SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to ___________________
Commission File No. 000-29284
TELEGROUP, INC.
(Exact name of Registrant as Specified in Its Charter)
Iowa 42-1344121
- - - ------------------------------ ----------------------------
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
2098 Nutmeg Avenue, Fairfield, IA 52556
- - - --------------------------------- -----------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: 515-472-5000
------------------------
- - ------------------------------------------------------------------------------
Former Name, Former Address and Former Fiscal Year, if Changed Since Last
Report
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of Common Stock, as of the latest practicable date: There are 33,635,039
shares of Common stock outstanding as of September 30, 1998 and 33,666,410 as
of the close of business on November 13, 1998.
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TELEGROUP, INC.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
- - ------------------------------- ----
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 1997
and September 30, 1998 (unaudited)............................. 3
Consolidated Statements of Operations for the Three and
Nine Months Ended September 30, 1997 (unaudited) and
September 30, 1998 (unaudited)................................. 4
Consolidated Statements of Comprehensive Earnings for the
Three and Nine Months Ended September 30, 1997 (unaudited) and
September 30, 1998 (unaudited)................................. 5
Consolidated Statement of Shareholders' Equity (Deficit)for
the Nine Months Ended September 30, 1998 (unaudited)........... 6
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1997 (unaudited) and September 30, 1998
(unaudited).................................................... 7
Notes to Consolidated Financial Statements (unaudited)......... 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 12
PART II - OTHER INFORMATION
- - - --------------------------
Item 1. Legal Proceedings.................................................17
Item 2. Changes in Securities and Use of Proceeds.........................17
Item 3. Defaults Upon Senior Securities...................................17
Item 4. Submission of Matters to a Vote of Security Holders...............17
Item 5. Other Information.................................................17
Item 6. Exhibits and Reports on Form 8-K..................................19
Exhibit Index.............................................................20
Signatures................................................................21
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PART I - FINANCIAL INFORMATION
- - -------------------------------
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND SEPTEMBER 30,1998 (UNAUDITED)
December 31, September 30,
-------------------------
ASSETS 1997 1998
------ ------------ -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 74,213,856 14,830,502
Securities available-for-sale 21,103,030 -
Accounts receivable and unbilled services, less
allowance for credit losses of $6,173,846 and
$6,072,064 at December 31, 1997 and September 30,
1998, respectively 54,188,757 63,163,888
Income tax recoverable 2,693,679 2,675,850
Prepaid expenses and other assets 1,384,886 6,020,945
Receivables from shareholders 39,376 624,816
Receivables from employees 152,259 515,061
----------- ----------
Total current assets 153,775,843 87,831,062
----------- ----------
Net property and equipment 27,912,978 61,783,463
----------- ----------
Other assets:
Deposits and other assets 3,594,101 16,362,103
Goodwill, net of amortization of $142,203 and
$1,950,467 at December 31, 1997 and
September 30,1998, respectively 3,102,707 36,321,149
Capitalized software, net of amortization 1,724,758 3,008,756
Debt issuance costs, net of amortization 3,648,026 3,661,603
----------- ----------
12,069,592 59,353,611
----------- ----------
Total assets $193,758,413 208,968,136
----------- ----------
----------- ----------
December 31, September 30,
------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) 1997 1998
---------------------------------------------- ------------ ---------
<S> <C> <C>
Current liabilities:
Accounts payable $ 48,434,985 73,851,327
Commissions payable 7,691,401 8,622,125
Accrued expenses 4,479,515 6,289,534
Note payable (note 3) - 15,000,000
Customer deposits 778,024 929,412
Unearned revenue 186,779 302,472
Current portion of capital lease obligations 158,706 188,916
Current portion of long-term debt (note 3) 93,788 1,065,203
----------- ----------
Total current liabilities 61,823,198 106,248,989
----------- ----------
Capital lease obligations, excluding current portion 221,179 134,576
Long-term debt, excluding current portion(note 3) 101,450,951 107,704,168
Minority interest - -
Shareholders' equity (deficit):
Common stock, no par or stated value;
150,000,000 shares authorized, 30,889,945
and 33,635,039 shares issued and outstanding
at December 31, 1997 and September 30,1998,
respectively - -
Additional paid-in capital 51,649,660 62,994,326
Retained deficit (21,125,080)(67,799,866)
Accumulated other comprehensive income (deficit) (261,495) (314,057)
----------- -----------
Total shareholders' equity (deficit) 30,263,085 (5,119,597)
----------- -----------
Commitments and contingencies (notes)
Total liabilities and
shareholders' equity (deficit) $193,758,413 208,968,136
----------- -----------
----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
3<PAGE>
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<TABLE>
<CAPTION>
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
Three months Nine months
ended September 30, ended September 30,
------------------ ------------------
1997 1998 1997 1998
---- ---- ---- ----
<C> <C> <C> <C>
Revenues:
Retail $ 56,192,571 66,485,458 169,720,131 187,805,828
Wholesale 28,128,733 40,319,060 68,757,955 105,929,907
---------- ---------- ----------- -----------
Total revenues 84,321,304 106,804,518 238,478,086 293,735,735
Cost of revenues 61,876,405 85,807,650 174,273,208 237,200,755
---------- ---------- ----------- -----------
Gross profit 22,444,899 20,996,868 64,204,878 56,534,980
---------- ---------- ----------- -----------
Operating expenses:
Selling, general and
administrative
expenses 23,114,929 34,426,835 63,174,487 85,675,402
Depreciation and
amortization 1,264,523 4,259,857 3,208,063 9,162,563
Stock option-based
compensation 85,595 85,595 256,785 256,785
Impairment of
goodwill (note 5) - 1,888,064 - 1,888,064
---------- ---------- ----------- -----------
Total operating
expenses 24,465,047 40,660,351 66,639,335 96,982,814
---------- ---------- ---------- -----------
Operating loss (2,020,148) (19,663,483) (2,434,457) (40,447,834)
Other income (expense):
Interest expense (645,311) (2,718,326) (2,134,691) (7,582,995)
Interest income 427,677 194,543 782,299 2,135,067
Foreign currency
transaction loss (130,522) (461,984) (587,291) (810,291)
Other 79,556 88,466 159,228 251,798
---------- ---------- ----------- -----------
Loss before
income taxes (2,288,748) (22,560,784) (4,214,912) (46,454,255)
Income tax benefit
(expense) 727,588 23,207 1,366,054 (220,531)
Minority interest in
share of loss - - - -
---------- ---------- ---------- ----------
Loss before
extraordinary item (1,561,160) (22,537,577) (2,848,858) (46,674,786)
Extraordinary item, loss on
extinguishment of debt,
net of income taxes of
$1,469,486 (9,970,815) - (9,970,815) -
---------- ---------- ---------- -----------
Net earnings (loss) (11,531,975) (22,537,577) (12,819,673) (46,674,786)
--------- ---------- ---------- -----------
--------- ---------- ---------- -----------
Per share amounts:
Earnings (loss) before
Extraordinary loss (0.05) (0.67) (0.10) (1.42)
--------- ---------- ---------- -----------
--------- ---------- ---------- -----------
Net earnings (loss) (0.39) (0.67) (0.47) (1.42)
--------- ---------- ---------- -----------
--------- ---------- ---------- -----------
Weighted-average common
shares outstanding--
basic and diluted 29,923,051 33,467,645 27,462,331 32,911,863
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
4<PAGE>
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<PAGE>
<TABLE>
<CAPTION>
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
Three months Nine months
ended September 30, ended September 30,
------------------ ------------------
1997 1998 1997 1998
---- ---- ---- ----
<C> <C> <C> <C>
Net earnings (loss) $(11,531,975) (22,537,577) (12,819,673) (46,674,786)
Foreign currency
translation
adjustment,
net of tax (209,761) 488,157 (260,274) (52,562)
---------- ---------- ----------- -----------
Comprehensive
earnings (loss) $(11,741,736) (22,049,420) (13,079,947) (46,727,348)
---------- ---------- ----------- -----------
---------- ---------- ----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
5<PAGE>
<PAGE>
<TABLE>
<CAPTION>
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,1998
Accumulated Total
Additional other share-
Common stock paid-in Retained comprehensive holders'
Shares Amount capital deficit income (deficit) equity
------ ------ ----------- --------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balances at
December 31,
1997 30,889,945 $ - 51,649,660 (21,125,080) (261,495) 30,263,085
Net loss - - - (46,674,786) - (46,674,786)
Shares issued
in connection
with business
combinations
(note 4) 593,526 - 7,802,717 - - 7,802,717
Compensation
expense in
connection
with stock
option plan - - 256,785 - - 256,785
Shares issued
in-lieu of
future
commissions
(note 7) 125,179 - 1,139,671 - - 1,139,671
Payment received
on note
receivable from
shareholder - - 52,367 - - 52,367
Issuance of shares
for options
exercised 495,021 - 646,477 - - 646,477
Issuance of shares
for warrants
exercised 1,327,333 - - - - -
Issuance of shares
for property
purchase 204,035 - 1,446,649 - - 1,446,649
Change in
foreign
currency
translation - - - - (52,562) (52,562)
---------- ---- --------- ---------- ------- ----------
Balances at
September 30,
1998 33,635,039 $ - 62,994,326 (67,799,866) (314,057) (5,119,597)
---------- ---- ---------- ---------- ------- ----------
---------- ---- ---------- ---------- ------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
6<PAGE>
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<TABLE>
<CAPTION>
TELEGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,1997 AND 1998
Nine months
ended September 30,
-------------------------
1997 1998
---------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(12,819,673) (46,674,786)
Adjustments to reconcile net loss
to net cash used in
operating activities:
Depreciation and amortization 3,208,063 9,162,563
Deferred income taxes (273,052) -
Loss on extinguishment of debt 10,040,301 -
Impairment of goodwill - 1,888,064
Loss on sale of equipment - 70,280
Provision for credit losses on
accounts receivable 6,384,001 9,398,100
Accretion of debt discounts 364,455 6,080,514
Stock option-based compensation expense 256,785 256,785
Changes in operating assets and liabilities,
excluding the effects of business
combinations:
Accounts receivable and
unbilled services (21,791,926) (5,865,534)
Prepaid expenses and other assets (462,267) (2,547,061)
Deposits and other assets (1,650,196) (10,619,246)
Accounts payable, commissions payable and
accrued expenses 16,826,408 11,061,019
Income taxes (1,295,174) 17,829
Unearned revenue 95,946 115,693
Customer deposits 114,284 151,388
---------- ---------
Net cash used in
operating activities (1,002,045) (27,504,392)
---------- ---------
Cash flows from investing activities:
Purchases of equipment (12,463,348) (32,277,597)
Sales of securities available-for-sale - 21,103,030
Proceeds from sale of equipment - 250
Capitalization of software (306,373) (1,909,450)
Cash paid in business combinations,
net of cash acquired (420,956) (27,664,833)
Net change in receivables from
shareholders and employees (134,437) (948,242)
--------- ---------
Net cash used in
investing activities (13,325,114) (41,696,842)
--------- ---------
Cash flows from financing activities:
Net proceeds from line of credit 15,000,000 -
Net proceeds from notes payable - 9,055,500
Net proceeds from long-term borrowing 24,578,885 1,478,553
Debt issuance costs (750,000) (458,548)
Net proceeds from options exercised 87,723 646,477
Principal payments under capital
lease obligations (94,283) (427,683)
Proceeds received on note due from
shareholder - 52,367
Prepayment of senior subordinated notes (20,000,000) -
Net proceeds from issuance of stock 39,825,343 -
Principal payments on long-term
borrowings - (476,224)
--------- ---------
Net cash provided by
financing activities 58,647,668 9,870,442
--------- ---------
Effect of exchange rate changes on cash (260,274) (52,562)
--------- ---------
Net increase (decrease) in cash and
cash equivalents $44,060,235 (59,383,354)
Cash and cash equivalents at beginning
of period 14,155,013 74,213,856
---------- ----------
Cash and cash equivalents at end of period $58,215,248 14,830,502
---------- ----------
---------- ----------
Supplemental disclosures of cash flow
information:
Interest paid $ 2,356,921 1,085,814
---------- ----------
---------- ----------
Taxes paid $ 2,622 12,770
---------- ----------
---------- ----------
Supplemental disclosures on noncash investing
and financing activities:
Common stock issued in connection
with business combinations $ 470,000 7,802,717
---------- ----------
---------- ----------
Common stock issued in-lieu of
future commissions - 1,139,671
---------- ----------
---------- ----------
Common stock issued in connection
with property purchase - 1,446,649
---------- ----------
---------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
7<PAGE>
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TELEGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) PREPARATION OF INTERIM FINANCIAL STATEMENTS
The consolidated financial statements of Telegroup, Inc. and subsidiaries
(the Company or Telegroup) have been prepared in accordance with the
rules and regulations of the Securities and Exchange Commission (SEC).
These consolidated financial statements include estimates and assumptions
that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities and the amounts of revenues and
expenses. Actual results could differ from those estimates. The
consolidated balance sheet at December 31, 1997, was derived from the
Company's audited consolidated balance sheet as of that date. The
consolidated financial statements as of September 30, 1998 and for the
three and nine month periods then ended are unaudited. In the opinion of
the Company, such interim financial statements include all adjustments
necessary for a fair presentation of the results of all interim periods
reported herein. All adjustments are of a normal recurring nature
unless otherwise disclosed. Certain information and footnote
disclosures prepared in accordance with generally accepted accounting
principles have been either condensed or omitted pursuant to SEC
rules and regulations. However, the Company believes that the disclosures
made are adequate for a fair presentation of results of operations,
financial position and cash flows. These consolidated financial
statements should be read in conjunction with the consolidated
financial statements and accompanying notes included in the Company's
Form 10-K as filed with the SEC.
8<PAGE>
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<PAGE>
(2) MANAGEMENT'S PLANS
In third quarter 1998, the Company's planned high yield debt and PIK
preferred equity offering was aborted due to a general downturn in the capital
markets. As a consequence, the Company has experienced, and continues to
experience, liquidity pressure. In October, the company announced a
restructuring plan to scale back low margin wholesale business, reduce its
workforce worldwide, suspend its ATM network initiative, and down-size senior
management.
As discussed more fully at footnote (3) below, the Company's existing
asset-based line of credit, originally due November 4, 1998, was extended to
December 15, 1998. In addition, the Company obtained commitment from the
lender to increase the loan from $15,000,000 to $25,000,000.
The Company is attempting to refinance the $25,000,000 loan and raise an
additional $35,000,000 to fully fund its business plan through 1999 through
public or private equity and/or debt sources or by attracting a strategic
business partner. In the event the Company is unable to obtain additional
equity or debt financing or to attract a strategic business partner, it will
be forced to consider alternatives, including sale of certain business assets
or filing a petition of relief under Chapter 11 of the Federal Bankruptcy
Code. If a petition for bankruptcy relief becomes necessary, the carrying
value of certain of the Company's long-lived assets, primarily capitalized
software development costs and goodwill, would be materially adversely
affected.
(3) DEBT
Long-term debt at December 31, 1997 and September 30,1998 is shown
below:
<TABLE>
<CAPTION>
December 31, September 30,
------------------------------
1997 1998
------------- -----------
<S> <C> <C>
8.0% convertible subordinated
notes, due April 15, 2005,
unsecured $ 25,000,000 25,000,000
10.5% senior discount notes,
net of discount, due
November 1, 2004, unsecured 76,442,135 82,522,649
8.5% note payable, paid in 1998 11,082 -
10.8% note payable, due monthly
through fiscal 1998, secured by
equipment financed 80,955 15,319
8.75% note payable, due monthly
through February, 1999, balloon
payment due March, 1999,
secured by building - 588,456
8.0% note payable, due through
February, 1999, unsecured - 402,630
6.85% note payable, due monthly
through fiscal 1999, unsecured 8,204 5,274
8.0% note payable, paid in 1998 2,363 -
2.5% above prime note payable, due
monthly through fiscal 2002,
secured by office unit, London - 115,753
8.7% note payable, due monthly
through fiscal 1998, secured by
vehicle - 25,409
10.35% note payable, due monthly
through 2001, secured by vehicle - 22,091
8.25% note payable, due monthly
through 2001, secured by vehicle - 26,387
9.28% note payable, due monthly
through 2001, secured by vehicle - 45,403
----------- -----------
101,544,739 108,769,371
Less current portion (93,788) (1,065,203)
----------- -----------
Total long-term debt $101,450,951 107,704,168
------------ ----------
------------ ----------
At September 30, 1998, the Company had an asset based line of credit with a
financial institution which provided for up to $15,000,000 in committed
credit. Borrowings under the line were $15,000,000 at September 30, 1998.
Interest is payable at 10.5 percent per annum. The credit line terminated on
November 4, 1998 and is collateralized by substantially all of the Company's
assets.
On November 13, 1998, the financial institution committed to increase
borrowings available under the line of credit to $25,000,000 and to extend the
due date to December 15, 1998.
</TABLE>
(4) BUSINESS COMBINATIONS
During the nine-month period ended September 30, 1998, the Company
acquired assets or common stock of various companies providing products or
services in the global telecommunications market. Each acquisition
(described below) was 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.
On January 15, 1998, the Company acquired the operations of its
Australian and New Zealand country coordinators (collectively the
Coordinators). Consideration for the Australian country coordinator was
$107,584 and 119,036 shares of unregistered common stock of the Company
valued at $1,581,982, for total consideration of $1,689,566.
Consideration for the New Zealand country coordinator was $105,649 and
178,554 shares of unregistered common stock of the Company valued at
$2,374,768, for total consideration of $2,480,417.
The agreements also contained provisions which called for additional
consideration if certain financial measures of the acquired entities were
met subsequent to the date of acquisition. On June 5, 1998, the
Company issued an additional 99,000 shares valued at $1,066,598 to the
Coordinators to cancel such contingent consideration provisions in the
original purchase agreements.
The aggregate purchase price for these acquisitions was allocated based on
estimated fair values as follows:
Property and equipment $ 36,226
Goodwill 5,200,355
----------
Total $ 5,236,581
----------
----------
On January 21, 1998, the Company acquired 60 percent of the common stock
of, and controlling interest in, Redicall Pty Limited (Redicall) for
$531,751 and 7,179 shares of unregistered common stock valued at $105,254,
for total consideration of $637,005. Redicall is engaged in the wholesale
distribution of prepaid telephone calling cards. The aggregate purchase
price for this acquisition was allocated based on estimated fair values as
follows:
Current assets $ 156,337
Property and equipment 1,672
Deposits 8,207
Goodwill 760,110
Current liabilities (147,532)
Non-current liabilities (141,789)
----------
Total $ 637,005
----------
----------
The minority interest's portion of the Redicall stockholders' deficit was
included in the Company's calculation of goodwill. Accordingly, the
Company will absorb all of Redicall's net earnings and losses until such
deficit becomes positive. At September 30, 1998, no minority interest has
been reflected in the accompanying financial statements.
On February 3, 1998, the Company acquired a 9.9% interest in Newsnet ITN
Limited (Newsnet), a provider of international and long-distance facsimile
services, for $880,770. On May 31, 1998, the Company acquired the
remaining 90.1% of Newsnet for an additional $8,909,565 bringing the total
consideration paid to $9,790,335. The aggregate purchase price for this
acquisition was allocated based on estimated fair values as follows:
Current assets $ 6,504,055
Property and equipment 682,398
Goodwill 8,719,794
Current liabilities (5,747,820)
Non-current liabilities (368,092)
----------
Total $ 9,790,335
----------
----------
On April 20, 1998, the Company purchased South East Telecom
Limited, Phone Centre Communications Limited, and Corporate
Networks Limited (collectively Corporate Networks). Corporate
Networks is engaged in the supply, installation, and maintenance of
telecommunications equipment. Consideration for the purchase
was cash of $62,544 and 164,463 shares of unregistered common
stock of the Company valued at $2,336,922. Additional
consideration to be paid in unregistered common stock of the
Company is due by April 1999 based on average monthly usage of
telephone related services by customers over a predetermined
length of time as specified in the agreement. Due to the
uncertainty of future customer usage, the Company is unable to
calculate the minimum additional consideration. The aggregate
purchase price for this acquisition as of September 30, 1998 was
allocated based on estimated fair values as follows:
Current assets $ 2,171,640
Property and equipment 501,673
Goodwill 3,678,908
Current liabilities (3,952,755)
---------
Total $ 2,399,466
---------
---------
Additional consideration resulting from the telephony usage of the
acquired customer accounts will be recorded as an addition to the purchase
price when known.
On May 31, 1998, the Company acquired the operations of its Latin American
coordinator. Consideration for the purchase was 25,294 shares of common
stock of the Company valued at $337,193. The aggregate purchase price for
this acquisition was allocated to goodwill based on estimated fair values
of the assets and liabilities acquired. The total consideration of
$337,193 is being amortized using an accelerated method over the estimated
life of the coordinator's customers or three years, whichever is shorter.
On June 5, 1998, the Company purchased approximately 2,500 long distance
customer accounts of Mediacom Telefacilities Limited (Mediacom). Mediacom
provides national and international long distance services to corporate
customers throughout the United Kingdom. In accordance with the purchase
agreement, the Company paid consideration of $576,100 and is obligated to
pay additional consideration in the form of cash and unregistered common
stock based upon the average monthly usage of the acquired customer
accounts from April 1, 1998 through October 31, 1998. Due to the timing of
billing cycles for Mediacom customers, the Company is unable to calculate
the minimum additional consideration at this time. The appropriate
adjustment will be reflected in the fourth quarter of 1998. The aggregate
purchase price of $576,100 was allocated to goodwill and will be amortized
using an accelerated method over the estimated life of the acquired
customers or three years, whichever is shorter. Additional consideration
resulting from the financial performance of the acquired customer accounts
will be recorded as an addition to the purchase price when known and
amortized over the remaining life of the customers.
On August 7, 1998, the Company purchased Switch Telecom Pty Ltd (Switch
Telecom). Switch Telecom is a full service telecommunications provider
serving medium-sized businesses throughout Australia. Consideration for
Switch Telecom was $12,952,500 in cash. As of September 30, 1998,
purchase price for Switch Telecom was allocated based on estimated fair
values as follows:
Current assets $ 6,441,499
Property and equipment 2,195,538
Goodwill 16,932,383
Current liabilities (12,616,920)
----------
Total $12,952,500
-----------
-----------
The Company, through its subsidiary Switch Telecom, purchased all the
assets of Frame Relay Pty Ltd. (Frame Relay). Frame Relay owns an
extensive data network throughout Australia and the Pacific Rim.
Consideration for Frame Relay was $3,333,000 in cash. As of September 30,
1998, the purchase price of Frame Relay was allocated based on estimated
fair values as follows:
Current assets $ 486,716
Property and equipment 2,862,597
Goodwill 657,177
Current liabilities (673,490)
----------
Total $ 3,333,000
----------
----------
Proforma operating results of the companies described above, assuming
these acquisitions were consummated on January 1, 1997, do not differ
significantly from reported amounts.
10<PAGE>
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<PAGE>
(5) IMPAIRMENT OF GOODWILL
In 1996, the Financial Accounting Standard Board issued Statement No. 121,
"Accounting for Impairment of Long Lived Assets and for Long-Lived Assets
to be Disposed Of" ("Statement 121"). Statement 121 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
recovered. An impairment loss is recognized when estimated undiscounted
future cash flows expected to be generated by the asset is less than its
carrying value. If such assets are considered to be impaired, the
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 cash flows.
Subsequent to September 30, 1998, the Company decided to significantly
scale back the development and assembly of calling card platforms at its
subsidiary, PCS Telecom, Inc. (PCS). This decision significantly reduced
the Company's estimated future cash flows for this subsidiary. As a
result of the Company's estimated shortfalls of cash flows, the Company
wrote-off its goodwill in the amount of $1,888,064 relating to this
subsidiary.
(6) SHAREHOLDERS' EQUITY
WARRRANTS
During the quarter ended March 31, 1998, all of the Company's outstanding
warrants were exercised in a cashless transaction. Total warrants
exercised were 1,327,333, which represented the total warrants outstanding
of 1,327,500 less 167 warrants which were canceled. The canceled warrants
represent the value of the consideration (exercise price) due from the
warrant holder at the time of exercise.
STOCK OPTION PLAN
On May 19, 1998, the Company increased the number of shares available for
grant under the Stock Option Plan to 4,750,000.
(7) CONSIDERATION GIVEN IN-LIEU OF FUTURE COMMISSIONS
On January 15, 1998, the Company prepaid sales commissions owed to certain
independent sales agents. Total consideration was $700,000 and 40,000
shares of unregistered common stock valued at $565,000. The total
consideration of $1,265,000 is being amortized to selling, general and
administrative expenses using an accelerated method over the estimated
life of the agent's customers or three years, whichever is shorter.
On April 30, 1998, the Company prepaid sales commissions owed to an
independent sales agent. Total consideration was $210,000. The total
consideration is being amortized to selling, general and administrative
expenses using an accelerated method over the estimated life of the
agent's customers or three years, whichever is shorter.
On June 30, 1998, the Company entered into an agreement to prepay
commissions owed to an independent sales agent. Total consideration was
$1,100,000 in cash and common stock valued at $1,000,000. As of June
30, 1998, the common stock was not issued. On August 29, 1998, the
agreement was amended. Instead of common stock valued at $1,000,000, the
Company agreed to issue 85,179 shares of registered common stock valued at
$574,671 and a promissory note for $500,000. The promissory note bears
interest at 8.0% per annum. An installment payment of $100,000 was made
in August, 1998. An installment payment of $100,000 is due November,
1998. An installment payment of $200,000 is due December, 1998, with the
balance of $100,000 due February, 1999.
(8) INDEFEASIBLE RIGHT OF USE AGREEMENTS
On April 23, 1998, the Company entered into a 25-year indefeasible right
of use (IRU) agreement with Cable and Wireless Communications Services
Limited (Cable and Wireless) for the right to use network capacity in an
under-sea fiber cable system. The Company paid $975,000 upon execution of
the agreement and $8,775,000 on June 15, 1998, the date of activation.
The cost of the IRU will be amortized over the life of the 25 year
agreement. In addition, the Company will be responsible for its pro rata
share of the cost and fees in relation to the operation and maintenance of
the cable system.
On May 21, 1998, the Company entered into an IRU agreement with Southern
Cross Cable Network for the right to use network capacity in an under-sea
fiber cable system. The Company paid $2,520,000 upon execution of the
agreement. The IRU is scheduled to be ready for service by December 1999.
Provided that the cable system is ready for service by this date, the
Company will owe an additional $17,480,000, payable $2,480,000 in
December, 1999, and in three annual installments of $5,000,000 thereafter.
Until such time as the cable system is ready for service, the Company is
accounting for the initial payment of $2,520,000 as a deposit. In
addition, the Company will be responsible for its pro rata share of the
cost and fees in relation to the operation and maintenance of the cable
system.
(9) COMMITMENTS AND CONTINGENCIES
COMMITMENTS WITH TELECOMMUNICATIONS COMPANIES
The Company has an agreement with Sprint Communications Company L.P.
(Sprint) to use Sprint's fiber-optic network in its delivery of
telecommunication services. This agreement requires net quarterly usage
commitments of $6,000,000. In the event such quarterly commitments are
not met, the Company is required to remit to Sprint 25% of the difference
between the $6,000,000 quarterly commitment and actual usage. This
agreement extends through December 1998. When total usage exceeds
$24,000,000 during 1998, the Company has no further commitment.
The Company has a one-year $3,000,000 usage commitment with MFS/WorldCom
in Frankfurt, Germany, to use MFS/WorldCom's fiber-optic network in its
delivery of telecommunication services. This agreement began on September
5, 1997. On July 28, 1998, the Company and MRS/Worldcom agreed to an
extension of the term of this agreement to June 30, 1999.
The Company also has a two-year minimum usage commitment of $55,000,000
with WorldCom which began on May 1, 1998 and extends through April 30,
2000.
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The Company had an agreement with Meyer Group Limited (Meyer) with a
usage commitment to terminate $3,000,000 in Hong Kong call traffic on
Meyer's network by December 31, 1998. On August 1, 1998, the Company
terminated this agreement without penalty.
The Company has an agreement with Epoch Networks, Inc. for internet
services, with a minimum usage total commitment of $875,000 over the next
two years. This agreement began June 1, 1998.
Shortfalls in usage commitments, if any, are recorded as cost of revenues
in the period identified.
LETTERS OF CREDIT
The Company has outstanding irrevocable letters of credit in the amount of
$1,049,380 as of September 30, 1998 with certain carriers. These letters
of credit, which have expiration dates from March 15, 1999 to July 27,
1999, collateralize the Company's obligations for network usage on the
carriers' networks. The fair value of these letters of credit is
estimated to be the same as the contract values based on the nature of the
arrangement with issuing banks.
OTHER COMMITMENTS
On August 3, 1998, the Company entered into a Construction and Maintenance
Agreement (C&MA) to build the Japan-U.S. Cable Network, an undersea cable
system that will connect Japan and the U.S. by mid-year 2000. The Company
is obligated to pay $2.7 million for ownership of its 0.17% share of this
trans-Pacific cable, 20% by year-end 1998, 50% in 1999, and the balance in
early 2000.
LITIGATION
The Company is a party to certain litigation which has arisen in the
ordinary course of business. In the opinion of management, the ultimate
resolution of these matters will not have a significant effect on the
financial statements of the Company.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, INCLUDING STATEMENTS
REGARDING THE COMPANY'S ABILITY TO SEIZE OPPORTUNITIES FROM CONTINUING
DEREGULATION OF THE TELECOMMUNICATIONS MARKETS, THE NUMBER OF SWITCHES/NODES
AND FACILITIES THE COMPANY PLANS TO INSTALL, TECHNOLOGICAL DEVELOPMENT OF THE
COMPANY'S NETWORK, THE ANTICIPATED EXPANSION OF REGIONAL CARRIER SALES, THE
PREPAYMENT OF EXISTING NOTES, AND THE INCREASE IN THE COMPANY'S INTERNAL AND
EXTERNAL SALES FORCES. THE COMPANY'S REVENUES AND ABILITY TO CONTINUE ITS
EXPANSION ARE DIFFICULT TO FORECAST AND COULD DIFFER MATERIALLY FROM THOSE
PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF NUMEROUS FACTORS,
INCLUDING WITHOUT LIMITATION, OPERATING AND TECHNICAL PROBLEMS, REGULATORY
UNCERTAINTIES, POSSIBLE DELAYS IN THE FULL IMPLEMENTATION OF LIBERALIZATION
INITIATIVES, COMPETITION, AVAILABILITY OF CAPITAL, FOREIGN CURRENCY
FLUCTUATIONS, AND CHANGES IN THE US AND FOREIGN TAX LAWS.
The following discussion of the financial condition and performance of
the Company should be read in conjunction with the consolidated financial
statements and related notes and other detailed information regarding the
Company included in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1997 and other reports filed by the Company with the
SEC.
SUMMARY
Telegroup is a growing multinational carrier of long distance
telecommunications services to over 200 countries. Telegroup offers services
to small and medium-sized businesses and residential customers. The Company
also provides value-added wholesale services to over 40 domestic and
international telecommunications carriers. Telegroup believes that it has one
of the most comprehensive global sales, marketing, and customer service
organizations of the emerging multinational carriers. The Company operates a
digital, facilities-based network, the Telegroup Intelligent Global Network,
which consists of a central operating center, twenty-five switches, five
enhanced service platforms, owned or leased capacity on ten digital
fiber-optic cable links, and leased parallel data transmission capacity.
In third quarter 1998, the Company's planned high yield debt and PIK
preferred equity offering was aborted due to a general downturn in the capital
markets. As a consequence, the Company has experienced, and continues to
experience, liquidity pressure. In October, the company announced a
restructuring plan to scale back low margin wholesale business, reduce its
workforce worldwide, suspend its ATM network initiative, and down-size senior
management.
As discussed more fully at footnote (3) to the financials, the Company's
existing asset-based line of credit, originally due November 4, 1998, was
extended to December 15, 1998. In addition, the Company obtained commitment
from the lender to increase the loan from $15,000,000 to $25,000,000.
The Company is attempting to refinance the $25,000,000 loan and raise an
additional $35,000,000 to fully fund its business plan through 1999 through
public or private equity and/or debt sources or by attracting a strategic
business partner. In the event the Company is unable to obtain additional
equity or debt financing or to attract a strategic business partner, it will
be forced to consider alternatives, including sale of certain business assets
or filing a petition of relief under Chapter 11 of the Federal Bankruptcy
Code. If a petition for bankruptcy relief becomes necessary, the carrying
value of certain of the Company's long-lived assets, primarily capitalized
software development costs and goodwill, would be materially adversely
affected.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
Revenues. Revenues increased 26.7%, or $22.5 million, from $84.3 million
in the three months ended September 30,1997 to $106.8 million in the three
months ended September 30,1998. Wholesale revenues increased from $28.1
million, or 33.3% of total revenues in the three months ended September
30,1997, to $40.3 million, or 37.7% of revenues for the three months ended
September 30,1998. Retail revenues increased from $56.2 million, or 66.7% of
total revenues in the three months ended September 30, 1997, to $66.5 million,
or 62.3% of total revenues for the three months ended September 30, 1998.
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Cost of Revenues. Cost of revenues increased 38.6% or $23.9 million,
from $61.9 million in the three months ended September 30, 1997 to $85.8
million in the three months ended September 30, 1998. As a percentage of
revenues, cost of revenues increased from 73.4% to 80.3%, primarily as a
result of a larger percentage of lower margin wholesale revenues, retail price
declines in certain deregulating markets, and an increase in fixed recurring
costs as the Company transitioned to becoming a facilities-based provider.
Operating Expenses. Operating expenses increased 66.1%, or $16.2 million,
from $24.5 million in the three months ended September 30,1997 to $40.7
million in the three months ended September 30,1998, primarily as a result of
professional services associated with the Company's aborted debt and equity
offering, increased advertising initiatives in foreign markets, an increase in
international subsidiaries and the number of employees necessary to provide
direct sales and sales support internationally, as well as an impairment
charge on goodwill incurred in anticipation of the Company's fourth quarter
plan of restructuring. Other contributing factors were bad debt expense and
depreciation and amortization expense, as discussed below. As a percentage of
revenues, operating expenses increased 9.0% from 29.1% in the three months
ended September 30,1997 to 38.1% in the three months ended September 30,1998.
The number of full and part-time employees grew from 576 in the three months
ended September 30,1997, to 1,065 in the three months ended September 30,
1998, representing a 84.9% increase.
Bad Debt. Bad debt expense increased from $1.9 million, or 2.3% of
revenues in the three months ended September 30, 1997 to $5.0 million, or 4.7%
of revenues, in the three months ended September 30,1998. The increase in bad
debt expense in the three months ended September 30, 1998 was due to a direct
write-off of a receivable from a joint venture marketing partner.
Depreciation and Amortization. Depreciation and amortization increased
from $1.3 million in the three months ended September 30,1997, to $4.3 million
in the three months ended September 30,1998, primarily due to increased
capital expenditures incurred in connection with the development and expansion
of the TIGN, as well as amortization expenses associated with intangible
assets.
Operating Loss. Operating loss increased by $17.7 million, from $2.0
million in the three months ended September 30,1997, to $19.7 million in the
three months ended September 30,1998, as a result of the preceding factors.
Net Loss. Net loss increased approximately $11 million, from $11.5
million in the three months ended September 30,1997, to $22.5 million in the
three months ended September 30,1998. The increase is attributable to lower
operating income and a $2.3 million increase in net interest expense.
EBITDA. EBITDA decreased from $(0.7) million in the three months ended
September 30, 1997, to $(13.8) million in the three months ended September 30,
1998, as a result of the foregoing factors.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1997
Revenues. Revenues increased 23.1%, or $55.2 million, from $238.5 million
in the nine months ended September 30, 1997 to $293.7 in the nine months ended
September 30, 1998. This increase was due to growth in international and
domestic retail sales and international and domestic wholesale revenues.
Wholesale revenues increased from $68.8 million, or 28.8% of total revenues in
the nine months ended September 30, 1997, to $105.9 million or 36.1% of total
revenues for the nine months ended September 30, 1998. Retail revenues
increased from $169.7 million, or 71.2% of total revenues in the nine months
ended September 30, 1997, to $187.8 million, or 63.9% of total revenues in the
nine months ended September 30, 1998.
Cost of Revenues. Cost of revenues increased 36.1%, or $62.9 million,
from $174.3 million to $237.2 million. As a percentage of revenues, cost of
revenues increased from 73.1% to 80.8%, primarily as a result of a larger
percentage of lower margin wholesale revenues, retail price declines in
certain deregulating markets, and an increase in fixed recurring costs as the
Company transitioned to becoming a facilities-based provider.
Gross Profits. Gross profit decreased 12.0%, or $7.7 million, from $64.2
million in the nine months ended September 30, 1997, to $56.5 million in the
nine months ended September 30, 1998. As a percentage of revenues, gross
profit decreased from 26.9% to 19.2%, due to the increase in the relative cost
of revenues as a percentage of overall revenues.
Operating Expenses. Operating expenses increased 45.6%, or $30.4 million,
from $66.6 million in the nine months ended September 30, 1997 to $97.0
million in the nine months ended September 30, 1998, as a result of increased
professional services associated with the Company's aborted debt and equity
offering, increased advertising initiatives in foreign markets, an increase in
international subsidiaries and the number of employees necessary to provide
direct sales and sales support internationally, as well as an impairment
charge on goodwill incurred in anticipation of the Company's fourth quarter
plan of restructuring. Other contributing factors were bad debt expense and
depreciation and amortization expense, as discussed below. As a percentage of
revenues, operating expenses increased 5.1% from 27.9% in the nine months
ended September 30, 1997 to 33.0% in the nine months ended September 30, 1998.
Bad debt expense increased from $6.4 million, or 2.7% of revenues in the
nine months ended September 30, 1997 to $9.4 million, or 3.2% of revenues, in
the nine months ended September 30, 1998. The increase in bad debt expense as
a percentage of revenues in the nine months ended September 30, 1998 was due
to direct write off of a receivable from a joint venture marketing partner.
Depreciation and amortization increased from $3.2 million in the nine
months ended September 30, 1997 to $9.2 million in the nine months ended
September 30, 1998, primarily due to increased capital expenditures incurred
in connection with the development and expansion of the TIGN, as well as
amortization expenses associated with intangible assets.
Operating Loss. Operating loss increased by $38.1 million, from $2.4
million in the nine months ended September 30, 1997, to $40.5 million in the
nine months ended September 30, 1998, as a result of the preceding factors.
Net Loss. Net loss increased approximately $33.9 million, from $12.8
million in the nine months ended September 30, 1997, to $46.7 million in the
nine months ended September 30, 1998, as a result of lower operating income
and a $4.1 million increase in interest expense net of interest income.
EBITDA. EBITDA decreased from $0.6 million in the nine months ended
September 30, 1997, to $(29.7) million in the nine months ended September 30,
1998, as a result of the foregoing factors.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company's capital requirements have consisted of
capital expenditures in connection with the acquisition and maintenance of
switching capacity and funding of accounts receivable and other working
capital requirements. The Company's capital requirements have been funded
primarily by funds provided by operations, revolving credit lines, the
Company's Initial Public Offering, convertible debentures, long-term debt,
additional equity issuances, and by capital leases. The Company requires
additional capital to
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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. The Company may seek to raise such additional capital from
public or private equity and/or debt sources or to attract a strategic
business partner. There can be no assurance that the Company will be able to
obtain the additional financings or attract a strategic partner or that it
will be able to do so on a timely basis or on terms favorable to the Company.
In the event the Company is unable to secure the additional financings or
attract a strategic partner, it will be forced to consider alternatives,
including sale of certain assets or filing a petition of relief under Chapter
11 of the Federal Bankruptcy Code.
Net cash used in operating activities was $1.0 million in the nine months
ended September 30, 1997 and $27.5 million in the nine months ended September
30, 1998. The net cash used in operating activities in the nine months ended
September 30, 1997, was primarily due to a greater increase in accounts
receivable from customers relative to an increase in accounts payable from
carriers, commissions payable and accrued expenses. The net cash used in
operating activities in the nine months ended September 30, 1998, was
primarily due to the net loss, partly offset by an increase in accounts
payable, an increase in depreciation and amortization expense, an impairment
charge on goodwill, an increase in the provision for credit losses, and an
increase in accretion of the debt discount. The $10.6 million increase in
deposits and other assets in the nine months ended September 30, 1998, was due
primarily to deposits on major accounting and billing software systems not yet
in service at period end.
Net cash used in investing activities was $13.3 million in the nine
months ended September 30, 1997, and $41.7 million in the nine months ended
September 30, 1998. The net cash used in the nine months ended September 30,
1997 was primarily due to increases in equipment purchases. The net cash used
in the nine months ended September 30, 1998 was primarily due to equipment
purchases and business combinations, partly offset by sales of securities-
available-for-sale.
Net cash provided by financing activities was $58.6 million in the nine
months ended September 30, 1997, and $9.9 million in the nine months ended
September 30, 1998. The net cash provided in the nine months ended
September 30, 1997, was primarily due to proceeds from issuance of stocks and
from long term borrowing. The net cash provided in the nine months ended
September 30, 1998, was primarily due to proceeds from notes payable.
YEAR 2000 (Y2K) COMPLIANCE
The Problem
The Year 2000 poses a series of risks for today's corporations. Most notable
is the inability of many legacy systems, whether internally developed or
purchased from third parties, to handle four-digit year processing (e.g.
1996). A large percentage of these systems are designed to process only two-
digit years (e.g. 96) and will treat the year 2000 as the year '00'
internally. Processing logic based on year comparisons and calculations will
generate false results. Also the year 2000 is a leap year. Systems
programmed to treat century years (i.e. those ending in '00') as non-leap
years will incorrectly designate the year 2000 as having a 365 day rather than
a 366 day calendar. Unless hardware, system software, and applications are
corrected to be Year 2000 (Y2K) compliant, computers and the devices they
control could generate miscalculations and create operational problems.
The Company's State of Readiness
The Company recognizes the importance of addressing the Y2K problem in a
timely and comprehensive manner. To that end, the Company has dedicated
resources to identify, resolve and test the issues related to Y2K compliance.
The Company is at work on and plans to complete by year end 1998 a
comprehensive test plan for all legacy systems. Legacy systems requiring
enhancement or modification to achieve Y2K compliance should be so enhanced or
modified by mid year 1999.
The Company has purchased several vendor packages for back-end office
processes, among them:
Convergent Billing Platform (CBP) from Saville, Inc. for Customer Care,
Event Processing, Billing, and Post Billing
PeopleSoft Financials (General Ledger, Accounts Payable, Asset Management,
Purchasing, Inventory, Budget, and Projects)
PeopleSoft HRMS (HR, Benefit Admin, and Payroll Interface)
Treasury Manager from Selkirk, Inc.
In all cases, the Company has required that within the contracts with these
vendors, the applications provided are certified to be Y2K compliant. Of the
listed vendor packages, only PeopleSoft Financials has been implemented as of
October, 1998. CBP from Saville, which has the longest implementation period,
was scheduled for a March, 1999 production date. It had been the Company's
intention to begin integration testing of all its systems to ensure Y2K
compliance simultaneously with the CBP production date. By December, 1998, the
Company intended having a detailed test plan developed to carry out such
tests. On October 12, 1998, the Company announced that as part of a strategic
repositioning, it would reduce its operating and capital expenditures.
Consequently, further expenditure and deployment of Saville CBP and the
PeopleSoft HR application have been placed on hold. Nevertheless, the Company
wiplans to develop by December, 1998, a detailed Y2K test plan, and plans to
modify and test all legacy systems, including those intended to be replaced by
Saville CBP and PeopleSoft HR, for Y2K compliance by mid year 1999.
In regard to the Company's network of telephony switching equipment, both the
Nortel built switches and the TIGN switches either are now Y2K compliant or
are planned to be by December, 1998,. The Company's Passport switches should
be Y2K compliant by March, 1999.
As part of the Company's Y2K readiness assessment, the Company intends to
contact significant suppliers, primarily of telephony services, to determine
the extent to which the Company is vulnerable to those third parties' failure
to remedy their Y2K compliance issues. The Company expects to contact all
such significant suppliers by end of year 1998. There can be no guarantee
that the systems of other companies on which the Company's business relies
will be timely converted or that failure to convert, or a conversion that is
incompatible with the Company's systems, would not have a material adverse
effect on the Company and its operations.
Costs to Address the Company's Y2K Issues
The delay in implementation of Saville CBP and PeopleSoft HR has altered the
Company's assessment of its costs to remedy any existing Y2K issues. The
Company expects to be able to make a revised determination of remediation
costs by year end 1998.
Risks Associated with the Company's Y2K Issues
Management believes it has an effective program in place to resolve the Y2K
issue in a timely manner. Nevertheless, since it is not possible to anticipate
all possible future outcomes, especially when third parties are involved,
there could be circumstances in which the Company would be unable to take
customer orders, provide and bill services, collect payments, or maintain
customer service. To date, management has not developed or implemented a Y2K
Contingency Plan. The amount of potential liability and lost revenue can not
be reasonably estimated at this time.
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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<PAGE> PART II. OTHER INFORMATION
TELEGROUP, INC.
Item 1. Legal Proceedings.
- - ------- -----------------
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.
Item 2. Changes in Securities and Use of Proceeds.
- - ------- -----------------------------------------
On January 15, 1998, to acquire business assets of the LeHeron
Corporation Limited in Australia and New Zealand, the Company issued 297,590
shares of common stock. On June 5, 1998, the Company issued an additional
98,600 shares of common stock to complete this acquisition. On January 15,
1998, the Company issued 40,000 shares of common stock in lieu of future sales
commissions to Katz & Associates in Brazil. On January 21, 1998, the Company
issued 7,179 shares of common stock to purchase 60% of the common stock of
RediCall Pty. Limited in Australia.
On April 20, 1998, the Company issued 164,463 shares of common stock to
purchase South East Telecom Limited, Phone Centre Communications Limited, and
Corporate Networks Limited (collectively, Corporate Networks). On May 31,
1998, to acquire the operations of its Latin American coordinator, the Company
issued 25,294 shares of common stock.
Each issuance of securities described above was made in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act as
a transaction by an issuer not involving any public offering. The recipients
of securities in each such transaction represented their intention to acquire
the securities for investment only and not with a view to or for sale in
connection with any distribution thereof and appropriate legends were affixed
to the share certificates in such transactions. All recipients had adequate
access, through their relationships with the Company, to information about the
Company.
Item 3. Defaults Upon Senior Securities.
- - ------- -------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders.
- - ------- ---------------------------------------------------
None.
Item 5. Other Information.
- - ------- -----------------
Forward-Looking Statements. Item 2 of Part I of this report
--------------------------
includes, and future oral or written statements of the Company and its
management may include, certain forward-looking statements, including without
limitation statements with respect to the Company's anticipated future
17PAGE
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operating and financial performance, financial position and liquidity, growth
opportunities and growth rates, business and competitive outlook, investment
and expenditure plans, pricing plans, strategic alternatives, business
strategies, and other similar statements of expectations or objectives that
are highlighted by words such as "expects," "anticipates," "intends," "plans,"
"believes," "projects," "seeks," "estimates," "should" or "may," and
variations thereof and similar expressions. Such forward-looking statements
are subject to uncertainties that could cause the Company's actual results to
differ materially from such statements. These uncertainties include but are
not limited to those set forth below:
(i) the effects of ongoing deregulation in the telecommunications industry
as a result of the World Trade Organization agreement on basic
telecommunications services and the Telecommunications Act of 1996
(the "1996 Act") and other similar federal and state legislation and
federal and state regulations enacted thereunder, including without
limitation (a) greater than anticipated competition in the Company's
telephone markets resulting therefrom, (b) the final outcome of the
FCC rulemakings with respect to interconnection agreements and access
charge reforms, and of foreign regulatory proceedings affecting the
Company's ability to compete in foreign markets, and (c) future state
regulatory actions taken in response to the 1996 Act.
(ii) the effects of greater than anticipated competition from other
telecommunications companies, including without limitation competition
requiring new pricing or marketing strategies or new product
offerings, and the attendant risk that the Company will not be able to
respond on a timely or profitable basis.
(iii) possible changes in the demand for the Company's products and
services, including without limitation lower than anticipated demand
for premium telephone services.
(iv) the Company's ability to successfully introduce new service offerings
on a timely and cost-effective basis, including without limitation the
Company's ability to (a) expand successfully its long distance and
enhanced service offerings to new markets, and (b) offer bundled
service packages on terms attractive to its customers.
(v) the risks inherent in rapid technological change, including without
limitation (a) the lack of assurance that the Company's ongoing TIGN
improvements will be sufficient to meet or exceed the capabilities and
quality of competing networks, and (b) the risk that technologies
will not be developed on a timely or cost-effective basis or perform
according to expectations.
(vi) regulatory limits on the Company's ability to change its prices for
telephone services in response to competitive pressures.
(vii) the Company's ability to effectively manage its growth, including
without limitation the Company's ability to (a) achieve projected
18<PAGE>
<PAGE>
<PAGE>
economies of scale and cost savings, (b) meet pro forma cash flow
projections developed by management in valuing newly acquired
businesses, and (c) implement necessary internal controls, and
retain and attract key personnel.
(viii) difficulties in the integration of the recent acquisitions, whether
caused by financing constraints, regulatory limitations, or management
capabilities.
(ix) higher than anticipated operating costs due to churn or fraudulent
uses of the Company's networks.
(x) the lack of assurance that the Company can compete effectively
against better capitalized competitors.
(xi the ability of the Company to identify and adequately address Y2K
issues, both internally and externally.
(xi) the effects of more general factors, including without limitation:
(a) changes in general industry and market conditions and growth
rates
(b) changes in interest rates or other general national, regional
or local economic conditions
(c) changes in legislation, regulation or public policy
(d) unanticipated increases in capital, operating or
administrative costs, or the impact of new business
opportunities requiring significant up-front investments
(e) the continued availability of financing in amounts, and on
terms and conditions, necessary to support the Company's
operations
(f) changes in the Company's relationships with vendors
(g) changes in accounting systems, policies or practices adopted
voluntarily or as required by generally accepted accounting
principles
(h) changes in VAT policies of the EU.
For a more detailed description of these and other uncertainties, see
Risk Factors in the Company's Prospectus dated July 8, 1997. Due to these
uncertainties, you are cautioned not to place undue reliance upon the
Company's forward-looking statements, which speak only as of the date hereof.
The Company undertakes no obligation to update or revise any of its forward-
looking statements for any reason.
Item 6. Exhibits and Reports on Form 8-K.
- - ------- --------------------------------
A. Exhibits
The exhibits filed as part of this report are set forth in the
Exhibit Index on page 24 of this report.
B. Reports on Form 8-K
None 19<PAGE>
<PAGE>
<PAGE>
EXHIBIT INDEX
The following exhibits are included in this Quarterly Report on Form 10-Q:
Exhibit Number Exhibit Description
- - --------------- -------------------
3.1 Form of Second Restated Articles of Incorporation of
Telegroup, Inc. (incorporated by reference to Exhibit 3.2
to the Company's Registration Statement on Form S-1,
File No. 333-25065)
3.2 Form of Amended and Restated Bylaws of Telegroup, Inc.
(incorporated by reference to Exhibit 3.4 to the
Company's Registration Statement on Form S-1, File No.
333-25065)
3.1 Form of Indenture for 8.0% Convertible Notes dated
September 30, 1997 (incorporated by reference to Exhibit
4.1 to the Company's Form 10-Q for the quarter-ended
September 30, 1997, SEC File No. 0-29284)
3.2 Form of Indenture for 10.5% Senior Discount Notes dated
October 23, 1997 (incorporated by reference to Exhibit 4.2
to the Company's Form 10-Q for the quarter-ended September
30, 1997, SEC File No. 0-29284)
27 Financial Data Schedule
20<PAGE>
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Telegroup, Inc.
Date: November 14, 1998 By: /s/ Douglas Neish
-----------------------
Douglas Neish
Vice President and
Chief Financial Officer
Date: November 14, 1998 By: /s/ Jerry Oliver
-----------------------
Jerry Oliver
Controller
21
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