<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 22, 1997
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM S-4
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 (PRIMARY STANDARD (I.R.S. EMPLOYER
JURISDICTION OF INDUSTRIAL IDENTIFICATION NO.)
INCORPORATION OR CLASSIFICATION CODE
ORGANIZATION) NUMBER
2098 NUTMEG AVENUE DOUGLAS A. NEISH
FAIRFIELD, IOWA 52556 CHIEF FINANCIAL OFFICER
(515) 472-5000 TELEGROUP, INC.
2098 NUTMEG AVENUE
FAIRFIELD, IOWA 52556
(ADDRESS, INCLUDING ZIP CODE AND (NAME, ADDRESS, INCLUDING ZIP CODE,
TELEPHONE NUMBER, INCLUDING AREA AND TELEPHONE NUMBER, INCLUDING
CODE OF REGISTRANT'S PRINCIPAL AREA CODE, OF AGENT FOR SERVICE)
EXECUTIVE OFFICES)
COPY TO:
MORRIS F. DEFEO, JR., ESQ.
EDSEL J. GUYDON, ESQ.
SWIDLER & BERLIN, CHARTERED
3000 K STREET, N.W. - SUITE 300
WASHINGTON, DC 20007
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
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 the securities being registered on this form are to be offered in
connection with the formation of a holding company and there is compliance
with General Instruction G under the Securities Act of 1933, check the
following box. [_]
CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF SECURITIES PROPOSED AMOUNT AGGREGATE OFFERING PRICE AMOUNT OF
TO BE REGISTERED TO BE REGISTERED OFFERING PRICE PER NOTE(1) REGISTRATION FEE
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<S> <C> <C> <C> <C>
Senior Discount Notes.. 97,000 $74,932,500 $772.50 $22,707
</TABLE>
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(1) The Proposed Maximum Offering Price per Note is based on the actual
Offering Price of $772.50.
----------------
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 THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATES AS THE COMMISSION, ACTING PURSUANT TO
SAID SECTION 8(A), MAY DETERMINE.
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<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
TELEGROUP, INC.
OFFER TO EXCHANGE
10 1/2% SENIOR DISCOUNT NOTES DUE 2004
FOR ANY AND ALL
10 1/2% SENIOR DISCOUNT NOTES DUE 2004
($97,000,000 AGGREGATE AMOUNT OUTSTANDING AT MATURITY)
-----------
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK
CITY TIME ON . , 1998, UNLESS EXTENDED
SEE "RISK FACTORS" IMMEDIATELY FOLLOWING THE PROSPECTUS SUMMARY FOR A
DISCUSSION OF CERTAIN INFORMATION THAT SHOULD BE CONSIDERED IN CONNECTION WITH
THE EXCHANGE OFFER AND AN INVESTMENT IN THE EXCHANGE NOTES.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE 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.
-----------
THE DATE OF THIS PROSPECTUS IS ., 1998
Telegroup, Inc. (the "Company" or "Telegroup") hereby offers, upon the terms
and subject to the conditions set forth in this Prospectus and the accompanying
Letter of Transmittal (which together constitute the "Exchange Offer"), to
exchange its $1,000 principal amount at maturity of 10 1/2% Senior Discount
Notes due 2004 (the "Exchange Notes") for an equal principal amount of its
outstanding $1,000 principal amount at maturity of 10 1/2% Senior Discount
Notes due 2004 (the "Old Notes" and together with the Exchange Notes, the
"Notes" ). As of the date of this Prospectus, there was $97,000,000 aggregate
principal amount at maturity of the Old Notes outstanding. The terms of the
Exchange Notes are identical in all material respects to the Old Notes, except
that (i) the Exchange Notes have been registered under the Securities Act of
1933, as amended (the "Securities Act"), and, therefore, will not bear legends
restricting their transfer and (ii) the holders of the Exchange Notes will not
be entitled to certain rights under the Notes Registration Rights Agreement (as
defined herein), including the terms providing for an increase in the interest
rate on the Old Notes under certain circumstances relating to the timing of the
Exchange Offer, all of which rights will terminate when the Exchange Offer is
consummated. See "The Exchange Offer--Purpose and Effect of the Exchange
Offer."
Based on an interpretation by the Securities and Exchange Commission (the
"Commission") set forth in no-action letters issued to third parties, the
Company believes that the Exchange Notes issued pursuant to the Exchange Offer
in exchange for Old Notes may be offered for resale, resold and otherwise
transferred by a holder thereof (other than (i) a broker-dealer who purchases
such Exchange Notes directly from the Company to resell pursuant to Rule 144A
under the Securities Act or any other available exemption under the Securities
Act or (ii) a person that is an affiliate (as defined in Rule 405 under the
Securities Act) of the Company, without compliance with the registration and
prospectus delivery provisions of the Securities Act, provided that the holder
is acquiring the Exchange Notes in the ordinary course of its business and is
not participating, and has no arrangement or understanding with any person to
participate, in the distribution of the Exchange Notes. Eligible holders
wishing to accept the Exchange Offer must represent to the Company that such
conditions have been met. Each broker-dealer that receives the Exchange Notes
for its own account in exchange for the Old Notes, where such Old Notes were
acquired by such broker-dealer as a result of market-making activities or other
<PAGE>
trading activities, must acknowledge that it will deliver a prospectus in
connection with any resale of such Exchange Notes. The Letter of Transmittal
states that by so acknowledging and by delivering a prospectus, a broker-
dealer will not be deemed to admit that it is an "underwriter" within the
meaning of the Securities Act. This Prospectus, as it may be amended or
supplemented from time to time, may be used by a broker-dealer in connection
with resales of Exchange Notes received in exchange for Old Notes where such
Old Notes were acquired by such broker-dealer as a result of market-making
activity or other trading activities. The Company has agreed that, for a
period of 180 days after the Expiration Date (as defined herein), it will make
this Prospectus available to any broker-dealer for use in connection with any
such resale. See "Plan of Distribution."
The Notes will mature on November 1, 2004. Cash interest on the Notes will
neither accrue nor be payable prior to May 1, 2000. Thereafter, interest will
be payable in cash on the Notes semi-annually in arrears on each May 1, and
November 1, commencing November 1, 2000, at the rate of 10 1/2% per annum. The
Notes will be redeemable at the option of the Company, in whole or in part, at
any time on and after November 1, 2001 at the redemption prices specified
herein, plus accrued and unpaid interest to the date of redemption. In
addition, the Company may redeem at its option at any time on or prior to
November 1, 2000 up to 33% of the aggregate outstanding principal amount at
maturity of the Notes at 110.5% of the Accreted Value (as defined) thereof on
the date of redemption, with the net proceeds of one or more public offerings
of its Common Stock; provided, however, that immediately after giving effect
to any such redemption, not less than 66% of the aggregate principal amount at
maturity of the Notes originally issued remains outstanding. In the event of a
Change of Control (as defined), each holder will have the option to require
the Company to repurchase such holder's Notes at 101% of the Accreted Value
thereof plus accrued and unpaid interest to the repurchase date. In addition,
the Company will be obligated to make an offer to repurchase the Notes for
cash at a price equal to 100% of the Accreted Value thereof plus accrued and
unpaid interest, if any, thereon to the date of repurchase with the net cash
proceeds of certain asset sales.
The Notes will rank senior in right of payment to all existing and future
subordinated Indebtedness (as defined) and pari passu in right of payment with
all unsubordinated Indebtedness of the Company. As of September 30, 1997,
after giving pro forma effect to the Offering and certain transactions more
fully described herein, the Company would have had outstanding $25.0 million
of subordinated Indebtedness.
The Exchange Offer is not conditioned on any minimum aggregate principal
amount of Old Notes being tendered for exchange. The Company will accept for
exchange any and all validly tendered Old Notes not withdrawn prior to 5:00
p.m., New York City time, on ., 1998 unless extended by the Company (the
"Expiration Date"). The Company can, in its sole discretion, extend the
Exchange Offer indefinitely, subject to the Company's obligation to pay
Additional Interest (as defined) if the Exchange Offer is not consummated by
., 1998 and, under certain circumstances, file a shelf registration statement
with respect to the Old Notes. Tenders of Old Notes may be withdrawn at any
time prior to the Expiration Date. The Exchange Offer is subject to certain
customary conditions. See "The Exchange Offer--Conditions." The Company has
agreed to pay all expenses incident to the Exchange Offer. The Company will
not receive any proceeds from the Exchange Offer.
The Notes are new securities for which there currently is no market. The
Company does not intend to apply for listing of the Exchange Notes on any
securities exchange or for quotation through the Nasdaq National Market
("Nasdaq"). Although the Initial Purchasers have informed the Company that
they currently intend to make a market in the Notes, they are not obligated to
do so and any such market-making may be discontinued at any time without
notice. In addition, such market-making activity may be limited during the
pendency of the Exchange Offer or the effectiveness of a shelf registration
statement in lieu thereof. Accordingly, there can be no assurance as to the
development or liquidity of any market for the Notes.
THE EXCHANGE OFFER IS NOT BEING MADE TO, NOR WILL THE COMPANY ACCEPT
SURRENDERS FOR EXCHANGE FROM, HOLDERS OF OLD NOTES IN ANY JURISDICTION IN
WHICH THE EXCHANGE OFFER OR THE ACCEPTANCE THEREOF WOULD NOT BE IN COMPLIANCE
WITH THE SECURITIES OR BLUE SKY LAWS OF SUCH JURISDICTION.
2
<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 compete 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 and 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.
3
<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
4
<PAGE>
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 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:
5
<PAGE>
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, 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
6
<PAGE>
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 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.
7
<PAGE>
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 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 Old Notes, receiving gross
proceeds of approximately $72.3 million. The Old 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.
8
<PAGE>
THE EXCHANGE OFFER
The Exchange Offer.......... The Company is offering to exchange $1,000
principal amount of Exchange Notes for each
$1,000 principal amount of Old Notes that are
properly tendered and accepted. The Company will
issue Exchange Notes on or promptly after the
Expiration Date. As of the date hereof,
$97,000,000 aggregate principal amount at
maturity of Old Notes is outstanding. The terms
of the Exchange Notes are substantially identical
in all respects to the terms of the Old Notes for
which they may be exchanged pursuant to the
Exchange Offer, except that (i) the Exchange
Notes are freely transferable by holders thereof
(other than as provided herein), and are not
subject to any covenant restricting transfer
absent registration under the Securities Act and
(ii) the holders of the Exchange Notes will not
be entitled to certain rights under the Notes
Registration Rights Agreement, including the
terms providing for an increase in the interest
rate on the Old Notes under certain circumstances
relating to the timing of the Exchange Offer, all
of which rights will terminate when the Exchange
Offer is consummated. See "The Exchange Offer."
The Exchange Offer is not conditioned upon any
minimum aggregate principal amount of Old Notes
being tendered for exchange.
Based on an interpretation by the Commission set
forth in no-action letters issued to third
parties, the Company believes that the Exchange
Notes issued pursuant to the Exchange Offer in
exchange for Old Notes may be offered for resale,
resold and otherwise transferred by a holder
thereof (other than (i) a broker-dealer who
purchases such Exchange Notes directly from the
Company to resell pursuant to Rule 144A under the
Securities Act or any other available exemption
under the Securities Act or (ii) a person that is
an affiliate (as defined in Rule 405 under the
Securities Act) of the Company, without
compliance with the registration and prospectus
delivery provisions of the Securities Act,
provided that the holder is acquiring the
Exchange Notes in the ordinary course of its
business and is not participating, and has no
arrangement or understanding with any person to
participate, in the distribution of the Exchange
Notes. Each broker-dealer that receives the
Exchange Notes for its own account in exchange
for the Old Notes, where such Old Notes were
acquired by such broker-dealer as a result of
market-making activities or other trading
activities, must acknowledge that it will deliver
a prospectus in connection with any resale of
such Exchange Notes. The Company has agreed that
for a period of 180 days after the Expiration
Date, it will make this Prospectus available to
any broker-dealer for use in connection with any
such resale. See "Plan of Distribution."
Notes Registration Rights
Agreement.................. The Old Notes were issued in transactions exempt
from the registration requirements of the
Securities Act by the Company on October 23, 1997
to Smith Barney Inc., and BT Alex. Brown
Incorporated (the "Initial Purchasers") pursuant
to a purchase
9
<PAGE>
agreement dated as of October 23, 1997 by and
among the Company and the Initial Purchasers (the
"Purchase Agreement"). The Initial Purchasers
subsequently sold the Old Notes to qualified
institutional buyers in reliance on Rule 144A
under the Securities Act. In connection
therewith, the Company executed and delivered for
the benefit of the holders of the Notes a notes
registration rights agreement (the "Notes
Registration Rights Agreement") which grants the
holders of the Old Notes certain exchange and
registration rights. The Exchange Offer is
intended to satisfy such rights. The holders of
the Exchange Notes are not entitled to any
exchange or registration rights with respect to
the Exchange Notes, except as described herein.
Expiration Date............. The Exchange Offer will expire at 5:00 p.m., New
York City time, on .,1998, unless the Exchange
Offer is extended, in which case the term
"Expiration Date" means the date and time to
which the Exchange Offer is extended.
Conditions to the Exchange
Offer...................... The Exchange Offer is subject to certain
customary conditions, which may be waived by the
Company. See "The Exchange Offer--Conditions."
The Company reserves the right to terminate or
amend the Exchange Offer at any time prior to the
Expiration Date upon the occurrence of any such
conditions.
Procedures for Tendering
Notes...................... Each holder of Old Notes wishing to accept the
Exchange Offer must complete, sign and date the
Letter of Transmittal, or a facsimile thereof, in
accordance with the instructions contained herein
and therein, and mail or otherwise deliver such
Letter of Transmittal, or such facsimile,
together with the Old Notes and any other
required documentation to the exchange agent (the
"Exchange Agent") at the address set forth
herein. Old Notes may be physically delivered,
but physical delivery is not required if a
confirmation of a book-entry transfer of such Old
Notes to the Exchange Agent's account at the
Depository Trust Company ("DTC" or the
"Depository") is delivered in a timely fashion.
By executing the Letter of Transmittal, each
holder will represent to the Company, among other
things, that (i) the Exchange Notes acquired
pursuant to the Exchange Offer by the holder and
any beneficial owners of Old Notes are being
obtained in the ordinary course of business of
the person receiving such Exchange Notes, (ii)
neither the holder nor such beneficial owner is
participating in, intends to participate in or
has an arrangement or understanding with any
person to participate in the distribution of such
Exchange Notes and (iii) neither the holder nor
such beneficial owner is an "affiliate," as
defined under Rule 405 of the Securities Act, of
the Company. Each broker-dealer that receives
Exchange Notes for its own account in exchange
for Old Notes, where such Old Notes were acquired
by such broker or dealer as a result of market-
making activities or other trading activities
(other than Old Notes acquired directly from the
Company), may participate in the Exchange Offer
but may be
10
<PAGE>
deemed an "underwriter" under the Securities Act
and, therefore, must acknowledge in the Letter of
Transmittal that it will deliver a prospectus in
connection with any resale of such Exchange
Notes. The Letter of Transmittal states that by
so acknowledging and by delivering a prospectus,
a broker or dealer will not be deemed to admit
that it is an "underwriter" within the meaning of
the Securities Act. See "The Exchange Offer--
Procedures for Tendering" and "Plan of
Distribution."
Special Procedures for
Beneficial Owners.......... Any beneficial owner whose Old Notes are
registered in the name of a broker, dealer,
commercial bank, trust company or other nominee
and who wishes to tender should contact such
registered holder promptly and instruct such
registered holder to tender on such beneficial
owner's behalf. If such beneficial owner wishes
to tender on such owner's own behalf, such owner
must, prior to completing and executing the
Letter of Transmittal and delivering his Old
Notes, either make appropriate arrangements to
register ownership of the Old Notes in such
owner's name or obtain a properly completed bond
power from the registered holder. The transfer of
registered ownership may take considerable time
and may not be completed prior to the Expiration
Date. See "The Exchange Offer--Procedures for
Tendering."
Guaranteed Delivery
Procedures................. Holders of Old Notes who wish to tender their Old
Notes and whose Old Notes are not immediately
available or who cannot deliver their Old Notes,
the Letter of Transmittal or any other documents
required by the Letter of Transmittal to the
Exchange Agent prior to the Expiration Date must
tender their Old Notes according to the
guaranteed delivery procedures set forth in "The
Offer--Guaranteed Delivery Procedures."
Acceptance of the Old Notes
and Delivery of the
Exchange Notes............. Subject to the satisfaction or waiver of the
conditions to the Exchange Offer, the Company
will accept for exchange any and all Old Notes
which are properly tendered in the Exchange Offer
prior to the Expiration Date.
Withdrawal Rights........... Tenders may be withdrawn at any time prior to
5:00 p.m., New York City time, on the Expiration
Date. See "The Exchange Offer--Withdrawal of
Tenders."
U.S. Federal Income Tax
Considerations............. The exchange of Old Notes for Exchange Notes by
tendering holders should not be a taxable
exchange for U.S. federal income tax purposes,
and such holders should not recognize any taxable
gain or loss or any interest income for U.S.
federal income tax purposes as a result of such
exchange. See "Certain United States Federal
Income Tax Considerations."
Use of the Proceeds......... There will be no proceeds to the Company from the
exchange pursuant to the Exchange Offer.
11
<PAGE>
Effect on Holders of Old
Notes...................... As a result of making this Exchange Offer, and
upon acceptance for exchange of all validly
tendered Old Notes pursuant to the terms of this
Exchange Offer, the Company will have fulfilled a
covenant contained in the terms of the Old Notes
and the Notes Registration Rights Agreement and,
accordingly, a holder of the Old Notes will have
no further registration or other rights under the
Notes Registration Rights Agreement, except under
certain limited circumstances. Holders of the Old
Notes who do not tender their Notes in the
Exchange Offer will continue to hold such Old
Notes and will be entitled to all the rights and
limitations applicable thereto under the
Indenture. All untendered, and tendered, but
unaccepted, Old Notes will continue to be subject
to the restrictions on transfer provided for in
the Old Notes and the Indenture. To the extent
that Old Notes are tendered and accepted in the
Exchange Offer, the trading market, if any, for
the Old Notes not so tendered could be adversely
affected. See "Risk Factors--Consequences of
Failure to Exchange Notes."
Exchange Agent.............. State Street Bank and Trust Company.
12
<PAGE>
THE NOTES
The Exchange Offer applies to $97,000,000 aggregate principal amount at
maturity of Old Notes. The terms of the Exchange Notes are identical in all
material respects to the Old Notes, except that the Exchange Notes have been
registered under the Securities Act and, therefore, will not bear legends
restricting their transfer and the holders of the Exchange Notes will not be
entitled to certain rights under the Notes Registration Rights Agreement,
including the terms providing for an increase in the interest rate on the Old
Notes under certain circumstances relating to the timing of the Exchange Offer,
all of which rights will terminate when the Exchange Offer is consummated. The
Exchange Notes will evidence the same debt as the Old Notes and will be
entitled to the benefits of the Indenture, under which both the Old Notes were,
and the Exchange Notes will be, issued. See "Description of the Notes."
Issue....................... $97,000,000 aggregate principal amount at Stated
Maturity of 10 1/2% Senior Discount Notes due
2004.
Maturity Date............... November 1, 2004.
Interest Rate and Payment
Dates...................... The 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. Cash interest on
the Notes will neither accrue nor be payable
prior to May 1, 2000. Thereafter, cash interest
will be payable on the Notes semi-annually in
arrears on each May 1, and November 1, commencing
November 1, 2000, at the rate of 10 1/2% per
annum.
Security.................... None
Ranking..................... The Notes will be general unsecured
unsubordinated obligations of the Company ranking
senior in right of payment to all existing and
future subordinated Indebtedness of the Company,
including the Convertible Notes, and pari passu
in right of payment with all unsubordinated
Indebtedness of the Company. The Notes will be
effectively subordinated to all secured
Indebtedness of the Company to the extent of the
value of the assets securing such Indebtedness.
Absence of Public Trading
Market for the New Notes... There is no public market for the Exchange Notes
and the Company does not intend to apply for
listing of the Exchange Notes on any national
securities exchange or for quotation of the
Exchange Notes through Nasdaq. Although the
Initial Purchasers have informed the Company that
they currently intend to make a market in the
Notes, they are not obligated to do so and any
such market-making may be discontinued at any
time without notice. In addition, such market-
making activity may be limited during the
pendency of the Exchange Offer or the
effectiveness of a shelf registration statement
in lieu thereof. Accordingly, there can be no
assurance as to the development or liquidity of
any market for the Notes.
Optional Redemption......... The Notes will be redeemable at the option of the
Company, in whole or in part, at any time on or
after November 1, 2001 at the redemption prices
set forth herein, plus accrued and unpaid
interest, if any, to the date of redemption. In
addition, at any time on or prior
13
<PAGE>
to November 1, 2000, the Company may redeem up to
33% of the aggregate outstanding principal amount
at maturity of the Notes originally issued with
the net proceeds of one or more public offerings
of its Common Stock at a redemption price equal
to 110.5% of the Accreted Value on the date of
redemption plus accrued and unpaid interest, if
any, thereon to the date of redemption; provided,
however, that immediately after giving effect to
any such redemption, not less than 66% of the
aggregate principal amount at maturity of the
Notes originally issued remains outstanding. See
"Description of the Notes--Optional Redemption."
Mandatory Redemption........ There will be no sinking fund requirements.
Offers to Purchase.......... In the event of a Change of Control, each holder
will have the option to require the Company to
repurchase such holder's Notes at a price equal
to 101% of the Accredited Value on the date of
repurchase plus accrued and unpaid interest, if
any, to the date of repurchase. See "Description
of the Notes--Change of Control." In addition,
the Company will be obligated to make an offer to
repurchase the Notes for cash at a price equal to
100% of the Accreted Value on the date of
repurchase, plus accrued and unpaid interest, if
any, thereon to the date of repurchase with the
net cash proceeds of certain asset sales. See
"Description of the Exchange Notes--Limitation on
Asset Sales."
Certain Covenants........... The Indenture imposes certain limitations on the
ability of the Company and its Subsidiaries to,
among other things, incur additional
indebtedness, pay dividends or make certain other
restricted payments and investments, consummate
certain asset sales, enter into certain
transactions with affiliates, incur liens, enter
into certain sale and leaseback transactions,
engage in certain businesses, merge or
consolidate with any other person or sell,
assign, transfer, lease, convey or otherwise
dispose of all or substantially all of its
assets. The Indenture also imposes limitations on
the Company's ability to restrict the ability of
its Subsidiaries to pay dividends or make certain
payments to the Company or any of its
Subsidiaries and on the ability of the Company's
Subsidiaries to issue preferred stock. See
"Description of the Notes."
Original Issue Discount..... The Notes will be issued with original issue
discount for U.S. federal income tax purposes.
See "Certain United States Federal Income Tax
Considerations."
14
<PAGE>
USE OF PROCEEDS
The Company will not receive any cash proceeds from the issuance of the
Exchange Notes pursuant to this Prospectus. The net proceeds to the Company
from the offering of the Old Notes were approximately $72.3 million. The
Company expects that approximately $15.0 million will be used to expand the
Telegroup Intelligent Global Network, primarily for the purchase of digital
fiber-optic transmission capacity. The Company anticipates that approximately
$9.7 million will be used to develop and upgrade management information
systems, and the balance will be used for working capital and other general
corporate purposes, including potential acquisitions and further expansion of
the TIGN. Pending application, net proceeds from the offering of the Old Notes
may be invested in short-term, marketable securities. For a discussion of the
Company's future capital requirements and the sources of funds therefor over
the next three years, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
RISK FACTORS
Holders of the Old Notes should consider carefully the information set forth
under the caption "Risk Factors," and all other information set forth in this
Prospectus, in evaluating the Exchange Offer.
15
<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>
16
<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 Old 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 Old 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 Old 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 Old 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 Old Notes
for the nine-months ended September 30, 1997, (ii) the elimination of $2.0
million with respect to the Senior Subordinated Notes, for
17
<PAGE>
the nine-months ended September 30, 1997, (iii) amortization of fees and
costs totaling $0.4 million relating to the Convertible Notes and the
offering of Old 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 Old 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.
18
<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 Old
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 71.0% 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."
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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
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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 Old 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 Old 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 Old
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
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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
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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
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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,
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traffic 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")
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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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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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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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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 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
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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 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
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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 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.
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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 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.
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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.
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
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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.
ORIGINAL ISSUE DISCOUNT; POSSIBLE TAX AND OTHER LEGAL CONSEQUENCES FOR HOLDERS
OF NOTES AND THE COMPANY
The Old Notes were issued at a substantial discount from their principal
amount of maturity. Since the Exchange Notes are treated as a continuation of
the Old Notes for U.S. federal income tax purposes, the Exchange Notes will
also be considered to have been issued at a substantial discount. Cash
payments of interest on the Notes will not be paid prior to May of 2000.
However, original issue discount (i.e., the difference between the "stated
redemption price at maturity" of the Notes and the "issue price" of the Notes)
has accrued from the issue date of the Old Notes and will continue to accrue
with respect to the Exchange Notes from the Issue Date of the Old Notes. Such
original issue discount will be includable as interest income periodically in
a holder's gross income for the U.S. federal income tax purposes in advance of
receipt of the cash payments to which the income is attributable. See "Certain
United States Federal Income Tax Considerations--U.S. Holders--Original Issue
Discount."
LACK OF PUBLIC MARKET; RESTRICTIONS ON TRANSFERABILITY
The Notes are new securities for which there currently is no market. The
Company does not intend to apply for listing of the Exchange Notes on any
national securities exchange or for quotation of the Exchange Notes through
Nasdaq. Although the Initial Purchasers have informed the Company that they
currently intend to make a market in the Notes, they are not obligated to do
so and any such market-making may be discontinued at any time without notice.
In addition, such market-making activity may be limited during the pendency of
the Exchange Offer or the effectiveness of a shelf registration statement in
lieu thereof. Accordingly, there can be no assurance as to the development or
liquidity of any market for the Notes.
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CONSEQUENCES OF FAILURE TO EXCHANGE
The Old Notes have not been registered under the Securities Act and are
subject to substantial restrictions on transfer. Old Notes that are not
tendered in exchange for Exchange Notes or are tendered but not accepted will,
following consummation of the Exchange Offer, continue to be subject to the
existing restrictions upon transfer thereof. The Company does not currently
anticipate that it will register the Old Notes under the Securities Act. To
the extent that Old Notes are tendered and accepted in the Exchange Offer, the
trading market for untendered and tendered but unaccepted Old Notes could be
adversely affected. In addition, although the Old Notes have been designated
for trading in the Private Offerings, Resale and Trading through Automatic
Linkages ("PORTAL") market, to the extent that Old Notes are tendered and
accepted in connection with the Exchange Offer, any trading market for Old
Notes that remain outstanding after the Exchange Offer could be adversely
affected. See "The Exchange Offer--Consequences of Failure to Exchange."
FAILURE TO COMPLY WITH EXCHANGE OFFER PROCEDURES
Issuance of the Exchange Notes in exchange for the Old Notes pursuant to the
Exchange Offer will be made only after timely receipt by the Exchange Agent of
such Old Notes, a properly completed and duly executed Letter of Transmittal
and all other required documents. Therefore, holders of the Old Notes desiring
to tender such Old Notes in exchange for Exchange Notes should allow
sufficient time to ensure timely delivery. The Company is under no duty to
give notification of defects or irregularities with respect to tenders of Old
Notes for exchange. Holders of Old Notes who do not exchange their Old Notes
for Exchange Notes pursuant to the Exchange Offer will continue to be subject
to the restrictions on transfer of such Old Notes as set forth in the legend
thereon. See "Exchange Offer."
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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THE EXCHANGE OFFER
PURPOSES AND EFFECTS OF THE EXCHANGE OFFER
The Old Notes were issued by the Company on October 23, 1997 (the "Issue
Date") to the Initial Purchasers pursuant to the Purchase Agreement. As a
condition to the sale of the Old Notes, the Company and the Initial Purchasers
entered into the Notes Registration Rights Agreement on the Issue Date.
Pursuant to the Notes Registration Rights Agreement, the Company agreed that,
unless the Exchange Offer is not permitted by applicable law or Commission
policy, it would (i) file with the Commission a Registration Statement under
the Securities Act with respect to the Exchange Notes within 90 days after the
Issue Date and (ii) use its best efforts to cause such Registration Statement
to become effective under the Securities Act within 180 days after the Issue
Date. Under existing Commission interpretations, the Exchange Notes would in
general be freely transferable after the Exchange Offer without further
registration under the Securities Act; provided, that in the case of broker-
dealers, a prospectus meeting the requirements of the Securities Act will be
delivered as required. A copy of the Notes Registration Rights Agreement has
been filed as an exhibit to the Registration Statement of which this
Prospectus is a part. The Registration Statement of which this Prospectus is a
part is intended to satisfy certain of the Company's obligations under the
Notes Registration Rights Agreement and the Purchase Agreement.
The Company is generally not required to file any registration statement to
register any outstanding Old Notes. Holders of Old Notes who do not tender
their Old Notes or whose Old Notes are tendered but not accepted will have to
rely on exemptions to registration requirements under the securities laws,
including the Securities Act, if they wish to sell their Old Notes.
With respect to the Exchange Notes, based upon an interpretation by the
staff of the Commission set forth in certain no-action letters issued to third
parties, the Company believes that a holder (other than (i) a broker-dealer
who purchases such Exchange Notes directly from the Company to resell pursuant
to Rule 144A or any other available exemption under the Securities Act or (ii)
any such holder which is an "affiliate" of the Company within the meaning of
Rule 405 under the Securities Act) who exchanges Old Notes for Exchange Notes
in the ordinary course of business and who is not participating, does not
intend to participate, and has no arrangement with any person to participate,
in the distribution of the Exchange Notes, will be allowed to resell the
Exchange Notes to the public without further registration under the Securities
Act and without delivering to the purchasers of the Exchange Notes a
prospectus that satisfies the requirements of Section 10 of the Securities
Act. However, if any holder acquires the Exchange Notes in the Exchange Offer
for the purpose of distributing or participating in the distribution of the
Exchange Notes or is a broker-dealer, such holder cannot rely on the position
of the staff of the Commission and must comply with the registration and
prospectus delivery requirements of the Securities Act in connection with any
resale transaction, unless an exemption from registration is otherwise
available. Each broker-dealer that receives Exchange Notes for its own account
in exchange for Old Notes, where such Old Notes were acquired by such broker-
dealer as a result of market-making activities or other trading activities,
must acknowledge that it will deliver a prospectus in connection with any
resale of such Exchange Notes. The Letter of Transmittal states that by so
acknowledging and by delivering a prospectus, a broker-dealer will not be
deemed to admit that it is an "underwriter" within the meaning of the
Securities Act. Pursuant to the Notes Registration Rights Agreement, the
Company has agreed to make this Prospectus, as it may be amended or
supplemented from time to time, available to broker-dealers for use in
connection with any resale for a period of 180 days after the Expiration Date.
If, (i) because of any change in law or in currently prevailing
interpretations of the staff of the Commission, the Company is not permitted
to effect an Exchange Offer, (ii) the Exchange Offer is not consummated within
160 days of the Issue Date, (iii) in certain circumstances, the Initial
Purchasers so request, or (iv) in the case of any holder that participates in
the Exchange Offer, such holder does not receive Exchange Notes on the date of
the exchange that may be sold without restriction under state and federal
securities laws, in the case of each of clauses (i) to and including (iv) of
this sentence, then the Company shall promptly deliver to the holders and the
Trustee (as defined herein) written notice thereof and the Company will, at
the sole expense of the Company, (a)
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as promptly as practicable, file a shelf registration statement covering
resales of the Notes (the "Shelf Registration Statement"), (b) use its best
efforts to cause the Shelf Registration Statement to be declared effective
under the Securities Act and (c) use its best efforts to keep effective the
Shelf Registration Statement until the earlier of two years after its
effective date or such time as all of the applicable Notes have been sold
thereunder. The Company will, in the event of the Shelf Registration
Statement, provide to each holder of the Notes copies of the prospectus, which
is a part of the Shelf Registration Statement, notify each such holder when
the Shelf Registration Statement for the Notes has become effective and take
certain other actions as are required to permit unrestricted resales of the
Notes. A holder of Notes who sells such Notes pursuant to the Shelf
Registration Statement will be required to be named as a selling security
holder in the related prospectus and to deliver a prospectus to purchasers,
will be subject to certain of the civil liability provisions under the
Securities Act in connection with such sales and will be bound by the
provisions of the Notes Registration Rights Agreement which are applicable to
such a holder (including certain indemnification rights and obligations).
If the Company fails to comply with the above provision or if such
registration statement fails to become effective, then, as liquidated damages,
additional interest (the "Additional Interest") shall become payable in
respect of the Notes as follows:
(i) if (A) neither the Exchange Offer Registration Statement nor
Shelf Registration Statement is filed with the Commission within 90
days of the Issue Date (the "Filing Date") or (B) notwithstanding that
the Company has consummated or will consummate an Exchange Offer, the
Company is required to file a Shelf Registration Statement and such
Shelf Registration Statement is not filed on or prior to the Filing
Date, then commencing on the day after either such required Filing
Date, Additional Interest shall accrue on the Accreted Value of the
Notes at a rate of .50% per annum for the first 90 days immediately
following each such filing date, such Additional Interest rate
increasing by an additional .50% per annum at the beginning of each
subsequent 90-day period; or
(ii) if (A) neither the Exchange Offer Registration Statement nor a
Shelf Registration Statement is declared effective by the Commission on
or prior to 180 days after the Issue Date or (B) notwithstanding that
the Company has consummated or will consummate an Exchange Offer, the
Company is required to file a Shelf Registration Statement and such
Shelf Registration Statement is not declared effective by the
Commission on or prior to the 75th day following the date such Shelf
Registration Statement was filed, then, commencing on the day after the
date such registration statement is required to be declared effective,
Additional Interest shall accrue on the Accreted Value of the Notes at
a rate of .50% per annum for the first 90 days immediately following
such date, such Additional Interest rate increasing by an additional
.50% per annum at the beginning of each subsequent 90-day period; or
(iii) if (A) the Company has not exchanged Exchange Notes for all Old
Notes validly tendered in accordance with the terms of the Exchange
Offer on or prior to the 30th day after the date on which the Exchange
Offer Registration Statement was declared effective or (B) if
applicable, the Shelf Registration Statement has been declared
effective and such Shelf Registration Statement ceases to be effective
at any time prior to the second anniversary of its effective date
(other than after such time as all Notes have been disposed of
thereunder), Additional Interest shall accrue on the Accreted Value of
the Notes at a rate of .50% per annum for the first 90 days commencing
on (x) the 31st day after such effective date, in the case of (A)
above, or (y) the day such Shelf Registration Statement ceases to be
effective in the case of (B) above, such Additional Interest rate
increasing by an additional .50%; provided, however, that the
Additional Interest rate on the Notes may not exceed in the aggregate
2.00% per annum, and provided, further, that (1) upon the filing of the
Exchange Offer Registration Statement or a Shelf Registration Statement
(in the case of clause (i) above), (2) upon the effectiveness of the
Exchange Offer Registration Statement or a Shelf Registration (in the
case of clause (ii) above), or (3) upon the exchange of Exchange Notes
for all Old Notes tendered (in the case of clause (iii) (A) above), or
upon the effectiveness of the Shelf Registration Statement which had
ceased to remain effective (in the case of clause (iii) (B) above),
Additional Interest on the Notes as a result of such clause (or the
relevant subclause thereof), as the case may be, shall cease to accrue.
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Any amounts of Additional Interest due pursuant to clause (i), (ii) or (iii)
above will be payable in cash on May 1 and November 1 of each year to the
holders of record on the preceding April 15 or October 15, respectively. The
amount of Additional Interest will be determined by multiplying the applicable
Additional Interest rate by the Accreted Value of the Notes, multiplied by a
fraction, the numerator of which is the number of days such Additional
Interest rate was applicable during such period (determined on the basis of a
360-day year comprised of twelve 30-day months, and, in the case of a partial
month, the actual number of days elapsed), and the denominator of which is
360.
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal, the Company will accept any and all Old
Notes validly tendered and not withdrawn prior to 5:00 p.m., New York City
time, on the Expiration Date. The Company will issue $1,000 principal amount
at maturity of Exchange Notes in exchange for each $1,000 principal amount at
maturity of outstanding Old Notes accepted in the Exchange Offer. Holders may
tender some or all of their Old Notes pursuant to the Exchange Offer. However,
Old Notes may be tendered only in integral multiples of $1,000. The Exchange
Offer is not conditioned upon any minimum aggregate principal amount of Old
Notes being tendered for exchange.
The form and terms of the Exchange Notes will be identical in all material
respect to the form and terms of the Old Notes, except that (i) the Exchange
Notes will have been registered under the Securities Act and hence will not
bear legends restricting the transfer thereof and (ii) the holders of the
Exchange Notes will not be entitled to certain rights under the Notes
Registration Rights Agreement, including the terms providing for an increase
in the interest rate on the Old Notes under certain circumstances relating to
the timing of the Exchange Offer, all of which rights will terminate when the
Exchange Offer is consummated. The Exchange Notes will evidence the same debt
as the Old Notes and will be entitled to the benefits of the Indenture under
which the Old Notes were, and the Exchange Notes will be, issued, such that
all outstanding Notes will be treated as a single class of debt securities
under the Indenture.
As of the date of this Prospectus, $97,000,000 aggregate principal amount at
maturity of the Old Notes was outstanding. Holders of Old Notes do not have
any appraisal or dissenters' rights under the Indenture in connection with the
Exchange Offer. The Company intends to conduct the Exchange Offer in
accordance with the provisions of the Notes Registration Rights Agreement and
the applicable requirements of the Securities Act, the Exchange Act and the
rules and regulations of the Commission thereunder.
The Company shall be deemed to have accepted validly tendered Old Notes
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as agent for the tendering holders
for the purpose of receiving the Exchange Notes from the Company.
If any tendered Old Notes are not accepted for exchange because of an
invalid tender, the occurrence of certain other events set forth herein or
otherwise, such unaccepted Old Notes will be returned, without expense, to the
tendering Holder thereof as promptly as practicable after the Expiration Date.
Holders who tender Old Notes in the Exchange Offer will not be required to
pay brokerage commission or fees or, subject to the instructions in the Letter
of Transmittal, transfer taxes with respect to the exchange of Old Notes
pursuant to the Exchange Offer. The Company will pay all charges and expenses,
other than certain applicable taxes, in connection with the Exchange Offer.
See "--Fees and Expenses."
EXPIRATION DATE
The term "Expiration Date" shall mean 5:00 p.m., New York City time, on .,
1998, unless the Company, in its sole discretion, extends the Exchange Offer,
in which case the term "Expiration Date" shall mean the latest date and time
to which the Exchange Offer is extended.
42
<PAGE>
In order to extend the Exchange Offer, the Company will notify the Exchange
Agent of any extension by oral (promptly confirmed in writing) or written
notice and will make a public announcement thereof, each prior to 9:00 a.m.,
New York City time, on the next business day after the previously scheduled
expiration date of the Exchange Offer. Without limiting the manner in which
the Company may choose to make a public announcement of any delay, extension,
amendment or termination of the Exchange Offer, the Company shall have no
obligation to publish, advertise or otherwise communicate any such public
announcement, other than by making a timely release to an appropriate news
agency.
The Company reserves the right, in its sole discretion, (i) to delay
accepting any Old Notes, (ii) to extend the Exchange Offer, (iii) if any
conditions set forth below under "--Certain Conditions to the Exchange Offer"
shall not have been satisfied, to terminate the Exchange Offer by giving oral
or written notice of such delay, extension or termination to the Exchange
Agent or (iv) to amend the terms of the Exchange Offer in any manner. Any such
delay in acceptance, extension, termination or amendment will be followed as
promptly as practicable by oral or written notice thereof to the registered
holders. If the Exchange Offer is amended in a manner determined by the
Company to constitute a material change, the Company will promptly disclose
such amendment by means of a prospectus supplement that will be distributed to
the registered holders of Old Notes, and the Company will extend the Exchange
Offer for a period of five to ten business days, depending upon the
significance of the amendment and the manner of disclosure to such registered
holders, if the Exchange Offer would otherwise expire during such five to ten
business day period. The rights reserved by the Company in this paragraph are
in addition to the Company's rights set forth below under the caption "--
Certain Conditions of the Exchange Offer."
If the Company extends the period of time during which the Exchange Offer is
open, or if it is delayed in accepting for exchange of, or in issuing and
exchanging the Exchange Notes for, any Old Notes, or is unable to accept for
exchange of, or issue Exchange Notes for, any Old Notes pursuant to the
Exchange Offer for any reason, then, without prejudice to the Company's rights
under the Exchange Offer, the Exchange Agent may, on behalf of the Company,
retain all Old Notes tendered, and such Old Notes may not be withdrawn except
as otherwise provided below in "--Withdrawal of Tenders." The adoption by the
Company of the right to delay acceptance for exchange of, or the issuance and
the exchange of the Exchange Notes, for any Old Notes is subject to applicable
law, including Rule 14e-1(c) under the Exchange Act, which requires that the
Company pay the consideration offered or return the Old Notes deposited by or
on behalf of the holders thereof promptly after the termination or withdrawal
of the Exchange Offer.
PROCEDURES FOR TENDERING
Only a registered holder of Old Notes may tender such Old Notes in the
Exchange Offer. To tender in the Exchange Offer, a holder must complete, sign
and date the Letter of Transmittal, or facsimile thereof, have the signature
thereon guaranteed if required by the Letter of Transmittal and mail or
otherwise deliver such Letter of Transmittal or such facsimile to the Exchange
Agent at the address set forth below under "The Exchange Offer--Exchange
Agent" for receipt prior to the Expiration Date. In addition, either (i)
certificates for such Old Notes must be received by the Exchange Agent along
with the Letter of Transmittal, or (ii) a timely confirmation of a book-entry
transfer of such Old Notes, if such procedure is available, into the Exchange
Agent's account at DTC pursuant to the procedure for book-entry transfer
described below, must be received by the Exchange Agent prior to the
Expiration Date, or (iii) the holders must comply with the guaranteed delivery
procedures described below.
Any financial institution that is a participant in the Depository's Book-
Entry Transfer facility system may make book-entry delivery of the Old Notes
by causing the Depository to transfer such Old Notes into the Exchange Agent's
account in accordance with the Depository's procedure for such transfer.
Although delivery of Old Notes may be effected through book-entry transfer
into the Exchange Agent's account at the Depository, the Letter of Transmittal
(or facsimile thereof), with any required signature guarantees and any other
required documents, must, in any case, be transmitted to and received and
confirmed by the Exchange Agent at its addresses set forth under "--Exchange
Agent" below prior to 5:00 p.m., New York City time, on the Expiration
43
<PAGE>
Date. DELIVERY OF DOCUMENTS TO THE DEPOSITORY IN ACCORDANCE WITH ITS
PROCEDURES DOES NOT CONSTITUTE DELIVERY TO THE EXCHANGE AGENT.
The tender by a holder which is not withdrawn prior to the Expiration Date
will constitute a binding agreement between such holder and the Company in
accordance with the terms and subject to the conditions set forth herein and
in the Letter of Transmittal.
THE METHOD OF DELIVERY OF OLD NOTES AND THE LETTER OF TRANSMITTAL AND ALL
OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK OF
THE HOLDER. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS USE AN
OVERNIGHT OR HAND DELIVERY SERVICE, PROPERLY INSURED. IF DELIVERY IS BY MAIL,
REGISTERED MAIL WITH RETURN RECEIPT REQUESTED, PROPERLY INSURED, IS
RECOMMENDED. IN ALL CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO ASSURE
DELIVERY TO THE EXCHANGE AGENT BEFORE THE EXPIRATION DATE. NO LETTER OF
TRANSMITTAL OR OLD NOTES SHOULD BE SENT TO THE COMPANY. HOLDERS MAY REQUEST
THEIR RESPECTIVE BROKERS, DEALERS, COMMERCIAL BANKS, TRUST COMPANIES OR
NOMINEES TO EFFECT THE ABOVE TRANSACTIONS FOR SUCH HOLDERS.
Any beneficial owner of the Old Notes whose Old Notes are registered in the
name of a broker, dealer, commercial bank, trust company or other nominee and
who wishes to tender should contact the registered holder promptly and
instruct such registered holder to tender on such beneficial owner's behalf.
If such beneficial owner wishes to tender on such owner's own behalf, such
owner must, prior to completing and executing the Letter of Transmittal and
delivering such owner's Old Notes either make appropriate arrangements to
register ownership of the Old Notes in such owner's name (to the extent
permitted by the Indenture) or obtain a properly completed assignment from the
registered holder. The transfer of registered ownership may take considerable
time.
If the Letter of Transmittal is signed by a person other than the registered
holder of any Old Notes (which term includes any participants in DTC whose
name appears on a security position listing as the owner of the Old Notes) or
if delivery of the Old Notes is to be made to a person other than the
registered holder, such Exchange Notes must be endorsed or accompanied by a
properly completed bond power, in either case signed by such registered holder
as such registered holder's name appears on such Old Notes with the signature
on the Old Notes or the bond power guaranteed by an Eligible Institution (as
defined below).
Signatures on a Letter of Transmittal or a notice of withdrawal described
below (see "--Withdrawal of Tenders"), as the case may be, must be guaranteed
by an Eligible Institution unless the Old Notes tendered pursuant thereto are
tendered (i) by a registered holder who has not completed the box entitled
"Special Delivery Instructions" on the Letter of Transmittal or (ii) for the
account of an Eligible Institution. In the event that signatures on a Letter
of Transmittal or a notice of withdrawal, as the case may be, are required to
be guaranteed, such guarantee must be made by a member firm of a registered
national securities exchange or of the National Association of Securities
Dealers, Inc., a commercial bank or trust company having an office or
correspondent in the United States, or another "Eligible Guarantor
Institution" within the meaning of Rule 17Ad-15 under the Exchange Act (any of
the foregoing an "Eligible Institution").
If the Letter of Transmittal or any Old Notes or assignments are signed by
trustees, executors, administrators, guardians, attorneys-in-fact, officers of
corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with the Letter of Transmittal.
The Exchange Agent and the Depository have confirmed that any financial
institution that is a participant in the Depository's system may utilize the
Depository's Automated Tender Offer Program to tender Old Notes.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of tendered Old Notes will be determined
by the Company in its sole discretion, which determination will be final
44
<PAGE>
and binding. The Company reserves the absolute right to reject any and all Old
Notes not properly tendered or any Old Notes, the Company's acceptance of
which would, in the opinion of counsel for the Company, be unlawful. The
Company also reserves the right to waive any defects, irregularities or
conditions of tender as to particular Old Notes. The Company's interpretation
of the terms and conditions of the Exchange Offer (including the instructions
in the Letter of Transmittal) will be final and binding on all parties. Unless
waived, any defects or irregularities in connection with tenders of Old Notes
must be cured within such time as the Company shall determine. Although the
Company intends to request the Exchange Agent to notify holders of defects or
irregularities with respect to tenders of Old Notes, neither the Company, the
Exchange Agent nor any other person shall incur any liability for failure to
give such notification. Tenders of Old Notes will not be deemed to have been
made until such defects or irregularities have been cured or waived.
While the Company has no present plan to acquire any Old Notes which are not
tendered in the Exchange Offer or to file a registration statement to permit
resales of any Old Notes which are not tendered pursuant to the Exchange
Offer, the Company reserves the right in its sole discretion to purchase or
make offers for any Old Notes that remain outstanding subsequent to the
Expiration Date or, as set forth below under "--Certain Conditions to the
Exchange Offer," to terminate the Exchange Offer and, to the extent permitted
by applicable law, purchase Old Notes in the open market, in privately
negotiated transactions or otherwise. The terms of any such purchase or offers
could differ from the terms of the Exchange Offer.
By tendering, each holder will represent to the Company that, among other
things, (i) the Exchange Notes to be acquired by the holder of the Old Notes
in connection with the Exchange Offer are being acquired by the holder in the
ordinary course of business of the holder, (ii) the holder has no arrangement
or understanding with any person to participate in the distribution of
Exchange Notes, (iii) the holder acknowledges and agrees that any person who
is a broker-dealer registered under the Exchange Act or is participating in
the Exchange Offer for the purpose of distributing the Exchange Notes must
comply with the registration and prospectus delivery requirements of the
Securities Act in connection with a secondary resale transaction of the
Exchange Notes acquired by such person and cannot rely on the position of the
staff of the Commission set forth in certain no-action letters, (iv) the
holder understands that a secondary resale transaction described in clause
(iii) above and any resales of Exchange Notes obtained by such holder in
exchange for Old Notes acquired by such holder directly from the Company
should be covered by an effective registration statement containing the
selling security holder information required by Item 507 or Item 508, as
applicable, of Regulation S-K of the Commission, and (v) the holder is not an
"affiliate," as defined in Rule 405 of the Securities Act, of the Company. If
the holder is a broker-dealer that will receive Exchange Notes for its own
account in exchange for Old Notes that were acquired as a result of market-
making activities or other trading activities, the holder is required to
acknowledge in the Letter of Transmittal that it will deliver a prospectus in
connection with any resale of such Exchange Notes; however, by so
acknowledging and by delivering a prospectus, the holder will not be deemed to
admit that it is an "underwriter" within the meaning of the Securities Act.
See "Plan of Distribution."
RETURN OF OLD NOTES
If any tendered Old Notes are not accepted for exchange because of an
invalid tender, the occurrence of certain other events set forth herein or
otherwise, certificates for any such unaccepted Old Notes will be returned
without expense to the tendering holder thereof (or, in the case of Old Notes
tendered by book-entry transfer into the Exchange Agent's account at the
Depository pursuant to the book-entry transfer procedures described below,
such Old Notes will be credited to an account maintained with the Depository)
as promptly as practicable.
BOOK-ENTRY TRANSFER
The Exchange Agent will make a request to establish an account with respect
to the Old Notes at the Depository for purposes of the Exchange Offer within
two business days after the date of this Prospectus, and any financial
institution that is a participant in the Depository's system may make book-
entry delivery of Old Notes by causing the Depository to transfer such Old
Notes into the Exchange Agent's account at the Depository
45
<PAGE>
in accordance with the Depository's procedures for transfer. However, although
delivery of Old Notes may be effected through book-entry transfer at the
Depository, the Letter of Transmittal or facsimile thereof, with any required
signature guarantees and any other required documents, must, in any case, be
transmitted to and received by the Exchange Agent at the address set forth
below under "--Exchange Agent" on or prior to the Expiration Date or pursuant
to the guaranteed delivery procedures described below.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Old Notes and (i) whose Old Notes are not
immediately available or (ii) who cannot deliver their Old Notes (or complete
the procedures for book-entry transfer), the Letters of Transmittal or any
other required documents to the Exchange Agent prior to the Expiration Date,
may effect a tender if:
(a) the tender is made through an Eligible Institution;
(b) prior to the Expiration Date, the Exchange Agent receives from such
Eligible Institution a properly completed and duly executed Notice of
Guaranteed Delivery substantially in the form provided by the Company (by
facsimile transmission, mail or hand delivery) setting forth the name and
address of the holder, the certificate number(s) of such Old Notes (if
available) and the principal amount of Old Notes tendered, stating that the
tender is being made thereby and guaranteeing that, within five New York
Stock Exchange trading days after the Expiration Date, the Letter of
Transmittal (or a facsimile thereof) together with the certificate(s)
representing the Old Notes in proper form (or transfer for a confirmation
of a book-entry transfer into the Exchange Agent's account at the
Depository of Old Notes delivered electronically), and any other documents
required by the Letter of Transmittal will be deposited by the Eligible
Institution with the Exchange Agent; and
(c) such properly executed Letter of Transmittal (or facsimile thereof),
as well as the certificate(s) representing all tendered Old Notes in proper
form for transfer (or a confirmation of a book-entry transfer into the
Exchange Agent's account at the Depository of Old Notes delivered
electronically), and all other documents required by the Letter of
Transmittal are received by the Exchange Agent within five New York Stock
Exchange trading days after the Expiration Date.
Upon request to the Exchange Agent, a Notice of Guaranteed Delivery will be
sent to the holders who wish to tender their Old Notes according to the
guaranteed delivery procedures set forth above.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Old Notes may be withdrawn
at any time prior to the Expiration Date. To withdraw a tender of Old Notes in
the Exchange Offer, a written or facsimile transmission notice of withdrawal
must be received by the Exchange Agent at its address set forth herein prior
to the Expiration Date. Any such notice of withdrawal must (i) specify the
name of the person having deposited the Old Notes to be withdrawn (the
"Depositor"), (ii) identify the Old Notes to be withdrawn (including the
certificate number or numbers (if applicable) and principal amount of such Old
Notes), and (iii) be signed by the holder in the same manner as the original
signature on the Letter of Transmittal by which such Old Notes were tendered
(including any required signature guarantees). All questions as to the
validity, form and eligibility (including time of receipt) of such notices
will be determined by the Company in its sole discretion, whose determination
shall be final and binding on all parties. Any Old Notes so withdrawn will be
deemed not to have been validly tendered for purposes of the Exchange Offer
and no Exchange Notes will be issued with respect thereto unless the Old Notes
so withdrawn are validly retendered. Properly withdrawn Old Notes may be
retendered by following one of the procedures described above under "--
Procedures for Tendering" at any time prior to the Expiration Date.
CONDITIONS TO EXCHANGE
Notwithstanding any other term of the Exchange Offer, the Company shall not
be required to accept for exchange, or exchange the Exchange Notes for, any
Old Notes not theretofore accepted for exchange, and may
46
<PAGE>
terminate or amend the Exchange Offer as provided herein before the acceptance
of such Old Notes, if any of the following conditions exist:
(a) any action or proceeding is instituted or threatened in any court or
by or before any governmental agency with respect to the Exchange Offer
which, in the reasonable judgment of the Company, might impair the ability
of the Company to proceed with the Exchange Offer or have a material
adverse effect on the contemplated benefits of the Exchange Offer to the
Company or there shall have occurred any material adverse development in
any existing action or proceeding with respect to the Company or any of its
Subsidiaries; or
(b) there shall have been any material change, or development involving a
prospective change, in the business or financial affairs of the Company or
any of its Subsidiaries which, in the reasonable judgment of the Company,
could reasonably be expected to materially impair the ability of the
Company to proceed with the Exchange Offer or materially impair the
contemplated benefits of the Exchange Offer to the Company; or
(c) there shall have been proposed, adopted or enacted any law, statute,
rule or regulation which, in the judgment of the Company, could reasonably
be expected to materially impair the ability of the Company to proceed with
the Exchange Offer or materially impair the contemplated benefits of the
Exchange Offer to the Company; or
(d) any governmental approval which the Company shall, in its reasonable
discretion, deem necessary for the consummation of the Exchange Offer as
contemplated hereby shall have not been obtained.
If the Company determines in its reasonable discretion that any of these
conditions are not satisfied, the Company may (i) refuse to accept any Old
Notes and return all tendered Old Notes to the tendering holders, (ii) extend
the Exchange Offer and retain all Old Notes tendered prior to the expiration
of the Exchange Offer, subject, however, to the rights of holders to withdraw
such Old Notes (see "The Exchange Offer--Withdrawal of Tenders") or (iii)
waive such unsatisfied conditions with respect to the Exchange Offer and
accept all properly tendered Old Notes which have not been withdrawn. If such
waiver constitutes a material change to the Exchange Offer, the Company will
promptly disclose such waiver by means of a prospectus supplement that will be
distributed to the registered holders of the Old Notes, and the Company will
extend the Exchange Offer for a period of five to ten business days, depending
upon the significance of the waiver and the manner of disclosure to the
registered holders, if the Exchange Offer would otherwise expire during such
five to ten business day period.
Holders may have certain rights and remedies against the Company under the
Notes Registration Rights Agreement should the Company fail to consummate the
Exchange Offer, notwithstanding a failure of the conditions stated above. See
"Description of the Notes." Such conditions are not intended to modify those
rights or remedies in any respect.
The foregoing conditions are for the sole benefit of the Company and may be
asserted by the Company regardless of the circumstances giving rise to such
condition or may be waived by the Company in whole or in part at any time and
from time to time in the Company's reasonable discretion. The failure by the
Company at any time to exercise the foregoing rights shall not be deemed a
waiver of any such right and each such right shall be deemed an ongoing right
which may be asserted at any time and from time to time.
TERMINATION OF REGISTRATION RIGHTS
All rights under the Notes Registration Rights Agreement (including
registration rights) of holders of the Old Notes eligible to participate in
this Exchange Offer will terminate upon consummation of the Exchange Offer
except with respect to the Company's continuing obligations (i) to indemnify
the holders (including any broker-dealers) and certain parties related to the
holders against certain liabilities (including liabilities under the
Securities Act), (ii) to provide, upon the request of any holder of any
transfer-restricted Old Notes, certain information in order to permit resales
of such Old Notes pursuant to Rule 144A, (iii) to use its best efforts to
47
<PAGE>
keep the Exchange Offer Registration Statement effective and to amend and
supplement this Prospectus in order to permit this Prospectus to be lawfully
delivered by all persons subject to the prospectus delivery requirements of
the Securities Act for such period of time as is necessary to comply with
applicable law in connection with any resale of the Exchange Notes; provided,
however, that such period shall not exceed 180 days after the Exchange Offer
has been consummated. Insofar as indemnification for liabilities arising under
the Securities Act may be permitted pursuant to the foregoing provisions, the
Company has been informed that in the opinion of the Commission such
indemnification is against public policy as expressed in the Securities Act
and is therefore unenforceable.
EXCHANGE AGENT
State Street Bank and Trust Company has been appointed as Exchange Agent for
the Exchange Offer. All questions and requests for assistance as well as
correspondence in connection with the Exchange Offer and the Letter of
Transmittal should be addressed to the Exchange Agent, as follows:
State Street Bank and Trust Company
Goodwin Square
225 Asylum Street
23rd Floor
Hartford, CT 06103
Requests for additional copies of this Prospectus, the Letter of Transmittal
or the Notice of Guaranteed Delivery should be directed to the Exchange Agent.
FEES AND EXPENSES
The expenses of soliciting tenders will be borne by the Company. The
principal solicitation is being made by mail; however, additional solicitation
may be made by telecopy, telephone or in person by officers and regular
employees of the Company and its affiliates.
The Company has not retained any dealer-manager or other soliciting agent in
connection with the Exchange Offer and will not make any payments to brokers,
dealers or others soliciting acceptance of the Exchange Offer. The Company,
however, will pay the Exchange Agent reasonable and customary fees for its
services and will reimburse it for its reasonable out-of-pocket expenses in
connection therewith.
The cash expenses to be incurred in connection with the Exchange Offer will
be paid by the Company and are estimated in the aggregate to be approximately
* . Such expenses include fees and expenses of the Exchange Agent and
Trustee, accounting and legal fees and printing costs, among others.
The Company will pay all transfer taxes, if any, applicable to the exchange
of Old Notes pursuant to the Exchange Offer. If, however, a transfer tax is
imposed for any reason other than the exchange of Old Notes pursuant to the
Exchange Offer, then the amount of any such transfer taxes (whether imposed on
the registered holder or any other persons) will be payable by the tendering
holder. If satisfactory evidence of payment of such taxes or exemption
therefrom is not submitted with the Letter of Transmittal, the amount of such
transfer taxes will be billed directly to such tendering holder of Old Notes.
ACCOUNTING TREATMENT
The Exchange Notes will be recorded at the same carrying value as the Old
Notes as reflected in the Company's accounting records on the date of the
exchange. Accordingly, no gain or loss for accounting purposes will be
recognized. The expenses of the Exchange Offer will be amortized over the term
of the Notes.
48
<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 Old Notes as if such transaction
had occured on September 30, 1997. See "Use of Proceeds," "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 outstanding.... -- --
Common Stock, no par value; 150,000,000 shares
authorized; 30,768,542 shares issued and out-
standing(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."
49
<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>
50
<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 Old 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 Old 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 Old 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 Old 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 Old Notes
for the nine-months ended September 30, 1997, (ii) the elimination of $2.0
million with respect to the Senior Subordinated Notes, for
51
<PAGE>
the nine-months ended September 30, 1997, (iii) amortization of fees and
costs totaling $0.4 million relating to the Convertible Notes and the
offering of Old 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 Old 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.
52
<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 Company's retail customer base is diversified both geographically
and by customer type. No single retail
53
<PAGE>
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 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>
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 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
54
<PAGE>
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.
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
55
<PAGE>
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 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,
56
<PAGE>
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 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
57
<PAGE>
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, 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 (net of interest income), 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 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.
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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.
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.
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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 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.
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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 Old Notes, with net proceeds of approximately $72.3
million. The Old 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. Cash
interest on the Old Notes will neither accrue nor be payable prior to May 1,
2000. Commencing May 1, 2000, interest will be payable in cash on the Old
Notes semi-annually in arrears on each May 1, and November 1, at a rate of 10
1/2% per annum. The Old 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
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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 Old 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
Old 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 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
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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.
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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.
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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 (IN BILLIONS)(1) DEREGULATION DATE ITO(S)
- ------- ---------------- ----------------- ------
<S> <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,
as early as 1999, its existing exclusive license, 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.
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
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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. 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 NETWORKSM 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
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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 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 Serv-
ice Office).................................. 2,100 April 1999
London, England (Sales and Customer Service
Office)...................................... 1,200 April 2001
Paris, France (Sales and Customer Service Of-
fice)........................................ 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.
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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 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.
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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 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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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 $183,732(2)
DeAngelis(1)...........
Vice President--Sales &
Marketing
</TABLE>
- --------
(1) Mr. DeAngelis was employed by the Company from 1993 until May 30, 1997.
(2) Represents payments by the Company for earned commissions.
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STOCK OPTION GRANTS
The following table sets forth certain information regarding grants of
options to purchase Common Stock made by the Company during the fiscal year
ended December 31, 1996 to each of the Named Officers. No stock appreciation
rights were granted during 1996.
OPTION GRANTS IN 1996 INDIVIDUAL GRANTS
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE AT
NUMBER OF PERCENT OF ASSUMED ANNUAL RATES OF STOCK
SECURITIES TOTAL OPTIONS PRICE APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM ($)(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
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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 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
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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 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
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<PAGE>
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 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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<PAGE>
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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<PAGE>
DESCRIPTION OF THE NOTES
The Old Notes were and the Exchange Notes will be issued under the
Indenture. The form and terms of the Exchange Notes will be the same as the
form and terms of the Old Notes except that (i) the Exchange Notes will be
registered under the Securities Act and, therefore, will not bear legends
restricting the transfer thereof and (ii) holders of the Exchange Notes will
not be entitled to certain rights of holders of the Old Notes under the Notes
Registration Rights Agreement, which will terminate upon consummation of the
Exchange Offer. 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 Notes," the "Company" means Telegroup, Inc. and
excludes its Subsidiaries.
GENERAL
The Old Notes are and the Exchange Notes will be unsecured unsubordinated
obligations of the Company. The 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 Notes. As of September 30, 1997, after giving pro forma
effect to the offering of the Old Notes and the transactions described herein,
the Company would have had $25.0 million of Indebtedness outstanding ranking
subordinate to the Notes. The 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 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 Notes will be payable, and the 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 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 Notes. The Company may change any paying agent and
registrar without notice to the holders.
MATURITY, INTEREST AND PRINCIPAL
The 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 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 Notes will not be entitled to the benefit of any mandatory sinking fund.
OPTIONAL REDEMPTION
The Indenture will provide that the Notes will not be redeemable prior to
November 1, 2001. On and after November 1, 2001 the 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
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amount) set forth below, plus accrued and unpaid interest, if any, to 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 Notes originally issued at a redemption price equal to
110.5% of the Accreted Value on the date of redemption of the 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 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 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 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 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 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
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 Notes as described above.
SELECTION AND NOTICE
The Indenture will provide that in the event that less than all of the Notes
are to be redeemed at any time, selection of such 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 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 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 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 Notes or portions thereof called for redemption, unless the Company
defaults in the payment of the redemption price therefor.
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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 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;
(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 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
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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 Notes and has an Average Life to Stated Maturity
longer than the Notes;
(i) Indebtedness of the Company, to the extent that the net proceeds
thereof are promptly (A) used to repurchase Notes tendered in an Change of
Control Offer or (B) deposited to defease all of the Notes as described
below under "Defeasance or Covenant Defeasance of Indenture";
(j) Indebtedness of a Subsidiary represented by a guarantee of the 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 Notes in the same manner and to the same
extent that the Subordinated Indebtedness being refinanced is subordinated
to the 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.
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
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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 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.
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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 Notes,
(y) has an Average Life to Stated Maturity equal to or greater than the
remaining Average Life to Stated Maturity of the Notes and (z) is subordinated
to the 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 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 Notes are equally and
ratably secured, except for (a) Liens existing as of the Issue Date; (b) Liens
securing the 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" 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
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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 Notes, not more than 40 Business Days thereafter, an aggregate
principal amount of 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 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 Notes validly
tendered and not withdrawn by holders thereof exceeds the Excess Proceeds,
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 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 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
Notes, any such assumption, guarantee or other 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
Notes substantially to the same extent as such Indebtedness is subordinated to
the 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
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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
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 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
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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 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 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 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 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 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
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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
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 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 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
(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 Notes
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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 Notes due and payable immediately, upon which declaration,
all amounts payable in respect of the 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 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 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 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 Notes, (iii) the principal of and premium, if any, on any Notes which
have become due otherwise than by such declaration of acceleration and
interest thereon at the rate borne by the 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 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 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 Notes may on behalf of the holders of all the 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 Notes has any right to institute any proceeding with
respect to the Indenture or the Notes or any remedy thereunder, unless the
holders of at least 25% in aggregate principal amount of the outstanding Notes
have made written request, and offered reasonable indemnity, to the Trustee to
institute such proceeding as Trustee under the 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 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 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 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 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 Notes, the Trustee may withhold the
notice to the holders of such 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 Notes.
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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 Notes ("defeasance"). Such
defeasance means that the Company shall be deemed to have paid and discharged
the entire Indebtedness represented by the outstanding Notes, except for (i)
the rights of holders of outstanding Notes to receive payment in respect of
the principal of, premium, if any, and interest on such Notes when such
payments are due, (ii) the Company's obligations to issue temporary Notes,
register the transfer or exchange of any Notes, replace mutilated, destroyed,
lost or stolen Notes and maintain an office or agency for payments in respect
of the 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 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 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 Notes to redemption or maturity (except lost,
stolen or destroyed 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 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 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
Notes, as expressly provided for in the Indenture) as to all outstanding Notes
when (i) either (a) all the Notes theretofore authenticated and delivered
(except lost, stolen or destroyed Notes which have been replaced or repaid and
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 Notes not theretofore delivered to the Trustee for
cancellation (except lost, stolen or destroyed Notes which have been replaced
or paid) have been called for redemption pursuant to the terms of the 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
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pay and discharge the entire Indebtedness on the Notes not theretofore
delivered to the Trustee for cancellation, for principal of, premium, if any,
and interest on the 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 Notes, amend, waive or supplement the Indenture or the 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 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
Notes. Other amendments and modifications of the Indenture or the 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
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 Notes, (ii) change the currency in which any
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 Notes that must consent to an amendment, supplement or waiver or
consent to take any action under the Indenture or the Notes, (iv) impair the
right to institute suit for the enforcement of any payment on or with respect
to the Notes, (v) waive a default in payment with respect to the 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 Notes, or (ix) modify or change
any provision of the Indenture affecting the ranking of the Notes in a manner
adverse to the holders of the Notes.
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 Notes are governed by the laws of the State of New
York, without regard to the principles of conflicts of law.
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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 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 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 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.
"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.
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"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.
"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/VMIG1/MIG1 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
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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.
"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.
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"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.
"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.
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"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, 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.
"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.
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"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 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 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.
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"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;
(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.
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"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.
"Subordinated Indebtedness" means Indebtedness of the Company which is
expressly subordinated in right of payment to the 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
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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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DESCRIPTION OF OTHER INDEBTEDNESS
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 respective properties and shall not be discharged or fully bonded and
there shall have been a period of 60
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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).
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;
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(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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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
THE SUMMARY OF FEDERAL INCOME TAX CONSEQUENCES SET FORTH BELOW IS FOR
GENERAL INFORMATION ONLY. PROSPECTIVE PURCHASERS OF THE NOTES ARE URGED TO
CONSULT THEIR OWN TAX ADVISORS AS TO THE PRECISE FEDERAL, STATE, LOCAL AND
OTHER TAX CONSEQUENCES OF ACQUIRING, OWNING AND DISPOSING OF THE NOTES.
The following discussion summarizes certain material United States federal
income tax consequences to beneficial owners arising from the exchange of Old
Notes for Exchange Notes and the purchase, ownership and disposition of the
Notes. The discussion which follows is based on the United States Internal
Revenue Code of 1986, as amended (the "Code"), the Treasury regulations
promulgated thereunder, and judicial and administrative interpretations
thereof, all as in effect on the date hereof, and such authorities may be
repealed, revoked or modified so as to result in federal income tax
consequences different from those discussed below, possibly with retroactive
effect. In addition, the recently enacted Taxpayer Relief Act of 1997 could
affect an investment in Notes in that, among other things, it reduces the rate
of federal income tax imposed on capital gains of individual taxpayers for
capital assets held more than eighteen months (and reduces such rate even
further for capital assets acquired after the year 2000 and held more than
five years). HOLDERS ARE URGED TO CONSULT THEIR TAX ADVISORS CONCERNING THE
FEDERAL INCOME TAX CONSIDERATIONS THAT MAY BE SPECIFIC TO THEM OF THE EXCHANGE
OF OLD NOTES FOR EXCHANGE NOTES AND THE OWNERSHIP OF THE EXCHANGE NOTES AS
WELL AS ANY TAX CONSEQUENCES ARISING UNDER THE LAW OF ANY OTHER TAXING
JURISDICTION.
For purposes of this summary, the term "U.S. Holder" means a beneficial
owner of a Note that is (a) an individual who is a United States citizen or
resident, (b) a corporation, partnership or other entity created or organized
under the laws of the United States or any political subdivision thereof, or
(c) an estate or trust the income of which is subject to federal income tax
regardless of source. The term "Non-U.S. Holder" means a beneficial owner of a
Note that is not a U.S. Holder.
The discussion which follows is intended as a descriptive summary only and
is not a complete analysis or listing of all potential United States federal
income tax consequences to U.S. Holders relating to the Notes. The discussion
is not intended as tax advice to any particular investor and does not address
the effect of any United States state or local tax law or foreign tax law on
the Notes.
This summary is generally limited to investors who will hold the Notes as
"capital assets" within the meaning of Section 1221 of the Code and whose
functional currency is the United States Dollar. This summary does not address
the tax treatment of U.S. Holders that may be subject to special income tax
rules such as insurance companies, tax-exempt organizations, banks, U.S.
Holders subject to the alternative minimum tax, U.S. Holders and Non-U.S.
Holders that are broker-dealers in securities, Non-U.S. Holders that own
(directly, indirectly or by attribution) 10 percent or more of the outstanding
stock of the Company, and U.S. Holders that hold the Notes as a hedge against
currency risks, as a position in a "straddle" for tax purposes, or as part of
an "integrated transaction".
EXCHANGE OF NOTES
There should be no federal income tax consequences to holders exchanging Old
Notes for Exchange Notes pursuant to the Exchange Offer since the Exchange
Offer will not result in any material alteration in the terms of the Old
Notes. Each exchanging holder will have the same adjusted tax basis and
holding period in the Exchange Notes as it had in the Old Notes immediately
before the exchange. Because the Exchange Notes are deemed to be the same as
Old Notes for federal income tax purposes, the tax consequences are the same
for both Notes.
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U.S. HOLDERS
Original Issue Discount. The Notes will be issued at a discount from their
stated principal amount. In addition, stated interest on the Notes is not
payable until May, 2000 (see "Description of the Notes--Maturity, Interest and
Principal"). As a result, the stated interest on the Notes will not be
"qualified stated interest" and, therefore, the Notes will be issued with
original issue discount ("OID"). "Qualified stated interest" generally means
stated interest that is unconditionally payable at least annually at a single
fixed rate applied to the outstanding principal amount of the Note.
U.S. Holders must generally include OID in gross income for federal income
tax purposes on an annual basis under a constant yield method. As a result,
U.S. Holders may be required to include OID in income in advance of the
receipt of cash attributable to the stated interest. However, U.S. Holders
generally will not be required to include separately in income cash payments
received on the Notes, even if denominated as interest.
The aggregate amount of OID on each Note will equal the excess of such
Note's stated redemption price at maturity (which will be equal to the sum of
the Note's stated principal amount plus all payments of stated interest) over
such Note's issue price. Generally, the "issue price" of a debt instrument
will equal the first price at which a substantial amount of such debt
instruments included in the issue of which the debt instrument is a part are
sold (ignoring sales to bond houses, brokers, or similar persons or
organizations acting in the capacity of underwriters, placement agents, or
wholesalers).
The amount of OID includible in income by a U.S. Holder of a Note is the sum
of the "daily portions" of OID with respect to the Note for each day during
the taxable year or portion of the taxable year in which such U.S. Holder held
such Note. The daily portion is determined by allocating to each day in any
"accrual period" a pro rata portion of the OID allocable to that accrual
period. The "accrual period" for a Note may be of any length and may vary in
length over the term of the Note, provided that each accrual period is no
longer than one year and each scheduled payment of principal or interest
occurs on the first day or the final day of an accrual period. In general, the
amount of OID allocable to an accrual period is an amount equal to the product
of the Note's adjusted issue price at the beginning of such accrual period and
its yield to maturity (determined on the basis of compounding at the close of
each accrual period and properly adjusted for the length of the accrual
period). The Notes' yield to maturity is, rounded to two decimal places,
10.50%, based on the issue price and computed on the basis of semi-annual
compounding. Special rules apply for calculating OID for an initial short
accrual period. OID allocable to a final accrual period is the difference
between the amount payable at maturity and the adjusted issue price at the
beginning of the final accrual period. The "adjusted issue price" of a Note at
the beginning of any accrual period is equal to its issue price increased by
the accrued OID for each prior accrual period (determined without regard to
the amortization of any acquisition premium, as described below) and reduced
by any payments made on such Note on or before the first day of the accrual
period.
Under certain circumstances relating to the Exchange Offer (see "Description
of the Notes--Registration Rights"), the Company will be required to make an
additional cash payment, as liquidated damages, to holders of the Notes
("Liquidated Damages"). Treasury regulations provide that in the case of a
debt instrument such as a Note that provides for an alternative payment
schedule applicable upon the occurrence of one or more contingencies, the
yield and maturity of such debt instrument for purposes of calculating the
amount of OID are determined by assuming that the payments will be made
according to the stated payment schedule of the debt instrument if, based on
all the facts and circumstances as of the closing date, such payment schedule
is significantly more likely than not to occur. The Company has determined
that it is significantly more likely than not that Liquidated Damages will not
be required to be paid. As a result, the Company will calculate OID with
respect to the Notes by assuming that no Liquidated Damages will be paid.
There can be no assurance that the IRS could not successfully assert that such
amounts must be included in computing the yield to maturity. If Liquidated
Damages become payable, then solely for purposes of the accrual of OID, the
yield and maturity of the Notes will be redetermined by treating the Notes as
retired and then reissued on the date that the registration requirement is not
met for an amount equal to its adjusted issue price on that date.
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The Notes are redeemable at the option of the Company, in whole or in part
and subject to certain conditions (see "Description of the Notes--Optional
Redemption"). For purposes of computing the Notes' yield to maturity, the
Company will be deemed to exercise or not exercise its option to redeem the
Notes in a manner that minimizes the yield on the Notes. The Company's option
to redeem the Notes prior to their stated maturity date at a premium should
not affect the computation of the amount of OID on the Notes.
In the event of a Change of Control, the Company will be required to offer
to repurchase all of the Notes at a purchase price of 101% of the principal
amount thereof, plus accrued and unpaid interest, if any, to the date of
purchase. The right of U.S. Holders to require repurchase upon a Change of
Control will not affect the yield or maturity date of the Notes provided that,
based on all the facts and circumstances as of the issue date, the payment
schedule on such Notes that does not reflect a Change of Control is
significantly more likely than not to occur. The Company does not intend to
treat the Change of Control provisions of the Notes as affecting the
computation of the amount of OID on the Notes.
Applicable High Yield Discount Obligations. If the yield to maturity on the
Notes equals or exceeds the sum of (x) the "applicable federal rate" (as
determined under Section 1274(d) of the Code) in effect for the month in which
the Notes are issued (the "AFR") and (y) 5%, and the OID on such Notes is
"significant," the Notes will be considered "applicable high yield discount
obligations" ("AHYDOs") under Section 163(i) of the Code. The "applicable
federal rate" is 6.34% for mid-term debt instruments issued in October 1997.
Moreover, if the Notes are characterized as AHYDOs and if the yield to
maturity of a Note exceeds the sum of (x) the AFR and (y) 6 percentage points,
then (1) a portion of such interest corresponding to the yield in excess of
six percentage points above the AFR will not be deductible by the Company at
any time, (2) the remaining portion of any OID will not be deductible until
paid, and (3) a corporate U.S. Holder may be entitled to treat the portion of
the interest that is not deductible by the Company as a dividend, which may
then qualify for the dividends received deduction provided for by the Code. In
such event, corporate U.S. Holders of Notes should consult with their own tax
advisors as to the applicability of the dividends received deduction.
Market Discount. A U.S. Holder that purchases a Note at a market discount
(as described below) generally will be required to treat any principal
payments on, or any gain on the disposition or maturity of, such Note as
ordinary income to the extent of the accrued market discount (not previously
included in income) at the time of such payment or disposition. In general,
market discount is the amount by which the Note's adjusted issue price exceeds
the U.S. Holder's basis in the Note immediately after the Note is acquired,
unless such difference is less than a specified de minimis amount. Market
discount on a Note will accrue ratably, unless the U.S. Holder elects the
constant interest method. This election is irrevocable and applies only to the
Note for which it is made. The U.S. Holder may also elect to include market
discount in income currently as it accrues. This election, once made, applies
to all market discount obligations acquired on or after the first day of the
first taxable year to which the election applies and may not be revoked
without the consent of the Internal Revenue Service ("IRS"). Generally, if a
Note with market discount is transferred in certain non-taxable transactions,
the market discount will be transferred to the property received in exchange
for the Note; however, under certain limited circumstances, the market
discount will be includible as ordinary income as if such Note had been sold
at its fair market value. A U.S. Holder may be required to defer until the
maturity of the Note or, in certain circumstances, its earlier disposition the
deduction for all or a portion of the interest expense attributable to debt
incurred or continued to purchase or carry a Note with market discount, unless
an election to include the market discount on a current basis is made.
Acquisition Premium. A U.S. Holder that purchases a Note for an amount that
is greater than the adjusted issue price of such Note, but that is less than
or equal to the sum of the amounts payable on the Note after the purchase
date, will be considered to have purchased such Note at an "acquisition
premium." Under the acquisition premium rules of the Code and the Treasury
regulations thereunder, the amount of OID which such U.S. Holder must include
in its gross income with respect to such Note will be reduced for each accrual
period by an amount determined by a fraction (1) the numerator of which is the
excess of the adjusted basis of the Note immediately after its acquisition by
such U.S. Holder over the adjusted issue price of the Note, and (2) the
denominator of which is the excess of the sum of all amounts payable on the
Note after the purchase date (other
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than payments of qualified stated interest) over such Note's adjusted issue
price immediately after its acquisition by such U.S. Holder.
Purchase, Sale, Retirement and Other Disposition of the Notes. In general, a
U.S. Holder's adjusted tax basis in a Note will equal the cost of such Note to
the U.S. Holder, increased by the amount of any (i) OID or (ii) market
discount previously included in the U.S. Holder's income with respect to the
Note, and reduced by the amount of any payments made on the Note.
A U.S. Holder will generally recognize gain or loss on the sale, retirement
or other disposition (including redemption) of a Note in an amount equal to
the difference between (i) the amount of cash and the fair market value of
property received by such U.S. Holder on such disposition (less any amounts
attributable to accrued but unpaid interest which will be taxable as such
unless previously taken into account) and (ii) the U.S. Holder's adjusted tax
basis in the Note (as described above). Gain or loss upon the sale, retirement
or other disposition (including redemption) of a Note will be capital gain or
loss if the Note is a capital asset in the hands of the U.S. Holder (except
that any portion of such gain attributable to market discount will be ordinary
income). Under recently enacted legislation, the maximum individual U.S.
federal income tax rate on net capital gains is 20% for capital assets held
for more than 18 months and 28% for capital assets held for more than 12
months but not more than 18 months. Gains on the sale of capital assets held
for one year or less are subject to U.S. federal income tax at ordinary income
tax rates. Certain limitations exist on the deductibility of capital losses by
both corporations and individual taxpayers.
NON-U.S. HOLDERS
Interest (including OID). Under the portfolio interest exemption of the
Code, a Non-U.S. Holder will generally not be subject to U.S. federal income
or withholding tax on payments of principal, premium, if any, and interest
(including OID) on the Notes, provided that (in the case of interest,
including OID) (i) the Non-U.S. Holder does not actually or constructively own
10% or more of the total combined voting power of all classes of stock of the
Company entitled to vote, (ii) the Non-U.S. Holder is not a controlled foreign
corporation that is related to the Company through stock ownership, (iii) such
interest or OID is not effectively connected with a United States trade or
business of the Non-U.S. Holder, (iv) generally either (a) the beneficial
owner of the Notes certifies to the Company or its agent, under penalties of
perjury, that it is a Non-U.S. Holder and provides a completed IRS Form W-8
("Certificate of Foreign Status") or (b) a securities clearing organization,
bank or other financial institution which holds customers' securities in the
ordinary course of its trade or business (a "financial institution") and which
holds the Notes, certifies to the Company or its agent, under penalties of
perjury, that it has received Form W-8 from the beneficial owner or that it
has received from another financial institution a Form W-8 and furnishes the
payor with a copy thereof, and (v) for payments made on or after January 1,
1999, the payment can be reliably associated (within the meaning of applicable
Treasury Regulations) with IRS Form W-8. If any of the situations described in
provision (i), (ii) or (iv) or the preceding sentence do not exist, interest
on the Notes when received is subject to United States withholding tax at the
rate of 30% unless an income tax treaty between the United States and the
country of which the Non-U.S. Holder is a tax resident provides for the
elimination or reduction in the rate of U.S. federal withholding tax.
If a Non-U.S. Holder of a Note is engaged in a trade or business in the
United States and interest (including OID) on the Note is effectively
connected with the conduct of such trade or business, such Non-U.S. Holder,
although exempt from U.S. federal withholding tax by reason of the delivery of
a properly completed Form 4224, will be subject to U.S. federal income tax on
such interest (including OID) and on any gain realized on the sale, exchange
or other disposition of a Note in the same manner as if it were a U.S. Holder.
In addition, if such Non-U.S. Holder is a foreign corporation, it may be
subject to a branch profits tax equal to 30% of its effectively connected
earnings and profits for that taxable year, unless it qualifies for a lower
rate under an applicable income tax treaty.
Sale, Retirement and Other Disposition of Notes. A Non-U.S. Holder generally
will not be subject to U.S. federal income tax on any gain realized in
connection with the sale, exchange, retirement or other disposition of
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Notes, unless (i) (a) the gain is effectively connected with a trade or
business carried on by the Non-U.S. Holder within the United States or, (b) if
a tax treaty applies, the gain is attributable to the United States permanent
establishment maintained by the Non-U.S. Holder, (ii) in the case of a Non-
U.S. Holder who is an individual, such holder is present in the United States
for 183 days or more in the taxable year of disposition and certain other
conditions are satisfied, or (iii) the Non-U.S. Holder is subject to tax
pursuant to provisions of the Code applicable to United States expatriates.
On October 6, 1997, the Treasury Department issued final regulations 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.
UNITED STATES INFORMATION REPORTING AND BACKUP WITHHOLDING
In general, under current U.S. federal tax law, payments to a U.S. Holder of
(a) principal, premium (if any) and interest (including OID) on a Note, and
(b) the proceeds of sale or other disposition of a Note before maturity will
be subject to U.S. information reporting requirements. Subject to certain
exceptions, such payments will also generally be subject to "backup"
withholding tax at a rate of 31% if such U.S. Holder fails to supply a correct
taxpayer identification number and certain other information in the required
manner. U.S. Holders should consult their own tax advisors regarding their
qualification for exemption from backup withholding and the procedure for
obtaining such an exemption if applicable.
In general, there is no U.S. information reporting requirement or backup
withholding tax on payments to Non-U.S. Holders who provide the appropriate
certification described above regarding qualification for the portfolio
interest exemption from U.S. federal income tax for payments of principal or
interest (including OID) on the Notes.
Payment by the Company of principal on the Notes or payment by a United
States office of a broker of the proceeds of a sale of Notes is subject to
both backup withholding and information reporting unless the beneficial owner
provides a completed IRS Form W-8 which certifies under penalties of perjury
that such owner is a Non-U.S. Holder who meets all the requirements for
exemption from U.S. federal income tax on any gain from the sale, exchange or
retirement of the Notes.
In general, backup withholding and information reporting will not apply to a
payment of the gross proceeds of a sale of Notes effected at a foreign office
of a broker. If, however, such broker is, for U.S. federal income tax
purposes, a U.S. person, a controlled foreign corporation or a foreign person
50% or more of whose gross income for certain periods is derived from
activities that are effectively connected with the conduct of a trade or
business in the United States, such payments will not be subject to backup
withholding, but will be subject to information reporting unless (i) such
broker has documentary evidence in its records that the beneficial owner is a
Non-U.S. Holder and certain other conditions are met, or (ii) the beneficial
owner otherwise establishes an exemption, provided such broker does not have
actual knowledge that the payee is a United States person. 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 and
the procedure for obtaining such an exemption, if available.
On October 6, 1997, the Treasury Department issued final regulations with
respect to the imposition of backup withholding on payments made to foreign
persons. These new regulations will generally be effective for payments made
after December 31, 1998, subject to certain transition rules. In general, the
regulations simplify certain of the certification requirements relating to
foreign persons. Non-U.S. Holders that are subject to withholding are urged to
consult their own tax advisors concerning the applicability of these new
regulations.
Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules will be allowed as a credit against such holder's
U.S. federal income tax liability and may entitle such holder to a refund,
provided the required information is furnished to the IRS.
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BOOK-ENTRY; DELIVERY AND FORM
The Old Notes were issued as single, permanent global certificates in
definitive, fully registered form (the "Old Global Notes"). Except for the
Exchange Notes issued to Non-Global Purchasers (as defined below), the
Exchange Notes will initially be issued in the form of one or more global
certificates (collectively, the "Exchange Global Notes"). The Old Global Notes
were deposited on the date of the closing of the sale of the Old Notes, and
the Exchange Global Notes will be deposited on the date of the closing of the
Exchange Offer with, or on behalf of, The Depository Trust Company ("DTC") and
registered in the name of a nominee of DTC.
Old Notes (i) transferred to "foreign purchasers" or Institutional
Accredited Investors (as defined in Rule 501(a)(1),(2), (3) or (7) promulgated
under the Securities Act) who are not qualified institutional buyers (as
defined in Rule 144A promulgated under the Securities Act)("QIBs"), or (ii)
held by QIBs who elect to take physical delivery of their certificates instead
of holding their interest through the Global Notes and which are thus
ineligible to trade through DTC (collectively referred to herein as the "Non-
Global Purchasers") will be issued, in registered form, without interest
coupons ("Certificated Notes"). Upon a permitted transfer to a QIB of such
Certificated Notes initially issued to a Non-Global Purchaser, such
Certificated Notes will, unless the transferee requests otherwise or the
Global Notes have previously been exchanged in whole for such Certificated
Notes, be exchanged for an interest in the applicable Global Notes. "Global
Notes" means the Old Global Notes or the Exchange Global Notes, as the case
may be.
The Global Notes. The Company expects that pursuant to procedures
established by DTC (i) upon deposit of the Global Notes, DTC or its custodian
will credit, on its internal system, the corresponding principal amount of
Global Notes to the respective accounts of persons who have accounts with such
depositary and (ii) ownership of the Notes will be shown on, and the transfer
of ownership thereof will be effected only through, records maintained by DTC
or its nominee (with respect to interests of participants) and the records of
participants (with respect to interests of persons other than participants).
Such accounts initially will be designated by or on behalf of the Initial
Purchasers and ownership of beneficial interests in the Global Notes will be
limited to persons who have accounts with DTC ("participants") or persons who
hold interests through participants. Qualified institutional buyers may hold
their interests in the Global Notes directly through the DTC if they are
participants in such system, or indirectly through organizations which are
participants in such system.
So long as DTC, or its nominee, is the registered owner or holder of the
Notes, DTC or such nominee will be considered the sole owner or holder of the
Notes represented by the applicable Global Notes for all purposes under the
Indenture. No beneficial owner of an interest in the Global Notes will be able
to transfer such interest except in accordance with DTC's applicable
procedures in addition to those provided for under the Indenture with respect
to the Notes.
Payments of the principal of, premium (if any) and interest on, the Global
Notes will be made to DTC or its nominee, as the case may be, as the
registered owner thereof. None of the Company, the Trustee or any paying agent
will have any responsibility or liability for any aspect of the records
relating to or payments made on account of beneficial ownership interests in
the Global Notes or for maintaining, supervising or reviewing any records
relating to such beneficial ownership interest.
The Company expects that DTC or its nominee, upon receipt of any payment of
the principal of, premium (if any) and interest on, the Global Notes, will
credit participants' accounts with payments in amounts proportionate to their
respective beneficial interests in the principal amount of such Global Note,
as shown on the records of DTC or its nominee. The Company also expects that
payments by participants to owners of beneficial interests in any such Global
Notes held through such participants will be governed by standing instructions
and customary practice, as is now the case with securities held for the
accounts of customers registered in the names of nominees for such customers.
Such payments will be the responsibility of such participants.
138
<PAGE>
Transfers between participants in DTC will be effected in the ordinary way
in accordance with DTC rules and will be settled in clearinghouse funds. If a
holder requires physical delivery of a Certificated Note for any reason,
including to sell Notes to persons in states which require physical delivery
of such securities or to pledge such securities, such holder must transfer its
interest in the applicable Global Note in accordance with the normal
procedures of DTC and the procedures set forth in the Indenture.
DTC has advised the Company that DTC will take any action permitted to be
taken by a holder of Notes (including the presentation of Notes for exchange
as described below) only at the direction of one or more participants to whose
account the DTC interests in the applicable Global Note is credited and only
in respect of such portion of Notes, the aggregate principal amount of Notes
as to which such participant or participants has or have given such direction.
However, if there is an Event of Default under the Indenture, DTC will
exchange the applicable Global Note for Certificated Notes, which it will
distribute to its participants and which, if representing interests in the
applicable Global Note, will be legended as set forth under the heading
"Transfer Restrictions."
DTC has advised the Company as follows: DTC is a limited purpose trust
company organized under the laws of the State of New York, a member of the
Federal Reserve System, a "clearing corporation" within the meaning of the
Uniform Commercial Code and a "Clearing Agency" registered pursuant to the
provisions of Section 17A of the Exchange Act. DTC was created to hold
securities for its participants and facilitate the clearance and settlement of
securities transactions between participants through electronic book-entry
changes in accounts of its participants, thereby eliminating the need for
physical movement of certificates. Participants include securities brokers and
dealers, banks, trust companies and clearing corporations and certain other
organizations. Indirect access to the DTC system is available to others such
as banks, brokers, dealers and trust companies that clear through or maintain
a custodial relationship with a participant, either directly or indirectly
("indirect participants").
Although DTC has agreed to the foregoing procedures in order to facilitate
transfers of interests in the Global Note among participants of DTC, it is
under no obligation to perform such procedures, and such procedures may be
discontinued at any time. Neither the Company nor the Trustee will have any
responsibility for the performance by DTC or its participants or indirect
participants of their respective obligations under the rules and procedures
governing their operations.
Certificated Notes. If DTC is at any time unwilling or unable to continue as
a depositary for any Global Note and a successor depositary is not appointed
by the Company within 90 days, the Company will issue Certificated Notes in
exchange for the Global Notes which will bear the legend referred to under the
heading "Transfer Restrictions."
PLAN OF DISTRIBUTION
Each broker-dealer that receives Exchange Notes for its own account pursuant
to the Exchange Offer must acknowledge that it will deliver a prospectus in
connection with any resale of such Exchange Notes. This Prospectus, as it may
be amended or supplemented from time to time, may be used by a broker-dealer
in connection with resales of Exchange Notes received in exchange for Old
Notes, where such Old Notes were acquired as a result of market-making
activities or other trading activities. The Company has agreed that for a
period of 180 days after the Expiration Date, it will make this Prospectus, as
amended or supplemented, available to any broker-dealer for use in connection
with any such resale.
The Company will not receive any proceeds from any sale of Old Notes by
broker-dealers. Exchange Notes received by broker-dealers for their own
account pursuant to the Exchange Offer may be sold from time to time in one or
more transactions in the over-the-counter market, in negotiated transactions,
through the writing of options on the Exchange Notes, or a combination of such
methods of resale, at market prices prevailing at the time of resale, at
prices related to such prevailing market prices or negotiated prices. Any such
resale may be
139
<PAGE>
made directly to purchasers or to or through brokers or dealers who may
receive compensation in the form of commission or concessions from any such
broker-dealer and/or the purchasers of any such Exchange Notes. Any broker-
dealer that resells Exchange Notes that were received by it for its own
account pursuant to the Exchange Offer and any broker or dealer that
participates in a distribution of such Exchange Notes may be deemed to be an
"underwriter" within the meaning of the Securities Act and any profit on any
such resale of Exchange Notes and any commissions or concessions received by
any such person may be deemed to be underwriting compensations under the
Securities Act. The Letter of Transmittal states that by acknowledging that it
will deliver and by delivering a prospectus, a broker-dealer will not be
deemed to admit that it is an "underwriter" within the meaning of the
Securities Act.
For a period of 180 days after the Expiration Date the Company will promptly
send additional copies of this Prospectus and any amendment or supplement to
this Prospectus to any broker-dealer that requests such documents in the
Letter of Transmittal. The Company has agreed to pay all expenses incident to
the Exchange Offer other than commissions or concessions of any brokers or
dealers and will indemnify the holders of the Old Notes (including any broker-
dealers) against certain liabilities, including liabilities under the
Securities Act.
LEGAL MATTERS
The validity of the Exchange Notes offered hereby will be passed upon for
the Company by Swidler & Berlin, Chartered, Washington, D.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.
140
<PAGE>
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.
141
<PAGE>
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 locations 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.
142
<PAGE>
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 points. 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.
143
<PAGE>
TABLE OF CONTENTS
TELEGROUP, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
----
<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................................................... 3
Disclosure Regarding Forward-Looking Statements......................... 3
Prospectus Summary...................................................... 4
Recent Developments..................................................... 7
Use of Proceeds......................................................... 15
Risk Factors............................................................ 15
The Exchange Offer...................................................... 40
Capitalization.......................................................... 49
Selected Financial Data................................................. 50
Management's Discussion and Analysis of Financial Condition and Results
of Operations......................................................... 53
The Global Telecommunications Industry.................................. 64
Business................................................................ 72
Management.............................................................. 98
Certain Transactions.................................................... 106
Principal Shareholders.................................................. 107
Description of the Notes................................................ 108
Description of Other Indebtedness....................................... 130
Certain United States Federal Income Tax Considerations................. 133
Book-Entry; Delivery and Form........................................... 138
Plan of Distribution.................................................... 139
Legal Matters........................................................... 140
Experts................................................................. 140
Glossary of Terms....................................................... 141
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 20. 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 to 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 Company 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 Company 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 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.
II-1
<PAGE>
ITEM 21. EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
1.1 Purchase Agreement Between the Company, Smith Barney Inc. and BT Alex.
Brown Incorporated Dated October 20, 1997
1.2 Purchase Agreement Between the Company and Smith Barney Inc. dated
September 30, 1997 (Incorporated by reference as Exhibit 1.1 to the
Company's Registration Statement on Form S-1, 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 the Company, Fastnet UK Limited, Telegroup UK
Limited, and Giles Redpath Dated as of November 25, 1997 (Incorporated
by reference as Exhibit 10 to the Company's Form 8-K, filed December
9, 1997, SEC File Number 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,
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,
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
*+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 BT Alex Brown Incorporated Dated as of October 23,
1997
10.14 Registration Rights Agreement Between the Company and Smith Barney
Inc., Dated as of September 30, 1997 (Incorporated by reference as
Exhibt 10.14 to the Company's Registration Statement on Form S-1,
filed on December 22, 1997).
*21.1 Subsidiaries of Telegroup, Inc.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
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
++25.1 Form T-1, Statement of Eligibility of Trustee
27.1 Financial Data Schedule
99.1 Form of Letter of Transmittal
99.2 Form of Notice of Guaranteed Delivery
99.3 Form of Letter to Brokers, Dealers, Commercial Banks, Trust Companies
and Other Nominees.
99.4 Form of Letter to Clients
99.5 Guides for Certification of Taxpayer Identification Number on Form W-9
++99.6 Form T-3, Statement of Qualification of Indenture
</TABLE>
- --------
* Previously filed as Exhibits to Form S-1, SEC Registration Statement File
Number 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 22. UNDERTAKINGS
(a) The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in the volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20 percent change
in the maximum aggregate offering price set forth in the "Calculation
of Registration Fee" table in the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment 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.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
(b)(1) The undersigned Registrant hereby undertakes as follows: that prior
to any public reoffering of the securities registered hereunder through use of
a prospectus which is a part of this registration statement, by any person or
party who is deemed to be an underwriter within the meaning of Rule 145(c),
the issuer undertakes that such reoffering prospectus will contain the
information called for by the applicable registration form with respect to
reofferings by persons who may be deemed underwriters, in addition to the
information called for by the other items of the applicable form.
(2) The Registrant undertakes that every prospectus: (i) that is filed
pursuant paragraph (1) immediately preceding, or (ii) that purports to meet
the requirements of Section 10(a)(3) of the Act and is used in connection
II-3
<PAGE>
with an offering of securities subject to Rule 415, will be filed as a part of
an amendment to the registration statement and will not be used until such
amendment is effective, and that, for purposes of determining any liability
under the Securities Act of 1933, each such post-effective amendment 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.
(c) The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
Registrant's annual report pursuant to Section 13(a) or Section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to Section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement 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.
(d) The undersigned Registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Items 4, 10(b), 11 or 13 of this Form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This includes information contained in documents
filed subsequent to the effective date of the registration statement through
the date of responding to the request.
(e) The undersigned Registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the registration statement when it becomes effective.
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
CLIFFORD REES and Director
(Principal
Executive Officer)
* Vice President--
- ------------------------------------- Finance, Chief
DOUGLAS A. NEISH Financial Officer,
Treasurer and
Director (Principal
Financial Officer)
* Director of Finance
- ------------------------------------- and Controller
GARY KORF (Principal
Accounting Officer)
Senior Vice
- ------------------------------------- President,
RONALD B. STAKLAND International
Services and
Director
* 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.
/s/ Charles Johanson
- -------------------------------------
ATTORNEY-IN-FACT
II-5
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
1.1 Purchase Agreement Between the Company, Smith Barney Inc. and BT Alex.
Brown Incorporated Dated October 20, 1997
1.2 Purchase Agreement Between the Company and Smith Barney Inc. dated
September 30, 1997 (Incorporated by reference as Exhibit 1.1 to the
Company's Registration Statement on Form S-1, 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 the Company, Fastnet UK Limited, Telegroup UK
Limited, and Giles Redpath Dated as of November 25, 1997 (Incorporated
by reference as Exhibit 10 to the Company's
Form 8-K, filed December 9, 1997, SEC File Number 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, 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,
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
*+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
BT Alex Brown Incorporated Dated as of October 23, 1997
10.14 Registration Rights Agreement Between the Company and Smith Barney
Inc., Dated as of
September 30, 1997 (Incorporated by reference as Exhibt 10.14 to the
Company's Registration Statement on Form S-1, filed on December 22,
1997).
*21.1 Subsidiaries of Telegroup, Inc.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
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
++25.1 Form T-1, Statement of Eligibility of Trustee
27.1 Financial Data Schedule
99.1 Form of Letter of Transmittal
99.2 Form of Notice of Guaranteed Delivery
99.3 Form of Letter to Brokers, Dealers, Commercia Banks, Trust Companies
and Other Nominees.
99.4 Form of Letter to Clients
99.5 Guides for Certification of Taxpayer Identification Number on Form W-9
++99.6 Form T-3, Statement of Qualification of Indenture
</TABLE>
- --------
* Previously filed as Exhibits to Form S-1, SEC Registration Statement File
Number 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.
<PAGE>
Exhibit 1.1
$97,000,000
TELEGROUP, INC.
10 1/2% Senior Discount Notes due 2004
PURCHASE AGREEMENT
------------------
October 20, 1997
SMITH BARNEY INC.
BT ALEX. BROWN INCORPORATED
As Initial Purchasers
c/o SMITH BARNEY INC.
388 Greenwich Street
New York, New York 10013
Dear Sirs:
Telegroup, Inc., an Iowa corporation (the "Company"), proposes, upon
the terms and conditions set forth herein, to issue and sell to Smith Barney
Inc. and BT Alex. Brown Incorporated, as the initial purchasers (the "Initial
Purchasers"), $97,000,000 aggregate principal amount at maturity of its 10 1/2%
Senior Discount Notes due 2004 (the "Notes"). The Notes will be issued pursuant
to the provisions of an Indenture, to be dated as of October 23, 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 Purchasers 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 Purchasers 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 October 9, 1997 (the "Preliminary
Offering Memorandum"), and an offering memorandum, dated October 20, 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. 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 Purchasers.
The Company understands that the Initial Purchasers propose to make
offers and sales (the "Exempt Resales") of the Notes purchased by the Initial
Purchasers hereunder only on the terms and in the
<PAGE>
manner set forth in the Offering Memorandum and Section 2 hereof, as soon as the
Initial Purchasers deem advisable after this Agreement has been executed and
delivered, (i) to persons in the United States whom the Initial Purchasers
reasonably believe 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 shall bear the legends set forth in paragraph
five under the section of the Offering Memorandum entitled "Transfer
Restrictions."
It is also understood and acknowledged that holders (including
subsequent transferees) 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 Notes constitute "Transfer Restricted Securities" (as defined in
the Registration Rights Agreement). 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 Purchasers 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, each Initial Purchaser, severally and not
jointly, agrees to purchase from the Company, at a purchase price of $723.09 per
$1,000 principal amount at maturity, the principal amount of Notes set forth
opposite the name of such Initial Purchaser in Schedule I hereto.
(b) The Initial Purchasers have advised the Company that they propose
to offer the Notes for sale upon the terms and conditions set forth in this
Agreement and in the Offering Memorandum. The Initial Purchasers hereby
represent and warrant to, and agree with, the Company that the Initial
Purchasers (i) are 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 (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 Purchasers reasonably believe 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 Purchasers 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 Purchasers have advised the Company that they will
offer the Notes to Eligible Purchasers at a price initially equal to the
Accreted Value of the Notes on the date of sale. Such price may be changed by
the Initial Purchasers at any time thereafter without notice.
2
<PAGE>
3. Delivery of the Notes and Payment Therefor. Delivery to the
Initial Purchasers 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 October 23, 1997 (the "Closing Date"). The place of closing
for the Notes and the Closing Date may be varied by agreement between the
Initial Purchasers and the Company.
The Notes will be delivered to the Initial Purchasers against payment
of the purchase price therefor in immediately available funds. The Notes will
be evidenced by one or more global securities in definitive form (the "Global
Notes") and/or by additional securities in definitive form and will be
registered in the name of Cede & Co. as nominee of The Depositary Trust Company
("DTC") and in the other cases, in such names and in such denominations as the
Initial Purchasers shall request prior to 1:00 p.m., New York City time, on the
second business day preceding the Closing Date, or such other times as otherwise
agreed by the parties hereto. The Notes to be delivered to the Initial
Purchasers shall be made available to the Initial Purchasers 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
Purchasers as follows:
(a) The Company will advise the Initial Purchasers promptly and, if
requested by them, 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 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 to comply with any law.
(b) The Company will furnish to the Initial Purchasers, without
charge, as of the date of the Offering Memorandum, such number of copies of the
Offering Memorandum, and any amendments or supplements thereto, as the Initial
Purchasers 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 Purchasers shall not previously have been advised or to which they 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 Purchasers, without charge,
in such quantities as the Initial Purchasers 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
Purchasers 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 Purchasers 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 Purchasers to
3
<PAGE>
Eligible Purchasers, any event shall occur that in the judgment of the Company
or in the opinion of counsel for the Initial Purchasers should be set forth in
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 Purchasers and dealers a reasonable number of copies thereof. In the
event that the Company and the Initial Purchasers agree that the Offering
Memorandum should be amended or supplemented, the Company, if requested by the
Initial Purchasers, 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 Purchasers and with
their counsel in connection with the qualification of the Notes for offering and
sale by the Initial Purchasers and by dealers under the securities or Blue Sky
laws of such jurisdictions as the Initial Purchasers 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 Purchasers (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 Purchasers 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 Purchasers terminating this Agreement pursuant to
Section 9 or Section 10 hereof) or if this Agreement shall be terminated by the
Initial Purchasers 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 Purchasers 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 under the caption "Use of
Proceeds."
(j) For a period of 90 days from the date of the Offering Memorandum,
the Company will not offer for sale, sell, contract to sell or otherwise dispose
of, directly or indirectly, or announce any offer, sale, contract for sale of or
other disposition of any debt securities substantially similar to the Notes, or
securities exchangeable for, or convertible into, debt securities substantially
similar to the Notes, issued or guaranteed by the Company or any of the
Subsidiaries (as hereinafter defined) without the prior written consent of the
Initial Purchasers.
(k) 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
4
<PAGE>
distribute any offering material in connection with the Exempt Resales.
(l) The Company will use its best efforts to cause the Notes to be
eligible for trading on The PORTAL Market prior to the Closing Date.
(m) 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.
(n) The Company has complied and will comply with all provisions of
Florida Statutes Section 517.075 relating to issuers doing business with Cuba.
(o) 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 Purchasers or
the Eligible Purchasers of the Notes.
(p) The Company agrees to comply with all of the terms and conditions
of the Registration Rights Agreement and all agreements set forth in the
representations and letters of the Company to DTC relating to the approval of
the Notes by DTC for "book entry" transfer.
(q) The Company agrees that prior to any registration of the Notes
pursuant to the Registration Rights Agreement, or at such earlier time as may be
required, the Indenture shall be qualified under the Trust Indenture Act of 1939
(the "1939 Act") and any necessary supplemental indentures will be entered into
in connection therewith.
5. Representations and Warranties of the Company. The Company
represents and warrants to the Initial Purchasers 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
Purchasers 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 Purchasers furnished to the
Company
5
<PAGE>
in writing by or on behalf of the Initial Purchasers expressly for use therein.
(c) 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.
(d) 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 Purchasers 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 (i) the enforcability 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.
(e) All the outstanding shares of capital stock of the Company have
been duly authorized and validly issued, are fully paid and nonassessable and
are free of any preemptive or similar rights and were issued and sold in
compliance with all applicable Federal and state securities laws.
(f) 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").
(g) 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
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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.
(h) There are no legal or governmental proceedings pending or, to the
knowledge of the Company, threatened, against the Company or any of the
Subsidiaries 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.
(i) 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.
(j) Neither the issuance, offer, sale or delivery of the Notes, 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 Notes in accordance with the Registration Rights Agreement,
qualification of the Indenture under the 1939 Act and 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
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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.
(k) The accountants, KPMG Peat Marwick LLP, KPMG Chartered
Accountants and Registered Auditors, and Wisneski, Blakiston & Leslie, P.A.,
have certified or shall certify the financial statements included as part of the
Offering Memorandum (or any amendment or supplement thereto), and, with respect
to KPMG Peat Markwick LLP and Wisneski, Blakiston & Leslie, P.A. are each
independent public accountants under Rule 101 of the AICPA'a Code of
Professional Conduct, and its interpretation and rulings.
(l) The financial statements (historical and pro forma), 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 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. The pro forma
financial data included in the Offering Memorandum have been prepared in
accordance with the Commission's applicable rules and guidelines with respect to
pro forma financial statements. The pro forma adjustments contained therein have
been properly applied to the historical amounts in the compilation of those
statements, and the Company believes that the assumptions used in the
preparation thereof are reasonable. The other financial and statistical
information and data set forth in the Offering Memorandum 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.
(m) 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.
(n) 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.
(o) Each of the Company and the Subsidiaries has good and marketable
title to all property
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<PAGE>
(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.
(p) 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.
(q) 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 conditions that is materially burdensome to the Company or
any of the Subsidiaries. Without limiting the generality of this paragraph 5(q):
(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
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<PAGE>
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 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;
(v) Neither the issuance and sale of the Notes 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.
(r) 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.
(s) 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 law, rule or regulation, which violation
would have a Material Adverse Effect.
(t) 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.
(u) No holder of any security of the Company 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
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the Offering Memorandum.
(v) 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.
(w) The Company is not and, upon sale of the Notes to be issued and
sold 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.
(x) 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 a United States automated interdealer quotation system.
(y) 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
Purchasers or any person acting on their 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.
(z) 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 Purchasers.
(aa) Assuming (i) the Initial Purchasers comply with the covenants
set forth in Section 2 hereof and (ii) that each person to whom the Initial
Purchasers offer, sell or deliver the Notes is a Qualified Institutional Buyer
or an Accredited Investor, the purchase and sale of the Notes pursuant hereto
(including the Initial Purchasers' 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.
(bb) The execution and delivery of this Agreement, the other
Operative Documents and the sale of the Notes to the Initial Purchasers or by
the Initial Purchasers 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."
(cc) The Company is not required to obtain stockholder consent or
approval pursuant to the rules of the Nasdaq National Market in connection with
the offering and sale of the Notes.
(dd) Each of the Company and the Subsidiaries maintains insurance of
the types and in the amounts
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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 each of the Initial Purchasers and each person, if
any, who controls an 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 Purchasers furnished in writing to the Company by or on
behalf of the Initial Purchasers 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 Purchasers (or to the benefit of any person controlling an Initial
Purchaser) on account of any such loss, claim, damage, liability or expense
arising from the sale of the Notes by an 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 such Initial Purchaser sold Notes to that person
without sending or giving at or prior to the 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
Purchasers 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 any of
the Initial Purchasers or any person controlling an Initial Purchaser in respect
of which indemnity may be sought against the Company, the Initial Purchasers 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 Purchasers 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
Purchasers 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 an Initial Purchaser or such controlling person and the indemnifying
parties and the Initial Purchasers 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
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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 Purchasers and controlling persons not having actual or potential
differing interests with the Initial Purchasers or among themselves, which firm
shall be designated in writing by Smith Barney Inc., and that all such
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 Purchasers, 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) Each Initial Purchaser agrees, severally and not jointly, 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 Purchasers furnished in
writing by or on behalf of the Initial Purchasers 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 Purchasers pursuant to this paragraph (c), the Initial
Purchasers 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 Purchasers 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 Purchasers' expense), and the
Company, its directors and officers, and any such controlling person shall have
the rights and duties given to the Initial Purchasers 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 received by the
Company on the one hand and the Initial Purchasers 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 Purchasers 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 Purchasers 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 Purchasers. The relative fault of the
Company on the one hand and the Initial Purchasers 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 Purchasers on the other hand and the parties' relative intent,
knowledge, access to information and opportunity to correct or prevent such
statement or omission.
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(e) The Company and the Initial Purchasers 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, no Initial
Purchaser shall be required to contribute any amount in excess of the amount by
which the total concessions price of the Notes purchased by it and resold
exceeds the amount of any damages which such 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.
(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 Purchasers or any person
controlling an 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
an Initial Purchaser or any person controlling an 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 Purchasers' Obligations. The
obligations of the Initial Purchasers 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 Purchasers 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.
(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
14
<PAGE>
Company or the Subsidiaries not contemplated by the Offering Memorandum
(excluding any amendments or supplements thereto after the date hereof), which
in the opinion of the Initial Purchasers, 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 (excluding any amendments or supplements thereto
after the date hereof) untrue in any material respect or which, in the opinion
of the Company and its counsel or the Initial Purchasers and their 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 Purchasers, materially adversely affect the
market for the Notes.
(c) The Initial Purchasers 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 Purchasers, in the form attached
hereto as Exhibit A.
(d) The Initial Purchasers 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 Purchasers,
in the form attached hereto as Exhibit B.
(e) The Initial Purchasers 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 Purchasers, in the form attached
hereto as Exhibit C.
(f) The Initial Purchasers 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 Purchasers in the form attached
hereto as Exhibit D.
(g) The Initial Purchasers 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 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 Purchasers.
(h) The Initial Purchasers shall have received on the Closing Date an
opinion of Chadbourne & Parke LLP, counsel for the Initial Purchasers, dated the
Closing Date, and addressed to the Initial Purchasers, with respect to certain
matter referred to above and such other related matters as the Initial
Purchasers may request.
(i) The Initial Purchasers shall have received letters addressed to
the Initial Purchasers, and dated the date hereof and the Closing Date from (i)
KPMG Peat Marwick LLP, independant certified public accountants, (ii) KPMG,
Chartered Accountants and Registered Auditors, independant certified public
accountants and (iii) Wisneski, Blakiston & Leslie, P.A., independent certified
public accountants, substantially in the forms heretofore approved by the
Initial Purchasers.
15
<PAGE>
(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 (excluding any amendment or supplement
thereto after the date hereof); (ii) there shall not have been, since the
respective dates as of which information is given in the Offering Memorandum
(excluding any amendment or supplement thereto after the date hereof), except as
may otherwise be stated in the Offering Memorandum (excluding any amendment or
supplement thereto after the date hereof), 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 (excluding any amendment or
supplement thereto after the date hereof); and (iv) all the representations and
warranties of the Company contained in this Agreement shall be true and correct
in all 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
Purchasers 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 Purchasers), 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)The Notes shall have been approved for trading on PORTAL.
(m) 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.
(n) The Company shall have furnished or caused to be furnished to the
Initial Purchasers such further certificates and documents as the Initial
Purchasers 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 Purchasers and counsel for the
Initial Purchasers.
Any certificate or document signed by any officer of the Company and
delivered to the Initial Purchasers, or to counsel for the Initial Purchasers,
shall be deemed a representation and warranty by the Company to the Initial
Purchasers 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 copies of the Offering
Memorandum, the Preliminary Offering Memorandum and all amendments or
supplements to any of them as
16
<PAGE>
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 on the PORTAL market; (vi) the qualification 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 Purchasers relating to the
preparation, printing or reproduction, and delivery of the preliminary and
supplemental Blue Sky Memoranda and such qualification); and (vii) the
performance by the Company of its obligation under the Registration Rights
Agreement; and (viii) the fees and expenses of the Company's accountants and the
fees and expenses of counsel (including local and special counsel) for 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 Purchasers, or by the
Initial Purchasers, 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 Purchasers, without
liability on the part of the Initial Purchasers 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 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 Purchasers, 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 Purchasers. 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 Purchasers. The statements
set forth in the last paragraph on the cover page, the stabilization legend on
page 2 and the fourth paragraph, the eight paragraph and the second sentence of
the fifth paragraph 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 Purchasers 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: Douglas Neish,
Vice President - Finance and Chief Financial Officer, or (ii) if to the Initial
Purchasers, c/o Smith Barney Inc., 388 Greenwich Street, New York, New York
10013, Attention: Manager, Investment Banking Division.
17
<PAGE>
This Agreement has been and is made solely for the benefit of the
Initial Purchasers, 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 Purchasers 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 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.
18
<PAGE>
Please confirm that the foregoing correctly sets forth the agreement
between the Company and the Initial Purchasers.
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:
BT ALEX. BROWN INCORPORATED
By:
Name:
Title:
19
<PAGE>
SCHEDULE I
TELEGROUP, INC.
Principal
Initial Purchaser Amount of Notes
- ----------------- ---------------
Smith Barney Inc. $58,200,000
BT Alex. Brown Incorporated $38,800,000
Total $97,000,000
===========
20
<PAGE>
SCHEDULE II
SUBSIDIARIES OF TELEGROUP, INC.
Global Access Pty Ltd.
PCS Telecom, Inc.
Telecontinent, S.A.
Telegroup Deutschland GmbH (Dusseldorf)
Telegroup Denmark ApS (ApS 235149)
Telegroup Network Services Deuschland GmbH (Dusseldorf)
Telegroup Financial Services Pty Limited
A.C.N. 069159646
Telegroup Italia S.r.l. (109221667)
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. (Geneva)
Telegroup UK Limited
Telegroup UK (No. 2) Limited
Telegroup South Europe, Inc.
Telegroup Technologies, Inc.
21
<PAGE>
Telegroup Technologies Limited
22
<PAGE>
EXHIBIT A
[FORM OF REGISTRATION RIGHTS AGREEMENT]
23
<PAGE>
Exhibit 10.13
================================================================================
NOTES REGISTRATION RIGHTS AGREEMENT
Dated as of October 23, 1997
Between
TELEGROUP, INC.,
as Issuer
and
SMITH BARNEY INC.,
and
BT ALEX. BROWN INCORPORATED,
as Initial Purchasers
================================================================================
<PAGE>
NOTES REGISTRATION RIGHTS AGREEMENT
This Registration Rights Agreement (the "Agreement") is dated as of October
---------
23, 1997, between TELEGROUP, INC., an Iowa corporation (the "Company"), SMITH
-------
BARNEY INC. and BT ALEX. BROWN INCORPORATED (collectively the "Initial
-------
Purchasers").
- ----------
This Agreement is entered into in connection with the Purchase Agreement,
dated October 20, 1997, between the Company and the Initial Purchasers (the
"Purchase Agreement") which provides for the sale by the Company to the Initial
------------------
Purchasers of $97,000,000 aggregate principal amount at maturity of 10 1/2%
Senior Discount Notes due 2004 (the "Notes"). In order to induce the Initial
-----
Purchasers to enter into the Purchase Agreement, the Company has agreed to
provide the Notes registration rights set forth in this Agreement for the
benefit of the Initial Purchasers and their direct and indirect transferees and
assigns. The execution and delivery of this Agreement is a condition to the
Initial Purchasers' obligation to purchase the Notes under the Purchase
Agreement.
The parties hereby agree as follows:
1. Definitions.
------------
As used in this Agreement, the following terms shall have the following
-----------------------------------------------------------------------
meanings:
- ---------
Additional Interest: See Section 4 hereof.
-------------------
Advice: See Section 5 hereof.
------
Agreement: See the introductory paragraphs hereto.
---------
Applicable Period: See Section 2 hereof.
-----------------
Company: See the introductory paragraphs hereto.
-------
Effectiveness Date: With respect to any Registration Statement, the day it
------------------
is declared effective by the SEC.
Effectiveness Deadline: With respect to any Registration Statement, the
----------------------
75th day after the date such Registration Statement was filed.
Effectiveness Period: See Section 3 hereof.
--------------------
Event Date: See Section 4 hereof.
----------
Exchange Act: The Securities Exchange Act of 1934, as amended, and the
------------
rules and regulations of the SEC promulgated thereunder.
Exchange Notes: See Section 2 hereof.
--------------
Exchange Offer: See Section 2 hereof.
--------------
Exchange Registration Statement: See Section 2 hereof.
-------------------------------
Filing Date: The 90th day after the Issue Date.
-----------
Holder: Any holder of a Registrable Note or Registrable Notes.
------
indemnified person: See Section 7(d) hereof.
------------------
indemnifying person: See Section 7(d) hereof.
-------------------
2
<PAGE>
Indenture: The Indenture, of even date herewith, between the Company and
---------
State Street Bank and Trust Company, as Trustee, pursuant to which the Notes are
being issued, as amended or supplemented from time to time in accordance with
the terms thereof.
Initial Effectiveness Deadline: The 180th day after the Issue Date.
------------------------------
Initial Purchasers: See the introductory paragraphs hereto.
------------------
Initial Shelf Registration: See Section 3(a) hereof.
--------------------------
Inspectors: See Section 5(o) hereof.
----------
Issue Date: The actual date of original issuance of the Notes.
----------
NASD: See Section 5(t) hereof.
----
Notes: See the introductory paragraphs hereto.
-----
Participant: See Section 7(a) hereof.
-----------
Participating Broker-Dealer: See Section 2 hereof.
---------------------------
Person: An individual, trustee, corporation, partnership, joint stock
------
company, trust, unincorporated association, union, business association, firm or
other legal entity.
Prepricing Prospectus: The prospectus subject to completion included in
---------------------
any Registration Statement, and as such prospectus shall have been amended from
time to time prior to the date of the Prospectus.
Private Exchange: See Section 2 hereof.
----------------
Private Exchange Notes: See Section 2 hereof.
----------------------
Prospectus: The prospectus included in any Registration Statement
----------
(including, without limitation, any prospectus subject to completion and a
prospectus that includes any information previously omitted from a prospectus
filed as part of an effective registration statement in reliance upon Rule 430A
promulgated under the Securities Act), as amended or supplemented by any
prospectus supplement, and all other amendments and supplements to the
Prospectus, including post-effective amendments, and all material incorporated
by reference or deemed to be incorporated by reference in such Prospectus.
Purchase Agreement: See the introductory paragraphs hereto.
------------------
Records: See Section 5(o) hereof.
-------
Registrable Notes: Each Note upon its original issuance and at all times
-----------------
subsequent thereto, each Exchange Note as to which Section 2(c)(iv) hereof is
applicable upon original issuance and at all times subsequent thereto and each
Private Exchange Note upon original issuance thereof and at all times subsequent
thereto, until in the case of any such Note, Exchange Note or Private Exchange
Note, as the case may be, the earliest to occur of (i) a Registration Statement
(other than, with respect to any Exchange Note as to which Section 2(c)(iv)
hereof is applicable, the Exchange Registration Statement) covering such Note,
Exchange Note or such Private Exchange Note has been declared effective by the
SEC and such Note or such Private Exchange Note, as the case may be, has been
disposed of in accordance with such effective Registration Statement, (ii) such
Note, Exchange Note or Private Exchange Note, as the case may be, may at the
time of determination be sold to the public pursuant to Rule 144(k) promulgated
under the Securities Act without the lapse of any further time or the
satisfaction of any other condition, (iii) such Note has been exchanged for an
Exchange Note or Exchange Notes pursuant to an Exchange Offer which may be
resold without restriction under state and federal securities laws, or (iv) such
Note, Exchange Note or Private Exchange Note, as the case may be, ceases to be
outstanding for purposes of the Indenture.
Registration Statement: Any registration statement of the Company,
----------------------
including, but not limited to, the Exchange
3
<PAGE>
Registration Statement, filed with the SEC pursuant to the provisions of this
Agreement, including the Prospectus, amendments and supplements to such
registration statement, including post-effective amendments, all exhibits, and
all material incorporated by reference or deemed to be incorporated by reference
in such registration statement.
Rule 144: Rule 144 promulgated under the Securities Act, as such Rule may
--------
be amended from time to time, or any similar rule (other than Rule 144A) or
regulation hereafter adopted by the SEC providing for offers and sales of
securities made in compliance therewith resulting in offers and sales by
subsequent holders that are not affiliates of an issuer of such securities being
free of the registration and prospectus delivery requirements of the Securities
Act.
Rule 144A: Rule 144A promulgated under the Securities Act, as such Rule
---------
may be amended from time to time, or any similar rule (other than Rule 144) or
regulation hereafter adopted by the SEC.
Rule 415: Rule 415 promulgated under the Securities Act, as such Rule may
--------
be amended from time to time, or any similar rule or regulation hereafter
adopted by the SEC.
SEC: The Securities and Exchange Commission.
---
Securities Act: The Securities Act of 1933, as amended, and the rules and
--------------
regulations of the SEC promulgated thereunder.
Shelf Notice: See Section 2 hereof.
------------
Shelf Registration: See Section 3(b) hereof.
------------------
Subsequent Shelf Registration: See Section 3(b) hereof.
-----------------------------
TIA: The Trust Indenture Act of 1939, as amended.
---
Trustee: The trustee under the Indenture and, if existent, the trustee
-------
under any indenture governing the Exchange Notes and Private Exchange Notes (if
any).
Underwritten registration or underwritten offering: A registration in
--------------------------------------------------
which securities of the Company are sold to an underwriter for reoffering to the
public.
2. Exchange Offer.
---------------
(a) The Company shall file with the SEC no later than the Filing Date, an
offer to exchange (the "Exchange Offer") any and all of the Registrable Notes
--------------
(other than Private Exchange Notes, if any) for a like aggregate principal
amount of debt securities of the Company which are substantially identical in
all material respects to the Notes (the "Exchange Notes"), except that the
--------------
Exchange Notes shall have been registered pursuant to an effective Registration
Statement under the Securities Act and shall contain no restrictive legend
thereon, and which are entitled to the benefits of the Indenture or a trust
indenture which is identical in all material respects to the Indenture (other
than such changes to the Indenture or any such identical trust indenture as are
necessary to comply with any requirements of the SEC to effect or maintain the
qualification thereof under the TIA) and which, in either case, has been
qualified under the TIA. The Exchange Offer shall be registered under the
Securities Act on the appropriate form (the "Exchange Registration Statement")
-------------------------------
and shall comply with all applicable tender offer rules and regulations under
the Exchange Act and other applicable law. The Company shall use its best
efforts to (x) cause the Exchange Registration Statement to be declared
effective under the Securities Act on or before the Initial Effectiveness
Deadline; (y) keep the Exchange Offer open for at least 30 days (or longer if
required by applicable law) after the date that notice of the Exchange Offer is
mailed to Holders; and (z) consummate the Exchange Offer on or prior to the 30th
day following the Effectiveness Date. For purposes of this Section 2(a) only,
if after such Exchange Registration Statement is initially declared effective by
the SEC, the Exchange Offer or the issuance of the Exchange Notes thereunder is
interfered with by any stop order, injunction or other order or requirement of
the SEC or any other governmental agency or court, such Exchange Registration
Statement shall be deemed not to have become effective for purposes of this
Agreement.
Each Holder who participates in the Exchange Offer will be required to
represent: (i) that any Exchange Notes received by it will be acquired in the
ordinary course of its business; (ii) that at the time of the commencement of
the Exchange Offer such Holder will have no arrangement or understanding with
any Person to participate in the distribution of the Exchange Notes in
4
<PAGE>
violation of the provisions of the Securities Act; and (iii) that such Holder is
not an affiliate of the Company within the meaning of the Securities Act.
No securities other than the Exchange Notes shall be included in the
Exchange Registration Statement.
(b) The Company shall include within the Prospectus contained in the
Exchange Registration Statement a section entitled "Plan of Distribution,"
reasonably acceptable to the Initial Purchasers, which shall contain a summary
statement of the positions taken or policies made by the staff of the SEC with
respect to the potential "underwriter" status of any broker-dealer that is the
beneficial owner (as defined in Rule 13d-3 under the Exchange Act) of Exchange
Notes received by such broker-dealer in the Exchange Offer (a "Participating
-------------
Broker-Dealer"), whether such positions or policies have been publicly
- -------------
disseminated by the staff of the SEC or such positions or policies, in the
judgment of the Initial Purchasers, represent the prevailing views of the staff
of the SEC. Such "Plan of Distribution" section shall also expressly permit the
use of the Prospectus by all Persons subject to the prospectus delivery
requirements of the Securities Act, including all Participating Broker-Dealers,
and include a statement describing the means by which Participating Broker-
Dealers may resell the Exchange Notes.
The Company shall use its best efforts to keep the Exchange Registration
Statement effective and to amend and supplement the Prospectus contained therein
in order to permit such Prospectus to be lawfully delivered by all Persons
subject to the prospectus delivery requirements of the Securities Act for such
period of time as is necessary to comply with applicable law in connection with
any resale of the Exchange Notes; provided, however, that such period shall not
-------- -------
exceed 180 days after the Exchange Offer has been consummated (or such longer
period if extended pursuant to the last paragraph of Section 5 hereof) (the
"Applicable Period").
-----------------
If, prior to consummation of the Exchange Offer, any of the Initial
Purchasers holds any Notes acquired by it and having, or which are reasonably
likely to be determined to have, the status of an unsold allotment in the
initial distribution, or any other Holder is not entitled to participate in the
Exchange Offer, the Company upon the request of any of the Initial Purchasers or
any such Holder shall simultaneously with the delivery of the Exchange Notes in
the Exchange Offer, issue and deliver to the Initial Purchasers and any such
Holder, in exchange (the "Private Exchange") for such Notes held by the Initial
----------------
Purchasers and any such Holder, to the extent and in the manner permitted by
securities laws, a like principal amount of debt securities of the Company that
are identical in all material respects to the Exchange Notes (the "Private
-------
Exchange Notes") (and which are issued pursuant to the same indenture as the
- --------------
Exchange Notes). The Private Exchange Notes shall bear the same CUSIP number as
the Exchange Notes.
In connection with the Exchange Offer, the Company shall:
(1) mail to each Holder a copy of the Prospectus forming part of the
Exchange Registration Statement, together with an appropriate letter of
transmittal and related documents;
(2) utilize the services of a depositary for the Exchange Offer with
an address in the Borough of Manhattan, The City of New York;
(3) permit Holders to withdraw tendered Notes at any time prior to
the close of business, New York time, on the last business day on which the
Exchange Offer shall remain open; and
(4) otherwise comply in all material respects with all applicable
laws, rules and regulations.
As soon as practicable after the close of the Exchange Offer or the
Private Exchange, as the case may be, the Company shall:
(1) accept for exchange all Notes tendered and not validly withdrawn
pursuant to the Exchange Offer or the Private Exchange;
(2) deliver to the Trustee for cancellation all Notes so accepted for
exchange; and
(3) cause the Trustee to authenticate and deliver promptly to each Holder
of Notes, Exchange Notes or Private Exchange Notes, as the case may be, equal in
principal amount to the Notes of such Holder so accepted for exchange.
The Exchange Offer and the Private Exchange shall not be subject to any
conditions, other than that (i) the Exchange Offer or the Private Exchange, as
the case may be, does not violate applicable law or any applicable
interpretation of the staff of the SEC,
5
<PAGE>
(ii) no action or proceeding is instituted or threatened in any court or by any
governmental agency which might materially impair the ability of the Company to
proceed with the Exchange Offer or the Private Exchange and (iii) all
governmental approvals have been obtained, which approvals the Company deems
necessary for the consummation of the Exchange Offer or Private Exchange.
The Exchange Notes and the Private Exchange Notes may be issued under (i)
the Indenture or (ii) an indenture identical in all material respects to the
Indenture, which in either event shall provide that the Exchange Notes shall not
be subject to the transfer restrictions set forth in the Indenture. The
Indenture or such indenture shall provide that the Exchange Notes, the Private
Exchange Notes and the Notes shall vote and consent together on all matters as
one class and that neither the Exchange Notes, the Private Exchange Notes or the
Notes will have the right to vote or consent as a separate class on any matter.
(c) If, (i) because of any change in law or in currently prevailing
interpretations of the staff of the SEC, the Company is not permitted to effect
an Exchange Offer, (ii) the Exchange Offer is not consummated within 160 days of
the Issue Date, (iii) upon the written request of any Holder of Private Exchange
Notes, or (iv) upon the written request of any Holder that participates in the
Exchange Offer, that such Holder did not receive Exchange Notes on the date of
the exchange that may be sold without restriction under state and federal
securities laws, in the case of each of clauses (i) to and including (iv) of
this sentence, then the Company shall promptly deliver to the Holders and the
Trustee written notice thereof (the "Shelf Notice") and shall file a Shelf
------------
Registration pursuant to Section 3 hereof.
(d) Whether or nor it is required to do so by the Exchange Act or the
rules and regulations of the SEC, for so long as any of the Registrable Notes or
Exchange Notes, as applicable, remain outstanding, the Company will furnish to
the holders of the Registrable Notes or Exchange Notes, as applicable, and file
with the SEC (unless the SEC will not accept such a filing) (i) all quarterly
and annual financial information that would be required to be contained in a
filing with the SEC on Forms 10-Q and 10-K if the Company were required to file
such forms and (ii) all reports that would be required to be filed with the SEC
on Form 8-K if the Company were required to file such reports. In addition, for
so long as any of the Registrable Notes remain outstanding, the Company shall
make available to any prospective purchaser of the Registrable Notes or
beneficial owner of the Registrable Notes in connection with any sale thereof
the information required by Rule 144A(d)(4) under the Securities Act.
3. Shelf Registration.
-------------------
If a Shelf Notice is delivered as contemplated by Section 2(c) hereof,
----------------------------------------------------------------------
then:
- -----
(a) Shelf Registration. As promptly as practicable, the Company shall
------------------
file with the SEC a Registration Statement for an offering to be made on a
continuous basis pursuant to Rule 415 covering all of the Registrable Notes (the
"Initial Shelf Registration"). The Initial Shelf Registration shall be on Form
--------------------------
S-1 or another appropriate form permitting registration of such Registrable
Notes for resale by Holders in the manner or manners designated by them
(including, without limitation, one or more underwritten offerings). The
Company shall not permit any securities other than the Registrable Notes to be
included in the Initial Shelf Registration or any Subsequent Shelf Registration
(as defined below).
The Company shall use its best efforts to cause the Initial Shelf
Registration to be declared effective under the Securities Act as soon as
practicable after it is filed and in any event on or prior to the Effectiveness
Deadline with respect thereto and to keep the Initial Shelf Registration
continuously effective under the Securities Act until the date which is 24
months from its Effectiveness Date, subject to extension pursuant to the last
paragraph of Section 5 hereof (the "Effectiveness Period"), or such shorter
--------------------
period ending when (i) all Registrable Notes covered by the Initial Shelf
Registration have been sold in the manner set forth and as contemplated in the
Initial Shelf Registration or (ii) a Subsequent Shelf Registration covering all
of the Registrable Notes has been declared effective under the Securities Act;
provided, however, that the Effectiveness Period shall be extended to the extent
- -------- -------
required to permit dealers to comply with the applicable prospectus delivery
requirements of Rule 174 under the Securities Act and as otherwise provided
herein.
(b) Subsequent Shelf Registrations. If the Initial Shelf Registration or
------------------------------
any Subsequent Shelf Registration ceases to be effective for any reason at any
time during the Effectiveness Period (other than because of the sale of all of
the securities registered thereunder), the Company shall use its best efforts to
obtain the prompt withdrawal of any order suspending the effectiveness thereof,
and in any event shall within 45 days of such cessation of effectiveness amend
the Initial Shelf Registration in a manner to obtain the withdrawal of the order
suspending the effectiveness thereof, or file an additional "shelf" Registration
Statement pursuant to Rule 415 covering all of the Registrable Notes (a
"Subsequent Shelf Registration"). If a Subsequent Shelf Registration is filed,
- ------------------------------
the Company shall use its best efforts to cause the Subsequent Shelf
Registration to be declared effective under the Securities Act as soon as
practicable after such filing and to keep such Registration Statement
continuously effective for a period equal to the number
6
<PAGE>
of days in the Effectiveness Period less the aggregate number of days during
which the Initial Shelf Registration or any Subsequent Shelf Registration was
previously continuously effective. As used herein the term "Shelf Registration"
------------------
means the Initial Shelf Registration and any Subsequent Shelf Registration.
(c) Supplements and Amendments. The Company shall promptly supplement and
--------------------------
amend the Shelf Registration if required by the rules, regulations or
instructions applicable to the registration form used for such Shelf
Registration, if required by the Securities Act, or if reasonably requested by
the Holders of a majority in aggregate principal amount of the Registrable Notes
covered by such Registration Statement or by any underwriter of such Registrable
Notes.
4. Additional Interest.
--------------------
(a) The Company and the Initial Purchasers agree that the Holders of Notes
will suffer damages if the Company fails to fulfill its obligations under
Section 2 or Section 3 hereof and that it would not be feasible to ascertain the
extent of such damages with precision. Accordingly, the Company agrees to pay,
as liquidated damages, additional interest on the Notes ("Additional Interest")
-------------------
under the circumstances and to the extent set forth below:
(i) if (A) neither the Exchange Registration Statement nor the Initial
Shelf Registration has been filed on or prior to the Filing Date or (B)
notwithstanding that the Company has consummated or will consummate an Exchange
Offer, the Company is required to file a Shelf Registration and such Shelf
Registration is not filed on or prior to the Filing Date applicable thereto,
then, commencing on the day after any Filing Date, Additional Interest shall
accrue on the Accreted Value of the Notes at a rate of .50% per annum for the
first 90 days immediately following each such Filing Date, such Additional
Interest rate increasing by an additional .50% per annum at the beginning of
each subsequent 90-day period; or
(ii) if (A) neither the Exchange Registration Statement nor the Initial
Shelf Registration is declared effective by the SEC on or prior to 180 days
after the Issue Date or (B) notwithstanding that the Company has consummated or
will consummate an Exchange Offer, the Company is required to file a Shelf
Registration and such Shelf Registration is not declared effective by the SEC on
or prior to the Effectiveness Deadline in respect of such Shelf Registration,
then, commencing on the day after the date such Registration Statement is
required to be declared effective, Additional Interest shall accrue on the
Accreted Value of the Notes included or which should have been included in such
Registration Statement at a rate of .50% per annum for the first 90 days
immediately following the day after the 180th day after the Issue Date or the
Effectiveness Deadline, as the case may be, such Additional Interest rate
increasing by an additional .50% per annum at the beginning of each subsequent
90-day period; or
(iii) if (A) the Company has not exchanged Exchange Notes for all Notes
validly tendered in accordance with the terms of the Exchange Offer on or prior
to the 30th day after the Effectiveness Date of the Exchange Registration
Statement or (B) if applicable, the Shelf Registration has been declared
effective and such Shelf Registration ceases to be effective at any time during
the Effectiveness Period (other than after such time as all Notes have been
disposed of thereunder), then Additional Interest shall accrue on the Accreted
Value of the Notes at a rate of .50% per annum for the first 90 days commencing
on the (x) 31st day after such Effectiveness Date, in the case of (A) above, or
(y) the day such Shelf Registration ceases to be effective in the case of (B)
above, such Additional Interest rate increasing by an additional .50% per annum
at the beginning of each such subsequent 90-day period;
provided, however, that the Additional Interest rate on the Notes may not exceed
- -------- -------
in the aggregate 2.0% per annum; provided, further, however, that (1) upon the
-------- ------- -------
filing of the Exchange Registration Statement or the Shelf Registration as
required hereunder (in the case of clause (i) of this Section 4), (2) upon the
effectiveness of the Exchange Registration Statement or the Shelf Registration
as required hereunder (in the case of clause (ii) of this Section 4), or (3)
upon the exchange of Exchange Notes for all Notes tendered (in the case of
clause (iii)(A) of this Section 4), or upon the effectiveness of the Shelf
Registration which had ceased to remain effective (in the case of (iii)(B) of
this Section 4), Additional Interest on the Notes as a result of such clause (or
the relevant subclause thereof), as the case may be, shall cease to accrue.
(b) The Company shall notify the Trustee within one business day after
each and every date on which an event occurs in respect of which Additional
Interest is required to be paid (an "Event Date"). Any amounts of Additional
----------
Interest due pursuant to (a)(i), (a)(ii) or (a)(iii) of this Section 4 will be
payable in cash on May 1 and November 1 of each year to the holders of record on
the preceding April 15 or October 15, respectively, commencing with the first
such date occurring after any such Additional Interest commences to accrue. The
amount of Additional Interest will be determined by multiplying the applicable
Additional Interest rate by the Accreted Value of the Registrable Notes,
multiplied by a fraction, the numerator of which is the number of days such
Additional Interest rate was applicable during such period (determined on the
basis of a 360-day year comprised of twelve 30-day
7
<PAGE>
months and, in the case of a partial month, the actual number of days elapsed),
and the denominator of which is 360.
5. Registration Procedures.
------------------------
In connection with the filing of any Registration Statement pursuant to
Sections 2 or 3 hereof, the Company shall effect such registrations to permit
the sale of the securities covered thereby in accordance with the intended
method or methods of disposition thereof, and pursuant thereto and in connection
with any Registration Statement filed by the Company hereunder the Company
shall:
(a) Prepare and file with the SEC within the time periods specified
herein, a Registration Statement or Registration Statements as prescribed by
Sections 2 or 3 hereof, and use its diligent best efforts to cause each such
Registration Statement to become effective and remain effective as provided
herein; provided, however, that, if (1) such filing is pursuant to Section 3
-------- -------
hereof, or (2) a Prospectus contained in an Exchange Registration Statement
filed pursuant to Section 2 hereof is required to be delivered under the
Securities Act by any Participating Broker-Dealer who seeks to sell Exchange
Notes during the Applicable Period, before filing any Registration Statement or
Prospectus or any amendments or supplements thereto, the Company shall furnish
to and afford the Holders of the Registrable Notes covered by such Registration
Statement or each such Participating Broker-Dealer, as the case may be, their
counsel and the managing underwriters, if any, a reasonable opportunity to
review copies of all such documents (including copies of any documents to be
incorporated by reference therein and all exhibits thereto) proposed to be filed
(in each case at least five business days prior to such filing, or such later
date as is reasonable under the circumstances). The Company shall not file any
Registration Statement or Prospectus or any amendments or supplements thereto if
the Holders of a majority in aggregate principal amount of the Registrable Notes
covered by such Registration Statement, or any such Participating Broker-Dealer,
as the case may be, their counsel, or the managing underwriters, if any, shall
reasonably object.
(b) Prepare and file with the SEC such amendments and post-effective
amendments to each Shelf Registration or Exchange Registration Statement, as the
case may be, as may be necessary to keep such Registration Statement
continuously effective for the Effectiveness Period or the Applicable Period, as
the case may be; cause the related Prospectus to be supplemented by any
Prospectus supplement required by applicable law, and as so supplemented to be
filed pursuant to Rule 424 (or any similar provisions then in force) promulgated
under the Securities Act; and comply with the provisions of the Securities Act
and the Exchange Act applicable to it with respect to the disposition of all
securities covered by such Registration Statement as so amended or in such
Prospectus as so supplemented and with respect to the subsequent resale of any
securities being sold by a Participating Broker-Dealer covered by any such
Prospectus. The Company shall be deemed not to have used its diligent best
efforts to keep a Registration Statement effective during the Applicable Period
if the Company voluntarily takes any action that would result in selling Holders
of the Registrable Notes covered thereby or Participating Broker-Dealers seeking
to sell Exchange Notes not being able to sell such Registrable Notes or such
Exchange Notes during that period unless (i) such action is required by
applicable law or (ii) such action is taken by the Company in good faith and for
valid business reasons (not including avoidance of the Company's obligations
hereunder), including, without limitation, the acquisition or divestiture of
assets, a merger, consolidation or other business combination or any financing
transaction.
(c) If (1) a Shelf Registration is filed pursuant to Section 3 hereof, or
(2) a Prospectus contained in an Exchange Registration Statement filed pursuant
to Section 2 hereof is required to be delivered under the Securities Act by any
Participating Broker-Dealer who seeks to sell Exchange Notes during the
Applicable Period, notify the selling Holders of Registrable Notes, or each such
Participating Broker-Dealer, as the case may be, their counsel and the managing
underwriters, if any, promptly (but in any event within two business days), and
confirm such notice in writing, (i) when a Prospectus or any Prospectus
supplement or post-effective amendment has been filed, and, with respect to a
Registration Statement or any post-effective amendment, when the same has become
effective under the Securities Act (including in such notice a written statement
that any Holder may, upon request, obtain, at the sole expense of the Company,
one conformed copy of such Registration Statement or post-effective amendment
including financial statements and schedules, documents incorporated or deemed
to be incorporated by reference and exhibits), (ii) of the issuance by the SEC
of any stop order suspending the effectiveness of a Registration Statement or of
any order preventing or suspending the use of any preliminary prospectus or the
initiation of any proceedings for that purpose, (iii) if at any time when a
prospectus is required by the Securities Act to be delivered in connection with
sales of the Registrable Notes or resales of Exchange Notes by Participating
Broker-Dealers the representations and warranties of the Company contained in
any agreement (including any underwriting agreement), contemplated by Section
5(n) hereof cease to be true and correct in all material respects, (iv) of the
receipt by the Company of any notification with respect to the suspension of the
qualification or exemption from qualification of a Registration Statement or any
of the Registrable Notes or the Exchange Notes to be sold by any Participating
Broker-Dealer for offer or sale in any jurisdiction, or the initiation or
threatening of any proceeding for such purpose, (v) of the happening of any
event, or any information becoming known to the Company that makes any statement
made in such Registration Statement or
8
<PAGE>
related Prospectus or any document incorporated or deemed to be incorporated
therein by reference untrue in any material respect or that requires the making
of any changes in or amendments or supplements to such Registration Statement,
Prospectus or documents so that, in the case of the Registration Statement, it
will not contain any untrue statement of a material fact or omit to state any
material fact required to be stated therein or necessary to make the statements
therein not misleading, and that in the case of the Prospectus, it will not
contain any untrue statement of a material fact or omit to state any material
fact required to be stated therein or necessary to make the statements therein,
in light of the circumstances under which they were made, not misleading, and
(vi) of the Company's determination that a post-effective amendment to a
Registration Statement would be appropriate.
(d) If (1) a Shelf Registration is filed pursuant to Section 3 hereof, or
(2) a Prospectus contained in an Exchange Registration Statement filed pursuant
to Section 2 hereof is required to be delivered under the Securities Act by any
Participating Broker-Dealer who seeks to sell Exchange Notes during the
Applicable Period, use its diligent best efforts to prevent the issuance of any
order suspending the effectiveness of a Registration Statement or of any order
preventing or suspending the use of a Prospectus or suspending the qualification
(or exemption from qualification) of any of the Registrable Notes or the
Exchange Notes to be sold by any Participating Broker-Dealer, for sale in any
jurisdiction (subject to the final proviso of Section 5(h)), and, if any such
order is issued, to use its diligent best efforts to obtain the withdrawal of
any such order at the earliest practicable moment.
(e) If a Shelf Registration is filed pursuant to Section 3 and if
requested by the managing underwriter or underwriters (if any), the Holders of a
majority in aggregate principal amount of the Registrable Notes being sold in
connection with an underwritten offering or any Participating Broker-Dealer, (i)
promptly incorporate in a prospectus supplement or post-effective amendment such
information as the managing underwriter or underwriters (if any), such Holders,
any Participating Broker-Dealer or counsel for any of them determine is
reasonably necessary to be included therein, (ii) make all required filings of
such prospectus supplement or such post-effective amendment as soon as
practicable after the Company has received notification of the matters to be
incorporated in such prospectus supplement or post-effective amendment, and
(iii) supplement or make amendments to such Registration Statement.
(f) If (1) a Shelf Registration is filed pursuant to Section 3 hereof, or
(2) a Prospectus contained in an Exchange Registration Statement filed pursuant
to Section 2 hereof is required to be delivered under the Securities Act by any
Participating Broker-Dealer who seeks to sell Exchange Notes during the
Applicable Period, furnish to each selling Holder of Registrable Notes and to
each such Participating Broker-Dealer who so requests and to counsel and each
managing underwriter, if any, at the sole expense of the Company, one conformed
copy of the Registration Statement or Registration Statements and each post-
effective amendment thereto, including financial statements and schedules, and,
if requested, all documents incorporated or deemed to be incorporated therein by
reference and all exhibits.
(g) If (1) a Shelf Registration is filed pursuant to Section 3 hereof, or
(2) a Prospectus contained in an Exchange Registration Statement filed pursuant
to Section 2 hereof is required to be delivered under the Securities Act by any
Participating Broker-Dealer who seeks to sell Exchange Notes during the
Applicable Period, deliver to each selling Holder of Registrable Notes, or each
such Participating Broker-Dealer, as the case may be, their respective counsel,
and the underwriters, if any, at the sole expense of the Company, as many copies
of the Prospectus or Prospectuses (including each form of preliminary
prospectus) and each amendment or supplement thereto and any documents
incorporated by reference therein as such Persons may reasonably request; and,
subject to the last paragraph of this Section 5, the Company hereby consents to
the use of such Prospectus and each amendment or supplement thereto by each of
the selling Holders of Registrable Notes or each such Participating Broker-
Dealer, as the case may be, and the underwriters or agents, if any, and dealers
(if any), in connection with the offering and sale of the Registrable Notes
covered by, or the sale by Participating Broker-Dealers of the Exchange Notes
pursuant to, such Prospectus and any amendment or supplement thereto.
(h) Prior to any public offering of Registrable Notes or any delivery of a
Prospectus contained in the Exchange Registration Statement by any Participating
Broker-Dealer who seeks to sell Exchange Notes during the Applicable Period, to
use its best efforts to register or qualify, and to cooperate with the selling
Holders of Registrable Notes or each such Participating Broker-Dealer, as the
case may be, the managing underwriter or underwriters, if any, and their
respective counsel in connection with the registration or qualification (or
exemption from such registration or qualification) of such Registrable Notes for
offer and sale under the securities or Blue Sky laws of such jurisdictions
within the United States as any selling Holder, Participating Broker-Dealer, or
the managing underwriter or underwriters reasonably request; provided, however,
-------- -------
that where Exchange Notes held by Participating Broker-Dealers or Registrable
Notes are offered other than through an underwritten offering, the Company
agrees to cause the Company's counsel to perform Blue Sky investigations and
file registrations and qualifications required to be filed pursuant to this
Section 5(h); keep each such registration or qualification (or exemption
therefrom) effective during the period such Registration Statement is required
to be kept effective and do any and all other acts or things reasonably
necessary or advisable to
9
<PAGE>
enable the disposition in such jurisdictions of the Exchange Notes held by
Participating Broker-Dealers or the Registrable Notes covered by the applicable
Registration Statement; provided, however, that the Company shall not be
-------- -------
required to (A) qualify generally to do business in any jurisdiction where it is
not then so qualified, (B) take any action that would subject it to general
service of process in any such jurisdiction where it is not then so subject or
(C) subject itself to taxation in excess of a nominal dollar amount in any such
jurisdiction where it is not then so subject.
(i) If a Shelf Registration is filed pursuant to Section 3 hereof,
cooperate with the selling Holders of Registrable Notes and the managing
underwriter or underwriters, if any, to facilitate the timely preparation and
delivery of certificates representing Registrable Notes to be sold, which
certificates shall not bear any restrictive legends and shall be in a form
eligible for deposit with The Depository Trust Company; and enable such
Registrable Notes to be in such denominations and registered in such names as
the managing underwriter or underwriters, if any, or Holders may request.
(j) Use its diligent best efforts to cause the Registrable Notes covered
by the Registration Statement to be registered with or approved by such other
governmental agencies or authorities as may be reasonably necessary to enable
the seller or sellers thereof or the underwriter or underwriters, if any, to
consummate the disposition of such Registrable Notes, except as may be required
solely as a consequence of the nature of such selling Holder's business, in
which case the Company will cooperate in all reasonable respects with the filing
of such Registration Statement and the granting of such approvals.
(k) If (1) a Shelf Registration is filed pursuant to Section 3 hereof, or
(2) a Prospectus contained in an Exchange Registration Statement filed pursuant
to Section 2 hereof is required to be delivered under the Securities Act by any
Participating Broker-Dealer who seeks to sell Exchange Notes during the
Applicable Period, upon the occurrence of any event contemplated by paragraph
5(c)(v) or 5(c)(vi) hereof, as promptly as practicable prepare and (subject to
Section 5(a) hereof) file with the SEC, at the sole expense of the Company, a
supplement or post-effective amendment to the Registration Statement or a
supplement to the related Prospectus or any document incorporated or deemed to
be incorporated therein by reference, or file any other required document so
that, as thereafter delivered to the purchasers of the Registrable Notes being
sold thereunder or to the purchasers of the Exchange Notes to whom such
Prospectus will be delivered by a Participating Broker-Dealer, any such
Prospectus will not 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, in light of the circumstances under which they were made,
not misleading.
(l) [Intentionally Omitted]
(m) (i) Prior to the effective date of the first Registration Statement
relating to the Registrable Notes, provide a CUSIP number for the Registrable
Notes and (ii) immediately after the effective date of the first Registration
Statement relating to the Registrable Notes, provide the Trustee with
certificates for the Registrable Notes in a form eligible for deposit with The
Depository Trust Company.
(n) In connection with any underwritten offering of Registrable Notes
pursuant to a Shelf Registration, enter into an underwriting agreement as is
customary in underwritten offerings of debt securities similar to the Notes and
take all such other actions as are reasonably requested by the managing
underwriter or underwriters in order to expedite or facilitate the registration
or the disposition of such Registrable Notes and, in such connection, (i) make
such representations and warranties to, and covenants with, the underwriters
with respect to the business of the Company and its subsidiaries (including any
acquired business, properties or entity, if applicable) and the Registration
Statement, Prospectus and documents, if any, incorporated or deemed to be
incorporated by reference therein, in each case, as are customarily made by
issuers to underwriters in underwritten offerings of debt securities similar to
the Notes, and confirm the same in writing if and when requested; (ii) obtain
the written opinions of counsel to the Company and written updates thereof in
form, scope and substance reasonably satisfactory to the managing underwriter or
underwriters, addressed to the underwriters covering the matters customarily
covered in opinions requested in underwritten offerings and such other matters
as may be reasonably requested by the managing underwriter or underwriters;
(iii) obtain "cold comfort" letters and updates thereof in form, scope and
substance reasonably satisfactory to the managing underwriter or underwriters
from the independent certified public accountants of the Company (and, if
necessary, any other independent certified public accountants of any subsidiary
of the Company or of any business acquired by the Company for which financial
statements and financial data are, or are required to be, included or
incorporated by reference in the Registration Statement), addressed to each of
the underwriters, such letters to be in customary form and covering matters of
the type customarily covered in "cold comfort" letters in connection with
underwritten offerings and such other matters as reasonably requested by the
managing underwriter or underwriters as permitted by the Statement on Auditing
Standards No. 72; and (iv) if an underwriting agreement is entered into, the
same shall contain indemnification provisions and procedures no less favorable
than those set forth in Section 7 hereof (or such other provisions and
procedures acceptable to Holders of a majority in aggregate principal amount of
Registrable Notes covered by
10
<PAGE>
such Registration Statement and the managing underwriter or underwriters or
agents) with respect to all parties to be indemnified pursuant to said Section.
The above shall be done at each closing under such underwriting agreement, or as
and to the extent required thereunder.
(o) If (1) a Shelf Registration is filed pursuant to Section 3 hereof, or
(2) a Prospectus contained in an Exchange Registration Statement filed pursuant
to Section 2 hereof is required to be delivered under the Securities Act by any
Participating Broker-Dealer who seeks to sell Exchange Notes during the
Applicable Period, make available for inspection by any selling Holder of such
Registrable Notes being sold, or each such Participating Broker-Dealer, as the
case may be, any underwriter participating in any such disposition of
Registrable Notes, if any, and any attorney, accountant or other agent retained
by any such selling Holder or each such Participating Broker-Dealer, as the case
may be, or underwriter (collectively, the "Inspectors"), at the offices where
----------
normally kept, during reasonable business hours and upon reasonable prior
notice, all financial and other records, pertinent corporate documents and
instruments of the Company and its subsidiaries (collectively, the "Records") as
-------
shall be reasonably necessary to enable them to exercise any applicable due
diligence responsibilities, and cause the officers, directors and employees of
the Company and its subsidiaries to supply all information reasonably requested
by any such Inspector in connection with such Registration Statement. Records
which the Company determines, in good faith, to be confidential and any Records
which it notifies the Inspectors are confidential shall not be disclosed by the
Inspectors unless (i) the disclosure of such Records is necessary or advisable
to avoid or correct a misstatement or omission in such Registration Statement;
provided, however, that prior notice is given to the Company, and the Company's
- -------- -------
legal counsel and such Holder's legal counsel concur that disclosure is
required, (ii) the release of such Records is ordered pursuant to a subpoena or
other order from a court of competent jurisdiction, (iii) disclosure of such
information is necessary or advisable in connection with any action, claim, suit
or proceeding, directly or indirectly, involving or potentially involving such
Inspector and arising out of, based upon, relating to, or involving this
Agreement or the Purchase Agreement, or any transactions contemplated hereby or
thereby or arising hereunder or thereunder; provided, however, that prior notice
-------- -------
shall be provided as soon as practicable to the Company of the potential
disclosure of any information by such Inspector pursuant to clauses (ii) or
(iii) of this sentence to permit the Company to obtain a protective order (or
waive the provisions of this paragraph (o)) and that such Inspector shall take
such actions as are reasonably necessary to protect the confidentiality of such
information (if practicable) to the extent such action is otherwise not
inconsistent with, an impairment of or in derogation of the rights and interests
of the Holder or any Inspector, or (iv) the information in such Records has been
made generally available to the public otherwise than by action of any Inspector
in contravention of this Agreement.
(p) Provide an indenture trustee for the Registrable Notes or the Exchange
Notes, as the case may be, and cause the Indenture or the trust indenture
provided for in Section 2(a) hereof, as the case may be, to be qualified under
the TIA not later than the effective date of the Exchange Offer or the first
Registration Statement relating to the Registrable Notes; and in connection
therewith, cooperate with the trustee under any such indenture and the Holders
of the Registrable Notes, to effect such changes to such indenture as may be
required for such indenture to be so qualified in accordance with the terms of
the TIA; and execute, and use its best efforts to cause such trustee to execute,
all documents as may be required to effect such changes, and all other forms and
documents required to be filed with the SEC to enable such indenture to be so
qualified in a timely manner.
(q) Comply with all applicable rules and regulations of the SEC and make
generally available to its securityholders earnings statements satisfying the
provisions of Section 11(a) of the Securities Act and Rule 158 thereunder (or
any similar rule promulgated under the Securities Act) no later than 45 days
after the end of any 12-month period (or 90 days after the end of any 12-month
period if such period is a fiscal year) (i) commencing at the end of any fiscal
quarter in which Registrable Notes are sold to underwriters in a firm commitment
or best efforts underwritten offering and (ii) if not sold to underwriters in
such an offering, commencing on the first day of the first fiscal quarter of the
Company after the effective date of a Registration Statement, which statements
shall cover said 12-month periods.
(r) Upon consummation of an Exchange Offer or a Private Exchange, if
requested by a majority of the holders of Exchange Notes or Private Exchange
Notes, as the case may be, obtain an opinion of counsel to the Company, in a
form customary for underwritten transactions, addressed to the Trustee for the
benefit of all Holders of Registrable Notes participating in the Exchange Offer
or the Private Exchange, as the case may be, that the Exchange Notes or Private
Exchange Notes, as the case may be, and the related indenture constitute legal,
valid and binding obligations of the Company, enforceable against the Company in
accordance with its respective terms, subject to customary exceptions and
qualifications.
(s) If an Exchange Offer or a Private Exchange is to be consummated, upon
delivery of the Registrable Notes by Holders to the Company (or to such other
Person as directed by the Company) in exchange for the Exchange Notes or the
Private Exchange Notes, as the case may be, the Company shall mark, or cause to
be marked, on such Registrable Notes that such Registrable Notes are being
cancelled in exchange for the Exchange Notes or the Private Exchange Notes, as
the case may be; in no event shall such
11
<PAGE>
Registrable Notes be marked as paid or otherwise satisfied.
(t) Cooperate with each seller of Registrable Notes covered by any
Registration Statement and each underwriter, if any, participating in the
disposition of such Registrable Notes and their respective counsel in connection
with any filings required to be made with the National Association of Securities
Dealers, Inc. (the "NASD").
----
(u) Use its diligent best efforts to take all other steps necessary or
advisable to effect the registration of the Exchange Notes and/or Registrable
Notes covered by a Registration Statement contemplated hereby.
The Company may require each seller of Registrable Notes as to which any
registration is being effected to furnish to the Company such information
regarding such seller and the distribution of such Registrable Notes as the
Company may, from time to time, reasonably request. The Company may exclude
from such registration the Registrable Notes of any seller so long as such
seller fails to furnish such information within a reasonable time after
receiving such request. Each seller as to which any Shelf Registration is being
effected agrees to furnish promptly to the Company in writing all information
required to be disclosed in order to make the information previously furnished
to the Company by such seller not materially misleading and the Company shall
not be liable for any Additional Interest otherwise payable to such Seller as a
result of such Seller's failure to so furnish such information.
If any such Registration Statement refers to any Holder by name or
otherwise as the holder of any securities of the Company, then such Holder shall
have the right to require (i) the insertion therein of language, in form and
substance reasonably satisfactory to such Holder, to the effect that the holding
by such Holder of such securities is not to be construed as a recommendation by
such Holder of the investment quality of the Company's securities covered
thereby and that such holding does not imply that such Holder will assist in
meeting any future financial requirements of the Company, or (ii) in the event
that such reference to such Holder by name or otherwise is not required by the
Securities Act or any similar federal statute then in force, the deletion of the
reference to such Holder in any amendment or supplement to the Registration
Statement filed or prepared subsequent to the time that such reference ceases to
be required.
Each Holder of Registrable Notes and each Participating Broker-Dealer
agrees by acquisition of such Registrable Notes or Exchange Notes to be sold by
such Participating Broker-Dealer, as the case may be, that, upon actual receipt
of any notice from the Company of the happening of any event of the kind
described in Section 5 (c)(ii), 5(c)(iv), 5(c)(v), or 5(c)(vi) hereof, such
Holder will forthwith discontinue disposition of such Registrable Notes covered
by such Registration Statement or Prospectus or Exchange Notes to be sold by
such Holder or Participating Broker-Dealer, as the case may be, until such
Holder's or Participating Broker-Dealer's receipt of the copies of the
supplemented or amended Prospectus contemplated by Section 5(k) hereof, or until
it is advised in writing (the "Advice") by the Company that the use of the
------
applicable Prospectus may be resumed, and has received copies of any amendments
or supplements thereto. In the event the Company shall give any such notice,
each of the Effectiveness Period and the Applicable Period shall be extended by
the number of days during such periods from and including the date of the giving
of such notice to and including the date when each seller of Registrable Notes
covered by such Registration Statement or Exchange Notes to be sold by such
Participating Broker-Dealer, as the case may be, shall have received (x) the
copies of the supplemented or amended Prospectus contemplated by Section 5(k)
hereof or (y) the Advice.
6. Registration Expenses.
----------------------
All fees and expenses incident to the performance of or compliance with
this Agreement by the Company shall be borne by the Company whether or not the
Exchange Offer or a Shelf Registration is filed or becomes effective, including,
without limitation, (i) all registration and filing fees (including, without
limitation, (A) fees with respect to filings required to be made with the NASD
in connection with an underwritten offering and (B) fees and expenses of
compliance with state securities or Blue Sky laws (including, without
limitation, reasonable fees and disbursements of counsel in connection with Blue
Sky qualifications of the Registrable Notes or Exchange Notes and determination
of the eligibility of the Registrable Notes or Exchange Notes for investment
under the laws of such jurisdictions (x) where the holders of Registrable Notes
are located, in the case of the Exchange Notes, or (y) as provided in Section
5(h) hereof, in the case of Registrable Notes or Exchange Notes to be sold by a
Participating Broker-Dealer during the Applicable Period)), (ii) printing
expenses, including, without limitation, expenses of printing certificates for
Registrable Notes or Exchange Notes in a form eligible for deposit with The
Depository Trust Company and of printing prospectuses if the printing of
prospectuses is requested by the managing underwriter or underwriters, if any,
by the Holders of a majority in aggregate principal amount of the Registrable
Notes included in any Registration Statement or in respect of Registrable Notes
or Exchange Notes to be sold by any Participating Broker-Dealer during the
Applicable Period, as the case may be, and related, messenger, telephone and
delivery expenses, (iii) fees and disbursements of counsel for the Company and
fees and disbursements of one special
12
<PAGE>
counsel for all of the sellers of Registrable Notes, (iv) fees and disbursements
of all independent certified public accountants referred to in Section 5(n)(iii)
hereof (including, without limitation, the expenses of any special audit and
"cold comfort" letters required by or incident to such performance), (v)
Securities Act liability insurance, if the Company desires such insurance, (vi)
fees and expenses of all other Persons retained by the Company, (vii) internal
expenses of the Company (including, without limitation, all salaries and
expenses of officers and employees of the Company performing legal or accounting
duties), (viii) the expense of any annual audit, (ix) the fees and expenses
incurred in connection with the listing of the securities to be registered on
any securities exchange, if applicable, and (x) the expenses relating to
printing, word processing and distributing all Registration Statements,
underwriting agreements, indentures and any other documents necessary in order
to comply with this Agreement.
7. Indemnification.
---------------
(a) In the event of a Shelf Registration or in connection with any
delivery by any Participating Broker-Dealer who seeks to sell Exchange Notes
during the Applicable Period, the Company agrees to indemnify and hold harmless
each Holder of Registrable Notes and each Participating Broker-Dealer selling
Exchange Notes during the Applicable Period, and each Person, if any, who
controls any such Person within the meaning of Section 15 of the Securities Act
or Section 20 of the Exchange Act (each, a "Participant"), 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 any Prepricing
Prospectus or in the Registration Statement or the Prospectus 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 (in the case of the Prospectus, in
light of the circumstances under which such statements were made) 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
any Participant furnished in writing to the Company by or on behalf of such
Participant expressly for use in connection therewith); provided, however, that
-------- -------
the indemnification contained in this paragraph (a) with respect to any
Prospectus shall not inure to the benefit of any Participant (or to the benefit
of any person controlling such Participant) on account of any such loss, claim,
damage, liability or expense arising from the sale of the Registrable Notes or
Exchange Notes by such Participant to any person if a copy of the Prospectus
shall not have been delivered or sent to such person within the time required by
the Securities Act and each untrue statement or alleged untrue statement of a
material fact contained in, and each omission or alleged omission of material
fact from, such Prospectus was corrected in the subsequently delivered
Prospectus; provided, however, that the Company has delivered the Prospectus to
-------- -------
the several Participants in requisite quantity on a timely basis to permit such
delivery or sending. 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 any
Participant or any person controlling any Participant in respect of which
indemnity may be sought against the Company, such Participant or such
controlling person shall promptly notify the Company (but the failure to so
notify the Company shall not relieve the Company from any liability under
Section 7(a) hereof unless the Company is prejudiced in any material respect by
such failure to notify) and the Company shall promptly assume the defense
thereof, including the employment of counsel acceptable to the indemnified
parties and payment of all fees and expenses in respect thereof. Such
Participant 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 such Participant or such controlling person unless (i) the Company
has agreed to pay such fees, (ii) the Company has failed promptly to assume the
defense and employ counsel acceptable to the indemnified parties, or (iii) the
named parties to any such action, suit or proceeding (including any impleaded
parties) include both the Company and such Participant or such controlling
person, and such Participant or such controlling person shall have been advised
by counsel that there may be one or more legal defenses available to it which
are different from or additional to those available to the Company, in which
case the Company shall not have the right to assume the defense of such action,
suit or proceeding on behalf of such Participant or such controlling person. It
is understood, however, that the Company 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 fees and expenses of
only one separate firm of attorneys (in addition to those of any local counsel)
at any time for all such Participants and controlling persons not having actual
or potential differing interests (as advised by counsel) with the Company or
among themselves, which firm shall be designated in writing by Participants who
sold a majority in aggregate principal amount at maturity of Registrable Notes
and Exchange Notes sold by all such Participants and reasonably acceptable to
the Company, and that all such fees and expenses shall be reimbursed as they are
incurred. The Company shall not be liable for any settlement of any such
action, suit or proceeding effected without its consent (which shall not be
unreasonably withheld or delayed), but if settled with such consent, or if there
be a final judgment for the plaintiff in any such action, suit or proceeding,
the Company agrees to indemnify and hold harmless any Participant, to the extent
provided in the preceding paragraph, and any such controlling person from and
against
13
<PAGE>
any loss, claim, damage, liability or expense by reason of such settlement or
judgment.
(c) Each Participant agrees, severally and not jointly, to indemnify and
hold harmless the Company, its directors and officers who sign the Registration
Statement, and any person who controls the Company within the meaning of Section
15 of the Securities Act or Section 20 of the Exchange Act, to the same extent
as the foregoing indemnity from the Company to each Participant, but only with
respect to information furnished in writing by or on behalf of such Participant
with respect to such Participant expressly for use in the Registration
Statement, the Prospectus or any Prepricing Prospectus, 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 Registration Statement, the Prospectus or any Prepricing
Prospectus, or any amendment or supplement thereto, and in respect of which
indemnity may be sought against any Participant pursuant to this paragraph (c),
such Participant 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 such Participant 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 such Participants' expense), and the
Company, its directors, any such officer, and any such controlling person, shall
have the rights and duties given to the Participants by paragraph (b) above.
The foregoing indemnity agreement shall be in addition to any liability which
the Participants may otherwise have.
(d) If the indemnification provided for in this Section 7 is for any
reason or to any extent unavailable to an indemnified party under paragraphs (a)
or (c) hereof (other than for failure to notify the indemnifying party, such
failures resulting in prejudice in any material respect to the indemnifying
party) 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 received by the Company, on the one hand, and the Participants, on the
other hand, from the offering of the Registrable Notes or Exchange 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 Participants, on the other hand, 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 Participants, on the other, shall be deemed to be in the same
proportion as the total proceeds from the offering (net of discounts and
commissions but before deducting expenses) of the Notes sold pursuant to the
Purchase Agreement received by the Company bears to the total proceeds from the
offering (net of discounts and commissions but before deducting expenses)
received by the Participants. For purposes of this paragraph (d), the parties
agree that the total proceeds received by the Company from the offering of the
Notes (prior to any deduction for discounts, commissions or expenses) sold
pursuant to the Purchase Agreement is $74,932,500. The relative fault of the
Company, on the one hand, and the Participants, 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 Participants, 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 Participants agree that it would not be just and
equitable if contribution pursuant to this Section 7 were determined by a pro
---
rata allocation (even if the Participants were treated as one entity for such
- ----
purpose) 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 in clauses (a), (b) and (c) above,
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 7, no Participant
shall be required to contribute any amount in excess of the amount by which
proceeds received by such Participant from sales of Registrable Notes or
Exchange Notes, as the case may be, exceeds the amount of any damages which such
Participant 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
Securities Act) shall be entitled to contribution from any person who was not
guilty of such fraudulent misrepresentation. The Participants' obligations to
contribute pursuant to this Section 7 are several and not joint.
(f) 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 written release of such
indemnified party, from all liability on claims that are the subject matter of
such action, suit or proceeding.
(g) Any losses, claims, damages, liabilities or expenses for which an
indemnified party is entitled to indemnification or
14
<PAGE>
contribution under this Section 7 shall be paid by the indemnifying party to the
indemnified party as such losses, claims, damages, liabilities or expenses are
incurred. A successor to any Participant or any person controlling any
Participant, 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 7. The
indemnity and contribution agreements contained in this Section 7 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 any Initial Purchaser or any person who
controls an Initial Purchaser, the Company, their respective directors or
officers or any person controlling the Company and (ii) any termination of this
Agreement.
8. Rule 144 and Rule 144A.
-----------------------
The Company covenants that, whether or not it is required to do so by the
rules and regulations of the SEC, for so long as the Registrable Notes or the
Exchange Notes, as applicable, remain outstanding, it will furnish to the
holders of the Registrable Notes or Exchange Notes, as applicable, and it will
file with the SEC (unless the SEC will not accept such a filing) (i) all
quarterly and annual financial information that would be required to be
contained in a filing with the SEC on Forms 10-Q and 10-K if the Company were
required to file such forms, including a "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and, with respect to the
annual information only, a report thereon by the Company's certified independent
accountants and (ii) all reports that would be required to be filed with the SEC
on Form 8-K if the Company were required to file such reports. If at any time
the Company is not required to file such reports, it will, upon the request of
any Holder or beneficial owner of Registrable Notes, make available such
information necessary to permit sales pursuant to Rule 144A under the Securities
Act. The Company further covenants that it will take such further action as any
Holder of Registrable Notes may reasonably request, all to the extent required
from time to time to enable such holder to sell Registrable Notes without
registration under the Securities Act within the limitation of the exemptions
provided by (a) Rule 144(k) and Rule 144A under the Securities Act, as such
Rules may be amended from time to time, or (b) any similar rule or regulation
hereafter adopted by the SEC.
9. Underwritten Registrations.
--------------------------
If any of the Registrable Notes covered by any Shelf Registration are to be
sold in an underwritten offering, the investment banker or investment bankers
and manager or managers that will manage the offering will be selected by the
Holders of a majority in aggregate principal amount of such Registrable Notes
included in such offering and reasonably acceptable to the Company.
No Holder of Registrable Notes may participate in any underwritten
registration hereunder unless such Holder (a) agrees to sell such Holder's
Registrable Notes on the basis provided in any underwriting arrangements
approved by the Persons entitled hereunder to approve such arrangements and (b)
completes and executes all questionnaires, powers of attorney, indemnities,
underwriting agreements and other documents required under the terms of such
underwriting arrangements.
10. Miscellaneous.
--------------
(a) No Inconsistent Agreements. The Company has not, as of the date
--------------------------
hereof, and the Company shall not, after the date of this Agreement, enter into
any agreement with respect to any of its securities that is inconsistent with
the rights granted to the Holders of Registrable Notes 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 other issued and outstanding
securities under any such agreements. The Company will not enter into any
agreement with respect to any of its securities which will grant to any Person
piggy-back registration rights with respect to a Registration Statement.
(b) Adjustments Affecting Registrable Notes. The Company shall not,
---------------------------------------
directly or indirectly, take any action with respect to the Registrable Notes as
a class that would adversely affect the ability of the Holders of Registrable
Notes to include such Registrable Notes in a registration undertaken pursuant to
this Agreement.
(c) Amendments and Waivers. The provisions of this Agreement may not be
----------------------
amended, modified or supplemented, and waivers or consents to departures from
the provisions hereof may not be given, otherwise than with the prior written
consent of (i) the Company and (ii) (A) the Holders of not less than a majority
in aggregate principal amount of the then outstanding Registrable Notes and (B)
in circumstances that would adversely affect the Participating Broker-Dealers,
the Participating Broker-Dealers holding not less than a majority in aggregate
principal amount of the Exchange Notes held by all Participating Broker-Dealers;
provided, however, that Section 7 and this Section 10(c) may not be amended,
- -------- -------
modified or supplemented without the prior written consent of each Holder and
each Participating Broker-Dealer (including any person who was
15
<PAGE>
a Holder or Participating Broker-Dealer of Registrable Notes or Exchange Notes,
as the case may be, disposed of pursuant to any Registration Statement) affected
by any such amendment, modification or supplement. Notwithstanding the
foregoing, a waiver or consent to depart from the provisions hereof with respect
to a matter that relates exclusively to the rights of Holders of Registrable
Notes whose securities are being sold pursuant to a Registration Statement and
that does not directly or indirectly affect, impair, limit or compromise the
rights of other Holders of Registrable Notes may be given by Holders of at least
a majority in aggregate principal amount of the Registrable Notes being sold by
such Holders pursuant to such Registration Statement.
(d) Notices. All notices and other communications (including without
-------
limitation any notices or other communications to the Trustee) provided for or
permitted hereunder shall be made in writing by hand-delivery, registered first-
class mail, next-day air courier or facsimile:
1. if to a Holder of the Registrable Notes or any Participating Broker-
Dealer, at the most current address of such Holder or Participating Broker-
Dealer, as the case may be, set forth on the records of the registrar under the
Indenture, with a copy in like manner to the Initial Purchasers as follows:
Smith Barney Inc.
388 Greenwich Street
New York, New York 10013
Facsimile No.: (212) 816-7816
Attention: Corporate Finance Department
2. if to the Initial Purchasers, at the addresses specified in Section
10(d)(1);
3. if to the Company, at the address as follows:
Telegroup, Inc.
2098 Nutmeg Avenue
Fairfield, IA 52556
Facsimile No.: (214) 472-4747
Attention: Chief Financial Officer
with copies to:
Swidler & Berlin, Chartered
3000 K Street, N.W.
Suite 300
Washington, D.C. 20007-5116
Facsimile No.: (202) 424-7500
Attention: Morris F. DeFeo, Jr.
All such notices and communications shall be deemed to have been duly
given: when delivered by hand, if personally delivered; five business days
after being deposited in the mail, postage prepaid, if mailed; one business day
after being timely delivered to a next-day air courier; and when receipt is
acknowledged by the addressee, if sent by facsimile.
Copies of all such notices, demands or other communications shall be
concurrently delivered by the Person giving the same to the Trustee at the
address and in the manner specified in such Indenture.
(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 hereto,
the Holders and the Participating Broker-Dealers; 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 holds
Registrable Notes.
(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
16
<PAGE>
otherwise affect the meaning hereof.
(h) Governing Law; Jurisdiction. THIS AGREEMENT SHALL BE GOVERNED BY AND
---------------------------
CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK, AS APPLIED TO
CONTRACTS MADE AND PERFORMED WHOLLY WITHIN THE STATE OF NEW YORK, WITHOUT REGARD
TO PRINCIPLES OF CONFLICTS OF LAW.
(i) Severability. If any term, provision, covenant or restriction of this
------------
Agreement is held by a court of competent jurisdiction to be invalid, illegal,
void or unenforceable, the remainder of the terms, provisions, covenants and
restrictions set forth herein shall remain in full force and effect and shall in
no way be affected, impaired or invalidated, and the parties hereto shall use
their best efforts to find and employ an alternative means to achieve the same
or substantially the same result as that contemplated by such term, provision,
covenant or restriction. It is hereby stipulated and declared to be the
intention of the parties that they would have executed the remaining terms,
provisions, covenants and restrictions without including any of such that may be
hereafter declared invalid, illegal, void or unenforceable.
(j) Securities Held by the Company or Its Affiliates. Whenever the
------------------------------------------------
consent or approval of Holders of a specified percentage of Registrable Notes is
required hereunder, Registrable Notes held by the Company or its affiliates (as
such term is defined in Rule 405 under the Securities Act) shall not be counted
(in either the numerator or the denominator) in determining whether such consent
or approval was given by the Holders of such required percentage.
(k) Third Party Beneficiaries. Holders of Registrable Notes and
-------------------------
Participating Broker-Dealers are intended third party beneficiaries of this
Agreement and this Agreement may be enforced by such Persons.
(l) Entire Agreement. This Agreement, together with the Purchase
----------------
Agreement and the Indenture, is intended by the parties as a final and exclusive
statement of the agreement and understanding of the parties hereto in respect of
the subject matter contained herein and therein and any and all prior oral or
written agreements, representations, or warranties, contracts, understandings,
correspondence, conversations and memoranda between the Initial Purchasers on
the one hand and the Company on the other, or between or among any agents,
representatives, parents, subsidiaries, affiliates, predecessors in interest or
successors in interest with respect to the subject matter hereof and thereof are
merged herein and replaced hereby.
(m) Remedies. In the event of a breach by the Company of any of its
--------
obligations under this Agreement, each Holder, in addition to being entitled to
exercise all rights provided herein, in the Purchase Agreement or granted by
law, including recovery of damages, will be entitled to specific performance of
its 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 any of the provisions of this Agreement.
17
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
first written above.
TELEGROUP, INC.
By:
Name:
Title:
SMITH BARNEY INC.
By:
Name:
Title:
BT ALEX. BROWN INCORPORATED
By:
Name:
Title:
18
<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.
/s/ MacIntyre & Co.
28, Ely Place
London
ECIN 6RL
December 19, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<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
<INVENTORY> 0
<CURRENT-ASSETS> 111,778,639
<PP&E> 26,869,648
<DEPRECIATION> 5,272,668
<TOTAL-ASSETS> 139,657,577
<CURRENT-LIABILITIES> 72,743,946
<BONDS> 25,260,377
0
0
<COMMON> 0
<OTHER-SE> 40,922,407
<TOTAL-LIABILITY-AND-EQUITY> 139,657,577
<SALES> 0
<TOTAL-REVENUES> 238,478,086
<CGS> 0
<TOTAL-COSTS> 174,273,208
<OTHER-EXPENSES> 57,047,271
<LOSS-PROVISION> 6,384,001
<INTEREST-EXPENSE> 1,352,392
<INCOME-PRETAX> (4,214,912)
<INCOME-TAX> 1,366,054
<INCOME-CONTINUING> (2,848,858)
<DISCONTINUED> 0
<EXTRAORDINARY> (9,970,815)
<CHANGES> 0
<NET-INCOME> (12,819,673)
<EPS-PRIMARY> (0.47)
<EPS-DILUTED> (0.47)
</TABLE>
<PAGE>
Exhibit 99.1
LETTER OF TRANSMITTAL
TO TENDER FOR EXCHANGE
10 1/2% SENIOR DISCOUNT NOTES DUE 2004
OF
TELEGROUP, INC.
PURSUANT TO THE PROSPECTUS DATED [ ], 1997
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON [ ],
1998 UNLESS EXTENDED.
TO: [_] AS EXCHANGE AGENT
By Registered or Certified Mail: By Overnight Courier: By Hand:
Certified Mail:
By Facsimile:
Confirm by telephone:
<PAGE>
Delivery of this instrument to an address other than as set forth above or
transmission of instructions via a facsimile number other than the one listed
above will not constitute a valid delivery. The instructions accompanying this
Letter of Transmittal should be read carefully before this Letter of Transmittal
is completed.
The undersigned acknowledges that he or she has received the Prospectus,
dated [ ], 1997 (the "Prospectus"), of TELEGROUP, Inc. (the
"Company") and this Letter of Transmittal (the "Letter of Transmittal"), which
together constitutes the Company's offer (the "Exchange Offer") to exchange its
10 1/2 % Senior Discount Notes due 2004 (the "Exchange Notes") for an equal
principal amount of its 10 1/2% Senior Discount Notes due 2004 (the "Old Notes"
and, together with the Exchange Notes, the "Notes"). The terms of the Exchange
Notes are identical in all material respects to the Old Notes, except that the
Exchange Notes have been registered under the Securities Act of 1933, as amended
(the "Securities Act"), and, therefore, will not bear legends restricting their
transfer and will not contain certain provisions relating to an increase in the
interest rate which were included in the Old Notes under certain circumstances
relating to the timing of the Exchange Offer. The term "Expiration Date" shall
mean 5:00 p.m., New York City time, on [ ], 1998, unless the
Company, in its sole discretion, extends the Exchange Offer, in which case the
term shall mean the latest date and time to which the Exchange Offer is
extended. Capitalized terms used but not defined herein have the meaning given
to them in the Prospectus.
The Letter of Transmittal is to be used by holders of Old Notes if
certificates are to be forwarded herewith. Holders of Old Notes whose
certificates are not immediately available, or who are unable to deliver their
certificates and all other documents required by this Letter of Transmittal to
the Exchange Agent on or prior to the Expiration Date, must tender their Old
Notes according to the guaranteed delivery procedures set forth in "The Exchange
Offer--Guaranteed Delivery Procedures" section of the Prospectus. See
Instruction 1.
The term "holder" with respect to the Exchange Offer means any person in
whose name Old Notes are registered on the books of the Company or any other
person who has obtained a properly completed bond power from the registered
holder. The undersigned has completed, executed and delivered this Letter of
Transmittal to indicate the action the undersigned desires to take with respect
to the Exchange Offer. Holders who wish to tender their Old Notes must complete
this Letter of Transmittal in its entirety.
The undersigned acknowledges that if it is a broker-dealer holding Old
Notes acquired for its own account as a result of market-making activities or
other trading activities (other than Old Notes acquired directly from the
Company), such holder may be deemed to be an "underwriter" within the meaning of
the Securities Act and, therefore, must deliver a prospectus meeting the
requirements of the Securities Act in connection with any resale of Exchange
Notes received in respect of such Old Notes pursuant to the Exchange Offer.
Notwithstanding the foregoing, the undersigned shall not be deemed to admit that
it is an "underwriter" within the meaning of such term under the Securities Act.
PLEASE READ THE ENTIRE LETTER OF TRANSMITTAL
CAREFULLY BEFORE COMPLETING THE LETTER OF TRANSMITTAL
2
<PAGE>
DESCRIPTION OF 10 1/2% SENIOR DISCOUNT NOTES DUE 2004
AGGREGATE PRINCIPAL AMOUNT CERTIFICATE
PRINCIPAL TENDERED (MUST BE IN NUMBER(S)
AMOUNT INTEGRAL MULTIPLES
REPRESENTED BY OF $1,000)* NAMES AND
CERTIFICATE(S) ADDRESS(ES) OF
REGISTERED HOLDER(S)
(PLEASE FILL IN, IF BLANK)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
*Unless indicated in the column labeled "Principal Amount Tendered," any
tendering holder of 10 1/2% Senior Discount Notes due 2004 will be deemed to
have tendered the entire aggregate principal amount represented by the column
labeled "Aggregate Principal Amount Represented by Certificate(s)." If the space
provided above is inadequate, list the certificate numbers and principal amounts
on a separate signed schedule and affix the list to this Letter of Transmittal.
The minimum permitted tender is $1,000 in principal amount. All other tenders
must be integral multiples of $1,000.
CHECK HERE IF TENDERED OLD NOTES ARE BEING DELIVERED PURSUANT TO A NOTICE OF
GUARANTEED DELIVERY PREVIOUSLY SENT TO THE EXCHANGE AGENT AND COMPLETE THE
FOLLOWING (SEE INSTRUCTION 1):
Name(s) of Registered Holder(s)
- --------------------------------------------------------
Window Ticket Number (if any)
- --------------------------------------------------------
Date of Execution of Notice of Guaranteed Delivery
- --------------------------------------------------------
Name of Institution which Guaranteed Delivery
- --------------------------------------------------------
3
<PAGE>
CHECK HERE IF YOU ARE A BROKER-DEALER AND WISH TO RECEIVE 10 ADDITIONAL
COPIES OF THE PROSPECTUS AND 10 COPIES OF ANY AMENDMENTS OR SUPPLEMENTS THERETO:
Name:
- --------------------------------------------------------
Address:
- --------------------------------------------------------
- --------------------------------------------------------
SPECIAL REGISTRATION INSTRUCTIONS SPECIAL DELIVERY INSTRUCTIONS
(SEE INSTRUCTIONS 4, 5 AND 6) (SEE INSTRUCTIONS 4, 5 AND 6)
To be completed ONLY if To be completed ONLY if certificates
certificates for Old Notes in a for Old Notes in a principal amount
principal amount not tendered, or not tendered, or Exchange Notes
tendered, or Exchange Notes issued issued in exchange for Old Notes
in exchange for Old Notes accepted accepted for exchange, are to be sent
for exchange are to be issued in the to someone other than the
name of someone other than the undersigned, or to the undersigned at
undersigned. an address other than the shown
above.
Issue certificate (s) to:
Deliver certificate (s) to:
Name: Name:
--------------------------- ----------------------------
(Please Print) (Please Print)
Address: Address:
------------------------ -------------------------
------------------------ -------------------------
(Include Zip Code) (Include Zip Code)
(Tax Identification or Social (Tax Identification or Social
Security No.) Security No.)
- ------------------------------ -------------------------------
Ladies and Gentlemen:
Subject to the terms and conditions of the Exchange Offer, the undersigned
hereby tenders to the Company the principal amount of Old Notes indicated above.
Subject to and effective upon the acceptance for exchange of the principal
amount of Old Notes tendered in accordance with this Letter of Transmittal, the
undersigned sells, assigns and transfers to, or
4
<PAGE>
upon the order of, the Company all right, title and interest in and to the Old
Notes tendered hereby. The undersigned hereby irrevocably constitutes and
appoints the Exchange Agent its agent and attorney-in-fact (with full knowledge
that the Exchange Agent also acts as the agent of the Company) with respect to
the tendered Old Notes with full power of substitution to (i) deliver
certificates for such Old Notes to the Company and deliver all accompanying
evidences of transfer and authenticity to, or upon the order of, the Company and
(ii) present such Old Notes for transfer on the books of the Company and receive
all benefits and otherwise exercise all rights of beneficial ownership of such
Old Notes, all in accordance with the terms of the Exchange Offer. The power of
attorney granted in this paragraph shall be deemed to be irrevocable and coupled
with an interest.
The undersigned hereby represents and warrants that he or she has full
power and authority to tender, sell, assign and transfer the Old Notes tendered
hereby and that the Company will acquire good and unencumbered title thereto,
free and clear of all liens, restrictions, charges and encumbrances and not
subject to any adverse claim, when the same are acquired by the Company. The
undersigned and any beneficial owner of Old Notes hereby further represent that
any Exchange Notes acquired in exchange for Old Notes tendered hereby will have
been acquired in the ordinary course of business of the undersigned and any such
beneficial owner of Old Notes receiving such Exchange Notes, that neither the
holder nor any such beneficial owner is participating in, intends to participate
in or has an arrangement or understanding with any person to participate in the
distribution of such Exchange Notes and that neither the holder nor any such
beneficial owner is an "affiliate," as defined in Rule 405 under the Securities
Act, of the Company. The undersigned and each beneficial owner acknowledge and
agree that any person participating in the Exchange Offer for the purpose of
distributing the Exchange Notes must comply with the registration and prospectus
delivery requirements of the Securities Act in connection with any secondary
resale transactions of the Exchange Notes acquired by such person and may not
rely on the position of the Staff of the Securities and Exchange Commission set
forth in the no-action letters discussed in the Prospectus under the caption
"The Exchange Offer." If the undersigned is not a broker- dealer, the
undersigned represents that it is not engaged in, and does not intend to engage
in, a public distribution of Exchange Notes. The undersigned and each beneficial
owner will, upon request, execute and deliver any additional documents deemed by
the Exchange Agent or the Company to be necessary or desirable to complete the
assignment, transfer and purchase of the Old Notes tendered hereby.
For purposes of the Exchange Offer, the Company shall be deemed to have
accepted validly tendered Old Notes when, as and if the Company has given oral
or written notice thereof to the Exchange Agent.
If any tendered Old Notes are not accepted for exchange pursuant to the
Exchange Offer for any reason, certificates for any such unaccepted Old Notes
will be returned, without expense, to the undersigned at the address shown below
or at a different address as may be indicated herein under "Special Delivery
Instructions" as promptly as practicable after the Expiration Date.
All authority conferred or agreed to be conferred by this Letter of
Transmittal shall survive the death, incapacity or dissolution of the
undersigned, and every obligation of the undersigned under this Letter of
Transmittal shall be binding upon the undersigned's heirs, personal
representatives, successors and assigns.
The undersigned understands that tenders of Old Notes pursuant to the
procedures described under the caption "The Exchange Offer--Procedures for
Tendering" in the Prospectus and in the instructions hereto will constitute a
binding agreement between the undersigned and the Company upon the terms and
subject to the conditions of the Exchange Offer, subject only to withdrawal of
such tenders on the terms set forth in the Prospectus under the caption "The
Exchange Offer--Withdrawal of Tenders."
Unless otherwise indicated under "Special Registration Instructions,"
please issue the certificates representing the Exchange Notes issued in exchange
for the Old Notes accepted for exchange and any certificates for Old Notes not
tendered or not exchanged, in the name(s) of the undersigned. Similarly, unless
otherwise indicated under "Special Delivery Instructions," please send the
certificates representing the Exchange Notes issued in exchange for the Old
Notes accepted for
5
<PAGE>
exchange and any certificates for Old Notes not tendered or not exchanged (and
accompanying documents, as appropriate) to the undersigned at the address shown
below the undersigned's signature(s). In the event that both "Special
Registration Instructions" and "Special Delivery Instructions" are completed,
please issue the certificates representing the Exchange Notes issued in exchange
for the Old Notes accepted for exchange in the name(s) of, and return any
certificates for Old Notes not tendered or not exchanged to, the person(s) so
indicated. The undersigned understands that the Company has no obligation
pursuant to the "Special Registration Instructions" and "Special Delivery
Instructions" to transfer any Old Notes from the name of the registered
holder(s) thereof if the Company does not accept for exchange any of the Old
Notes so tendered.
Holders who wish to tender their Old Notes and whose Old Notes are not
immediately available or who cannot deliver their certificates and all other
documents required by this Letter of Transmittal to the Exchange Agent prior to
the Expiration Date, may tender their Old Notes according to the guaranteed
delivery procedures set forth in the Prospectus under the caption "The Exchange
Offer--Guaranteed Delivery Procedures." See Instruction 1 regarding the
completion of this Letter of Transmittal printed below.
PLEASE SIGN HERE WHETHER OR NOT
OLD NOTES ARE BEING PHYSICALLY TENDERED HEREBY
X
Date:
----------------------
- --------------------------------------------------------------------------------
X
Date:
----------------------
- --------------------------------------------------------------------------------
Signature(s) of Registered Holder(s) or Authorized Signatory
Area Code and Telephone Number:
- -------------------------------------------------
The above lines must be signed by the registered holder(s) as their name(s)
appear(s) on the Old Notes or by person(s) authorized to become registered
holder(s) by a properly completed bond power from the registered holder(s), a
copy of which must be transmitted with this Letter of Transmittal. If the Old
Notes to which this Letter of Transmittal relate are held of record by two or
more joint holders, then all such holders must sign this Letter of Transmittal.
If signature is by a trustee, executor, administrator, guardian, attorney-in-
fact, officer of a corporation or other person acting in a fiduciary or
representative capacity, then such person must (i) set forth his or her full
title below and (ii) unless waived by the Company, submit evidence satisfactory
to the Company of such person's authority so to act. See Instruction 4 regarding
the completion of this Letter of Transmittal printed below.
Name(s):
---------------------------------------------------------
(Please Print)
Capacity:
--------------------------------------------------------
(Please Print)
Address:
--------------------------------------------------------
(Include Zip Code)
6
<PAGE>
Signature(s) Guaranteed by an Eligible Institution:
(If required by Instruction 4)
- --------------------------------------------------------------------------------
(Authorized Signature)
- --------------------------------------------------------------------------------
(Title)
- --------------------------------------------------------------------------------
(Name of Firm)
Date:
-------------------------------------
7
<PAGE>
INSTRUCTIONS
FORMING PART OF THE TERMS AND CONDITIONS
OF THE EXCHANGE OFFER
1. DELIVERY OF THIS LETTER OF TRANSMITTAL AND OLD NOTES; GUARANTEED DELIVERY
PROCEDURES. The tendered Old Notes as well as a properly completed and duly
executed copy of this Letter of Transmittal or facsimile hereof and any other
documents required by this Letter of Transmittal must be received by the
Exchange Agent at its address set forth herein prior to 5:00 p.m., New York City
time, on the Expiration Date. The method of delivery of the tendered Old Notes,
this Letter of Transmittal and all other required documents to the Exchange
Agent is at the election and risk of the holder and, except as otherwise
provided below, the delivery will be deemed made only when actually received by
the Exchange Agent. Instead of delivery by mail, it is recommended that the
holder use an overnight or hand delivery service. In all cases, sufficient time
should be allowed to assure timely delivery. No Letter of Transmittal or Old
Notes should be sent to the Company.
Holders who wish to tender their Old Notes and (i) whose Old Notes are not
immediately available or (ii) who cannot deliver their Old Notes, this Letter of
Transmittal or any other documents required hereby to the Exchange Agent prior
to the Expiration Date must tender their Old Notes according to the guaranteed
delivery procedures set forth in the Prospectus. Pursuant to such procedure: (a)
such tender must be made by or through an Eligible Institution (defined below);
(b) prior to the Expiration Date, the Exchange Agent must have received from the
Eligible Institution a properly completed and duly executed Notice of Guaranteed
Delivery (by facsimile transmission, mail or hand delivery) setting forth the
name and address of the holder, the certificate number or numbers of such Old
Notes and the principal amount of Old Notes tendered, stating that the tender is
being made thereby and guaranteeing that, within three New York Stock Exchange
trading days after the Expiration Date, this Letter of Transmittal (or facsimile
hereof) together with the certificate(s) representing the Old Notes and any
other required documents will be deposited by the Eligible Institution with the
Exchange Agent; and (c) such properly completed and executed Letter of
Transmittal (or facsimile hereof), as well as the certificate(s) representing
all tendered Old Notes in proper form for transfer and all other documents
required by this Letter of Transmittal must be received by the Exchange Agent
within three New York Stock Exchange trading days after the Expiration Date, all
as provided in the Prospectus under the caption "The Exchange Offer--Guaranteed
Delivery Procedures." Any holder who wishes to tender his or her Old Notes
pursuant to the guaranteed delivery procedures described above must ensure that
the Exchange Agent receives the Notice of Guaranteed Delivery prior to 5:00
p.m., New York City time, on the Expiration Date. Upon request to the Exchange
Agent, a Notice of Guaranteed Delivery will be sent to holders who wish to
tender their Old Notes according to the guaranteed delivery procedures set forth
above.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance of tendered Old Notes, and withdrawal of tendered Old Notes
will be determined by the Company in its sole discretion, which determination
will be final and binding. The Company reserves the absolute right to reject any
and all Old Notes not properly tendered or any Old Notes the Company's
acceptance of which would, in the opinion of counsel for the Company, be
unlawful. The Company also reserves the right to waive any irregularities or
conditions of tender as to particular Old Notes. The Company's interpretation of
the terms and conditions of the Exchange Offer (including the instructions in
this Letter of Transmittal) shall be firm and binding on all parties. Unless
waived, any defects or irregularities in connection with tenders of Old Notes
must be cured within such time as the Company shall determine. Neither the
Company, the Exchange Agent nor any other person shall be under any duty to give
notification of defects or irregularities with respect to tenders of Old Notes,
nor shall any of them incur any liability for failure to give such notification.
Tenders of Old Notes will not be deemed to have been made until such defects or
irregularities have been cured or waived. Any Old Notes received by the Exchange
Agent that are not properly tendered and as to which the defects or
irregularities have not been cured or waived will be returned by the Exchange
Agent to the tendering holders, unless otherwise provided in this Letter of
Transmittal, as soon as practicable following the Expiration
8
<PAGE>
Date.
2. TENDER BY HOLDER. Only a holder of Old Notes may tender such Old Notes in
the Exchange Offer. Any beneficial owner of Old Notes who is not the registered
holder and who wishes to tender should arrange with such registered holder to
execute and deliver this Letter of Transmittal on such owner's behalf or must,
prior to completing and executing this Letter of Transmittal and delivering his
or her Old Notes, either make appropriate arrangements to register ownership of
the Old Notes in such owner's name or obtain a properly completed bond power
from the registered holder.
3. PARTIAL TENDERS. Tenders of Old Notes will be accepted only in integral
multiples of $1,000. If less than the entire principal amount of any Old Notes
is tendered, the tendering holder should fill in the principal amount tendered
in the fourth column of the box entitled "Description of 10 1/2% Senior Discount
Notes due 2004" above. The entire principal amount of any Old Notes delivered to
the Exchange Agent will be deemed to have been tendered unless otherwise
indicated. If the entire principal amount of all Old Notes is not tendered, then
Old Notes for the principal amount of Old Notes not tendered and a certificate
or certificates representing Exchange Notes issued in exchange for any Old Notes
accepted will be sent to the holder at his or her registered address, unless a
different address is provided in the appropriate box on this Letter of
Transmittal, promptly after the Old Notes are accepted for exchange.
4. SIGNATURES ON THE LETTER OF TRANSMITTAL; BOND POWERS AND ENDORSEMENTS;
GUARANTEE OF SIGNATURES. If this Letter of Transmittal (or facsimile hereof) is
signed by the registered holder(s) of the Old Notes tendered hereby, the
signature must correspond with the name(s) as written on the face of the Old
Notes without alteration, enlargement or any change whatsoever.
If this Letter of Transmittal (or facsimile hereof) is signed by the
registered holder or holders of Old Notes tendered and the certificate or
certificates for Exchange Notes issued in exchange therefor is to be issued (or
any untendered principal amount of Old Notes is to be reissued) to the
registered holder and neither the "Special Delivery Instructions" nor the
"Special Registration Instructions" has been completed, then such holder need
not and should not endorse any tendered Old Notes, nor provide a separate bond
power. In any other case, such holder must either properly endorse the Old Notes
tendered or transmit a properly completed separate bond power with this Letter
of Transmittal with the signatures on the endorsement or bond power guaranteed
by an Eligible Institution.
If this Letter of Transmittal (or facsimile hereof) is signed by a person
other than the registered holder or holders of any Old Notes listed, such Old
Notes must be endorsed or accompanied by appropriate bond powers in each case
signed as the name of the registered holder or holders appears on the Old Notes.
If this Letter of Transmittal (or facsimile hereof) or any Old Notes or
bond powers are signed by trustees, executors, administrators, guardians,
attorneys-in-fact, or officers of corporations or others acting in a fiduciary
or representative capacity, such persons should so indicate when signing, and,
unless waived by the Company, evidence satisfactory to the Company of their
authority so to act must be submitted with this Letter of Transmittal.
Endorsements on Old Notes or signatures on bond powers required by this
Instruction 4 must be guaranteed by an Eligible Institution which is a member of
(a) the Securities Transfer Agents Medallion Program, (b) the New York Stock
Exchange Medallion Signature Program or (c) the Stock Exchange Medallion
Program.
Except as otherwise provided below, all signatures on this Letter of
Transmittal must be guaranteed by a firm that is a member of a registered
national securities exchange or the National Association of Securities Dealers,
Inc., a commercial bank or trust company having an office or correspondent in
the United States or an "eligible guarantor institution" within the meaning of
Rule 17Ad-15 under the Securities Exchange Act of 1934, as amended (an "Eligible
Institution"). Signatures on this Letter of Transmittal need not be guaranteed
if (a) this Letter of Transmittal is signed by the registered holder(s) of the
Old Notes tendered herewith and such holder(s) have not completed the box set
forth herein entitled "Special Registration
9
<PAGE>
Instructions" or the box entitled "Special Delivery Instructions" or (b) such
Old Notes are tendered for the account of an Eligible Institution.
5. SPECIAL REGISTRATION AND DELIVERY INSTRUCTIONS. Tendering holders should
indicate, in the applicable box or boxes, the name and address to which Exchange
Notes or substitute Old Notes for principal amounts not tendered or not accepted
for exchange are to be issued or sent, if different from the name and address of
the person signing this Letter of Transmittal. In the case of issuance in a
different name, the taxpayer identification or social security number of the
person named must also be indicated.
6. TRANSFER TAXES. The Company will pay all transfer taxes, if any, applicable
to the exchange of Old Notes pursuant to the Exchange Offer. If, however,
certificates representing Exchange Notes or Old Notes for principal amounts not
tendered or accepted for exchange are to be delivered to, or are to be
registered in the name of, any person other than the registered holder of the
Old Notes tendered hereby, or if tendered Old Notes are registered in the name
of any person other than the person signing this Letter of Transmittal, or if a
transfer tax is imposed for any reason other than the exchange of Old Notes
pursuant to the Exchange Offer, then the amount of any such transfer taxes
(whether imposed on the registered holder or on any other persons) will be
payable by the tendering holder. If satisfactory evidence of payment of such
taxes or exemption therefrom is not submitted with this Letter of Transmittal,
the amount of such transfer taxes will be billed directly to such tendering
holder.
Except as provided in this Instruction 6, it will not be necessary for
transfer tax stamps to be affixed to the Old Notes listed in this Letter of
Transmittal.
7. WAIVER OF CONDITIONS. The Company reserves the right, in its sole
discretion, to amend, waive or modify specified conditions in the Exchange Offer
in the case of any Old Notes tendered.
8. MUTILATED, LOST, STOLEN OR DESTROYED OLD NOTES. Any tendering holder
whose Old Notes have been mutilated, lost, stolen or destroyed should contact
the Exchange Agent at the address indicated herein for further instructions.
9. REQUESTS FOR ASSISTANCE OR ADDITIONAL COPIES. Questions and requests for
assistance and requests for additional copies of the Prospectus or this Letter
of Transmittal may be directed to the Exchange Agent at the address specified in
the Prospectus. Holders may also contact their broker, dealer, commercial bank,
trust company or other nominee for assistance concerning the Exchange Offer.
10
<PAGE>
(DO NOT WRITE IN SPACE BELOW)
CERTIFICATE
SURRENDERED OLD NOTES TENDERED OLD NOTES ACCEPTED
Delivery Prepared by Checked by Date
11
<PAGE>
Exhibit 99.2
TELEGROUP, INC.
NOTICE OF GUARANTEED DELIVERY
OF
10 1/2% SENIOR DISCOUNT NOTES DUE 2004
As set forth in the Prospectus, dated __, 1997 (as the same may be amended
from time to time, the "Prospectus"), of TELEGROUP, Inc. (the "Company") under
the caption ("The Exchange Offer--Guaranteed Delivery Procedures") this form or
one substantially equivalent hereto must be used to accept the Company's offer
(the "Exchange Offer") to exchange its 10 1/2% Senior Discount Notes due 2004
(the "Exchange Notes"), which have been registered under the Securities Act of
1933, as amended (the "Securities Act"), for an equal principal amount of its
10 1/2% Senior Discount Notes due 2004 (the "Old Notes"), if (i) certificates
representing the Old Notes to be exchanged are not lost but are not immediately
available or (ii) time will not permit all required documents to reach the
Exchange Agent prior to the Expiration Date. This form may be delivered by an
Eligible Institution by mail or hand delivery or transmitted, via facsimile, to
the Exchange Agent at its address set forth below not later than 5:00 p.m., New
York City time, on , 1998. All capitalized terms used herein but not defined
herein shall have the meanings ascribed to them in the Prospectus.
The Exchange Agent is:
By Registered or By Overnight Courier: By Hand:
Certified Mail:
By Facsimile:
Confirm by Telephone:
DELIVERY, OR TRANSMISSION VIA FACSIMILE, OF THIS INSTRUMENT TO AN ADDRESS OTHER
THAN AS SET FORTH ABOVE WILL NOT CONSTITUTE A VALID DELIVERY.
Ladies and Gentlemen:
The undersigned hereby tender(s) for exchange to the Company, upon the
terms and subject to the conditions set forth in the Prospectus and Letter of
Transmittal, receipt of which is hereby acknowledged, the principal amount of
Old Notes set forth below pursuant to the guaranteed delivery procedures set
forth in the Prospectus under the caption "The Exchange Offer--Guaranteed
Delivery Procedures."
The undersigned understands and acknowledges that the Exchange Offer will
expire at 5:00 p.m., New York City time, on, 1998, unless extended by the
Company. With respect to the Exchange Offer, "Expiration Date" means such time
and date, or if the Exchange Offer is extended, the latest time and date to
which the Exchange Offer is so extended by the Company.
All authority herein conferred or agreed to be conferred by this Notice of
Guaranteed Delivery shall survive the death or incapacity of the undersigned and
every obligation of the undersigned under this Notice of Guaranteed Delivery
shall be
1
<PAGE>
binding upon the heirs, personal representatives, executors, administrators,
successors, assigns, trustees in bankruptcy and other legal representatives of
the undersigned.
Principal Amount of Old Notes Exchanged:
$
-----------------------------------
SIGNATURES Certificate Nos. of Old Notes
(if available)
- -------------------------------------
Signature of Owner
- -------------------------------------
- -------------------------------------
Signature of Owner (if more than one)
- -------------------------------------
$
-----------------------------------
Dated:
DELIVERED BY IF OLD NOTES WILL BE BOOK-ENTRY
TRANSFER, PROVIDE THE DEPOSITORY
Names(s): TRUST COMPANY ("DTC") ACCOUNT NO.:
- -------------------------------------
(Please Print)
Address (Include Zip Code):
- -------------------------------------
- -------------------------------------
- -------------------------------------
Area Code and Telephone No.
- -------------------------------------
Capacity (full title), if signing in a representative capacity
-----------------
2
<PAGE>
Taxpayer Identification or
Social Security No.:
-----------------------
GUARANTEE OF DELIVERY
(NOT TO BE USED FOR SIGNATURE GUARANTEE)
The undersigned, a firm which is a member of a registered national
securities exchange or of the National Association of Securities Dealers, Inc.,
or is a commercial bank or trust company having an office or correspondent in
the United States, or is otherwise an "eligible guaranteed institution" within
the meaning of Rule 17Ad-15 under the Securities Exchange Act of 1934, as
amended, guarantees deposit with the Exchange Agent of the Letter of Transmittal
(or facsimile thereof), together with the Old Notes tendered hereby in proper
form for transfer (or confirmation of the book-entry transfer of such Old Notes
into the Exchange Agent's account at the Book-Entry Transfer Facility described
in the Prospectus under the caption "The Exchange Offer--Guaranteed Delivery
Procedures" and in the Letter of Transmittal) and any other required document,
all by 5.00 p.m., New York City time, on the third New York Stock Exchange
trading day following the Expiration Date.
Authorized Signature
Name of Firm: Name:
-------------------------- ----------------------------
Address:
-------------------------------
Title:
- --------------------------------------- ---------------------------
- ---------------------------------------
Area Code and Telephone No.: Date:
----------- ----------------------------
NOTE: DO NOT SEND OLD NOTES WITH THIS FORM. ACTUAL SURRENDER OF OLD NOTES
MUST BE MADE PURSUANT TO, AND BE ACCOMPANIED BY, THE LETTER OF TRANSMITTAL.
3
<PAGE>
Exhibit 99.3
TELEGROUP, INC.
OFFER TO EXCHANGE ITS
10 1/2 SENIOR DISCOUNT NOTES DUE 2004
FOR ANY AND ALL OF ITS OUTSTANDING
10 1/2% SENIOR DISCOUNT NOTES DUE 2004
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M.. NEW YORK TIME, ON ______________,
1998 UNLESS EXTENDED.
To Brokers, Dealers, Commercial Banks,
1997 Trust Companies and Other Nominees:
TELEGROUP, Inc. an Iowa corporation, (the "Company") is offering upon the terms
and conditions set forth in the Prospectus, dated __, 1997 (as the same may be
amended from time to time, the "Prospectus"), and in the related Letter of
Transmittal enclosed herewith, to exchange (the "Exchange Offer") its 10
1/2%Series B Senior Discount Notes due 2004 (the "Exchange Notes") for an equal
principal amount of its 10 1/2% Senior Discount Notes due 2004 (the "Old Notes"
and together with the Exchange Notes, the "Notes"). As set forth in the
Prospectus, the terms of the Exchange Notes are identical in all material
respects to the Old Notes, except for certain transfer restrictions relating to
the Old Notes and except that the Exchange Notes will not contain certain
provisions relating to an increase in the interest rate which were included in
the Old Notes under certain circumstances relating to the timing of the Exchange
Offer. Old Notes may only be tendered in integral multiples of $1,000.
THE EXCHANGE OFFER IS SUBJECT TO CERTAIN CONDITIONS. SEE "THE EXCHANGE OFFER--
CONDITIONS" IN THE PROSPECTUS.
Enclosed herewith for your information and forwarding to your clients are
copies of the following documents:
1. The Prospectus, dated __, 1997.
2. The Letter of Transmittal to exchange Notes for your use and for the
information of your clients. Facsimile copies of the Letter of Transmittal may
be used to exchange Notes.
3. A form of letter which may be sent to your clients for whose accounts
you hold Old Notes registered in your name or in the name of your nominee, with
space provided for obtaining such client's instructions with regard to the
Exchange Offer.
4. A Notice of Guaranteed Delivery.
5. Guidelines of the Internal Revenue Service for Certification of
Taxpayer Identification Number on Substitute Form W-9.
6. A return envelope addressed to __, the Exchange Agent.
YOUR PROMPT ACTION IS REQUESTED. WE URGE YOU TO CONTACT YOUR CLIENTS AS
PROMPTLY AS POSSIBLE. PLEASE NOTE THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M.,
NEW YORK CITY TIME, ON
<PAGE>
__, 1998, UNLESS EXTENDED. PLEASE FURNISH COPIES OF THE ENCLOSED MATERIALS TO
THOSE OF YOUR CLIENTS FOR WHOM YOU HOLD OLD NOTES REGISTERED IN YOUR NAME OR IN
THE NAME OF YOUR NOMINEE AS QUICKLY AS POSSIBLE.
In all cases, exchanges of Old Notes accepted for exchange pursuant to the
Exchange Offer will be made only after timely receipt by the Exchange Agent of
(a) certificates representing such Old Notes, (b) the Letter of Transmittal (or
facsimile thereof) properly completed and duly executed with any required
signature guarantees, and (c) any other documents required by the Letter of
Transmittal.
If holders of Old Notes wish to tender, but it is impracticable for them to
forward their certificates for Old Notes prior to the expiration of the Exchange
Offer or to comply with the book-entry transfer procedures on a timely basis, a
tender may be offered by following the guaranteed delivery procedure described
in the Prospectus under "The Exchange Offer--Guaranteed Delivery Procedures."
The Exchange Offer is not being made to (nor will tenders be accepted from
or on behalf of) holders of Old Notes residing in any jurisdiction in which the
making of the Exchange Offer or the acceptance thereof would not be in
compliance with the laws of such jurisdiction.
The Company will not pay any fees or commissions to brokers, dealers or
other persons for soliciting exchanges of Notes pursuant to the Exchange Offer.
The Company will, however, upon request, reimburse you for customary clerical
and mailing expenses incurred by you in forwarding any of the enclosed materials
to your clients. The Company will pay or cause to be paid any transfer taxes
payable on the transfer of Notes to it, except as otherwise provided in
Instruction 6 of the Letter of Transmittal.
Questions and requests for assistance with respect to the Exchange Offer or
for copies of the Prospectus and Letter of Transmittal may be directed to the
Exchange Agent at its address set forth in the Prospectus or at __.
Very truly yours,
TELEGROUP, INC.
NOTHING CONTAINED HEREIN OR IN THE ENCLOSED DOCUMENTS SHALL CONSTITUTE YOU
OR ANY OTHER PERSON THE AGENT OF THE COMPANY, OR ANY AFFILIATE THEREOF, OR
AUTHORIZE YOU OR ANY OTHER PERSON TO MAKE ANY STATEMENT OR USE ANY DOCUMENT ON
BEHALF OF ANY OF THEM IN CONNECTION WITH THE OFFER OTHER THAN THE ENCLOSED
DOCUMENTS AND THE STATEMENTS CONTAINED THEREIN.
2
<PAGE>
Exhibit 99.4
TELEGROUP, INC.
OFFER TO EXCHANGE ITS
10 1/2% SENIOR DISCOUNT NOTES DUE 2004
FOR ANY AND ALL OF ITS OUTSTANDING
10 1/2% SENIOR DISCOUNT NOTES DUE 2004
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON, __ 1998
(THE "INITIAL EXPIRATION DATE"), UNLESS EXTENDED.
To Our Clients:
Enclosed for your consideration is a Prospectus, dated __ 1997 (as the same
may be amended from time to time, the "Prospectus"), and a Letter of Transmittal
(the "Letter of Transmittal") relating to the offer by Telegroup, Inc. (the
"Company") to exchange (the "Exchange Offer") its 10 1/2% Senior Discount Notes
due 2004 (the "Exchange Notes") for an equal principal amount of its 10 1/2%
Senior Discount Notes due 2004 (the "Old Notes") upon the terms and conditions
set forth in the Prospectus and in the related Letter of Transmittal. As set
forth in the Prospectus, the terms of the Exchange Notes are identical in all
material respects to the Old Notes, except for certain transfer restrictions
relating to the Old Notes and except that the Exchange Notes will not contain
certain provisions relating to an increase in the interest rate which were
included in the Old Notes under certain circumstances relating to the timing of
the Exchange Offer. The Exchange Offer is subject to certain customary
conditions. See "The Exchange Offer" in the Prospectus. Old Notes may be
tendered only in integral multiples of $1,000.
The material is being forwarded to you as the beneficial owner of Old Notes
carried by us for your account or benefit but not registered in your name. An
exchange of any Old Notes may only be made by us as the registered holder and
pursuant to your instructions. Therefore, the Company urges beneficial owners of
Old Notes registered in the name of a broker, dealer, commercial bank, trust
company or other nominee to contact such holder promptly if they wish to
exchange Old Notes in the Exchange Offer.
Accordingly, we request instructions as to whether you wish us to exchange
any or all such Old Notes held by us for your account or benefit, pursuant to
the terms and conditions set forth in the Prospectus and Letter of Transmittal.
We urge you to read carefully the Prospectus and Letter of Transmittal before
instructing us to exchange your Old Notes.
Your instructions to us should be forwarded as promptly as possible in
order to permit us to exchange Old Notes on your behalf in accordance with the
provisions of the Exchange Offer. The Exchange Offer expires at 5:00 pm., New
York City time, on __, 1997, unless extended. With respect to the Exchange
Offer, "Expiration Date" means the Initial Expiration Date, or if the Exchange
Offer is extended, the latest time and date to which the Exchange Offer is so
extended by the Company. Tender of Old Notes may be withdrawn at any time prior
to 5:00 p.m., New York City time, on the Expiration Date.
Your attention is directed to the following:
1. The Exchange Offer is for the exchange of $1,000 principal amount of the
Exchange Notes for each $1,000 principal amount of the Old Notes, of which
[97,000,000] aggregate principal amount of the Old Notes was outstanding as of
__ 1997. The terms of the Exchange Notes are identical in all material respects
to the Old Notes, except for certain transfer restrictions relating to the Old
Notes and except that the Exchange Notes will not contain certain provisions
relating to an increase in the interest rate which were included in the Old
Notes under certain circumstances relating to the timing of the Exchange Offer.
<PAGE>
2. THE EXCHANGE OFFER IS SUBJECT TO CERTAIN CONDITIONS. SEE "THE EXCHANGE
OFFER--CONDITIONS" IN THE PROSPECTUS.
3. The Exchange Offer and withdrawal rights will expire at 5:00 p.m., New York
City time, on __________________ __, 1997, unless extended.
4. The Company has agreed to pay the expenses of the Exchange Offer.
5. Any transfer taxes incident to the transfer of Notes from the tendering
holder to the Company will be paid by the Company, except as provided in the
Prospectus and the Letter of Transmittal.
The Exchange Offer is not being made to, nor will exchanges be accepted
from or on behalf of, holders of Old Notes residing in any jurisdiction in which
the making of the Exchange Offer or acceptance thereof would not be in
compliance with the laws of such jurisdiction
If you wish us to exchange any or all of your Old Notes held by us for your
account or benefit, please so instruct us by completing, executing and returning
to us the instruction form that appears below.
2
<PAGE>
THE ACCOMPANYING LETTER OF TRANSMITTAL IS FURNISHED TO YOU FOR INFORMATIONAL
PURPOSES ONLY AND MAY NOT BE USED BY YOU TO EXCHANGE OLD NOTES HELD BY US AND
REGISTERED IN YOUR NAME FOR YOUR ACCOUNT OR BENEFIT.
INSTRUCTIONS
The undersigned acknowledge(s) receipt of your letter and the enclosed
material referred to therein relating to the Exchange Offer of Telegroup, Inc.
This will instruct you to exchange the aggregate principal amount of Old
Notes indicated below (or, if no aggregate principal amount is indicated below,
all Old Notes) held by you for the account or benefit of the undersigned,
pursuant to the terms of and conditions set forth in the Prospectus and the
Letter of Transmittal.
Aggregate Principal Amount of Old Notes to be exchanged
$ *
I (WE) UNDERSTAND THAT IF I (WE) SIGN THESE INSTRUCTION FORMS WITHOUT INDICATING
AN AGGREGATE PRINCIPAL AMOUNT OF OLD NOTES IN THE SPACE ABOVE, ALL OLD NOTES
HELD BY YOU FOR MY (OUR) ACCOUNT WILL BE EXCHANGED.
(PLEASE PRINT NAME(S) AND ADDRESS HERE)
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
DATED:
------------------------------------------------
(AREA CODE AND TELEPHONE NUMBER)
- --------------------------------
(TAXPAYER IDENTIFICATION OR SOCIAL SECURITY NUMBER)
- ------------------------------------------------------
* UNLESS OTHERWISE INDICATED, IT WILL BE ASSUMED THAT ALL OF YOUR OLD NOTES
ARE TO BE EXCHANGED.
3
<PAGE>
Exhibit 99.5
GUIDELINES FOR CERTIFICATION OF TAXPAYER
IDENTIFICATION NUMBER ON SUBSTITUTE FORM W-9
Guidelines for determining the proper identification number to give the payer.
- --Social Security numbers have nine digits separated by two hyphens: i.e.
000-00-0000. Employer identification numbers have nine digits separated by only
one hyphen: i.e. 00-0000000. The table below will help determine the number to
give the payer.
<TABLE>
<CAPTION>
GIVE THE SOCIAL SECURITY
FOR THIS TYPE OF ACCOUNT: NUMBER OF --
<S> <C>
1. An individual The individual's account
2. Two or more individuals The actual owner
(joint account) of the account or, if combined funds,
any one of the individuals(1)
3. Husband and wife (joint The actual owner
account) of the account or, if joint funds,
either person(1)
4 Custodian account of a The minor(2)
minor (Uniform Gift to
Minors Act)
5. Adult and minor (joint The adult or, if
account) the minor is the only contributor,
the minor(1)
6. Account in the name of The ward, minor, guardian or committee
for a or incompetent designated ward,
minor, or person(3) incompetent person
7. a. The usual revocable The grantor-
savings trust account trustee(1)
(grantor is also trustee)
b. So-called trust account The actual
that is not a legal or owner(1)
valid trust under State law
GIVE THE EMPLOYER
FOR THIS TYPE OF ACCOUNT: IDENTIFICATION NUMBER OF --
8. Sole proprietorship The owner(4)
account
9. A valid trust, estate, or The legal entity
pension trust (Do not furnish the identifying number
of the personal representative or
trustee unless the legal entity itself
is not designated in the account
title.)(5)
10. Corporate account The corporation
</TABLE>
<PAGE>
<TABLE>
<S> <C>
11. Religious, charitable, or The organization
educational organization account
12. Partnership account held The partnership
in the name of the business
13. Association, club, or The organization
other tax-exempt organization
14. A broker or registered The broker or
nominee nominee
15. Account with the The public entity
Department of Agriculture in the name of public entity
(such as a State or local a government,
school district, or prison) that receives
agricultural program payments
</TABLE>
(1) List first and circle the name of the person whose number you furnish.
(2) Circle the minor's name and furnish the minor's social security number.
(3) Circle the ward's, minor's or incompetent person's name and furnish such
person's social security number.
(4) Show the name of the owner.
(5) List first and circle the name of the legal trust, estate, or pension
trust.
NOTE: If no name is circled when there is more than one name, the number will
be considered to be that of the first name listed.
2
<PAGE>
GUIDELINES FOR CERTIFICATION OF TAXPAYER IDENTIFICATION
NUMBER OF SUBSTITUTE FORM W-9
PAGE 2
OBTAINING A NUMBER
If you don't have a taxpayer identification number or you don't know your
number, obtain Form SS-5, Application for a Social Security Number Card, or
Form SS-4, Application for Employer Identification Number, at the local
office of the Social Security Administration or the Internal Revenue Service
and apply for a number.
PAYEES EXEMPT FROM BACKUP WITHHOLDING
Payees specifically exempted from backup withholding on ALL payments include
the following:
. A corporation.
. A financial institution.
. An organization exempt from tax under section 501(a), or an individual
retirement plan.
. The United States or any agency or instrumentality thereof.
. A State, the District of Columbia, a possession of the United States, or
any subdivision or instrumentality thereof.
. A foreign government, a political subdivision of a foreign government, or
any agency or instrumentality thereof.
. An international organization or any agency, or instrumentality thereof.
. A registered dealer in securities or commodities registered in the U.S. or
a possession of the U.S.
. A real estate investment trust.
. A common trust fund operated by a bank under section 584(a).
. An exempt charitable remainder trust, or a non-exempt trust described in
section 4947(a)(1).
. An entity registered at all times under the Investment Company Act of
1940.
. A foreign central bank of Issue.
Payments of dividends and patronage dividends not generally subject to backup
withholding include the following:
. Payments to nonresident aliens subject to withholding under section 1441.
. Payments to partnerships not engaged in a trade or business in the U.S.
and which have at least one nonresident partner.
3
<PAGE>
. Payments of patronage dividends where the amount received is not paid in
money.
. Payments made by certain foreign organizations.
. Payments made to a nominee.
Payments of interest not generally subject to backup withholding include the
following:
. Payments of interest on obligations issued by individuals. Note: You may
----
be subject to backup withholding if this interest is $600 or more and is
paid in the course of the payer's trade or business and you have not
provided your correct taxpayer identification number to the payer.
. Payments of tax-exempt interest (including exempt-interest dividends under
section 852).
. Payments described in section 6049(b)(5) to non-resident aliens.
. Payments on tax-free covenant bonds under section 1451.
. Payments made by certain foreign organizations.
. Payments made to a nominee.
Exempt payees described above should file Form W-9 to avoid possible
erroneous backup withholding. FILE THIS FORM WITH THE PAYER, FURNISH YOUR
TAXPAYER IDENTIFICATION NUMBER, WRITE "EXEMPT" ON THE FACE OF THE FORM, AND
RETURN IT TO THE PAYER. IF THE PAYMENTS ARE INTEREST, DIVIDENDS, OR
PATRONAGE DIVIDENDS, ALSO SIGN AND DATE THE FORM.
Certain payments other than interest, dividends, and patronage dividends,
that are not subject to information reporting are also not subject to backup
withholding. For details, see the regulations under sections 6041, 6041A(a),
6045, and 6050A.
PRIVACY ACT NOTICE. -- Section 6109 requires most recipients of dividend,
interest, or other payments to give taxpayer identification number to payers
who must report the payments to IRS. IRS uses the numbers for identification
purposes. Payers must be given the numbers whether or not recipients are
required to file tax returns. Beginning January 1, 1993, payers must
generally withhold 31% of taxable interest, dividend, and certain other
payments to a payee who does not furnish a taxpayer identification number to
a payer. Certain penalties may also apply.
PENALTIES
(1) PENALTY FOR FAILURE TO FURNISH TAXPAYER IDENTIFICATION NUMBER. -- If
you fail to furnish your taxpayer identification number to a payer, you are
subject to a penalty of $50 for each such failure unless your failure is due
to reasonable cause and not to willful neglect.
(2) FAILURE TO REPORT CERTAIN DIVIDEND AND INTEREST PAYMENTS. -- If you fail
to include any portion of an includible payment for interest, dividends, or
patronage dividends in gross income, such failure will be treated as being
due to negligence and will be subject to a penalty of 5% on any portion of an
underpayment attributable to that failure unless there is clear and
convincing evidence to the contrary.
(3) CIVIL PENALTY FOR FALSE INFORMATION WITH RESPECT TO WITHHOLDING. -- If
you make a false statement with no reasonable basis which results in no
imposition of backup withholding, you are subject to a penalty of $500.
4
<PAGE>
(4) CRIMINAL PENALTY FOR FALSIFYING INFORMATION. -- Falsifying certifications
or affirmations may subject you to criminal penalties including fines and/or
imprisonment.
FOR ADDITIONAL INFORMATION CONTACT YOUR TAX CONSULTANT OR THE INTERNAL
REVENUE SERVICE
5
