<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q/A
AMENDMENT NO. 1
(AMENDING PART I, ITEMS 1 AND 2)
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE THREE MONTHS ENDED JUNE 30, 1999.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM --------- TO -----------.
COMMISSION FILE NUMBER 0-29782
WORLD ACCESS, INC.
(Exact name of Registrant as specified in its Charter)
<TABLE>
<S> <C>
DELAWARE 58-2398004
(State of Incorporation) (I.R.S. Employer Identification No.)
945 E. PACES FERRY ROAD, SUITE 2200, 30326
ATLANTA, GEORGIA (Zip Code)
(Address of principal executive offices)
</TABLE>
(404) 231-2025
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares outstanding of the Registrant's common stock, par
value $.01 per share, at August 16, 1999 was 44,920,342.
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<PAGE> 2
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets
Cash and equivalents...................................... $ 98,996 $ 55,176
Accounts receivable....................................... 97,342 70,485
Inventories............................................... 45,216 48,591
Deferred income taxes..................................... 33,022 37,185
Other current assets...................................... 21,907 21,381
--------- ---------
Total Current Assets.............................. 296,483 232,818
Property and equipment...................................... 62,325 63,602
Goodwill and other intangibles.............................. 309,540 298,780
Other assets................................................ 24,798 18,612
--------- ---------
Total Assets...................................... $ 693,146 $ 613,812
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Short-term debt........................................... $ 12,285 $ 17,989
Accounts payable.......................................... 58,393 36,418
Other accrued liabilities................................. 45,744 52,825
--------- ---------
Total Current Liabilities......................... 116,422 107,232
Long-term debt.............................................. 140,728 137,864
Noncurrent liabilities...................................... 10,204 8,133
--------- ---------
Total Liabilities................................. 267,354 253,229
--------- ---------
Stockholders' Equity
Preferred stock........................................... 1 --
Common stock.............................................. 448 441
Capital in excess of par value............................ 544,481 472,945
Accumulated deficit....................................... (119,138) (112,803)
--------- ---------
Total Stockholders' Equity........................ 425,792 360,583
--------- ---------
Total Liabilities and Stockholders' Equity........ $ 693,146 $ 613,812
========= =========
</TABLE>
See notes to consolidated financial statements
1
<PAGE> 3
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------ -------------------
1999 1998 1999 1998
-------- ------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
Carrier service revenues.................................... $113,279 $ 718 $198,891 $ 1,263
Equipment sales............................................. 64,493 33,824 122,360 56,684
-------- ------- -------- --------
Total Sales........................................ 177,772 34,542 321,251 57,947
Cost of carrier services.................................... 99,611 587 175,269 1,041
Cost of services network.................................... 4,394 38 9,963 76
Cost of equipment sold...................................... 36,748 17,171 68,690 29,353
Amortization of acquired technology......................... 1,200 -- 2,400 --
-------- ------- -------- --------
Total Cost of Sales................................ 141,953 17,796 256,322 30,470
-------- ------- -------- --------
Gross Profit................................................ 35,819 16,746 64,929 27,477
Research and development.................................... 4,419 1,746 8,773 2,478
Selling, general and administrative......................... 15,032 4,013 28,939 6,798
Amortization of goodwill.................................... 3,251 833 6,369 1,475
In-process research and development......................... -- -- -- 35,400
Restructuring and other charges............................. -- -- -- 590
-------- ------- -------- --------
Operating Income (Loss)..................................... 13,117 10,154 20,848 (19,264)
Interest and other income................................... 1,083 699 1,506 1,970
Interest expense............................................ (1,976) (1,515) (4,604) (2,958)
-------- ------- -------- --------
Income (Loss) From Continuing Operations Before Income Taxes
and Minority Interests.................................... 12,224 9,338 17,750 (20,252)
Income taxes................................................ 5,952 3,721 9,357 5,906
-------- ------- -------- --------
Income (Loss) From Continuing Operations Before Minority
Interests................................................. 6,272 5,617 8,393 (26,158)
Minority interests in earnings of subsidiary................ -- 848 -- 1,532
-------- ------- -------- --------
Income (Loss) From Continuing Operations.................... 6,272 4,769 8,393 (27,690)
Net income (loss) from discontinued operations.............. (685) 1,702 (653) (40)
Write-down of discontinued operations to net realizable
value..................................................... (13,662) -- (13,662) --
-------- ------- -------- --------
Net Income (Loss)........................................... (8,075) 6,471 (5,922) (27,730)
Preferred stock dividends................................... 413 -- 413 --
-------- ------- -------- --------
Net Income (Loss) Available to Common
Stockholders..................................... (8,488) $ 6,471 $ (6,335) $(27,730)
======== ======= ======== ========
Income (Loss) Per Common Share:
Basic:
Continuing Operations................................... $ 0.16 $ 0.23 $ 0.22 $ (1.39)
Discontinued Operations................................. (0.39) 0.08 (0.40) --
-------- ------- -------- --------
Net Income (Loss)....................................... $ (0.23) $ 0.31 $ (0.18) $ (1.39)
======== ======= ======== ========
Diluted:
Continuing Operations................................... $ 0.16 $ 0.22 $ 0.22 $ (1.39)
Discontinued Operations................................. (0.36) 0.08 (0.37) --
-------- ------- -------- --------
Net Income (Loss)....................................... $ (0.20) $ 0.30 $ (0.15) $ (1.39)
======== ======= ======== ========
Weighted Average Shares Outstanding:
Basic..................................................... 36,375 20,576 36,232 19,960
======== ======= ======== ========
Diluted................................................... 40,296 21,822 38,446 19,960
======== ======= ======== ========
</TABLE>
See notes to consolidated financial statements.
2
<PAGE> 4
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
CAPITAL IN
PREFERRED COMMON EXCESS OF ACCUMULATED
STOCK STOCK PAR VALUE DEFICIT TOTAL
--------- -------- ---------- ----------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1999................. $ -- $ 441 $472,945 $(112,803) $360,583
Net and comprehensive net loss........... (5,922) (5,922)
Issuance of preferred shares in private
offering.............................. 1 47,750 47,751
Issuance of preferred shares for
acquisition of business............... 18,539 18,539
Dividends on preferred stock............. (413) (413)
Release of escrowed shares for
acquisition........................... 1 2,824 2,825
Issuance of shares for technology
license............................... 5 1,705 1,710
Issuance of shares for options and
warrants.............................. 1 479 480
Tax benefit from option and warrant
exercises............................. 54 54
Issuance of shares to 401K plan.......... 185 185
-------- -------- -------- --------- --------
Balance at June 30, 1999................... $ 1 $ 448 $544,481 $(119,138) $425,792
======== ======== ======== ========= ========
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 5
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-------------------
1999 1998
-------- --------
(UNAUDITED)
<S> <C> <C>
Cash Flows From Operating Activities:
Net loss.................................................. $ (5,922) $(27,731)
Adjustments to reconcile net loss to net cash from
operating activities:
Depreciation and amortization.......................... 15,123 3,194
Write-down of discontinued operations to net realizable
value................................................. 13,662 --
Income tax benefit from stock warrants and options..... 54 4,222
Special charges........................................ -- 40,434
Minority interests in earnings of subsidiary........... -- 1,532
Provision for inventory reserves....................... 680 144
Provision for bad debts................................ 1,453 316
Stock contributed to employee benefit plan............. 185 92
Changes in operating assets and liabilities, net of
effects from businesses acquired:
Accounts receivable.................................. (23,121) (13,088)
Inventories.......................................... (10,236) (9,294)
Accounts payable..................................... 13,909 9,101
Other assets and liabilities......................... (1,499) (5,970)
-------- --------
Net Cash From Operating Activities................ 4,288 2,952
-------- --------
Cash Flows From Investing Activities:
Acquisitions of businesses, net of cash acquired.......... (2,241) (62,084)
Proceeds from sales of assets............................. 4,754 --
Capitalization of software development costs.............. (2,452) (1,831)
Expenditures for property and equipment................... (4,163) (5,859)
-------- --------
Net Cash Used By Investing Activities............. (4,102) (69,774)
-------- --------
Cash Flows From Financing Activities:
Net proceeds from sale of preferred stock................. 47,788 --
Short-term borrowings..................................... 1,200 4,297
Principal payments under capital lease obligations........ (1,626) --
Repayment of industrial revenue bond...................... (4,072) --
Proceeds from exercise of stock warrants and options...... 480 3,080
Long-term debt repayments................................. -- (967)
Debt issuance costs....................................... (136) --
-------- --------
Net Cash From Financing Activities................ 43,634 6,410
-------- --------
Decrease in Cash and Equivalents.......................... 43,820 (60,412)
Cash and Equivalents at Beginning of Period............... 55,176 118,065
-------- --------
Cash and Equivalents at End of Period..................... $ 98,996 $ 57,653
======== ========
Supplemental Schedule of Noncash Financing and Investing
Activities:
Issuance of common stock for businesses acquired.......... $ 2,825 $ 33,397
Issuance of preferred stock for business acquired......... 18,539 --
Issuance of common stock for technology license
agreements............................................. 1,710 --
Issuance of stock options for businesses acquired......... -- 8,360
Conversion of note receivable to investment in ATI........ -- 4,485
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 6
WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the
accounts of World Access, Inc. and its majority owned subsidiaries (the
"Company") from their effective dates of acquisition. These financial statements
have been prepared in accordance with the instructions to Form 10-Q and do not
include all the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation of the results of the interim periods covered
have been included.
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 and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
The estimated fair value of financial instruments has been determined by
the Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required in interpreting data
to develop the estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts that the Company could
realize in a current market exchange. The fair value estimates presented herein
are based on pertinent information available to management as of the respective
balance sheet dates. Although management is not aware of any factors that would
significantly affect the estimated fair value amounts, such amounts have not
been comprehensively revalued for purposes of these financial statements since
that date and current estimates of fair value may differ significantly from the
amounts presented herein.
The fair values of cash equivalents, accounts receivable, accounts payable
and accrued expenses approximate the carrying values due to their short-term
nature. The fair values of long-term debt are estimated based on current market
rates and instruments with the same risk and maturities and approximate the
carrying value.
The results of operations for the three and six months ended June 30, 1999
are not necessarily indicative of the results expected for the full year.
Certain reclassifications have been made to the prior period's financial
information to conform with the presentations used in 1999.
NOTE 2. ACQUISITIONS
In May 1999, the Company concluded negotiations to acquire substantially
all the assets and assume certain liabilities of Comm/Net Holding Corporation
and its wholly owned subsidiaries, Enhanced Communications Corporation, Comm/Net
Services Corporation and Long Distance Exchange Corporation (Comm/Net Holdings
and its wholly owned subsidiaries are collectively referred to herein as
"Comm/Net") and assumed effective control of Comm/Net's operations at that time.
Comm/Net, headquartered in Plano, Texas, is a facilities-based provider of
wholesale international long distance and wholesale prepaid calling card
services, primarily to the Mexican telecommunications markets.
In connection with the acquisition, the Company issued 23,174 shares of
4.25% Cumulative Junior Convertible Preferred Stock, Series B ( the "Series B
Preferred Stock") to the stockholders of Comm/Net valued at approximately $18.5
million and paid approximately $3.5 million to retire certain notes payable
outstanding at the time of acquisition. The Series B Preferred Stock is
convertible into shares of World Access common stock at a conversion rate of
$16.00 per common share, subject to standard anti-dilution adjustments. If the
closing trading price of World Access common stock exceeds $16.00 per share for
45 consecutive trading days, the Preferred Stock will automatically convert into
common stock. Preferred dividends begin accruing effective July 1, 1999.
5
<PAGE> 7
WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The acquisition of Comm/Net has been accounted for under the purchase
method of accounting. The purchase price allocation to the assets acquired and
liabilities assumed was based on information currently available to management
as follows (in thousands):
<TABLE>
<S> <C>
Purchase price:
Preferred stock issued.................................... $18,539
Debt paid................................................. 3,502
Fees and expenses......................................... 500
-------
Total purchase price.............................. $22,541
Allocation to fair values of assets and liabilities:
Current assets............................................ $(8,420)
Property and equipment.................................... (3,351)
Current liabilities....................................... 8,697
Other assets and liabilities, net......................... 1,182
-------
Goodwill.................................................. $20,649
=======
</TABLE>
During 1998, the Company acquired four businesses: Advanced TechCom, Inc.
("ATI") effective January 29, 1998; a majority interest in NACT
Telecommunications, Inc. ("NACT") (the "NACT Acquisition") effective February
27, 1998 and the remaining minority interest in NACT (the "NACT Merger")
effective October 28, 1998; Telco Systems, Inc. ("Telco" ) effective November
30, 1999; and Cherry Communications Incorporated, d/b/a Resurgens Communications
Group ("RCG"), and Cherry Communications U.K. Limited ("Cherry U.K.", and
together with RCG, "Resurgens") effective December 14, 1998 and in May 1999, the
Company acquired Comm/Net, these transactions are collectively refered to herein
as (the "Acquisitions").
On a pro forma, unaudited basis, as if the Acquisitions had occurred as of
January 1, 1998, total revenues, operating income (loss) from continuing
operations, income (loss) from continuing operations and income (loss) from
continuing operations per diluted common share for the six months ended June 30,
1999 and 1998 would have been approximately $335.1 million and $179.3 million,
$21.6 million and $(18.9) million, $8.6 million and $(19.1) million and $0.20
and $(0.57), respectively.
These unaudited pro forma results have been prepared for comparative
purposes only and are not necessarily indicative of the results of operations
which would actually have occurred had the Acquisitions been in effect on the
date indicated. Purchased in-process research and development ("R&D") expensed
in connection with the Acquisitions has been excluded from the pro forma results
due to its nonrecurring nature.
NOTE 3. SALE OF PREFERRED STOCK
In April 1999, the Company issued 50,000 shares of 4.25% Cumulative Senior
Perpetual Convertible Preferred Stock, Series A (the "Preferred Stock") to The
1818 Fund III, L.P. ("The 1818 Fund III") for an aggregate amount of $50.0
million. The General Partner of The 1818 Fund III, L.P. is Brown Brothers
Harriman & Co. ("BBH"), America's largest private bank and the oldest
owner-managed business partnership in the country. As part of the above sale,
The 1818 Fund III also received an option to purchase an additional $20 million
in Preferred Stock from the Company prior to June 30, 2000 at the original
purchase price per share. The Company allocated approximately $44.8 million to
the Preferred Stock and $5.2 million to the option to purchase an additional
$20.0 million in Preferred Stock.
Each share of Preferred Stock is convertible at the option of the holder
into the Company's common stock in accordance with a conversion formula equal to
the liquidation preference per share divided by a conversion price of $11.50 per
share, subject to adjustment. If the closing trading price of the Company's
common stock as quoted by The Nasdaq Stock Market exceeds $30 per share for 45
consecutive trading days,
6
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WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Preferred Stock will be automatically converted into the Company's common
stock. The Preferred Stock may be voted with the Company's common stock on an as
converted basis. The holders of Preferred Stock also have the right to designate
one member to the Board of Directors. The holders of Preferred Stock have
certain supermajority voting rights upon certain circumstances, such as the
authorization of a class of securities having senior or parity rights with the
Preferred Stock, a reorganization or liquidation of the Company, or a
consolidation or merger of the Company into a third party.
Upon the closing of the transaction, Lawrence C. Tucker, a partner at BBH
and co-manager of The 1818 Fund III, became a member of the Company's Board of
Directors.
NOTE 4. DISCONTINUED OPERATIONS
In December 1998, the Company formalized its plan to offer for sale two
non-core businesses, (i) the resale and repair of Nortel and other original
equipment manufacturers' wireline switching equipment, and (ii) pay telephone
refurbishment. On January 5, 1999, the Company formally announced its intention
to sell these businesses. In connection therewith, the Company recorded a $3.5
million charge in the fourth quarter of 1998, for the estimated loss to dispose
of these discontinued operations. This loss, which was recorded as partial
impairment of existing goodwill, was determined by comparing the book value of
the net assets of the discontinued operations to their net realizable value. The
net realizable value was estimated based on preliminary valuation work performed
by an investment banking firm engaged by the Company to assist in the sale of
these businesses and a preliminary non-committal offer from a prospective buyer.
During the first six months of 1999, the Company and its investment bankers
formally solicited offers for the two businesses. The preliminary offer referred
to above was eventually withdrawn by the potential suitor and the formal selling
process generated only one serious offer for the businesses. After several weeks
of negotiations, the Company refused this offer due to its low price and
substantial credit risk.
During this selling process, the Company's Nortel resale business
significantly deteriorated and its pay telephone refurbishment business began
showing signs of weakness. Management was cautiously optimistic in early 1999
that the negative market trends and operating losses experienced in its Nortel
resale business during the fourth quarter of 1998 were temporary in nature and
the market/business would rebound in 1999. Unfortunately, this turnaround did
not occur as evidenced by the Company's sales in this business which declined
from $12.8 million in the fourth quarter of 1998 to $6.0 million in the first
quarter of 1999 and $3.6 million in the second quarter of 1999. Several market
pressures influenced this negative trend including increased pricing competition
in the secondary equipment market, more aggressive participation in this market
by Nortel and other telecom equipment manufacturers and the reluctance of
customers to purchase used equipment due to year 2000 compliance concerns.
Although the discontinued businesses collectively generated a small profit
in the first quarter of 1999, they realized an operating loss of approximately
$700,000 in the second quarter of 1999. In July 1999, faced with an unsuccessful
selling process and future operating losses, management elected to begin
liquidating the Nortel resale and repair business. A formal liquidation plan
designed to eliminate future quarterly losses, maximize net cash proceeds and
realize significant deferred tax credits, was adopted, by management and
communicated to all affected employees in July 1999. The pay telephone
refurbishment business continues to be offered for sale by the Company.
As a result of this plan, the Company recorded a charge of $13.7 million in
the second quarter of 1999 to reflect the additional loss now expected to be
realized on the liquidation of the Nortel resale and repair business.
Significant elements of this charge consisted of $5.6 million to write-off all
remaining goodwill, $5.2 million to write-down inventories to estimated
realizable value, $1.3 million to write-down leasehold improvements, test
equipment and other assets to estimated realizable value, $300,000 for severance
benefits, and $300,000 for the estimated loss on the disposal of facility
leases. The charge also included approximately
7
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WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$200,000 for net operating losses expected to be incurred by the Company during
this liquidation process, which is expected to be completed by November 1999.
These businesses have been accounted for as discontinued operations and,
accordingly, the results of operations have been excluded from continuing
operations in the Consolidated Statements of Operations for all periods
presented.
The assets and liabilities of the discontinued operations included in the
Consolidated Balance Sheets consisted of the following (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
Current Assets
Accounts receivable....................................... $3,284 $11,453
Inventories............................................... 6,347 12,083
Other current assets...................................... 109 252
------ -------
$9,740 $23,788
====== =======
Noncurrent Assets
Property and equipment.................................... $ 773 $ 2,028
Goodwill and other intangibles............................ -- 5,335
Other assets.............................................. 6 --
------ -------
$ 779 $ 7,363
====== =======
Current Liabilities
Accounts payable.......................................... $2,776 $ 4,083
Other accrued liabilities................................. 1,768 3,741
------ -------
$4,544 $ 7,824
====== =======
</TABLE>
NOTE 5: PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
OVERVIEW
During the first quarter of 1998, $5.4 million and $44.6 million of
purchased in-process R&D was initially expensed in connection with the
acquisition of ATI and the NACT Acquisition, respectively. In connection with
the NACT Merger, the Company revalued purchased in-process R&D to reflect the
current status of in-process NACT technology and related business forecasts and
to ensure compliance with the additional guidance provided by the Securities and
Exchange Commission in its September 15, 1998 letter to the American Institute
of Certified Public Accountants. The revalued amount approximated the $44.6
million expensed in connection with the NACT Acquisition, therefore no
additional charge was recorded for purchased in-process R&D. However, the effect
of the revaluation required the Company to reduce the first quarter of 1998
charge related to the purchased in-process R&D by $14.6 million and record an
additional charge of $14.6 million in the fourth quarter of 1998, the period in
which the NACT Merger was consummated. Consequently, net loss for the six months
ended June 30, 1998 of $42.3 million as reported in the Company's Report on Form
10-Q for the three months ended June 30, 1998 is now reported as $27.7 million
in this Form 10-Q Report. During the fourth quarter of 1998, $14.6 million and
$50.3 million of purchased in-process R&D was expensed in connection with the
NACT Merger and the Telco Merger, respectively.
These amounts were expensed as non-recurring charges on the respective
acquisition dates. These write-offs were necessary because the acquired
technology had not yet reached technological feasibility and had no future
alternate use.
8
<PAGE> 10
WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The value of the purchased in-process technology from ATI was determined by
estimating the projected net cash flows related to in-process research and
development projects, including costs to complete the development of the
technology. These cash flows were discounted back to their net present value.
The projected net cash flows from such projects were based on management's
estimates of revenues and operating profits related to such projects. These
estimates were based on several assumptions, including those summarized below.
The value of the purchased in-process technology from NACT and Telco was
determined by estimating the projected net cash flows related to in-process
research and development projects, excluding costs to complete the development
of the technology. These cash flows were discounted back to their net present
value. The projected net cash flows from such projects were based on
management's estimates of revenues and operating profits related to such
projects. These estimates were based on several assumptions, including those
summarized below for each respective acquisition. The resultant net present
value amount was then reduced by a percentage of completion factor. The
percentage of completion for a particular project was determined by dividing the
development spending from the inception of the project until the measurement
date by the total estimated development spending for the project. This factor
more specifically captures the development risk of an in-process technology
(i.e., market risk is still incorporated in the estimated rate of return).
The nature of the efforts required to develop the purchased in-process
technology into commercially viable products principally relate to the
completion of all planning, designing, prototyping, verification, and test
activities that are necessary to establish that the product can be produced to
meet its design specifications, including functions, features, and technical
performance requirements. The progress on these activities determines the stage
of completion of each project in the life cycle of the development. Projects
described as being in the "early" or "early concept" stage are not expected to
achieve technological feasibility and commercial application within twelve
months from the valuation date. These projects are typically in the stage of
documenting hardware and software design and preparation of circuit board
layouts. Projects described as being in the "mid" stage of development are
expected to achieve technological feasibility and commercial application within
6 to 12 months from the valuation date. These projects are typically in the
stage of finalizing circuit board layouts and performing engineering integration
tests prior to prototype builds. Projects described as being in the "late" stage
of development are expected to achieve technological feasibility and commercial
application within 6 months from the valuation date. These projects are
typically in stage of prototype builds, initial system testing, quality
assurance and field trials. It should be noted that stages of completion refer
to specific development milestones, and do not necessarily directly correlate to
the percentage of completion used in the IPR&D valuation. The percentage of
completion for the IPR&D valuation is based on the development costs incurred on
each acquired IPR&D project as of the Acquisition Date, as a percentage of the
total development costs expected to be incurred on that project, from the
inception of its development (prior to the acquisition date) until its
development is completed (after the acquisition date).
If these projects to develop commercially viable products based on the
purchased in-process technology are not successfully completed, the sales and
profitability of the Company may be adversely affected in future periods.
Additionally, the value of other intangible assets may become impaired.
ATI MERGER
ATI develops and manufactures a series of high-performance digital
microwave and millimeterwave radio equipment. Their products reach across all
frequency bands and data rates and offer numerous features. The nature of the
in-process research and development was such that technological feasibility had
not been attained. Failure to attain technological feasibility would have
rendered partially designed equipment useless for other applications. ATI's
products are designed for specific frequency bandwidths and, as such, are highly
customized to those bandwidths and the needs of customers wishing to operate in
them. Products only partially completed for certain bandwidths cannot be used in
other bandwidths.
9
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WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Between each product line, various stages of development had been reached.
Additionally, within each product line, different units had reached various
stages of development. Of the products management considered in-process, none
had attained technological feasibility. The purchased in-process technology
acquired in the ATI acquisition was comprised of three primary projects related
to high-performance, digital microwave and millimeterwave radio equipment. Each
project consists of multiple products. These projects were at multiple stages
along ATI's typical development timeline. Some projects were beginning testing
in ATI labs; others were at earlier stages of planning and designing. The
majority of the products were scheduled to be released during 1998, 1999 and
early 2000. Revenue projections for the in-process technologies reflected the
anticipated release dates of each project.
Revenue attributable to in-process technology was estimated to increase
within the first three years of the seven-year projection at annual rates
ranging from a high of 240.7% to a low of 2.3%, decreasing within the remaining
years at annual rates ranging from 30.9% to 60.9% as other products are released
in the marketplace. Projected annual revenue attributable to in-process
technology ranged from approximately a low of $11.8 million to a high of $71.1
million within the term of the projections. These projections were based on
assumed penetration of the existing customer base and movement into new markets.
Projected revenues from in-process technology were assumed to peak in 2001 and
decline from 2002 through 2004 as other new products are expected to enter the
market.
In-process technology's contribution to the operating profit of ATI
(earnings before interest, taxes and depreciation and amortization) was
estimated to grow within the projection period at annual rates ranging from a
high of 665.9% to a low of 43.9% during the first four years, decreasing during
the remaining years of the projection period similar to the revenue growth
projections described above. Projected in-process technology's annual
contribution to operating profit (loss) ranged from approximately a low of
$(900,000) to a high of $9.1 million within the term of the projections.
The discount rate used to value the in-process technology of ATI was 26.0%.
This discount rate was estimated relative to the overall business discount rate
of 25.0% based on (1) the incomplete status of the products expected to utilize
the in-process technology (i.e., development risk), (2) the expected market risk
of the planned products relative to the existing products, (3) the emphasis on
different markets than those currently pursued by ATI, and (4) the nature of
remaining development tasks relative to previous development efforts.
Management estimated that the costs to develop the in-process technology
acquired in the ATI acquisition would be approximately $24.3 million in the
aggregate through the year 2002. The expected sources of funding were scheduled
R&D expenses from the operating budget of ATI.
NACT MERGER
NACT provides advanced telecommunications switching platforms with
integrated applications software and network telemanagement capabilities. NACT
designs, develops, and manufacturers all hardware and software elements
necessary for a fully integrated, turnkey telecommunications switching solution.
The nature of the in-process research and development was such that
technological feasibility had not been attained. Failure to attain technological
feasibility, especially given the high degree of customization required for
complete integration into the NACT solution, would have rendered partially
designed hardware and software useless for other applications. Incomplete design
of hardware and software coding would create a non-connective, inoperable
product that would have no alternative use.
NACT's business plan called for a shift in market focus to large customers,
both domestic and international; therefore, NACT had numerous projects in
development at the time of the acquisition. Additionally, the pending completion
of a major release of NACT's billing system required significant development
efforts to ensure continued integration with NACT's product suite. The purchased
in-process
10
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WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
technology acquired in the NACT acquisition was comprised of 13 projects related
to switching and billing systems. These projects were scheduled to be released
between February 1998 and April 2000. These projects included planned additions
of new products, based on undeveloped technologies, to NACT's suite of STX and
NTS products. The projects also include the creation of products for new product
suites. The research and development projects were at various stages of
development. None of the in-process projects considered in the write-off had
attained technological feasibility. The in-process projects do not build on
existing core technology; such existing technologies were valued as a separate
asset.
A brief summary of the significant technologies NACT was developing for
their STX and NTS products at the time of the acquisition are as follows:
STX Application Switching Platform ("STX"). STX was introduced in May 1996
as an integrated digital tandem switching system which allows scalability from
24 ports to a capacity of 1,024 ports per switch. The STX can be combined with
three additional STXs to provide a total capacity of 4,096 ports per system. The
current STX is not sufficiently developed to address NACT's objective of
targeting larger, more diverse telecommunications companies. To move into this
expanded customer base, NACT has multiple development tasks planned for the STX
product. NACT plans to incorporate into the STX certain features and
enhancements such as SS7 and E1 (discussed below), R-2 signaling, and Integrated
Services Digital Network, which are critical to the Company's strategy to
broaden its customer base. The SS7 and E1 features are considered new products
within the STX family of products.
Master Control Unit ("MCU"). MCU is a database hub which can link up to
four switches, creating a larger capacity tandem switch. NACT is developing an
updated MCU, called the "redundant MCU", which allows for intelligent peripheral
or recognition of pre-paid caller numbers. Redundant MCU is an important
extension to the MCU system because it will allow a telecommunications company
to create an entire switching network outside of the public network owned by
major telecommunications firms.
NTS Telemanagement and Billing System ("NTS"). NTS performs call rating,
accounting, switch management, invoicing, and traffic engineering for multiple
NACT switches. NACT recently finished development of an improved billing system,
the NTS 2000, which is designed for real-time transaction processing with
graphical user interface and improved call reports. The NTS 2000 is compatible
with non-NACT switches. The NTS 2000 also allows for customization of invoices
and reports.
E1 to T1 Conversion. The T1 is the switchboard hardware used in the STX.
The T1 product has been in existence for several years. The E1 is the standard
switchboard used in Europe. NACT is creating a technology which facilitates
compatibility between the T1 and the switchboard hardware currently used in
Europe. In addition, NACT is currently developing enhanced switchboard hardware
called the T3, which will allow for more calls to pass through the switchboard
at one time. Both development efforts, the T3 and compatibility between E1 and
T1, are necessary as NACT moves into international markets.
Transmission Control Protocol/Internet Protocol ("TCP/IP")
Connectivity. TCP/IP is the most common method of connecting personal
computers, workstations and servers. Other historically dominant networking
protocols, such as the local area network ("LAN") protocol and international
packet exchange/sequence packet exchange, are losing ground to TCP/IP. The
addition of TCP/IP is vital relative to NACT's strategic objective of offering
voice-over-Internet.
68060. The Company has now completed the incorporation of the Motorola
68060 processing board in the STX application platform to enable the STX to
support 2,048 ports per switch or 8,192 ports per integrated MCU system. With
this development, the STX can process significantly more call minutes per month,
with enhanced processing speed.
Signaling System 7 ("SS7/C7"). SS7 is software that allows a call, which
normally would have to go through a series of switchboards to reach its
destination, to instead skip from the first switchboard to the last.
11
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WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
With the addition of this enhancement, the STX switch can interface with
carriers more quickly and efficiently. In addition, NACT is developing the C7,
which is the European version of the SS7.
The seven technologies reflected above represent 11 of the 13 projects that
NACT had in development at the time of acquisition. The STX development consists
of four separate projects, and the MCU development consists of two separate
projects. These projects were at multiple stages along NACT's development
timeline. Some projects were beginning testing in NACT labs; others were at
earlier stages of planning and designing. These projects were scheduled for
release between December 1998 and December 2000. Revenue projections for the
in-process technologies reflected the anticipated release dates of each project.
Revenue attributable to in-process technology was assumed to increase in
the first five years of the 12-year projection at annual rates ranging from
61.4% to 2.81%, decreasing over the remaining years at annual rates ranging from
16.0% to 48.5% as other products are released in the marketplace. Projected
annual revenue attributable to in-process technology ranged from approximately a
low of $8.0 million to a high of $101.1 million within the term of the
projections. These projections were based on assumed penetration of the existing
customer base and movement into new markets. Projected revenues from in-process
technology were assumed to peak in 2003 and decline from 2004 through 2009 as
other new products are expected to enter the market.
In-process technology's contribution to the operating profit of NACT
(earnings before interest, taxes and depreciation and amortization) was
projected to grow within the projection period at annual rates ranging from a
high of 67.2% to a low of 2.8% during the first five years, decreasing during
the remaining years of the projection period similar to the revenue growth
projections described above. Projected in-process technology's annual
contribution to operating profit ranged from approximately $2.1 million to $29.3
million within the term of the projections.
The discount rate used to value the existing technology of NACT was 14.0%.
This discount rate was estimated relative to the overall business discount rate
of 15.0% based on (1) the completed status of the products utilizing existing
technology (i.e., the lack of development risk), and (2) the potential for
obsolescence of current products in the marketplace.
The discount rate used to value the in-process technology of NACT was
15.0%. This discount rate was estimated relative to the overall business
discount rate of 15.0% based on (1) the incomplete status of the products
expected to utilize the in-process technology (i.e., development risk), (2) the
expected market risk of the planned products relative to the existing products,
(3) the emphasis on targeting larger customers for the planned products, (4) the
expected demand for the products from current and prospective NACT customers,
(5) the anticipated increase in NACT's sales force, and (6) the nature of
remaining development tasks relative to previous development efforts.
12
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WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Set forth in the table below are details relating to the in-process
research and development charge for the seven key NACT technologies, which
account for 11 of the 13 development projects:
<TABLE>
<CAPTION>
PERCENTAGE OF COMPLETION AS OF
-------------------------------
PERCENTAGE OF COSTS INCURRED
NACT IPR&D AS OF ACQUISITION ACQUISITION JUNE 30,
DEVELOPMENT PROJECT CHARGE DATE DATE 1999
- ------------------- ------------- ----------------- ----------- --------------
(000)
<S> <C> <C> <C> <C>
STX Hardware & Software.... 43% $1,347 80% 93%
TCPIP...................... 7 227 90 95
SS7/C7..................... 14 1,280 72 84
NTS2000.................... 26 1,425 91 100
E1/T1 conversion........... 6 125 48 77
MCU........................ 1 123 24 74
68060...................... 2 218 48 100
<CAPTION>
ESTIMATED COST TO COMPLETION
AS OF THE ACQUISITION DATE FOR
---------------------------------
DEVELOPMENT PROJECT 1998 1999 2000
- ------------------- --------- --------- ---------
<S> <C> <C> <C>
STX Hardware & Software.... $56 $285
TCPIP...................... 8 17
SS7/C7..................... 54 324 $116
NTS2000.................... 54 82
E1/T1 conversion........... 20 117
MCU........................ 66 334
68060...................... 60 178
</TABLE>
TELCO MERGER
Telco develops and manufactures products focused on providing integrated
access for network services. Telco's products can be separated into three
categories: (1) broadband transmission products, (2) network access products,
and (3) bandwidth optimization products. Telco's products are deployed at the
edge of the service provider's networks to provide organizations with a
flexible, cost-effective means of transmitting voice, data, video and image
traffic over public or private networks.
At the time of acquisition, Telco had several primary projects in
development relating to next-generation telecommunication and data network
hardware. These projects were at various stages in the development process. Some
were about to enter the testing phase of the initial hardware prototype, while
others were still in the early concept and design specification stages. These
projects were scheduled for commercial release at various points in time from
December 1998 through early 2000.
Telco's in-process research and development projects are being developed to
run on new communications protocols and technologies not employed in its current
products. These include HDSL, SONET, Voice over IP and ATM inverse multiplexing.
Additionally, the products to be commercialized from Telco's in process research
and development are expected to include interface support not in Telco's current
product line, including E1, DS3 and OC3.
A brief description of the significant in-process projects is set forth
below:
Access 45/60 Release 1. Access 45/60 Release 1 product provides
essentially the same functional service as the existing Access 45/60 network
access servers by providing highly reliable digital access to public, private
and hybrid networks, integrating multiple business applications through
cost-effective connections to dedicated, switched and packet network services.
However, unlike the current versions, the technology underlying the Release 1
(R1) version is based on high-bit-rate digital subscriber line (HDSL)
technology. This HDSL technology will enable high-density voice and data
applications to travel simultaneously over one to ten HDSL lines from a single
platform, which will launch the R1 product into a whole new loop market by
eliminating the need for service providers to have separate platforms for voice
and data at the customer's premises or at the provider's central office.
Although the Access 45/60 R1 product is designed to provide a service similar to
the current Access 45/60 product, the core functional technology of the new R1
is very different, and the target market of the R1 product is different. This
project was in the late stage of development and has been recently completed.
EdgeLink100 E1 -- The EdgeLink100 E1 version is an addition to the 100
family which will be marketed internationally. Conforming to all applicable ETSI
and ITU standards, this product will provide a cornerstone to the next
generation of international product offerings. This product was in the early
stage of development at the time of acquisition, and is expected to achieve
commercial viability by the end of 1999. Software code
13
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WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
generation is expected to be completed in April 1999. Prototype builds for
initial units were completed in June 1999, and initial beta field tests are
expected to begin in the third quarter of 1999.
EdgeLink300 -- The EdgeLink300 is an intelligent integrated access device,
which will provide low cost integration of voice and data services at the
customer premise by incorporating the functionality of several different
customer premise devices to allow low cost integration of POTS (plain old
telephone service), PBX, corporate LAN access and Internet access services in a
single box. The product can be connected to the network via a DS1, SDSL or HDSL.
These multiple access choices allow for lowest cost access to customers under
various regulatory conditions. This project was acquired by Telco through its
acquisition of Synaptyx in October of 1998. This product was in the late stage
of development and was introduced in the first half of 1999.
SONET Edge Device -- The SONET Edge Device is a next-generation edge device
expected to provide access to SONET networks. This access device will be
designed to take a T1 voice input from a PBX or an Access60 and convert to SONET
formatted tributaries and send it out via a traditional STS1 interface.
This project was in the early stage of development at the time of
acquisition, and is not expected to reach commercial viability until early 2000.
Documentation of the hardware and software design is expected to be completed in
April 1999; software code generation is expected to be completed in August 1999;
prototype builds for initial units are expected to be completed in October 1999;
and initial beta field tests are expected to begin in January 2000.
EdgeLink600 -- The EdgeLink600 ATM access device is expected to be the
first of Telco's new class of remote access systems designed to support
mission-critical multimedia traffic with guaranteed end-to-end quality of
service. This device is expected to consolidate mission-critical data, voice and
video traffic onto ATM or Frame Relay networks, allowing cost effective video
conferencing and voice integration without compromising critical data traffic.
These systems will address users who wish to take advantage of the quality and
cost effectiveness of ATM but do not wish to run ATM to their desktop.
Although much of the hardware and software design documentation and the
board layouts have been completed, in the second quarter of 1999, the
development of this product has been temporarily suspended to allow the Company
to focus its development efforts on completing certain other projects.
EdgeLink650 IMA -- The EdgeLink650 ATM device will be designed to be a
multislot version of the Edgelink600 with DS3 and NxDS1 interface support. This
product will incorporate an ATM Inverse Multiplexer (IMA). This product was in
the early stage of development at the time of acquisition, and is expected to
reach commercial viability in early 2000. Documentation of the hardware and
software design is expected to be completed in July 1999; prototype builds for
initial units are expected to be completed in September 1999; and initial beta
field tests are expected to begin in December 1999.
Voice-Over-Packet Engines -- Voice-over-packet refers to sending voice
transmissions over packet-based communication protocols, such as internet
protocols (IP telephony), Frame Relay, or ATM. Telco is currently developing the
software and hardware for a generic "engine" to be integrated into the EdgeLink
family of products to enable this functionality. This product was in the mid
stage of development at the time of acquisition, and is expected to be
commercially viable by October 2000. Software code generation is expected to be
completed in March 2000; prototype builds for initial units are expected to be
completed in May 2000; and initial beta field tests are expected to begin in
July 2000.
Hyperspan SMUG -- A new application specific integrated circuit (ASIC) is
being designed to be integrated into the HyperSPAN multiplexer boards in order
to (i) avoid technological obsolescence, and (ii) to reduce production costs.
The development of this replacement technology was at an early to mid stage at
the time of acquisition and is expected to be commercially viable by the end of
1999.
14
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WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Set forth in the table below are details relating to the significant Telco
in-process research and development projects (dollar amounts in thousands):
<TABLE>
<CAPTION>
PERCENTAGE OF
COMPLETION AS OF
PERCENTAGE OF ---------------------- ESTIMATED COSTS TO COMPLETION
TELCO COSTS INCURRED AS OF THE ACQUISITION DATE FOR
IPR&D AS OF ACQUISITION ACQUISITION ------------------------------
DEVELOPMENT PROJECT CHARGE DATE DATE 6/30/99 1998 1999 2000
- ------------------- ------------- ----------------- ----------- -------- ------ -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Access 45/60 Release 1........... 1% $2,610 72% 87% $ 77 $ 923
EdgeLink 100 E1.................. 4 880 47 75 76 914
Sonet IAD........................ 6 1,090 24 54 195 2,345 $1,000
EdgeLink 650/IMA................. 16 1,830 39 50 227 2,723
Voice over Packet................ 11 1,730 45 75 162 1,948
EdgeLink 300..................... 48 2,200 90 100 100 200
EdgeLink 600..................... 12 3,300 85 95 197 393
Hyperspan SMUG................... 2 760 77 90 38 192
</TABLE>
If these projects are not completed as planned, the in-process research and
development will have no alternative use. Failure of the in-process technologies
to achieve technological feasibility may adversely affect the future
profitability of World Access.
Revenue attributable to Telco's aggregate in-process technology was assumed
to increase over the first six years of the projection period at annual rates
ranging from a high of 103.6% to a low of 3.8%, reflecting both the displacement
of Telco's old products by these new products as well as the expected growth in
the overall market in which Telco's products compete. Thereafter, revenues are
projected to decline over the remaining projection period at annual rates
ranging from 15.2% to 42.6%, as the acquired in process technologies become
obsolete and are replaced by newer technologies.
Management's projected annual revenues attributable to the aggregate
acquired in-process technologies, which assume that all such technologies
achieve technological feasibility, ranged from a low of approximately $39.0
million to a high of approximately $276 million. Projected revenues were
projected to peak in 2004 and decline thereafter through 2009 as other new
products enter the market.
The acquired in-process technology's contribution to the operating income
was projected to grow over the first five years of the projection period at
annual rates ranging from a high of 240.9% to a low of 22.2% with one
intermediate year of marginally declining operating income. Thereafter, the
contribution to operating income was projected to decline through the projection
period. The acquired in-process technology's contribution to operating income
ranged from a low of approximately $4.4 million to a high of approximately $70.5
million.
The discount rate used to value the existing technology was 20.0%. This
discount rate was selected because of the asset's intangible characteristics,
the risk associated with the economic life expectations of the technology and
potential obsolescence of legacy products, and the risk associated with the
financial assumptions with respect to the projections used in the analysis.
The discount rates used to value the in-process technologies were 21.5% and
23.5%, depending on the stage of development. These discount rates were selected
due to several incremental inherent risks. First the actual useful economic life
of such technologies may differ from the estimates used in the analysis. Second,
risks associated with the financial projections on the specific products that
comprise the acquired in-process research and development. The third factor is
the incomplete and unproven nature of the technologies. Finally, future
technological advances that are currently unknown may negatively impact the
economic and functional viability of the in-process R&D.
The discount rates used to value in-process research and development are
different in each of the three mergers due to the following factors: (i) The
nature of the markets for the products under development, including factors such
as market size, ability to enter the markets, competitive landscape, possibility
of
15
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WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
technological obsolescence, and target customer base; and (ii) The nature of the
acquired businesses, including the historical success with product
introductions, ability to meet development milestones, strength of the sales and
marketing organizations, access to market channels and strength of the brand
names.
NOTE 6. RESTRUCTURING AND OTHER CHARGES
SUMMARY
During 1998, the Company approved and began implementing two restructuring
programs designed to reduce operating costs, outsource manufacturing
requirements and focus Company resources on recently acquired business units
containing proprietary technology or services.
In the first quarter of 1998, the Company approved and began implementing a
restructuring program to consolidate several operations and exit the contract
manufacturing business. In connection with these activities, the Company
recorded restructuring and other charges of approximately $6.6 million of which
$1.1 million was charged to continuing operations and $5.5 million was charged
to discontinued operations. This restructuring activity was substantially
completed as of June 30, 1998.
In the fourth quarter of 1998, in connection with the (i) NACT, Telco and
Resurgens Mergers; (ii) election of several new outside directors to the
Company's Board; and (iii) appointment of a new Chief Executive Officer, the
Company approved and began implementing a major restructuring program to
reorganize its operating structure, consolidate several facilities, outsource
its manufacturing requirements, rationalize its product offerings and related
development efforts, and pursue other potential synergies expected to be
realized as a result of the integration of recently acquired businesses. In
connection with these activities, the Company recorded restructuring and other
charges of approximately $43.0 million of which $36.2 million was charged to
continuing operations and $6.8 million was charged to discontinued operations.
As of the date of this Report, the Company has substantially completed these
restructuring activities.
The following details the charges during the first six months of 1999 to
the reserve for the fourth quarter 1998 restructuring activities:
<TABLE>
<CAPTION>
RESERVE BALANCE 1999 RESERVE BALANCE
AT 12/31/98 ACTIVITY AT 6/30/99
--------------- -------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C>
Reorganize Operating Structure
Employee termination benefits................... $ 449 $ 250 $ 199
Idle facility costs............................. 258 73 185
Other........................................... 304 251 53
------ ------ ------
1,011 574 437
Consolidation of ATI and Telco
Employee termination benefits................... 1,175 866 309
Idle facility costs............................. 577 102 475
Other........................................... 300 118 182
------ ------ ------
2,052 1,086 966
Outsource Manufacturing
Employee termination benefits................... 310 195 115
Idle facility costs............................. 365 286 79
Other........................................... 332 332 --
------ ------ ------
1,007 813 194
Product Line Rationalization...................... 568 338 230
------ ------ ------
Total................................... $4,638 $2,811 $1,827
====== ====== ======
</TABLE>
16
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WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Costs associated with the reorganized operating structure consist primarily
of termination benefits payable to the Company's former President, which will be
paid throughout 1999, and remaining lease obligations on the Company's Equipment
Group headquarters facility in Alpharetta, Georgia. In February 1999, Equipment
Group personnel relocated to the Company's headquarters in Atlanta and the
facility was closed.
Restructuring costs also included amounts associated with the consolidation
of the Company's ATI operations in Wilmington, Massachusetts into Telco's
facility in Norwood, Massachusetts. Manufacturing of ATI's wireless radios has
been out-sourced to a contact manufacturer and all other aspects of ATI's
operations are being integrated into Telco's existing operating infrastructure.
Severance and other termination benefits of approximately $1.2 million are to be
paid to approximately 60 ATI employees as the consolidation program is completed
during 1999. A provision of $577,000 was recorded for the costs associated with
the idle portion of the Wilmington facility, which is leased through November
2000.
An integral part of the restructuring program was the Company's decision to
outsource all its electrical manufacturing requirements and sell its Alpharetta,
Georgia manufacturing facility to an established contract manufacturer.
Severance and other termination benefits of $426,000 were provided for in
December 1998 to approximately 25 personnel. The Company completed the sale of
its manufacturing operations in March 1999. The actual loss incurred in
connection with the sale did not differ materially from the amounts recorded in
the restructuring charges. As part of this sale agreement, the Company committed
to purchase a minimum of $15.0 million of products and services from the
contract manufacturer in each of three consecutive 12 month periods beginning
April 1, 1999.
Costs related to product line rationalization related to the phase out of
the Company's Compact Digital Exchange ("CDX") switch. In January 1999, the
Company elected to reallocate development resources targeted for the CDX switch
as a stand-alone product to the integration of the central office functionally
of the CDX switch and the long-distance functionality of NACT's switch into a
common, next generation technology platform. Costs incurred in the first quarter
of 1999 related primarily to engineering efforts incurred related to 1998 and
prior CDX contracts.
NOTE 7. INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
Transport and access products............................... $ 6,402 $ 8,723
Switching products.......................................... 2,026 986
Cellular equipment.......................................... 18,700 9,421
Work in progress............................................ 2,629 4,953
Raw materials............................................... 9,112 12,425
------- -------
Continuing operations....................................... 38,869 36,508
Discontinued operations..................................... 6,347 12,083
------- -------
Total inventories................................. $45,216 $48,591
======= =======
</TABLE>
During the first quarter of 1999, in connection with the sale of the
Company's Alpharetta, Georgia manufacturing facility and the outsourcing of
manufacturing for ATI's wireless radios, the Company sold approximately $3.3
million and $2.1 million of inventories, respectively. In the second quarter of
1999, the Company wrote down inventories of the discontinued operations by $6.5
million to adjust the carrying cost to net realizable value.
17
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WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8. REPORTABLE SEGMENT DATA
The Company has two reportable segments: telecommunications carrier
services ("World Access Telecommunications Group") and telecommunications
equipment ("World Access Equipment Group"). The World Access Telecommunications
Group provides wholesale international long distance service through a
combination of its own international network facilities, various international
termination relationships and resale arrangements with other international long
distance service providers. The World Access Equipment Group develops,
manufactures and markets digital switches, billing and network telemanagement
systems, cellular base stations, fixed wireless local loop systems, intelligent
multiplexers, digital microwave radio systems and other telecommunications
network products.
The World Access Telecommunications Group consists of the Resurgens
business which was acquired in December 1998 and a portion of the NACT business
which was acquired in February and October 1998.
The Company evaluates performance and allocates resources based on
operating income or loss before interest and other income, interest expense and
income taxes. The accounting policies of the reportable segments are the same as
those described in the summary of significant accounting policies. Intersegment
sales and transfers are recorded at cost plus a markup that equals current
market prices. There were no significant intersegment sales during the six
months ended June 30, 1999 and the year ended December 31, 1998.
The Company's reportable segments are business units that offer different
products and services. The reportable segments are each managed separately due
to the unique nature of each segment (i.e., selling telecommunications equipment
versus providing international long distance services). The following tables
present revenues and other financial information by business segment:
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------------------------------------------
EQUIPMENT TELECOM CONTINUING DISCONTINUED
GROUP GROUP OTHER OPERATIONS OPERATIONS TOTAL
--------- -------- ------- ---------- ------------ --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Revenues from external customers
1999....................................... $122,360 $198,891 $ -- $321,251 $13,767 $335,018
1998....................................... 57,402 545 -- 57,947 25,291 83,238
In-process research and development
1999....................................... -- -- -- -- -- --
1998....................................... 35,400 -- -- 35,400 -- 35,400
Restructuring and other charges
1999....................................... -- -- -- -- 13,662 13,662
1998....................................... 1,055 -- -- 1,055 5,545 6,600
Segment income or loss
1999....................................... 10,126 1,734 (3,467) 8,393 (14,315) (5,922)
1998....................................... (25,334) 53 (2,409) (27,690) (40) (27,730)
</TABLE>
<TABLE>
<CAPTION>
EQUIPMENT TELECOM CONTINUING DISCONTINUED
GROUP GROUP OTHER OPERATIONS OPERATIONS TOTAL
--------- -------- ------- ---------- ------------ --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Segment assets
As of June 30, 1999........................ 385,584 206,332 99,813 691,729 10,519 702,248
As of December 31, 1998.................... 380,721 161,137 40,823 582,681 31,131 613,812
</TABLE>
NOTE 9. LITIGATION
Following the Company's announcement on January 5, 1999, regarding earnings
expectations for the quarter and year ended December 31, 1998, and the
subsequent decline in the price of the Company's
18
<PAGE> 20
WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
common stock, 22 putative class action complaints were filed against the Company
in the United States District Court for the Northern District of Georgia,
Atlanta Division (the "Court"). The Company and certain of its then current
officers and directors were named as defendants. A second decline in the
Company's stock price occurred shortly after actual earnings were announced on
February 11, 1999, and a few of these cases were amended, and additional,
similar complaints were filed. The pending cases were consolidated pursuant to
an order entered by the Court on April 28, 1999. The Court has deferred ruling
on a pending motion regarding the appointment of lead plaintiffs and lead
counsel.
The plaintiffs filed a Consolidated Amended Class Action Complaint (the
"Amended Complaint") on May 28, 1999, naming as defendants the Company, Steven
A. Odom, Mark A. Gergel, Hensley E. West, Martin D. Kidder, and Stephen J.
Clearman. In the Amended Complaint, the plaintiffs have asserted claims for
violations of the federal securities laws arising from alleged misstatements of
material information in and/or omissions of material information from certain of
the Company's securities filings and other public disclosures, principally
related to alleged performance problems with the Company's CDX switch and
alleged customer and sales problems arising therefrom. Although the issue of
class certification has not yet been addressed, the Amended Complaint is filed
on behalf of: (a) persons who purchased shares of the Company's common stock
during the period from April 29, 1997 through February 11, 1999; (b)
shareholders of Telco who received shares of the Company's common stock as a
result of the Company's acquisition of Telco that closed on November 30, 1998;
and (c) shareholders of NACT who received shares of the Company's common stock
as a result of the Company's acquisition of NACT that closed on October 28,
1998. The plaintiffs have requested damages in an unspecified amount and
litigation expenses in their Amended Complaint.
On June 28, 1999, the defendants moved to dismiss the Amended Complaint on
both substantive and procedural grounds. The motion is currently pending before
the Court. Although the Company and the individuals named as defendants deny
that they have violated any of the requirements or obligations of the federal
securities laws, there can be no assurance that the Company will not sustain
material liability as a result of or related to this shareholder suit.
NOTE 10. INCOME TAXES
The Company's provision for income taxes attributable to continuing
operations for the six months ended June 30, 1999 was $9.4 million or
approximately 52.7% of income from continuing operations before income taxes.
The provision for income taxes differs from the amount computed by applying the
statutory federal and state income tax rates due to non-deductible expenses,
primarily goodwill amortization.
NOTE 11. SUMMARIZED FINANCIAL INFORMATION OF WA TELCOM PRODUCTS CO., INC.
On October 28, 1998, World Access, Inc. reorganized its operations into a
holding company structure and changed its name to WA Telcom Products Co., Inc.
("WA Telcom"). As a result of the reorganization, WA Telcom became a
wholly-owned subsidiary of WAXS INC., which changed its name to World Access,
Inc. and is the Company filing this Report. Pursuant to the reorganization, the
Company exchanged each outstanding share of common stock of WA Telcom for one
share of common stock of the Company, converted each option and warrant to
purchase shares of common stock of WA Telcom into options and warrants to
purchase a like number of shares of common stock of the Company, and fully and
unconditionally guaranteed the payment of the $115.0 million aggregate principal
amount 4.5% convertible subordinated notes dated October 1, 1997 (due 2002)
previously issued by WA Telcom.
Set forth below is summarized financial information of WA Telcom presented
for the information of its debtholders. The summarized financial information
presented below includes the results of operations for the following businesses
from their respective dates of acquisitions: Cellular Infrastructure Supply,
Inc. -- January 1997; Galaxy Personal Communications Services, Inc. -- July
1997; Advanced TechCom, Inc. --
19
<PAGE> 21
WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
January 1998; NACT Telecommunications, Inc. -- February 1998; and Cherry
Communications Incorporated and Cherry Communications U.K. Limited -- December
1998.
BALANCE SHEET INFORMATION
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
Current assets.............................................. $146,283 $162,554
Non-current assets.......................................... 315,499 300,139
Total assets................................................ 461,782 462,693
Current liabilities......................................... 92,362 70,976
Non-current liabilities..................................... 144,228 138,529
Stockholders equity......................................... 225,192 253,188
Total liabilities and stockholders equity................... 461,782 462,693
</TABLE>
OPERATING STATEMENT INFORMATION
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1999(1)
----------------
<S> <C>
Total sales................................................. $262,469
Gross profit................................................ 38,405
Income (loss) from continuing operations.................... 6,785
Income (loss) from discontinued operations(2)............... (14,315)
Net income.................................................. (7,530)
</TABLE>
- ---------------
(1) No operating statement information is presented for the three months ended
June 30, 1998 as the holding company reorganization was not completed until
October 28, 1998.
(2) Reflects the Company's plan to sell all of its non-core businesses, which
consist of the resale of Nortel and other original equipment manufacturers'
wireline switching equipment, third party repair of telecom equipment and
pay telephone refurbishment. The discontinued operations had total assets of
$10.0 million and $31.1 million as of June 30, 1999 and December 31, 1998,
respectively, and total liabilities of $6.2 million and $7.8 million as of
June 30, 1999 and December 31, 1998, respectively.
NOTE 12. SUBSEQUENT EVENTS
PENDING MERGER
On August 17, 1999, the Company entered into a definitive merger agreement
with FaciliCom International, Inc. ("FaciliCom"). FaciliCom, a privately owned
company headquartered in Washington, D.C., is a leading facilities-based
provider of European and U.S. originated international long-distance voice, data
and Internet services.
Pursuant to the terms of the agreement, the shareholders of FaciliCom will
receive approximately $436 million in consideration, primarily in the form of
the Company's Convertible Preferred Stock, Series C (the "Series C Preferred
Stock"). The Series C Preferred Stock bears no dividend and is convertible into
shares of the Company's common stock at a conversion rate of $20.38 per common
share, subject to potential adjustment under certain circumstances. If the
closing trading price of the Company's common stock exceeds $20.38 per share for
60 consecutive trading days, the Series C Preferred Stock will automatically
convert into common stock. Initially, the holders of the Series C Preferred
Stock will be entitled to elect four new directors to the Company's Board of
Directors. Except for certain other specified matters, the holders of the Series
C
20
<PAGE> 22
WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Preferred Stock will vote on an as-converted basis with the holders of the
Company's common stock. In addition, the Company will assume $300 million of
FaciliCom's 10.5% Senior Notes due 2008 (the "FaciliCom Senior Notes").
The transaction is conditioned upon a majority of the holders of FaciliCom
Senior Notes allowing the Company to assume the FaciliCom Senior Notes, waive
any put rights triggered by the merger and make certain amendments thereto. The
merger is also subject to the approval of the Company's shareholders and certain
regulatory agencies. Certain shareholders of the Company (including MCI
WorldCom, Brown Brothers Harriman and senior members of management) and the
Armstrong Group of Companies, FaciliCom's majority shareholder, have entered
into a Voting Agreement whereby they have committed to vote in favor of the
merger. The merger is expected to close in the fourth quarter of 1999 and will
be accounted for as a purchase transaction.
INVESTMENT IN MARKETABLE EQUITY SECURITIES
In connection with the acquisition of Telco, the Company acquired an
investment in the common stock of Omnia Communications, Inc. ("Omnia") and
warrants to purchase additional common stock of Omnia. The fair value of the
investment in Omnia at the time of the acquisition of Telco was approximately
$3.0 million.
In March 1999, Omnia announced that it had entered into an agreement to be
acquired by Ciena Corp. ("Ciena"). In June 1999, the Company exercised the
outstanding warrants to purchase additional common stock in Omnia. In July 1999,
Ciena's acquisition of Omnia was completed and the Company received
approximately 445,000 shares of Ciena common stock in exchange for its holdings
of Omnia common stock of which approximately 45,000 shares or 10% are being held
in escrow for a period of one year related to certain representations and
warranties made by Omnia. The Company will account for its investment in Ciena
in accordance with Statement of Financial Accounting Standards No. 115 ("SFAS
No. 115)", "Accounting for Certain Investment in Debt and Equity Securities".
The Company's investment in Ciena will qualify as available-for-sale securities
under SFAS No. 115. Such securities will be recorded at fair value, and
unrealized holding gains and losses, net of the related tax effect, will not be
reflected in earnings but will be reported as a separate component of
stockholders' equity (accumulated deficit) until realized.
Since the acquisition transaction did not close until July 1999, the
Company has not reflected the unrealized gain on its investment in Ciena on the
Company's June 30, 1999 balance sheet. Based upon the trading price of Ciena
common stock as of June 30, 1999, the Company would have an unrealized gain, net
of tax, of approximately $5.6 million.
21
<PAGE> 23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
This Form 10-Q Report contains certain "forward-looking statements" within
the meaning of Section 27A of the Securities Act of 1993, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended, which are intended to be covered by the safe harbors created thereby.
Forward-looking statements are statements other than historical information or
statements of current condition. Some forward looking statements may be
identified by use of such terms as "believes", "anticipates", "intends", or
"expects". These forward-looking statements relate to the plans, objectives and
expectations of the Company for future operations. In light of the risks and
uncertainties inherent in all such projected operational matters, the inclusion
of forward-looking statements in this Report should not be regarded as a
representation by the Company or any other person that the objectives or plans
of the Company will be achieved or that any of the Company's operating
expectations will be realized.
Factors that could cause actual results to differ from the results
discussed in the forward-looking statements include, but are not limited to, the
Company's dependence on (i) recently introduced products and products under
development; (ii) successful integration of new acquisitions; (iii) the impact
of technological change on the Company's products; (iv) changes in customer
rates per minute; (v) termination of certain service agreements or inability to
enter into additional service agreements; (vi) changes in or developments under
domestic or foreign laws, regulations, licensing requirements or
telecommunications standards; (vii) changes in the availability of transmission
facilities; (viii) loss of the services of key officers; (ix) loss of a customer
which provides significant revenues to the Company; (x) highly competitive
market conditions in the industry; and (xi) concentration of credit risk. The
foregoing review of the important factors should not be considered as
exhaustive. The Company undertakes no obligation to release publicly the results
of any future revisions it may make to forward-looking statements to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
OVERVIEW
The Company provides international long distance voice and data services
and proprietary network equipment to the global telecommunications markets. The
World Access Telecommunications Group, (the "Telecommunications Group"),
provides wholesale international long distance service through a combination of
its own international network facilities, various international termination
relationships and resale arrangements with other international long distance
service providers. The World Access Equipment Group, (the "Equipment Group"),
develops, manufactures and markets digital switches, billing and network
telemanagement systems, cellular base stations, fixed wireless local loop
systems, intelligent multiplexers, digital microwave radio systems and other
telecommunications network products. To support and complement its product
sales, the Company also provides its customers with a broad range of network
design, engineering, testing, installation and other value-added services.
During 1998, the Company continued to execute its Total Network Solutions
strategy of broadening its offering of proprietary equipment and services by
acquiring four businesses. In the first quarter of 1998, the Company acquired
Advanced TechCom, Inc. ("ATI"), a designer and manufacturer of digital microwave
and millimeterwave radio systems for voice, data and/or video applications and a
majority stake in NACT Telecommunications, Inc. ("NACT"), a single-source
provider of advanced telecommunications switching platforms with integrated
telephony software applications and network telemanagement capabilities. In
October 1998, the Company acquired the remaining minority interest in NACT. In
November 1998, the Company acquired Telco Systems, Inc. ("Telco"), a designer
and manufacturer of broadband transmission, network access and bandwidth
optimization products.
During 1998, Telco built a core product portfolio that incorporates new
technologies and strategically positions it for the impending evolution of
telecommunications markets. Telco made two strategic acquisitions in 1998 that
expanded its product offerings from circuit switched into packet switched, frame
relay and ATM markets.
22
<PAGE> 24
In December 1998, the Company acquired Cherry Communications Incorporated,
d/b/a Resurgens Communications Group ("RCG"), and Cherry Communications U.K.
Limited ("Cherry U.K.", and together with RCG, "Resurgens"). Resurgens, a
provider of wholesale international long distance services. Resurgens now
conducts its business as the World Access Telecommunications Group. As a result
of the Resurgens acquisition, MCI WorldCom, Inc. ("MCI Worldcom"), a major
customer and vendor of Resurgens, now owns approximately 14% of the outstanding
common stock of the Company.
Through its completed acquisitions in 1998, the Company believes it is now
positioned to offer its customers complete telecommunications network solutions,
including access to international long distance, proprietary equipment, and
network planning and engineering services. The Company's management believes
that numerous synergies exist as a result of these acquisitions, including
cross-selling opportunities, technology development and cost savings.
In December 1998, John D. ("Jack") Phillips was appointed the Company's new
President and Chief Executive Officer. Mr. Phillips was formerly the President
and Chief Executive Officer of Resurgens. Also in December 1998, two new outside
directors joined the Company's Board.
In connection with the recently completed acquisitions, the appointment of
a new Chief Executive Officer and the election of new directors, the Company
approved and began implementing a major restructuring program to reorganize its
operating structure, consolidate several facilities, outsource its manufacturing
requirements, rationalize its product offerings and related development efforts,
and pursue other potential synergies expected to be realized as a result of the
integration of recently acquired businesses. As of the date of this Report, the
restructuring activities are substantially complete.
In December 1998, the Company formalized its plan to offer for sale all of
its non-core businesses, which consist of the resale of Nortel and other
original equipment manufacturers' wireline switching equipment, third party
repair of telecom equipment and pay telephone refurbishment. These businesses
have been accounted for as discontinued operations and, accordingly, their
results of operations have been excluded from continuing operations in the
Consolidated Statements of Operations.
In April 1999, the Company raised approximately $47.8 million in equity,
net of expenses, through the sale of 50,000 newly issued shares of 4.25%
Cumulative Senior Perpetual Convertible Preferred Stock to The 1818 Fund III,
L.P. The 1818 Fund III is one of a family of private equity partnerships (the
"Funds") organized to acquire substantial, non-controlling, long-term ownership
positions in growing, strongly positioned companies. The Funds have provided
active early support and capital to a number of highly successful
telecommunications and media companies, including MCI WorldCom and Frontier
Vision. The General Partner of the Funds is Brown Brothers Harriman & Co.
("BBH"), America's largest private bank and the oldest owner-managed business
partnership in the country. Upon the closing of the transaction, Lawrence C.
Tucker, a partner at BBH and co-manager of The 1818 Fund III, became a member of
the Company's Board of Directors. Mr. Tucker has been a partner of BBH since
1979 and currently serves as a director of MCI WorldCom, National HealthCare
Corporation, Riverwood International Corporation and the MCI WorldCom Venture
Fund.
In May 1999, the Company concluded negotiations to acquire substantially
all the assets and assume certain liabilities of Comm/Net Holding Corporation
and its wholly owned subsidiaries, Enhanced Communications Corporation, Comm/Net
Services Corporation and Long Distance Exchange Corporation (Comm/Net Holdings
and its wholly owned subsidiaries are collectively referred to herein as
"Comm/Net") and assumed effective control of Comm/Net's operations at that time.
Comm/Net headquartered in Plano, Texas, is a facilities-based provider of
wholesale international long distance and wholesale prepaid calling card
services, primarily to the Mexican telecommunications Comm/Net's facilities and
dedicated bandwidth agreements expand the Telecommunications Group's dedicated
network facilities into Mexico and will serve as a foundation for network
development in other Latin American countries.
On August 17, 1999, the Company entered into a definitive merger agreement
with FaciliCom International, Inc. ("FaciliCom"). FaciliCom, a privately owned
company headquartered in Washington, D.C., is a leading facilities-based
provider of European and U.S. originated international long-distance voice,
23
<PAGE> 25
data and Internet services. FaciliCom has invested over $200 million during the
past two years to establish an extensive and high quality switching and
transport network in Europe.
Pursuant to the terms of the agreement, the shareholders of FaciliCom will
receive approximately $436 million in consideration, primarily in the form of
the Company's Convertible Preferred Stock, Series C (the "Series C Preferred
Stock"). The Series C Preferred Stock bears no dividend and is convertible into
shares of the Company's common stock at a conversion rate of $20.38 per common
share, subject to potential adjustment under certain circumstances. If the
closing trading price of the Company's common stock exceeds $20.38 per share for
60 consecutive trading days, the Series C Preferred Stock will automatically
convert into common stock. Initially, the holders of the Series C Preferred
Stock will be entitled to elect four new directors to the Company's Board of
Directors. Except for certain other specified matters, the holders of the Series
C Preferred Stock will vote on an as-converted basis with the holders of the
Company's common stock. In addition, the Company will assume $300 million of
FaciliCom's 10.5% Senior Notes due 2008 (the "FaciliCom Senior Notes").
The transaction is conditioned upon a majority of the holders of FaciliCom
Senior Notes allowing the Company to assume the FaciliCom Senior Notes, waive
any put rights triggered by the merger and make certain amendments thereto. The
merger is also subject to the approval of the Company's shareholders and certain
regulatory agencies. Certain shareholders of the Company (including MCI
WorldCom, Brown Brothers Harriman and senior members of management) and the
Armstrong Group of Companies, FaciliCom's majority shareholder, have entered
into a Voting Agreement whereby they have committed to vote in favor of the
merger. The merger is expected to close in the fourth quarter of 1999 and will
be accounted for as a purchase transaction.
During the past few years, the Company has significantly strengthened its
balance sheet through improved operating results, the recently completed sale of
$50.0 million of preferred stock, a $115.0 million sale of convertible
subordinated notes, a $26.2 million secondary public equity offering and a $75.0
million credit facility. The Company has used this capital for acquisitions and
to support the working capital requirements associated with the Company's
growth.
QUARTERLY OPERATING RESULTS
The Company's quarterly operating results are difficult to forecast with
any degree of accuracy because a number of factors subject these results to
significant fluctuations. As a result, the Company believes that
period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied upon as indications of future performance.
The Company's Telecommunications Group carrier service revenues, costs and
expenses have fluctuated significantly in the past and are likely to continue to
fluctuate significantly in the future as a result of numerous factors. The
Company's revenues in any given period can vary due to factors such as call
volume fluctuations, particularly in regions with relatively high per-minute
rates; the addition or loss of major customers, whether through competition,
merger, consolidation or otherwise; the loss of economically beneficial routing
options for the termination of the Company's traffic; financial difficulties of
major customers; pricing pressure resulting from increased competition; and
technical difficulties with or failures of portions of the Company's network
that impact the Company's ability to provide service to or bill its customers.
The Company's operating expenses in any given period can vary due to factors
such as fluctuations in rates charged by carriers to terminate traffic;
increases in bad debt expense and reserves; the timing of capital expenditures,
and other costs associated with acquiring or obtaining other rights to switching
and other transmission facilities; and costs associated with changes in staffing
levels of sales, marketing, technical support and administrative personnel. In
addition, the Company's operating results can vary due to factors such as
changes in routing due to variations in the quality of vendor transmission
capability; loss of favorable routing options; the amount of, and the accounting
policy for, return traffic under operating agreements; actions by domestic or
foreign regulatory entities; the level, timing and pace of the Company's
expansion in international and commercial markets; and general domestic and
international economic and political conditions. Further, a substantial portion
of transmission capacity used by the Company is obtained on a variable, per
minute and short-term
24
<PAGE> 26
basis, subjecting the Company to the possibility of unanticipated price
increases and service cancellations. Since the Company does not generally have
long-term arrangements for the purchase or resale of long distance services, and
since rates fluctuate significantly over short periods of time, the Company's
operating results may vary significantly.
As the Company's Equipment Group increases its number of telecommunications
product offerings, its future operating results may vary significantly depending
on factors such as the timing and shipment of significant orders, new product
offerings by the Company and its competitors, market acceptance of new and
enhanced versions of the Company's products, changes in pricing policies by the
Company and its competitors, the availability of new technologies, the mix of
distribution channels through which the Company's products are sold, the
inability to obtain sufficient supplies of sole or limited source components for
the Company's products, gains or losses of significant customers, the timing of
customers' upgrade and expansion programs, changes in the level of operating
expenses, the timing of acquisitions, seasonality and general economic
conditions.
RESULTS OF CONTINUING OPERATIONS
The following table sets forth certain financial data expressed as a
percentage of total sales from continuing operations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -----------------
1999 1998 1999 1998
------ ------ ----- ------
<S> <C> <C> <C> <C>
Carrier service revenues......................... 63.7% 2.1% 61.9% 2.2%
Equipment sales.................................. 36.3 97.9 38.1 97.8
----- ----- ----- ------
Total sales............................ 100.0 100.0 100.0 100.0
Cost of carrier services......................... 56.0 1.7 54.6 1.8
Cost of services network......................... 2.5 0.1 3.1 0.1
Cost of equipment sold........................... 20.7 49.7 21.4 50.7
Amortization of acquired technology.............. 0.7 0.0 0.7 0.0
----- ----- ----- ------
Total cost of sales.................... 79.9 51.5 79.8 52.6
----- ----- ----- ------
Gross profit........................... 20.1 48.5 20.2 47.4
Research and development......................... 2.5 5.1 2.7 4.3
Selling, general and administrative.............. 8.4 11.6 9.0 11.7
Amortization of goodwill......................... 1.8 2.4 2.0 2.5
In-process research and development.............. 0.0 0.0 0.0 61.1
Restructuring and other charges.................. 0.0 0.0 0.0 1.0
----- ----- ----- ------
Operating income (loss).......................... 7.4 29.4 6.5 (33.2)
Interest and other income........................ 0.6 2.0 0.4 3.4
Interest expense................................. (1.1) (4.4) (1.4) (5.1)
----- ----- ----- ------
Income (loss) from continuing operations before
income taxes and minority interests............ 6.9 27.0 5.5 (34.9)
Income taxes..................................... 3.4 10.7 2.9 10.2
----- ----- ----- ------
Income (loss) from continuing operations before
minority Interests............................. 3.5 16.3 2.6 (45.1)
Minority interests in earnings of subsidiary..... 0.0 2.5 0.0 2.7
----- ----- ----- ------
Income (loss) from continuing operations......... 3.5 13.8 2.6 (47.8)
===== ===== ===== ======
</TABLE>
THREE MONTHS ENDED JUNE 30, 1999 CONTINUING OPERATIONS COMPARED TO THREE MONTHS
ENDED JUNE 30, 1998 CONTINUING OPERATIONS
Sales. Total sales increased $143.2 million, or 414.7%, to $177.7 million
in the second quarter of 1999 from $35.4 million in the second quarter of 1998.
25
<PAGE> 27
Carrier service revenues were $113.3 million in the second quarter of 1999
as compared to $718,000, in the second quarter of 1998 which consisted of
facilities management services at NACT. This increase is due to revenues from
Resurgens which was acquired in December 1998 and Comm/Net which was acquired
effective May 1999 and represented an increase of approximately $27.7 million,
or 32.3%, over carrier service revenues realized by the Company in the first
quarter of 1999.
Equipment sales increased $30.7 million, or 90.7% to $64.5 million in the
second quarter of 1999 from $33.8 million in the second quarter of 1998. The
increase in equipment sales related to increases in sales of switching products
by NACT, cellular equipment by CIS, and the Company's newly acquired
transmission and access products business, Telco, which was acquired effective
November 30, 1998.
Gross Profit. Gross profit increased $19.1 million, or 113.9%, to $35.8
million in the second quarter of 1999 from $16.7 million in the second quarter
of 1998. Gross profit margin decreased to 20.1% in the second quarter of 1999 as
compared to 48.5% in the second quarter of 1998.
Carrier service gross profit increased to $9.3 million in the second
quarter of 1999 from $93,000 in the second quarter of 1998. Gross profit margin
was 8.2% in the second quarter of 1999 as compared to 5.1% in the first quarter
of 1999. Gross profit margin was 12.9% in the second quarter of 1998, which
consisted of facilities management services at NACT. Variable gross margins on
these revenues, which excludes the fixed costs associated with the services
network, increased to 12.1% in the second quarter of 1999 from the 11.6% that
the Company realized in the first quarter of 1999. The increase in variable
margins is due to increased economies of scale associated with the internal
services network and an increase in the number of direct and transit agreements.
Equipment Group gross profit increased $9.8 million, or 58.7%, to $26.5
million in the second quarter of 1999 from $16.7 million in the second quarter
of 1998. Gross profit margin decreased to 41.2% in the second quarter of 1999
from 49.2% in the second quarter of 1998. The decreased margin performance of
the Equipment Group relates to the $1.2 million of amortization of acquired
technology costs in the second quarter 1999 relating to the technology acquired
in the Telco and NACT acquisitions, digital radio systems sold by ATI, which
included sales of the new WavePLEX radio system which carries a lower profit
margin than the Equipment Group's other proprietary products, and lower margins
on sales of cellular equipment sold by CIS over the second quarter of 1998,
resulting from large contract price negotiations which enabled CIS to obtain
sales growth of 22.0% over the second quarter of 1998.
Research and Development. Research and development expenses which relate
exclusively to the Equipment Group increased $2.7 million, or 153.1%, to $4.4
million in the second quarter of 1999 from $1.7 million in the second quarter of
1998. The increase in expenses was attributable to the acquisitions of Telco,
NACT and ATI due to the proprietary nature of their existing products requiring
sustaining engineering expenses and their on-going product development efforts.
Research and development expenses increased to 6.9% of total equipment sales in
the second quarter of 1999 from 5.2% of total equipment sales in the second
quarter of 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $11.0 million, or 274.6%, to $15.0 million in
the second quarter of 1999 from $4.0 million in the second quarter of 1998. The
increase primarily related to expenses associated with the operations of
Resurgens and Telco , which were acquired in the fourth quarter of 1998.
Economies of scale have resulted in selling, general and administrative expenses
decreasing as a percentage of total sales to 8.5% in the second quarter of 1999
from 11.6% in the second quarter of 1998.
Amortization of Goodwill. Amortization of goodwill increased $2.4 million
to $3.2 million in the second quarter of 1999 from $833,000 in the second
quarter of 1998, primarily as a result of the goodwill generated in connection
with the fourth quarter 1999 Resurgens and Telco acquisitions.
Operating Income (Loss). Operating income increased $3.0 million to $13.1
million in the second quarter of 1999 as compared to $10.1 million in the second
quarter of 1998. Operating income margin, decreased to 7.4% in the second
quarter of 1999 from 29.4% in the second quarter of 1998. The reduction in
operating income margin is due to the margins of the newly formed
Telecommunications Group which are
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<PAGE> 28
substantially less than those of the Equipment Group and the increased charges
to operations for amortization of goodwill and acquired technology .
Earning Before Interest, Taxes, Depreciation and Amortization
("EBITDA"). EBITDA increased $9.9 million, or 97.0 %, to $20.1 million in the
second quarter of 1999 from $10.2 million before special charges in the first
quarter of 1998.
Interest and Other Income. Interest and other income increased $384,000,
or 54.9%, to $1.1 million in the second quarter of 1999 from $700,000 in the
second quarter of 1998 due to the increase in invested cash balances of the
Company resulting from the sale of $50.0 million of Convertible Preferred Stock
in the second quarter of 1999.
Interest Expense. Interest expense increased $500,000 to $2.0 million in
the second quarter of 1999 from $1.5 million in the second quarter of 1998. The
increase is primarily related to the interest costs attributable to capital
lease obligations at Resurgens and amortization of debt issue costs related to
the $75.0 million line of credit received in December 1998.
SIX MONTHS ENDED JUNE 30, 1999 CONTINUING OPERATIONS COMPARED TO SIX MONTHS
ENDED JUNE 30, 1998 CONTINUING OPERATIONS
Sales. Total sales increased $263.3 million, or 454.4%, to $321.2 million
in the first six months of 1999 from $57.9 million in the first six months of
1998.
Carrier service revenues were $198.9 million in the first six months of
1999 as compared to $1.3 million in the first six months of 1998 which consisted
of facilities management services at NACT. This increase is due to revenues from
Resurgens which was acquired in December 1998 and Comm/Net which was acquired
effective May 1999.
Equipment sales increased $65.7 million, or 115.9 % to $122.4 million in
the first six months of 1999 from $56.7 million in the first six months of 1998.
The increase in equipment sales related to an increase in sales of cellular
equipment sold by CIS, and the Company's newly acquired businesses, including
transmission and access products sold by Telco, which was acquired effective
November 30, 1998, switching products sold by NACT, which was acquired effective
February 28, 1998, and digital radio systems sold by ATI, which was acquired
effective January 29, 1998.
Gross Profit. Gross profit increased $37.4 million, or 136.3%, to $64.9
million in the first six months of 1999 from $27.5 million in the first six
months of 1998. Gross profit margin decreased to 20.2% in the first six months
of 1999 as compared to 47.4 % in the first six months of 1998.
Carrier service gross profit increased to $13.7 million in the first six
months of 1999 from $146,000 in the first six months of 1998. Gross profit
margin was 6.9% in the first six months of 1999 as compared to 11.6% in the
first six months of 1998, which consisted of facilities management services at
NACT. Variable gross margins on these revenues, which excludes the fixed costs
associated with the services network, was approximately 11.9% in the first six
months of 1999 from approximately 8.0% that Resurgens realized in the last six
months of 1998. The change in variable margins is due to increased economies of
scale associated with the internal services network and an increase in the
number of direct and transit agreements.
Equipment Group gross profit increased $24.0 million, or 87.9%, to $51.3
million in the first six months of 1999 from $27.3 million in the first six
months of 1998. Gross profit margin decreased to 41.9% in the first six months
of 1999 from 48.2% in the first six months of 1998. The decreased margin
performance of the Equipment Group relates to the $2.4 million of amortization
of acquired technology costs in the first six months of 1999 relating to the
technology acquired in the Telco and NACT acquisitions, digital radio systems
sold by ATI, which included sales of the new WavePLEX radio system which carries
a lower profit margin than the Equipment Group's other proprietary products, and
lower margins on sales of cellular equipment sold by CIS over the first six
months of 1998, resulting from large contract price negotiations which enabled
CIS to obtain significant sales growth of 52.1% over the first six months of
1998.
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<PAGE> 29
Research and Development. Research and development expenses which relate
exclusively to the Equipment Group increased $6.3 million, or 254.0%, to $8.8
million in the first six months of 1999 from $2.5 million in the first six
months of 1998. The increase in expenses was attributable to the acquisitions of
Telco, NACT and ATI due to the proprietary nature of their existing products
requiring sustaining engineering expenses and their on-going product development
efforts. Research and development expenses increased to 7.2% of total equipment
sales in the first six months of 1999 from 4.4% of total equipment sales in the
first six months of 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $22.1 million, or 325.7%, to $28.9 million in
the first six months of 1999 from $6.8 million in the first six months of 1998.
The increase primarily related to expenses associated with the operations of
NACT, which was acquired in late February 1998 and expenses related to the
operations of Resurgens and Telco , which were acquired in the fourth quarter of
1998. Economies of scale have resulted in selling, general and administrative
expenses decreasing as a percentage of total sales to 9.0% in the first six
months of 1999 from 11.7% in the first six months of 1998.
Amortization of Goodwill. Amortization of goodwill increased $4.9 million
to $6.4 million in the first six months of 1999 from $1.5 million in the first
six months of 1998, primarily as a result of the goodwill generated in
connection with the Resurgens, Telco and NACT acquisitions and additional
goodwill amortization recorded relating to the earnouts of CIS and Galaxy.
Operating Income (Loss). Operating income increased $40.1 million to $20.8
million in the first six months of 1999 as compared to a loss of $19.3 million
in the first six months of 1998 due to the significant special charges recorded
during the first quarter of 1998 related to acquisitions and restructuring
programs. Operating income margin was 6.5% in the first six months of 1999 as
compared to (33.2%) in the first six months of 1998. Operating income increased
$3.7 million , or 21.7%, in the first six months of 1999 from $17.1 million
before special charges in the first six months of 1998. Operating income margin,
decreased to 6.5% in the first six months of 1999 from 29.5% before special
charges in the first six months of 1998. The reduction in operating income
margin is due to the margins of the newly formed Telecommunications Group which
are substantially less than those of the Equipment Group and the increased
charges to operations for amortization of goodwill and acquired technology.
Earning Before Interest, Taxes, Depreciation and Amortization ("EBITDA").
EBITDA increased $17.9 million, or 105.3 %, to $34.9 million in the first six
months of 1999 from $17.0 million before special charges in the first six months
of 1998.
Interest and Other Income. Interest and other income decreased $500,000,
or 25.0%, to $1.5 million in the first six months of 1999 from $2.0 million in
the first six months of 1998 due to the reduction in invested cash balances of
the Company.
Interest Expense. Interest expense increased $1.6 million to $4.6 million
in the first six months of 1999 from $3.0 million in the first six months of
1998. The increase is primarily related to the interest costs attributable to
capital lease obligations at Resurgens and amortization of debt issue costs
related to the $75.0 million line of credit received in December 1998.
PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
Overview. During the first quarter of 1998, $5.4 million and $44.6 million
of purchased in-process R&D was initially expensed in connection with the
acquisition of ATI and the NACT Acquisition, respectively. The $44.6 million of
in-process R&D at NACT consisted of 67.3% of the value of NACT products in the
development stage that were not considered to have reached technological
feasibility as of the date of the NACT Acquisition. In connection with the NACT
Merger, the Company revalued purchased in-process R&D to reflect the current
status of in-process NACT technology and related business forecasts and to
ensure compliance with the additional guidance provided by the Securities and
Exchange Commission in its September 15, 1998 letter to the American Institute
of Certified Public Accountants. The revalued amount approximated the $44.6
million expensed in connection with the NACT Acquisition, therefore no
additional
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<PAGE> 30
charge was recorded for purchased in-process R&D. However, the effect of the
revaluation required the Company to reduce the first quarter of 1998 charge
related to the purchased in-process R&D by $14.6 million and record an
additional charge of $14.6 million in the fourth quarter of 1998, the period in
which the NACT Merger was consummated. Consequently, net loss for the six months
ended June 30, 1998 of $42.3 million as reported in the Company's Report on Form
10-Q for the three months ended June 30, 1998 is now reported as $27.7 million
in this Form 10-Q Report.
The value of the purchased in-process technology from ATI was determined by
estimating the projected net cash flows related to in-process research and
development projects, including costs to complete the development of the
technology. These cash flows were discounted back to their net present value.
The projected net cash flows from such projects were based on management's
estimates of revenues and operating profits related to such projects.
The value of the purchased in-process technology from NACT was determined
by estimating the projected net cash flows related to in-process research and
development projects, excluding costs to complete the development of the
technology. These cash flows were discounted back to their net present value.
The projected net cash flows from such projects were based on management's
estimates of revenues and operating profits related to such projects. These
estimates were based on several assumptions, including those summarized below
for each respective acquisition. The resultant net present value amount was then
reduced by a stage of completion factor. This factor more specifically captures
the development risk of an in-process technology (i.e., market risk is still
incorporated in the estimated rate of return).
The nature of the efforts required to develop the purchased in-process
technology into commercially viable products principally relate to the
completion of all planning, designing, prototyping, verification, and test
activities that are necessary to establish that the product can be produced to
meet its design specifications, including functions, features, and technical
performance requirements. The progress on these activities determines the stage
of completion of each project in the life cycle of the development. Projects
described as being in the "early" or "early concept" stage are not expected to
achieve technological feasibility and commercial application within twelve
months from the valuation date. These projects are typically in the stage of
documenting hardware and software design and preparation of circuit board
layouts. Projects described as being in the "mid" stage of development are
expected to achieve technological feasibility and commercial application within
6 to 12 months from the valuation date. These projects are typically in the
stage of finalizing circuit board layouts and performing engineering integration
tests prior to prototype builds. Projects described as being in the "late" stage
of development are expected to achieve technological feasibility and commercial
application within 6 months from the valuation date. These projects are
typically in stage of prototype builds, initial system testing, quality
assurance and field trials. It should be noted that stages of completion refer
to specific development milestones, and do not necessarily directly correlate to
the percentage of completion used in the IPR&D valuation. The percentage of
completion for the IPR&D valuation is based on the development costs incurred on
each acquired IPR&D project as of the Acquisition Date, as a percentage of the
total development costs expected to be incurred on that project, from the
inception of its development (prior to the acquisition date) until its
development is completed (after the acquisition date).
If these projects to develop commercially viable products based on the
purchased in-process technology are not successfully completed, the sales and
profitability of the Company may be adversely affected in future periods.
Additionally, the value of other intangible assets may become impaired.
See Note 5 to the Consolidated Financial Statements for further discussion
of the valuation of the in-process R&D.
RESTRUCTURING AND OTHER CHARGES
Summary. During 1998, the Company approved and began implementing two
restructuring programs designed to reduce operating costs, outsource
manufacturing requirements and focus Company resources on recently acquired
business units containing proprietary technology or services. Management
carefully reviewed the provisions of EITF 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity" in
determining which costs related to the various actions should be included in the
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<PAGE> 31
special charges. No costs were included in the charge that would derive future
economic benefit to the Company, e.g., relocation of existing employees,
recruiting and training of new employees and facility start-up costs.
In the first quarter of 1998, the Company approved and began implementing a
restructuring program to consolidate several operations and exit the contract
manufacturing business. In connection with these activities the Company recorded
restructuring and other charges of approximately $6.6 million of which $1.1
million was charged to continuing operations and $5.5 million was charged to
discontinued operations. This restructuring activity was substantially completed
as of June 30, 1998.
In the fourth quarter of 1998, in connection with the (i) mergers with
NACT, Telco and Resurgens completed in the fourth quarter of 1998; (ii) election
of several new outside directors to the Company's Board; and (iii) appointment
of a new Chief Executive Officer, the Company approved and began implementing a
major restructuring program to reorganize its operative structure, consolidate
several facilities, outsource its manufacturing requirements, rationalize its
product offerings and related development efforts, and pursue other potential
synergies expected to be realized as a result of the integration of recently
acquired businesses. In connection with these activities, the Company recorded
restructuring and other charges of approximately $43.0 million of which $36.2
million was charged to continuing operations and $6.8 million was charged to
discontinued operations. As of the date of this Report, the Company has
substantially completed these restructuring activities.
The following details the activity charged to the accrual for the fourth
quarter 1998 restructuring activities during the first six months of 1999:
<TABLE>
<CAPTION>
RESERVE BALANCE 1999 RESERVE BALANCE
AT 12/31/98 ACTIVITY AT 6/30/99
--------------- -------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C>
Reorganize Operating Structure Employee
termination benefits............................ $ 449 $ 250 $ 199
Idle facility costs............................. 258 73 185
Other........................................... 304 251 53
------ ------ ------
1,011 574 437
Consolidation of ATI and Telco Employee
termination benefits............................ 1,175 866 309
Idle facility costs............................. 577 102 475
Other........................................... 300 118 182
------ ------ ------
2,052 1,086 966
Outsource Manufacturing Employee termination
benefits........................................ 310 195 115
Idle facility costs............................. 365 286 79
Other........................................... 332 332 --
------ ------ ------
1,007 813 194
Product Line Rationalization...................... 568 338 230
------ ------ ------
Total................................... $4,638 $2,811 $1,827
====== ====== ======
</TABLE>
Costs associated with the reorganized operating structure consist primarily
of termination benefits payable to the Company's former President, which will be
paid throughout 1999, and remaining lease obligations on the Company's Equipment
Group headquarters facility in Alpharetta, Georgia. In February 1999, Equipment
Group personnel relocated to the Company's headquarters in Atlanta and the
facility was closed.
Restructuring costs were recorded associated with the consolidation of the
Company's ATI operations in Wilmington, Massachusetts into Telco's facility in
Norwood, Massachusetts. Manufacturing of ATI's wireless radios is being
out-sourced to a contact manufacturer and all other aspects of ATI's operations
are being integrated into Telco's existing operating infrastructure. Severance
and other termination benefits of approxi-
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<PAGE> 32
mately $1.2 million are being paid to approximately 60 ATI employees who lost
their jobs. Severance and other termination benefits were determined consistent
with the Company's severance policy. An accrual associated with the idle portion
of the Wilmington facility, which is leased through November 2000, is being
charged each period for the idle facility lease cost.
An integral part of the restructuring program was the Company's decision to
outsource all its electrical manufacturing requirements and sell its Alpharetta,
Georgia manufacturing facility to an established contract manufacturer.
Severance and other termination benefits of $426,000 were provided for in
December 1998 to approximately 25 personnel. The Company completed the sale of
its manufacturing operations in March 1999. The actual loss incurred in
connection with the sale did not differ materially from the amounts recorded in
the restructuring charges. As part of this sale agreement, the Company committed
to purchase a minimum of $15.0 million of products and services from the
contract manufacturer in each of three consecutive 12 month periods beginning
April 1, 1999.
Costs related to product line rationalization related to the phase out of
the Company's Compact Digital Exchange ("CDX") switch. In January 1999, the
Company elected to reallocate development resources targeted for the CDX switch
as a stand-alone product to the integration of the central office functionally
of the CDX switch and the long-distance functionality of NACT's switch into a
common, next generation technology platform. Costs incurred in the first quarter
of 1999 relating mainly to engineering efforts incurred related to 1998 and
prior CDX contracts were charged to the restructuring accrual.
DISCONTINUED OPERATIONS
Overview. During 1998, the Company broadened its offering of proprietary
equipment by acquiring three equipment businesses. The Company acquired ATI, a
designer and manufacturer of digital microwave and millimeterwave radio systems
for voice, data and/or video applications; NACT, a single-source provider of
advanced telecommunications switching platforms with integrated telephony
software applications and network telemanagement capabilities and Telco, a
designer and manufacturer of broadband transmission, network access and
bandwidth optimization products.
In connection with the completion of the acquisitions above, the Company
decided that certain of the Company's non-proprietary businesses were
non-strategic. In December 1998, the Company formalized its plan to offer for
sale two non-core businesses, (i) the resale and repair of Nortel and other
original equipment manufacturers' wireline switching equipment, and (ii) pay
telephone refurbishment. On January 5, 1999, the Company formally announced its
intention to sell these businesses. In connection therewith, the Company
recorded a $3.5 million charge in the fourth quarter of 1998, for the estimated
loss to dispose of these discontinued operations. This loss, which was recorded
as partial impairment of existing goodwill, was determined by comparing the book
value of the net assets of the discontinued operations to their net realizable
value. The net realizable value was estimated based on preliminary valuation
work performed by an investment banking firm engaged by the Company to assist in
the sale of these businesses and a preliminary non-committal offer from a
prospective buyer.
During the first six months of 1999, the Company and its investment bankers
formally solicited offers for the two businesses. The preliminary offer referred
to above was eventually withdrawn by the potential suitor and the formal selling
process generated only one serious offer for the businesses. After several weeks
of negotiations, the Company refused this offer due to its low price and
substantial credit risk.
During this selling process, the Company's Nortel resale business
significantly deteriorated and its pay telephone refurbishment business began
showing signs of weakness. Management was cautiously optimistic in early 1999
that the negative market trends and operating losses experienced in its Nortel
resale business during the fourth quarter of 1998 were temporary in nature and
the market/business would rebound in 1999. Unfortunately, this turnaround did
not occur as evidenced by the Company's sales in this business which declined
from $12.8 million in the fourth quarter of 1998 to $6.0 million in the first
quarter of 1999 and $3.6 million in the second quarter of 1999. Several market
pressures influenced this negative trend including increased pricing competition
in the secondary equipment market, more aggressive participation in this market
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<PAGE> 33
by Nortel and other telecom equipment manufacturers and the reluctance of
customers to purchase used equipment due to year 2000 compliance concerns.
Although the discontinued businesses collectively generated a small profit
in the first quarter of 1999, they realized an operating loss of approximately
$700,000 in the second quarter of 1999. In July 1999, faced with an unsuccessful
selling process and future operating losses, management elected to begin
liquidating the Nortel resale and repair business. A formal liquidation plan
designed to eliminate future quarterly losses, maximize net cash proceeds and
realize significant deferred tax credits, was adopted, by management and
communicated to all affected employees in July 1999. The pay telephone
refurbishment business continues to be offered for sale by the Company.
As a result of this plan, the Company recorded a charge of $13.7 million in
the second quarter of 1999 to reflect the additional loss now expected to be
realized on the liquidation of the Nortel resale and repair business.
Significant elements of this charge consisted of $5.6 million to write-off all
remaining goodwill, $5.2 million to write-down inventories to estimated
realizable value, $1.3 million to write-down leasehold improvements, test
equipment and other assets to estimated realizable value, $300,000 for severance
benefits, and $300,000 for the estimated loss on the disposal of facility
leases. The charge also included approximately $200,000 for net operating losses
expected to be incurred by the Company during this liquidation process, which is
expected to be completed by November 1999.
These businesses have been accounted for as discontinued operations and,
accordingly, the results of operations have been excluded from continuing
operations in the Consolidated Statements of Operations for all periods
presented.
Three Months Ended June 30, 1999 Compared to Three Months Ended June
30,1998. Sales decreased $7.4 million, or 57.1%, to $5.6 million in second
quarter of 1999 from $13.0 million in the second quarter of 1998. This decrease
was primarily due to a weakness in the resale of Nortel and other original
equipment manufacturers' wireline switching equipment at the Company's AIT
business and a decline in pay telephone refurbishment. Gross profit margin
before special charges declined to (6.7%) in the second quarter of 1999 from
29.0% in the second quarter of 1998. The Company's resale of Nortel equipment
business achieved a substantially lower gross margin in the first quarter of
1999 as compared to the gross margin in the first quarter of 1998 because of
pricing pressures in its market and reduced sales levels. The Company also
experienced margin declines in the telephone refurbishment business in 1999
primarily resulting from the reduced economies of scale related to the decline
in its refurbishment revenues.
Six Months Ended June 30, 1999 Compared to Six Months Ended June
30,1998. Sales decreased $11.5 million, or 45.6%, to $13.8 million in the six
months of 1999 from $25.3 million in the first six months of 1998. This decrease
was primarily due to a weakness in the resale of Nortel and other original
equipment manufacturers' wireline switching equipment at the Company's AIT
business and a decline in pay telephone refurbishment. Gross profit margin
before special charges declined to 2.5% in the first months of 1999 from 29.5%
in the first six months of 1998. The Company's resale of Nortel equipment
business achieved a substantially lower gross margin in the first quarter of
1999 as compared to the gross margin in the first quarter of 1998 because of
pricing pressures in its market and reduced sales levels. The Company also
experienced margin declines in the telephone refurbishment business in 1999
primarily resulting from the reduced economies of scale related to the decline
in its refurbishment revenues.
During the first six months of 1998, the Company recorded special charges
of approximately $5.5 million relating to the non-core businesses (see "--
Restructuring and Other Charges").
LIQUIDITY AND CAPITAL RESOURCES
Overview. Cash management is a key element of the Company's operating
philosophy and strategic plans. Acquisitions to date have been structured to
minimize the cash element of the purchase price and ensure that appropriate
levels of cash are available to support the increased product development,
marketing programs and working capital normally associated with the growth
initiatives of acquired businesses. As of June 30, 1999, the Company had $99.0
million of cash and equivalents and approximately $69.1 million in
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<PAGE> 34
borrowings available under its credit line to support its current working
capital requirements and strategic growth initiatives.
Operating Activities. Cash provided from operating activities was
approximately $4.3 million and $3.0 million in the first six months of 1999 and
1998, respectively.
Accounts receivable increased $26.9 million, or 38.1%, to $97.3 million at
June 30, 1999 from $70.5 million at December 31, 1998. This was mainly due to
increased sales activity at the Company (second quarter 1999 total sales were
$183.3 million as compared to fourth quarter 1998 total sales of $73.6 million).
Average days sales outstanding at June 30, 1999 were approximately 48 days as
compared to 88 days at December 31, 1998. The Company's average days outstanding
has declined primarily as a result of the Resurgens acquisition, as Resurgens'
customers generally pay for services in 30 days or less. MCI WorldCom, the
Telecommunications Group's largest customer, prepays the services it purchases
twice a month. Equipment Group sales typically have terms of 30-60 days, except
for sales to international customers, which generally have payment terms in
excess of 90 days. The Company also has begun to enter into long-term notes
receivable with selected customers. To maximize cash flow, the Company sells the
notes where possible on either a non-recourse or recourse basis to a third party
financing institution. As of June 30, 1999, the Company has a contingent
liability of approximately $22.0 million related to notes sold with recourse.
The Company believes it has recorded sufficient reserves to recognize the
current risk associated with these recourse sales.
Inventories decreased $3.4 million, or 6.9%, to $45.2 million at June 30,
1999 from $48.6 million at December 31, 1998. The decrease was due to the sale
of $5.2 million of inventories related to the sale of the Company's Alpharetta,
Georgia manufacturing facility and the outsourcing of ATI's wireless radios and
$6.5 million write-down to inventories of the discontinued operations to the
Company's evaluation of the estimated loss on sale . This decrease was partially
offset by an increase in CIS inventories as a result of the timing of large
equipment purchases in the first half of 1999.
Investing Activities. Cash used by investing activities was $4.1 million
and $69.8 million for the first six months of 1999 and 1998, respectively.
In May 1999, the Company concluded negotiations to acquire substantially
all the assets and assume certain liabilities of Comm/Net Holding Corporation
and its wholly owned subsidiaries, Enhanced Communications Corporation, Comm/Net
Services Corporation and Long Distance Exchange Corporation (Comm/Net Holdings
and its wholly owned subsidiaries are collectively referred to herein as
"Comm/Net") and assumed effective control of Comm/Net's operations at that time.
Comm/Net headquartered in Plano, Texas, is a facilities-based provider of
wholesale international long distance and wholesale prepaid calling card
services, primarily to the Mexican telecommunications markets.
In connection with the acquisition, the Company issued 23,174 shares of
4.25% Cumulative Junior Convertible Preferred Stock, Series B ( the "Series B
Preferred Stock") to the stockholders of Comm/Net valued at approximately $18.5
million and paid approximately $3.5 million to retire certain notes payable
outstanding at the time of acquisition. The Series B Preferred Stock is
convertible into shares of World Access common stock at a conversion rate of
$16.00 per common share, subject to standard anti-dilution adjustments. If the
closing trading price of World Access common stock exceeds $16.00 per share for
45 consecutive trading days, the Preferred Stock will automatically convert into
common stock. Preferred stock dividends begin accruing effective July 1, 1999.
The acquisition of Comm/Net has been accounted for under the purchase method of
accounting.
In connection with the acquisition of Cellular Infrastructure Supply, Inc.
("CIS"), the Company paid $3.5 million and issued 440,874 shares of common stock
up front to the CIS stockholders. In addition, the stockholders of CIS were
issued 845,010 restricted shares of common stock. These shares were immediately
placed into escrow and, together with $6.5 million in additional purchase price,
will be released and paid to the stockholders of CIS contingent upon the
realization of certain predefined levels of pre-tax income from CIS's operations
during three one-year periods beginning January 1, 1997.
The first measurement period for purposes of releasing escrowed shares and
paying contingent cash consideration was January 1, 1997 to December 31, 1997.
In reviewing CIS's pre-tax income performance as
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<PAGE> 35
of April 30, 1997, the Company determined that it was determinable beyond a
reasonable doubt that the conditions for release and payment for this first
period would be met. Accordingly, 317,427 escrowed shares were accounted for as
if released and $3.5 million in contingent cash payments were accounted for as
if paid as of April 30, 1997. The net effect of this accounting was to increase
goodwill and stockholders' equity by approximately $6.5 million at April 30,
1997. These shares were released and payment was made to the former stockholders
of CIS on February 15, 1998.
The second measurement period for purposes of releasing escrowed shares and
paying CIS Additional Consideration was January 1, 1998 to December 31, 1998. In
reviewing CIS's pre-tax income performance as of August 31, 1998, the Company
determined that it was determinable beyond a reasonable doubt that the
conditions for release and payment for the second period would be met.
Accordingly, 244,929 escrowed shares were accounted for as if released and $2.0
million of CIS Additional Consideration was accounted for as if paid as of
August 31, 1998. The net effect of this accounting was to increase goodwill and
stockholders' equity by approximately $5.1 million and $3.1 million,
respectively, as of August 31, 1998. These escrowed shares were released and CIS
Additional Consideration was paid to the former stockholders of CIS on February
15, 1999.
The third measurement period for purposes of releasing escrowed shares and
paying CIS Additional Consideration is January 1, 1999 to December 31, 1999. In
reviewing CIS's pre-tax income performance as of May 31, 1999, the Company
determined that it was determinable beyond a reasonable doubt that the
conditions for release and payment for the third period would be met.
Accordingly, 122,426 escrowed shares were accounted for as if released and $1.0
million of CIS Additional Consideration was accounted for as if paid as of May
31, 1999. The net effect of this accounting was to increase goodwill and
stockholders' equity by approximately $2.4 million and $1.3 million,
respectively, as of May 31, 1999. These escrowed shares will be released and the
CIS Additional Consideration will be paid to the former stockholders of CIS on
February 15, 2000.
In the fourth quarter of 1997, the Company began its three phase
acquisition of NACT. During November and December 1997, the Company purchased
355,000 shares of NACT common stock in the open market for approximately $5.0
million.
On December 31, 1997, the Company entered into a stock purchase agreement
with GST Telecommunications, Inc. ("GST") and GST USA, Inc. ("GST USA") to
acquire 5,113,712 shares of NACT common stock owned by GST USA, representing
approximately 63% of the outstanding shares of NACT common stock (the "NACT
Acquisition"). On February 27, 1998 the NACT Acquisition was completed with GST
USA receiving $59.7 million in cash and 1,429,907 restricted shares of the
Company's common stock valued at approximately $26.9 million.
On February 24, 1998 the Company entered into a merger agreement with NACT
pursuant to which the Company agreed to acquire all of the shares of NACT common
stock not already then owned by the Company or GST USA. On October 28, 1998, the
NACT Merger was completed whereby the Company issued 2,790,182 shares of the
Company's common stock valued at approximately $67.8 million for the remaining
minority interest of NACT.
On December 24, 1997, the Company entered into an agreement to acquire ATI.
On January 29, 1998, the transaction was completed in its final form whereby ATI
was merged with and into CIS (the "ATI Merger"). In connection with the ATI
Merger, the stockholders of ATI received approximately $300,000 and 424,932
restricted shares of the Company's common stock. These shares had an initial
fair value of approximately $6.3 million.
In addition to the 424,932 shares noted above, the stockholders of ATI were
issued 209,050 restricted shares of the Company's common stock. These shares
were immediately placed into escrow and will be released to the stockholders of
ATI contingent upon the realization of predefined levels of pre-tax net income
from ATI's operations during calendar years 1998 and 1999. The pre-tax income of
ATI for 1998 fell below the level required to release escrowed shares in 1998.
34
<PAGE> 36
In connection with the Company's sale of its Alpharetta, Georgia
manufacturing facility and the outsourcing of the ATI wireless radios the
Company sold certain inventories to established contract manufacturing
suppliers. During the second quarter the Company received approximately $4.8
million from these inventory sales.
During each of the first six months of 1999 and 1998, the Company invested
$4.2 million and $5.9 million capital expenditures, respectively. These
expenditures in 1999 were primarily for enhancing and standardizing the
Company's research and development operating platforms, new test equipment
relating to newly introduced products, computer network and related
communications equipment designed to facilitate the integration of the recent
acquisitions and facility improvements required in connection with the Company's
growth.
The Company began capitalizing software development costs in the fourth
quarter of 1997 in connection with its increased focus on developing proprietary
technology and products. Software development costs are capitalized upon the
establishment of technological feasibility of the product. During the first six
months of 1999 and 1998, the Company capitalized approximately $2.5 million and
$1.8 million of software development costs, respectively. The increase is
primarily related to the increased development activities associated with the
Company's wireless local loop product and development activities at Telco and
ATI.
Financing Activities. Cash provided from financing activities was $43.6
million and $6.4 million for the first six months of 1999 and 1998,
respectively.
In December 1998, the Company entered into a $75.0 million revolving line
of credit facility (the "Facility"), with a banking syndicate group led by Bank
of America, Fleet National Bank and Bank Austria Creditanstalt. The new facility
consists of a 364-day revolving line of credit which may be extended under
certain conditions and provides the Company the option to convert existing
borrowings to a three year term loan. Borrowings under the line are secured by a
first lien on substantially all the assets of the Company. The Facility, which
expires in December 2001, contains standard lending covenants including
financial ratios, restrictions on dividends and limitations on additional debt
and the disposition of Company assets. Interest is paid at the rate of prime
plus 1 1/4% or LIBOR plus 2 1/4%, at the option of the Company. As of June 30,
1999, borrowings of $5.9 million were outstanding under the Facility.
The Facility restricts distributions from the Company's consolidated
subsidiaries. Accordingly, the assets and cash flows of such subsidiaries,
including WA Telcom, the primary obligor on the Notes, may not be used to pay
any dividends to World Access, Inc.
In April 1999, the Company raised approximately $47.8 million in equity,
net of expenses, through the sale of 50,000 newly issued shares of 4.25%
Cumulative Senior Perpetual Convertible Preferred Stock, Series A to The 1818
Fund III, L.P. The 1818 Fund III is one of a family of private equity
partnerships (the "Funds") organized to acquire substantial, non-controlling,
long-term ownership positions in growing, strongly positioned companies. The
Funds have provided active early support and capital to a number of highly
successful telecommunications and media companies, including MCI WorldCom and
Frontier Vision. The General Partner of the Funds is Brown Brothers Harriman &
Co., America's largest private bank and the oldest owner-managed business
partnership in the country.
In September 1998, the Company entered into a loan agreement with the
Public Development Authority of Forsyth County, Georgia ( the "Issuer"), in the
principal amount of $7,365,000. The issuer issued its tax exempt industrial
revenue bonds (the "Bonds") for the sole purpose of financing a portion of the
cost of the acquisition, construction and installation of the Company's
Alpharetta, Georgia telecommunications equipment and printed circuit boards
manufacturing plant. In March 1999, the Company sold the Alpharetta, Georgia
based manufacturing operation. At the time of the sale, the Company had
qualifying expenditures under the Bonds of approximately $4.1 million. The
remaining $3.3 million of the proceeds were restricted for qualifying future
expenditures The Bonds were completely repaid in April 1999 as required under
the terms and conditions of the Bonds.
35
<PAGE> 37
During the first six months of 1999, the Company made principal payments
under capital lease obligations of approximately $1.6 million. The capital lease
obligations relate mainly to leases of the Telecommunications Group network
equipment.
During the first six months of 1999 and 1998, the Company received
approximately $535,000 and 7.3 million, respectively, in cash, including related
income tax benefits, from the exercises of incentive and non-qualified stock
options and warrants by the Company's directors and employees.
Income Taxes. As a result of the exercises of non-qualified stock options
and warrants by the Company's directors and employees, the Company realized
federal income tax benefits during 1998 and 1997 of approximately $19.5 million.
Although these tax benefits do not have any effect on the Company's provision
for income tax expense, they represent a significant cash benefit to the
Company. This tax benefit is accounted for as a decrease in current income taxes
payable and an increase in capital in excess of par value. Due to the Company's
net operating losses during 1998, approximately $10.5 million of these tax
benefits have not yet been utilized and are available to reduce future taxable
income of the Company. These benefits are included in Deferred income taxes on
the Company's balance sheet at June 30, 1999.
The Company's provision for income taxes attributable to continuing
operations for the six months ended June 30, 1999 was $9.4 million or
approximately 52.7% of income from continuing operations before income taxes.
The provision for income taxes differs from the amount computed by applying the
statutory federal and state income tax rates due to non-deductible expenses,
primarily goodwill amortization.
Summary. The completion of the sale of $50.0 million of preferred stock in
April 1999, the sale of $115.0 million of Notes in October 1997 and the $75.0
million line of credit received in December 1998 have significantly enhanced the
financial strength of the Company and improved its liquidity. The Company
believes that existing cash balances, available borrowings under the Company's
line of credit and cash projected to be generated from operations will provide
the Company with sufficient capital resources to support its current working
capital requirements and business plans for at least the next 12 months.
YEAR 2000 ISSUE
The turn of the century, Year 2000, poses a serious challenge for
Information Technology ("IT") used by virtually every corporation around the
world. The problem arises as a result of past standard industry practices to
store year date data in a 2-digit (YY) field, instead of a 4-digit (CCYY) format
where the first 2 digits (CC) represent the century and the last 2 digits (YY)
represent the year. Thus, in the two digit format, 1999 is stored as 99. This
causes programs that perform arithmetic operations, comparisons, or date sorts
to possibly generate erroneous results when the program is required to process
dates from both centuries. The absence of the century information adds an
ambiguity to the date information is stored or processed by the program, and it
may also cause problems with data entry and display screens. The problem is
further complicated because many applications are not stand-alone, but interface
with one or more applications.
State of Readiness. The Company is addressing the Year 2000 issue by
implementing its comprehensive Year 2000 Readiness Plan (the "Y2K Plan"). The
Y2K Plan involves the following phases: (1) developing an inventory of products,
systems and equipment that may be affected by the Year 2000 date change, (2)
assessment and (3) remediation. Efforts have been underway in certain
subsidiaries of the Company since 1997, and a formal Year 2000 Readiness Program
was developed in the first quarter of 1998. With the inventory and assessment
phases completed for the Company's core businesses, the Company's business units
are now focused on remediating Year 2000 issues. In addition, the Company has
retained one of the nation's largest and most reputable providers of Year 2000
remediation and compliance services to assist in the execution of the Y2K Plan.
The Y2K Plan consists of several phases that overlap in areas and may be in
progress simultaneously. The first phase involves developing an inventory of all
products, IT and non-IT systems, software, and business infrastructure systems
and equipment that may be affected by the Year 2000 date change. External
parties, including customers, suppliers and service providers, with which the
Company interacts, and which may have Year 2000 readiness issues are also
identified. This phase was completed in May 1999. Inventory listings include
computers, computer network equipment, routers, servers, computer software,
telephony systems,
36
<PAGE> 38
telecommunications equipment, facilities equipment, test equipment, business
tools, as well as all suppliers and all Company products.
The second phase involves risk and impact assessment, selection of
appropriate remediation methods, and resource/cost assessment for compliance.
Each inventory item identified in the first phase is assigned a compliance
status risk level of critical, moderate, low or no risk. Items associated with
critical or moderate risk are addressed with highest priority. Similarly, a risk
assessment is made for the customers, suppliers and service providers
identified. This phase includes contacting suppliers or manufacturers for
information regarding their Year 2000 readiness, technical review of products
and systems, and compliance testing. The necessary actions to bring each item
into compliance are determined, and remediation costs are estimated. To address
potential problems, contingency plans are developed as necessary. This phase was
completed in July 1999. Information received from manufacturers and suppliers is
maintained in databases to monitor compliance status, and compliance testing has
been completed for Company products.
The third phase involves the remediation for items found to be non-Year
2000 compliant. This involves replacement of equipment or upgrading of software
or hardware. This phase includes communications with the Company's customers and
suppliers to determine Year 2000 issues as appropriate. Verification testing is
done to ensure the effectiveness of the remediation efforts. Capital assets
found to be non-compliant have been, or will be replaced or remediated in this
phase. This phase is expected to be completed before the end of September 1999.
Most of the Company's internally controlled software has been remediated and
verified. Integrated testing (also known as "end-to-end" testing) is planned and
should expose unforeseen compliance problems associated with system interfaces
and dependencies.
Organizationally, the Company established a Program Management Office
("PMO") and support teams, including the Year 2000 Steering Committee, the Year
2000 Management Team and the Year 2000 Implementation Teams. A representative
from the Company's senior management has been appointed as the overall Year 2000
Program Director, who works closely with the support teams and manages the PMO.
The Year 2000 Steering Committee consists of the Company's senior managers
for Information Technology and Quality, the Company's Chief Financial Officer,
and the Company's President and Chief Executive Officer. The committee provides
high-level direction for the Y2K Plan and approves requests for Year 2000
resources.
The Year 2000 Management Team consists of the business unit managers from
each internal department of the Company. Each such manager monitors progress of
the program in his or her respective department and allocates resources to
remediate Year 2000 issues.
The Year 2000 Implementation Teams are directly responsible for ensuring
Year 2000 compliance for the Company's products and information systems
infrastructure. This includes efforts to ensure suppliers and service providers
are able to provide uninterrupted product or services through the Year 2000. The
Year 2000 Implementation Teams consist of personnel from each of the Company's
internal departments, including: Information Technology, Quality, Operations,
Materials, Product Development, Human Resources, Finance and Contracts. Members
of the Year 2000 Implementation Teams are responsible for developing the
inventory listings and assessing the inventory for compliance, assuring that
each Company product is assessed for compliance, handling customer requests for
compliance information, auditing Year 2000 test plans and results, and reporting
status and progress of team activities to the Company's management on a
divisional level and to the PMO.
The PMO provides planning and project management support to the teams, as
well as assisting in each phase of the Y2K Plan. The Company's Year 2000 outside
consultant furnishes expert Year 2000 professionals for the PMO, including a
Service Delivery Manager, a Project Manager, Senior Analysts, Analysts and a
Project Administrator. The PMO meets with the Company's management weekly to
review Y2K Plan status and costs, plan activities and schedule resources, and
report progress, status, risks, issues and costs.
To aid in communication with the Company's customers, suppliers and
business partners, the Company is making Year 2000 readiness and product
compliance information available on the internet. This information is updated
periodically to include the most current information on products and services.
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<PAGE> 39
All Transport and Access products have been determined to be Year 2000
compliant, or may be upgraded. Software required for upgrades is presently
available. Switching products have also been determined to be Year 2000
compliant, or may be upgraded at no charge, with the exception of the obsolete
LCX (superseded by the STX). LCX customers have been contacted to advise them
that this product may experience minor data-logging failures associated with the
Year 2000, and that the fully compliant STX provides direct replacement.
NTS-2000 Billing System software is fully Year 2000 compliant, and compliant
NTS-1000 Billing System software was released in April 1999.
The Telecommunications Group has assessed their switching and billing
systems and identified the required upgrades for Year 2000 compliance, as well
as estimated costs. These upgrades are expected to be implemented by the end of
the third quarter of 1999 and will enable ongoing, uninterrupted business
operations through the Year 2000. The Telecommunications Group continually
updates and maintains its switching and billing systems to the state of the art,
and to comply with FCC and international regulations, which include Year 2000
specific requirements.
Costs. The total cost associated with the Company's Year 2000 remediation
initiative is not expected to be material to the Company's financial condition
or results of operations. During the first six months of 1999, the Company spent
approximately $600,000 in connection with Year 2000 issues and the Company has
spent a total of approximately $1.9 million since 1997 in connection with Year
2000 issues. The Telecommunications Group estimates $2.0 million will be
required in 1999 for upgrades to switching equipment and billing systems. The
Equipment Group estimates $800,000 million will be required in 1999 for upgrades
and remediation efforts. The estimated total cost of the Company's Year 2000
initiative is not expected to exceed $4.7 million and is being funded through
operating cash flows of the Company.
Risks. The Company believes, based on currently available information,
that it will be able to properly manage its total Year 2000 exposure. There can
be no assurance, however, that the Company will be successful in its efforts, or
that the computer systems of other companies on which the Company relies will be
modified in a timely manner. Additionally, there can be no assurance that a
failure to modify such systems by another company, or modifications that are
incompatible with the Company's systems, would not have a material adverse
effect on the Company's business, financial condition or results of operations.
Contingency Plans. All of the Company's inventory items that are
identified as having a compliance status risk level of critical in the first
phase of the Y2K Plan are expected to be Year 2000 compliant within the
timeframe planned, and the Y2K Plan is currently on schedule. However, the
Company will develop business continuation or "contingency" plans for potential
areas of exposure as they are identified.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement is effective for all fiscal
quarters of all fiscal years beginning after June 15, 1999. The future adoption
of SFAS 133 is not expected to have a material effect on the Company's
consolidated financial position or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
At June 30, 1999, the Company was not invested in any market risk sensitive
instruments held for either trading purposes or for purposes other than trading.
As a result, the Company is not subject to interest rate risk, foreign currency
exchange rate risk, commodity price risk, or other relevant market risks, such
as equity price risk.
The Company invests cash balances in excess of operating requirements in
short-term securities, generally with maturities of 90 days or less. In
addition, the Company's revolving line of credit agreement provides for
borrowings which bear interest at variable rates based on either the prime rate
or two percent over the London Interbank Offered Rates. The Company had $5.9
million outstanding pursuant to its revolving line of credit agreement at June
30, 1999. The Company believes that the effect, if any, of reasonably possible
near-term changes in interest rates on the Company's financial position, results
of operations and cash flows should not be material.
38
<PAGE> 40
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Following the Company's announcement on January 5, 1999, regarding earnings
expectations for the quarter and year ended December 31, 1998, and the
subsequent decline in the price of the Company's common stock, 22 putative class
action complaints were filed against the Company in the United States District
Court for the Northern District of Georgia, Atlanta Division (the "Court"). The
Company and certain of its then current officers and directors were named as
defendants. A second decline in the Company's stock price occurred shortly after
actual earnings were announced on February 11, 1999, and a few of these cases
were amended, and additional, similar complaints were filed. The pending cases
were consolidated pursuant to an order entered by the Court on April 28, 1999.
The Court has deferred ruling on a pending motion regarding the appointment of
lead plaintiffs and lead counsel.
The plaintiffs filed a Consolidated Amended Class Action Complaint (the
"Amended Complaint") on May 28, 1999, naming as defendants the Company, Steven
A. Odom, Mark A. Gergel, Hensley E. West, Martin D. Kidder, and Stephen J.
Clearman. In the Amended Complaint, the plaintiffs have asserted claims for
violations of the federal securities laws arising from alleged misstatements of
material information in and/or omissions of material information from certain of
the Company's securities filings and other public disclosures, principally
related to alleged performance problems with the Company's CDX switch and
alleged customer and sales problems arising therefrom. Although the issue of
class certification has not yet been addressed, the Amended Complaint is filed
on behalf of: (a) persons who purchased shares of the Company's common stock
during the period from April 29, 1997 through February 11, 1999; (b)
shareholders of Telco who received shares of the Company's common stock as a
result of the Company's acquisition of Telco that closed on November 30, 1998;
and (c) shareholders of NACT who received shares of the Company's common stock
as a result of the Company's acquisition of NACT that closed on October 28,
1998. The plaintiffs have requested damages in an unspecified amount and
litigation expenses in their Amended Complaint.
On June 28, 1999, the defendants moved to dismiss the Amended Complaint on
both substantive and procedural grounds. The motion is currently pending before
the Court. Although the Company and the individuals named as defendants deny
that they have violated any of the requirements or obligations of the federal
securities laws, there can be no assurance that the Company will not sustain
material liability as a result of or related to this shareholder suit.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On April 21, 1999, the Company sold 50,000 newly issued shares of 4.25%
Cumulative Senior Perpetual Convertible Preferred Stock, Series A (the "Series A
Preferred Stock") to The 1818 Fund III, L.P. Each share of Series A Preferred
Stock is convertible at the option of the holder into the Company's common stock
in accordance with a conversion formula equal to the liquidation preference per
share divided by a conversion price of $11.50 per share, subject to adjustment.
If the closing trading price of the Company's common stock as quoted by The
Nasdaq Stock Market ("Nasdaq") exceeds $30 per share for 45 consecutive trading
days, the Series A Preferred Stock will be automatically converted into the
Company's common stock. Pursuant to an amendment to the Company's Certificate of
Incorporation, the holders of Series A Preferred Stock have certain
supermajority voting rights upon certain circumstances such as the authorization
of a class of securities having senior or parity rights with the Series A
Preferred Stock, a reorganization or liquidation of the Company or a
consolidation or merger of the Company with a third party. In addition, the
Series A Preferred Stock ranks senior to the Company's Common Stock with respect
to dividend rights and rights on liquidation, dissolution or winding up. The
Series A Preferred Stock was issued pursuant to an exemption from registration
under the Securities Act of 1933, as amended (the "Securities Act"), under
Section 4(2) of the Securities Act, which provides an exemption from
registration for transactions by an issuer not involving a public filing, as the
securities were issued to only one party.
39
<PAGE> 41
In June 1999, in connection with the acquisition of substantially all the
assets of and assumption of certain liabilities of Comm/Net Holding Corporation
and its wholly owned subsidiaries, Enhanced Communications Corporation, Comm/Net
Services Corporation and Long Distance Exchange Corporation (Comm/Net Holdings
and its wholly owned subsidiaries (collectively referred to herein as
"Comm/Net"), the Company issued an aggregate of 23,174 shares of 4.25%
Cumulative Junior Convertible Preferred Stock, Series B ( the "Series B
Preferred Stock") to Comm/Net. The Series B Preferred Stock is convertible into
shares of World Access common stock at a conversion rate of $16.00 per common
share, subject to standard anti-dilution adjustments. If the closing trading
price of the Company's common stock as quoted on Nasdaq exceeds $16 per share
for 45 consecutive trading days, the Series B Preferred Stock will be
automatically converted into the Company's common stock. Pursuant to an
amendment to the Company's Certificate of Incorporation, the Series B Preferred
Stock ranks senior to the Company's Common Stock and junior to the Series A
Preferred Stock with respect to dividend rights and rights on liquidation,
dissolution or winding up. The Series B referred Stock was issued pursuant to an
exemption from registration under Section 4(2) of the Securities Act, which
provides an exemption from registration for transactions by an issuer not
involving a public filing, as the securities were issued to only one party.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 1999 Annual Meeting of the stockholders of World Access, Inc. was held
on June 15, 1999 at the Resurgens Plaza building in Atlanta, Georgia. There were
44,885,893 shares of Common Stock of issued and outstanding and entitled to vote
the meeting, of which 39,442,238 were present in person or by proxy. In
addition, there were 50,000 shares of Series A Preferred Stock issued and
outstanding and entitled to vote at the meeting with the Company's Common Stock
on an as converted basis into 4,347,826 common shares, all of which were present
in person or by proxy. At the meeting, the following matters were voted on:
<TABLE>
<CAPTION>
FOR WITHHELD
---------- ---------
<S> <C> <C> <C> <C>
To approve the election of Lawrence C.
Tucker to the Board of Directors......... 43,202,065 587,999
</TABLE>
<TABLE>
<CAPTION>
BROKER
FOR AGAINST ABSTAIN NON VOTES
---------- --------- ------- ----------
<S> <C> <C> <C> <C>
To approve the proposal to amend the
Company's Outside Director Warrant Plan
to increase the number of warrants
issuable under the Plan from 1.2 million
to 2.4 million........................... 23,689,525 2,090,500 290,873 17,719,166
To approve the proposal to amend the
Company's 1998 Incentive Equity Plan to
increase the number of stock options
issuable under the Plan from 5.0 million
to 7.5 million........................... 22,870,296 2,500,739 199,523 18,219,506
To approve the proposal to adopt the
Company's Short-Term Incentive Plan for
Senior Executives........................ 23,215,292 2,155,552 199,714 18,219,506
</TABLE>
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
40
<PAGE> 42
<TABLE>
<C> <C> <S>
2.1 -- Agreement and Plan of Reorganization, dated May 27, 1999, by
and among WA Telcom Products Co., Inc., World Access, Inc.,
Comm/Net Holding Corporation, Enhanced Communications
Corporation, Comm/Net Services Corporation, Long Distance
Exchange Corporation, Gregory A. Somers, Kelli J. Somers, R.
Scott Birdwell, Teleplus Telecommunications, Inc., Jeff
Becker, Michael Billingsly, Chris Johns and Denny D. Somers
(incorporated herein by reference to Exhibit 2 to the
Company's Form 8-K, filed with the Commission on July 14,
1999).
3.1 -- Certificate of Incorporation of the Company and Amendments
to Certificate of Incorporation (incorporated by reference
herein to Exhibit 3.1 to the Company's Form S-4, filed with
the Commission on October 6, 1998, Registration No.
333-65386; Amendment to Certificate of Incorporation
incorporated by reference herein to Exhibit 3.2 to Form 8-K
of the Company's predecessor, World Access, Inc., filed with
the Commission on October 28, 1998).
3.2 -- Certificate of Designation of 4.25% Cumulative Senior
Perpetual Convertible Preferred Stock, Series A
(incorporated by reference herein to Exhibit 4 to the
Company's Form 8-K, filed with the Commission on May 3,
1999).
3.3 -- Certificate of Designation of 4.25% Cumulative Junior
Convertible Preferred Stock, Series B (incorporated by
reference herein to Exhibit 4.1 to the Company's Form 8-K,
filed with the Commission on July 14, 1999).
3.4 -- Bylaws of the Company (incorporated by reference herein to
Exhibit 3.2 to the Company's Form S-4, filed with the
Commission on October 6, 1998, Registration No. 333-65389).
4.1 -- Certificate of Designation of 4.25% Cumulative Senior
Perpetual Convertible Preferred Stock, Series A
(incorporated by reference herein to Exhibit 4 to the
Company's Form 8-K, filed with the Commission on May 3,
1999).
4.2 -- Certificate of Designation of 4.25% Cumulative Junior
Convertible Preferred Stock, Series B (incorporated by
reference herein to Exhibit 4.1 to the Company's Form 8-K,
filed with the Commission on July 14, 1999).
27.1* -- Financial Data Schedule (for SEC use only).
</TABLE>
- ---------------
* Previously filed.
(b) Reports on Form 8-K
The Company filed a Report on Form 8-K on May 3, 1999 reporting the sale of
50,000 shares of 4.25% Cumulative Senior Perpetual Convertible Preferred Stock,
Series A to The 1818 Fund III, L.P.
On July 14, 1999, the Company filed a Report on Form 8-K announcing that WA
Telcom Products Co., Inc., a wholly owned subsidiary of the Company, acquired
substantially all the assets and assumed certain liabilities of Comm/Net Holding
Corporation and its wholly owned subsidiaries, Enhanced Communications
Corporation, Comm/Net Services Corporation and Long Distance Exchange
Corporation.
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<PAGE> 43
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
WORLD ACCESS, INC.
By: /s/ MARTIN D. KIDDER
------------------------------------
Martin D. Kidder
Vice President and Controller
Dated: October 7, 1999
42
