefor. See "Dividends." Holders of shares of Common
Stock have no preemptive, conversion, redemption, subscription or similar
rights. In the event of a liquidation, dissolution or winding up of the
Company, whether voluntary or involuntary, holders of shares of Common Stock
are entitled to share ratably in the assets of the Company which are legally
available for distribution, if any, remaining after the payment or provision
for the payment of all debts and other liabilities of the Company and the
payment and setting aside for payment of any preferential amount due to the
holders of shares of any series of Preferred Stock. All outstanding shares of
Common Stock are, and all shares of Common Stock offered hereby when issued
will be, upon payment therefor, validly issued, fully paid and nonassessable.
At present there is no established trading market for the Common Stock. The
Common Stock has been approved for quotation on the Nasdaq National market
under the proposed symbol "TGRP," subject to official notice of issuance.
PREFERRED STOCK
The Company's Board of Directors is authorized to issue from time to time up
to 10,000,000 shares of Preferred Stock in one or more series and to fix the
rights, designations, preferences, qualifications, limitations and
restrictions thereof, including dividend rights, dividend rates, conversion
rights, voting rights, terms of redemption, redemption prices, the terms of
any sinking fund, liquidation preferences and the number of shares
constituting any series, without any further action by the shareholders of the
Company. The issuance of Preferred Stock with voting rights could have an
adverse effect on the voting power of holders of Common Stock by increasing
the number of outstanding shares. In addition, if the Board of Directors
authorizes Preferred Stock with conversion rights, the number of shares of
Common Stock outstanding could potentially be increased up to the amount
authorized under the Articles. The issuance of Preferred Stock could decrease
the amount of earnings
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and assets available for distribution to holders of Common Stock. Any such
issuance could also have the effect of delaying, deterring or preventing a
change in control of the Company and may adversely affect the rights of
holders of Common Stock. The Board of Directors does not currently intend to
issue any shares of Preferred Stock.
WARRANTS
As of December 31, 1996, there were outstanding Warrants granting the
holders of the Warrants the right to acquire up to 1,160,107 shares of Common
Stock. Pursuant to their terms, the Warrants will be adjusted on July 2, 1997
to increase the number of shares issuable upon exercise of the Warrants to
4.5% of the issued and outstanding shares of Common Stock as of such date,
less certain excluded shares. In the event that the Company does not complete
the Offering prior to January 2, 1998, the holders of the Warrants will have
the right to acquire up to an additional 0.5% of the issued and outstanding
Shares of Common Stock on a fully diluted basis on such date, less certain
excluded shares. The Warrants are exercisable at any time prior to November
28, 2003. The Warrants are entitled to certain antidilution protection in the
event of additional issuances of Common Stock, stock splits, stock dividends,
reorganizations and other similar events. The shares of Common Stock issued
pursuant to the exercise of the Warrants are entitled to certain registration
rights described below. As a result of certain options which were granted
since March 31, 1997 and pursuant to the adjustments described above, the
holders of Warrants will have the right to acquire 1,327,500 shares of Common
Stock.
REGISTRATION RIGHTS
Holders of the Warrants. The holders of the Warrants were granted
registration rights pursuant to the Warrant Shares Registration Rights
Agreement with the Company. Under the Warrant Shares Registration Rights
Agreement, a majority of the holders of the Warrants will be entitled to
demand registration of their shares once in each of the two years following
the Offering, provided that any exercise must include at least twenty percent
(20%) of the shares into which the Warrants are exercisable (the "Warrant
Shares"). The holders of the Warrants have piggyback registration rights with
respect to all registrations by the Company (other than a registration
statement filed on Form S-4 or S-8), including the Offering, pursuant to the
following priority rules: (i) in the case of the Offering, the Company has
first priority, the holders of the Warrants have second priority (with respect
to up to fifty percent (50%) of the Warrant Shares then held by such holders
of the Warrants), other shareholders have third priority (up to 4.5% of the
issued and outstanding shares of Common Stock prior to the Offering), and
thereafter the holders of the Warrants and other shareholders share on a one-
third to two-thirds basis; (ii) in the case of all other underwritten
offerings the Company has first priority, and the holders of the Warrants and
other shareholders (with rights to participate in the offering) have second
priority, pro rata with their holdings; and (iii) in all other offerings, the
Company has first priority, other shareholders with demand registration rights
have second priority, and the holders of the Warrants and all holders of
piggyback registration rights have third priority, pro rata with their
holdings. Pursuant to the terms of the Warrant Shares Registration Rights
Agreement, the Company agreed to (i) pay all fees and expenses incurred with
any registration, except for all underwriting discounts and commissions
relating to the Common Stock sold by such holders, which will be borne by the
holders thereof, and (ii) indemnify the holders in connection with any
registration effected pursuant to the Warrant Shares Registration Rights
Agreement, including liabilities under the Securities Act.
Principal Shareholders. Prior to completion of the Offering, the Principal
Shareholders will be granted registration rights pursuant to the Principal
Shareholders Registration Rights Agreement. Under the Principal Shareholders
Registration Rights Agreement, the Principal Shareholders are entitled to
demand registration of their shares once in each of the two years following
the date the Company is eligible to file a registration statement on Form S-3,
provided that any such demand must include at least twenty percent (20%) of
the shares beneficially owned by the Principal Shareholders on the date of
such demand.
The Principal Shareholders have piggyback registration rights with respect
to all other registrations by the Company (other than a registration statement
filed on Form S-4 or S-8), pursuant to the following priority rules: (i) in
the case of any underwritten registration on behalf of the Company, the
Company has first priority, and the Principal Shareholders and other
shareholders (with rights to participate in the offering) have second
priority,
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pro rata with their holdings; and (ii) in any underwritten secondary
registration on behalf of the Company's shareholders other than the Principal
Shareholders, the other shareholders with priority demand registration rights
have first priority, and the Principal Shareholders and all holders of
incidental registration rights have second priority, pro rata with their
holdings.
CERTAIN PROVISIONS OF THE COMPANY'S ARTICLES AND BYLAWS
The Company's Second Restated Articles of Incorporation contain a provision
that eliminates the personal liability of the Company's directors to the
Company or its shareholders for monetary damages for breach of fiduciary duty
as a director, except (i) for liability for any breach of the director's duty
of loyalty to the Corporation or its shareholders, (ii) for acts or omissions
not in good faith or which involve intentional misconduct or knowing violation
of the law, (iii) for any transactions from which the director derived an
improper personal benefit, or (iv) for unlawful distributions in violation of
Section 490.833 of the Iowa Business Corporation Act. Any repeal or amendment
of this provision by the shareholders of the Corporation will not adversely
affect any right or protection of a director existing at the time of such
repeal or amendment.
In addition, the Company's Bylaws provide that the Company will indemnify
directors and officers of the Company to the fullest extent permitted by the
Iowa Business Corporation Act. The Second Restated Articles of Incorporation
and Bylaws include certain provisions which are intended to enhance the
likelihood of continuity and stability in the composition of the Company's
Board of Directors and which may have the effect of delaying, deterring or
preventing a future takeover or change in control of the Company unless such
takeover or change in control is approved by the Company's Board of Directors.
Such provisions may also render the removal of the directors and management
more difficult.
The Second Restated Articles of Incorporation provide that the Board of
Directors of the Company be divided into three classes serving staggered
three-year terms. The Company's Second Restated Articles of Incorporation or
Bylaws and/or the Iowa Business Corporation Act include restrictions on who
may call a special meeting of shareholders and/or that shareholders may only
act at an annual or special meeting or with the written consent of holders of
at least 90% of the outstanding shares of Common Stock. The Company's Bylaws
contain an advance notice procedure with regard to the nomination, other than
by or at the direction of the Board of Directors, of candidates for election
as directors and with regard to certain matters to be brought before an annual
meeting of shareholders of the Company. In general, notice must be received by
the Company not less than 90 days prior to the meeting and must contain
certain specified information concerning the person to be nominated or the
matter to be brought before the meeting and concerning the shareholder
submitting the proposal. The Second Restated Articles of Incorporation and
Bylaws provide that the affirmative vote of the holders of at least 65% of the
voting stock of the Company is required to amend the foregoing provisions.
The Second Restated Articles of Incorporation contain provisions restricting
certain "Business Combinations". The Second Restated Articles of Incorporation
require the affirmative vote of at least 65% of the outstanding shares of
voting stock of the Company for the approval of certain material transactions
between the Company and any individual, corporation, partnership or other
person or entity which, together with its affiliates and associates
beneficially owns in the aggregate 20% or more of the outstanding voting stock
of the Company ("Substantial Shareholder") unless one of the following is
true: (1) 2/3 of the "Continuing Directors" on the Board (a) have approved in
advance the acquisition that caused the Substantial Shareholder to become a
Substantial Shareholder or (b) have approved the Business Combination prior to
the Substantial Shareholder involved in the Business Combination having become
a Substantial Shareholder; (2) the Business Combination is solely between the
Company and one of its wholly owned subsidiaries; or (3) the Business
Combination is a merger or consolidation and the consideration per share by
holders of Common Stock of the Company in the Business Combination satisfies
the "fair price" requirements in the Second Restated Articles of
Incorporation. In general, a "fair-price" is not less than the greater of (a)
the highest per share price paid by the Substantial Shareholder in acquiring
any of it shares of stock of the Company or (b) an amount which bears the same
or greater percentage relationship to the market price of the Common Stock of
the Company immediately prior to
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the announcement of the Business Combination equal to the highest percentage
relationship that any per share price theretofore paid by the Substantial
Shareholder for any of its holdings of Common Stock of the Company bore to the
market price of the Common Stock of the Company immediately prior to
commencement of the acquisition by the Substantial Shareholder. "Continuing
Director" means, with respect to a particular Substantial Shareholder, a
member of the Company's Board of Directors who was (1) a member prior to the
date on which a Substantial Shareholder became a Substantial Shareholder or
(2) designated as a Continuing Director by a majority of the whole board, but
only if a majority of the whole board shall then consist of Continuing
Directors, or if a majority of the whole board does not then consist of
Continuing Directors, by a majority of the then Continuing Directors.
"Business combinations" subject to this approval requirement include
mergers, share exchanges, material dispositions of corporate assets not in the
ordinary course of business, certain dispositions to a Substantial Shareholder
of voting stock of the Company, or any reclassification, including reverse
stock splits, recapitalization or merger of the Company with its subsidiaries,
which increases the percentage of voting stock owned beneficially by a
Substantial Shareholder. The "Business Combination" provisions of the Second
Restated Articles of Incorporation may not be repealed or amended in any
respect, unless such action is approved by the affirmative vote of the holders
of not less than 65% of the outstanding shares of voting stock of the Company;
provided, that if an amendment is recommended to shareholders by 2/3 of the
whole board of directors when a majority of the members of the board of
directors acting upon such matters are Continuing Directors then the
affirmative vote of the holders of not less than 50% of the outstanding shares
of voting stock of the Company is required.
IOWA BUSINESS CORPORATION ACT; ANTITAKEOVER EFFECTS
Under Chapter 502 of the Iowa Code a person making a "takeover offer,"
defined as an offer to acquire any equity securities of a "target company"
(defined as a public company with substantial assets in Iowa that is at least
20% owned by Iowa residents) from an Iowa resident pursuant to a tender offer
is required to file a registration statement with the designated Iowa public
official if the bidder would then own 10% of any class of outstanding equity
securities. Chapter 502 contains antifraud provisions and prohibits the
acquisition of equity securities from an Iowa resident within two years
following a takeover offer unless the holders are afforded a reasonable
opportunity to sell to the offeror upon substantially equivalent terms as
those provided in the earlier takeover offer.
The Iowa Business Corporation Act provides that in considering acquisition
proposals, directors may consider the effects on the Company's employees,
suppliers, creditors, customers and the communities in which it operates, as
well as the long-term and short-term interests of the Company. Consideration
of any or all community interest factors is not a violation of the business
judgment rule, even if the directors reasonably determine that effects on a
community or other factors outweigh the financial or other benefits to the
Company or a shareholder or group of shareholders. The Act also includes
authorization of "poison pills" which include, without limitation, provisions
that preclude or limit the exercise, transfer or receipt of stock rights by
persons owning or offering to acquire a specified number or percentage of a
corporation's outstanding shares. Unlike most states, Iowa does not presently
have a "business combination" law prohibiting business combinations with a
stockholder who holds over a specified percentage of stock for less than a
specified period after crossing the threshold. See "--Certain Provisions of
the Company's Articles and Bylaws."
The foregoing provisions of state law could have the effect of delaying,
deferring or preventing a change in control of the Company if the Board of
Directors determines that a change of control is not in the best interest of
the Company, its shareholders and other constituencies. In addition, the
regulatory restrictions on acquisition of securities of the Company may also
deter attempts to effect, or prevent the consummation of, a change in control
of the Company.
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DESCRIPTION OF CONVERTIBLE SUBORDINATED NOTES
CONVERTIBLE NOTES
On September 30, 1997, the Company issued $25,000,000 in aggregate principal
amount of Convertible Notes. The Convertible Notes will mature on April 15,
2005. The Convertible Notes are unsecured obligations of the Company and are
subordinated to all existing and future Senior Indebtedness (as defined in the
indenture governing the Convertible Notes, (the "Convertible Note Indenture"))
of the Company, including the Notes offered hereby.
Interest. The Convertible Notes bear interest at 8% per annum, payable in
cash, on each April 15 and October 15, commencing April 15, 1998; provided
that, until the earlier of (x) April 15, 1999 or (y) the Final Note Interest
Time (as defined in the Convertible Note Indenture), at the option of the
Company, interest may be paid by the issuance of additional Convertible Notes.
Conversion. The Convertible Notes are convertible into shares of Common
Stock of the Company at any time on or before the business day next preceding
April 15, 2005, unless previously redeemed, at a conversion price of $12.00
per share, subject to adjustment upon the occurrence of certain events.
Redemption. The Convertible Notes are redeemable, in whole or in part, at
the option of the Company, at any time on or after October 15, 2000 at
redemption prices (expressed as a percentage of the principal amount)
declining annually from 104.0% beginning on October 15, 2000 to 100.0%
beginning on October 15, 2003 and thereafter, together with accrued interest
to the redemption date and subject to certain conditions.
Covenants. The Convertible Note Indenture places certain restrictions on the
ability of the Company and its Subsidiaries to (i) incur additional
indebtedness, (ii) make restricted payments (dividends, redemptions and
certain other payments), (iii) incur liens, (iv) enter into mergers,
consolidations or acquisitions, (v) sell or otherwise dispose of property,
business or assets, (vi) issue and sell preferred stock of a Subsidiary and
(vii) engage in transactions with affiliates.
Events of Default. The following are "Events of Default" under the
Convertible Note Indenture:
(i) default in the payment of the principal of or premium, if any, on any
Convertible Note when the same becomes due and payable (upon stated
maturity, acceleration, optional redemption, required purchase, scheduled
principal payment or otherwise); or
(ii) default in the payment of an installment of interest on any of the
Convertible Notes, when the same becomes due and payable, which default
continues for a period of 30 days; or
(iii) failure to perform or observe any other term, covenant or agreement
contained in the Convertible Notes or the Indenture governing the
Convertible Notes (other than a default specified in clause (i) or (ii)
above) and such default continues for a period of 30 days after written
notice of such default requiring the Company to remedy the same shall have
been given (x) to the Company by the trustee or (y) to the Company and the
trustee by holders of 25% in aggregate principal amount of the Convertible
Notes then outstanding; or
(iv) default or defaults under one or more agreements, instruments,
mortgages, bonds, debentures or other evidences of Indebtedness under which
the Company or any Subsidiary of the Company then has outstanding
Indebtedness in excess of $5,000,000, individually or in the aggregate, and
either (a) such Indebtedness is already due and payable in full or (b) such
default or defaults have resulted in the acceleration of the maturity of
such Indebtedness; or
(v) one or more judgments, orders or decrees of any court or regulatory
or administrative agency of competent jurisdiction for the payment of money
in excess of $5,000,000, either individually or in the aggregate, shall be
entered against the Company or any Subsidiary of the Company or any of
their
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respective properties and shall not be discharged or fully bonded and there
shall have been a period of 60 days after the date on which any period for
appeal has expired and during which a stay of enforcement of such
judgement, order or decree shall not be in effect; or
(vi) certain events of bankruptcy, insolvency or reorganization with
respect to the Company or any Significant Subsidiary of the Company shall
have occurred.
If an event of default (other than as specified in clause (vi) above) shall
occur and be continuing, the trustee, by notice to the Company, or the holders
of at least 25% in aggregate principal amount of the Convertible Notes then
outstanding, by notice to the trustee and the Company, may declare the
principal of, premium, if any, and accrued and unpaid interest, if any, on all
of the outstanding Convertible Notes due and payable immediately, upon which
declaration, all amounts payable in respect of the Convertible Notes shall be
immediately due and payable. If an event of default specified in clause (vi)
above occurs and is continuing, then the principal of, premium, if any, and
accrued and unpaid interest, if any, on all of the outstanding Convertible
Notes shall ipso facto become and be immediately due and payable without any
declaration or other act on the part of the trustee or any holder of the
Convertible Notes.
Change of Control; Sale of Assets. In the event of a Change of Control (as
defined in the Convertible Note Indenture), the holder of a Convertible Note
will have the right to require the Company to repurchase such holder's
Convertible Notes at 101.0% of the principal amount thereof plus accrued and
unpaid interest to the repurchase date. In addition, the Company will be
obligated to make an offer to repurchase the Convertible Notes for cash at a
price equal to 100.0% of the principal amount thereof plus accrued and unpaid
interest, if any, to the date of repurchase with the net cash proceeds of
certain asset sales.
Registration Rights. Holders of the Convertible Notes have certain resale
registration rights with respect to the Common Stock issuable upon conversion
of the Convertible Notes. The Company has agreed to file with the Commission a
registration statement on Form S-1 or Form S-3, if the use of that form is
then available, to cover resales of Common Stock issuable upon conversion of
the Convertible Notes. The Company will be permitted to prohibit offers and
sales of Common Stock issuable upon conversion of the Convertible Notes
pursuant to the shelf registration under certain circumstances and subject to
certain conditions. Telegroup has agreed to maintain the shelf registration
until the first to occur of (i) the second anniversary of the issue date of
the Convertible Notes or (ii) the day when no security covered by the shelf
registration remains a Transfer Restricted Security (as defined).
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DESCRIPTION OF OTHER INDEBTEDNESS
SENIOR DISCOUNT NOTES
The Senior Discount Notes were issued under an Indenture dated October 23,
1997. The terms of the Notes include those stated in the Indenture and those
made part of the Indenture by reference to the Trust Indenture Act of 1939, as
amended (the "Trust Indenture Act"), as in effect on the date of the
Indenture. The following summary of the material provisions of the Notes does
not purport to be complete and is subject to, and qualified in its entirety by
reference to, the provisions of the Indenture (a copy of which is available,
upon request, from the Company), including the definitions of certain terms
contained therein and those terms made part of the Indenture by reference to
the Trust Indenture Act, as in effect on the date of the Indenture. The
definitions of certain capitalized terms used in the following summary are set
forth below under "--Certain Definitions." For purposes of this description of
the Senior Discount Notes, the "Company" means Telegroup, Inc. and excludes
its Subsidiaries.
GENERAL
The Senior Discount Notes are unsecured unsubordinated obligations of the
Company. The Senior Discount Notes will rank senior to all existing and future
subordinated Indebtedness of the Company, and pari passu with all unsecured
Indebtedness of the Company which is not by its terms expressly subordinated
to the Senior Discount Notes. As of September 30, 1997, after giving pro forma
effect to the offering of the Old and the transactions described herein, the
Company would have had $25.0 million of Indebtedness outstanding ranking
subordinate to the Senior Discount Notes. The Senior Discount Notes will be
effectively subordinated to all secured Indebtedness of the Company to the
extent of the value of the assets securing such Indebtedness.
The Senior Discount Notes will be issued only in registered form, without
coupons, in principal denominations of $1,000 and integral multiples thereof.
Principal of, premium, if any, and interest on the Senior Discount Notes will
be payable, and the Senior Discount Notes will be transferable, at the office
of the Company's agent in the City of New York located at the corporate trust
office of the Trustee. In addition, cash interest may be paid at the option of
the Company, by check mailed to the person entitled thereto as shown on the
security register. No service charge will be made for any transfer, exchange
or redemption of Senior Discount Notes, except in certain circumstances for
any tax or other governmental charge that may be imposed in connection
therewith. Initially, the Trustee will act as paying agent and registrar for
the Senior Discount Notes. The Company may change any paying agent and
registrar without notice to the holders.
MATURITY, INTEREST AND PRINCIPAL
The Senior Discount Notes are limited to an aggregate principal amount at
maturity of $150,000,000 and will mature on November 1, 2004. Cash interest on
the Senior Discount Notes will neither accrue nor be payable prior to May 1,
2000. Thereafter, cash interest will accrue at a rate of 10 1/2% per annum and
will be payable semi-annually on each May 1, and November 1, commencing on
November 1, 2000, to the persons who are registered Noteholders at the close
of business on the April 15 and October 15 immediately preceding the
applicable interest payment date. Interest will be computed on the basis of a
360-day year comprised of twelve 30-day months.
The Senior Discount Notes will not be entitled to the benefit of any
mandatory sinking fund.
OPTIONAL REDEMPTION
The Indenture will provide that the Senior Discount Notes will not be
redeemable prior to November 1, 2001. On and after November 1, 2001 the Senior
Discount Notes will be redeemable, at the option of the Company, in whole or
in part, on not less than 30 nor more than 60 days' prior notice, at the
redemption prices (expressed as percentages of the principal amount) set forth
below, plus accrued and unpaid interest, if any, to
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the redemption date if redeemed during the 12-month period beginning on
November 1 of the years indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
---- ----------
<S> <C>
2001............................................................ 105.25%
2002............................................................ 103.50%
2003............................................................ 101.75%
</TABLE>
The Indenture will provide that in the event that on or prior to November 1,
2000, the Company consummates one or more public offerings of its Common
Stock, the Company may, at its option, redeem from the net proceeds of such
public offerings of the Company's Common Stock no later than 60 days following
the consummation of such offerings up to 33% of the aggregate principal amount
at maturity of the Senior Discount Notes originally issued at a redemption
price equal to 110.5% of the Accreted Value on the date of redemption of the
Senior Discount Notes so redeemed plus accrued and unpaid interest, if any;
provided, however, that immediately after giving effect to any such
redemption, not less than 66.0% of the aggregate principal amount at maturity
of the Senior Discount Notes originally issued remains outstanding.
CHANGE OF CONTROL
Upon the occurrence of a Change of Control, the Company shall be obligated
to make an offer to purchase (a "Change of Control Offer"), and shall
purchase, on a business day (the "Change of Control Purchase Date") not more
than 60 nor less than 30 days following the occurrence of the Change of
Control, all of the then outstanding Senior Discount Notes at a purchase price
(the "Change of Control Purchase Price") equal to 101% of the Accreted Value
thereof on the Change of Control Purchase Date plus accrued and unpaid
interest, if any, to the Change of Control Purchase Date. The Company shall be
required to purchase all Senior Discount Notes properly tendered into the
Change of Control Offer and not withdrawn. The Change of Control Offer is
required to remain open for at least 20 business days and until the close of
business on the Change of Control Purchase Date.
In order to effect such Change of Control Offer, the Company shall, not
later than the 30th day after the occurrence of the Change of Control, mail to
each holder of Senior Discount Notes notice of the Change of Control Offer,
which notice shall govern the terms of the Change of Control Offer and shall
state, among other things, the procedures that holders of Senior Discount
Notes must follow to accept the Change of Control Offer.
The Company shall not be required to make a Change of Control Offer upon a
Change of Control if a third party makes the Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements
applicable to a Change of Control Offer made by the Company and purchases all
Senior Discount Notes validly tendered and not withdrawn under such Change of
Control Offer.
The Company will comply with Rule 14e-1 under the Exchange Act and any other
securities laws and regulations thereunder to the extent such laws and
regulations are applicable, in the event that a Change of Control occurs and
the Company is required to purchase Senior Discount Notes as described above.
SELECTION AND NOTICE
The Indenture will provide that in the event that less than all of the
Senior Discount Notes are to be redeemed at any time, selection of such Senior
Discount Notes for redemption will be made by the Trustee pro rata, by a lot
or by such method as the Trustee shall deem fair and appropriate. No Senior
Discount Notes of a principal amount of $1,000 or less shall be redeemed in
part. Notice of redemption shall be mailed by first-class mail at least 30 but
not more than 60 days before the redemption date to each holder of Senior
Discount Notes to be redeemed at its registered address. If any Note is to be
redeemed in part only, the notice of redemption that relates to such Note
shall state the portion of the principal amount thereof to be redeemed. A new
Note in a principal amount equal to the unredeemed portion thereof will be
issued in the name of the Noteholder thereof
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upon surrender for cancellation of the original Note. On and after the
redemption date, interest will cease to accrue and original issue discount
will cease to accrete, as the case may be, on Senior Discount Notes or
portions thereof called for redemption, unless the Company defaults in the
payment of the redemption price therefor.
CERTAIN COVENANTS
The Indenture will contain the following covenants, among others:
Limitation on Indebtedness. The Company will not, and will not permit any of
its Subsidiaries to, directly or indirectly, create, incur, issue, assume,
guarantee or in any manner become directly or indirectly liable, contingently
or otherwise, for the payment of (in each case, to "incur") any Indebtedness
(including, without limitation, any Acquired Indebtedness); provided, however,
that the Company will be permitted to incur Indebtedness (including, without
limitation, Acquired Indebtedness) and any Subsidiary will be permitted to
incur Acquired Indebtedness, if immediately thereafter the ratio of (i) the
aggregate principal amount (or accreted value, as the case may be) of
Indebtedness of the Company and its Subsidiaries on a consolidated basis
outstanding as of the Transaction Date to (ii) the Pro Forma Consolidated Cash
Flow for the preceding two fiscal quarters multiplied by two, determined on a
pro forma basis as if any such Indebtedness had been incurred and the proceeds
thereof had been applied at the beginning of such two fiscal quarters, would
be greater than zero and less than 5.0 to 1.
Notwithstanding the foregoing, the Company and its Subsidiaries may, to the
extent specifically set forth below, incur each and all of the following (each
of which will be given independent effect):
(a) Indebtedness of the Company evidenced by the Senior Discount Notes
and issued on the Issue Date;
(b) Indebtedness of the Company and its Subsidiaries outstanding on the
Issue Date;
(c) Indebtedness, including Acquired Indebtedness, in an aggregate
principal amount at any one time outstanding not to exceed $25 million;
(d) Indebtedness (other than Acquired Indebtedness) incurred to finance
the cost (including the cost of design, development, construction,
acquisition, installation or integration) of equipment used in the
telecommunications business or ownership rights with respect to
indefeasible rights of use or minimum investment units (or similar
ownership interests) in transnational fiber optic cable or other
transmission facilities, in each case purchased or leased by the Company or
a Subsidiary after the Issue Date;
(e) Indebtedness of the Company or any Subsidiary (A) in respect of
performance, surety or appeal bonds or letters of credit supporting trade
payables, in each case provided in the ordinary course of business, (B)
under Currency Agreements and Interest Rate Protection Agreements; provided
that such agreements do not increase the Indebtedness of the obligor
outstanding at any time other than as a result of fluctuations in foreign
currency exchange rates or interest rates or by reason of fees, indemnities
and compensation payable thereunder; and (C) arising from agreements
providing for indemnification, adjustment of purchase price or similar
obligations, or from guarantees or letters of credit, surety bonds or
performance bonds securing any obligations of the Company or any of its
Subsidiaries pursuant to such agreements, in any case incurred in
connection with the disposition of any business, assets or Subsidiary of
the Company (other than guarantees of Indebtedness incurred by any Person
acquiring all or any portion of such business, assets or Subsidiary for the
purpose of financing such acquisition), in a principal amount not to exceed
the gross proceeds actually received by the Company or any Subsidiary in
connection with such disposition;
(f) Indebtedness of a Wholly-Owned Subsidiary owed to and held by the
Company or another Wholly-Owned Subsidiary, in each case which is not
subordinated in right of payment to any Indebtedness of such Wholly-Owned
Subsidiary, except that any transfer of such Indebtedness by the Company or
a Wholly-Owned Subsidiary (other than to the Company or to a Wholly-Owned
Subsidiary) or any event which results in any such Wholly-Owned Subsidiary
ceasing to be a Wholly-Owned Subsidiary shall, in each case, be an
incurrence of Indebtedness by such Wholly-Owned Subsidiary subject to the
other provisions of this covenant;
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(g) Indebtedness of the Company owed to and held by a Wholly-Owned
Subsidiary of the Company which is unsecured and subordinated in right of
payment to the payment and performance of the Company's obligations under
the Indenture and the Senior Discount Notes except that any transfer of
such Indebtedness by a Wholly-Owned Subsidiary of the Company (other than
to another Wholly-Owned Subsidiary of the Company) or any event which
results in any such Wholly-Owned Subsidiary ceasing to be a Wholly-Owned
Subsidiary shall, in each case, be an incurrence of Indebtedness by the
Company subject to the other provisions of this covenant;
(h) Indebtedness of (x) the Company not to exceed, at any one time
outstanding, 1.75 times the net cash proceeds (less the amount of such
proceeds applied as provided in clause (ii) or (iii) of the second
paragraph of the "Limitation on Restricted Payments" covenant) received by
the Company after the Issue Date from the issuance and sale of its Common
Stock to a Person that is not a Subsidiary of the Company and (y) the
Company or Acquired Indebtedness of a Subsidiary not to exceed, at one time
outstanding, 1.5 times the Fair Market Value of any Common Stock of the
Company issued after the Issue Date as consideration for an Asset
Acquisition in the Company's line of business; provided that, in any such
case, such Indebtedness (other than Acquired Indebtedness) matures after
the Stated Maturity of the Senior Discount Notes and has an Average Life to
Stated Maturity longer than the Senior Discount Notes;
(i) Indebtedness of the Company, to the extent that the net proceeds
thereof are promptly (A) used to repurchase Senior Discount Notes tendered
in an Change of Control Offer or (B) deposited to defease all of the Senior
Discount Notes as described below under "Defeasance or Covenant Defeasance
of Indenture";
(j) Indebtedness of a Subsidiary represented by a guarantee of the Senior
Discount Notes permitted by and made in accordance with the "Limitation on
Issuances of Guarantees of Indebtedness by Subsidiaries" covenant;
(k) Indebtedness of the Company or any Subsidiary under one or more
Credit Facilities, provided that if any Indebtedness is incurred pursuant
to this clause (k), total Indebtedness under this clause (k) and clause (c)
above does not exceed at any one time outstanding an amount equal to the
sum of (x) 65% of Eligible Accounts receivable and (y) without duplication
of amounts included in the previous clause (x), 30% of the Company's
unbilled, domestic unencumbered accounts receivable; and
(l) (i) Indebtedness of the Company the proceeds of which are used solely
to refinance (whether by amendment, renewal, extension or refunding)
Indebtedness of the Company or any of its Subsidiaries and (ii)
Indebtedness of any Subsidiary of the Company the proceeds of which are
used solely to refinance (whether by amendment, renewal, extension or
refunding) Indebtedness of such Subsidiary, in each case other than the
Indebtedness incurred under clause (c) through (k) of this covenant (which
clauses provide for the refinancing of Indebtedness incurred thereunder);
provided, however, that (x) the principal amount of Indebtedness incurred
pursuant to this clause (l) (or, if such Indebtedness provides for an
amount less than the principal amount thereof to be due and payable upon a
declaration of acceleration of the maturity thereof, the original issue
price of such Indebtedness) shall not exceed the sum of the principal
amount of Indebtedness so refinanced, plus the amount of any premium
required to be paid in connection with such refinancing pursuant to the
terms of such Indebtedness or the amount of any premium reasonably
determined by the Board of Directors of the Company as necessary to
accomplish such refinancing by means of a tender offer or privately
negotiated purchase, plus the amount of expenses in connection therewith,
(y) in the case of Indebtedness incurred by the Company pursuant to this
clause (l) to refinance Subordinated Indebtedness, such Indebtedness (A)
has an Average Life to Stated Maturity greater than the remaining Average
Life to Stated Maturity of the Indebtedness being refinanced and (B) is
expressly subordinated to the Senior Discount Notes in the same manner and
to the same extent that the Subordinated Indebtedness being refinanced is
subordinated to the Senior Discount Notes and (z) in the case of
Indebtedness incurred by the Company pursuant to this clause (l) to
refinance Pari Passu Indebtedness, such Indebtedness (A) has an Average
Life to Stated Maturity greater than the remaining Average Life to Stated
Maturity of the Indebtedness being refinanced and (B) constitutes Pari
Passu Indebtedness or Subordinated Indebtedness.
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For purposes of determining any particular amount of Indebtedness under this
"Limitation on Indebtedness" covenant, guarantees, Liens or obligations with
respect to letters of credit supporting Indebtedness otherwise included in the
determination of such particular amount shall not be included. For purposes of
determining compliance with this "Limitation on Indebtedness" covenant, (A) in
the event that an item of Indebtedness meets the criteria of more than one of
the types of Indebtedness described in the above clauses, the Company, in its
sole discretion, shall classify such item of Indebtedness and only be required
to include the amount and type of such Indebtedness in one of such clauses and
(B) the principal amount of Indebtedness issued at a price that is less than
the principal amount thereof shall be equal to the amount of the liability in
respect thereof determined in conformity with GAAP.
Limitation on Restricted Payments. The Company will not, and will not permit
any of its Subsidiaries to, directly or indirectly:
(a) declare or pay any dividend or make any other distribution or payment
on or in respect of Capital Stock of the Company or any of its Subsidiaries
or any payment made to the direct or indirect holders (in their capacities
as such) of Capital Stock of the Company or any of its Subsidiaries (other
than (x) dividends or distributions payable solely in Capital Stock of the
Company (other than Redeemable Capital Stock) or in options, warrants or
other rights to purchase Capital Stock of the Company (other than
Redeemable Capital Stock), (y) the declaration or payment of dividends or
other distributions to the extent declared or paid to the Company or any
Subsidiary of the Company and (z) the declaration or payment of dividends
or other distributions by any Subsidiary of the Company to all holders of
Common Stock of such Subsidiary on a pro rata basis),
(b) purchase, redeem, defease or otherwise acquire or retire for value
any Capital Stock of the Company or any of its Subsidiaries (other than any
such Capital Stock owned by a Wholly-Owned Subsidiary of the Company),
(c) make any principal payment on, or purchase, defease, repurchase,
redeem or otherwise acquire or retire for value, prior to any scheduled
maturity, scheduled repayment, scheduled sinking fund payment or other
Stated Maturity, any Subordinated Indebtedness (other than any such
Indebtedness owned by the Company or a Wholly-Owned Subsidiary of the
Company), or
(d) make any Investment (other than any Permitted Investment) in any
person (such payments or Investments described in the preceding clauses
(a), (b), (c) and (d) are collectively referred to as "Restricted
Payments"), unless, at the time of and after giving effect to the proposed
Restricted Payment (the amount of any such Restricted Payment, if other
than cash, shall be the Fair Market Value on the date of such Restricted
Payment of the asset(s) proposed to be transferred by the Company or such
Subsidiary, as the case may be, pursuant to such Restricted Payment), (A)
no Default or Event of Default shall have occurred and be continuing, (B)
immediately prior to and after giving effect to such Restricted Payment,
the Company would be able to incur $1.00 of additional Indebtedness
pursuant to the first paragraph of the covenant described under "--
Limitation on Indebtedness" above (assuming a market rate of interest with
respect to such additional Indebtedness) and (C) the aggregate amount of
all Restricted Payments declared or made from and after the Issue Date
would not exceed the sum of (1) the remainder of (a) 100% of the aggregate
amount of the Consolidated Cash Flow accrued on a cumulative basis during
the period (taken as one accounting period) beginning on the first day of
the last fiscal quarter immediately preceding the Issue Date and ending on
the last day of the last fiscal quarter preceding the date of such proposed
Restricted Payment minus (b) the product of 2.00 times cumulative
Consolidated Fixed Charges accrued on a cumulative basis during the period
(taken as one accounting period) beginning on the first day of the last
fiscal quarter immediately preceding the Issue Date and ending on the last
day of the last fiscal quarter preceding the date of such proposed
Restricted Payment plus (2) the aggregate net cash proceeds received by the
Company after the Issue Date from the issuance and sale permitted by the
Indenture of its Capital Stock (other than Redeemable Capital Stock) to a
Person who is not a Subsidiary of the Company (except to the extent such
net cash proceeds are used to incur new Indebtedness outstanding pursuant
to clause (h) of the second paragraph of the "Limitation on Indebtedness"
Covenant) plus (3) the aggregate net cash proceeds received
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after the Issue Date by the Company from the issuance or sale of debt
securities that have been converted into or exchanged for Capital Stock of
the Company (other than Redeemable Capital Stock) together with the
aggregate cash received by the Company at the time of such conversion or
exchange plus (4) without duplication of any amount included in the
calculation of Consolidated Cash Flow, in the case of repayment of, or
return of capital in respect of, any Investment constituting a Restricted
Payment made after the Issue Date, an amount equal to the lesser of the
return of capital with respect to such Investment and the cost of such
Investment, in either case less the cost of the disposition of such
Investment.
None of the foregoing provisions will prohibit (i) the payment of any
dividend within 60 days after the date of its declaration, if at the date of
declaration such payment would be permitted by the foregoing paragraph; (ii)
so long as no Default or Event of Default shall have occurred and be
continuing, the redemption, repurchase or other acquisition or retirement of
any shares of any class of Capital Stock of the Company or any Subsidiary of
the Company in exchange for, or out of the net cash proceeds of, a
substantially concurrent (x) capital contribution to the Company from any
person (other than a Subsidiary of the Company) or (y) issue and sale of other
shares of Capital Stock (other than Redeemable Capital Stock) of the Company
to any person (other than to a Subsidiary of the Company); provided, however,
that the amount of any such net cash proceeds that are utilized for any such
redemption, repurchase or other acquisition or retirement shall be excluded
from clause (C)(2) and (3) of the preceding paragraph; (iii) so long as no
Default or Event of Default shall have occurred and be continuing, any
redemption, repurchase or other acquisition or retirement of Subordinated
Indebtedness by exchange for, or out of the net cash proceeds of, a
substantially concurrent (x) capital contribution to the Company from any
person (other than a Subsidiary of the Company) or (y) issue and sale of (1)
Capital Stock (other than Redeemable Capital Stock) of the Company to any
person (other than to a Subsidiary of the Company); provided, however, that
the amount of any such net cash proceeds that are utilized for any such
redemption, repurchase or other acquisition or retirement shall be excluded
from clause (C)(2) and (3) of the preceding paragraph; or (2) Indebtedness of
the Company issued to any person (other than a Subsidiary of the Company), so
long as such Indebtedness is Subordinated Indebtedness which (x) has no Stated
Maturity earlier than the 91st day after the Final Maturity Date of the Senior
Discount Notes, (y) has an Average Life to Stated Maturity equal to or greater
than the remaining Average Life to Stated Maturity of the Senior Discount
Notes and (z) is subordinated to the Senior Discount Notes in the same manner
and at least to the same extent as the Subordinated Indebtedness so purchased,
exchanged, redeemed, acquired or retired; (iv) Investments constituting
Restricted Payments made as a result of the receipt of non-cash consideration
from any Asset Sale made pursuant to and in compliance with the covenant
described under "--Disposition of Proceeds of Asset Sales" below; (v) so long
as no Default or Event of Default has occurred and is continuing, repurchases
by the Company of Common Stock of the Company from employees of the Company or
any of its Subsidiaries or their authorized representatives upon the death,
disability or termination of employment of such employees, in an aggregate
amount not exceeding $1,000,000 in any calendar year; (vi) Investments in
persons other than Subsidiaries at any one time outstanding (measured on the
date each such Investment was made without giving effect to subsequent changes
in value) not to exceed $20 million in the aggregate provided that such
persons primary business is related, ancillary or complementary to the
business of the Company and its Subsidiaries on the date of such Investment;
and (vii) Investments in any person at any one time outstanding (measured on
the date each such Investment was made without giving effect to subsequent
changes in value) in an aggregate amount not to exceed 5.0% of the Company's
total consolidated assets. In computing the amount of Restricted Payments
previously made for purposes of clause (C) of the preceding paragraph,
Restricted Payments made under the preceding clauses (v), (vi) and (vii) shall
be included and clauses (i), (ii), (iii) and (iv) shall not be so included.
Limitation on Liens. The Company will not, and will not permit any of its
Subsidiaries to, create, incur, assume or suffer to exist any Liens of any
kind against or upon any of its property or assets, or any proceeds therefrom,
unless (x) in the case of Liens securing Subordinated Indebtedness, the Senior
Discount Notes are secured by a Lien on such property, assets or proceeds that
is senior in priority to such Liens and (y) in all other cases, the Senior
Discount Notes are equally and ratably secured, except for (a) Liens existing
as of the Issue Date; (b) Liens securing the Senior Discount Notes; (c) Liens
securing Indebtedness under Credit Facilities incurred in compliance with
clauses (k) and (c) of the second paragraph of the "Limitation on
Indebtedness"
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covenant; (d) Liens on the Company's headquarters and other business premises
securing Indebtedness in an aggregate principal amount not to exceed $10
million; (e) Liens in favor of the Company or any Subsidiary; (f) Liens
securing Indebtedness which is incurred to refinance Indebtedness which has
been secured by a Lien permitted under the Indenture and which has been
incurred in accordance with the provisions of the Indenture; provided,
however, that such Liens do not extend to or cover any property or assets of
the Company or any of its Subsidiaries not securing the Indebtedness so
refinanced; and (g) Permitted Liens.
Disposition of Proceeds of Asset Sales. The Company will not, and will not
permit any of its Subsidiaries to, make any Asset Sale unless (a) the Company
or such Subsidiary, as the case may be, receives consideration at the time of
such Asset Sale at least equal to the Fair Market Value of the shares or
assets sold or otherwise disposed of and (b) at least 80% of such
consideration consists of cash or Cash Equivalents. To the extent the Net Cash
Proceeds of any Asset Sale are not used to permanently repay unsubordinated
Indebtedness of the Company or Indebtedness of any Subsidiary, in each case
owing to a person other than the Company or any of its Subsidiaries, the
Company or such Subsidiary, as the case may be, may, within 180 days of such
Asset Sale, apply such Net Cash Proceeds to an investment in properties and
assets that replace the properties and assets that were the subject of such
Asset Sale or in properties and assets that will be used in the business of
the Company and its Subsidiaries existing on the Issue Date or in businesses
reasonably related thereto ("Replacement Assets"). Any Net Cash Proceeds from
any Asset Sale that are neither used to repay, and permanently reduce any
commitments under such unsubordinated Indebtedness of the Company or
Indebtedness of a Subsidiary nor invested in Replacement Assets within the 180
period described above constitute "Excess Proceeds" subject to disposition as
provided below.
When the aggregate amount of Excess Proceeds equals or exceeds $10,000,000,
the Company shall make an offer to purchase (an "Asset Sale Offer"), from all
holders of the Senior Discount Notes, not more than 40 Business Days
thereafter, an aggregate principal amount of Senior Discount Notes equal to
such Excess Proceeds, at a price in cash equal to 100% of the outstanding
principal amount thereof plus accrued and unpaid interest, if any, to the
purchase date. To the extent that the aggregate principal amount of Senior
Discount Notes tendered pursuant to an Asset Sale Offer is less than the
Excess Proceeds, the Company may use such deficiency for general corporate
purposes. If the aggregate principal amount of Senior Discount Notes validly
tendered and not withdrawn by holders thereof exceeds the Excess Proceeds,
Senior Discount Notes to be purchased will be selected on a pro rata basis.
Upon completion of such Asset Sale Offer, the amount of Excess Proceeds shall
be reset to zero.
The Company will comply with Rule 14e-1 under the Exchange Act and any other
securities laws and regulations thereunder to the extent such laws and
regulations are applicable, in the event that an Asset Sale occurs and the
Company is required to purchase Senior Discount Notes as described above.
Limitation on Issuances and Sale of Preferred Stock by Subsidiaries. The
Company (a) will not permit any of its Subsidiaries to issue any Preferred
Stock (other than to the Company or a Wholly-Owned Subsidiary of the Company)
and (b) will not permit any person (other than the Company or a Wholly-Owned
Subsidiary of the Company) to own any Preferred Stock of any Subsidiary of the
Company; provided, however, that this covenant shall not prohibit the issuance
and sale of (x) all, but not less than all, of the issued and outstanding
Capital Stock of any Subsidiary of the Company owned by the Company or any of
its Subsidiaries in compliance with the other provisions of the Indenture or
(y) directors' qualifying shares or investments by foreign nationals mandated
by applicable law.
Limitation on Issuances of Guarantees of Indebtedness by Subsidiaries. The
Company will not permit any Subsidiary, directly or indirectly, to guarantee,
assume or in any other manner become liable with respect to any Indebtedness
of the Company, other than Indebtedness under Credit Facilities incurred under
clauses (c) and (l) in the "Limitation on Indebtedness" covenant, unless (i)
such Subsidiary simultaneously executes and delivers a supplemental indenture
to the Indenture providing for a guarantee of the Senior Discount Notes on
terms substantially similar to the guarantee of such Indebtedness, except that
if such Indebtedness is by its express terms subordinated in right of payment
to the Senior Discount Notes, any such assumption, guarantee or other
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liability of such Subsidiary with respect to such Indebtedness shall be
subordinated in right of payment to such Subsidiary's assumption, guarantee or
other liability with respect to the Senior Discount Notes substantially to the
same extent as such Indebtedness is subordinated to the Senior Discount Notes
and (ii) such Subsidiary waives, and will not in any manner whatsoever claim
or take the benefit or advantage of, any rights of reimbursement, indemnity or
subrogation or any rights against the Company or any other Subsidiary as a
result of any payment by such Subsidiary under its guarantee.
Notwithstanding the foregoing, any guarantee by a Subsidiary may provide by
its terms that it will be automatically and unconditionally released and
discharged upon (i) any sale, exchange or transfer, to any person not an
Affiliate of the Company, of all of the Company's and each Subsidiary's
Capital Stock in, or all or substantially all of the assets of, such
Subsidiary (which sale, exchange or transfer is not prohibited by the
Indenture) or (ii) the release or discharge of the guarantee, which resulted
in the creation of such guarantee of the Senior Discount Notes, except a
discharge or release by or as a result of payment under such guarantee.
Limitation on Transactions with Interested Persons. The Company will not,
and will not permit any of its Subsidiaries to, directly or indirectly, enter
into or suffer to exist any transaction or series of related transactions
(including, without limitation, the sale, transfer, disposition, purchase,
exchange or lease of assets, property or services) with, or for the benefit
of, any Affiliate of the Company or any beneficial owner (determined in
accordance with the Indenture) of 5% or more of the Company's Common Stock at
any time outstanding ("Interested Persons"), unless (a) such transaction or
series of related transactions is on terms that are no less favorable to the
Company or such Subsidiary, as the case may be, than those which could have
been obtained in a comparable transaction at such time from persons who are
not Affiliates of the Company or Interested Persons, (b) with respect to a
transaction or series of transactions involving aggregate payments or value
equal to or greater than $10,000,000, the Company has obtained a written
opinion from an Independent Financial Advisor stating that the terms of such
transaction or series of transactions are fair to the Company or its
Subsidiary, as the case may be, from a financial point of view and (c) with
respect to a transaction or series of transactions involving aggregate
payments or value equal to or greater than $2,000,000, the Company shall have
delivered an officer's certificate to the Trustee certifying that such
transaction or series of transactions complies with the preceding clause (a)
and, if applicable, certifying that the opinion referred to in the preceding
clause (b) has been delivered and that such transaction or series of
transactions has been approved by a majority of the disinterested members of
the Board of Directors of the Company; provided, however, that this covenant
will not restrict the Company or any Subsidiary from (i) making any payment
permitted under the covenant described under "--Limitation on Restricted
Payments" above, (ii) paying reasonable and customary fees to directors of the
Company who are not employees of the Company, (iii) making loans or advances
to officers, employees or consultants of the Company and its Subsidiaries
(including travel and moving expenses) in the ordinary course of business for
bona fide business purposes of the Company or such Subsidiary not in excess of
$2,000,000 in the aggregate at any one time outstanding, (iv) entering into
any transaction between the Company and any of its Subsidiaries or between
Subsidiaries or (v) compensation arrangements with the Company's executive
officers.
Limitation on Dividends and Other Payment Restrictions Affecting
Subsidiaries. The Company will not, and will not permit any of its
Subsidiaries to, directly or indirectly, create or otherwise cause or suffer
to exist or become effective any encumbrance or restriction on the ability of
any Subsidiary of the Company to (a) pay dividends, in cash or otherwise, or
make any other distributions on or in respect of its Capital Stock or any
other interest or participation in, or measured by, its profits, (b) pay any
Indebtedness owed to the Company or any other Subsidiary of the Company, (c)
make loans or advances to, or any Investment in, the Company or any other
Subsidiary of the Company, (d) transfer any of its properties or assets to the
Company or any other Subsidiary of the Company or (e) guarantee any
Indebtedness of the Company or any other Subsidiary of the Company, except for
such encumbrances or restrictions existing under or by reason of (i)
applicable law, (ii) customary non-assignment provisions of any contract or
any lease governing a leasehold interest of the Company or any Subsidiary of
the Company, (iii) customary restrictions on transfers of property subject to
a Lien permitted under the Indenture, (iv) any agreement or other instrument
of a person acquired by the Company or any Subsidiary of the Company (or a
Subsidiary of such person) in existence at the time of such acquisition (but
not
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created in contemplation thereof), which encumbrance or restriction is not
applicable to any person, or the properties or assets of any person, other
than the person, or the properties or assets of the person, so acquired, (v)
provisions contained in agreements or instruments relating to Indebtedness
which prohibit the transfer of all or substantially all of the assets of the
obligor thereunder unless the transferee shall assume the obligations of the
obligor under such agreement or instrument, (vi) any such encumbrance or
restriction existing on the Issue Date in the Indenture or any other
agreements in effect on the Issue Date, and any extensions, refinancings,
renewals or replacements of such agreements; provided that the encumbrances
and restrictions in any such extensions, refinancings, renewals or
replacements are no less favorable in any material respect to the holders than
those encumbrances or restrictions that are then in effect and that are being
extended, refinanced, renewed or replaced; and (vii) contained in the terms of
any Indebtedness or any agreement pursuant to which such Indebtedness was
issued if the encumbrance or restriction applies only in the event of a
default with respect to a financial covenant contained in such Indebtedness or
agreement and such encumbrance or restriction is not materially more
disadvantageous to the holders of the Senior Discount Notes than is customary
in comparable financing (as determined by the Company) and the Company
determines that any such encumbrance or restriction will not materially affect
the Company's ability to make principal or interest payments on the Senior
Discount Notes. Nothing contained in this "Limitation on Dividend and Other
Payment Restrictions Affecting Subsidiaries" covenant shall prevent the
Company or any Subsidiary from (1) creating, incurring, assuming or suffering
to exist any Liens otherwise permitted in the "Limitation on Liens" covenant
or (2) restricting the sale or other disposition of property or assets of the
Company or any of its Subsidiaries that secure Indebtedness of the Company or
any of its Subsidiaries.
Limitation on Sale and Leaseback Transactions. Neither the Company nor any
Subsidiary will, directly or indirectly, enter into any Sale and Leaseback
Transaction, except that the Company or any Subsidiary may enter into a Sale
and Leaseback Transaction if (x) the aggregate Fair Market Value of all Sale
and Leaseback Transactions entered into by the Company and its Subsidiaries
after the Issue Date shall not involve property or assets having an aggregate
Fair Market Value of more than $20 million or (y) (i) immediately prior
thereto, and after giving effect to such Sale and Leaseback Transaction (the
Indebtedness thereunder being equivalent to the attributable Value thereof)
the Company could incur at least $1.00 of additional Indebtedness pursuant to
the first paragraph of the covenant described under "--Limitation on
Indebtedness" above and (ii) the Sale and Leaseback Transaction constitutes an
Asset Sale effected in accordance with the requirements of the covenant
described under "--Disposition of Proceeds of Asset Sales" above.
Reporting Requirements. The Company will file with the Commission the annual
reports, quarterly reports and other documents required to be filed with the
Commission pursuant to Sections 13 and 15 of the Exchange Act, whether or not
the Company has a class of securities registered under the Exchange Act. The
Company will be required to file with the Trustee and provide to each
Noteholder within 15 days after it files them with the Commission (or if any
such filing is not permitted under the Exchange Act, 15 days after the Company
would have been required to make such filing) copies of such reports and
documents.
MERGER, SALE OF ASSETS, ETC.
The Company will not, in any transaction or series of transactions, merge or
consolidate with or into, or sell, assign, convey, transfer, lease or
otherwise dispose of all or substantially all of its properties and assets as
an entirety to, any person or persons, and the Company will not permit any of
its Subsidiaries to enter into any such transaction or series of transactions
if such transaction or series of transactions, in the aggregate, would result
in a sale, assignment, conveyance, transfer, lease or other disposition of all
or substantially all of the properties and assets of the Company or the
Company and its Subsidiaries, taken as a whole, to any other person or
persons, unless at the time of and after giving effect thereto (a) either (i)
if the transaction or series of transactions is a merger or consolidation, the
Company shall be the surviving person of such merger or consolidation, or (ii)
the person formed by such consolidation or into which the Company or such
Subsidiary is merged or to which the properties and assets of the Company or
such Subsidiary, as the case may be, are transferred (any such surviving
person or transferee person being the "Surviving Entity") shall be a
corporation organized and existing under the laws of the United States of
America, any state thereof or the District of
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Columbia and shall expressly assume by a supplemental indenture executed and
delivered to the Trustee, in form reasonably satisfactory to the Trustee, all
the obligations of the Company under the Senior Discount Notes and the
Indenture, and in each case, the Indenture shall remain in full force and
effect; (b) immediately before and immediately after giving effect to such
transaction or series of transactions on a pro forma basis (including, without
limitation, any Indebtedness incurred or anticipated to be incurred in
connection with or in respect of such transaction or series of transactions),
no Default or Event of Default shall have occurred and be continuing and the
Company or the Surviving Entity, as the case may be, after giving effect to
such transaction or series of transactions on a pro forma basis (including,
without limitation, any Indebtedness incurred or anticipated to be incurred in
connection with or in respect of such transaction or series of transactions),
could incur $1.00 of additional Indebtedness pursuant to the first paragraph
of the covenant described under "--Limitation on Indebtedness" above (assuming
a market rate of interest with respect to such additional Indebtedness); and
(c) immediately after giving effect to such transaction or series of
transactions on a pro forma basis (including, without limitation, any
Indebtedness incurred or anticipated to be incurred in connection with or in
respect of such transaction or series of transactions), the Consolidated Net
Worth of the Company or the Surviving Entity, as the case may be, is at least
equal to the Consolidated Net Worth of the Company immediately before such
transaction or series of transactions.
In connection with any consolidation, merger, transfer, lease, assignment or
other disposition contemplated hereby, the Company shall deliver, or cause to
be delivered, to the Trustee, in form and substance reasonably satisfactory to
the Trustee, an officer's certificate and an opinion of counsel, each stating
that such consolidation, merger, transfer, lease, assignment or other
disposition and the supplemental indenture in respect thereof comply with the
requirements under the Indenture; provided, however, that solely for purposes
of computing amounts described in subclause (C) of the covenant described
under "--Limitation on Restricted Payments" above, any such successor person
shall only be deemed to have succeeded to and be substituted for the Company
with respect to periods subsequent to the effective time of such merger,
consolidation or transfer of assets.
Upon any consolidation or merger or any transfer of all or substantially all
of the assets of the Company in accordance with the foregoing, in which the
Company is not the continuing corporation, the successor corporation formed by
such a consolidation or into which the Company is merged or to which such
transfer is made shall succeed to, and be substituted for, and may exercise
every right and power of, the Company under the Indenture with the same effect
as if such successor corporation had been named as the Company therein.
EVENTS OF DEFAULT
The following will be "Events of Default" under the Indenture:
(i) default in the payment of the principal of or premium, if any, on any
Note when the same becomes due and payable (upon Stated Maturity,
acceleration, optional redemption, required purchase, scheduled principal
payment or otherwise); or
(ii) default in the payment of an installment of interest on any of the
Senior Discount Notes, when the same becomes due and payable, which default
continues for a period of 30 days; or
(iii) failure to perform or observe any other term, covenant or agreement
contained in the Senior Discount Notes or the Indenture (other than a
default specified in clause (i) or (ii) above) and such default continues
for a period of 30 days after written notice of such default requiring the
Company to remedy the same shall have been given (x) to the Company by the
Trustee or (y) to the Company and the Trustee by holders of 25% in
aggregate principal amount of the Senior Discount Notes then outstanding;
or
(iv) default or defaults under one or more agreements, instruments,
mortgages, bonds, debentures or other evidences of Indebtedness under which
the Company or any Subsidiary of the Company then has outstanding
Indebtedness in excess of $10,000,000, individually or in the aggregate,
and either (a) such Indebtedness is already due and payable in full or (b)
such default or defaults have resulted in the acceleration of the maturity
of such Indebtedness; or
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(v) one or more judgments, orders or decrees of any court or regulatory
or administrative agency of competent jurisdiction for the payment of money
in excess of $10,000,000, either individually or in the aggregate, shall be
entered against the Company or any Subsidiary of the Company or any of
their respective properties and shall not be discharged or fully bonded and
there shall have been a period of 60 days after the date on which any
period for appeal has expired and during which a stay of enforcement of
such judgment, order or decree shall not be in effect; or
(vi) certain events of bankruptcy, insolvency or reorganization with
respect to the Company or any Significant Subsidiary of the Company shall
have occurred.
If an Event of Default (other than as specified in clause (vi) above) shall
occur and be continuing, the Trustee, by notice to the Company, or the holders
of at least 25% in aggregate principal amount of the Senior Discount Notes
then outstanding, by notice to the Trustee and the Company, may declare the
principal of, premium, if any, and accrued and unpaid interest, if any, on all
of the outstanding Senior Discount Notes due and payable immediately, upon
which declaration, all amounts payable in respect of the Senior Discount Notes
shall be immediately due and payable. If an Event of Default specified in
clause (vi) above occurs and is continuing, then the principal of, premium, if
any, and accrued and unpaid interest, if any, on all of the outstanding Senior
Discount Notes shall ipso facto become and be immediately due and payable
without any declaration or other act on the part of the Trustee or any holder
of Senior Discount Notes.
After a declaration of acceleration under the Indenture, but before a
judgment or decree for payment of the money due has been obtained by the
Trustee, the holders of a majority in aggregate principal amount of the
outstanding Senior Discount Notes, by written notice to the Company and the
Trustee, may rescind such declaration if (a) the Company has paid or deposited
with the Trustee a sum sufficient to pay (i) all sums paid or advanced by the
Trustee under the Indenture and the reasonable compensation, expenses,
disbursements and advances of the Trustee, its agents and counsel, (ii) all
overdue interest on all Senior Discount Notes, (iii) the principal of and
premium, if any, on any Senior Discount Notes which have become due otherwise
than by such declaration of acceleration and interest thereon at the rate
borne by the Senior Discount Notes, and (iv) to the extent that payment of
such interest is lawful, interest upon overdue interest and overdue principal
at the rate borne by the Senior Discount Notes which has become due otherwise
than by such declaration of acceleration; (b) the rescission would not
conflict with any judgment or decree of a court of competent jurisdiction; and
(c) all Events of Default, other than the non-payment of principal of,
premium, if any, and interest on the Senior Discount Notes that have become
due solely by such declaration of acceleration, have been cured or waived.
The holders of not less than a majority in aggregate principal amount of the
outstanding Senior Discount Notes may on behalf of the holders of all the
Senior Discount Notes waive any past defaults under the Indenture, except a
default in the payment of the principal of, premium, if any, or interest on
any Note, or in respect of a covenant or provision which under the Indenture
cannot be modified or amended without the consent of the holder of each Note
outstanding.
No holder of any of the Senior Discount Notes has any right to institute any
proceeding with respect to the Indenture or the Senior Discount Notes or any
remedy thereunder, unless the holders of at least 25% in aggregate principal
amount of the outstanding Senior Discount Notes have made written request, and
offered reasonable indemnity, to the Trustee to institute such proceeding as
Trustee under the Senior Discount Notes and the Indenture, the Trustee has
failed to institute such proceeding within 30 days after receipt of such
notice and the Trustee, within such 30-day period, has not received directions
inconsistent with such written request by holders of a majority in aggregate
principal amount of the outstanding Senior Discount Notes. Such limitations do
not apply, however, to a suit instituted by a holder of a Note for the
enforcement of the payment of the principal of, premium, if any, or interest
on such Note on or after the respective due dates expressed in such Note.
During the existence of an Event of Default, the Trustee is required to
exercise such rights and powers vested in it under the Indenture and use the
same degree of care and skill in its exercise thereof as a prudent person
would exercise under the circumstances in the conduct of such person's own
affairs. Subject to the
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provisions of the Indenture relating to the duties of the Trustee, whether or
not an Event of Default shall occur and be continuing, the Trustee under the
Indenture is not under any obligation to exercise any of its rights or powers
under the Indenture at the request or direction of any of the holders unless
such holders shall have offered to the Trustee reasonable security or
indemnity. Subject to certain provisions concerning the rights of the Trustee,
the holders of not less than a majority in aggregate principal amount of the
outstanding Senior Discount Notes have the right to direct the time, method
and place of conducting any proceeding for any remedy available to the
Trustee, or exercising any trust or power conferred on the Trustee under the
Indenture.
If a Default or an Event of Default occurs and is continuing and is known to
the Trustee, the Trustee shall mail to each holder of the Senior Discount
Notes notice of the Default or Event of Default within 30 days after obtaining
knowledge thereof. Except in the case of a Default or an Event of Default in
payment of principal of, premium, if any, or interest on any Senior Discount
Notes, the Trustee may withhold the notice to the holders of such Senior
Discount Notes if a committee of its trust officers in good faith determines
that withholding the notice is in the interest of the holders of the Senior
Discount Notes.
The Company is required to furnish to the Trustee annual and quarterly
statements as to the performance by the Company of its obligations under the
Indenture and as to any default in such performance. The Company is also
required to notify the Trustee within ten days of any event which is, or after
notice or lapse of time or both would become, an Event of Default.
DEFEASANCE OR COVENANT DEFEASANCE OF INDENTURE
The Company may, at its option and at any time, terminate the obligations of
the Company with respect to the outstanding Senior Discount Notes
("defeasance"). Such defeasance means that the Company shall be deemed to have
paid and discharged the entire Indebtedness represented by the outstanding
Senior Discount Notes, except for (i) the rights of holders of outstanding
Senior Discount Notes to receive payment in respect of the principal of,
premium, if any, and interest on such Senior Discount Notes when such payments
are due, (ii) the Company's obligations to issue temporary Senior Discount
Notes, register the transfer or exchange of any Senior Discount Notes, replace
mutilated, destroyed, lost or stolen Senior Discount Notes and maintain an
office or agency for payments in respect of the Senior Discount Notes, (iii)
the rights, powers, trusts, duties and immunities of the Trustee, and (iv) the
defeasance provisions of the Indenture. In addition, the Company may, at its
option and at any time, elect to terminate the obligations of the Company with
respect to certain covenants that are set forth in the Indenture, some of
which are described under "--Certain Covenants" above (including the covenant
described under "Change of Control" above) and any subsequent failure to
comply with such obligations shall not constitute a Default or Event of
Default with respect to the Senior Discount Notes ("covenant defeasance").
In order to exercise either defeasance or covenant defeasance, (i) the
Company must irrevocably deposit with the Trustee, in trust, for the benefit
of the holders of the Senior Discount Notes, cash in United States dollars,
U.S. Government Obligations (as defined in the Indenture), or a combination
thereof, in such amounts as will be sufficient, in the opinion of a nationally
recognized firm of independent public accountants, to pay the principal of,
premium, if any, and interest on the outstanding Senior Discount Notes to
redemption or maturity (except lost, stolen or destroyed Senior Discount Notes
which have been replaced or paid); (ii) the Company shall have delivered to
the Trustee an opinion of counsel to the effect that the holders of the
outstanding Senior Discount Notes will not recognize income, gain or loss for
federal income tax purposes as a result of such defeasance or covenant
defeasance and will be subject to federal income tax on the same amounts, in
the same manner and at the same times as would have been the case if such
defeasance or covenant defeasance had not occurred (in the case of defeasance,
such opinion must refer to and be based upon a ruling of the Internal Revenue
Service or a change in applicable federal income tax laws); (iii) no Default
or Event of Default shall have occurred and be continuing on the date of such
deposit; (iv) such defeasance or covenant defeasance shall not cause the
Trustee to have a conflicting interest with respect to any securities of the
Company; (v) such defeasance or covenant defeasance shall not result in a
breach or violation of, or constitute a default under, any material agreement
or instrument to which the Company is a party or by which it is bound; (vi)
the Company
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shall have delivered to the Trustee an opinion of counsel to the effect that
after the 91st day following the deposit, the trust funds will not be subject
to the effect of any applicable bankruptcy, insolvency, reorganization or
similar laws affecting creditors' rights generally; and (vii) the Company
shall have delivered to the Trustee an officers' certificate and an opinion of
counsel, each stating that all conditions precedent under the Indenture to
either defeasance or covenant defeasance, as the case may be, have been
complied with.
SATISFACTION AND DISCHARGE
The Indenture will be discharged and will cease to be of further effect
(except as to surviving rights or registration of transfer or exchange of the
Senior Discount Notes, as expressly provided for in the Indenture) as to all
outstanding Senior Discount Notes when (i) either (a) all the Senior Discount
Notes theretofore authenticated and delivered (except lost, stolen or
destroyed Senior Discount Notes which have been replaced or repaid and Senior
Discount Notes for whose payment money has theretofore been deposited in trust
or segregated and held in trust by the Company and thereafter repaid to the
Company or discharged from such trust) have been delivered to the Trustee for
cancellation or (b) all Senior Discount Notes not theretofore delivered to the
Trustee for cancellation (except lost, stolen or destroyed Senior Discount
Notes which have been replaced or paid) have been called for redemption
pursuant to the terms of the Senior Discount Notes or have otherwise become
due and payable and the Company has irrevocably deposited or caused to be
deposited with the Trustee funds in an amount sufficient to pay and discharge
the entire Indebtedness on the Senior Discount Notes not theretofore delivered
to the Trustee for cancellation, for principal of, premium, if any, and
interest on the Senior Discount Notes to the date of deposit together with
irrevocable instructions from the Company directing the Trustee to apply such
funds to the payment thereof at maturity or redemption, as the case may be;
(ii) the Company has paid all other sums payable under the Indenture by the
Company; (iii) there exists no Default or Event of Default under the
Indenture; and (iv) the Company has delivered to the Trustee an officers'
certificate and an opinion of counsel stating that all conditions precedent
under the Indenture relating to the satisfaction and discharge of the
Indenture have been complied with.
AMENDMENTS AND WAIVERS
From time to time, the Company, when authorized by a resolution of its Board
of Directors, and the Trustee may, without the consent of the holders of any
outstanding Senior Discount Notes, amend, waive or supplement the Indenture or
the Senior Discount Notes for certain specified purposes, including, among
other things, curing ambiguities, defects or inconsistencies, qualifying, or
maintaining the qualification of, the Indenture under the Trust Indenture Act
of 1939 or making any other change that does not adversely affect the rights
of any holder of Senior Discount Notes; provided, however, that the Company
has delivered to the Trustee an opinion of counsel stating that such change
does not adversely affect the rights of any holder of Senior Discount Notes.
Other amendments and modifications of the Indenture or the Senior Discount
Notes may be made by the Company and the Trustee with the consent of the
holders of not less than a majority of the aggregate principal amount of the
outstanding Senior Discount Notes; provided, however, that no such
modification or amendment may, without the consent of the holder of each
outstanding Note affected thereby, (i) reduce the principal amount of, extend
the fixed maturity of or alter the redemption provisions of, the Senior
Discount Notes, (ii) change the currency in which any Senior Discount Notes or
any premium or the interest thereon is payable or make the principal of,
premium, if any, or interest on any Note payable in money other than that
stated in the Note, (iii) reduce the percentage in principal amount of
outstanding Senior Discount Notes that must consent to an amendment,
supplement or waiver or consent to take any action under the Indenture or the
Senior Discount Notes, (iv) impair the right to institute suit for the
enforcement of any payment on or with respect to the Senior Discount Notes,
(v) waive a default in payment with respect to the Senior Discount Notes, (vi)
amend, change or modify the obligations of the Company to make and consummate
a Change of Control Offer in the event of a Change of Control or make and
consummate the offer with respect to any Asset Sale or modify any of the
provisions or definitions with respect thereto, (viii) reduce or change the
rate or time for payment of interest on the Senior Discount Notes, or (ix)
modify or change any provision of the Indenture affecting the ranking of the
Senior Discount Notes in a manner adverse to the holders of the Senior
Discount Notes.
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THE TRUSTEE
The Indenture provides that, except during the continuance of an Event of
Default, the Trustee thereunder will perform only such duties as are
specifically set forth in the Indenture. If an Event of Default has occurred
and is continuing, the Trustee will exercise such rights and powers vested in
it under the Indenture and use the same degree of care and skill in its
exercise as a prudent person would exercise under the circumstances in the
conduct of such person's own affairs.
The Indenture and provisions of the Trust Indenture Act of 1939, as amended,
incorporated by reference therein contain limitations on the rights of the
Trustee thereunder, should it become a creditor of the Company, to obtain
payment of claims in certain cases or to realize on certain property received
by it in respect of any such claims, as security or otherwise. The Trustee is
permitted to engage in other transactions; provided, however, that if it
acquires any conflicting interest (as defined in such Act) it must eliminate
such conflict or resign.
GOVERNING LAW
The Indenture and the Senior Discount Notes are governed by the laws of the
State of New York, without regard to the principles of conflicts of law.
CERTAIN DEFINITIONS
"Accreted Value" is defined to mean, for any specified date (the "Specified
Date"), the amount calculated pursuant to (i), (ii), (iii) or (iv) for each
$1,000 principal amount at maturity of Senior Discount Notes:
(i) if the Specified Date occurs on one or more of the following dates
(each a "Semi-Annual Accrual Date"), the Accreted Value will equal the
amount set forth below for such Semi-Annual Accrual Date:
<TABLE>
<CAPTION>
SEMI-ANNUAL ACCRUAL DATE ACCRETED VALUE
------------------------ --------------
<S> <C>
November 1, 1997.......................................... $ 774.26
May 1, 1998............................................... $ 814.91
November 1, 1998.......................................... $ 857.69
May 1, 1999............................................... $ 902.72
November 1, 1999.......................................... $ 950.11
May 1, 2000............................................... $1,000.00
</TABLE>
(ii) if the Specified Date occurs before the first Semi-Annual Accrual
Date, the Accreted Value will equal the sum of (a) the original issue price
and (b) an amount equal to the product of (1) the Accreted Value for the
first Semi-Annual Accrual Date less the original issue price multiplied by
(2) a fraction, the numerator of which is the number of days from the issue
date of the Senior Discount Notes to the Specified Date, using a 360-day
year of twelve 30-day months, and the denominator of which is the number of
days elapsed from the issue date of the Senior Discount Notes to the first
Semi-Annual Accrual Date, using a 360-day year of twelve 30-day months;
(iii) if the Specified Date occurs between two Semi-Annual Accrual Dates,
the Accreted Value will equal the sum of (a) the Accreted Value for the
Semi-Annual Accrual Date immediately preceding such Specified Date and (b)
an amount equal to the product of (1) the Accreted Value for the
immediately following Semi-Annual Accrual Date less the Accreted Value for
the immediately preceding Semi-Annual Accrual Date multiplied by (2) a
fraction, the numerator of which is the number of days from the immediately
preceding Semi-Annual Accrual Date to the Specified Date, using a 360-day
year of twelve 30-day months, and the denominator of which is 180; or
(iv) if the Specified Date occurs after the last Semi-Annual Accrual
Date, the Accreted Value will equal $1,000.
"Acquired Indebtedness" means Indebtedness of a person (a) assumed in
connection with an Asset Acquisition from such person or (b) existing at the
time such person becomes a Subsidiary of any other person; provided that
Acquired Indebtedness shall not include any such Indebtedness that was
incurred in anticipation or contemplation of such Asset Acquisition or such
person becoming a Subsidiary.
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"Affiliate" means, with respect to any specified person, any other person
directly or indirectly controlling or controlled by or under direct or
indirect common control with such specified person.
"Asset Acquisition" means (a) an Investment by the Company or any Subsidiary
of the Company in any other person pursuant to which such person shall become
a Subsidiary of the Company, or shall be merged with or into the Company or
any Subsidiary of the Company, (b) the acquisition by the Company or any
Subsidiary of the Company of the assets of any person (other than a Subsidiary
of the Company) which constitute all or substantially all of the assets of
such person or (c) the acquisition by the Company or any Subsidiary of the
Company of any division or line of business of any person (other than a
Subsidiary of the Company).
"Asset Disposition" means the sale or other disposition by the Company or
any of its Subsidiaries (other than to the Company or another Subsidiary of
the Company) of (i) all or substantially all of the Capital Stock of any
Subsidiary of the Company or (ii) all or substantially all of the assets that
constitute a division or line of business of the Company or any of its
Subsidiaries.
"Asset Sale" means any direct or indirect sale, issuance, conveyance,
transfer, lease or other disposition to any person other than the Company or a
Wholly-Owned Subsidiary of the Company, in one or a series of related
transactions, of (a) any Capital Stock of any Subsidiary of the Company (other
than in respect of director's qualifying shares or investments by foreign
nationals mandated by applicable law); (b) all or substantially all of the
properties and assets of any division or line of business of the Company or
any Subsidiary of the Company; or (c) any other properties or assets of the
Company or any Subsidiary of the Company other than in the ordinary course of
business. For the purposes of this definition, the term "Asset Sale" shall not
include (i) any sale, transfer or other disposition of equipment, tools or
other assets (including Capital Stock of any Subsidiary of the Company) by the
Company or any of its Subsidiaries in one or a series of related transactions
in respect of which the Company or such Subsidiary receives cash or property
with an aggregate Fair Market Value of $1,000,000 or less; and (ii) any sale,
issuance, conveyance, transfer, lease or other disposition of properties or
assets that is governed by the provisions described under "--Merger, Sale of
Assets, Etc." above.
"Attributable Value" means, as to any particular lease and at any date as of
which the amount thereof is to be determined, the total net amount of rent
required to be paid by such Person under such lease during the initial term
thereof as determined in accordance with GAAP, discounted from the last date
of such initial term to the date of determination at a rate per annum equal to
the discount rate which would be applicable to a Capitalized Lease Obligation
with a like term in accordance with GAAP. The net amount of rent required to
be paid under any such lease for any such period shall be the aggregate amount
of rent payable by the lessee with respect to such period after excluding
amounts required to be paid on account of insurance, taxes, assessments,
utility, operating and labor costs and similar charges. In the case of any
lease which is terminable by the lessee upon the payment of a penalty, such
net amount shall also include the amount of such penalty, but no rent shall be
considered as required to be paid under such lease subsequent to the first
date upon which it may be so terminated.
"Average Life to Stated Maturity" means, with respect to any Indebtedness,
as at any date of determination, the quotient obtained by dividing (i) the sum
of the products of (a) the number of years (or any fraction thereof) from such
date to the date or dates of each successive scheduled principal payment
(including, without limitation, any sinking fund requirements) of such
Indebtedness multiplied by (b) the amount of each such principal payment by
(ii) the sum of all such principal payments.
"Capital Stock" means, with respect to any person, any and all shares,
interests, participations, rights in or other equivalents (however designated)
of such person's capital stock, and any rights (other than debt securities
convertible into capital stock), warrants or options exchangeable for or
convertible into such capital stock.
"Capitalized Lease Obligation" means any obligation under a lease of (or
other agreement conveying the right to use) any property (whether real,
personal or mixed) that is required to be classified and accounted for as a
capital lease obligation under GAAP, and, for the purpose of the Indenture,
the amount of such obligation at any date shall be the capitalized amount
thereof at such date, determined in accordance with GAAP.
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"Cash Equivalents" means, at any time, (i) any evidence of Indebtedness with
a maturity of 180 days or less issued or directly and fully guaranteed or
insured by the Untied States of America or any agency or instrumentality
thereof (provided that the full faith and credit of the United States of
America is pledged in support thereof); (ii) certificates of deposit or
acceptances with a maturity of 180 days or less of any financial institution
that is a member of the Federal Reserve System having combined capital and
surplus and undivided profits of not less than $500,000,000; (iii) Eurodollar
time deposits with a maturity of 180 days or less of any financial institution
that is not organized under the laws of the United States, any state thereof
or the District of Columbia that are rated at least A-1 by S&P or at least P-1
by Moody's or at least an equivalent rating category of another nationally
recognized securities rating agency; (iv) commercial paper with a maturity of
180 days or less that are rated at least A-1 by S&P, or at least P-1 by
Moody's or at least an equivalent rating category of another nationally
recognized securities rating agency; (v) tax-exempt investments that are rated
at least SP1/A1 by S&P and/or P1/VM1G1/M1G1 by Moody's; (vi) money market
accounts of any financial institution that is a member of the Federal Reserve
System having combined capital and surplus and undivided profits of not less
than $500,000,000; and (vii) repurchase agreements and reverse repurchase
agreements relating to marketable direct obligations issued or unconditionally
guaranteed by the government of the United States of America or issued by any
agency thereof and backed by the full faith and credit of the United States of
America, in each case maturing within 180 days from the date of acquisition;
provided that the terms of such agreements comply with the guidelines set
forth in the Federal Financial Agreements of Depository Institutions With
Securities Dealers and Others, as adopted by the Comptroller of the Currency
on October 31, 1985.
"Change of Control" means the occurrence of any of the following events: (a)
any "person" or "group" (as such terms are used in Sections 13(d) and 14(d) of
the Exchange Act), excluding Permitted Holders, is or becomes the "Beneficial
owner" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act, except
that a person shall be deemed to have "Beneficial ownership" of all securities
that such person has the right to acquire, whether such right is exercisable
immediately or only after the passage of time, upon the happening of an event
or otherwise), directly or indirectly, of more than 35% of the voting power of
the total Voting Stock of the Company; provided, however, that the Permitted
Holders (i) "Beneficially own" (as so defined) a lower percentage of the
voting power of the Voting Stock than such other person or "group" and (ii) do
not have the right or ability by voting power, contract or otherwise to elect
or designate for election a majority of the Board of Directors of the Company;
or (b) individuals who on the Issue Date constitute the Board of Directors of
the Company (together with any new directors whose election by the Board of
Directors of the Company or whose nomination for election by the Company's
stockholders was approved by a vote of at least two-thirds of the members of
the Board of Directors of the Company then in office who either were members
of the Board of Directors of the Company on the Issue Date of whose election
or nomination for election was previously so approved) cease for any reason to
constitute a majority of the members of the Board of Directors of the Company
then in office.
"Common Stock" means, with respect to any person, any and all shares,
interests or other participations in, and other equivalents (however
designated and whether voting or nonvoting) of, such person's common stock,
whether outstanding at the Issue Date or issued after the Issue Date, and
includes, without limitation, all series and classes of such common stock.
"Consolidated Cash Flow" means, for any period, the sum of the amounts for
such period of (i) Consolidated Net Income, (ii) Consolidated Interest
Expense, (iii) income taxes, to the extent such amount was deducted in
calculating Consolidated Net Income (other than income taxes (either positive
or negative) attributable to extraordinary and non-recurring gains or losses
or sales of assets), (iv) depreciation expense, to the extent such amount was
deducted in calculating Consolidated Net Income, (v) amortization expense, to
the extent such amount was deducted in calculating Consolidated Net Income,
and (vi) all other non-cash items reducing Consolidated Net Income (excluding
any non-cash charge to the extent that it represents an accrual of or reserve
for cash charges in any future period), less all non-cash items increasing
Consolidated Net Income, all as determined on a consolidated basis for the
Company and its Subsidiaries in conformity with GAAP.
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"Consolidated Fixed Charges" means, for any period, Consolidated Interest
Expense plus dividends declared and payable on Preferred Stock.
"Consolidated Interest Expense" means, for any period, the aggregate amount
of interest in respect of Indebtedness (including capitalized interest,
amortization of original issue discount on any Indebtedness and the interest
portion of any deferred payment obligation, calculated in accordance with the
effective interest method of accounting; all commissions, discounts and other
fees and charges owed with respect to letters of credit and bankers'
acceptance financing; the net costs associated with Interest Rate Protection
Agreements; and interest on Indebtedness that is guaranteed or secured by the
Company or any of its Subsidiaries) and all but the principal component of
rentals in respect of Capitalized Lease Obligations paid, accrued or scheduled
to be paid or to be accrued by the Company and its Subsidiaries during such
period.
"Consolidated Net Income" means, for any period, the aggregate net income
(or loss) of the Company and its Subsidiaries for such period determined in
conformity with GAAP; provided that the following items shall be excluded in
computing Consolidated Net Income (without duplication): (i) solely for the
purposes of calculating the amount of Restricted Payments that may be made
pursuant to clause (C) of the first paragraph of the "Limitation on Restricted
Payments" covenant described above, the net income (or loss) of any Person
accrued prior to the date it becomes a Subsidiary or is merged into or
consolidated with the Company or any of its Subsidiaries or all or
substantially all of the property and assets of such Person are acquired by
the Company or any of its Subsidiaries; (ii) any gains or losses (on an after-
tax basis) attributable to Asset Sales; (iii) except for purposes of
calculating the amount of Restricted Payments that may be pursuant to clause
(C) of the first paragraph of the "Limitation on Restricted Payments" covenant
described above, any amount paid or accrued as dividends on Preferred Stock of
the Company or Preferred Stock of any Subsidiary owned by Persons other than
the Company and any of its Subsidiaries; (iv) all extraordinary gains and
extraordinary losses; and (v) the net income (or loss) of any Person (other
than net income (or loss) attributable to a Subsidiary) in which any Person
(other than the Company or any of its Subsidiaries) has a joint interest,
except to the extent of the amount of dividends or other distributions
actually paid to the Company or any of its Subsidiaries by such other Person
during such period.
"Consolidated Net Worth" means, with respect to any person at any date, the
consolidated stockholders' equity of such person less the amount of such
stockholders, equity attributable to Redeemable Capital Stock of such person
and its Subsidiaries, as determined in accordance with GAAP.
"Credit Facilities" is defined to mean, with respect to the Company, one or
more debt facilities or commercial paper facilities with banks or other
institutional lenders providing for revolving credit loans, term loans,
receivables financing (including through the sale of receivables to such
lenders or to special purpose entities formed to borrow from such lenders
against such receivables) or letters of credit, in each case, as amended,
restated, modified, renewed, refunded, replaced or refinanced in whole or in
part from time to time.
"Currency Agreement" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement designed to protect the
Company or any of its Subsidiaries against fluctuations in currency values.
"Default" means any event that is, or after notice or passage of time or
both would be, an Event of Default.
"Eligible Accounts Receivable" is defined to mean the accounts receivables
(net of any reserves and allowances for doubtful accounts in accordance with
GAAP) of any person that are not more than 60 days past their due date and
that were entered into in the ordinary course of business on normal payment
terms as shown on the most recent consolidated balance sheet of such person
filed with the Commission, all in accordance with GAAP.
"Event of Default" has the meaning set forth under "Events of Default"
herein.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
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"Fair Market Value" means, with respect to any assets, the price, as
determined by the Board of Directors of the Company, acting in good faith,
which could be negotiated in an arm's-length free market transaction, for
cash, between a willing seller and a willing buyer, neither of which is under
pressure or compulsion to complete the transaction; provided, however, that,
with respect to any transaction which involves an asset or assets in excess of
$2,000,000, such determination shall be evidenced by resolutions of the Board
of Directors of the Company delivered to the Trustee.
"Final Maturity Date" means November 1, 2004.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as may be approved by a significant segment of the accounting
profession of the United States of America, which are applicable from time to
time and are consistently applied.
"Guarantee" means, as applied to any obligation, (i) a guarantee (other than
by endorsement of negotiable instruments for collection in the ordinary course
of business), direct or indirect, in any manner, of any part or all of such
obligation and (ii) an agreement, direct or indirect, contingent or otherwise,
the practical effect of which is to assure in any way the payment or
performance (or payment of damages in the event of non-performance) of all or
any part of such obligation, including, without limiting the foregoing, the
payment of amounts drawn down by letters of credit.
"Indebtedness" means, with respect to any person at any date of
determination (without duplication), (i) all indebtedness of such person for
borrowed money, (ii) all obligations of such person evidenced by bonds,
debentures, Senior Discount Notes or other similar instruments, (iii) all
obligations of such person in respect of letters of credit or other similar
instruments (including reimbursement obligations with respect thereto), (iv)
all obligations of such person to pay the deferred and unpaid purchase price
of property or services, which purchase price is due more than six months
after the date of placing such property in service or taking delivery and
title thereto or the completion of such services, except Trade payables, (v)
all obligations of such person as lessee under Capitalized Lease Obligations,
(vi) all Indebtedness of other persons secured by a Lien on any asset of such
person, whether or not such Indebtedness is assumed by such person; provided
that the amount of such Indebtedness shall be the lesser of (A) the fair
market value of such asset at such date of determination and (B) the amount of
such Indebtedness, (vii) all Indebtedness of other persons guaranteed by such
person to the extent such Indebtedness is guaranteed by such person, (viii)
the maximum fixed redemption or repurchase price of Redeemable Capital Stock
of such person at the time of determination and (ix) to the extent not
otherwise included in this definition, obligations under Currency Agreements
and Interest Rate Protection Agreements. The amount of Indebtedness of any
Person at any date shall be the outstanding balance at such date of all
unconditional obligations as described above and, with respect to contingent
obligations, the maximum liability upon the occurrence of the contingency
giving rise to the obligation, (i) that the amount outstanding at any time of
any Indebtedness issued with original issue discount is the face amount of
such Indebtedness less the remaining unamortized portion of the original issue
discount of such Indebtedness at such time as determined in conformity with
GAAP and (ii) that Indebtedness shall not include any liability for federal,
state, local or other taxes.
"Independent Financial Advisor" means a firm (i) which does not, and whose
directors, officers and employees or Affiliates do not, have a direct or
indirect financial interest in the Company and (ii) which, in the judgment of
the Board of Directors of the Company, is otherwise independent and qualified
to perform the task for which it is to be engaged.
"Interest Rate Protection Agreement" means any arrangement with any other
person whereby, directly or indirectly, such person is entitled to receive
from time to time periodic payments calculated by applying either a floating
or a fixed rate of interest on a stated notional amount in exchange for
periodic payments made by such person calculated by applying a fixed or a
floating rate of interest on the same notional amount and shall include
without limitation, interest rate swaps, caps, floors, collars and similar
agreements.
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"Investment" means, with respect to any person, any direct or indirect,
loan, guarantee, or other extension of credit or capital contribution to (by
means of any transfer of cash or other property to others or any payment for
property or services for the account or use of others), or any purchase or
acquisition by such person of any Capital Stock, bonds, notes, debentures or
other securities or evidences of Indebtedness issued by, any other person. In
addition, the Fair Market Value of the assets of any Subsidiary of the Company
at the time that such Subsidiary is designated as an Unrestricted Subsidiary
shall be deemed to be an Investment made by the Company in such Unrestricted
Subsidiary at such time. "Investments" shall exclude extensions of trade
credit by the Company and its Subsidiaries in the ordinary course of business
in accordance with normal trade practices of the Company or such Subsidiary,
as the case may be.
"Lien" means any mortgage, charge, pledge, lien (statutory or other),
security interest, hypothecation, assignment for security, claim, or
preference or priority or other encumbrance upon or with respect to any
property of any kind. A person shall be deemed to own subject to a Lien any
property which such person has acquired or holds subject to the interest of a
vendor or lessor under any conditional sale agreement, capital lease or other
title retention agreement.
"Maturity Date" means, with respect to any security, the date on which any
principal of such security becomes due and payable as therein or herein
provided, whether at the Stated Maturity with respect to such principal or by
declaration of acceleration, call for redemption or purchase or otherwise.
"Moody's" means Moody's Investors Service, Inc. and its successors.
"Net Cash Proceeds" means, with respect to any Asset Sale, the proceeds
thereof in the form of cash or Cash Equivalents including payments in respect
of deferred payment obligations when received in the form of cash or Cash
Equivalents (except to the extent that such obligations are financed or sold
with recourse to the Company or any Subsidiary of the Company) net of (i)
brokerage commissions and other fees and expenses (including, without
limitation, fees and expenses of legal counsel and investment bankers) related
to such Asset Sale, (ii) provisions for all taxes payable as a result of such
Asset Sale, (iii) amounts required to be paid to any person (other than the
Company or any Subsidiary of the Company) owning a beneficial interest in the
assets subject to the Asset Sale or has a security interest in such assets and
(iv) appropriate amounts to be provided by the Company or any Subsidiary of
the Company, as the case may be, as a reserve required in accordance with GAAP
against any liabilities associated with such Asset Sale and retained by the
Company or any Subsidiary of the Company, as the case may be, after such Asset
Sale, including, without limitation, pension and other post-employment benefit
liabilities, liabilities related to environmental matters and liabilities
under any indemnification obligations associated with such Asset Sale, all as
reflected in an officers' certificate delivered to the Trustee.
"Pari Passu Indebtedness" means Indebtedness of the Company which ranks pari
passu in right of payment with the Senior Discount Notes.
"Permitted Holder" means (x) Fred Gratzon, Shelley Levin-Gratzon or Clifford
Rees or (y) any Affiliate of any Person named in the foregoing clause or (x)
any trust for the benefit of any such Person or any of such Person's family
members or descendants.
"Permitted Investments" means any of the following: (i) Investments in any
Subsidiary of the Company (including any person that pursuant to such
Investment becomes a Subsidiary of the Company) and any person that is merged
or consolidated with or into, or transfers or conveys all or substantially all
of its assets to, the Company or any Subsidiary of the Company at the time
such Investment is made; (ii) Investments in Cash Equivalents; (iii)
Investments in deposits with respect to leases or utilities provided to third
parties in the ordinary course of business; (iv) Investments in Currency
Agreements on commercially reasonable terms entered into by the Company or any
of its Subsidiaries in the ordinary course of business in connection with the
operations of the business of the Company or its Subsidiaries to hedge against
fluctuations in foreign exchange rates; (v) loans or advances to officers,
employees or consultants of the Company and its Subsidiaries in the ordinary
course of
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business for bona fide business purposes of the Company and its Subsidiaries
(including travel and moving expenses) not in excess of $1,000,000 in the
aggregate at any one time outstanding; (vi) Investments in evidences of
Indebtedness, securities or other property received from another person by the
Company or any of its Subsidiaries in connection with any bankruptcy
proceeding or by reason of a composition or readjustment of debt or a
reorganization of such person or as a result of foreclosure, perfection or
enforcement of any Lien in exchange for evidences of Indebtedness, securities
or other property of such person held by the Company or any of its
Subsidiaries, or for other liabilities or obligations of such other person to
the Company or any of its Subsidiaries that were created, in accordance with
the terms of the Indenture; and (vii) Investments in Interest Rate Protection
Agreements on commercially reasonably terms entered into by the Company or any
of its Subsidiaries in the ordinary course of business in connection with the
operations of the business of the Company or its Subsidiaries to hedge against
fluctuations in interest rates.
"Permitted Liens" means the following types of Liens:
(a) Liens for taxes, assessments or governmental charges or claims either
(a) not delinquent or (b) contested in good faith by appropriate
proceedings and as to which the Company or any of its Subsidiaries shall
have set aside on its books such reserves as may be required pursuant to
GAAP;
(b) statutory Liens of landlords and Liens of carriers, warehousemen,
mechanics, suppliers, materialmen, repairmen and other Liens imposed by law
incurred in the ordinary course of business for sums not yet delinquent or
being contested in good faith, if such reserve or other appropriate
provision, if any, as shall be required by GAAP shall have been made in
respect thereof;
(c) Liens incurred or deposits made in the ordinary course of business in
connection with workers' compensation, unemployment insurance and other
types of social security, or to secure the performance of tenders,
statutory obligations, surety and appeal bonds, bids, leases, governmental
contracts, performance and return-of-money bonds and other similar
obligations (exclusive of obligations for the payment of borrowed money);
(d) judgment Liens not giving rise to an Event of Default so long as such
Lien is adequately bonded and any appropriate legal proceedings which may
have been duly initiated for the review of such judgment shall not have
been finally terminated or the period within which such proceedings may be
initiated shall not have expired;
(e) easements, rights-of-way, zoning restrictions and other similar
charges or encumbrances in respect of real property not interfering in any
material respect with the ordinary conduct of the business of the Company
or any of its Subsidiaries;
(f) any interest or title of a lessor under any Capitalized Lease
Obligation or operating lease;
(g) Liens to finance the acquisition, cost of design, development,
construction, installation or integration of property or assets of the
Company or any Subsidiary of the Company in the ordinary course of
business; provided, however, that (i) the related Indebtedness shall not be
secured by any property or assets of the Company or any Subsidiary of the
Company other than such property or assets and any improvements thereto and
(ii) the Lien securing such Indebtedness either (x) exists at the time of
such acquisition or construction or (y) shall be created within 90 days of
such acquisition, construction or commencement of full operation of such
property or assets;
(h) Liens in favor of customs and revenue authorities arising as a matter
of law to secure payment of customs duties in connection with the
importation of goods;
(i) leases or subleases granted to others that do not materially
interfere with the ordinary course of business of the Company and its
Subsidiaries, taken as a whole;
(j) Liens encumbering property or assets under construction arising from
progress or partial payments by a customer of the Company or its
Subsidiaries relating to such property or assets;
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(k) Liens arising from filing Uniform Commercial Code financing
statements regarding leases;
(l) Liens on property of, or on shares of stock or Indebtedness of, any
corporation existing at the time such corporation becomes, or becomes a
part of, any Subsidiary; provided that such Liens do not extend to or cover
any property or assets of the Company or any Subsidiary other than the
property or assets acquired and were not created in contemplation of such
transaction;
(m) Liens securing reimbursement obligations with respect to letters of
credit that encumber documents and other property relating to such letters
of credit and the products and proceeds thereof; and
(n) Liens encumbering customary initial deposits and margin deposits and
other Liens that are either within the general parameters customary in the
industry or incurred in the ordinary course of business, in each case
securing Indebtedness under Interest Rate Protection Agreements and
Currency Agreements.
"Person" or "person" means any individual, corporation, limited liability
company partnership, joint venture, association, joint-stock company, trust,
charitable foundation, unincorporated organization, government or any agency
or political subdivision thereof or any other entity.
"Preferred Stock" means, with respect to any person, any and all shares,
interests, participations or other equivalents, however designated, whether
voting or nonvoting, of such persons preferred or preferred stock, whether new
outstanding or issued after the Issue Date, including without limitation, all
series and classes of such preferred or preferred stock.
"Pro Forma Consolidated Cash Flow" is defined to mean, for any period, the
Consolidated Cash Flow of the Company for such period calculated on a pro
forma basis to give effect to any Asset Disposition or Asset Acquisition not
in the ordinary course of business (including acquisition of other persons by
merger, consolidation or purchase of Capital Stock) during such period as if
such Asset Disposition or Asset Acquisition had taken place on the first day
of such period.
"Property" means, with respect to any Person, any interest of such Person in
any kind of property or asset, whether real, personal or mixed, or tangible or
intangible, excluding Capital Stock in any other Person.
"Redeemable Capital Stock" means any shares of any class or series of
Capital Stock, that, either by the terms thereof, by the terms of any security
into which it is convertible or exchangeable or by contract or otherwise, is
or upon the happening of an event or passage of time would be, required to be
redeemed prior to the final Stated Maturity with respect to any Note or is
redeemable at the option of the holder thereof at any time prior to any such
Stated Maturity Date, or is convertible into or exchangeable for debt
securities at any time prior to any such Stated Maturity.
"Sale and Leaseback Transaction" means, with respect to any Person, any
direct or indirect arrangement pursuant to which Property is sold or
transferred by such Person or a Subsidiary of such Person and is thereafter
leased back from the purchaser or transferee thereof by such Person or one of
its Subsidiaries.
"Significant Subsidiary" shall have the same meaning as in Rule 1.02(w) of
Regulation S-X under the Securities Act.
"S&P" means Standard & Poor's Corporation, and its successors.
"Stated Maturity" means, when used with respect to any Note or any
installment of interest thereon, the date specified in such Note as the fixed
date on which the principal of such Note or such installment of interest is
due and payable, and when used with respect to any other Indebtedness, means
the date specified in the instrument governing such Indebtedness as the fixed
date on which the principal of such Indebtedness, or any installment of
interest thereon, is due and payable.
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"Subordinated Indebtedness" means Indebtedness of the Company which is
expressly subordinated in right of payment to the Senior Discount Notes.
"Subsidiary" means, with respect to any person, (i) a corporation a majority
of whose Voting Stock is at the time, directly or indirectly, owned by such
person, by one or more Subsidiaries of such person or by such person and one
or more Subsidiaries thereof and (ii) any other person (other than a
corporation), including, without limitation, a joint venture, in which such
person, one or more Subsidiaries thereof or such person and one or more
Subsidiaries thereof, directly or indirectly, at the date of determination
thereof, has at least majority ownership interest entitled to vote in the
election of directors, managers or trustees thereof (or other person
performing similar functions). For purposes of this definition, any directors'
qualifying shares or investments by foreign nationals mandated by applicable
law shall be disregarded in determining the ownership of a Subsidiary.
Notwithstanding the foregoing, an Unrestricted Subsidiary shall not be deemed
a Subsidiary of the Company under the Indenture, other than for purposes of
the definition of an Unrestricted Subsidiary, unless the Company shall have
designated an Unrestricted Subsidiary as a "Subsidiary" by written notice to
the Trustee under the Indenture, accompanied by an Officers' Certificate as to
compliance with the Indenture; provided, however, that the Company shall not
be permitted to designate any Unrestricted Subsidiary as a Subsidiary unless,
after giving pro forma effect to such designation, (i) the Company would be
permitted to incur $1.00 of additional Indebtedness under the first paragraph
of the covenant described under "--Limitation on Indebtedness" above (assuming
a market rate of interest with respect to such Indebtedness) and (ii) all
Indebtedness and Liens of such Unrestricted Subsidiary would be permitted to
be incurred by a Subsidiary of the Company under the Indenture. A designation
of an Unrestricted Subsidiary as a Subsidiary may not thereafter be rescinded.
"Trade Payables" means any accounts payable or any other indebtedness or
monetary obligation to trade creditors created, assumed or guaranteed by the
Company or any of its Subsidiaries arising in the ordinary course of business
in connection with the acquisition of goods and services.
"Transaction Date" means, with respect to the incurrence of any Indebtedness
by the Company or any of its Subsidiaries, the date such Indebtedness is to be
incurred.
"Unrestricted Subsidiary" means (i) any Subsidiary of the Company that shall
be designated an Unrestricted Subsidiary by the Board of Directors of the
Company in the manner provided below and (ii) any Subsidiary of an
Unrestricted Subsidiary. The Board of Directors may designate any Subsidiary
(including any newly acquired or newly formed Subsidiary of the Company) to be
an Unrestricted Subsidiary unless such Subsidiary owns any Capital Stock of,
or owns or holds any Lien on any property of, the Company or any Subsidiary;
provided that (A) any guarantee by the Company or any Subsidiary of any
Indebtedness of the Subsidiary being so designated shall be deemed an
"incurrence" of such Indebtedness and an "Investment" by the Company or such
Subsidiary (or both, if applicable) at the time of such designation; (B) such
designation would be permitted under the "Limitation on Restricted Payments"
covenants described below and (C) if applicable, the Incurrence of
Indebtedness and the Investment referred to in clause (A) of this proviso
would be permitted under the "Limitation on Indebtedness" and "Limitation on
Restricted Payments" covenants described below.
"Voting Stock" means any class or classes of Capital Stock pursuant to which
the holders thereof have the general voting power under ordinary circumstances
to elect a least a majority of the board of directors, managers or trustees of
any person (irrespective of whether or not, at the time, Capital Stock of any
other class or classes shall have, or might have, voting power by reason of
the happening of any contingency).
"Wholly-Owned Subsidiary" means any Subsidiary of the Company of which 100%
of the outstanding Capital Stock is owned by one or more Wholly-Owned
Subsidiaries of the Company or by the Company and one or more Wholly-Owned
Subsidiaries of the Company. For purposes of this definition, any directors'
qualifying shares or investments by foreign nationals mandated by applicable
law shall be disregarded in determining the ownership of a Subsidiary.
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REVOLVING CREDIT FACILITY
The Company's Revolving Credit Facility with First Chicago NBD, Inc. (the
"Bank") (the "Revolving Credit Facility") had a maximum borrowing availability
up to $15 million. The Revolving Credit Facility expired October 31, 1997.
Interest. Borrowings under the Revolving Credit Facility bear interest at a
rate per annum equal to the sum of (i) the higher of the Bank's base rate or
the Federal Funds Effective Rate plus one half of one percent (.5%) per annum
and (ii) one quarter of one percent (.25%).
Security. The Revolving Credit Facility is secured by collateral consisting
of substantially all the assets of the Company.
Events of Default. The occurrence of any one or more of the following events
shall constitute a default of the Company under the Revolving Credit Facility:
(a) any representation or warranty made by or on behalf of the Company to
the Bank under or in connection with the Revolving Credit Facility or any
loan shall be materially false as of the date on which made;
(b) nonpayment of the principal amount of any loan when due;
(c) nonpayment of interest upon any loan or of any commitment fee within
five (5) days after the same becomes due;
(d) failure of the Company to pay when due (subject to any applicable
grace period) any material indebtedness or the default by the Company in
the performance of any other term, provision or condition contained in any
agreement (other than the Revolving Credit Facility ) under which any such
indebtedness was created or is governed, the effect of which is to cause,
or to permit the holder or holders of such indebtedness to cause, such
indebtedness to become due prior to its stated maturity; or any such
indebtedness shall be declared to be due and payable or required to be
prepaid (other than by a regularly scheduled payment) prior to maturity
thereof;
(e) the Company shall (i) have an order for relief entered with respect
to it under the Federal Bankruptcy Code, Title 11, United States Code,
Sections 1 et. seq., (ii) not pay, or admit in writing its inability to
pay, its debts generally as they become due, (iii) make an assignment for
the benefit of creditors, (iv) apply for, seek, consent to, or acquiesce in
the appointment of a receiver, custodian, trustee, examiner, liquidator or
similar official for it or any substantial part of its property, (v)
institute any proceeding seeking to adjudicate it bankrupt or insolvent, or
seeking dissolution, winding up, liquidation, reorganization, arrangement,
adjustment or composition of it or its debts under any law relating to
bankruptcy, insolvency or reorganization or relief of debtors, or fail to
file any answer or other pleading denying the material allegations of any
such proceeding filed against it, (vi) take any corporate action to
authorize or effect any of the foregoing actions set forth in this
subparagraph, or (vii) fail to contest in good faith any appointment or
proceeding described in subparagraph (f);
(f) without the application, approval or consent of the Company, a
receiver, trustee, examiner, liquidator or similar official shall be
appointed for the Company or any substantial part of its property, or a
proceeding described in clause (v) of subparagraph (e) shall be instituted
against the Company, and such appointment continues undischarged or such
proceeding continues undismissed or unstayed for a period of sixty (60)
consecutive days; or
(g) The aggregate face amount of outstanding letters of credit issued on
the application of the Company shall exceed $2,000,000.
If any default described in paragraphs (e) or (f), above, occurs, the
commitment of the Bank to make loans under the Revolving Credit Facility shall
automatically terminate and any loans outstanding to the Company shall
immediately become due and payable without any election or action on the part
of the Bank. If any other Default occurs, the Bank may terminate or suspend
the commitment of the Bank to make loans under the Revolving Credit Facility,
or declare the loans outstanding to the Company to be due and payable,
whereupon such loan shall become immediately due and payable, or both, without
presentment, demand, protest or notice of any kind.
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PLAN OF DISTRIBUTION
The Shares offered by the Selling Shareholders may be sold from time to time
by the Selling Shareholders, or by pledgees, donees, transferees or other
successors in interest of the Selling Shareholders, at their sole discretion.
Such sales may be made on the Shareholders, at their sole discretion. Such
sales may be made on the NASDAQ National Market or otherwise at prices and on
terms then prevailing or at prices related to the then current market price,
or in negotiated transactions. The Shares offered by the Selling Shareholders
are not being underwritten.
In general, the Shares may be sold by one or more of the following means:
(a) a block trade in which the broker or dealer so engaged will attempt to
sell the securities as agent but may position and resell a portion of the
block as principal to facilitate the transaction; (b) purchases by a broker or
dealer as principal and resale by such broker or dealer for its account
pursuant to this Prospectus; (c) an exchange distribution in accordance with
the rules of such exchange (if the securities are then listed on an exchange);
(d) ordinary brokerage transactions and transactions in which the broker
solicits purchasers; or (e) other securities transactions. In effecting sales,
brokers or dealers engaged by the Selling Shareholders may arrange for other
brokers or dealers to participate. Brokers or dealers will receive commissions
or discounts from the Selling Shareholders in amounts to be negotiated
immediately prior to the sale. No commissions or other fees shall be payable
by the Company to any broker or dealer in connection with this offering. Such
brokers or dealers and any other participating brokers or dealers may be
deemed to be "underwriters' within the meaning of the Securities Act of 1933,
as amended, in connection with such sales. The Company will pay the expenses
of this offering, estimated at $ .
TRANSFER AGENT AND REGISTRAR
First Chicago Trust Company of New York will serve as transfer agent and
registrar for the Common Stock.
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SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, the Company will have 31,003,431
outstanding shares of Common Stock and 2,086,630 shares of Common Stock
subject to outstanding options, of which options to purchase 1,677,153 shares
will then be exercisable. In addition, 2,322,847 shares of Common Stock are
issuable upon exercise of options available for grant under the Stock Option
Plan and 1,160,107 shares are issuable upon exercise of the Warrants. The
234,889 shares of Common Stock sold in the Offering will be freely tradeable
without restriction or further registration under the Securities Act. Pursuant
to the Principal Shareholders Registration Rights Agreement, the Principal
Shareholders or their permitted transferees are entitled to certain piggyback
registration rights, and, in the event the Company becomes eligible to use a
Form S-3 registration statement, two demand registration rights.
These rights are generally subject to certain conditions and limitations,
among them the right of the underwriters of an offering to limit the number of
shares included in such registration in certain circumstances. The Principal
Shareholders Registration Rights Agreement obligates the Company to pay all
expenses of any such registration, other than underwriting discounts and
commissions relating to the shares being sold on behalf of any Principal
Shareholders and to indemnify the Principal Shareholders against certain
liabilities, including liabilities under the Securities Act. Sales of
restricted securities in the public market or the perception that such sales
could occur could adversely affect the market price of the Common Stock.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including persons deemed to be "affiliates" of
the Company, who has beneficially owned his or her shares for at least one
year since the later of the date of the acquisition of the securities from the
Company or from an affiliate is entitled to sell within any three-month period
that number of restricted securities that does not exceed the greater of (i)
1% of the then outstanding shares of securities of the same class or (ii) the
average weekly trading volume of such securities during the four calendar
weeks immediately preceding such sale, or the filing of notice of proposed
sale, if required, subject to the availability of adequate current public
information about the Company. After two years have elapsed since the later of
the date the securities were acquired from the Company or from an affiliate of
the Company, such shares may be sold without limitation by persons who are not
affiliates of the Company at the time and have not been affiliates of the
Company for at least three months under Rule 144(k).
Rule 701 under the Securities Act provides that, beginning 90 days after the
date of this Prospectus, shares of Common Stock acquired on the exercise of
outstanding options prior to the date of this Prospectus may be resold by
persons other than affiliates subject only to the manner of sale provisions of
Rule 144, and by affiliates subject to all provisions of Rule 144 except its
one-year minimum holding period. The Company intends to file one or more
registration statements under the Securities Act to register the shares of
Common Stock issued and reserved for issuance in compensatory arrangements and
under the Stock Option Plan. Registration would permit the resale of such
shares by non-affiliates and affiliates, subject to the lock-up described
above, in the public market without restriction under the Securities Act.
In addition, the Company intends to register on Form S-8 under the
Securities Act 4,000,000 shares of Common Stock issuable under options subject
to the Company's Stock Option Plan. Shares issued under the Stock Option Plan
pursuant to such registration statement on Form S-8 (other than shares issued
to affiliates) generally may be sold immediately in the public market, subject
to vesting requirements and the lock-up agreements described below under
"Underwriters."
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS FOR NON-U.S. HOLDERS
OF COMMON STOCK
General. The following discussion concerns the material United States
federal income and estate tax consequences of the ownership and disposition of
shares of Common Stock applicable to holders of such shares of Common Stock
who are not U.S. persons. The discussion is based on current law, which is
subject to change retroactively or prospectively, and is for general
information only. The discussion does not address all aspects of United States
federal income and estate taxation and does not address any aspects of state,
local or foreign tax laws. The discussion does not consider any specific facts
or circumstances that may apply to a particular investor. Accordingly,
prospective investors are urged to consult their tax advisors regarding the
current and possible future United States federal, state, local and non-U.S.
income and other tax consequences of holding and disposing of shares of Common
Stock.
In general, a "Non-U.S. Holder" is any beneficial owner of Common Stock that
is not (i) a citizen or resident, as specifically defined for U.S. federal
income tax purposes, of the United States, (ii) a corporation, partnership or
any entity treated as a corporation or partnership for U.S. federal income tax
purposes created or organized in the United States or under the laws of the
United States or of any State thereof, (iii) any other entity, including an
estate, whose income is includible in gross income for United States federal
income tax purposes regardless of its source, or (iv) a trust whose
administration is subject to the primary supervision of a U.S. court and which
has one or more U.S. fiduciaries who have the authority to control all
substantial decisions of the trust.
Dividends. In general, dividends paid to a Non-U.S. Holder will be subject
to United States withholding tax at a 30% rate (or a lower rate as may be
specified by an applicable tax treaty) unless the dividends are (i)
effectively connected with a trade or business carried on by the Non-U.S.
Holder within the United States, and (ii) if a tax treaty applies,
attributable to a United States permanent establishment maintained by the Non-
U.S. Holder. Dividends effectively connected with such a trade or business or,
if a tax treaty applies, attributable to such permanent establishment will
generally not be subject to withholding (if the Non-U.S. Holder files certain
forms annually with the payor of the dividend) but will generally be subject
to United States federal income tax on a net income basis at regular graduated
individual or corporate rates. In the case of a Non-U.S. Holder that is a
corporation, such effectively connected income also may be subject to the
branch profits tax (which is generally imposed on a foreign corporation on the
deemed repatriation from the United States of effectively connected earnings
and profits) at a 30% rate or such lower rate as may be specified by an
applicable income tax treaty. The branch profits tax may not apply if the
recipient is a qualified resident of certain countries with which the United
States has an income tax treaty.
To determine the applicability of a tax treaty providing for a lower rate of
withholding, dividends paid to an address in a foreign country are presumed
under current Treasury Regulations to be paid to a resident of that country,
unless the payor has definite knowledge that such presumption is not warranted
or an applicable tax treaty (or United States Treasury Regulations thereunder)
requires some other method for determining a Non-U.S. Holder's residence.
However, under new regulations adopted by the U.S. Treasury on October 6,
1997, dividends paid after December 31, 1998 to a non-U.S. Holder could be
subject to backup withholding at a 31 percent rate, rather than at a 30
percent rate or at a reduced rate under an income tax treaty, unless certain
documentation procedures are complied with. Under current regulations, the
Company must report annually to the United States Internal Revenue Service
(the "IRS") and to each Non-U.S. Holder the amount of dividends paid to, and
the tax withheld with respect to, each Non-U.S. Holder. These reporting
requirements apply regardless of whether withholding was reduced or eliminated
by an applicable tax treaty. Copies of these information returns also may be
made available under the provisions of a specific treaty or agreement with the
tax authorities of the country in which the Non-U.S. Holder resides.
On October 6, 1997, the Treasury Department issued final rules with respect
to withholding tax on income paid to foreign persons and related matters (the
"New Withholding Regulations"). The New Withholding Regulations will generally
be effective for payments made after December 31, 1998, subject to certain
transition rules. Non-U.S. Holders that are subject to withholding are urged
to consult their own tax advisors with respect to the New Withholding
Regulations.
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A Non-U.S. Holder that is eligible for a reduced rate of United States
withholding tax pursuant to an income tax treaty may obtain a refund of any
excess amounts currently withheld by filing an appropriate claim for refund
with the IRS.
Sale of Common Stock. Generally, a Non-U.S. Holder will not be subject to
United States federal income tax, by withholding or otherwise, on any gain
realized upon the sale or other disposition of such holder's shares of Common
Stock unless (i) the gain is effectively connected with a trade or business
carried on by the Non-U.S. Holder within the United States and, if a tax
treaty applies, the gain is attributable to a permanent establishment
maintained by the Non-U.S. Holder in the United States; (ii) the Non-U.S.
Holder is an individual who holds the shares of Common Stock as a capital
asset and is present in the United States for 183 days or more in the taxable
year of the disposition, and either (a) such Non-U.S. Holder has a "tax home"
(as specifically defined for U.S. federal income tax purposes) in the United
States (unless the gain from disposition is attributable to an office or other
fixed place of business maintained by such non-U.S. Holder in a foreign
country and a foreign tax equal to at least 10% of such gain has been paid to
a foreign country), or (b) the gain from the disposition is attributable to an
office or other fixed place of business maintained by such Non-U.S. Holder in
the United States; (iii) the Non-U.S. Holder is subject to tax pursuant to the
provisions of U.S. tax law applicable to certain United States expatriates, or
(iv) the Company is or has been during certain periods a "U.S. real property
holding corporation" for U.S. federal income tax purposes (which the Company
does not believe that it has been, currently is or is likely to become) and,
assuming that the Common Stock is deemed for tax purposes to be "regularly
traded on an established securities market," the Non-U.S. Holder held, at any
time during the five-year period ending on the date of disposition (or such
shorter period that such shares were held), directly or indirectly, more than
five percent of the Common Stock.
Estate Tax. Shares of Common Stock owned or treated as owned by an
individual who is not a citizen or resident (as specially defined for United
States federal estate tax purposes) of the United States at the time of death
will be includible in the individual's gross estate for United States federal
estate tax purposes, unless an applicable tax treaty provides otherwise, and
may be subject to United States federal estate tax.
Backup Withholding and Information Reporting. As a general rule, under
current United States federal income tax law, backup withholding tax (which
generally is a withholding tax imposed at the rate of 31% on certain payments
to persons that fail to furnish the information required under the U.S.
information reporting requirements) and information reporting requirements
apply to the actual and constructive payments of dividends. The United States
backup withholding tax and information reporting requirements generally, under
current regulations, will not apply to dividends paid on Common Stock to a
Non-U.S. Holder at an address outside the United States that are either
subject to the 30% withholding discussed above or that are not so subject
because a tax treaty applies that reduces or eliminates such 30% withholding,
unless the payer has knowledge that the payee is a U.S. person. Backup
withholding and information reporting generally will apply to dividends paid
to addresses inside the United States on shares of Common Stock to beneficial
owners that are not recipients that are entitled to an exemption, as discussed
above and that fail to provide in the manner required certain identifying
information. However, under new regulations adopted by the U.S. Treasury on
October 6, 1997, dividends paid after December 31, 1998 to a non-U.S. Holder
could be subject to backup withholding at a 31 percent rate, rather than at a
30 percent rate or at a reduced rate under an income tax treaty, unless
certain documentation procedures are complied with. Non-U.S. Holders are urged
to consult their own tax advisors concerning the effect of these new
regulations.
The payment of the proceeds from the disposition of shares of Common Stock
to or through the United States office of a broker will be subject to
information reporting and backup withholding unless the holder, under
penalties of perjury, certifies, among other things, its status as a Non-U.S.
Holder, or otherwise establishes an exemption. Generally, the payment of the
proceeds from the disposition of shares of Common Stock to or through a non-
U.S. office of a non-U.S. broker will not be subject to backup withholding and
will not be subject to information reporting. In the case of the payment of
proceeds from the disposition of shares of Common Stock to or through a non-
U.S. office of a broker that is a U.S. person or a "U.S.-related person,"
existing regulations require (i) backup withholding if the broker has actual
knowledge that the owner is not a Non-U.S. Holder, and
(ii) information reporting on the payment unless the broker receives a
statement from the owner, signed under penalties of perjury, certifying, among
other things, its status as a Non-U.S. Holder, or the broker has
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documentary evidence in its files that the owner is a Non-U.S. Holder and the
broker has no actual knowledge to the contrary. For this purpose, a "U.S.-
related person" is (i) a "controlled foreign corporation" for United States
federal income tax purposes or (ii) a foreign person 50% or more of whose
gross income from all sources for the three-year period ending with the close
of its taxable year preceding the payment (or for such part of the period that
the broker has been in existence) is derived from activities that are
effectively connected with the conduct of a United States trade or business.
The IRS recently proposed regulations addressing the withholding and
information reporting rules which could affect the treatment of the payment of
proceeds discussed above. Non-U.S. Holders should consult their tax advisors
regarding the application of these rules to their particular situations, the
availability of an exemption therefrom, the procedure for obtaining such an
exemption, if available, and the possible application of the proposed
regulations addressing the withholding and information reporting rules.
Backup withholding is not an additional tax. Any amounts withheld from a
payment to a Non-U.S. Holder under the backup withholding rules will be
allowed as a credit against such holder's United States federal income tax
liability, if any, and provided that such holder furnishes the IRS with the
information entitling such holder to an exemption from or reduced rate of
withholding, such holder would be entitled to a refund.
LEGAL MATTERS
Certain legal matters in connection with the Common Stock offered hereby
will be passed upon for the Company by Swidler & Berlin, Chartered,
Washington, D.C. The validity of the issuance of the shares of Common Stock
offered hereby will be passed upon for the Company by Marcus and Thompson,
P.C.
EXPERTS
The consolidated financial statements of Telegroup, Inc. as of December 31,
1995 and 1996, and for each of the years in the three-year period ended
December 31, 1996, included herein and the registration statement in reliance
upon the reports of KPMG Peat Marwick LLP, independent certified public
accountants, included herein, and upon authority of said firm as experts in
accounting and auditing.
MacIntyre & Co., who have audited the divisional financial statements of
Fastnet U.K. Limited for the period from 1 October 1996 to 28 February 1997,
have given and have not withdrawn their written consent to the inclusion
herein of their auditors' report and the references thereto and to themselves
in the form and context in which they are included.
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GLOSSARY OF TERMS
accounting or settlement rate--The per minute rate negotiated between
carriers in different countries for termination of international long distance
traffic in, and return traffic to, the carriers' respective countries.
call-reorigination
traditional call-reorigination (also known as "callback")--A form of dial
up access that allows a user to access a telecommunications company's
network by placing a telephone call, hanging up, and waiting for an
automated callback. The callback then provides the user with dial tone
which enables the user to initiate and complete a call.
transparent call-reorigination--Technical innovations have enabled
telecommunications carriers to offer a "transparent" form of call
reorigination without the usual "hang up" and "callback" whereby the call
is automatically and swiftly processed by a programmed switch.
call-through--The provision of international long distance service
through conventional long distance or "transparent" call-reorigination.
CLEC--Competitive Local Exchange Carrier.
core markets--The Company's "core markets" are the U.S., Germany, the U.K.,
France, Switzerland, Hong Kong, Japan, the Netherlands, Australia and Sweden.
Country Coordinators--Persons in the Company's markets responsible for
coordinating Telegroup's operations, including sales, marketing, customer
service and independent agent support. Telegroup currently has 28 Country
Coordinators responsible for providing such support in 72 countries.
CUG (Closed User Group)--A group of specified users, such as employees of a
company, permitted by applicable regulations to access a private voice or data
network, which access would otherwise be denied to them as individuals.
dedicated or direct access--A means of accessing a network through the use
of a permanent point-to-point circuit typically leased from a facilities-based
carrier. The advantage of dedicated access is simplified premises-to-anywhere
calling, faster call set-up times and potentially lower access and
transmission costs (provided there is sufficient traffic over the circuit to
generate economies of scale).
dial-up access--A form of service whereby access to a network is obtained by
dialing an international toll-free number or a paid local access number.
distributed intelligence--The proprietary architecture supporting the TIGN
which allows customer information, such as credit limits, language selection,
waiting voice-mail and faxes, and speed dial numbers to be distributed to
customers cost-effectively over a parallel data network wherever.
European Union--Austria, Belgium, Denmark, Finland, France, Germany, Greece,
Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the
United Kingdom.
facilities-based carrier--A carrier which transmits a significant portion of
its traffic over owned transmission facilities.
fiber-optic--A transmission medium consisting of high-grade glass fiber
through which light beams are transmitted carrying a high volume of
telecommunications traffic.
IPLC (International Private Line Circuits)--Point-to-point permanent
connections which can carry voice and data. IPLCs are owned and maintained by
ITOs or third party resellers.
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IRU (Indefeasible Rights of Use)--The rights to use a telecommunications
system, usually an undersea cable, with most of the rights and duties of
ownership, but without the right to control or manage the facility and,
depending upon the particular agreement, without any right to salvage or duty
to dispose of the cable at the end of its useful life.
ISDN (Integrated Services Digital Network)--A hybrid digital network capable
of providing transmission speeds of up to 128 kilobits per second for both
voice and data.
ISR (International Simple Resale)--The use of international leased lines for
the resale of switched telephony services to the public, by-passing the
current system of accounting rates.
ITO (Incumbent Telecommunications Operator)--The dominant carrier or
carriers in each country, often, but not always, government-owned or protected
(alternatively referred to as the Postal, Telephone and Telegraph Company, or
PTT).
LEC (Local Exchange Carrier)--Companies from which the Company and other
long distance providers must purchase "access services" to originate and
terminate calls in the U.S.
local connectivity--Physical circuits connecting the switching facilities of
a telecommunications services provider to the interexchange and transmission
facilities of a facilities-based carrier.
local exchange--A geographic area determined by the appropriate regulatory
authority in which calls generally are transmitted without toll charges to the
calling or called party.
node--A specially configured multiplexer which provides the interface
between the local PSTN where the node is located and the TIGN switch. A node
collects and concentrates call traffic from its local area and transfers it to
TIGN switches via private line for call processing. Nodes permit Telegroup to
extend its network into a new geographic location by accessing the local PSTN
without requiring the deployment of a switch.
operating agreement--An agreement that provides for the exchange of
international long distance traffic between correspondent international long
distance providers that own facilities in different countries. These
agreements provide for the termination of traffic in, and return traffic from,
the international long distance providers' respective countries at a
negotiated "accounting rate." Under a traditional operating agreement, the
international long distance provider that originates more traffic compensates
the corresponding long distance provider in the other country by paying an
amount determined by multiplying the net traffic imbalance by the latter's
share of the accounting rate.
PBX (Public Branch Exchange)--Switching equipment that allows connection of
a private extension telephone to the PSTN or to a private line.
PNETs (Public Non-Exclusive Telecommunications Services) License--A license
allowing the licensee to provide certain telecommunications services in Hong
Kong. A PNETs licensee may not provide services the provision of which are
reserved to Hong Kong Telecommunications International Limited.
PSTN (Public Switched Telephone Network)--A telephone network which is
accessible by the public through private lines, wireless systems and pay
phones.
private line--A dedicated telecommunications connection between end user
locations.
resale--Resale by a provider of telecommunications services of services sold
to it by other providers or carriers on a wholesale basis.
Switching facility--A device that opens or closes circuits or selects the
paths or circuits to be used for transmission of information. Switching is a
process of interconnecting circuits to form a transmission path between users.
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TIGN--The Telegroup Intelligent Global Network.
Transit/termination agreements--An agreement that provides for the exchange
of international long distance traffic between international long distance
providers, which agreement provides for the termination of traffic in one or
more countries at negotiated termination costs. Such an agreement usually does
not include an "accounting rate" and often is not limited to the termination
of traffic in the home territories of the parties in the agreement.
Value-Added Tax (VAT)--A consumption tax levied on end-consumers of goods
and services in applicable jurisdictions.
Voice Telephony--A term used by the EU, defined as the commercial provision
for the public of the direct transport, enabling any user to use equipment
connected to such a network termination point in order to communicate with
another termination point. The term "voice telephony" is also used in the
Prospectus generally to refer to the direct transport and switching of speech
in real-time between public switched network termination points.
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TABLE OF CONTENTS
TELEGROUP, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Independent Auditors' Report.............................................. F-2
Consolidated Balance Sheets as of December 31, 1995 and 1996 and September
30, 1997 (unaudited)..................................................... F-3
Consolidated Statements of Operations for the years ended December 31,
1994, 1995 and 1996 and the nine-month periods ended September 30, 1996
and 1997 (unaudited)..................................................... F-4
Consolidated Statements of Shareholders' Equity (Deficit) for the years
ended December 31, 1994, 1995 and 1996 and the nine-month period ended
September 30, 1997 (unaudited)........................................... F-5
Consolidated Statements of Cash Flows for the years ended December 31,
1994, 1995 and 1996 and the nine-month periods ended September 30, 1996
and 1997 (unaudited)..................................................... F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Telegroup, Inc.:
We have audited the accompanying consolidated balance sheets of Telegroup,
Inc. and subsidiaries as of December 31, 1995 and 1996, and the related
consolidated statements of operations, shareholders' equity (deficit), and
cash flows for each of the years in the three-year period ended December 31,
1996. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Telegroup,
Inc. and subsidiaries as of December 31, 1995 and 1996, and the results of its
operations and its cash flows for each of the years in the three-year period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Lincoln, Nebraska
March 28, 1997, except as to note 1 (m)
and the last paragraph of note 7
which are as of July 8, 1997
F-2
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1995 AND 1996 AND SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1995 1996 SEPTEMBER 30, 1997
----------- ---------- ------------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......... $ 4,591,399 14,155,013 58,215,248
Accounts receivable and unbilled
services, less allowance for
credit losses of $2,100,000 in
1995, $3,321,119 in 1996, and
$4,639,183 at September 30, 1997.. 23,196,743 32,288,507 48,007,389
Income tax recoverable............. -- 1,796,792 2,924,478
Deferred taxes (note 8)............ 1,134,730 1,392,058 1,639,066
Prepaid expenses and other assets.. 110,325 245,271 757,508
Receivables from shareholders...... 75,952 14,974 45,880
Receivables from employees......... 87,895 85,539 189,070
----------- ---------- -----------
Total current assets............... 29,197,044 49,978,154 111,778,639
----------- ---------- -----------
Net property and equipment (note
5)................................. 3,979,039 11,256,139 21,596,980
----------- ---------- -----------
Other assets:
Deposits and other assets.......... 282,378 376,614 688,665
Goodwill, net of amortization of
$22,768 in 1996 and $96,520 at
September 30, 1997................ -- 1,001,841 2,969,347
Capitalized software, net of amor-
tization (note 1e)................ 117,051 1,906,655 1,873,946
Debt issuance costs, net of amorti-
zation (note 2)................... -- 1,437,004 750,000
----------- ---------- -----------
399,429 4,722,114 6,281,958
----------- ---------- -----------
Total assets....................... $33,575,512 65,956,407 139,657,577
=========== ========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable................... $16,479,564 30,719,562 44,413,669
Accrued expenses................... 6,990,053 8,561,041 12,233,538
Unearned revenue................... -- 64,276 160,222
Income taxes payable............... 3,526,900 -- --
Note payable....................... 2,000,000 -- 15,000,000
Customer deposits.................. 515,434 602,940 717,224
Current portion of long-term debt
(note 2).......................... -- 232,596 92,194
Current portion of capital lease
obligations (note 6).............. 137,114 138,309 127,099
Due to shareholders................ 25,881 -- --
----------- ---------- -----------
Total current liabilities.......... 29,674,946 40,318,724 72,743,946
Deferred taxes (note 8)............. 269,630 756,891 730,847
Capital lease obligations (note 6).. 483,489 301,393 218,320
Long-term debt (note 2)............. -- 11,216,896 25,042,057
Minority interest................... -- -- --
Shareholders' equity (note 7):
Common stock, no par or stated val-
ue; 150,000,000 shares authorized,
issued and outstanding 24,651,989
in 1995, 26,211,578 in 1996 and
30,768,542 at September 30, 1997.. -- -- --
Additional paid-in capital......... 4,595 10,765,176 51,405,027
Retained earnings (deficit)........ 3,142,852 2,599,530 (10,220,143)
Foreign currency translation ad-
justment.......................... -- (2,203) (262,477)
----------- ---------- -----------
Total shareholders' equity......... 3,147,447 13,362,503 40,922,407
----------- ---------- -----------
Commitments and contingencies (note
9)
Total liabilities and shareholders'
equity............................ $33,575,512 65,956,407 139,657,577
=========== ========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996 AND
NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------------------------------- ------------------------
1994 1995 1996 1996 1997
----------- ----------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Retail................ $68,713,965 128,138,947 179,146,795 128,827,926 169,720,131
Wholesale............. -- 980,443 34,060,714 18,950,715 68,757,955
----------- ----------- ----------- ----------- -----------
Total revenues...... 68,713,965 129,119,390 213,207,509 147,778,641 238,478,086
Cost of revenues........ 49,512,724 83,100,708 150,536,859 100,794,086 174,273,208
----------- ----------- ----------- ----------- -----------
Gross profit.......... 19,201,241 46,018,682 62,670,650 46,984,555 64,204,878
----------- ----------- ----------- ----------- -----------
Operating expenses:
Selling, general and
administrative ex-
penses............... 19,914,168 39,221,849 59,651,857 42,648,269 63,174,487
Depreciation and amor-
tization............. 300,784 654,966 1,881,619 1,158,124 3,208,063
Stock option based
compensation......... -- -- 1,032,646 -- 256,785
----------- ----------- ----------- ----------- -----------
Total operating ex-
penses............. 20,214,952 39,876,815 62,566,122 43,806,393 66,639,335
----------- ----------- ----------- ----------- -----------
Operating income
(loss)............. (1,013,711) 6,141,867 104,528 3,178,162 (2,434,457)
----------- ----------- ----------- ----------- -----------
Other income (expense):
Interest expense...... (112,152) (120,604) (578,500) (200,209) (2,134,691)
Interest income....... 102,836 193,061 377,450 210,859 782,299
Foreign currency
transaction gain
(loss)............... 31,024 (101,792) (147,752) (56,688) (587,291)
Other................. 105,303 298,627 118,504 60,966 159,228
----------- ----------- ----------- ----------- -----------
Earnings (loss) before
income taxes and ex-
traordinary item....... (886,700) 6,411,159 (125,770) 3,193,090 (4,214,912)
Income tax benefit (ex-
pense) (note 8)........ 348,300 (2,589,700) 7,448 (1,143,538) 1,366,054
Minority interest in
shares of earnings
(loss)................. -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Earnings (loss) before
extraordinary item..... (538,400) 3,821,459 (118,322) 2,049,552 (2,848,858)
Extraordinary item, loss
on extinguishment of
debt, net of income
taxes of $1,469,486.... -- -- -- -- (9, 970,815)
----------- ----------- ----------- ----------- -----------
Net earnings
(loss)............. $ (538,400) 3,821,459 (118,322) 2,049,552 (12,819,673)
=========== =========== =========== =========== ===========
Per share amounts:
Earnings (loss) before
extraordinary item... (0.02) 0.13 (0.00) 0.07 (0.10)
=========== =========== =========== =========== ===========
Net earnings (loss)... $ (0.02) 0.13 (0.00) 0.07 (0.47)
=========== =========== =========== =========== ===========
Weighted-average
shares................. 28,784,635 28,784,635 28,784,635 28,784,635 27,462,331
=========== =========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
AND NINE-MONTH PERIOD ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
COMMON STOCK
-----------------
FOREIGN TOTAL
ADDITIONAL RETAINED CURRENCY SHAREHOLDERS'
PAID-IN EARNINGS TRANSLATION EQUITY
SHARES AMOUNT CAPITAL (DEFICIT) ADJUSTMENT (DEFICIT)
---------- ------ ---------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balances at January 1,
1994.................. 24,651,989 $-- 4,595 384,793 -- 389,388
Net loss............... -- -- -- (538,400) -- (538,400)
---------- ---- ---------- ----------- -------- -----------
Balances at December
31, 1994.............. 24,651,989 -- 4,595 (153,607) -- (149,012)
Dividends.............. -- -- -- (525,000) -- (525,000)
Net earnings........... -- -- -- 3,821,459 -- 3,821,459
---------- ---- ---------- ----------- -------- -----------
Balances at December
31, 1995.............. 24,651,989 -- 4,595 3,142,852 -- 3,147,447
Dividends.............. -- -- -- (425,000) -- (425,000)
Net loss............... -- -- -- (118,322) -- (118,322)
Issuance of common
stock................. 1,297,473 -- 52,366 -- -- 52,366
Notes receivable from
shareholders for com-
mon stock............. -- -- (52,366) -- -- (52,366)
Shares issued in con-
nection with business
combinations (note
3).................... 262,116 -- 573,984 -- -- 573,984
Compensation expense in
connection with stock
option plan (note 7).. -- -- 1,032,646 -- -- 1,032,646
Warrants issued in con-
nection with the Pri-
vate Offering (note
7).................... -- -- 9,153,951 -- -- 9,153,951
Change in foreign cur-
rency translation..... -- -- -- -- (2,203) (2,203)
---------- ---- ---------- ----------- -------- -----------
Balances at December
31, 1996.............. 26,211,578 -- 10,765,176 2,599,530 (2,203) 13,362,503
Net loss (unaudited)... -- -- -- (12,819,673) -- (12,819,673)
Issuance of shares, net
of offering expenses
(unaudited)........... 4,450,000 -- 39,825,343 -- -- 39,825,343
Shares issued in con-
nection with business
combination (unau-
dited)................ 40,000 -- 470,000 -- -- 470,000
Compensation expense in
connection with stock
option plan (unau-
dited)................ -- -- 256,785 -- -- 256,785
Issuance of shares for
options exercised (un-
audited).............. 66,964 -- 87,723 -- -- 87,723
Change in foreign cur-
rency translation (un-
audited).............. -- -- -- -- (260,274) (260,274)
---------- ---- ---------- ----------- -------- -----------
Balances at September
30, 1997 (unaudited).. 30,768,542 $-- 51,405,027 (10,220,143) (262,477) 40,922,407
========== ==== ========== =========== ======== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1997
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------------------------------- -----------------------
1994 1995 1996 1996 1997
----------- ----------- ----------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from
operating activities:
Net earnings (loss)... $ (538,400) 3,821,459 (118,322) 2,049,552 (12,819,673)
Adjustments to
reconcile net
earnings (loss) to
net cash provided by
operating
activities:
Depreciation and
amortization......... 300,784 654,966 1,881,619 1,158,124 3,208,063
Deferred income
taxes................ (198,200) (937,200) 229,933 362,790 (273,052)
Loss on
extinguishment of
debt................. -- -- -- -- 10,040,301
Loss on sale of
equipment............ 4,422 261,241 -- -- --
Provision for credit
losses on accounts
receivable........... 1,056,781 3,981,525 5,124,008 3,730,892 6,384,001
Accretion of debt
discount............. -- -- 48,077 -- 364,455
Stock option based
compensation
expense.............. -- -- 1,032,646 -- 256,785
Changes in operating
assets and
liabilities, excluding
the effects of
business combinations:
Accounts receivable... (8,450,053) (14,571,500) (14,199,095) (9,753,315) (21,791,926)
Prepaid expenses and
other assets......... 1,603 145,656 (134,946) (86,267) (462,267)
Deposits and other
assets............... 28,669 157,762 (80,001) 187,565 (1,650,196)
Accounts payable and
accrued expenses..... 8,860,164 8,375,566 16,292,448 10,510,992 16,826,408
Income taxes.......... -- 3,526,900 (5,323,692) (4,202,227) (1,295,174)
Unearned revenue...... -- -- 64,276 41,986 95,946
Customer deposits..... 298,418 144,961 87,506 82,978 114,284
----------- ----------- ----------- ---------- -----------
Net cash provided by
(used in) operating
activities......... 1,364,188 5,561,336 4,904,457 4,083,070 (1,002,045)
----------- ----------- ----------- ---------- -----------
Cash flows from
investing activities:
Purchases of
equipment............ (1,056,430) (2,651,823) (9,067,923) (6,263,952) (12,463,348)
Proceeds from sale of
equipment............ 13,815 9,543 -- -- --
Capitalization of
software............. -- (117,051) (1,789,604) (1,326,858) (306,373)
Cash paid in business
combinations, net of
cash acquired........ -- -- (468,187) (468,187) (420,956)
Net change in
receivables from
shareholders and
employees............ 342,416 (58,464) 63,334 (202,003) (134,437)
----------- ----------- ----------- ---------- -----------
Net cash used in
investing
activities......... (700,199) (2,817,795) (11,262,380) (8,261,000) (13,325,114)
----------- ----------- ----------- ---------- -----------
Cash flows from
financing activities:
Net payments on notes
payable.............. -- -- (2,000,000) (2,000,000) --
Proceeds from
issuance
(prepayment) of
Private Offering..... -- -- 20,000,000 -- (20,000,000)
Debt issuance costs... -- -- (1,450,281) -- (750,000)
Dividends paid........ -- -- (950,000) -- --
Net proceeds from
line of credit....... -- -- -- 4,800,000 15,000,000
Net proceeds from
issuance of stock.... -- -- -- -- 39,825,343
Net proceeds from
options exercised.... -- -- -- -- 87,723
Net proceeds from
long-term
borrowings........... 1,000,000 -- 530,803 1,254,596 24,578,885
Payments on capital
lease obligations.... (42,926) (112,863) (180,901) (151,948) (94,283)
Net change in due to
shareholders......... -- (2,119) (25,881) (25,881) --
----------- ----------- ----------- ---------- -----------
Net cash (used in)
provided by
financing
activities......... 957,074 (114,982) 15,923,740 3,876,767 58,647,668
----------- ----------- ----------- ---------- -----------
Effect of exchange rate
changes on cash....... -- -- (2,203) (730) (260,274)
----------- ----------- ----------- ---------- -----------
Net increase (decrease)
in cash and cash
equivalents........... 1,621,063 2,628,559 9,563,614 (301,893) 44,060,235
----------- ----------- ----------- ---------- -----------
Cash and cash
equivalents at
beginning of year..... 341,777 1,962,840 4,591,399 4,591,399 14,155,013
----------- ----------- ----------- ---------- -----------
Cash and cash
equivalents at end of
year.................. $ 1,962,840 4,591,399 14,155,013 4,289,506 58,215,248
=========== =========== =========== ========== ===========
Supplemental cash flow
disclosures:
Dividends declared.... -- $ 525,000 425,000 425,000 --
=========== =========== =========== ========== ===========
Common stock issued
in connection with
business
combinations......... -- -- $ 573,984 573,984 470,000
=========== =========== =========== ========== ===========
Common stock issued
in consideration for
notes receivable..... -- -- 52,366 52,366 --
=========== =========== =========== ========== ===========
Equipment acquired
under capital
lease................ $ 480,007 87,553 -- -- --
=========== =========== =========== ========== ===========
Interest paid......... $ 112,152 120,604 356,270 200,209 2,356,921
=========== =========== =========== ========== ===========
Taxes paid............ -- -- 5,164,634 5,040,634 2,622
=========== =========== =========== ========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994, 1995 AND 1996 AND SEPTEMBER 30, 1997
(INFORMATION AS OF AND FOR THE NINE-MONTH PERIODSENDED SEPTEMBER 30, 1996 AND
1997 IS UNAUDITED)
(1) NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(a) Nature of Business
Telegroup, Inc. and subsidiaries (the Company) is a provider of domestic and
international telecommunications services. Telegroup's revenues are derived
from the sale of telecommunications to retail customers, typically residential
users and small to medium-sized business and wholesale customers, typically
telecommunications carriers. The Company's customers are principally located
in the United States, Europe and the Pacific Rim which consists of Asia,
Australia and New Zealand. In both the retail and wholesale aspects of its
business, the Company extends credit to customers on an unsecured basis with
the risk of loss limited to outstanding amounts.
The Company markets its services through a worldwide network of independent
agents and supervisory "country coordinators". The Company extends credit to
its sales representatives and country coordinators on an unsecured basis with
the risk of loss limited to outstanding amounts, less commissions payable to
the representatives and coordinators.
A summary of the Company's significant accounting policies follows:
(b) Basis of Presentation
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States,
and include the accounts of the Company and its wholly-owned subsidiaries.
The financial information as of September 30, 1997 and for the nine-month
periods ended September 30, 1996 and 1997 is unaudited and has been prepared
in conformity with generally accepted accounting principles and includes all
adjustments, in the opinions of management, necessary to a fair presentation
of the results of operations for the interim periods presented. Such
adjustments are, in the opinion of management, of a normal, recurring nature.
All significant intercompany accounts and transactions have been eliminated
in consolidation.
(c) Cash Equivalents
The Company considers all highly liquid investments with original maturities
of three months or less to be cash equivalents. At December 31, 1996 and
September 30, 1997 cash equivalents consisted of a certificate of deposit in
the amount of $60,000 and various government securities in the amount of
$25,030,700, respectively. There were no cash equivalents at December 31,
1995.
(d) Property and Equipment
Property and equipment are stated at cost. Equipment held under capital
leases is stated at the lower of the fair value of the asset or the net
present value of the minimum lease payments at the inception of the lease.
Depreciation is provided using the straight-line method over the useful lives
of the assets owned and the related lease term for equipment held under
capital leases.
F-7
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(e) Capitalized Software Development Costs
The Company capitalizes software costs incurred in the development of its
telecommunications switching software, billing systems and other support
platforms. The Company capitalizes only direct labor costs incurred in the
development of internal use software. Capitalization begins at achievement of
technological feasibility and ends when the software is placed in service.
Amortization of capitalized software will be provided using the straight-line
method over the software's estimated useful life, which ranges from 3 to 5
years. There was no amortization during 1995 or 1996 as the software had not
yet been placed in service. For the nine-month period ended September 30,
1997, amortization of software development costs totalled $339,082.
(f) Stock-Based Compensation
The Company accounts for its stock-based employee compensation plan using
the intrinsic value based method prescribed by Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretation (APB No. 25). The Company has provided pro forma disclosures as
if the fair value based method of accounting for these plans, as prescribed by
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation (SFAS No. 123), had been applied.
(g) Impairment of Long-Lived Assets
Effective January 1, 1996, the Company adopted SFAS No. 121, Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of
(SFAS No. 121), which requires that the long-lived assets and certain
identifiable intangibles, held and used by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable. An impairment loss is
recognized when estimated undiscounted future cash flows expected to be
generated by the asset is less than its carrying value. Measurement of the
impairment loss is based on the fair value of the asset, which is generally
determined using valuation techniques such as the discounted present value of
expected future cash flows. The adoption of SFAS No. 121 had no effect on the
consolidated financial statements of the Company.
(h) Other Assets
Goodwill results from the application of the purchase method of accounting
for business combinations. Amortization is provided using the straight-line
method over a maximum of 15 years. Impairment is determined pursuant to the
methodology in SFAS No. 121.
(i) Income Taxes
The Company accounts for income taxes under the provisions of SFAS No. 109,
Accounting for Income Taxes (SFAS No. 109). Under the asset and liability
method of SFAS No. 109, deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Under
SFAS No. 109, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
(j) Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual amounts could differ from those
estimates.
F-8
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(k) Business and Credit Concentration
Financial instruments which potentially expose the Company to a
concentration of credit risk, as defined by SFAS No. 105, Disclosure of
Information about Financial Instruments with Off-Balance-Sheet Risk and
Financial Instruments with Concentrations of Credit Risk, consist primarily of
accounts receivable. At December 31, 1996 and September 30, 1997, the
Company's accounts receivable balance from customers in countries outside of
the United States was approximately $18,100,000 and $34,500,000, respectively,
with an associated reserve for credit losses of $2,400,000 and $3,400,000,
respectively. At December 31, 1996 and September 30, 1997, approximately 3%
and 2%, respectively of the international accounts receivable balance is
collateralized by deposits paid by a portion of its international customers
upon the initiation of service.
(l) Foreign Currency Contracts
During 1996, the Company began to use foreign currency contracts to hedge
foreign currency risk associated with its international accounts receivable
balances. Gains or losses pursuant to these foreign currency contracts are
reflected as an adjustment of the carrying value of the hedged accounts
receivable. At December 31, 1996 and September 30, 1997, the Company had no
material deferred hedging gains or losses.
(m) Common Stock and Earnings (Loss) Per Share
Earnings (loss) per share have been computed using the weighted-average
number of shares of common stock outstanding during each period as adjusted
for the effects of the Securities and Exchange Commission Staff Accounting
Bulletin No. 83. Accordingly, options and warrants to purchase common stock
granted within one year of the Company's initial public offering, which have
exercise prices below the assumed initial public offering price per share,
have been included in the calculation of common equivalent shares, using the
treasury stock method, as if they were outstanding for all periods presented.
Common stock equivalents, which includes options and convertible subordinated
notes, are not included in the loss per share calculation as their effect is
anti-dilutive. Additionally, common share amounts have been adjusted to
reflect the stock split of approximately 5.48-for-1 and reclassification of
the Company's Class A and Class B common stock into a single class of common
stock which will occur immediately prior to the effectiveness of the
Registration Statement.
For the nine-month period ended September 30, 1997, earnings per common
share has been computed under the provisions of Accounting Principles Board
Opinion No. 15, Earnings per Share.
(n) Revenues, Cost of Revenues and Commissions Expense
Revenues from retail telecommunications services are recognized when
customer calls are completed. Revenues from wholesale telecommunications
services are recognized when the wholesale carrier's customers' calls are
completed. Cost of retail and wholesale revenues is based primarily on the
direct costs associated with owned and leased transmission capacity and the
cost of transmitting and terminating traffic on other carriers' facilities.
The Company does not differentiate between the cost of providing transmission
services on a retail or wholesale basis. Commissions paid to acquire customer
call traffic are expensed in the period when associated call revenues are
recognized.
(o) Prepaid Phone Cards
Substantially all the prepaid phone cards sold by the Company have an
expiration date of 24 months after issuance or six months after last use. The
Company records the net sales price as deferred revenue when cards are sold
and recognizes revenue as the ultimate consumer utilizes calling time.
Deferred revenue relating to unused calling time remaining at each card's
expiration is recognized as revenue upon the expiration of such card.
F-9
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(p) Foreign Currency Translation
The functional currency of the Company is the United States (U.S.) dollar.
The functional currency of the Company's foreign operations generally is the
applicable local currency for each wholly-owned foreign subsidiary. Assets and
liabilities of its foreign subsidiaries are translated at the spot rate in
effect at the applicable reporting date, and the combined statements of
operations and the Company's share of the results of operations of its foreign
subsidiaries are translated at the average exchange rates in effect during the
applicable period. The resulting unrealized cumulative translation adjustment
is recorded as a separate component of equity.
(q) Fair Value of Financial Instruments
The fair values of cash and cash equivalents, receivables, accounts payable
and lease obligations are estimated to approximate carrying value due to the
short-term maturities of these financial instruments. The carrying value of
the long-term debt approximates fair value as the debt was secured primarily
during November 1996 at rates consistent with those in effect at December 31,
1996 and September 30, 1997.
(r) Reclassifications
Certain amounts have been reclassified for comparability with the 1996
presentation.
(2) DEBT
Long-term debt at December 31, 1996 and September 30, 1997 is shown below:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
<S> <C> <C>
12% senior subordinated notes, net of discount,
paid in September 1997........................ $10,894,126 --
8.0% convertible subordinated notes, due April
15, 2005, unsecured........................... -- 25,000,000
8.5% note payable, due monthly through fiscal
2000, secured by vehicle...................... 19,003 12,493
10.8% note payable, due monthly through fiscal
1998, secured by equipment financed........... 160,628 108,327
12.0% note payable, paid in 1997............... 74,319 --
12.0% note payable, paid in 1997............... 276,853 --
6.85% note payable, due monthly through fiscal
1999, unsecured............................... 14,138 9,291
8.0% note payable, due monthly through fiscal
1998, unsecured............................... 10,425 4,140
----------- ----------
11,449,492 25,134,251
Less current portion........................... (232,596) (92,194)
----------- ----------
$11,216,896 25,042,057
=========== ==========
</TABLE>
There was no long-term debt at December 31, 1995.
On November 27, 1996, the Company completed a private placement (Private
Offering) of 12% Senior Subordinated Notes (Note) for gross proceeds of
$20,000,000 which is due and payable on November 27, 2003. Net proceeds from
the Private Offering, after issuance costs of $1,450,281, were $18,549,719. In
connection with the Private Offering, the Company issued 20,000 warrants to
purchase 1,160,107 of the Company's common stock (see note 7).
F-10
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Note was originally recorded at $10,846,049 (a yield of 26.8%), which
represents the $20,000,000 in proceeds less the $9,153,951 value assigned to
the detachable warrants, which is included in additional paid-in capital. The
value of the warrants was based on a valuation performed by the Company's
independent financial advisors. The value assigned to the warrants is being
accreted to the debt using the interest method over 7 years. The accretion of
the value assigned to the warrants is included in interest expense in the
accompanying consolidated financial statements.
The Company may redeem the Note in whole or in part, at the redemption prices
set forth in the agreement plus unpaid interest, if any, and a prepayment fee
of $1,400,000, if applicable, at the date of redemption. The Note indenture
contains certain covenants which provide for limitations on indebtedness,
dividend payments, changes in control, and certain other business transactions.
The Company had a credit agreement with a bank which provided for up to
$5,000,000 in committed credit at December 31, 1996. On September 12, 1997, the
Company entered into a $15 million revolving credit facility (the "Facility")
which replaced the previous credit facility. The Facility expired October 31,
1997 and was secured by the Company's accounts receivable and other assets.
Amounts outstanding under the Facility bear interest at a fluctuating rate
which was 8.75% at September 30, 1997. There were no borrowings under the
credit agreement at December 31, 1996 and $15,000,000 borrowed under the
Facility at September 30, 1997.
The following is a schedule by years of future minimum debt service
requirements as of December 31, 1996 and September 30, 1997:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
<S> <C> <C>
1997............................................. $ 232,596 92,194
1998............................................. 229,684 41,250
1999............................................. 91,271 807
2000............................................. 1,815 --
2001............................................. -- --
Later years...................................... 20,000,000 25,000,000
----------- ----------
20,555,366 25,134,251
Less unaccreted discount on the 12% note......... (9,105,874) --
----------- ----------
$11,449,492 25,134,251
=========== ==========
</TABLE>
On September 5, 1997, the Company prepaid in full all of its outstanding
senior subordinated notes. The Company paid $21,400,000, which included
$20,000,000 in principal and $1,400,000 for a prepayment penalty. In addition,
the Company recognized a loss of $8,741,419 and $1,298,882 for the write-off of
the unamortized original issue discount and debt issuance costs, respectively.
The early extinguishment of the senior subordinated notes is reflected on the
statement of operations as an extraordinary item, net of income taxes.
On September 30, 1997, the Company issued $25 million in aggregate principal
amount of convertible subordinated notes due April 15, 2005. The net proceeds
from the issuance of the convertible notes were approximately $24.3 million.
The convertible notes are unsecured obligations of the Company and are
subordinated to all existing and future senior indebtedness of the Company. The
convertible notes bear interest at 8% per annum. The convertible notes are
convertible into shares of common stock of the Company at any time on or before
April 15, 2005, unless previously redeemed, at a conversion price of $12.00 per
share.
F-11
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The convertible notes are redeemable, in whole or in part, at the option of
the Company, at any time on or after October 15, 2000 at redemption prices
(expressed as a percentage of the principal amount) declining annually from
104.0% beginning October 15, 2000 to 100.0% beginning on October 15, 2003 and
thereafter, together with accrued interest to the redemption date and subject
to certain conditions.
The convertible note indenture places certain restrictions on the ability of
the Company and its subsidiaries to (i) incur additional indebtedness, (ii)
make restricted payments (dividends, redemptions and certain other payments),
(iii) incur liens, (iv) enter into mergers, consolidations or acquisitions,
(v) sell or otherwise dispose of property, business or assets, (vi) issue and
sell preferred stock of a subsidiary and (vii) engage in transactions with
affiliates.
(3) BUSINESS COMBINATIONS
On August 21, 1996, the Company purchased TeleContinent, S.A. for $200,000.
Also on August 21, 1996, the Company purchased Telegroup South Europe, Inc.
Consideration for the purchase was $1,031,547 and 262,116 shares of common
stock of the Company valued at $573,984, for total consideration of
$1,605,531. The value of the common stock was determined by management based
on information obtained from the Company's independent financial advisors.
The acquisitions have been accounted for using the purchase method of
accounting and, accordingly, the net assets and results of operations are
included in the consolidated financial statements from the date of
acquisition. The aggregate purchase price of the acquisitions was allocated
based on fair values as follows:
<TABLE>
<S> <C>
Current assets................................................... $ 794,452
Property and equipment........................................... 54,571
Goodwill......................................................... 1,024,609
Current liabilities.............................................. (68,101)
----------
Total.......................................................... $1,805,531
==========
</TABLE>
Pro forma operating results of the Company, assuming these acquisitions were
consummated on January 1, 1994, do not significantly differ from reported
amounts.
On August 14, 1997, the Company acquired 60 percent of the common stock of,
and a controlling interest in, PCS Telecom, Inc. ("PCS Telecom") for
$1,340,000 in cash and 40,000 shares of unregistered common stock valued at
$470,000, for total consideration of $1,810,000. PCS Telecom is a developer
and manufacturer of state of the art, feature-rich, calling card platforms
used by the Company and numerous other companies.
The acquisition has been accounted for using the purchase method of
accounting and, accordingly, the net assets and results of operations are
included in the consolidated financial statements from the date of
acquisition. The aggregate purchase price of the acquisition was allocated
based on fair values as follows:
<TABLE>
<S> <C>
Current assets.................................................. $ 1,281,826
Property and equipment.......................................... 534,600
Goodwill........................................................ 2,041,258
Current liabilities............................................. (2,047,684)
-----------
Total......................................................... $ 1,810,000
===========
</TABLE>
F-12
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Pro forma operating results of the Company, assuming the acquisition was
consummated on January 1, 1995 would have been as follows:
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
DECEMBER 31, SEPTEMBER 30,
------------------------ -------------
1995 1996 1997
------------ ----------- -------------
<S> <C> <C> <C>
Revenue............................... $130,545,090 216,488,287 239,989,539
============ =========== ===========
Income before extraordinary item...... 3,799,274 (181,282) (2,839,205)
============ =========== ===========
Net income (loss)..................... 3,799,274 (181,282) (12,810,020)
============ =========== ===========
Earnings (loss) per share before ex-
traordinary item..................... 0.13 (0.01) (0.10)
============ =========== ===========
Net earnings (loss) per share......... 0.13 (0.01) (0.47)
============ =========== ===========
</TABLE>
(4) RELATED PARTIES
During 1994, 1995, and a portion of 1996, the Company had a management
agreement with an affiliate owned by certain shareholders of the Company
whereby it paid a management fee, determined annually, plus an incentive fee
based upon performance. Amounts paid under this agreement totaled $1,155,000,
$1,334,000 and $415,000 during 1994, 1995 and 1996, respectively. The
management agreement was terminated on May 15, 1996.
(5) PROPERTY AND EQUIPMENT
Property and equipment, including assets owned under capital leases of
$813,790 in 1995 and $612,278 as of December 31, 1996 and September 30, 1997,
is comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
USEFUL ---------------------- SEPTEMBER 30,
LIVES 1995 1996 1997
------ ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Land.......................... -- $ 34,290 88,857 155,708
Building and improvements..... 2-20 -- 298,483 644,407
Furniture, fixtures and office
equipment.................... 5-7 172,016 327,368 617,776
Computer equipment............ 5 2,363,954 5,021,884 9,040,093
Network equipment............. 5 2,409,848 8,344,824 16,287,330
Automobiles................... 5 62,055 104,260 124,334
---------- ----------- ----------- ---
5,042,163 14,185,676 26,869,648
Less accumulated depreciation,
including amounts applicable
to assets acquired under cap-
ital leases of $338,665 in
1995, $269,098 in 1996 and
$273,573 as of September 30,
1997......................... 1,063,124 2,929,537 5,272,668
---------- ----------- -----------
Net property and equipment.... $3,979,039 11,256,139 21,596,980
========== =========== ===========
</TABLE>
Property and equipment includes approximately $800,000 of equipment which has
not been placed in service at December 31, 1996 and, accordingly, is not being
depreciated. The majority of this amount is related to new network
construction.
F-13
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(6) LEASES
The Company leases certain network equipment under capital leases and leases
office space under operating leases. Future minimum lease payments under these
lease agreements for each of the next five years are summarized as shown
below.
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------- ---------
<S> <C> <C>
Year ending December 31:
1997................................................... $187,421 860,777
1998................................................... 164,626 527,175
1999................................................... 143,120 437,981
2000................................................... 43,149 437,160
2001................................................... -- 106,630
Thereafter............................................. -- --
-------- ---------
Total minimum lease payments......................... 538,316 2,369,723
=========
Less amount representing interest...................... (98,614)
--------
$439,702
========
</TABLE>
As operating leases expire, it is expected that they will be replaced with
similar leases. Rent expense under operating leases totaled $224,504, $306,933
and $682,630 for the years ended December 31, 1994, 1995 and 1996,
respectively, and $414,158 and $1,004,558 for the nine-month periods ended
September 30, 1996 and 1997, respectively.
(7) SHAREHOLDERS' EQUITY
Initial Public Offering
On July 14, 1997, the Company consummated an initial public offering. The
Company sold 4,000,000 shares of common stock at a price to public of $10 per
share for net proceeds of approximately $35.6 million. On August 12, 1997, the
underwriters exercised their over-allotment option and purchased an additional
450,000 shares at $10 per share which yielded net proceeds to the Company of
approximately $4.2 million.
Stock Option Plan
The Company has a stock option plan (the Plan) pursuant to which the
Company's Board of Directors may grant unqualified and performance-based
options to employees. The Plan authorizes grants of option to purchase up to
4,000,000 shares of authorized but unissued common stock. All stock options
have a ten-year term and become fully exercisable on the date of grant or in
increments over a three-year vesting period. The following table summarizes
the stock option activity since the inception of the Plan through December 31,
1996.
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF EXERCISE PRICE REMAINING
SHARES PER SHARE TERM
--------- -------------- -----------
<S> <C> <C> <C>
Outstanding at January 1, 1996........ -- --
Granted............................. 1,631,031 $1.31
Canceled............................ (4,110) --
Exercised........................... -- --
--------- -----
Outstanding at December 31, 1996...... 1,626,921 $1.31 9.2 years
========= =====
Exercisable at December 31, 1996...... 537,039 $1.31
========= =====
</TABLE>
F-14
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company applies the intrinsic value method prescribed by APB Opinion No.
25 in accounting for its Plan and, accordingly, compensation costs of
$1,032,646 and $256,785 have been recognized for its stock options for the year
ended December 31, 1996 and for the nine-month period ended September 30, 1997,
respectively. Had the Company determined compensation cost based on the fair
value at the grant date for its stock options under SFAS No. 123, the Company's
net loss and loss per share would have been:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------
AS REPORTED PRO FORMA
----------- ---------
<S> <C> <C>
Net loss.................................................. $118,322 79,767
======== ======
Loss per common equivalent share.......................... $ 0.00 0.00
======== ======
</TABLE>
Under SFAS No. 123, the per-share minimum value of stock options granted in
1996 was $0.61. The minimum value, estimated as of the grant date, does not
take into account the expected volatility of the underlying stock as is
prescribed by SFAS No. 123 for privately held companies. Input variables used
in the model included an interest free rate of 6.43%, no expected dividend
yields, and an estimated option life of 10 years. The pro forma impact on
income assumes no options will be forfeited.
Options granted during 1996 included performance based options. The
compensation expense recorded for these performance based options under APB
Opinion No. 25 was greater than the expense recorded if the Company had
determined compensation cost under SFAS No. 123.
Warrants
In connection with the Private Offering, the Company issued warrants to
purchase 1,160,107 shares of the Company's common stock which, at the time of
closing of the Private Offering, represented four percent of the Company's
fully diluted common stock. The warrants are currently exercisable, carry an
exercise price of $.002 per share, and expire November 27, 2003. As of December
31, 1996, all of these warrants remain outstanding. If the Company has not
consummated an initial public offering (IPO) prior to July 2, 1997, the holder
of the warrants will receive additional shares equal to one-half of one percent
of the outstanding shares on a fully diluted basis. If the Company has not
consummated an IPO prior to January 2, 1998, the holder of the warrants will
receive an additional amount equal to one-half of one percent of the
outstanding shares on a fully diluted basis.
The Company did not consummate its initial public offering prior to July 2,
1997. Accordingly, the number of shares of common stock issuable upon exercise
of the warrants will be increased by 153,644 shares, which represents one-half
of one percent of the outstanding shares at July 2, 1997 on a fully diluted
basis.
(8) INCOME TAX MATTERS
Income tax expense (benefit) is comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------------------------ --------------------
1994 1995 1996 1996 1997
--------- --------- -------- --------- ----------
<S> <C> <C> <C> <C> <C>
Current................... $(150,100) 3,526,900 (237,381) 780,748 (1,093,002)
Deferred.................. (198,200) (937,200) 229,933 362,790 (273,052)
--------- --------- -------- --------- ----------
$(348,300) 2,589,700 (7,448) 1,143,538 (1,366,054)
========= ========= ======== ========= ==========
</TABLE>
F-15
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Income tax expense differs from the amount computed by applying the federal
income tax rate of 34% to earnings (loss) before taxes, as follows:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
---------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- ------- --------- ----------
<S> <C> <C> <C> <C> <C>
Expected federal income
tax (benefit)............ $(301,500) 2,180,000 (42,762) 1,085,651 (1,433,070)
State income tax (bene-
fit), net of federal ef-
fect..................... (53,200) 384,700 (1,344) 35,002 (46,203)
Environmental tax......... -- 10,200 -- -- --
Other nondeductible ex-
penses, net.............. 6,400 14,800 36,658 22,885 113,219
--------- --------- ------- --------- ----------
$(348,300) 2,589,700 (7,448) 1,143,538 (1,366,054)
========= ========= ======= ========= ==========
</TABLE>
The tax effect of significant temporary differences giving rise to deferred
income tax assets and liabilities are shown below:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
----------------------------- -------------
1994 1995 1996 1997
-------- --------- --------- -------------
<S> <C> <C> <C> <C>
Deferred income tax liabilities:
Property and equipment, princi-
pally depreciation adjustments.. $148,200 269,630 502,711 797,791
Capitalized software............. -- -- 669,160 657,680
Basis in subsidiaries............ -- -- 32,898 --
Stock options exercised.......... -- -- -- 89,490
Unearned foreign exchange differ-
ence............................ -- -- -- 6,677
Cumulative adjustment, change in
accounting for income tax pur-
poses........................... 153,600 -- -- --
-------- --------- --------- ---------
Total gross deferred tax
liabilities................... $301,800 269,630 1,204,769 1,551,638
======== ========= ========= =========
Deferred income tax assets:
Allowance for credit losses...... 130,000 840,000 1,151,172 1,534,167
Accrued compensation............. 19,200 294,730 447,878 704,837
Net operating loss carryforward.. 44,900 -- -- --
Charitable contribution
carryforward.................... 35,600 -- 107,729 117,000
Unearned revenue................. -- -- 22,558 56,232
Basis in subsidiaries............ -- -- -- 361,575
Unearned foreign exchange differ-
ence............................ -- -- 4,543 --
Other............................ -- -- 106,056 381,214
-------- --------- --------- ---------
Total gross deferred tax as-
sets.......................... 229,700 1,134,730 1,839,936 3,155,025
Less valuation allowance....... -- -- -- (695,168)
-------- --------- --------- ---------
Net deferred tax assets........ 229,700 1,134,730 1,839,936 2,459,857
======== ========= ========= =========
Net deferred tax asset (liabil-
ity).......................... $(72,100) 865,100 635,167 908,219
======== ========= ========= =========
</TABLE>
(9) COMMITMENTS AND CONTINGENCIES
Commitment with Telecommunications Company
The Company has an agreement with Sprint Communications Company L.P. (Sprint)
with net monthly usage commitments of $1,500,000. In the event such monthly
commitments are not met, the Company is required
F-16
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
to remit to Sprint 25% of the difference between the $1,500,000 monthly
commitment and actual usage. Such amount, if necessary, would be recorded as
cost of revenue in the period incurred. The Company has exceeded the monthly
usage commitments since the inception of this agreement. This agreement
extends through December 1997.
Network
At September 30, 1997, the Company had $4.5 million in commitments for
capital expenditures. The Company has identified a total of $60.1 million of
capital expenditures which the Company intends to undertake in 1997 and 1998
and approximately $75.0 million of additional capital expenditures during the
period from 1999 though 2001, subject to the ability to obtain additional
financing.
Retirement Plan
Effective January 1, 1996, the Company adopted the Telegroup, Inc. 401(k)
Retirement Savings Plan (the Plan). The Plan is a defined contribution plan
covering all employees of the Company who have one year of service and have
attained the age of 21. Participants may contribute up to 15% of their base
pay in pretax dollars. The Company will match employee contributions on a
discretionary basis. Vesting in Company contributions is 100% after 5 years in
the Plan. The Company made no contributions to the Plan in 1996.
Litigation
In September 1996, Macrophone Worldwide (PTY) Ltd. (the "Plaintiff"), a
former Country Coordinator for South Africa, filed a complaint (the
"Complaint") against the Company in the United States District Court for the
Southern District of Iowa (the "Action") alleging, among other things, breach
of contract, wrongful termination and intentional interference with
contractual relations. The Complaint requests compensatory and exemplary
damages. Although the Company is vigorously defending the Action, management
believes that the Company will ultimately prevail and does not believe the
outcome of the Action, if unfavorable, will have a material adverse effect on
the Company's business, financial condition or results of operations, although
there can be no assurance that this will be the case.
The Company is a party to certain other litigation which has arisen in the
ordinary course of business. In the opinion of management, the ultimate
resolution of these matters will not have a significant effect on the
financial statements of the Company.
(10) BUSINESS SEGMENT AND SIGNIFICANT CUSTOMER
The Company operates in a single industry segment. For the years ended
December 31, 1994, 1995 and 1996, substantially all of the Company's revenues
were derived from traffic transmitted through switch facilities in New York
and the United Kingdom. The geographic origin of revenue is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, PERIOD ENDED SEPTEMBER 30,
------------------------------------- ---------------------------
1994 1995 1996 1996 1997
----------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
United States........... 29,490,585 35,154,246 60,360,882 44,080,498 81,521,394
Europe.................. 12,306,408 41,173,425 81,137,404 57,157,577 74,741,219
Pacific Rim............. 8,485,055 22,613,550 42,185,403 24,911,285 58,357,738
Other................... 18,431,917 30,178,169 29,523,820 21,629,281 23,857,735
----------- ------------ ------------ ------------- -------------
$68,713,965 $129,119,390 $213,207,509 $ 147,778,641 $238,478,086
=========== ============ ============ ============= =============
</TABLE>
All revenue was derived from unaffiliated customers. For the nine-month
period ended September 30, 1997 approximately 12% of the Company's total
revenues were derived from a single customer.
F-17
<PAGE>
FASTNET U.K. LIMITED
DIVISIONAL FINANCIAL STATEMENTS
FOR THE PERIOD FROM 1 OCTOBER 1996 TO 28 FEBRUARY 1997
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Introduction............................................................... 2
Auditor's Report........................................................... 3
Divisional Balance Sheet as at 28 February 1997............................ 4
Divisional Statement of Operations......................................... 5
Divisional Statement of Shareholder's Deficit.............................. 6
Divisional Statement of Cash Flows......................................... 7
Notes to the Divisional Financial Statements............................... 8-10
</TABLE>
FD-1
<PAGE>
FASTNET U.K. LIMITED
DIVISIONAL FINANCIAL STATEMENTS
FOR THE PERIOD FROM 1 OCTOBER 1996 TO 28 FEBRUARY 1997
INTRODUCTION
The attached divisional financial statements have been extracted from the
books and records of Fastnet U.K. Limited and represent that part of the
company's activities that relate to its business with Telegroup Inc. under a
marketing and co-ordination agreement dated 20 October 1996 (and as
subsequently amended by mutual consent of both parties).
The divisional financial statements have been prepared in accordance with
U.S. generally accepted accounting principles and are stated in U.S. dollars.
The divisional balance sheet has been prepared from the books and records
and includes the assets and liabilities of the division together with the
earnings/(losses) from that division. For the purposes of the divisional
balance sheet the financing of the division is shown as a liability to the
other divisions of the company. The balance sheet is therefore an extract
taken from the total company position, and does not include equity or other
share capital.
FD-2
<PAGE>
AUDITORS' REPORT TO THE BOARD OF DIRECTORS OF TELEGROUP, INC.
ON THE DIVISIONAL FINANCIAL STATEMENTS OF FASTNET U.K. LIMITED
FOR THE PERIOD FROM 1 OCTOBER 1996 TO 28 FEBRUARY 1997
We have audited the divisional financial statements on pages 3 to 10 which
have been prepared under the historical cost convention and the accounting
policies set out on pages 7 to 8. These divisional financial statements have
been extracted from the books and records of the company and represent that
part of the company's activities that relate to its business undertaken as a
co-ordinator on behalf of Telegroup, Inc. As detailed in an agreement dated 20
October 1996 (and as subsequently amended by mutual consent of both parties)
and as specified in Note 1(a) to the divisional financial statements.
RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS
The directors of Fastnet U.K. Limited are responsible for the preparation of
divisional financial statements. It is our responsibility to form an
independent opinion, based on our audit, on those statements and to report our
opinion to you.
BASIS OF OPINION
We conducted our audit in accordance with U.K. Auditing Standards issued by
the Auditing Practices Board. An audit includes examination, on a test basis,
of evidence relevant to the amounts and disclosures in the divisional
financial statements. It also includes an assessment of the significant
estimates and judgements made by the directors in the preparation of the
divisional financial statements, and of whether the accounting policies are
appropriate to the company's circumstances, consistently applied and
adequately disclosed.
We planned and performed our audit so as to obtain all the information and
explanations which we considered necessary in order to provide us with
sufficient evidence to give reasonable assurance that the divisional financial
statements are free from material misstatement, whether caused by fraud or
other irregularity or error. In forming our opinion we also evaluated the
overall adequacy of the presentation of information in the divisional
financial statements.
OPINION
In our opinion the divisional financial statements give a true and fair view
of the state of the division's affairs as at 28 February 1997 and of its
result and cash flow for the period then ended. These divisional financial
statements have been properly prepared in accordance with generally accepted
accounting principles.
MacIntyre & Co.
Chartered Accountants
Registered Auditors
28 Ely Place
London
EC1N 6RL
FD-3
<PAGE>
FASTNET U.K. LIMITED
DIVISIONAL BALANCE SHEET
AS AT 28 FEBRUARY 1997
<TABLE>
<CAPTION>
28 FEBRUARY
NOTES 1997
----- -----------
$
<S> <C> <C>
ASSETS
Current Assets
Accounts receivable and unbilled services.................. 17,991
Prepaid expenses........................................... 15,333
--------
Total current assets..................................... 33,324
Net property and equipment................................... 3 72,093
--------
TOTAL ASSETS............................................. $105,417
========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................... 6,208
Accrued expenses........................................... 3,936
Amounts owed to other divisions of the company in respect
of financing of trading activities........................ 7 192,743
Amounts owed to directors.................................. 11,807
--------
Total current liabilities................................ 214,694
Shareholders' deficit
Common stock, no par or stated value
Retained losses............................................ (109,277)
--------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY................... $105,417
========
</TABLE>
FD-4
<PAGE>
FASTNET U.K. LIMITED
DIVISIONAL STATEMENT OF OPERATIONS
FOR THE PERIOD ENDED 28 FEBRUARY 1997
<TABLE>
<CAPTION>
NOTES $ $
----- ------- ---------
<S> <C> <C> <C>
Revenues:
Commissions receivable.............................. 1(g) 36,560
---------
Total revenues.................................... 36,560
Operating Expenses
Selling, general and administrative expenses........ 117,258
Depreciation........................................ 30,071
-------
Total operating expenses............................ 1(g) (147,329)
---------
Operating loss........................................ (110,769)
Other income:
Foreign currency transaction gain..................... 1,492
---------
Loss before income taxes.............................. (109,277)
Income tax expense.................................... 5 --
---------
Net loss.............................................. $(109,277)
=========
</TABLE>
See accompanying notes to the divisional financial statements.
FD-5
<PAGE>
FASTNET U.K. LIMITED
DIVISIONAL STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
FOR THE PERIOD ENDED 28 FEBRUARY 1997
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK ADDITIONAL RETAINED SHAREHOLDERS
------------- PAID-IN EARNINGS EQUITY
SHARES AMOUNT CAPITAL (DEFICIT) (DEFICIT)
NO. $ $ $ $
------ ------ ----------- --------- ------------
<S> <C> <C> <C> <C> <C>
Issue of common stock....... -- -- -- -- --
Net loss.................... -- -- -- (109,277) (109,277)
--- --- --- -------- --------
Balances at 28 February
1997....................... -- -- -- (109,277) (109,277)
--- --- --- -------- --------
</TABLE>
FD-6
<PAGE>
FASTNET U.K. LIMITED
DIVISIONAL STATEMENT OF CASH FLOWS
FOR THE PERIOD ENDED 28 FEBRUARY 1997
<TABLE>
<CAPTION>
$ $
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss............................................... (110,769)
Adjustments to reconcile net loss to net cash provided
by operating activities...............................
Depreciation........................................... 30,071
Changes in operating assets and liabilities, excluding
the effects of business combinations
Accounts receivable.................................... (17,991)
Prepaid expenses....................................... (15,333)
Accounts payable and accrued expenses.................. 10,144
Amounts owed to directors.............................. 11,807
--------
NET CASH USED IN OPERATING ACTIVITIES.................... (92,071)
Cash flows from investing activities
Purchases of equipment................................. 102,164
--------
NET CASH USED IN INVESTING ACTIVITIES.................... (102,164)
---------
(194,235)
Effect of exchange rate changes on cash.................. 1,492
---------
NET DECREASE IN CASH AND CASH EQUIVALENTS BEING AMOUNT
OWED TO OTHER DIVISIONS OF THE COMPANY IN RESPECT OF
FINANCING OF TRADING ACTIVITIES......................... $(192,743)
---------
</TABLE>
FD-7
<PAGE>
FASTNET U.K. LIMITED
NOTES TO THE DIVISIONAL FINANCIAL STATEMENTS
FOR THE PERIOD ENDED 28 FEBRUARY 1997
1. NATURE OF THE DIVISION AND SIGNIFICANT ACCOUNTING POLICIES
a) Nature of the division
The divisional financial statements have been extracted from the books and
records of Fastnet U.K. Limited, and represent that part of the company's
activities that relate to its business undertaken as a co-ordinator on behalf
of Telegroup, Inc. In an agreement dated 20 October 1996, (and as subsequently
amended by mutual consent as detailed of both parties).
Telegroup, Inc. is in the business of providing telecommunications services
and under the agreement, Fastnet U.K. Limited has the right to market and
distribute certain of Telegroup Inc.'s services in the United Kingdom.
The divisional balance sheet has been prepared from the books and records
and includes the assets and liabilities of the division together with the
retained losses of that division. For the purposes of the divisional balance
sheet these divisional financing of the division is shown as a liability to
the other divisions of the company. The balance sheet is therefore on extract
taken from the total company position, and does not include equity or other
share capital.
A summary of the division's significant accounting policies follows
b) Basis of Presentation
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles.
c) Cash Equivalents
The division considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. There were no cash
equivalents at 28 February 1997.
d) Property and Equipment
Property and equipment are stated at cost less depreciation. Depreciation is
provided using the straight-line method over the useful lives of the assets as
follows:
<TABLE>
<S> <C>
Computer equipment 31 1/3%
Office fixtures, fitting and equipment 20%
</TABLE>
All items of property and equipment purchased by the company as a whole
since its incorporation relate entirely to this division and have been
included in these divisional financial statements accordingly.
e) Income Taxes
The division accounts for U.K. taxes under the provisions of Statement of
Standard Accounting Practice (SSAP). Numbers 8 and 15. Under the asset and
liability method of SSAP 15, deferred tax assets and liabilities are
recognised for the future tax consequences attributable to differences between
the carrying amounts in the divisional financial statement of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. Under SSAP 15, the effect on deferred tax assets and
liabilities of a change in tax rates is recognised in income in the period
that includes the enactment date.
FD-8
<PAGE>
FASTNET U.K. LIMITED
NOTES TO THE DIVISIONAL FINANCIAL STATEMENTS--(CONTINUED)
FOR THE PERIOD ENDED 28 FEBRUARY 1997
f) Estimates
The preparation of divisional financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenue
during the reporting period. Actual amounts could differ from those estimates.
g) Revenues and Expenses
Commissions receivable are recognised in the period that the associated
telephone call revenues are recognised by Telegroup, Inc., and relate to the
period from 290 October 1996 to 28 February 1997. Expenditure recognised in
these financial statements relates to the period from 1 October 1996 to 28
February 1997 in respect of all divisions of the company, as the operations of
the other divisions of the company ceased prior to this date.
h) Foreign Currency Translation
The functional currency of the division is the United States (U.S.) dollar.
Assets and liabilities are translated at the closing rate in effect at the
applicable reporting date, and the statement of operations is translated at
the average exchange rates in effect during the applicable period.
i) Fair Value of Financial Instruments
The fairness of cash and cash equivalents, receivables, accounts payable and
lease obligations are estimated to approximate to carrying value due to the
short-term maturities of these financial instruments.
2. RELATED PARTIES
At 28 February 1997, the division owed $11,807 to T.G. Redpath, Esq. a
director of the company in respect of a rent deposit made on leasehold
premises from which the company trades.
3. PROPERTY AND EQUIPMENT
Property and equipment at 28 February 1997 is comprised of the following
<TABLE>
<CAPTION>
28 FEBRUARY
1997
-----------
$
<S> <C>
Furniture, fixtures and office equipment......................... 30,507
Computer equipment............................................... 71,657
-------
102,164
Less accumulated depreciation.................................... (30,071)
-------
Net property and equipment....................................... $72,093
=======
</TABLE>
FD-9
<PAGE>
FASTNET U.K. LIMITED
NOTES TO THE DIVISIONAL FINANCIAL STATEMENTS--(CONTINUED)
FOR THE PERIOD ENDED 28 FEBRUARY 1997
4. LEASES
The company leases office space under an operating lease and the future
minimum lease payments under this agreement for each of the next five years is
summarised below.
<TABLE>
<CAPTION>
OPERATING
LEASES
---------
$
<S> <C>
Period ending 28 February 1998..................................... 5,904
=====
</TABLE>
Rent expense under operating leases totalled $9,974 for the period ended 28
February 1997.
5. INCOME TAX MATTERS
As the division has made a tax allowable loss for U.K. corporation tax
purposes, no provision for tax has been included within the divisional
financial statements.
6. BUSINESS SEGMENT AND SIGNIFICANT CUSTOMER
The division operates in a single industry segment. For the period ended 28
February 1997, all of the division's revenues were derived from commissions
earned under the marketing and co-ordination agreement with Telegroup, Inc.,
in respect of activities undertaken in the United Kingdom.
7. AMOUNTS OWED TO OTHER DIVISIONS OF THE COMPANY IN RESPECT OF FINANCING OF
TRADING ACTIVITIES
These divisional financial statements represent the activities of a division
of the company which operates under the marketing and co-ordination agreement
with Telegroup, Inc. dated 20 October 1996, (and as subsequently amended by
mutual consent between the parties). In order to finance these activities, the
division has relied on funding by other divisions of the company and at 28
February 1997 the extent of these borrowings was $192,743.
FD-10
<PAGE>
FASTNET U.K. LIMITED
UNAUDITED DIVISIONAL FINANCIAL STATEMENTS
FOR THE PERIOD FROM 1 MARCH 1997 TO 30 NOVEMBER 1997
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Introduction.............................................................. FUD-2
Unaudited Divisional Balance Sheet as of 30 November 1997................. FUD-3
Unaudited Divisional Statement of Operations.............................. FUD-4
Unaudited Divisional Statement of Shareholders' Deficit................... FUD-5
Unaudited Divisional Statement of Cash Flows.............................. FUD-6
Notes to the Unaudited Divisional Financial Statements....................
</TABLE>
FUD-1
<PAGE>
FASTNET U.K. LIMITED
UNAUDITED DIVISIONAL FINANCIAL STATEMENTS
FOR THE PERIOD FROM 1 MARCH 1997 TO 30 NOVEMBER 1997
INTRODUCTION
The attached divisional financial statements have been extracted from the
books and records of Fastnet U.K. Limited, and represent that part of the
company's activities that relate to its business with Telegroup Inc. under a
marketing and co-ordination agreement dated 20 October 1996 (and as
subsequently amended to mutual consent of both parties).
The divisional financial statements have been prepared in accordance with
generally accepted accounting principles and are stated in U.S. dollars.
The divisional balance sheet has been prepared from the books and records
and includes the assets and liabilities of the division together with the
earnings/(losses) from that division. For the purposes of the divisional
balance sheet the financing of the division is shown as a liability to the
other divisions of the company. The balance sheet is therefore an extract
taken from the total company position, and does not include equity or other
share capital.
On 25 November 1997 the division sold its business as a going concern to
Telegroup U.K. Limited as detailed in a sale agreement of the same date. This
transaction has not been reflected in the divisional financial statements.
FUD-2
<PAGE>
FASTNET U.K. LIMITED
UNAUDITED DIVISIONAL BALANCE SHEET
AS AT 30 NOVEMBER 1997
<TABLE>
<CAPTION>
30 NOVEMBER
1997
NOTES $
----- -----------
<S> <C> <C>
ASSETS
Current Assets
Accounts receivable and unbilled services.................. 61,329
Prepaid expenses........................................... 200
--------
Total current assets..................................... 61,529
Net property and equipment................................... 3 82,337
--------
TOTAL ASSETS............................................. $143,866
========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................... 11,612
Accrued expenses........................................... 4,082
Amounts owed to other divisions of the company in respect
of financing of trading activities........................ 6 267,831
Amounts owed to directors.................................. 12,245
--------
Total current liabilities................................ 295,770
Shareholders' deficit Common stock, no par or stated value... --
Retained losses............................................ (151,904)
--------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............... $143,866
========
</TABLE>
FUD-3
<PAGE>
FASTNET U.K. LIMITED
DIVISIONAL STATEMENT OF OPERATIONS
FOR THE PERIOD ENDED 30 NOVEMBER 1997
<TABLE>
<CAPTION>
NOTES $ $
----- ------ --------
<S> <C> <C> <C>
Revenues:
Commissions receivable................................ 1(g) 33,293
Consultancy fees receivable........................... 1(g) 72,179
------
Total revenues...................................... 105,472
Operating Expenses
Selling, general and administrative expenses.......... 1(g) (143,025)
--------
Operating loss........................................ (37,553)
Other expense
Foreign currency transaction loss..................... (5,074)
--------
Net loss before income taxes............................ $(42,627)
========
</TABLE>
FUD-4
<PAGE>
FASTNET U.K. LIMITED
UNAUDITED DIVISIONAL STATEMENT OF SHAREHOLDERS' DEFICIT
FOR THE PERIOD ENDED 30 NOVEMBER 1997
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK ADDITIONAL RETAINED SHAREHOLDERS'
------------- PAID-IN EARNINGS EQUITY
SHARES AMOUNT CAPITAL (DEFICIT) (DEFICIT)
NO. $ $ $ $
------ ------ ---------- --------- -------------
<S> <C> <C> <C> <C> <C>
Issue of common stock....... -- -- -- (109,277) (109,277)
Issue of common stock....... -- -- -- -- --
Net loss.................... -- -- -- (42,627) (42,627)
--- --- --- -------- --------
Balances at 30 November
1997....................... -- -- -- (151,904) (151,904)
=== === === ======== ========
</TABLE>
FUD-5
<PAGE>
FASTNET U.K. LIMITED
UNAUDITED DIVISIONAL STATEMENT OF CASH FLOWS
FOR THE PERIOD ENDED 30 NOVEMBER 1997
<TABLE>
<CAPTION>
$ $
------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss................................................ (37,553)
Changes in operating assets and liabilities, excluding the
effects of business combinations
Accounts receivable..................................... (43,338)
Prepaid expenses........................................ 15,133
Accounts payable and accrued expenses................... 5,550
Amounts owed to directors............................... 438
-------
NET CASH USED IN OPERATING ACTIVITIES................... (59,770)
Cash flows from investing activities:
Purchases of equipment.................................. 7,570
-------
NET CASH USED IN INVESTING ACTIVITIES..................... (7,570)
---------
(67,340)
Effect of exchange rate changes on cash................... (7,748)
---------
NET DECREASE IN CASH AND CASH EQUIVALENTS................. (75,088)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.......... (192,743)
---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD BEING AMOUNT
OWED TO OTHER DIVISIONS OF THE COMPANY IN RESPECT OF
FINANCING OF TRADING ACTIVITIES.......................... $(267,831)
=========
</TABLE>
FUD-6
<PAGE>
FASTNET U.K. LIMITED
NOTES TO THE UNAUDITED DIVISIONAL FINANCIAL STATEMENTS
FOR THE PERIOD ENDED 30 NOVEMBER 1997
(1) NATURE OF THE DIVISION AND SIGNIFICANT ACCOUNTING POLICIES
(a) Nature of the division
The divisional financial statements have been extracted from the books and
records of Fastnet U.K. Limited, and represent that part of the company's
activities that relate to its business undertaken as a co-ordinator on behalf
of Telegroup, Inc. in an agreement dated 20 October 1996. (and as subsequently
amended by mutual consent as detailed of both parties).
Telegroup, Inc. is in the business of providing telecommunications services
and under the agreement, Fastnet U.K. Limited has the right to market and
distribute certain of Telegroup, Inc.'s services in the United Kingdom.
The divisional balance sheet has been prepared from the books and records
and includes the assets and liabilities of the division together with the
retained earnings from that division. For the purposes of the divisional
balance sheet the financing of the division is shown as a liability to the
other divisions of the company. The balance sheet is therefore an extract
taken from the total company position, and does not include equity or other
share capital.
On 25 November 1997 the division sold its business as a going concern to
Telegroup U.K. Limited as detailed in a sale agreement of the same date. This
transaction has not been reflected in the divisional financial statements.
A summary of the division's significant accounting policies follows:
(b) Basis of Presentation
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles.
(c) Cash Equivalents
The division considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. There were no cash
equivalents at 30 November 1997.
(d) Property and Equipment
Property and equipment are stated at cost less depreciation. Depreciation is
provided using the straight-line method over the useful lives of the assets as
follows:
<TABLE>
<S> <C>
Computer equipment................................................ 33 1/3%
Office fixtures, fittings and equipment........................... 20 %
</TABLE>
All items of property and equipment purchased by the company as a whole
since its incorporation relate entirely to this division and have been
included in these divisional financial statements accordingly.
(e) Income Taxes
The division accounts for U.K. taxes under the provisions of Statement of
Standard Accounting Practice (SSAP), Numbers 8 and 15. Under the asset and
liability method of SSAP 15, deferred tax assets and liabilities
FUD-7
<PAGE>
FASTNET U.K. LIMITED
NOTES TO THE UNAUDITED DIVISIONAL FINANCIAL STATEMENTS--(CONTINUED)
FOR THE PERIOD ENDED 30 NOVEMBER 1997
are recognised for the future tax consequences attributable to differences
between the carrying amounts in the divisional financial statements of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are
expected to be recovered or settled. Under SSAP 15, the effect on deferred tax
assets and liabilities of a change in tax rates is recognised in income in the
period that includes the enactment date.
(f) Estimates
The preparation of divisional financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenue
during the reporting period. Actual amounts could differ from those estimates.
(g) Revenues and Expenses
Commissions receivable are recognised in the period when the associated
telephone call revenues are recognised by Telegroup, Inc., and relate to the
period from 1 March 1997 and 31 May 1997 Consultancy fees receivable are for
the period from 1 June 1997 to 25 November 1997 as detailed in the amendments
to the agreement with Telegroup, Inc. Expenditure is in respect of all
divisions of the company, as the operations of the other divisions of the
company ceased prior to this date.
(h) Foreign Currency Translation
The functional currency of the division is the United States (U.S.) dollar.
Assets and liabilities are translated at the closing rate in effect at the
applicable reporting date, and the statement of operations is translated at
the average exchange rates in effect during the applicable period.
(i) Fair Value of Financial Instruments
The fair values of cash and cash equivalents, receivables, accounts payable
and lease obligations are estimated to approximate to carrying value due to
the short-term maturities of these financial instruments.
(2) RELATED PARTIES
At 30 November 1997 the division owed $12,245 to T.G. Redpath, Esq. a
director of the company in respect of a rent deposit made on leasehold
premises from which it trades.
(3) PROPERTY AND EQUIPMENT
Property and equipment at 24 November 1997 is comprised of the following:
<TABLE>
<CAPTION>
NOVEMBER 24, 1997
-----------------
<S> <C>
Furniture, fixtures and office equipment................... $ 33,166
Computer equipment......................................... 79,938
--------
113,104
Less accumulated depreciation.............................. (30,767)
--------
Net property and equipment................................. $ 82,337
========
</TABLE>
FUD-8
<PAGE>
FASTNET U.K. LIMITED
NOTES TO THE UNAUDITED DIVISIONAL FINANCIAL STATEMENTS--(CONTINUED)
FOR THE PERIOD ENDED 30 NOVEMBER 1997
(4) INCOME TAX MATTERS
No provision for U.K. corporation tax has been made in these unaudited
divisional financial statements.
(5) BUSINESS SEGMENT AND SIGNIFICANT CUSTOMER
The division operates a single industry segment. For the period ended 30
November 1997, all of the division's operating revenues were derived from
commissions and consultancy fees earned under the marketing and co-ordination
agreement with Telegroup, Inc., in respect of activities undertaken in the
United Kingdom.
(6) AMOUNTS OWED TO OTHER DIVISIONS OF THE COMPANY IN RESPECT OF FINANCING OF
TRADING ACTIVITIES
These unaudited divisional financial statements represent the activities of
a division of the company which operates under the marketing and co-ordination
agreement with Telegroup, Inc. dated 20 October 1996, (and as subsequently
amended by mutual consent between the parties). In order to finance these
activities, the division has relied on funding by other divisions of the
company and at 30 November 1997 the extent of these borrowings was $267,831.
FUD-9
<PAGE>
PRO FORMA CONDENSED FINANCIAL STATEMENTS
The following unaudited pro forma consolidated balance sheet and
consolidated statements of operations are based on historical results of
Telegroup, Inc and subsidiaries (the "Company") and Fastnet U.K. Limited
("Fastnet") giving effect to the Company's acquisition of Fastnet's assets,
accounted for as a purchase in accordance with generally accepted accounting
principles. Pro forma adjustments, and the assumptions on which they are based
are described in the accompanying footnotes to the pro forma consolidated
financial statements. The accompanying pro forma consolidated balance sheet as
of September 30, 1997 contains those pro forma adjustments necessary to
reflect the Fastnet acquisition as if it was consummated on that date. The
accompanying pro forma consolidated statements of operations for the year
ended December 31, 1996 and the nine months ended September 30, 1997 contain
those pro forma adjustments necessary to reflect the Fastnet acquisition as if
it was consummated on January 1, 1996. Because these pro forma financial
statements are prepared utilizing certain assumptions, the pro forma
consolidated financial statements may not be indicative of actual financial
position or results of operations as of the date and for the periods
presented, respectively.
FP-1
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996
(UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA ADJUSTMENTS GIVING EFFECT
FOR FASTNET U.K. LIMITED ACQUISITION
TELEGROUP, INC. FASTNET U.K.
AND SUBSIDIARIES LIMITED
(HISTORICAL) (HISTORICAL)(A) DEBIT CREDIT PRO FORMA
---------------- --------------- ------------------ ------------------ -----------
<S> <C> <C> <C> <C> <C>
Revenues:
Retail................ $179,146,795 36,560 36,560(d) -- 179,146,795
Wholesale............. 34,060,714 -- -- -- 34,060,714
------------ -------- ------------------ ----------------- -----------
Total revenues...... 213,207,509 36,560 36,560 -- 213,207,509
Cost of revenues........ 150,536,859 -- -- -- 150,536,859
------------ -------- ------------------ ----------------- -----------
Gross profit.......... 62,670,650 36,560 36,560 -- 62,670,650
------------ -------- ------------------ ----------------- -----------
Operating expenses:
Selling, general and
administrative
expenses............. 59,651,857 117,258 -- 36,560(d) 59,732,555
Depreciation and
amortization......... 1,881,619 30,071 13,164(e) -- 1,924,854
Stock option based
compensation......... 1,032,646 -- -- -- 1,032,646
------------ -------- ------------------ ----------------- -----------
Total operating
expenses........... 62,566,122 147,329 13,164 36,560 62,690,055
------------ -------- ------------------ ----------------- -----------
Operating income
(loss)............. 104,528 (110,769) (49,724) 36,560 (19,405)
Other income (expense):
Interest expense...... (578,500) -- -- -- (578,500)
Interest income....... 377,450 -- -- -- 377,450
Foreign currency
transaction gain
(loss)............... (147,752) 1,492 -- -- (146,260)
Other................. 118,504 -- -- -- 118,504
------------ -------- ------------------ ----------------- -----------
Earnings (loss) before
income taxes and
extraordinary item..... (125,770) (109,277) (49,724) 36,560 (248,211)
Income tax benefit...... 7,448 -- 44,079(f) -- 51,527
Minority interest in
shares of earnings
(loss)................. -- -- -- -- --
------------ -------- ------------------ ----------------- -----------
Earnings (loss) before
extraordinary item..... (118,322) (109,277) (5,645) 36,560 (196,684)
Extraordinary item, loss
on extinguishment of
debt, net of income
taxes.................. -- -- -- -- --
------------ -------- ------------------ ----------------- -----------
Net earnings
(loss)............. $ (118,322) (109,277) (5,645) 36,560 (196,684)
============ ======== ================== ================= ===========
Per share amounts (g):
Earnings (loss) before
extraordinary item... ($0.00) ($0.01)
============ ===========
Net earnings (loss)... ($0.00) ($0.01)
============ ===========
Weighted-average
shares................. 28,784,635 28,784,635
============ ===========
</TABLE>
See accompanying notes to unaudited pro forma financial statements.
FP-2
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
NINE-MONTHS ENDED SEPTEMBER 30, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
GIVING EFFECT
FOR FASLNET
TELEGROUP, INC. FASLNET U.K. U.K. LIMITED
AND SUBSIDIARIES LIMITED ACQUISITION
(HISTORICAL) (HISTORICAL)(B) DEBIT CREDIT PRO FORMA
---------------- --------------- ------- ------ -----------
<S> <C> <C> <C> <C> <C>
Revenues:
Retail................ $ 169,720,131 105,472 33,293(d) -- 169,792,310
Wholesale............. 68,757,955 -- -- -- 68,757,955
------------- ------- ------- ------ -----------
Total revenues...... 238,478,086 105,472 33,293 -- 238,550,265
Cost of revenues........ 174,273,208 -- -- -- 174,273,208
------------- ------- ------- ------ -----------
Gross profit.......... 64,204,878 105,472 33,293 -- 64,277,057
------------- ------- ------- ------ -----------
Operating expenses:
Selling, general and
administrative
expenses............. 63,174,487 143,025 -- 33,293(d) 63,284,219
Depreciation and amor-
tization............. 3,208,063 -- 9,873(e) -- 3,217,936
Stock option based
compensation......... 256,785 -- -- -- 256,785
------------- ------- ------- ------ -----------
Total operating ex-
penses............. 66,639,335 143,025 9,873 33,293 66,758,940
------------- ------- ------- ------ -----------
Operating income
(loss)............. (2,434,457) (37,553) (43,166) 33,293 (2,481,883)
Other income (expense):
Interest expense...... (2,134,691) -- -- -- (2,134,691)
Interest income....... 782,299 -- -- -- 782,299
Foreign currency
transaction gain
(loss)............... (587,291) (5,074) -- -- (592,365)
Other................. 159,228 -- -- -- 159,228
------------- ------- ------- ------ -----------
Earnings (loss) before
income taxes and
extraordinary item..... (4,214,912) (42,627) (43,166) 33,293 (4,267,412)
Income tax benefit...... 1,366,054 -- 18,900(f) -- 1,384,954
Minority interest in
shares of earnings
(loss)................. -- -- -- -- --
------------- ------- ------- ------ -----------
Earnings (loss) before
extraordinary item..... (2,848,858) (42,627) (24,266) 33,293 (2,882,458)
Extraordinary item, loss
on extinguishment of
debt, net of income
taxes.................. (9,970,815) -- -- -- (9,970,815)
------------- ------- ------- ------ -----------
Net earnings
(loss)............. $ (12,819,673) (42,627) (24,266) 33,293 (12,853,273)
============= ======= ======= ====== ===========
Per share amounts(g):
Earnings (loss) before
extraordinary item... ($0.10) ($0.10)
============= ===========
Net earnings (loss)... ($0.47) ($0.47)
============= ===========
Weighted-average
shares................. 27,462,331 27,462,331
============= ===========
</TABLE>
See accompanying notes to unaudited pro forma financial statements.
FP-3
<PAGE>
TELEGROUP, INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS GIVING
TELEGROUP, INC. FASTNET U.K. EFFECT FOR FASTNET
AND SUBSIDIARIES LIMITED U.K. LIMITED ACQUISITION
(HISTORICAL) (HISTORICAL)(B) DEBIT CREDIT PRO FORMA
---------------- --------------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equiva-
lents................ $ 58,215,248 -- -- 238,503(c) 57,976,745
Accounts receivable
and unbilled
services, less
allowance for credit
losses............... 48,007,389 61,329 -- 61,329(c) 48,007,389
Income tax recover-
able................. 2,924,478 -- -- -- 2,924,478
Deferred taxes........ 1,639,066 -- -- -- 1,639,066
Prepaid expenses and
other assets......... 757,508 200 -- 200(c) 757,508
Receivables from
shareholders......... 45,880 -- -- -- 45,880
Receivables from em-
ployees.............. 189,070 -- -- -- 189,070
------------ -------- ------------ ------------ -----------
Total current
assets............. 111,778,639 61,529 -- 300,032 111,540,136
------------ -------- ------------ ------------ -----------
Net property and
equipment.............. 21,596,980 82,337 -- 41,298(c) 21,638,019
------------ -------- ------------ ------------ -----------
Other assets:
Deposits and other as-
sets................. 688,665 -- -- -- 688,665
Goodwill, net of amor-
tization............. 2,969,347 -- 197,464(c) -- 3,166,811
Capitalized software,
net of amortization.. 1,873,946 -- -- -- 1,873,946
Debt issuance costs,
net of amortization.. 750,000 -- -- -- 750,000
------------ -------- ------------ ------------ -----------
6,281,958 -- 197,464 -- 6,479,422
------------ -------- ------------ ------------ -----------
Total assets........ $139,657,577 143,866 197,464 341,330 139,657,577
============ ======== ============ ============ ===========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable...... 44,413,669 291,688 291,688(c) -- 44,413,669
Accrued expense....... 12,233,538 4,082 4,082(c) -- 12,233,538
Unearned revenue...... 160,222 -- -- -- 160,222
Note payable.......... 15,000,000 -- -- -- 15,000,000
Customer deposits..... 717,224 -- -- -- 717,224
Current portion of
long-term debt....... 92,194 -- -- -- 92,194
Current portion of
capital lease
obligations.......... 127,099 -- -- -- 127,099
------------ -------- ------------ ------------ -----------
Total current
liabilities........ 72,743,946 295,770 295,770 -- 72,743,946
Deferred taxes.......... 730,847 -- -- -- 730,847
Capital lease
obligations............ 218,320 -- -- -- 218,320
Long-term debt.......... 25,042,057 -- -- -- 25,042,057
Minority interest....... -- -- -- -- --
Shareholders' equity.... 40,922,407 (151,904) -- 151,904(c) 40,922,407
------------ -------- ------------ ------------ -----------
Total liabilities
and shareholders'
equity............. $139,657,577 143,866 295,770 151,904 139,657,577
============ ======== ============ ============ ===========
</TABLE>
See accompanying notes to unaudited pro forma financial statements.
FP-4
<PAGE>
NOTES TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS
The unaudited pro forma consolidated balance sheet reflects the historical
financial position at September 30, 1997, with pro forma adjustments as if the
Fastnet acquisition had taken place on September 30, 1997. The unaudited pro
forma consolidated statements of operations for the year ended December 31,
1996 and the nine months ended September 30, 1997 reflect the historical
results of operations with pro forma adjustments based on the assumption the
Fastnet acquisition was effective as of January 1, 1996. The following
adjustments give pro forma effect to the Fastnet acquisition (in addition to
certain reclassifications to conform presentations):
(a) The historical financial statements of Fastnet are presented using
Fastnet's fiscal period, which is February 28, 1997.
(b) The historical financial statements of Fastnet are presented as of
and for the nine months ended November 30, 1997.
(c) The acquisition of Fastnet will be accounted for as a purchase. The
Company gave $238,503 in cash in consideration for certain Fastnet
assets. The Company recorded the estimated fair value of Fastnet's
assets on the date of purchase.
<TABLE>
<S> <C>
Cost of acquisition............................................ $238,503
Estimated fair value of assets acquired........................ (41,039)
--------
Excess of cost over estimated fair value..................... $197,464
========
</TABLE>
(d) The elimination in consolidation of commissions paid by the Company
to Fastnet.
(e) The amortization of goodwill created from the acquisition of
Fastnet over the estimated useful life of 15 years.
(f) The tax effect of the pro forma adjustments using a 36 percent tax
rate.
(g) For the year ended December 31, 1996, earnings (loss) per share has
been computed using the weighted-average number of shares of common
stock outstanding as adjusted for the effects of the Securities and
Exchange Commission Staff Accounting Bulletin No. 83. Accordingly,
options and warrants to purchase common stock granted within one year
of the Company's initial public offering, which have exercise prices
below the assumed initial public offering price per share, have been
included in the calculation of common equivalent shares, using the
treasury stock method, as if they were outstanding for the entire
year. For the nine month period ended September 30, 1997, earnings
(loss) per share has been computed under the provisions of Accounting
Principles Board Opinion No. 15, Earnings Per Share.
FP-5
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER CONTAINED HEREIN AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AU-
THORIZED BY THE COMPANY, ANY SELLING SHAREHOLDERS, OR BY ANY OF THE UNDERWRIT-
ERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN
THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO
BUY, THOSE TO WHICH IT RELATES IN ANY STATE TO ANY PERSON TO WHOM IT IS NOT
LAWFUL TO MAKE SUCH OFFER IN SUCH STATE. THE DELIVERY OF THIS PROSPECTUS DOES
NOT IMPLY THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO
ITS DATE.
----------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Available Information................................................... 2
Disclosure Regarding Forward-Looking Statements......................... 2
Prospectus Summary...................................................... 3
Recent Developments..................................................... 6
The Offering............................................................ 7
Summary Financial Data.................................................. 8
Risk Factors............................................................ 10
Use of Proceeds......................................................... 30
Dividend Policy......................................................... 30
Market for the Common Equity and Related Stockholder Matters............ 30
Capitalization.......................................................... 31
Selected Financial Data................................................. 32
Management's Discussion and Analysis of Financial Condition and Results
of Operations......................................................... 34
The Global Telecommunications Industry.................................. 45
Business................................................................ 53
Management.............................................................. 79
Certain Transactions.................................................... 87
Principal Shareholders.................................................. 88
Selling Shareholders.................................................... 89
Description of the Capital Stock........................................ 90
Description of Convertible Subordinated Notes........................... 94
Description of Other Indebtedness....................................... 96
Plan of Distribution.................................................... 119
Transfer Agent and Registrar............................................ 119
Shares Eligible for Future Sale......................................... 120
Certain United States Federal Income Tax Considerations for Non-U.S.
Holders of Common Stock............................................... 121
Legal Matters........................................................... 123
Experts................................................................. 123
Glossary of Terms....................................................... 124
Index to Consolidated Financial Statements.............................. F-1
Index to Fastnet Financial Statements................................... FD-1
Index to Fastnet Unaudited Financial Statements......................... FUD-1
Pro Forma Condensed Financial Statements................................ FP-1
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The table below sets forth the expenses to be incurred by the Company in
connection with the issuance and distribution of the shares registered for
offer and sale hereby. All amounts shown represent estimates except the
Securities Act registration fee.
<TABLE>
<S> <C>
Registration fee under the Securities Act of 1933...................... $
Printing and EDGAR expenses............................................
Registrar and Transfer Agent's fees and expenses.......................
Accountants' fees and expenses.........................................
Legal fees and expenses................................................
Blue Sky fees and expenses.............................................
Miscellaneous..........................................................
----
Total................................................................ $
====
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Iowa Business Corporation Act confers broad powers upon corporations
incorporated in Iowa with respect to indemnification of any person against
liabilities incurred by reason of the fact that such person is or was a
director, officer, employee or agent of the corporation, or is or was serving
at the request of the corporation as a director, officer, employee or agent of
another Corporation or other business entity. These provisions are not
exclusive of any other rights to which those seeking indemnification may be
entitled under any bylaw, agreement or otherwise.
The Company's Second Restated Articles of Incorporation contain a provision
that eliminates the personal liability of the Company's directors to the
Company or its shareholders for monetary damages for breach of fiduciary duty
as a director, except (i) for liability for any breach of the director's duty
of loyalty to the Corporation or its shareholders, (ii) for acts or omissions
not in good faith or which involve intentional misconduct or knowing violation
of the law, (iii) for any transaction from which the director derived an
improper personal benefit, or (iv) for unlawful distributions in violation of
Section 490.833 of the Iowa Business Corporation Act. Any repeal or amendment
of this provision by the shareholders of the Corporation will not adversely
affect any right or protection of a director existing at the time of such
repeal or amendment.
The Company's Amended and Restated Bylaws contain a provision entitling
officers and directors to be indemnified and held harmless by the Company
against expenses, liabilities and costs (including attorneys' fees) actually
and reasonably incurred by such person, to the fullest extent permitted by the
Iowa Business Corporation Act.
The Company has obtained a director and officer liability policy, under
which each director and certain officers of the Company would be insured
against certain liabilities.
The Company entered into indemnification agreements with certain of its
executive officers and directors (collectively, the "Indemnification
Agreements"). Pursuant to the terms of the Indemnification Agreements, each of
the executive officers and directors who are parties thereto will be
indemnified by the Company to the full extent provided by law in the event
such officer or director is made or threatened to be made a party to a claim
arising out of such person acting in his capacity as an officer or director of
the Company. The Company has further agreed that, upon a change in control, as
defined in the Indemnification Agreements, the rights of such officers and
directors to indemnification payments and expense advances will be determined
in accordance with the provisions of the Iowa Business Corporation Act and has
also agreed that, upon a potential change of control, as defined in the
Indemnification Agreements, it will create a trust in an amount sufficient to
satisfy all indemnity
II-1
<PAGE>
expenses reasonably anticipated at the time a written request to create such a
trust is submitted by an officer or director. Insofar as indemnification for
liabilities arising under the Securities Act may be permitted to directors,
officers and controlling persons of the Registrant pursuant to the foregoing
provisions, or otherwise, the Registrant has been advised that in the opinion
of the Commission such indemnification is against public policy as expressed
in the Securities Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the Registrant
will, unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
The following paragraphs of this Item 15 describe all offers and sales of
securities by the Company within the last three years which were not
registered under the Securities Act of 1933, other than securities issued in
connection with stock reclassifications, stock dividends or stock splits:
On April 23, 1996, the Company issued 518,988 shares of Common Stock to
Michael Lackman for the aggregate consideration of $20,946.53 paid by Mr.
Lackman with a promissory note in the principal amount of $20,946.53.
On April 26, 1996, the Company issued 778,485 shares of Common Stock to
Ronald Stakland for the aggregate consideration of $31,419.80 paid by Mr.
Stakland with a promissory note in the principal amount of $31,419.80.
On August 21, 1996, in connection with the Plan and Agreement of
Reorganization between the Company, George Apple and Telegroup South Europe,
Inc. ("TGSE"), the Company issued 262,116 shares of Common Stock and made a
cash payment to George Apple in exchange for substantially all of the assets
of TGSE.
Amended and Restated 1996 Telegroup, Inc. Stock Option Plan. See
"Management--Amended and Restated 1996 Telegroup, Inc. Stock Option Plan"
incorporated by reference herein from the Prospectus included in Part I of
this Registration Statement.
November 27, 1996 Issuance of Senior Subordinated Notes and Warrants. On
November 27, 1996, the Company completed a $20 million private placement of
its 12.0% Senior Subordinated Notes, together with warrants to purchase 4.0%
of the Company's fully-diluted Common Stock. See "Certain Transactions--
Subordinated Note Placement" and "Description of Capital Stock--Warrants."
Each issuance of securities described above was made in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act as
a transaction by an issuer not involving any public offering. The recipients
of securities in each such transaction represented their intention to acquire
the securities for investment only and not with a view to or for sale in
connection with any distribution thereof and appropriate legends were affixed
to the share certificates issued in such transactions. All recipients had
adequate access, through their relationships with the Company, to information
about the Company.
II-2
<PAGE>
ITEM 16(A). EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION NUMBERED PAGE
------- ----------- -------------
<C> <S> <C>
1.1 Purchase Agreement Between the Company and Smith
Barney Inc. Dated September 30, 1997
1.2 Purchase Agreement Between the Company, Smith Barney
Inc. and BT Alex. Brown Incorporated Dated October
20, 1997 (Incorporated by reference as Exhibit 1.1 to
the Company's Form S-4 Registration Statement filed
on December 19, 1997)
*2.1 Plan and Agreement of Reorganization Between the
Company, George Apple and Telegroup South Europe,
Inc. Dated September 6, 1996
*2.2 Plan and Agreement of acquisition between the Company,
Telecontinent, S.A. and Georges Apple dated September
6, 1996
2.3 Agreement Between Fastnet UK Limited, Telegroup UK
Limited, Giles Redpath and Telegroup, Inc.
(Incorporated by reference as Exhibit 10 to the
Company's Form 8-K filed on December 9, 1997, SEC
File No. 0-29284)
*3.1 Restated Articles of Incorporation of Telegroup, Inc.
*3.2 Form of Second Restated Articles of Incorporation of
Telegroup, Inc.
*3.3 Bylaws of Telegroup, Inc.
*3.4 Form of Amended and Restated Bylaws of Telegroup, Inc.
*4.1 Form of Common Stock Certificate of Telegroup, Inc.
*4.2 Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4
*4.3 Note and Warrant Purchase Agreement dated as of
November 27, 1996
*4.4 Form of Warrant to Purchase Class A Common Stock of
Telegroup, Inc.
*4.5 Indenture dated as of November 27, 1996 between
Telegroup, Inc. and The Chase Manhattan Bank
4.6 Indenture for 8.0% Convertible Notes dated September
30, 1997 (Incorporated by reference as Exhibit 4.1to
the Company's Form 10-Q for the quarter-ended
September 30, 1997, SEC File No. 0-29284)
4.7 Indenture for 10.5% Senior Discount Notes dated
October 23, 1997 (Incorporated by reference as
Exhibit 4.2 to the Company's Form 10-Q for the
quarter-ended September 30, 1997, SEC File No. 0-
29284)
++5.1 Opinion of Swidler & Berlin, Chartered regarding
legality
*10.1 Loan Agreement Dated as of March 28, 1997 by and
between the Company and American National Bank and
Trust Company of Chicago
*10.1.1 First Amendment to Loan Agreement between the Company
and American National Bank and Trust Company of
Chicago dated as of June 6, 1997.
*10.2 Amended and Restated 1996 Telegroup, Inc. Stock Option
Plan
*10.3 Form of Employment Agreement between the Company and
Fred Gratzon
*10.4 Form of Employment Agreement between the Company and
Clifford Rees
*10.5 Form of Indemnification Agreement
*10.6 Registration Rights Agreement among Telegroup, Inc.,
Greenwich Street Capital Partners, L.P., Greenwich
Street Capital Offshore Fund, Ltd., TRV Employees
Fund, L.P., The Travelers Insurance Company and The
Travelers Life and Annuity Company Dated as of
November 27, 1996
*10.7 Form of Registration Rights Agreement between the
Company and certain Shareholders of the Company
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION NUMBERED PAGE
------- ----------- -------------
<C> <S> <C>
*+10.8 Agreement between Telegroup, Inc. and New T & T Hong
Kong Limited
*+10.9 Resale Solutions Switched Services Agreement between
Sprint Communications
Company L.P. and Telegroup, Inc.
*10.10 Form of Employment Agreement between the Company and
John P. Lass
*10.11 Form of Employment Agreement between the Company and
Ron Jackenthal
*10.12 Form of Employment Agreement between the Company and
Certain Executive Officers
10.13 Notes Registration Rights Agreement between the
Company and Smith Barney Inc.,
and Alex Brown Incorporated Dated as of October 23,
1997 (Incorporated by reference as Exhibit 10.13 to
the Company's Form S-4 Registration Statement filed
on December 19, 1997
10.14 Registration Rights Agreement between the Company and
Smith Barney Inc. Dated
as of September 30, 1997
*21.1 Subsidiaries of Telegroup, Inc.
23.1 Consent of KPMG Peat Marwick, LLP
23.2 Consent of MacIntyre & Co.
23.3 Consent of Swidler & Berlin, Chartered (to be included
in Exhibit 5.1 to this Registration Statement)
*24.1 Power of Attorney
27.1 Financial Data Schedule
</TABLE>
- --------
* Previously filed as Exhibits to Form S-1, SEC Registration Statement File
No. 333-25065.
+ Confidential Treatment has been requested for portions of this document.
The redacted material has been filed separately with the Commission.
++ To be filed by amendment.
ITEM 16(B). FINANCIAL STATEMENT SCHEDULES.
II--Valuation and Qualifying Accounts (previously filed)
All other schedules are omitted either because they are not applicable or
are not material, or the information presented therein is contained in the
Financial Statements or notes thereto.
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act, the
information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be
deemed to be a new Registration Statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to
be the initial bona fide offering thereof.
II-4
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS DULY CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF FAIRFIELD, STATE OF
IOWA, ON DECEMBER 22, 1997.
Telegroup, Inc.
By: *
-----------------------------------
CLIFFORD REES, PRESIDENT AND
CHIEF EXECUTIVE OFFICER
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES INDICATED ON DECEMBER 22, 1997.
SIGNATURE TITLE
--------- -----
* Chairman of the Board and Director
- -------------------------------------
FRED GRATZON
* Chief Executive Officer, President
- ------------------------------------- and Director (Principal Executive
CLIFFORD REES Officer)
* Vice President--Finance, Chief
- ------------------------------------- Financial Officer, Treasurer and
DOUGLAS A. NEISH Director (Principal Financial
Officer)
* Director of Finance and Controller
- ------------------------------------- (Principal Accounting Officer)
GARY KORF
Senior Vice President, International
- ------------------------------------- Services and Director
RONALD B. STAKLAND
/s/ Charles Johanson Attorney-in-Fact
- -------------------------------------
CHARLES JOHANSON
* Charles Johanson, by signing his name hereto, signs this document on behalf
of each of the persons so indicated above pursuant to powers of attorney duly
executed by such persons and filed with the Securities and Exchange
Commission.
II-5
<PAGE>
EXHIBIT INDEX
<TABLE>
<C> <S>
1.1 Purchase Agreement Between the Company and Smith Barney Inc. Dated
September 30, 1997.
1.2 Purchase Agreement Between the Company, Smith Barney Inc. and BT
Alex. Brown Incorporated Dated October 20, 1997 (Incorporated by
reference as Exhibit 1.1 to the Company's Form S-4 Registration
Statement filed on December 22, 1997)
*2.1 Plan and Agreement of Reorganization Between the Company, George
Apple and Telegroup South Europe, Inc. Dated September 6, 1996
*2.2 Plan and Agreement of acquisition between the Company,
Telecontinent, S.A. and Georges Apple dated September 6, 1996.
2.3 Agreement Between Fastnet UK Limited, Telegroup UK Limited, Giles
Redpath and Telegroup, Inc. (Incorporated by reference as Exhibit
10 to the Company's Form 8-K filed on December 9, 1997, SEC File
No. 0-29284)
*3.1 Restated Articles of Incorporation of Telegroup, Inc.
*3.2 Form of Second Restated Articles of Incorporation of Telegroup, Inc.
*3.3 Bylaws of Telegroup, Inc.
*3.4 Form of Amended and Restated Bylaws of Telegroup, Inc.
*4.1 Form of Common Stock Certificate of Telegroup, Inc.
*4.2 Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4
*4.3 Note and Warrant Purchase Agreement dated as of November 27, 1996
*4.4 Form of Warrant to Purchase Class A Common Stock of Telegroup, Inc.
*4.5 Indenture dated as of November 27, 1996 between Telegroup, Inc. and
The Chase Manhattan Bank
4.6 Indenture for 8.0% Convertible Notes dated September 30, 1997
(Incorporated by reference as Exhibit 4.1 to the Company's Form 10-
Q for the quarter-ended September 30, 1997, SEC File No. 0-29284)
4.7 Indenture for 10.5% Senior Discount Notes dated October 23, 1997
(Incorporated by reference as Exhibit 4.2 to the Company's Form 10-
Q for the quarter-ended September 30, 1997, SEC File No. 0-29284)
++5.1 Opinion of Swidler & Berlin, Chartered regarding legality
*10.1 Loan Agreement Dated as of March 28, 1997 by and between the Company
and American National Bank and Trust Company of Chicago
*10.1.1 First Amendment to Loan Agreement between the Company and American
National Bank and Trust Companyof Chicago dated as of June 6, 1997.
*10.2 Amended and Restated 1996 Telegroup, Inc. Stock Option Plan
*10.3 Form of Employment Agreement between the Company and Fred Gratzon
*10.4 Form of Employment Agreement between the Company and Clifford Rees
*10.5 Form of Indemnification Agreement
*10.6 Registration Rights Agreement among Telegroup, Inc., Greenwich
Street Capital Partners, L.P., Greenwich Street Capital Offshore
Fund, Ltd., TRV Employees Fund, L.P., The Travelers Insurance
Company and The Travelers Life and Annuity Company Dated as of
November 27, 1996
*10.7 Form of Registration Rights Agreement between the Company and
certain Shareholders of the Company
</TABLE>
<PAGE>
<TABLE>
<C> <S>
*+10.8 Agreement between Telegroup, Inc. and New T & T Hong Kong Limited
*+10.9 Resale Solutions Switched Services Agreement between Sprint
Communications Company L.P. and Telegroup, Inc.
*10.10 Form of Employment Agreement between the Company and John P. Lass
*10.11 Form of Employment Agreement between the Company and Ron Jackenthal
*10.12 Form of Employment Agreement between the Company and Certain
Executive Officers
10.13 Notes Registration Rights Agreement between the Company and Smith
Barney Inc., and Alex Brown Incorporated Dated as of October 23,
1997 (Incorporated by reference as Exhibit 10.13 to the Company's
Form S-4 Registration Statement filed on December 22, 1997
10.14 Registration Rights Agreement between the Company and Smith Barney
Inc. Dated as of September 30, 1997
*21.1 Subsidiaries of Telegroup, Inc.
23.1 Consent of KPMG Peat Marwick, LLP
23.2 Consent of MacIntyre & Co.
++23.3 Consent of Swidler & Berlin, Chartered (to be included in Exhibit 5.1
to this Registration Statement)
*24.1 Power of Attorney
27.1 Financial Data Schedule
</TABLE>
- --------
* Previously filed as Exhibits to Form S-1, SEC Registration Statement File No.
333-25065.
+ Confidential Treatment has been requested for portions of this document. The
redated material has been filed separately with the Commission.
++To be filed by amendment.
<PAGE>
EXHIBIT 1.1
$25,000,000
TELEGROUP, INC.
8% Convertible Senior Subordinated Notes due 2005
PURCHASE AGREEMENT
------------------
September 30, 1997
SMITH BARNEY INC.
388 Greenwich Street
New York, New York 10013
Dear Sirs:
Telegroup, an Iowa corporation (the "Company"), proposes, upon the
terms and conditions set forth herein, to issue and sell to you, as the initial
purchaser (the "Initial Purchaser"), $25,000,000 aggregate principal amount of
its 8% Convertible Senior Subordinated Notes due 2005 (the "Notes"). The Notes
will be issued pursuant to the provisions of an Indenture, to be dated as of
September 30, 1997 (the "Indenture"), between the Company and State Street Bank
and Trust Company, as Trustee (the "Trustee"). The Company's common stock, no
par value per share, is hereinafter referred to as the "Common Stock."
The Company wishes to confirm as follows its agreement with the
Initial Purchaser in connection with the purchase and resale of the Notes.
1. Preliminary Offering Memorandum and Offering Memorandum. The
Notes will be offered and sold to the Initial Purchaser without registration
under the Securities Act of 1933, as amended (the "Act"), in reliance on an
exemption pursuant to Section 4(2) under the Act. The Company has prepared a
preliminary offering memorandum, dated September 26, 1997 (the "Preliminary
Offering Memorandum"), and an offering memorandum, dated September
<PAGE>
30, 1997 (the "Offering Memorandum"), setting forth information regarding the
Company and the Notes. Any references herein to the Preliminary Offering
Memorandum and the Offering Memorandum shall be deemed to include all amendments
and supplements thereto and (i) the Form 10-Q for the quarterly period ended
June 30, 1997 (the "10-Q") previously filed by the Company under the Securities
Exchange Act of 1934, as amended, and the rules and regulations of the
Securities and Exchange Commission (the "Commission") thereunder (collectively,
the "Exchange Act") and (ii) the Company's Prospectus dated July 9, 1997 (the
"Prospectus") relating to the Company's initial public offering of 4,450,000
shares of Common Stock. The 10-Q and the Prospectus are hereinafter collectively
referred to as the "Incorporated Documents." The Company hereby confirms that it
has authorized the use of the Preliminary Offering Memorandum and the Offering
Memorandum in connection with the offering and resale of the Notes by the
Initial Purchaser.
The Company understands that the Initial Purchaser proposes to make
offers and sales (the "Exempt Resales") of the Notes purchased by the Initial
Purchaser hereunder only on the terms and in the manner set forth in the
Offering Memorandum and Section 2 hereof, as soon as the Initial Purchaser deems
advisable after this Agreement has been executed and delivered, (i) to persons
in the United States whom the Initial Purchaser reasonably believes to be
qualified institutional buyers ("Qualified Institutional Buyers") as defined
in Rule 144A under the Act, as such rule may be amended from time to time ("Rule
144A"), in transactions under Rule 144A and (ii) to a limited number of other
institutional "accredited investors" (as defined in Rule 501(a)(1), (2), (3) and
(7) under Regulation D of the Act) ("Accredited Investors") in private sales
exempt from registration under the Act (such persons specified in clauses (i)
and (ii) being referred to herein as the "Eligible Purchasers").
It is understood and acknowledged that upon original issuance thereof,
and until such time as the same is no longer required under the applicable
requirements of the Act, the Notes (and all securities issued in exchange
therefor, in substitution thereof upon conversion thereof (including the Common
Stock)) shall bear the following legend:
THIS SECURITY HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS
AMENDED (THE "SECURITIES ACT"), OR ANY STATE
<PAGE>
SECURITIES LAWS. NEITHER THIS SECURITY NOR ANY INTEREST OR PARTICIPATION
HEREIN MAY BE REOFFERED, SOLD, ASSIGNED, TRANSFERRED, PLEDGED, ENCUMBERED
OR OTHERWISE DISPOSED OF IN THE ABSENCE OF SUCH REGISTRATION OR UNLESS SUCH
TRANSACTION IS EXEMPT FROM, OR NOT SUBJECT TO, REGISTRATION.
THE HOLDER OF THIS SECURITY BY ITS ACCEPTANCE HEREOF AGREES NOT TO OFFER,
SELL OR OTHERWISE TRANSFER SUCH SECURITY, PRIOR TO THE DATE (THE "RESALE
RESTRICTION TERMINATION DATE") WHICH IS TWO YEARS AFTER THE LATER OF THE
ORIGINAL ISSUE DATE HEREOF AND THE LAST DATE ON WHICH THE COMPANY OR ANY
AFFILIATED PERSON OF THE COMPANY WAS THE OWNER OF THIS SECURITY (OR ANY
PREDECESSOR OF SUCH SECURITY) UNLESS SUCH OFFER, SALE OR OTHER TRANSFER IS
(A) TO THE COMPANY, (B) PURSUANT TO A REGISTRATION STATEMENT WHICH HAS BEEN
DECLARED EFFECTIVE UNDER THE SECURITIES ACT, (C) FOR SO LONG AS THE
SECURITIES ARE ELIGIBLE FOR RESALE PURSUANT TO RULE 144A, TO A PERSON THE
HOLDER REASONABLY BELIEVES IS A "QUALIFIED INSTITUTIONAL BUYER" AS DEFINED
IN RULE 144A UNDER THE SECURITIES ACT THAT PURCHASES FOR ITS OWN ACCOUNT OR
FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER TO WHOM NOTICE IS GIVEN
THAT THE TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A, (D) PURSUANT TO
OFFERS AND SALES THAT OCCUR OUTSIDE THE UNITED STATES WITHIN THE MEANING OF
REGULATION S UNDER THE SECURITIES ACT, (E) TO AN INSTITUTIONAL "ACCREDITED
INVESTOR" WITHIN THE MEANING OF SUBPARAGRAPH (A)(1), (A)(2), (A)(3) OR
(A)(7) OF RULE 501 UNDER THE SECURITIES ACT THAT IS ACQUIRING THE SECURITY
FOR ITS OWN ACCOUNT, OR FOR THE ACCOUNT OF SUCH AN INSTITUTIONAL
"ACCREDITED INVESTOR," FOR INVESTMENT PURPOSES AND NOT WITH A VIEW TO, OR
FOR OFFER OR SALE IN CONNECTION WITH, ANY DISTRIBUTION IN VIOLATION OF THE
SECURITIES ACT, OR (F) PURSUANT TO ANOTHER AVAILABLE EXEMPTION FROM THE
REGISTRATION REQUIREMENTS OF THE SECURITIES ACT, SUBJECT TO THE COMPANY'S
AND THE TRUSTEE'S AND THE TRANSFER AGENT'S RIGHT PRIOR TO ANY SUCH OFFER,
SALE OR TRANSFER PURSUANT TO CLAUSES (D), (E) OR (F) TO REQUIRE THE
DELIVERY OF AN OPINION OF COUNSEL, CERTIFICATION AND/OR OTHER INFORMATION
SATISFACTORY TO EACH OF THEM, AND IN EACH OF THE FOREGOING CASES, A
CERTIFICATE OF TRANSFER IN THE FORM APPEARING ON THIS SECURITY IS COMPLETED
AND DELIVERED BY THE TRANSFEROR TO THE TRUSTEE OR THE TRANSFER AGENT. THIS
LEGEND WILL BE REMOVED UPON THE REQUEST OF THE THEN HOLDER OF THIS SECURITY
AFTER THE RESALE RESTRICTION TERMINATION DATE.
<PAGE>
It is also understood and acknowledged that holders (including
subsequent transferees) of the shares of Common Stock issuable upon conversion
of the Notes will have the registration rights set forth in the registration
rights agreement (the "Registration Rights Agreement"), to be dated the date
hereof, in substantially the form of Exhibit A hereto, for so long as such
shares of Common Stock constitute "Transfer Restricted Securities" (as defined
in the Registration Rights Agreement). Pursuant to the Registration Rights
Agreement, the Company will agree (i) to file with the Commission under the
circumstances set forth therein, a registration statement on the appropriate
form under the Act relating to the resale of the Common Stock by certain holders
thereof from time to time in accordance with the methods of distribution set
forth in such registration statement and Rule 415 under the Act (the "Shelf
Registration Statement") and (ii) to use its reasonable best efforts to cause
such Shelf Registration Statement to be declared effective. This Agreement, the
Indenture and the Registration Rights Agreement are hereinafter referred to
collectively as the "Operative Documents".
Capitalized terms used herein without definition have the respective
meanings specified therefor in the Indenture or the Offering Memorandum.
2. Agreements to Sell, Purchase and Resell. (a) The Company hereby
agrees, subject to all the terms and conditions set forth herein, to issue and
sell to the Initial Purchaser and, upon the basis of the representations,
warranties and agreements of the Company herein contained and subject to all the
terms and conditions set forth herein, the Initial Purchaser agrees to purchase
from the Company, at a purchase price of 97% of the principal amount thereof,
the principal amount of Notes set forth opposite the name of the Initial
Purchaser in Schedule I hereto.
(b) The Initial Purchaser has advised the Company that it proposes to
offer the Notes for sale upon the terms and conditions set forth in this
Agreement and in the Offering Memorandum. The Initial Purchaser hereby
represents and warrants to, and agrees with, the Company that the Initial
Purchaser (i) is purchasing the Notes pursuant to a private sale exempt from
registration under the Act, (ii) will not solicit offers for, or offer or sell,
the Notes by means of any form of general solicitation or general advertising or
in any manner involving a public offering within the meaning of Section 4(2) of
the Act, and
<PAGE>
(iii) will solicit offers for the Notes only from, and will offer, sell or
deliver the Notes as part of its initial offering, only to (A) persons in the
United States whom the Initial Purchaser reasonably believes to be Qualified
Institutional Buyers, or if any such person is buying for one or more
institutional accounts for which such person is acting as fiduciary or agent,
only when such person has represented to the Initial Purchaser that each such
account is a Qualified Institutional Buyer, to whom notice has been given that
such sale or delivery is being made in reliance on Rule 144A, in each case, in
transactions under Rule 144A and (B) to a limited number of Accredited Investors
that make the representations to and agreements with the Company specified in
Annex A to the Offering Memorandum in private sales exempt from registration
under the Act. The Initial Purchaser has advised the Company that it will offer
the Notes to Eligible Purchasers at a price initially equal to 100% of the
principal amount thereof, plus accrued interest, if any, from the date of
issuance of the Notes. Such price may be changed by the Initial Purchaser at any
time thereafter without notice.
3. Delivery of the Notes and Payment Therefor. Delivery to the
Initial Purchaser of and payment for the Notes shall be made at the office of
Smith Barney Inc., 388 Greenwich Street, New York, NY 10013, at 10:00 A.M., New
York City time, on September 30, 1997 (the "Closing Date"). The place of
closing for the Notes and the Closing Date may be varied by agreement between
the Initial Purchaser and the Company.
The Notes will be delivered to the Initial Purchaser against payment
of the purchase price therefor in immediately available funds. The Notes will
be evidenced by securities in definitive form in such names and in such
denominations as the Initial Purchaser shall request prior to 1:00 p.m., New
York City time, on the third business day preceding the Closing Date, or such
other time as otherwise agreed by the parties hereto. The Notes to be delivered
to the Initial Purchaser shall be made available to the Initial Purchaser in New
York City for inspection and packaging not later than 9:30 a.m., New York City
time, on the business day next preceding the Closing Date.
4. Agreements of the Company. The Company agrees with the Initial
Purchaser as follows:
(a) The Company will advise the Initial Purchaser
<PAGE>
promptly and, if requested by it, will confirm such advice in writing, within
the period of time referred to in paragraph (e) below, of any change in the
Company's financial condition, business, prospects, properties, net worth or
results of operations, or of the happening of any event which makes any
statement made in the Offering Memorandum (as then amended or supplemented)
untrue or which requires the making of any additions to or changes in the
Offering Memorandum (as then amended or supplemented) in order to make the
statements therein not misleading, or of the necessity to amend or supplement
the Offering Memorandum (as then amended or supplemented) to comply with any
law.
(b) The Company will furnish to the Initial Purchaser, without charge,
as of the date of the Offering Memorandum, such number of copies of the Offering
Memorandum as may then be amended or supplemented as it may reasonably request.
(c) The Company will not make any amendment or supplement to the
Preliminary Offering Memorandum or to the Offering Memorandum of which the
Initial Purchaser shall not previously have been advised or to which it shall
reasonably object in writing after being so advised.
(d) Prior to the execution and delivery of this Agreement, the Company
has delivered or will deliver to the Initial Purchaser, without charge, in such
quantities as the Initial Purchaser shall have reasonably requested or may
hereafter reasonably request, copies of the Preliminary Offering Memorandum. The
Company consents to the use, in accordance with the securities or Blue Sky laws
of the jurisdictions in which the Notes are offered by the Initial Purchaser and
by dealers, prior to the date of the Offering Memorandum, of each Preliminary
Offering Memorandum so furnished by the Company. The Company consents to the
use of the Offering Memorandum (and of any amendment or supplement thereto) in
accordance with the securities or Blue Sky laws of the jurisdictions in which
the Notes are offered by the Initial Purchaser and by all dealers to whom Notes
may be sold, in connection with the offering and sale of the Notes.
(e) If, at any time prior to completion of the resale of the Notes by
the Initial Purchaser to Eligible Purchasers, any event shall occur that in the
judgment of the Company or in the opinion of counsel for the Initial Purchaser
should be set forth in
<PAGE>
the Offering Memorandum (as then amended or supplemented) in order to make the
statements therein, in the light of the circumstances under which they were
made, not misleading, or if it is necessary to supplement or amend the Offering
Memorandum to comply with any law, the Company will forthwith prepare an
appropriate supplement or amendment thereto, and will expeditiously furnish to
the Initial Purchaser and dealers a reasonable number of copies thereof. In the
event that the Company and the Initial Purchaser agree that the Offering
Memorandum should be amended or supplemented, the Company, if requested by the
Initial Purchaser, will promptly issue a press release announcing or disclosing
the matters to be covered by the proposed amendment or supplement.
(f) The Company will cooperate with the Initial Purchaser and with its
counsel in connection with the qualification of the Notes and the Common Stock
issuable upon conversion of the Notes for offering and sale by the Initial
Purchaser and by dealers under the securities or Blue Sky laws of such
jurisdictions as the Initial Purchaser may reasonably designate and will file
such consents to service of process or other documents necessary or appropriate
in order to effect such qualification; provided that in no event shall the
--------
Company be obligated to qualify to do business in any jurisdiction where it is
not now so qualified or to take any action which would subject it to service of
process in suits, other than those arising out of the offering or sale of the
Notes, in any jurisdiction where it is not now so subject.
(g) So long as any of the Notes are outstanding, the Company will
furnish to the Initial Purchaser (i) as soon as available, a copy of each report
of the Company mailed to stockholders or filed with the Commission or the Nasdaq
National Market, and (ii) from time to time such other information concerning
the Company as the Initial Purchaser may reasonably request.
(h) If this Agreement shall terminate or shall be terminated after
execution and delivery pursuant to any provisions hereof (otherwise than by
notice given by the Initial Purchaser terminating this Agreement pursuant to
Section 9 or Section 10 hereof) or if this Agreement shall be terminated by the
Initial Purchaser because of any failure or refusal on the part of the Company
to comply, in any material respect, with the terms or fulfill, in any material
respect, any of the conditions of this Agreement, the Company agrees to
reimburse the Initial Purchaser
<PAGE>
for all reasonable out-of-pocket expenses (including reasonable fees and
expenses of its counsel) incurred by it in connection herewith.
(i) The Company will apply the net proceeds from the sale of the Notes
to be sold by it hereunder substantially in accordance with the description set
forth in the Offering Memorandum.
(j) Except as stated in this Agreement and in the Preliminary Offering
Memorandum and Offering Memorandum, the Company has not taken, nor will it take,
directly or indirectly, any action designed to or that might reasonably be
expected to cause or result in stabilization or manipulation of the price of the
Notes to facilitate the sale or resale of the Notes. Except as permitted by the
Act, the Company will not distribute any offering material in connection with
the Exempt Resales.
(k) To the extent necessary, the Company will use its best efforts as
soon as possible after such time as it becomes necessary, to submit to its
stockholders for approval, an amendment to its articles of incorporation to
increase the authorized number of shares of Common Stock, such that, if such
proposal is approved, the Company will have, as of the close of business on such
date, available free from pre-emptive rights, and reserved for issuance upon
conversion of the Notes, a number of authorized but unissued shares of Common
Stock which, when added to the number of shares of Common Stock held in its
treasury, will be sufficient to honor the conversion in full of all outstanding
Notes.
(l) From and after the Closing Date, so long as any of the Notes are
outstanding and are "Restricted Securities" within the meaning of Rule 144(a)(3)
under the Act or, if earlier, until two years after the Closing Date, and during
any period in which the Company is not subject to Section 13 or 15(d) of the
Exchange Act, the Company will furnish to holders of the Notes and prospective
purchasers of Notes designated by such holders, upon request of such holders or
such prospective purchasers, the information required to be delivered pursuant
to Rule 144A(d)(4) under the Act to permit compliance with Rule 144A in
connection with resale of the Notes.
(m) The Company has complied and will comply with all provisions of
Florida Statutes Section 517.075 relating to issuers
<PAGE>
doing business with Cuba.
(n) The Company agrees not to sell, offer for sale or solicit offers
to buy or otherwise negotiate in respect of any security (as defined in the Act)
that would be integrated with the sale of the Notes in a manner that would
require the registration under the Act of the sale to the Initial Purchaser or
the Eligible Purchasers of the Notes.
(o) The Company agrees to comply with all of the terms and conditions
of the Registration Rights Agreement.
5. Representations and Warranties of the Company. The Company
represents and warrants to the Initial Purchaser that:
(a) The Preliminary Offering Memorandum and Offering Memorandum with
respect to the Notes have been prepared by the Company for use by the Initial
Purchaser in connection with the Exempt Resales. No order or decree preventing
the use of the Preliminary Offering Memorandum or the Offering Memorandum or any
amendment or supplement thereto, or any order asserting that the transactions
contemplated by this Agreement are subject to the registration requirements of
the Act has been issued and no proceeding for that purpose has commenced or is
pending or, to the knowledge of the Company, is contemplated.
(b) The Preliminary Offering Memorandum and the Offering Memorandum as
of their respective dates and the Offering Memorandum as of the Closing Date,
did not or will not at any time contain an untrue statement of a material fact
or omit to state a material fact required to be stated therein or necessary to
make the statements therein not misleading, except that this representation and
warranty does not apply to statements in or omissions from the Preliminary
Offering Memorandum and Offering Memorandum made in reliance upon and in
conformity with information relating to the Initial Purchaser furnished to the
Company in writing by or on behalf of the Initial Purchaser expressly for use
therein.
(c) The Incorporated Documents, as applicable, heretofore filed were
filed in a timely manner and, when they were filed (or, if any amendment with
respect to any such document was filed, when such document was filed), conformed
in all material respects to the requirements of the Exchange Act and did not
contain an untrue statement of a material fact or omit to state a
<PAGE>
material fact required to be stated therein or necessary to make the statements
therein not misleading.
(d) The Indenture has been duly and validly authorized by the Company
and, upon its execution, delivery and performance by the Company and assuming
due authorization, execution, delivery and performance by the Trustee, will be a
valid and binding agreement of the Company, enforceable in accordance with its
terms, except (i) the enforceability thereof may be limited by bankruptcy,
insolvency, reorganization, fraudulent conveyance, moratorium or other similar
laws now or hereafter in effect relating to rights of creditors and other
obligees generally, (ii) the remedy of specific performance and other forms of
equitable relief may be subject to certain equitable defenses and principles and
to the discretion of the court before which the proceedings may be brought and
(iii) rights to indemnity and contribution thereunder may be limited by federal
or state securities laws or the public policy underlying such laws; The
Indenture conforms in all material respects to the description thereof in the
Offering Memorandum and no qualification of the Indenture under the 1939 Act is
required in connection with the offer and sale of the Notes contemplated hereby
or in connection with the Exempt Resales.
(e) The Notes have been duly authorized by the Company and, when
executed by the Company and authenticated by the Trustee in accordance with the
Indenture and delivered to the Initial Purchaser against payment therefor in
accordance with the terms hereof, will have been validly issued and delivered,
and will constitute valid and binding obligations of the Company entitled to the
benefits of the Indenture and enforceable in accordance with their terms, except
as enforcement thereof may be limited by except (i) the enforceability thereof
may be limited by bankruptcy, insolvency, reorganization, fraudulent conveyance,
moratorium or other similar laws now or hereafter in effect relating to rights
of creditors and other obligees generally, (ii) the remedy of specific
performance and other forms of equitable relief may be subject to certain
equitable defenses and principles and to the discretion of the court before
which the proceedings may be brought and (iii) rights to indemnity and
contribution thereunder may be limited by federal or state securities laws or
the public policy underlying such laws; the Notes will conform in all material
respects to the description thereof in the Offering Memorandum.
(f) All the outstanding shares of capital stock of the
<PAGE>
Company have been duly authorized and validly issued, are fully paid and
nonassessable and are free of any preemptive or, except as set forth in the
Offering Memorandum, similar rights and were issued and sold in compliance with
all applicable Federal and state securities laws; the Common Stock to be issued
upon conversion of the Notes will be, prior to its issuance, duly authorized and
reserved for issuance and, when delivered upon conversion of the Notes, will be
validly issued, fully paid and nonassessable and free of any preemptive or
similar rights; and the authorized capital stock of the Company conforms to the
description thereof in the Offering Memorandum.
(g) The Company is a corporation duly organized, validly existing and
in good standing under the laws of the State of Iowa with full corporate power
and authority to own, lease and operate its properties and to conduct its
business as described in the Offering Memorandum, and is duly registered and
qualified to conduct its business and is in good standing in each jurisdiction
or place where the nature of its properties or the conduct of its business
requires such registration or qualification, except where the failure so to
register or qualify does not have a material adverse effect on the financial
condition, business, properties, net worth or results of operations of the
Company and the Subsidiaries (as hereinafter defined), taken as a whole (a
"Material Adverse Effect").
(h) All the Company's subsidiaries (collectively, the "Subsidiaries")
are listed on Schedule II hereto. Each Subsidiary is a corporation duly
organized, validly existing and in good standing in the jurisdiction of its
incorporation, with full corporate power and authority to own, lease and operate
its properties and to conduct its business as described in the Offering
Memorandum, and is duly registered and qualified to conduct its business and is
in good standing in each jurisdiction or place where the nature of its
properties or the conduct of its business requires such registration or
qualification, except where the failure so to register or qualify does not have
a Material Adverse Effect. All the outstanding shares of capital stock of each
of the Subsidiaries have been duly authorized and validly issued, are fully paid
and nonassessable, and are wholly owned by the Company directly or indirectly
through one of the other Subsidiaries, free and clear of any lien, adverse
claim, security interest, equity or other encumbrance, except as described in
the Offering Memorandum.
<PAGE>
(i) There are no legal or governmental proceedings pending or, to the
knowledge of the Company, threatened, against the Company or any of the
Subsidiaries which are materially adverse to the Company, or to which the
Company or any of the Subsidiaries, or to which any of their respective
properties, is subject, which are material to the Company or its Subsidiaries,
taken as a whole, that are not disclosed in the Offering Memorandum and which,
if adversely decided, are reasonably likely to cause a Material Adverse Effect
or materially affect the issuance of the Notes or the consummation of the
transactions contemplated by the Operative Documents. There are no material
agreements, contracts, indentures, leases, licenses or other instruments or
documents relating to the Company or the Subsidiaries that are not described in
the Offering Memorandum. The descriptions of the terms of any such agreements,
indentures, leases, licenses, instruments, contracts or documents contained in
the Offering Memorandum are correct in all material respects. Neither the
Company nor any Subsidiary is involved in any strike, job action or labor
dispute with any group of employees, and, to the Company's knowledge, no such
action or dispute is threatened.
(j) Neither the Company nor any of the Subsidiaries is (i) in
violation of its certificate or articles of incorporation or by-laws or other
organizational documents, (ii) in violation of any law, ordinance,
administrative or governmental rule or regulation applicable to the Company or
any of the Subsidiaries or of any decree of any court or governmental agency or
body having jurisdiction over the Company or any of the Subsidiaries, except
where any such violation or violations in the aggregate would not have a
Material Adverse Effect or (iii) in default in the performance of any
obligation, agreement or condition contained in any bond, debenture, note or any
other evidence of indebtedness or in any agreement, indenture, lease or other
instrument to which the Company or any of the Subsidiaries is a party or by
which any of them or any of their respective properties may be bound, and no
condition or state of facts exists which with the passage of time or the giving
of notice or both, would constitute such a default (except where any such
default or defaults in the aggregate would not have a Material Adverse Effect)
except as may be disclosed in the Offering Memorandum.
(k) Neither the issuance, offer, sale or delivery of the Notes, the
issuance of Common Stock upon conversion of the Notes or the payment to holders
of Notes of an amount of cash equal to the
<PAGE>
market price of the underlying Common Stock in lieu of conversion into Common
Stock in accordance with the terms of the Indenture, the execution, delivery or
performance of this Agreement, the Indenture or the Registration Rights
Agreement by the Company nor the consummation by the Company of the transactions
contemplated hereby or thereby (i) requires any consent, approval, authorization
or other order of, or registration or filing with, any court, regulatory body,
administrative agency or other governmental body, agency or official (except
such as may be required in connection with the registration under the Act of the
Common Stock in accordance with the Registration Rights Agreement, and except
for compliance with the securities or Blue Sky laws of various jurisdictions) or
conflicts or will conflict with or constitutes or will constitute a breach of,
or a default under, the certificate or articles of incorporation or bylaws, or
other organizational documents, of the Company or any of the Subsidiaries or
(ii) conflicts or will conflict with or constitutes or will constitute a breach
of, or a default under, in any material respect, any material agreement,
indenture, lease or other instrument to which the Company or any of the
Subsidiaries is a party or by which any of them or any of their respective
properties may be bound, or violates or will violate in any material respect any
statute, law, regulation or filing or judgment, injunction, order or decree
applicable to the Company or any of the Subsidiaries or any of their respective
properties, or will result in the creation or imposition of any lien, charge or
encumbrance upon any property or assets of the Company or any of the
Subsidiaries pursuant to the terms of any agreement or instrument to which any
of them is a party or by which any of them may be bound or to which any of the
property or assets of any of them is subject.
(l) The accountants, KPMG Peat Marwick LLP, who have certified or
shall certify the financial statements included as part of the Offering
Memorandum (or any amendment or supplement thereto), each are independent public
accountants under Rule 101 of the AICPA'a Code of Professional Conduct, and its
interpretation and rulings.
(m) The financial statements, together with related schedules and
notes forming part of the Offering Memorandum (and any amendment or supplement
thereto), present fairly the consolidated financial position, results of
operations and changes in stockholders' equity and cash flows of the Company and
the Subsidiaries on the basis stated in the Offering Memorandum at the
<PAGE>
respective dates or for the respective periods to which they apply; such
statements and related schedules and notes have been prepared in accordance with
generally accepted accounting principles consistently applied throughout the
periods involved, except as disclosed therein and the other financial and
statistical information and data set forth in the Offering Memorandum (and any
amendment or supplement thereto) are accurately presented in all material
respects and prepared on a basis consistent in all material respects with the
books and records of the Company and its Subsidiaries.
(n) The Company has all requisite power and authority to execute,
deliver and perform its obligations under this Agreement and the Registration
Rights Agreement; the execution and delivery of, and the performance by the
Company of its obligations under, this Agreement and the Registration Rights
Agreement have been duly and validly authorized by the Company, and this
Agreement and the Registration Rights Agreement have been duly executed and
delivered by the Company and constitute the valid and legally binding agreements
of the Company, enforceable against the Company in accordance with their terms,
except (i) the enforceability hereof or thereof may be limited by bankruptcy,
insolvency, reorganization, fraudulent conveyance, moratorium or other similar
laws now or hereafter in effect relating to rights of creditors and other
obligees generally, (ii) the remedy of specific performance and other forms of
equitable relief may be subject to certain equitable defenses and principles and
to the discretion of the court before which the proceedings may be brought and
(iii) rights to indemnity and contribution hereunder or thereunder may be
limited by federal or state securities laws or the public policy underlying such
laws.
(o) Except as disclosed in the Offering Memorandum (or any amendment
or supplement thereto), subsequent to the date as of which such information is
given in the Offering Memorandum (or any amendment or supplement thereto),
neither the Company nor any of the Subsidiaries has incurred any liability or
obligation, direct or contingent, or entered into any transaction, not in the
ordinary course of business, that is material to the Company and the
Subsidiaries taken as a whole, and there has not been any change in the capital
stock of the Company, or material increase in the short-term or long-term debt,
of the Company or any of the Subsidiaries, or any material adverse change, or
any development involving or which could reasonably be expected to have a
Material Adverse Effect.
<PAGE>
(p) Each of the Company and the Subsidiaries has good and marketable
title to all property (real and personal) described in the Offering Memorandum
as being owned by it, free and clear of all liens, claims, security interests or
other encumbrances except such as are described in the Offering Memorandum,
except where the failure to have such title would not, individually or in the
aggregate, have a Material Adverse Effect and all the property described in the
Offering Memorandum as being held under lease by each of the Company and the
Subsidiaries is held by it under valid, subsisting and enforceable leases,
except as enforcement may be limited by applicable bankruptcy, insolvency,
reorganization, fraudulent conveyance, moratorium or other similar laws now or
hereafter in effect relating to rights of creditors and other obligees generally
or by general equitable principles with only such exceptions as in the aggregate
are not materially burdensome and do not interfere in any material respect with
the conduct of the business of the Company and the Subsidiaries, taken as a
whole.
(q) Except as permitted by the Act, the Company has not distributed
and, prior to the later to occur of the Closing Date and completion of the
distribution of the Notes, will not distribute any offering material in
connection with the offering and sale of the Notes other than the Preliminary
Offering Memorandum and Offering Memorandum.
(r) The Company and each of the Subsidiaries have such consents,
approvals, permits, licenses, franchises and authorizations of and from all
United States and foreign, federal, state or provincial, local and other
governmental or regulatory authorities (collectively, the "Licenses") as are
necessary to own its respective properties and to conduct its business in the
manner described in the Offering Memorandum, except where the failure to have
any such Licenses would not have a Material Adverse Effect and subject to such
qualifications as may be set forth in the Offering Memorandum; the Company and
each of the Subsidiaries has fulfilled and performed all its material
obligations with respect to such Licenses and no event has occurred that allows,
or after notice or lapse of time or both would allow, revocation or termination
thereof or results in any other material impairment of the rights of the holder
of any such Licenses, except where any of the foregoing would not have,
individually or in the aggregate, a Material Adverse Effect and subject in each
case to such qualification as may be set forth in the Offering Memorandum; and,
except as described in the Offering Memorandum, none of such Licenses contains
any restriction or
<PAGE>
conditions that is materially burdensome to the Company or any of the
Subsidiaries. Without limiting the generality of this paragraph 5(r):
(i) The Company and each of the Subsidiaries hold all
telecommunications regulatory licenses, permits, authorizations, consents
and approvals (the "Telecommunications Licenses") required from the Federal
Communications Commission (the "FCC") for the Company and the Subsidiaries
to conduct their business in the manner described in or contemplated by the
Offering Memorandum, except as would not have, individually or in the
aggregate, a Material Adverse Effect; the Telecommunications Licenses have
been duly and validly issued and are in full force and effect, except where
the failure to be in full force and effect would not have, individually or
in the aggregate, a Material Adverse Effect; no proceedings to revoke or
restrict the Telecommunications Licenses are pending or, to the best of our
knowledge, threatened; neither the Company nor the Subsidiaries are in
violation of any of the terms and conditions of any of the
Telecommunications Licenses, are in violation of the Communications Act of
1934, as amended (the "Communications Act"), or are in violation of any FCC
rules and regulations, except as would not have, individually or in the
aggregate, a Material Adverse Effect; and the Company and the Subsidiaries
have in effect with the FCC all international and domestic service tariffs
necessary to conduct their business in the manner described in or
contemplated by the Offering Memorandum except as would not have,
individually or in the aggregate, a Material Adverse Effect;
(ii) The Company and the Subsidiaries have obtained all state
Telecommunications Licenses and filed all tariffs required for the
provision of telecommunications services in any state to conduct their
business in the manner described in or contemplated by the Offering
Memorandum, except where the failure to do so would not have, individually
or in the aggregate, a Material Adverse Effect;
(iii) There is no outstanding adverse judgment, injunction, decree or
order that has been issued by the FCC or any state public utility
commission or similar state agency ("PUC") against the Company or the
Subsidiaries or any action, proceeding or investigation pending before the
FCC or any state PUC, or, to the Company's knowledge, threatened by the FCC
or any state PUC against the Company or the Subsidiaries which, if
<PAGE>
the subject of any unfavorable decision, ruling or finding, would have a
Material Adverse Effect on the Company or the Subsidiaries;
(iv) No license, permit, consent, approval, order or
authorization of, or filing with, the FCC or with any state PUC on the part
of the Company or the Subsidiaries is required in connection with the
issuance or sale of the Notes or the shares of Common Stock received upon
conversion thereof;
(v) Neither the issuance and sale of the Notes or the shares of
Common Stock received upon conversion thereof nor the performance by the
Company or the Subsidiaries of their obligations under this Agreement, the
Registration Rights Agreement or the Indenture will result in a violation
in any material respect of the Communications Act or any applicable FCC
rules or regulations, or any order, writ, judgment, injunction, decree or
award of the FCC binding on the Company or the Subsidiaries; and
(vi) Neither the Company nor the Subsidiaries are in non-
compliance in the provision of international call-back service with the
laws of any foreign jurisdiction that would constitute a violation of the
Telecommunications Licenses, except where such non-compliance would not
have a Material Adverse Effect and subject to such qualifications as may be
set forth in the Offering Memorandum.
(s) The Company maintains a system of internal accounting controls
sufficient to provide reasonable assurances that (i) transactions are executed
in accordance with management's general or specific authorization; (ii)
transactions are recorded as necessary to permit preparation of financial
statements in conformity with generally accepted accounting principles and to
maintain accountability for assets; (iii) access to assets is permitted only in
accordance with management's general or specific authorization; and (iv) the
recorded accountability for assets is compared with existing assets at
reasonable intervals and appropriate action is taken with respect to any
differences.
(t) Neither the Company nor any of the Subsidiaries nor, to the
Company's knowledge, any employee or agent of the Company or any Subsidiary has
made any payment of funds of the Company or any Subsidiary or received or
retained any funds in violation of any
<PAGE>
law, rule or regulation, which violation would have a Material Adverse Effect.
(u) Except as disclosed in the Offering Memorandum, the Company and
each of the Subsidiaries have filed all tax returns required to be filed, which
returns are true and correct in all material respects, and neither the Company
nor any Subsidiary is in default in the payment of any taxes which were payable
pursuant to said returns or any assessments with respect thereto.
(v) Except as described in the Offering Memorandum, no holder of any
security of the Company (other than holders of the Notes with respect to shares
of Common Stock upon conversion thereof and holders of shares of Common Stock
received upon conversion thereof) has any right to request or demand
registration of shares of Common Stock or any other security of the Company
because of the consummation of the transactions contemplated by this Agreement
or the Registration Rights Agreement, except as described in the Offering
Memorandum under the caption "Description of Capital Stock--Registration
Rights."
(w) The Company and the Subsidiaries own or possess all patents,
trademarks, trademark registration, service marks, service mark registrations,
trade names, copyrights, licenses, inventions, trade secrets and rights
described in the Offering Memorandum as being owned by any of them or necessary
for the conduct of their respective businesses, except where the lack of such
ownership would not have a Material Adverse Effect, and the Company is not aware
of any claim to the contrary or any challenge by any other person to the rights
of the Company and the Subsidiaries with respect to the foregoing.
(x) The Company is not and, upon sale of the Notes to be issued and
sold thereby in accordance herewith and the application of the net proceeds to
the Company of such sale as described in the Offering Memorandum under the
caption "Use of Proceeds," will not be an "investment company" within the
meaning of the Investment Company Act of 1940, as amended.
(y) When the Notes are issued and delivered pursuant to this
Agreement, such Notes will not be of the same class (within the meaning of Rule
144A(d)(3) under the Act) as any security of the Company that is listed on a
national securities exchange registered under Section 6 of the Exchange Act or
that is quoted in
<PAGE>
a United States automated interdealer quotation system.
(z) Neither the Company nor any affiliate (as defined in Rule 501(b)
of Regulation D ("Regulation D") under the Act) of the Company has directly, or
through any agent (provided that no representation is made as to the Initial
Purchaser or any person acting on its behalf), (i) sold, offered for sale,
solicited offers to buy or otherwise negotiated in respect of, any security (as
defined in the Act) which is or will be integrated with the offering and sale of
the Notes in a manner that would require the registration of the Notes under the
Act or (ii) engaged in any form of general solicitation or general advertising
(within the meaning of Regulation D) in connection with the offering of the
Notes.
(aa) The Company is not required to deliver the information specified
in Rule 144A(d)(4) in connection with the offering and resale of the Notes by
the Initial Purchaser.
(bb) Assuming (i) that the representations and warranties in Section
5 hereof are true, (ii) the Initial Purchaser complies with the covenants set
forth in Section 2 hereof and (iii) that each person to whom the Initial
Purchaser offers, sells or delivers the Notes is a Qualified Institutional Buyer
or an Accredited Investor, the purchase and sale of the Notes pursuant hereto
(including the Initial Purchaser's proposed offering of the Notes on the terms
and in the manner set forth in the Offering Memorandum and Section 2 hereof) is
exempt from the registration requirements of the Act.
(cc) The execution and delivery of this Agreement, the other
Operative Documents and the sale of the Notes to the Initial Purchaser or by the
Initial Purchaser to Eligible Purchasers will not involve any prohibited
transaction within the meaning of Section 406 of ERISA or Section 4975 of the
Code. The representation made by the Company in the preceding sentence is made
in reliance upon and subject to the accuracy of, and compliance with, the
representations and covenants made or deemed made by the Eligible Purchasers as
set forth in the Offering Memorandum under the section entitled "Transfer
Restrictions."
(dd) Except for the stockholder approval, to the extent necessary, of
the increase in the authorized number of shares of Common Stock necessary in
order for the Notes to be convertible into Common Stock, the Company is not
required to obtain
<PAGE>
stockholder consent or approval pursuant to the rules of the Nasdaq National
Market in connection with the offering and sale of the Notes.
(ee) Each of the Company and the Subsidiaries maintains insurance of
the types and in the amounts reasonably adequate for its business, including,
but not limited to, business interruption insurance and insurance covering real
and personal property owned or leased by the Company or such Subsidiary against
theft, damage, destruction, acts of vandalism and other risks customarily
insured against by corporations of established reputation engaged in the same or
similar businesses and similarly situated, all of which insurance is in full
force and effect.
6. Indemnification and Contribution. (a) The Company agrees to
indemnify and hold harmless the Initial Purchaser and each person, if any, who
controls the Initial Purchaser within the meaning of Section 15 of the Act or
Section 20 of the Exchange Act, from and against any and all losses, claims,
damages, liabilities and expenses (including reasonable costs of investigation)
arising out of or based upon any untrue statement or alleged untrue statement of
a material fact contained in the Preliminary Offering Memorandum or Offering
Memorandum or in any amendment or supplement thereto, or arising out of or based
upon any omission or alleged omission to state therein a material fact required
to be stated therein or necessary to make the statements therein not misleading,
except insofar as such losses, claims, damages, liabilities or expenses arise
out of or are based upon any untrue statement or omission or alleged untrue
statement or omission which has been made therein or omitted therefrom in
reliance upon and in conformity with the information relating to the Initial
Purchaser furnished in writing to the Company by or on behalf of the Initial
Purchaser expressly for use in connection therewith; provided, however, that the
-------- -------
indemnification contained in this paragraph (a) with respect to the Preliminary
Offering Memorandum shall not inure to the benefit of the Initial Purchaser (or
to the benefit of any person controlling the Initial Purchaser) on account of
any such loss, claim, damage, liability or expense arising from the sale of the
Notes by the Initial Purchaser to any person if the untrue statement or alleged
untrue statement or omission or alleged omission of a material fact contained in
the Preliminary Offering Memorandum was corrected in the Offering Memorandum and
the Initial Purchaser sold Notes to that person without sending or giving at or
prior to the
<PAGE>
written confirmation of such sale, a copy of the Offering Memorandum (as then
amended or supplemented) if the Company has previously furnished sufficient
copies thereof to the Initial Purchaser on a timely basis. The foregoing
indemnity agreement shall be in addition to any liability which the Company may
otherwise have.
(b) If any action, suit or proceeding shall be brought against the
Initial Purchaser or any person controlling the Initial Purchaser in respect of
which indemnity may be sought against the Company, the Initial Purchaser or such
controlling person shall promptly notify the parties against whom
indemnification is being sought (the "indemnifying parties"), and such
indemnifying parties shall assume the defense thereof, including the employment
of counsel and payment of all fees and expenses. The Initial Purchaser or any
such controlling person shall have the right to employ separate counsel in any
such action, suit or proceeding and to participate in the defense thereof, but
the fees and expenses of such counsel shall be at the expense of the Initial
Purchaser or such controlling person unless (i) the indemnifying parties have
agreed in writing to pay such fees and expenses, (ii) the indemnifying parties
have failed to assume the defense and employ counsel, or (iii) the named parties
to any such action, suit or proceeding (including any impleaded parties) include
both the Initial Purchaser or such controlling person and the indemnifying
parties and the Initial Purchaser or such controlling person shall have been
advised by its counsel in writing that representation of such indemnified party
and any indemnifying party by the same counsel would be inappropriate under
applicable standards of professional conduct (whether or not such representation
by the same counsel has been proposed) due to actual or potential differing
interests between them (in which case the indemnifying party shall not have the
right to assume the defense of such action, suit or proceeding on behalf of the
Initial Purchaser or such controlling person). It is understood, however, that
the indemnifying parties shall, in connection with any one such action, suit or
proceeding or separate but substantially similar or related actions, suits or
proceedings in the same jurisdiction arising out of the same general allegations
or circumstances, be liable for the reasonable fees and expenses of only one
separate firm of attorneys (in addition to any local counsel) at any time for
the Initial Purchaser and controlling persons not having actual or potential
differing interests with the Initial Purchaser or among themselves, which firm
shall be designated in writing by Smith Barney Inc., and that all such
<PAGE>
reasonable fees and expenses shall be reimbursed as they are incurred upon
submission to the indemnifying party of invoices or other evidence of payment.
The indemnifying parties shall not be liable for any settlement of any such
action, suit or proceeding effected without their express prior written consent,
but if settled with such written consent, or if there be a final judgment for
the plaintiff in any such action, suit or proceeding, the indemnifying parties
agree to indemnify and hold harmless the Initial Purchaser, to the extent
provided in paragraph (a), and any such controlling person from and against any
loss, claim, damage, liability or expense by reason of such settlement or
judgment.
(c) The Initial Purchaser agrees to indemnify and hold harmless the
Company, and its directors and officers, and any person who controls the Company
within the meaning of Section 15 of the Act or Section 20 of the Exchange Act to
the same extent as the indemnity from the Company to the Initial Purchaser set
forth in paragraph (a) hereof, but only with respect to information relating to
the Initial Purchaser furnished in writing by or on behalf of the Initial
Purchaser expressly for use in the Preliminary Offering Memorandum or Offering
Memorandum or any amendment or supplement thereto. If any action, suit or
proceeding shall be brought against the Company, any of its directors or
officers, or any such controlling person based on the Preliminary Offering
Memorandum or Offering Memorandum, or any amendment or supplement thereto, and
in respect of which indemnity may be sought against the Initial Purchaser
pursuant to this paragraph (c), the Initial Purchaser shall have the rights and
duties given to the Company by paragraph (b) above (except that if the Company
shall have assumed the defense thereof the Initial Purchaser shall not be
required to do so, but may employ separate counsel therein and participate in
the defense thereof, but the fees and expenses of such counsel shall be at the
Initial Purchaser's expense), and the Company, its directors and officers, and
any such controlling person shall have the rights and duties given to the
Initial Purchaser by paragraph (b) above.
(d) If the indemnification provided for in this Section 6 is
unavailable to an indemnified party under paragraphs (a) or (c) hereof in
respect of any losses, claims, damages, liabilities or expenses referred to
therein, then an indemnifying party, in lieu of indemnifying such indemnified
party, shall contribute to the amount paid or payable by such indemnified party
as a result of such losses, claims, damages, liabilities or expenses (i) in such
proportion as is appropriate to reflect the relative benefits
<PAGE>
received by the Company on the one hand and the Initial Purchaser on the other
hand from the offering of the Notes, or (ii) if the allocation provided by
clause (i) above is not permitted by applicable law, in such proportion as is
appropriate to reflect not only the relative benefits referred to in clause (i)
above but also the relative fault of the Company on the one hand and the Initial
Purchaser on the other in connection with the statements or omissions that
resulted in such losses, claims, damages, liabilities or expenses, as well as
any other relevant equitable considerations. The relative benefits received by
the Company on the one hand and the Initial Purchaser on the other shall be
deemed to be in the same proportion as the total net proceeds from the offering
(before deducting expenses) received by the Company bear to the total
underwriting discounts and commissions received by the Initial Purchaser. The
relative fault of the Company on the one hand and the Initial Purchaser on the
other hand shall be determined by reference to, among other things, whether the
untrue or alleged untrue statement of a material fact or the omission or alleged
omission to state a material fact relates to information supplied by the Company
on the one hand or by the Initial Purchaser on the other hand and the parties'
relative intent, knowledge, access to information and opportunity to correct or
prevent such statement or omission.
(e) The Company and the Initial Purchaser agree that it would not be
just and equitable if contribution pursuant to this Section 6 were determined by
a pro rata allocation or by any other method of allocation that does not take
account of the equitable considerations referred to in paragraph (d) above. The
amount paid or payable by an indemnified party as a result of the losses,
claims, damages, liabilities and expenses referred to in paragraph (d) above
shall be deemed to include, subject to the limitations set forth above, any
legal or other expenses reasonably incurred by such indemnified party in
connection with investigating any claim or defending any such action, suit or
proceeding. Notwithstanding the provisions of this Section 6, the Initial
Purchaser shall not be required to contribute any amount in excess of the amount
by which the total price of the Notes purchased by it and resold exceeds the
amount of any damages which the Initial Purchaser has otherwise been required to
pay by reason of such untrue or alleged untrue statement or omission or alleged
omission. No person guilty of fraudulent misrepresentation (within the meaning
of Section 11(f) of the Act) shall be entitled to contribution from any person
who was not guilty of such fraudulent misrepresentation.
<PAGE>
(f) Any losses, claims, damages, liabilities or expenses for which an
indemnified party is entitled to indemnification or contribution under this
Section 6 shall be paid by the indemnifying party to the indemnified party as
such losses, claims, damages, liabilities or expenses are incurred. The
indemnity and contribution agreements contained in this Section 6 and the
representations and warranties of the Company set forth in this Agreement shall
remain operative and in full force and effect, regardless of (i) any
investigation made by or on behalf of the Initial Purchaser or any person
controlling the Initial Purchaser, the Company, its directors or officers or any
person controlling the Company, (ii) acceptance of any Notes and payment
therefor hereunder, and (iii) any termination of this Agreement. A successor to
the Initial Purchaser or any person controlling the Initial Purchaser, or to the
Company, its directors or officers or any person controlling the Company, shall
be entitled to the benefits of the indemnity, contribution and reimbursement
agreements contained in this Section 6.
(g) No indemnifying party shall, without the prior written consent of
the indemnified party, effect any settlement of any pending or threatened
action, suit or proceeding in respect of which any indemnified party is or could
have been a party and indemnity could have been sought hereunder by such
indemnified party, unless such settlement includes an unconditional release of
such indemnified party from all liability on claims that are the subject matter
of such action, suit or proceeding.
7. Conditions of the Initial Purchaser's Obligations. The
obligations of the Initial Purchaser to purchase the Notes hereunder are subject
to the following conditions:
(a) At the time of execution of this Agreement and on the Closing
Date, no order or decree preventing the use of the Offering Memorandum or any
amendment or supplement thereto, or any order asserting that the transactions
contemplated by this Agreement are subject to the registration requirements of
the Act shall have been issued and no proceedings for that purpose shall have
been commenced or shall be pending or, to the knowledge of the Company, be
contemplated. No stop order suspending the sale of the Notes in any
jurisdiction designated by the Initial Purchaser shall have been issued and no
proceedings for that purpose shall have been commenced or shall be pending or,
to the knowledge of the Company, shall be contemplated.
<PAGE>
(b) Subsequent to the effective date of this Agreement, there shall
not have occurred (i) any change, or any development involving a prospective
change, that would have a Material Adverse Effect in or affecting the financial
condition, business, prospects, properties, net worth, or results of operations
of the Company or the Subsidiaries not contemplated by the Offering Memorandum,
which in the opinion of the Initial Purchaser, would materially adversely affect
the market for the Notes, or (ii) any event or development relating to or
involving the Company or any officer or director of the Company which makes any
statement made in the Offering Memorandum untrue in any material respect or
which, in the opinion of the Company and its counsel or the Initial Purchaser
and its counsel, requires the making of any addition to or change in the
Offering Memorandum in order to state a material fact required by any law to be
stated therein or necessary in order to make the statements therein not
misleading, if amending or supplementing the Offering Memorandum to reflect such
event or development would, in the opinion of the Initial Purchaser, materially
adversely affect the market for the Notes.
(c) The Initial Purchaser shall have received on the Closing Date a
corporate opinion of Swidler & Berlin, Chartered, counsel for the Company, dated
the Closing Date and addressed to the Initial Purchaser, in the form attached
hereto as Exhibit A.
(d) The Initial Purchaser shall have received on the Closing Date a
regulatory opinion from Swidler & Berlin, Chartered, special regulatory counsel
to the Company, dated the Closing Date and addressed to the Initial Purchaser,
in the form attached hereto as Exhibit B.
(e) The Initial Purchaser shall have received on the Closing Date an
opinion from Marcus & Thompson, P.C., local counsel to the Company, dated the
Closing Date and addressed to the Initial Purchaser, in the form attached hereto
as Exhibit C.
(f) The Initial Purchaser shall have received on the Closing Date an
opinion of Charles E. Johanson, Esq., Corporate Counsel of the Company, dated
the Closing Date and addressed to the Initial Purchaser in the form attached
hereto as Exhibit D.
(g) You shall have received on the Closing Date opinions of Baker &
McKenzie (Australia) in the form attached hereto as Exhibit E, Baker & McKenzie
(Hong Kong) in the form attached hereto
<PAGE>
as Exhibit F, Baker & McKenzie (Germany) in the form attached hereto as Exhibit
G, Coudert Freres (France) in the form attached hereto as Exhibit H, TMI
Associates (Japan) in the form attached hereto as Exhibit I, Stibbe Simont
Monahan Duhot (The Netherlands) in the form attached hereto as Exhibit J, Taylor
Joynson Garrett (United Kingdom) in the form attached hereto as Exhibit K,
Advokatfirman Lindahl (Sweden) in the form attached hereto as Exhibit L and
Baker & McKenzie (Switzerland) in the form attached hereto as Exhibit M, special
regulatory counsel for the Company in each of the jurisdictions described above,
each dated the Closing Date and addressed to you, as Initial Purchaser.
(h) The Initial Purchaser shall have received on the Closing Date an
opinion of Chadbourne & Parke LLP, counsel for the Initial Purchaser, dated the
Closing Date, and addressed to the Initial Purchaser, with respect to certain
matter referred to above and such other related matters as the Initial Purchaser
may request.
(i) The Initial Purchaser shall have received letters addressed to the
Initial Purchaser, and dated the date hereof and the Closing Date from KPMG Peat
Marwick LLP, independent certified public accountants, substantially in the
forms heretofore approved by the Initial Purchaser.
(j) (i) There shall not have been any change in the capital stock of
the Company nor any material increase in the short-term or long-term debt of the
Company (other than in the ordinary course of business) from that set forth or
contemplated in the Offering Memorandum (or any amendment or supplement
thereto); (ii) there shall not have been, since the respective dates as of which
information is given in the Offering Memorandum (or any amendment or supplement
thereto), except as may otherwise be stated in the Offering Memorandum (or any
amendment or supplement thereto), any material adverse change in the financial
condition, business, prospects, properties, net worth or results of operations
of the Company and the Subsidiaries taken as a whole; (iii) the Company and the
Subsidiaries shall not have any liabilities or obligations, direct or contingent
(whether or not in the ordinary course of business), that are material to the
Company and the Subsidiaries, taken as a whole, other than those reflected in
the Offering Memorandum (or any amendment or supplement thereto); and (iv) all
the representations and warranties of the Company contained in this Agreement
shall be true and correct in all
<PAGE>
material respects on and as of the date hereof and on and as of the Closing Date
as if made on and as of the Closing Date, and the Initial Purchaser shall have
received a certificate, dated the Closing Date and signed by the chief executive
officer and the chief accounting officer of the Company (or such other officers
as are acceptable to the Initial Purchaser), to the effect set forth in this
Section 7(j) and in Section 7(k) hereof.
(k) The Company shall not have failed at or prior to the Closing Date
to have performed or complied with any of its agreements herein contained and
required to be performed or complied with by it hereunder at or prior to the
Closing Date.
(l) There shall not have been any announcement by any "nationally
recognized statistical rating organization," as defined for purposes of Rule
436(g) under the Act, that (i) it is downgrading its rating assigned to any
class of securities of the Company, or (ii) it is reviewing its ratings assigned
to any class of securities of the Company with a view to possible downgrading,
or with negative implications, or direction not determined.
(m) The Company shall have furnished or caused to be furnished to the
Initial Purchaser such further certificates and documents as the Initial
Purchaser shall reasonably have requested.
All such opinions, certificates, letters and other documents will be
in compliance with the provisions hereof only if they are reasonably
satisfactory in form and substance to the Initial Purchaser and counsel for the
Initial Purchaser.
Any certificate or document signed by any officer of the Company and
delivered to the Initial Purchaser, or to counsel for the Initial Purchaser,
shall be deemed a representation and warranty by the Company to the Initial
Purchaser as to the statements made therein.
8. Expenses. The Company agrees to pay the following costs and
expenses and all other costs and expenses incident to the performance by it of
its obligations hereunder: (i) the preparation, printing or reproduction of the
Offering Memorandum (including financial statements thereto), and each amendment
or supplement to any of them, this Agreement and the Indenture; (ii) the
printing (or reproduction) and delivery (including postage, air freight charges
and charges for counting and packaging) of such
<PAGE>
copies of the Offering Memorandum, the Preliminary Offering Memorandum, the
Incorporated Documents, and all amendments or supplements to any of them as may
be reasonably requested for use in connection with the offering and sale of the
Notes; (iii) the preparation, printing, authentication, issuance and delivery of
certificates for the Notes, including any stamp taxes in connection with the
original issuance and sale of the Notes; (iv) the printing (or reproduction) and
delivery of this Agreement, the preliminary and supplemental Blue Sky Memoranda
and all other agreements or documents printed (or reproduced) and delivered in
connection with the offering of the Notes; (v) the qualification of the Notes
and the shares of Common Stock issuable upon conversion of the Notes for offer
and sale under the securities or Blue Sky laws of the several states as provided
in Section 4(f) hereof (including the reasonable fees, expenses and
disbursements of counsel for the Initial Purchaser relating to the preparation,
printing or reproduction, and delivery of the preliminary and supplemental Blue
Sky Memoranda and such qualification); and (vi) the fees and expenses of the
Company's accountants and the fees and expenses of counsel (including local and
special counsel) for the Company; provided that the fees and expenses of
--------
Chadbourne & Parke LLP shall be paid 50% by the Initial Purchaser and 50% by the
Company.
9. Effective Date of Agreement. This Agreement shall become
effective upon the execution and delivery hereof by all the parties hereto.
Until such time as this Agreement shall have become effective, it may be
terminated by the Company, by notifying the Initial Purchaser, or by the Initial
Purchaser, by notifying the Company.
Any notice under this Section 9 may be given by telegram, telecopy or
telephone but shall be subsequently confirmed by letter.
10. Termination of Agreement. This Agreement shall be subject to
termination in the absolute discretion of the Initial Purchaser, without
liability on the part of the Initial Purchaser to the Company, by notice to the
Company, if prior to the Closing Date (i) trading in securities generally on the
New York Stock Exchange, American Stock Exchange or the Nasdaq National Market
shall have been suspended or materially limited, (ii) a general moratorium on
commercial banking activities in New York shall have been declared by either
Federal or state authorities, or (iii) there shall have occurred any outbreak or
escalation of hostilities
<PAGE>
or other international or domestic calamity, crisis or change in political,
financial or economic conditions, the effect of which on the financial markets
of the United States is such as to make it, in the judgment of the Initial
Purchaser, impracticable or inadvisable to commence or continue the offering of
the Notes on the terms set forth on the cover page of the Offering Memorandum or
to enforce contracts for the resale of the Notes by the Initial Purchaser.
Notice of such termination may be given to the Company by telegram, telecopy or
telephone and shall be subsequently confirmed by letter.
11. Information Furnished by the Initial Purchaser. The statements
set forth in the last paragraph on the cover page and in the fourth and fifth
paragraphs under the caption "Private Placement" in the Preliminary Offering
Memorandum and Offering Memorandum, constitute the only information furnished by
or on behalf of the Initial Purchaser as such information is referred to in
Sections 5(b) and 6 hereof.
12. Miscellaneous. Except as otherwise provided in Sections 4, 9 and
10 hereof, notice given pursuant to any provision of this Agreement shall be in
writing and shall be delivered (i) if to the Company, at the office of the
Company at 2908 Nutmeg Avenue, Fairfield Avenue 52556, Attention: Fred Gratzon,
Chairman or (ii) if to the Initial Purchaser, to Smith Barney Inc., 388
Greenwich Street, New York, New York 10013, Attention: Manager, Investment
Banking Division.
This Agreement has been and is made solely for the benefit of the
Initial Purchaser, the Company, its directors, its officers and the controlling
persons referred to in Section 6 hereof and their respective successors and
assigns, to the extent provided herein, and no other person shall acquire or
have any right under or by virtue of this Agreement. Neither the term
"successor" nor the term "successors and assigns" as used in this Agreement
shall include a purchaser from the Initial Purchaser of any of the Notes in his
status as such purchaser.
13. Applicable Law; Counterparts. This Agreement shall be governed
by and construed in accordance with the laws of the State of New York applicable
to contracts made and to be performed within the State of New York.
This Agreement may be signed in various counterparts
<PAGE>
which together constitute one and the same instrument. If signed in
counterparts, this Agreement shall not become effective unless at least one
counterpart hereof shall have been executed and delivered on behalf of each
party hereto.
<PAGE>
Please confirm that the foregoing correctly sets forth the agreement
between the Company and the Initial Purchaser.
Very truly yours,
TELEGROUP, INC.
By:
Name: Douglas A. Neish
Title: Vice President -
Finance, Chief
Financial Officer
and Treasurer
Confirmed as of the date first
above mentioned.
SMITH BARNEY INC.
By:
Name:
Title:
<PAGE>
SCHEDULE I
TELEGROUP, INC.
<TABLE>
<CAPTION>
Principal
Initial Purchaser Amount of Notes
- ----------------- ---------------
<S> <C>
Smith Barney Inc. $25,000,000
-----------
Total $25,000,000
===========
</TABLE>
<PAGE>
SCHEDULE II
SUBSIDIARIES OF TELEGROUP, INC.
Global Access Pty Ltd.
Telecontinent, S.A.
Telegroup Deutschland GmbH (Dusseldorf)
Telegroup Financial Services Pty Limited
A.C.N. 069159646
Telegroup Hong Kong Limited
Telegroup International Management Pty Limited
Australian Company Number 075 304 915
Telegroup Japan Kabushiki Kaisha
Telegroup Nederland B.V.
Telegroup Network Services Pty Limited
Australian Company Number 075 304 871
Telegroup Network Services New Zealand Limited
Telegroup Network Services, S.A.
Telegroup UK Limited
Telegroup UK (No. 2) Limited
Telegroup South Europe, Inc.
Telegroup Technologies, Inc.
Telegroup Technologies Limited
<PAGE>
EXHIBIT
10.14
REGISTRATION RIGHTS AGREEMENT
- --------------------------------------------------------------------------------
Dated as of September 30, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
relating to
- --------------------------------------------------------------------------------
$25,000,000 Aggregate Principal Amount
of 8% Convertible Subordinated
Notes due 2005
- --------------------------------------------------------------------------------
by and between
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Telegroup, Inc.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
and
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Smith Barney Inc.
- --------------------------------------------------------------------------------
This Registration Rights Agreement (this "Agreement") is made and entered
into as of September 30, 1997, by and between Telegroup, Inc., an Iowa
corporation (the "Company"), and Smith Barney Inc., (the "Initial Purchaser"),
who has purchased $25,000,000 aggregate principal amount of 8% Convertible
Subordinated Notes due 2005 (such $25,000,000 aggregate principal amount of
Convertible Subordinated Notes and any additional Convertible Subordinated Notes
issued in the future to pay interest on any Convertible Subordinated Notes are
referred to herein as the "Notes") of the Company pursuant to the Purchase
Agreement, dated September 30, 1997 (the "Purchase Agreement"), between the
Company and the Initial Purchaser. In order to induce the Initial Purchaser to
enter into the Purchase Agreement, the Company has agreed to provide the
registration rights set forth in this Agreement. The execution and delivery of
this Agreement is a condition to closing under the Purchase Agreement. All
defined terms used but not defined herein shall have the meanings ascribed to
them in the Indenture (as defined herein).
<PAGE>
The parties hereby agree as follows:
SECTION 1. DEFINITIONS
As used in this Agreement, the following capitalized terms shall have the
following meanings:
Black-out Period: The period beginning on the date which any Holder is
----------------
prohibited from selling or distributing Common Stock pursuant to Section 3(h)
and ending on the earlier to occur of the expiration of the period specified in
such Section 3(h) and the waiver by any managing underwriter of such Holder's
obligation not to sell or distribute Common Stock pursuant to such Section 3(h);
provided that such period will not exceed 90 days unless the Holder requests
that such managing underwriter waive such Holder's obligation not to sell or
distribute Common Stock pursuant to such Section 3(h).
Closing Date: The date on which the Notes are sold by the Company to the
Initial Purchaser pursuant to the Purchase Agreement.
Commission: The Securities and Exchange Commission.
----------
Common Stock: The Common Stock, no par value, of the Company.
------------
Damages Payment Date: With respect to the Notes or the Common Stock, as
--------------------
applicable, each Interest Payment Date (as defined in the Indenture) as of which
Liquidated Damages shall have accrued and shall not yet have been paid under the
provisions of Section 4 of this Agreement.
Effectiveness Target Date: As defined in Section 4 hereof.
-------------------------
Exchange Act: The Securities Exchange Act of 1934, as amended.
------------
Exempt Resales: The transactions in which the Initial Purchaser proposes
--------------
to sell the Notes to certain "qualified institutional buyers" (as such term is
defined in Rule 144A under the Securities Act) or institutional "accredited
investors" (as defined in Rule 501(a)1,2,3 or 7 under the Securities Act.
Greenwich Street Registration Rights Agreement: That certain Registration
----------------------------------------------
Rights Agreement among Telegroup, Inc., Greenwich Street Capital Partners, L.P.,
Greenwich Street Capital Offshore Fund, Ltd., TRV Employees Fund, L.P., The
Travelers Insurance Company and The Travelers Life and Annuity Company, dated as
of November 27, 1996.
Holders: As defined in Section 2(b) hereof.
-------
Indenture: The Indenture, dated as of September 30, 1997, between the
---------
Company and State Street Bank and Trust Company, as trustee (the "Trustee"),
pursuant to which the Notes are to be issued, as such Indenture is amended or
supplemented from time to time in accordance with the terms thereof.
Interest Payment Date: As defined in the Indenture.
---------------------
NASD: National Association of Securities Dealers, Inc.
----
Offering Memorandum: The Offering Memorandum, dated September 30, 1997,
-------------------
and all amendments and supplements thereto, relating to the Notes and prepared
by the Company pursuant to the Purchase Agreement.
Person: An individual, partnership, corporation, trust or unincorporated
------
organization, or a government or agency or political subdivision thereof.
Preliminary Prospectus: As defined in Section 3(g) hereof.
----------------------
<PAGE>
Prospectus: The prospectus included in the Shelf Registration Statement
----------
(as defined herein), as amended or supplemented by any Prospectus Supplement
with respect to the terms of the offering of any portion of the Transfer
Restricted Securities (as defined herein) covered by the Shelf Registration
Statement and by all other amendments and supplements to the prospectus,
including post-effective amendments, and all documents which may be incorporated
by reference into such prospectus.
Prospectus Supplement: As defined in Section 5(b) hereof.
---------------------
Record Holder: (i) With respect to any Damages Payment Date relating to
-------------
the Notes, each Person who is registered on the books of the Registrar as the
holder of Notes on the record date with respect to the Interest Payment Date on
which such Damages Payment Date shall occur and (ii) with respect to any Damages
Payment Date relating to the Common Stock, each Person who is a holder of record
of such Common Stock fifteen days prior to the Damages Payment Date.
Registration Expenses: As defined in Section 6(a) hereof.
---------------------
Securities Act: The Securities Act of 1933, as amended.
--------------
Shelf Registration Statement: As defined in Section 3(a) hereof.
----------------------------
TIA: The Trust Indenture Act of 1939 (15 U.S.C. Section 77aaa-77bbbb), as
---
amended through the date of the Indenture.
Transfer Restricted Securities: Each share of Common Stock of the Company
------------------------------
issuable upon conversion of a Note, until such share (i) has been transferred
pursuant to the Shelf Registration Statement or another registration statement
covering it which has been filed with the Commission pursuant to the Securities
Act, in either case after such registration statement has become effective under
the Securities Act, (ii) has been transferred pursuant to Rule 144 under the
Securities Act or (iii) may be sold or transferred pursuant to Rule 144(k) under
the Securities Act (or any similar provisions then in force) under the
Securities Act or otherwise.
Underwriter: Any underwriter, placement agent, selling broker, dealer
-----------
manager, qualified independent underwriter or similar securities industry
professional.
Underwritten Offering: An offering in which Transfer Restricted Securities
---------------------
are sold to an Underwriter or with the assistance of an Underwriter for
reoffering to the public on a firm commitment or best efforts basis pursuant to
the Shelf Registration Statement.
SECTION 2. SECURITIES SUBJECT TO THIS AGREEMENT
(a) Securities Subject to this Agreement. The only securities entitled to
------------------------------------
the benefits of this Agreement are the Transfer Restricted Securities.
(b) Holders of Transfer Restricted Securities. A Person is deemed to be a
-----------------------------------------
holder of Transfer Restricted Securities (each, a "Holder") whenever such Person
is a "beneficial owner" (as that term is used in Rule 13d-3 under the Exchange
Act) of Transfer Restricted Securities.
SECTION 3. SHELF REGISTRATION
(a) The Company shall cause to be filed with the Commission on or prior to
90 days after the Closing Date, a shelf registration statement pursuant to Rule
415 under the Securities Act (as may then be amended, the "Shelf Registration
Statement") on Form S-1 or, at the option of the Company, on Form S-3, if the
use of such form is then available to the Company, to cover resales of Transfer
Restricted Securities by the Holders who satisfy the provisions of Section 3(g)
hereof relating to the provision of information in connection with the Shelf
Registration Statement. The Company shall use its best efforts to cause the
Shelf Registration Statement to be declared effective by the Commission
<PAGE>
on or prior to 180 days after the Closing Date. The Company shall use its best
efforts to keep the Shelf Registration Statement continuously effective for a
period ending two years from the Closing Date or such shorter period that will
terminate when each of the Transfer Restricted Securities covered by the Shelf
Registration Statement shall cease to be a Transfer Restricted Security.
Upon the occurrence of any event that would cause the Shelf Registration
Statement (i) to contain any untrue statement of a material fact or omit to
state a material fact required to be stated therein or necessary to make the
statements therein not misleading or (ii) to be not effective and usable for
resale of Transfer Restricted Securities during the period the Shelf
Registration Statement is required to be effective and usable, the Company shall
as promptly as reasonably practicable file an amendment to the Shelf
Registration Statement, in the case of an event described in clause (i),
correcting any such misstatement or omission, and in the case of an event
described in either clause (i) or (ii), use its reasonable best efforts to cause
such amendment to be declared effective and the Shelf Registration Statement to
become usable as soon as reasonably practicable thereafter.
Notwithstanding anything to the contrary in this Section 3, subject to
compliance with Section 4 hereof, if applicable, the Company may prohibit offers
and sales of Transfer Restricted Securities pursuant to the Shelf Registration
Statement at any time if (A)(i) it is in possession of material non-public
information, (ii) the Board of Directors of the Company or the Executive
Committee thereof determines that such prohibition is necessary in order to
avoid a requirement to disclose such material non-public information and (iii)
the Board of Directors of the Company or the Executive Committee thereof
determines in good faith that disclosure of such material non-public information
would be materially adverse to the interests of the Company and its shareholders
or (B) the Company has made a public announcement relating to an acquisition or
business combination transaction including the Company and/or one or more of its
subsidiaries (i) that is material to the Company and its subsidiaries taken as a
whole and (ii) the Board of Directors of the Company or the Executive Committee
thereof determines in good faith that offers and sales of Transfer Restricted
Securities pursuant to the Shelf Registration Statement prior to the
consummation of such transaction (or such earlier date as the Board of Directors
or the Executive Committee thereof shall determine) is materially adverse to the
interests of the Company and its shareholders (the period during which any such
prohibition of offers and sales of Transfer Restricted Securities pursuant to
the Shelf Registration Statement is in effect pursuant to clause (A) or (B) of
this subparagraph (a) is referred to herein as a "Suspension Period"). A
Suspension Period shall commence on and include the date specified as such in
the written notice to Holders of Transfer Restricted Securities covered by the
Shelf Registration Statement (but shall not commence on any day prior to the
date on which the Company provides such written notice that offers and sales of
Transfer Restricted Securities cannot be made under the Shelf Registration
Statement in accordance with this Section 3) and shall end on the date on which
each Holder of Transfer Restricted Securities covered by the Shelf Registration
Statement either receives copies of a Prospectus Supplement contemplated by
Section 5(b) hereof or is advised in writing by the Company that offers and
sales of Transfer Restricted Securities pursuant to the Shelf Registration
Statement and use of the Prospectus may be resumed.
(b) Except to the extent otherwise required by the Greenwich Street
Registration Rights Agreement as in effect on the date hereof, none of the
Company nor any of its security holders (other than the Holders in such
capacity) shall have the right to include any of the Company's securities in the
Shelf Registration Statement.
(c) Subject to clause (g) below, if Holders of a majority of the shares of
Common Stock to be registered in the Shelf Registration Statement so elect, one
offering of Transfer Restricted Securities pursuant to the Shelf Registration
Statement may be effected in the form of an Underwritten Offering; provided,
that, such Underwritten Offering shall be required to be consummated as promptly
as reasonably practicable and in no event later than 30 days following the
commencement of the marketing of such Underwritten Offering. In such event, if
(A) the only securities to be sold pursuant to such Underwritten Offering are
Transfer Restricted Securities and the Underwriter for such Underwritten
Offering advises the Company and the Holders electing to participate in that
Underwritten Offering (the "Selling Holders") in writing that in that
Underwriters opinion the amount or number of Transfer Restricted Securities
proposed to be sold in that Underwritten Offering exceeds the amount or number
of Transfer Restricted Securities which can be sold in that Underwritten
Offering without materially and adversely affecting the offering price, there
shall be included in that Underwritten Offering the amount of such Transfer
Restricted Securities which in the opinion of such
<PAGE>
Underwriter can be sold therein without such material adverse effect, and such
amount or number of shares shall be allocated pro rata among the Selling Holders
on the basis of the number of shares of Transfer Restricted Securities requested
to be included by such Holders and (B) if the securities to be sold pursuant to
such Underwritten Offering are Transfer Restricted Securities and securities
offered for the account of other persons as contemplated by the foregoing clause
(b), and the Underwriter for such Underwritten Offering advises the Company and
such Selling Holders in writing that in that Underwriter's opinion the amount of
Transfer Restricted Securities and securities offered for the account of other
persons exceeds the amount or number of Transfer Restricted Securities and such
other securities which can be sold in that Underwritten Offering without
materially and adversely affecting the offering price, there shall be included
in that Underwritten Offering the amount of such Transfer Restricted Securities
and such other securities which in the opinion of such Underwriter can be sold
therein without such material adverse effect and such amount or number of shares
shall be allocated pro rata among such holders of such Transfer Restricted
Securities and other securities on the basis of the number of Transfer
Restricted Securities and other securities to be included therein. The Selling
Holders shall pay all underwriting discounts and commissions of the Underwriters
with respect to any Transfer Restricted Securities sold in such Underwritten
Offering. Notwithstanding anything herein to the contrary, holders of Transfer
Restricted Securities shall be entitled to only one Underwritten Offering.
(d) If any of the Transfer Restricted Securities covered by the Shelf
Registration Statement are to be sold in an Underwritten Offering, the
Underwriter(s) that will administer the offering will be selected by the Selling
Holders of a majority of the Transfer Restricted Securities to be covered by the
Shelf Registration Statement; provided, however, that such Underwriter(s) shall
-------- -------
be reasonably satisfactory to the Company.
(e) Each Holder whose Transfer Restricted Securities are covered by the
Shelf Registration Statement filed pursuant to this Section 3 agrees, upon the
request of the Underwriter(s) in an Underwritten Offering, not to effect any
sale or distribution of securities of the Company of the same class as the
securities included in such Shelf Registration Statement, including a sale
pursuant to Rule 144 under the Securities Act (except as part of such
registration), during the 10-day period prior to, and during the 180-day period
beginning on, the date of the underwriting agreement entered into in connection
with that Underwritten Offering.
The foregoing provisions of this Section 3(e) shall not apply to any Holder
of Transfer Restricted Securities if such Holder is prevented by applicable
statute or regulation from entering into any such agreement; provided, however,
-------- -------
that any such Holder shall undertake, in its request to participate in any
Underwritten Offering, not to effect any sale or distribution of any of its
Transfer Restricted Securities commencing on the date of sale of such Transfer
Restricted Securities unless it has provided 180 days prior written notice of
such sale or distribution to the Underwriter(s).
(f) No Holder of Transfer Restricted Securities may include any of its
Transfer Restricted Securities in the Shelf Registration Statement pursuant to
this Agreement unless such Holder first furnishes to the Company in writing (i)
such Holder's name and mailing address (which may be used for purposes of
providing written notices and other communications contemplated by this
Agreement) and (ii) within 10 business days after receipt of a request therefor,
such information as the Company may reasonably request for use in connection
with any Shelf Registration Statement or Prospectus or preliminary Prospectus (a
"Preliminary Prospectus") included in the Shelf Registration Statement.
(g) Notwithstanding anything to the contrary set forth in this Section 3,
the Holders shall not have the right to sell Transfer Restricted Securities in
an Underwritten Offering (i) at any time during which the Company is engaged in
a registration of securities for its own account which are to be sold pursuant
to an underwritten offering with respect to which an underwriter has been
selected, to the extent so requested by such underwriter, or, to the extent
that, prior to or as of the date of any request for an Underwritten Offering,
the Company has engaged (and continues to be engaged as of the date of such
request) in discussions with an underwriter, so long as, no later than 30 days
after such request, the Company is in registration, and (ii) during any
customary "lock-up" period thereafter (not to last beyond the 180-day period
beginning on the closing date of such underwritten offering) required by such
underwriter in connection with such underwritten offering.
(h) Each Holder agrees by acquisition of any Transfer Restricted Securities
not to effect any public sale or
<PAGE>
distribution of Common Stock or securities convertible into or exchangeable or
exercisable for any of such securities, other than any such securities acquired
in a public offering, within seven days prior to and 90 days (unless advised in
writing by the managing underwriter that a longer period, not to exceed 180
days, is required, or such shorter period as the managing underwriter for any
underwritten offering may agree) after the effective date of any registration
statement (except as part of any such registration) covering Registrable
Securities (as defined in the Greenwich Street Registration Rights Agreement).
SECTION 4. LIQUIDATED DAMAGES
(a) If (i) the Shelf Registration Statement is not filed with the Commission
on or prior to 90 days after the Closing Date, (ii) the Shelf Registration
Statement has not been declared effective by the Commission within 180 days
after the Closing Date (the "Effectiveness Target Date"), or (iii) the Shelf
Registration Statement is filed and declared effective but shall thereafter
cease to be effective (without being succeeded immediately by a replacement
shelf registration statement filed and declared effective) or usable for the
offer and sale of Transfer Restricted Securities for a period of time (including
any Suspension Period) which shall exceed 60 days in the aggregate in any of the
one-year periods ending on the first or second anniversaries of the Closing
Date, or which shall exceed 30 days in any calendar quarter within any of such
one-year periods (each such event referred to in clauses (i) through (iii), a
"Registration Default"), the Company will pay liquidated damages ("Ordinary
Liquidated Damages") to each Holder who has furnished the information requested
of him pursuant to Section 3(f) of this Agreement and who has otherwise complied
with his respective obligations under this Agreement. The amount of Ordinary
Liquidated Damages payable during any period in which any Registration Default
shall have occurred and be continuing is that amount which is equal to one-
quarter of one percent (25 basis points) per annum per $1,000 principal amount
of the Notes, if such Notes have not yet been converted into Transfer Restricted
Securities, or $2.50 per annum per 83.333 shares of Common Stock (subject to
adjustment in the event of a stock split, stock re-combination, stock dividend
and the like) which have been so converted into Transfer Restricted Securities
for each 90-day period until the applicable registration statement is filed and
the applicable registration statement is declared effective or the Shelf
Registration Statement again becomes effective or usable, as the case may be, up
to a maximum of one and one-quarter percent (125 basis points) per annum per
$1,000 principal amount of such Notes or $12.50 per annum per 83.333 shares of
Common Stock (subject to adjustment as aforesaid) constituting Transfer
Restricted Securities. Following the cure of a Registration Default, Ordinary
Liquidated Damages will cease to accrue with respect to such Registration
Default. In addition to any Ordinary Liquidated Damages that may become
payable, the Company will pay during the continuation of any Black-out Period
liquidated damages ("Special Liquidated Damages" and collectively with any
Ordinary Liquidated Damages, "Liquidated Damages") to each Holder who has
furnished the information requested of him pursuant to Section 3(f) of this
Agreement and who has otherwise complied with his respective obligations under
this Agreement. The amount of Special Liquidated Damages payable during any
period in which any Black-out Period shall have occurred and be continuing is
that amount which is equal to one percent (100 basis points) per annum per
$1,000 principal amount of the Notes, if such Notes have not yet been converted
into Transfer Restricted Securities, or $10.00 per annum per 83.333 shares of
Common Stock (subject to adjustment in the event of a stock split, stock re-
combination, stock dividend and the like) which have been so converted into
Transfer Restricted Securities. The Company shall notify the Trustee, the
Initial Purchaser and Holders of Transfer Restricted Securities within three
business days after each and every date on which a Registration Default or
Black-out Period first occurs. All accrued Liquidated Damages shall be paid to
Record Holders entitled thereto pursuant to the foregoing provisions by wire
transfer of immediately available funds or by federal funds check by the Company
on each Damages Payment Date. No Liquidated Damages shall be payable with
respect to any week commencing two years or more after the Closing Date (or
commencing after the expiration of such shorter period as may hereafter become
applicable as the holding period for restricted securities under Rule 144(k)
under the Securities Act).
All of the Company's obligations set forth in the preceding paragraph which
are outstanding with respect to any Transfer Restricted Security at the time
such security ceases to be a Transfer Restricted Security shall survive until
such time as all such obligations with respect to such security shall have been
satisfied in full.
SECTION 5. REGISTRATION PROCEDURES
In connection with the Shelf Registration Statement, the Company will use its
reasonable best efforts to effect
<PAGE>
such registration to permit the sale of the Transfer Restricted Securities being
sold in accordance with the intended method or methods of distribution or
disposition thereof, and pursuant thereto the Company will:
(a) on or prior to the date 90 days after the Closing Date, prepare and file
with the Commission the Shelf Registration Statement, including all financial
statements required to be included or incorporated by reference therein pursuant
to the provisions of the Securities Act and the rules and regulations
thereunder; cooperate and assist in any filings required to be made with the
NASD with respect to the offers and sales to be made under the Shelf
Registration Statement; and use its reasonable best efforts to cause the Shelf
Registration Statement to become effective under the Securities Act on or prior
to the date 180 days after the Closing Date and approved on or prior to such
date by such governmental agencies or authorities as may be necessary under the
state securities laws to enable the Selling Holders to consummate the
disposition of such Transfer Restricted Securities; provided, however, that
-------- -------
before filing the Shelf Registration Statement or any Prospectus, or any
amendments or supplements thereto, the Company will furnish to the Holders of
Transfer Restricted Securities included in the Shelf Registration Statement and
the Underwriters), if any, copies of all such documents proposed to be filed
(except that the Company shall not be required to furnish any exhibits to such
documents, including those incorporated by reference, unless so requested by
such a Holder in writing), and the Company will not file any Shelf Registration
Statement or amendment thereto or any Prospectus or any supplement thereto to
which (i) the Underwriter(s), if any, shall reasonably object or (ii) if there
are no Underwriter(s) and the Holders of a majority of the shares of Common
Stock so registered in the Shelf Registration Statement shall reasonably object,
in each such case within five business days after the receipt thereof. A Holder
or Underwriter, if any, shall be deemed to have reasonably objected to such
filing if the Shelf Registration Statement, amendment, Prospectus or supplement,
as applicable, as proposed to be filed contains any untrue statement of a
material fact or omits to state a material fact required to be stated therein or
necessary to make the statements therein not misleading which misstatement or
omission is specifically identified by that Holder or Underwriter, as the case
may be, to the Company in writing within such five business days;
(b) subject to the provisions of Section 3(a) hereof, prepare and file with
the Commission such amendments and post-effective amendments to the Shelf
Registration Statement as may be necessary to keep the Shelf Registration
Statement effective for the applicable period set forth in Section 3(a) hereof,
or such shorter period terminating when all Transfer Restricted Securities
covered by the Shelf Registration Statement have been sold or when, for any
other reason, there are no remaining Transfer Restricted Securities; cause the
Prospectus to be supplemented by any required supplement thereto (a "Prospectus
Supplement"), and as so supplemented to be filed pursuant to Rule 424 under the
Securities Act, and to comply fully with the applicable provisions of Rules 424
and 430A under the Securities Act in a timely manner; and comply with the
provisions of the Securities Act applicable to it with respect to the
disposition of all securities covered by the Shelf Registration Statement during
the applicable period in accordance with the intended method or methods of
distribution by the sellers thereof set forth in the Shelf Registration
Statement, the Prospectus or such Prospectus Supplement as applicable;
(c) if requested by the Holders of Transfer Restricted Securities included
in the Shelf Registration Statement or, if the Transfer Restricted Securities
are being sold in an Underwritten Offering, the Underwriter(s) of such
Underwritten Offering, promptly incorporate in the Prospectus, any Prospectus
Supplement or post-effective amendment to the Shelf Registration Statement such
appropriate information as the Underwriter(s) and/or the Holders of Transfer
Restricted Securities being sold agree in writing should be included therein
relating to the plan of distribution of the Transfer Restricted Securities,
including, without limitation, information with respect to the amount of
Transfer Restricted Securities being sold to such Underwriter(s), the purchase
price being paid therefor and any other terms with respect to the offering of
the Transfer Restricted Securities to be sold in such offering; and make all
required filings of such Prospectus, Prospectus Supplement or post-effective
amendment as soon as practicable after the Company is notified of the matters to
be incorporated in such Prospectus, Prospectus Supplement or post-effective
amendment;
(d) advise the Underwriter(s), if any, and the Holders of Transfer
Restricted Securities included in the Shelf Registration Statement promptly and,
if requested by such Persons, confirm such advice in writing, (i) when the
Prospectus or any Prospectus Supplement or post-effective amendment to the Shelf
Registration Statement has been filed, and, with respect to the Shelf
Registration Statement or any post-effective amendment thereto, when the same
has
<PAGE>
become effective, (ii) of any request by the Commission to the Company for
amendments to the Shelf Registration Statement or amendments or supplements to
the Prospectus or for additional information relating thereto, (iii) of the
issuance by the Commission of any stop order suspending the effectiveness of the
Shelf Registration Statement under the Securities Act or of the suspension by
any state securities commission of the qualification of the Transfer Restricted
Securities for offering or sale in any jurisdiction, or the initiation of any
proceeding for any of those purposes and (iv) if at any time the representations
and warranties of the Company contemplated by paragraph (l)(i) below cease to be
true and correct and (v) of the existence of any fact and the happening of any
event that makes any statement of a material fact made or incorporated by
reference in the Shelf Registration Statement, the Prospectus, any amendment or
supplement thereto untrue, or that requires the making of any additions to or
changes in the Shelf Registration Statement or the Prospectus in order to make
the statements therein not misleading. If at any time the Commission shall issue
any stop order suspending the effectiveness of the Shelf Registration Statement,
or any state securities commission or other regulatory authority, shall issue an
order suspending the qualification or exemption from qualification of the
Transfer Restricted Securities under state securities or Blue Sky laws, the
Company shall use its reasonable best efforts to obtain the withdrawal or
lifting of such order at the earliest practicable time;
(e) promptly following the filing of any document that is to be incorporated
by reference into the Shelf Registration Statement or the Prospectus subsequent
to the initial filing of the Shelf Registration Statement, provide copies of
such document (excluding exhibits, unless requested by a Holder in writing) to
the Holders of Transfer Restricted Securities included in the Shelf Registration
Statement;
(f) furnish to each Holder and each of the Underwriter(s), if any, without
charge, at least one copy of the Shelf Registration Statement, as first filed
with the Commission, and of each amendment thereto (excluding exhibits thereto
and documents incorporated by reference therein unless requested by such Holder
in writing or by such Underwriter);
(g) deliver to each Holder of Transfer Restricted Securities included in the
Shelf Registration Statement and each of the Underwriter(s), if any, without
charge, as many copies of any Preliminary Prospectus and the Prospectus and any
amendments or supplements thereto as such Persons may reasonably request; the
Company consents to the use of any Preliminary Prospectus and the Prospectus and
any amendments or supplements thereto by each Holder of Transfer Restricted
Securities included in the Shelf Registration Statement and each of the
Underwriter(s), if any, in connection with the public offering and the sale of
the Transfer Restricted Securities covered by any Preliminary Prospectus and the
Prospectus or any amendments or supplements thereto;
(h) prior to any public offering of Transfer Restricted Securities,
cooperate with the Holders of Transfer Restricted Securities included in the
Shelf Registration Statement, the Underwriter(s), if any, and their respective
counsel in connection with the registration and qualification of the Transfer
Restricted Securities under the securities or Blue Sky laws of such
jurisdictions as those Holders or Underwriter(s) may reasonably request and do
any and all other acts or things reasonably necessary or appropriate to enable
the disposition in such jurisdictions of the Transfer Restricted Securities
covered by the Shelf Registration Statement; provided, however, that the Company
-------- -------
shall not be required (i) to register or qualify as a foreign corporation where
it is not now so qualified, (ii) to take any action that would subject it to the
service of process in suits, other than as to matters and transactions relating
to the Shelf Registration Statement, in any jurisdiction where it is not now so
subject, or (iii) to take any action that would subject it to taxation in any
jurisdiction in an amount greater than it would be so subject without having
taken such action;
(i) cooperate with the Holders of Transfer Restricted Securities included in
the Shelf Registration Statement and the Underwriter(s), if any, to facilitate
the timely preparation and delivery of certificates representing Transfer
Restricted Securities to be sold under the Shelf Registration Statement and not
bearing any restrictive legends; and, enable such Transfer Restricted Securities
to be in such denominations and registered in such names as the Holders of
Transfer Restricted Securities included in the Shelf Registration Statement or
the Underwriter(s), if any, may request at least two full business days prior to
any sale of Transfer Restricted Securities under the Shelf Registration
Statement;
(j) if any fact or event contemplated by clause (d)(v) above shall exist or
have occurred, prepare a post-effective amendment or supplement to the Shelf
Registration Statement or related Prospectus or any document incorporated
<PAGE>
therein by reference or file any other required document so that, as thereafter
delivered to the purchasers of Transfer Restricted Securities, the Prospectus
will not contain an untrue statement of a material fact or omit to state any
material fact necessary to make the statements therein not misleading;
(k) provide a CUSIP number for all Transfer Restricted Securities not later
than the effective date of the Shelf Registration Statement and provide the
transfer agent for the Common Stock with printed certificates for the Transfer
Restricted Securities which are in a form eligible for deposit with the
Depository Trust Company;
(l) enter into such agreements (including an underwriting agreement) and
take all such other actions in connection therewith as may reasonably be
requested in order to expedite or facilitate the disposition of the Transfer
Restricted Securities pursuant to the Shelf Registration Agreement, in
connection with an Underwritten Offering, and in connection therewith, (i) make
such representations and warranties to the Underwriter(s), in form, substance
and scope as they may reasonably request and as are customarily made by issuers
to Underwriters in primary underwritten offerings; (ii) obtain opinions of
counsel to the Company and updates thereof in customary form and covering
matters reasonably requested by the Underwriter(s) of the type customarily
covered in legal opinions to Underwriter(s) in connection with primary
underwritten offerings addressed to each selling Holder and the Underwriter(s)
requesting the same and covering the matters as may be reasonably requested by
such Holders and Underwriter(s); (iii) obtain, to the extent permitted by
Statement on Auditing Standards No. 72 or any successor Statement thereto, "cold
comfort" letters and updates thereof from the Company's independent certified
public accountants addressed to the selling Holders of Transfer Restricted
Securities and the Underwriter(s) requesting the same, such letters to be in
customary form and covering matters of the type customarily covered in "cold
comfort" letters to Underwriter(s) in connection with primary underwritten
offerings; and (iv) deliver such documents and certificates as may be reasonably
requested by the Holders of the Transfer Restricted Securities being sold or the
Underwriter(s) of such Underwritten Offering to evidence compliance with clause
(i) above and with any customary conditions contained in the underwriting
agreement entered into by the Company pursuant to this clause (l). The above
shall be done at or prior to each closing under such underwriting agreement, as
and to the extent required thereunder;
(m) make available at reasonable times and in a reasonable manner for
inspection by a representative of the Holders of Transfer Restricted Securities
covered by the Shelf Registration Statement, any Underwriter participating in
any disposition pursuant to the Shelf Registration Statement, and any attorney
or accountant retained by such Holders or any of the Underwriter(s), all
financial and other records, pertinent corporate documents and properties of the
Company and cause the Company's officers, directors and employees to supply all
information reasonably requested by any such Holder, Underwriter, attorney or
accountant in connection with such Shelf Registration Statement prior to its
effectiveness, provided, however, that such representatives, attorneys or
-------- -------
accountants shall agree to keep confidential (which agreement shall be confirmed
in writing in advance to the Company if the Company shall so request) all
information, records or documents made available to such persons which are not
otherwise available to the general public unless disclosure of such records,
information or documents is required by court or administrative order (of which
the Company shall have been given prior notice and an opportunity to defend)
after the exhaustion of all appeals therefrom, and to use such information
obtained pursuant to this provision only in connection with the transaction for
which such information was obtained, and not for any other purpose;
(n) otherwise use its reasonable best efforts to comply with all applicable
rules and regulations of the Commission, and make generally available to its
security holders, as soon as practicable, a consolidated earnings statement,
which consolidated earnings statement shall satisfy the provisions of Section
11(a) of the Securities Act, for the twelve-month period (i) commencing at the
end of any fiscal quarter in which Transfer Restricted Securities are sold to
Underwriter(s) in a firm commitment or best efforts Underwritten Offering or
(ii) if not sold to Underwriter(s) in such an offering, beginning with the first
month of the Company's first fiscal quarter commencing after the effective date
of the Shelf Registration Statement;
(o) cause all Transfer Restricted Securities covered by the Shelf
Registration Statement to be listed on each securities exchange or quotation
system on which similar securities issues by the Company are then listed if
requested by the Selling Holders of a majority of the outstanding Transfer
Restricted Securities or the Underwriter(s), if any;
<PAGE>
(p) cooperate and assist in any filings required to be made with the NASD
and in the performance of any due diligence investigation by any Underwriter
(including any "qualified independent Underwriter" that is required to be
retained in accordance with the rules and regulations of the NASD);
(q) use its reasonable best efforts to cause the Transfer Restricted
Securities covered by the Shelf Registration Statement to be registered with or
approved by such other governmental agencies or authorities as may be necessary
to enable the seller or seller thereof or the Underwriter(s), if any, to
consummate the disposition of such Transfer Restricted Securities, subject to
the proviso contained in clause (h) above; and
(r) make every reasonable effort to obtain the withdrawal of any order
suspending the effectiveness of the Shelf Registration Statement at the earliest
possible moment.
Each Holder agrees to furnish promptly to the Company all information
required to be disclosed in the Shelf Registration Statement in order to make
the information previously furnished to the Company by such Holder for that
purpose not materially misleading or necessary to cause the Shelf Registration
Statement not to omit a material fact with respect to such Holder necessary in
order to make the statements therein not misleading.
Each Holder agrees by acquisition of any Transfer Restricted Securities that,
upon receipt of any notice from the Company contemplated by Section 5(d)(iii) or
(v) hereof, such Holder will forthwith discontinue disposition of Transfer
Restricted Securities until such Holder's receipt of the copies of the
supplemented or amended Prospectus contemplated by Section 5(j) hereof, or until
it is advised in writing (the "Advice") by the Company that the use of the
Prospectus may be resumed, and has received copies of any additional or
supplemental filings with respect to the Prospectus. If so directed by the
Company, each Holder will deliver to the Company (at the Company's expense) all
copies, other than permanent file copies then in such Holder's possession, of
the Prospectus covering such Transfer Restricted Securities current at the time
of receipt of such notice. In the event the Company shall give any such notice,
the time period regarding the effectiveness of the Shelf Registration Statement
set forth in Section 3(a) hereof shall be extended by the number of days during
the period from and including the date of the giving of such notice pursuant to
Section 5(d)(iii) or (v) hereof to and including the date when each Holder of
Transfer Restricted Securities covered by such Shelf Registration Statement
shall have received the copies of the supplemented or amended Prospectus
contemplated by Section 5(j) hereof or shall have received the Advice.
SECTION 6. REGISTRATION EXPENSES
(a) All expenses incident to the Company's performance of or compliance with
this Agreement (the "Registration Expenses") will be borne by the Company,
regardless of whether a Shelf Registration Statement becomes effective,
including without limitation:
(i) all registration and filing fees (including NASD filing fees, and
if applicable, the fees and expenses of any "qualified independent
Underwriter" (and its counsel) that is required to be retained in accordance
with the rules and regulations of the NASD);
(ii) fees and expenses of the Company's compliance with federal
securities, state or foreign blue sky laws;
(iii) expenses of printing or engraving certificates for the Transfer
Restricted Securities in a form eligible for deposit with Depository Trust
Company and
<PAGE>
of printing the Prospectus and any Preliminary Prospectus;
(iv) reasonable fees and disbursements of counsel for the Company;
(v) fees and disbursements of all independent certified public
accountants of the Company (including the expenses of any special audit and
"cold comfort" letters required by or incidental to the preparation and
filing of a Shelf Registration Statement and Prospectus and the disposition
of Transfer Restricted Securities); and
(vi) fees and expenses of listing the Transfer Restricted Securities
on any securities exchange or quotation system in accordance with Section
5(q) hereof.
The Company will, in any event, bear its internal expenses (including,
without limitation, all salaries and expenses of its officers and employees
performing legal or accounting duties), the expense of any annual audit, rating
agency fees and the fees and expenses of any Person, including special experts,
retained by the Company. Notwithstanding any other provisions herein to the
contrary, the Holders of Transfer Restricted Securities shall bear the expense
of any broker's commission, agency fee or Underwriter's discount or commission
and the fees and expenses of counsel to the Holders and any Underwriter.
SECTION 7. INDEMNIFICATION
(a) The Company agrees to indemnify and hold harmless each Holder who offers
Transfer Restricted Securities pursuant to the Shelf Registration Statement
(each such Holder an "Indemnified Holder"), each agent, representative,
employee, officer and director of any Indemnified Holder and each person, if
any, that controls each Indemnified Holder within the meaning of Section 15 of
the Securities Act or Section 20 of the Exchange Act, and agents,
representatives, employees, officers and directors or any such controlling
person of any Indemnified Holder from and against any and all losses, claims,
damages, judgments, liabilities and expenses (including the reasonable fees and
expenses of counsel and other expenses in connection with investigating or,
subject to the provisions of Section 7(b), defending or settling any such action
or claim) as they are incurred which arise out of or based upon any untrue
statement or alleged untrue statement of a material fact contained in the Shelf
Registration Statement or the Prospectus or any amendment or supplement thereto
or any Preliminary Prospectus or arising out of or based upon any omission or
alleged omission to state therein a material fact required to be stated therein
or necessary to make the statements therein not misleading, except (i) the
Company shall not be liable to any Indemnified Holder in any such case insofar
as such losses, claims, damages, judgments, liabilities or expenses arise out
of, or are based upon, any such untrue statement or omission or alleged untrue
statement or omission based upon information relating to any Indemnified Holder
furnished in writing by any Indemnified Holder to the Company expressly for use
therein and (ii) the Company shall not be liable to any Indemnified Holder under
the indemnity agreement in this Section 7(a) with respect to any Preliminary
Prospectus to the extent that any such loss, claim, damage, judgment, liability
or expense results from the fact that any Indemnified Holder sold Transfer
Restricted Securities to a person to whom there was not sent or given, at or
prior to the written confirmation of such sale, a copy of the Prospectus as then
amended or supplemented, if the Company has previously furnished sufficient
copies thereof to the Indemnified Holder. The foregoing indemnity agreement
shall be in addition to any liability which the Company may otherwise have.
(b) If any action or proceeding (including any governmental or regulatory
investigation or proceeding) shall be brought or asserted against any
Indemnified Holder with respect to which indemnity may be sought against the
Company pursuant to this Section 7, such Indemnified Holder shall promptly
notify the Company in writing, and the
<PAGE>
Company shall have the right to assume the defense thereof, including the
employment of counsel reasonably satisfactory to such Indemnified Holder and
payment of all fees and expenses; provided, however, that the omission so to
-------- -------
notify the Company shall not relieve the Company from any liability that they
may have to any Indemnified Holder (except to the extent that the Company is
materially prejudiced or otherwise forfeits substantive rights or defenses by
reason of such failure). An Indemnified Holder shall have the right to employ
separate counsel in any such action or proceeding and to participate in the
defense thereof, but the fees and expenses of such counsel shall be at the
expense of such Indemnified Holder unless (i) the Company agrees in writing to
pay such fees and expenses, (ii) the Company has failed promptly to assume the
defense and employ counsel reasonably satisfactory to the Indemnified Holder or
(iii) the named parties to any such action or proceeding (including any
impleaded parties) include both the Indemnified Holder and the Company and such
Indemnified Holder shall have been advised in writing by its counsel that
representation of such Indemnified Party and the Company by the same counsel
would be inappropriate under applicable standards of professional conduct
(whether or not such representation has been proposed) due to actual or
potential differing interests between them (in which case the Company shall not
have the right to assume the defense of such action on behalf of such
Indemnified Holder). It is understood that the Company shall not, in connection
with any one such action or separate but substantially similar or related
actions in the same jurisdiction arising out of the same general allegations or
circumstances, be liable for the fees and expenses of more than one separate
firm of attorneys (in addition to any local counsel) at any time for all
Indemnified Holders, which firm shall be designated in writing by the
Indemnified Holders of the majority of the outstanding Transfer Restricted
Securities held by Indemnified Holders and that all such fees and expenses shall
be reimbursed on a monthly basis. The Company shall not be liable for any
settlement of any such action effected without the written consent of the
Company, but if settled with the written consent of the Company, or if there is
a final judgment with respect thereto, the Company agrees to indemnify and hold
harmless each Indemnified Holder from and against any loss or liability by
reason of such settlement or judgment. The Company shall not, without the prior
written consent of each Indemnified Holder affected thereby, effect any
settlement of any pending or threatened proceeding in which such Indemnified
Holder has sought indemnity hereunder, unless such settlement includes an
unconditional release of such Indemnified Holder from all liability arising out
of such action, claim, litigation or proceeding.
(c) Each Indemnified Holder agrees to indemnify and hold harmless the
Company, its directors, its officers who sign the Registration Statement and any
person controlling the Company within the meaning of Section 15 of the
Securities Act or Section 20 of the Exchange Act (collectively, the "Company
Indemnified Parties") to the same extent as the foregoing indemnity from the
Company to any Indemnified Holder, but only with respect to information relating
to each Indemnified Holder furnished to the Company in writing by each
Indemnified Holder, expressly for use in the Registration Statement, Prospectus
(or any amendment or supplement thereto), or any Preliminary Prospectus. In
case any action shall be brought against any Company Indemnified Party based on
the Registration Statement, Prospectus (or any amendment or supplement thereto),
or any Preliminary Prospectus and in respect of which indemnification may be
sought against each Indemnified Holder pursuant to this Section 7(c), each
Indemnified Holder shall have the rights and duties given to the Company by
Section 7(b) hereof (except that if the Company shall have assumed the defense
thereof, each Indemnified Holder may, but shall not be required to, employ
separate counsel therein and participate in the defense thereof and the fees and
expenses of such counsel shall be at the expense of the Indemnified Holder) and
the Company Indemnified Parties shall have the rights and duties given to the
Indemnified Holders by Section 7(b) hereof. The foregoing indemnity agreement
shall be in addition to any liability which the Indemnified Holders may
otherwise have.
(d) If the indemnification provided for in this Section 7 is unavailable to
any party entitled to indemnification pursuant to Section 7(a) or 7(c) hereof,
then each indemnifying party, in lieu of indemnifying such indemnified party,
shall contribute to the amount paid or payable by such indemnified party as a
result of such losses, claims, damages, judgments, liabilities and expenses (i)
in such proportion as is appropriate to reflect the relative benefits received
by the Company on the one hand and the Indemnified Holders on the other from the
offering of the Transfer Restricted Securities or (ii) if the allocation
provided by clause (i) above is not permitted by applicable law, in such
proportion as is appropriate to reflect not only the relative benefits referred
to in clause (i) above but also the relative fault of the Company on the one
hand and the Indemnified Holders on the other in connection with the statements
or omissions which resulted in such losses, claims, damages, judgments,
liabilities or expenses, as well as any other relevant equitable
<PAGE>
considerations. The relative benefits received by the Company on the one hand
and the Indemnified Holders on the other shall be deemed to be in the same
proportion as the total net proceeds from the offering (before deducting
expenses) received by the Company bear to the total net proceeds from the
offering (before deducting expenses) received by the Indemnified Holders. The
relative fault of the Company on the one hand and the Indemnified Holders on the
other shall be determined by reference to, among other things, whether the
untrue or alleged untrue statement of a material fact or the omission or alleged
omission to state a material fact relates to information supplied by the Company
on the one hand or by any of the Indemnified Holders on the other and the
parties' relative intent, knowledge, access to information and opportunity to
correct or prevent such statement or omission.
(e) The Company and each Indemnified Holder agree that it would not be just
and equitable if contribution pursuant to Section 7(d) hereof were determined by
pro rata allocation or by any other method of allocation that does not take
account of the equitable considerations referred to in Section 7(d) hereof. The
amount paid or payable by an indemnified party as a result of the losses,
claims, damages, liabilities or expenses referred to in the immediately
preceding paragraph shall be deemed to include, subject to the limitations set
forth above, any legal or other expenses reasonably incurred by such indemnified
party in connection with investigating or defending any such action or claim. No
person found guilty of fraudulent misrepresentation (within the meaning of
Section 11(f) of the Securities Act) shall be entitled to contribution hereunder
from any other person.
(f) The Company shall also indemnify each Underwriter participating in the
distribution (as described in such registration statement), their officers and
directors and each person who controls such persons (within the meaning of
Section 15 of the Securities Act or Section 20 of the Exchange Act) to the same
extent as provided above with respect to the indemnification of the Holders.
(g) The indemnity and contribution agreements contained in this Section 7,
(i) are in addition to any liability that any indemnifying party may otherwise
have to any indemnified party and (ii) shall apply to any Underwritten Offering
under the Shelf Registration Statement except to the extent the same are
explicitly stated not to apply in an underwriting agreement to which the Selling
Holders in such Underwritten Offering are parties.
SECTION 8. RULE 144A
The Company hereby agrees with each Holder, during any period in which the
Company is not subject to Section 13 or 15(d) of the Exchange Act, to make
available to the Holders in connection with any sale of Transfer Restricted
Securities and any prospective purchaser (identified as such in a written notice
to the Company from the Selling Holder) of such Transfer Restricted Securities,
the information required by Rule 144A(d)(4) under the Securities Act in order to
permit resales of such Transfer Restricted Securities pursuant to Rule 144A.
SECTION 9. PARTICIPATION IN UNDERWRITTEN OFFERINGS
No Holder may participate in any Underwritten Offering hereunder unless such
Holder (a) agrees to sell such Holder's Transfer Restricted Securities on the
basis provided in any underwriting arrangements approved by the Persons entitled
hereunder to approve such arrangements, (b) completes and executes all
questionnaires, powers of attorney, indemnities, underwriting agreements and
other documents required under the terms of such underwriting arrangements and
(c) furnishes the Company in writing all information reasonably requested in
accordance with Section 3(f) hereof and agrees in writing to indemnify and hold
harmless the Company, its directors, its officers who sign the Registration
Statement, any underwriter and any person controlling the Company or any such
underwriter within the meaning of Section 15 of the Securities Act or Section 20
of the Exchange Act to the extent contemplated by Section 7(c) hereof.
SECTION 10. SELECTION OF UNDERWRITERS
Subject to the other provisions of this Agreement, the Holders of Transfer
Restricted Securities covered by the Shelf Registration Statement who desire to
do so may sell such Transfer Restricted Securities in an Underwritten Offering.
In any such Underwritten Offering, the Underwriter(s) that will administer the
offering will be selected by
<PAGE>
the Holders of the Transfer Restricted Securities included in such offering in
the manner specified in Section 3(c) hereof, provided, however, that such
-------- -------
Underwriter(s) must be reasonably satisfactory to the Company.
SECTION 11. MISCELLANEOUS
(a) Remedies. Each Holder of Transfer Restricted Securities, in addition to
--------
being entitled to exercise all rights provided herein, and as provided in the
Purchase Agreement (for any Holders who are parties thereto) and granted by
applicable law, including recovery of damages, will be entitled to specific
performance of such Holder's rights under this Agreement. The Company agrees
that monetary damages would not be adequate compensation for any loss incurred
by reason of a breach by it of the provisions of this Agreement and hereby
agrees to waive the defense in any action for specific performance that a remedy
at law would be adequate.
(b) No Inconsistent Agreements. The Company will not on or after the date
--------------------------
of this Agreement enter into any agreement with respect to its securities that
is inconsistent with the rights granted to the Holders in this Agreement or
otherwise conflicts with the provisions hereof. The rights granted to the
Holders hereunder do not in any way conflict with and are not inconsistent with
the rights granted to the holders of the Company's securities under any other
agreements.
(c) Amendments and Waivers. The provisions of this Agreement, including the
----------------------
provisions of this sentence, may not be amended, modified or supplemented, and
waivers or consents to departures from the provisions hereof may not be given
unless the Company has obtained the written consent of Holders of a majority of
Transfer Restricted Securities affected by such amendment, modification,
supplement, waiver or departure. Notwithstanding the foregoing, a waiver or
consent to departure from the provisions hereof that relates exclusively to the
rights of Holders of Transfer Restricted Securities whose securities are being
sold pursuant to the Shelf Registration Statement and that does not directly or
indirectly affect the rights of other Holders shall be valid only with the
written consent of Holders of at least 66-2/3% of Transfer Restricted Securities
being sold, calculated as aforesaid.
(d) Notices. All notices and other communications provided for or permitted
-------
hereunder shall be made in writing by hand delivery, first-class mail
(registered or certified, return receipt requested), telex, telecopier, or air
courier guaranteeing overnight delivery:
(i) if to a Holder of Transfer Restricted Securities,
initially at the address set forth on the records of the Registrar under
the Indenture or Transfer Agent for Common Stock and thereafter at such
address or at any address provided by such Holder to the Company
pursuant to the provisions of Section 3(g) hereof, with a copy to the
Registrar; and
(ii) if to the Company or the Initial Purchaser, initially at
its address set forth in the Purchase Agreement and thereafter at such
other address, notice of which is given in accordance with the
provisions of this Section.
All such notices and communications shall be deemed to have been duly given:
at the time delivered by hand, if personally delivered; five business days after
being deposited in the mail, postage prepaid, if mailed; when answered back, if
telexed; when receipt acknowledged, if telecopied; and on the next business day,
if timely delivered to an air courier guaranteeing overnight delivery.
<PAGE>
(e) Successors and Assigns. This Agreement shall inure to the benefit of
----------------------
and be binding upon the successors and assigns of each of the parties, including
without limitation and without the need for an express assignment, subsequent
Holders; provided, however, that this Agreement shall not inure to the benefit
-------- -------
of or be binding upon a successor or assign of a Holder unless and to the extent
such successor or assign acquired Transfer Restricted Securities from such
Holder; and provided further that nothing herein shall be deemed to permit any
assignment, transfer or any disposition of Transfer Restricted Securities in
violation of the terms of the Purchase Agreement. If any transferee of any
Holder shall acquire Transfer Restricted Securities, in any manner, whether by
operation of law or otherwise, such Transfer Restricted Securities shall be held
subject to all of the terms of this Agreement and by taking and holding such
Transfer Restricted Securities such person shall be conclusively deemed to have
agreed to be bound by and to perform all of the terms and provisions of this
Agreement and such Person shall be entitled to receive the benefits hereof.
(f) Counterparts. This Agreement may be executed in any number of
------------
counterparts and by the parties hereto in separate counterparts, each of which
when so executed shall be deemed to be an original and all of which taken
together shall constitute one and the same agreement.
(g) Headings. The headings in this Agreement are for convenience of
--------
reference only and shall not limit or otherwise affect the meaning hereof.
(h) GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN
-------------
ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK APPLICABLE TO CONTACTS MADE
AND TO BE PERFORMED WITHIN THE STATE OF NEW YORK.
(i) Severability. In the event that any one or more of the provisions
------------
contained herein, or the application thereof in any circumstance, is held
invalid, illegal or unenforceable, the validity, legality and enforceability of
any such provision in every other respect and of the remaining provisions
contained herein shall not be affected or impaired thereby.
(j) Entire Agreement. Each of this Agreement and, to the extent specified
----------------
in Section 3 hereof, the Greenwich Street Registration Rights Agreement, is
intended by the parties as a final expression of their agreement and intended to
be a complete and exclusive statement of the agreement and understanding of the
parties hereto in respect of the subject matter contained herein. There are no
restrictions, promises, warranties or undertakings, other than those set forth
or referred to herein or to the extent specified in Section 3 hereof, the
Greenwich Street Registration Rights Agreement, with respect to the registration
rights granted by the Company with respect to the securities sold pursuant to
the Purchase Agreement. Each of this Agreement and, to the extent specified in
Section 3 hereof, the Greenwich Street Registration Rights Agreement, supersedes
all prior agreements and understandings between the parties with respect to such
subject matter.
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
first written above.
TELEGROUP, INC.
By:
SMITH BARNEY INC.
By:
<PAGE>
EXHIBIT 23.1
[LETTERHEAD OF KPMG PEAT MARWICK LLP APPEARS HERE]
ACCOUNTANTS' CONSENT
The Board of Directors
Telegroup, Inc.:
We consent to the use of our reports included herein and to the reference to
our firm under the heading "Experts" in the prospectus.
KPMG Peat Marwick LLP
Lincoln, Nebraska
December 22, 1997
<PAGE>
Exhibit 23.2
[LETTERHEAD OF MACINTYRE & CO. APPEARS HERE]
The Board of Directors
Telegroup, Inc.
We consent to the use of our reports included herein and to the reference to our
firm under the heading "Experts" in the prospectus.
McIntyre & Co.
28, Ely Place
London
EC1N 6RL
December 19, 1997
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<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 58,215,248
<SECURITIES> 0
<RECEIVABLES> 52,646,572
<ALLOWANCES> 4,639,183
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<CURRENT-ASSETS> 111,778,639
<PP&E> 26,869,648
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0
0
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<OTHER-SE> 40,922,407
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<OTHER-EXPENSES> 57,047,271
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<INCOME-TAX> 1,366,054
<INCOME-CONTINUING> (2,848,858)
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