UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the three months ended March 31, 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)
Delaware 58-2398004
(State of Incorporation) (I.R.S. Employer Identification No.)
945 E. Paces Ferry Road, Suite 2200,
Atlanta, Georgia 30326
(Address of principal executive offices) (Zip Code)
(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 May 20, 1999 was 44,802,809.
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
March 31 December 31
1999 1998
----------- -----------
(Unaudited)
ASSETS
Current Assets
Cash and equivalents $ 41,112 $ 55,176
Accounts receivable 74,687 70,485
Inventories 53,711 48,591
Deferred income taxes 33,022 37,185
Other current assets 20,452 21,381
--------- ---------
Total Current Assets 222,984 232,818
Property and equipment 59,886 63,602
Goodwill and other intangibles 297,552 298,780
Other assets 25,552 18,612
--------- ---------
Total Assets $ 605,974 $ 613,812
========= =========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current Liabilities
Short-term debt $ 20,643 $ 17,989
Accounts payable 42,714 36,418
Other accrued liabilities 31,940 52,825
--------- ---------
Total Current Liabilities 95,297 107,232
Long-term debt 135,631 137,864
Noncurrent liabilities 9,405 8,133
--------- ---------
Total Liabilities 240,333 253,229
--------- ---------
Stockholders' Equity
Preferred stock --- ---
Common stock 448 441
Capital in excess of par value 475,843 472,945
Accumulated deficit (110,650) (112,803)
--------- ---------
Total Stockholders' Equity 365,641 360,583
--------- ---------
Total Liabilities and
Stockholders' Equity $ 605,974 $ 613,812
========= =========
See notes to consolidated financial statements.
1
<PAGE>
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended March 31
---------------------------
1999 1998
----------- -----------
(Unaudited)
Carrier service revenues $ 85,612 $ 545
Equipment sales 57,867 22,860
--------- ---------
Total Sales 143,479 23,405
Cost of carrier services 75,658 454
Cost of services network 5,569 38
Cost of equipment sold 31,942 12,182
Amortization of acquired technology 1,200 ---
--------- ---------
Total Cost of Sales 114,369 12,674
--------- ---------
Gross Profit 29,110 10,731
Research and development 4,354 732
Selling, general and administrative 13,907 2,785
Amortization of goodwill 3,118 642
In-process research and development --- 35,400
Restructuring and other charges --- 590
--------- ---------
Operating Income (Loss) 7,731 (29,418)
Interest and other income 423 1,271
Interest expense (2,628) (1,443)
--------- ---------
Income (Loss) From Continuing
Operations Before Income Taxes
and Minority Interests 5,526 (29,590)
Income taxes 3,405 2,185
--------- ---------
Income (Loss) From Continuing
Operations Before
Minority Interests 2,121 (31,775)
Minority interests in earnings
of subsidiary --- 684
--------- ---------
Income (Loss) From
Continuing Operations 2,121 (32,459)
Net income (loss)from
discontinued operations 32 (1,742)
--------- ---------
Net Income (Loss) $ 2,153 $ (34,201)
========= =========
Income (Loss) Per Common Share:
Basic:
Continuing Operations $ 0.06 $ (1.68)
Discontinued Operations --- (0.09)
--------- ---------
Net Income (Loss) $ 0.06 $ (1.77)
========= =========
Diluted:
Continuing Operations $ 0.06 $ (1.68)
Discontinued Operations --- (0.09)
--------- ---------
Net Income (Loss) $ 0.06 $ (1.77)
========= =========
Weighted Average
Shares Outstanding:
Basic 36,089 19,343
========= =========
Diluted 36,595 19,343
========= =========
See notes to consolidated financial statements.
2
<PAGE>
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
Capital in
Common Excess of Accumulated
Stock Par Value Deficit Total
-------- ---------- ----------- ----------
(Unaudited)
Balance at January 1, 1999 $ 441 $ 472,945 $ (112,803) $ 360,583
Net and comprehensive
net income 2,153 2,153
Issuance of shares
for acquisition of business 4 1,450 1,454
Release of escrowed
shares for acquisition 1 999 1,000
Issuance of shares
for technology license 1 255 256
Issuance of shares
for options and warrants 1 104 105
Tax benefit from option
and warrant exercises 13 13
Issuance of shares
to 401K plan 77 77
-------- ---------- ----------- ----------
Balance at March 31, 1999 $ 448 $ 475,843 $ (110,650) $ 365,641
======== ========== =========== ==========
See notes to consolidated financial statements.
3
<PAGE>
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Three Months Ended March 31
1999 1998
---------- ----------
(Unaudited)
Cash Flows From Operating Activities:
Net income (loss) $ 2,153 $ (34,201)
Adjustments to reconcile net income
(loss) to net cash from
(used by) operating activities:
Depreciation and amortization 7,537 1,545
Income tax benefit from stock
warrants and options 13 2,662
Special charges --- 41,393
Minority interests in
earnings of subsidiary --- 684
Provision for inventory reserves 365 78
Provision for bad debts 1,022 (8)
Stock contributed to
employee benefit plan 77 37
Changes in operating assets and
liabilities, net of effects
from businesses acquired:
Accounts receivable (6,022) (9,993)
Inventories (10,918) (3,101)
Accounts payable 6,296 3,606
Other assets and liabilities (9,482) (238)
---------- ----------
Net Cash From (Used By)
Operating Activities (8,959) 2,464
---------- ----------
Cash Flows From Investing Activities:
Acquisitions of businesses (2,486) (57,407)
Capitalization of software development costs (1,204) (425)
Expenditures for property and equipment (1,895) (1,919)
---------- ----------
Net Cash Used By Investing Activities (5,585) (59,751)
---------- ----------
Cash Flows From Financing Activities:
Short-term debt borrowings 1,200 1,772
Principal payments under capital
lease obligations (779) ---
Proceeds from exercise of
stock warrants and options 105 1,695
Long-term debt repayments --- (967)
Debt issuance costs (46) ---
---------- ----------
Net Cash From Financing Activities 480 2,500
---------- ----------
Decrease in Cash and Equivalents (14,064) (54,787)
Cash and Equivalents at
Beginning of Period 55,176 118,065
---------- ----------
Cash and Equivalents at
End of Period $ 41,112 $ 63,278
========== ==========
Supplemental Schedule of Noncash
Financing and Investing Activities:
Issuance of common stock
for businesses acquired $ 2,454 $ 33,397
Issuance of stock options
for businesses acquired --- 8,360
Conversion of note receivable
to investment in ATI --- 4,485
See notes to consolidated financial statements.
4
<PAGE>
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 months ended March 31, 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. DISCONTINUED OPERATIONS
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. In connection
therewith, goodwill recorded for these businesses was written-down by $3.5
million to reflect the estimated net realizable value. On January 5, 1999, the
Company formally announced its intention to sell these businesses. Management
expects that the sale will be completed in 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.
5
<PAGE>
The assets and liabilities of the discontinued operations included in the
Consolidated Balance Sheet at March 31, 1999 consisted of the following (in
thousands):
Current Assets
Accounts receivable........ $ 7,456
Inventories................ 13,071
Other current assets....... 630
--------
$ 21,157
========
Noncurrent Assets
Property and equipment..... $ 1,908
Goodwill and other
intangibles.............. 5,281
Other assets............... 1,075
--------
$ 8,264
========
Current Liabilities
Accounts payable........... $ 2,769
Other accrued liabilities.. 3,308
--------
$ 6,077
========
NOTE 3. PRO FORMA RESULTS OF OPERATIONS
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, 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 loss from continuing operations, loss
from continuing operations and net loss from continuing operations per diluted
common share for the three months ended March 31, 1998 would have been
approximately $55.2 million, $12.0 million, $15.4 million and $0.51,
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 4: 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 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 charge was
recorded for purchased in-process R&D. However, the effect of the revaluation
required the Company to reduce the first quarter 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 as of the date of the NACT Merger. Consequently, net loss
6
<PAGE>
and net loss per diluted common share for the quarter ended March 31, 1998 of
$48.8 million and $2.52, respectively, as reported in the Company's Report on
Form 10-Q for the three months ended March 31, 1998 is now reported as $34.2
million and $1.77, respectively, in this Form 10-Q Report.
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.
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 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.
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.
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.
7
<PAGE>
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 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 include
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 is as follows:
8
<PAGE>
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 is incorporating the Motorola 68060 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 enhancement, the STX is
expected to process significantly more call minutes per month.
Signaling System 7 ("SS7") -- 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. 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.
NACT had 13 projects in development at the time of acquisition. 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.
9
<PAGE>
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.
Management estimates that the costs to develop the in-process technology
acquired in the NACT acquisition will be approximately $5.0 million in the
aggregate through the year 1999. The expected sources of funding were scheduled
research and development expenses from the operating budget of NACT.
NOTE 5. 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.
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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 quarter of 1999 to the
reserve for the fourth quarter 1998 restructuring activities:
Reserve Reserve
Balance 1999 Balance
At 12/31/98 Activity At 3/31/99
----------- -------- ----------
(In thousands)
Reorganize Operating Structure
Employee termination benefits.......... $ 449 $ 125 $ 324
Idle facility costs.................... 258 62 196
Other.................................. 304 176 128
------- -------- ------
1,011 363 648
Consolidation of ATI and Telco
Employee termination benefits.......... 1,175 369 806
Idle facility costs.................... 577 102 475
Other.................................. 300 -- 300
------- -------- ------
2,052 471 1,581
Outsource Manufacturing
Employee termination benefits.......... 310 98 212
Idle facility costs.................... 365 239 126
Other.................................. 332 332 --
------- -------- --------
1,007 669 338
Product Line Rationalization............. 568 228 340
------- -------- ------
Total.......................... $ 4,638 $ 1,731 $2,907
======= ======== ======
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 the first half of 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.
11
<PAGE>
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 6. INVENTORIES
Inventories consisted of the following:
March 31, December 31,
1999 1998
-------- --------
Transport and access products.......... $ 9,445 $ 8,723
Switching products..................... 1,339 986
Cellular equipment..................... 16,178 9,421
Work in progress....................... 5,266 4,953
Raw materials.......................... 8,414 12,425
-------- --------
Continuing operations 40,642 36,508
Discontinued operations 13,069 12,083
-------- --------
Total inventories $ 53,711 $ 48,591
======== ========
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.
NOTE 7: 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 intersegment sales during the three months ended March
31, 1999 and the year ended December 31, 1998.
12
<PAGE>
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 Three Months Ended March 31,
Equipment Telecom Continuing Discontinued
Group Group Other Operations Operations Total
--------- -------- ------- ---------- ------------ ---------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Revenues from external customers
1999 $ 57,867 $ 85,612 $ -- $ 143,479 $ 8,208 $ 151,687
1998 22,860 545 -- 23,405 12,326 35,731
In-process research and development
1999 -- -- -- -- -- --
1998 35,400 -- -- 35,400 -- 35,400
Restructuring and other charges
1999 -- -- -- -- -- --
1998 1,055 -- -- 1,055 5,545 6,600
Segment income or loss
1999 6,453 (56) (4,276) 2,121 32 2,153
1998 (24,864) 54 (7,649) (32,459) (1,742) (34,201)
Equipment Telecom Continuing Discontinued
Group Group Other Operations Operations Total
--------- -------- ------- ---------- ------------ ---------
(In thousands)
Segment assets
As of March 31, 1999 387,648 160,473 28,432 576,553 29,421 605,974
As of December 31, 1998 380,721 161,137 40,823 582,681 31,131 613,812
</TABLE>
NOTE 8: LITIGATION
Following the Company's announcement in January 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. 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 in
February 1999, and a few of these cases were amended, and additional similar
complaints were filed. The 22 cases were consolidated pursuant to a court order
entered on April 28, 1999. The Company expects that an amended consolidated
complaint will be filed in May 1999. The court has deferred ruling on a pending
motion regarding the appointment of lead plaintiffs and lead counsel.
Although the 22 complaints differ in some respects, the plaintiffs,
generally, have alleged violations of the federal securities laws arising from
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 inventory and sales activities during the
fourth quarter of 1998. In general, the complaints are filed on behalf of: (a)
persons who purchased shares of the Company's common stock between October 7,
1998 and February 11, 1999; (b) shareholders of Telco who received shares of
common stock of the Company 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 common stock of the Company as a result of the Company's acquisition
of NACT that closed on October 28, 1998. Plaintiffs have requested damages in an
unspecified amount in their complaints. 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 the
Company will not sustain material liability as a result of or related to these
shareholder suits.
13
<PAGE>
In addition to the proceedings described above, on March 18, 1999,
plaintiffs Craig Illausky, John Ufkes and Steven R. Mason filed an additional
putative class action complaint in the United States District Court for the
Northern District of Georgia. The Company and certain of its officers, directors
and former directors were named as defendants. The complaint is similar to the
complaints filed in the proceedings described above, alleging violations of
federal securities laws arising from misstatements of material information in
and/or omissions of material information from certain of the Company's
securities filings and other public disclosures. The Company expects to file a
motion requesting that this action be consolidated with the other pending cases.
NOTE 9: INCOME TAXES
The Company's provision for income taxes attributable to continuing
operations for the three months ended March 31, 1999 was $3.5 million or
approximately 61.6% 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 10: SUBSEQUENT EVENTS
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 is Brown Brothers Harriman &
Co. ("BBH"), America's largest private bank and the oldest owner-managed
business partnership in the country.
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, 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. 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.
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.
14
<PAGE>
WORLD ACCESS, INC.
SUPPLEMENTARY INFORMATION
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. -- January 1998; NACT Telecommunications, Inc. --
February 1998; and Cherry Communications Incorporated and Cherry Communications
U.K. Limited -- December 1998.
BALANCE SHEET INFORMATION
(In thousands)
March 31, December 31,
1999 1998
-------- ------------
Current assets............................... $ 158,315 $ 162,554
Non-current assets........................... 311,134 300,139
Total assets................................. 469,449 462,693
Current liabilities.......................... 61,984 70,976
Non-current liabilities...................... 137,969 138,529
Stockholders equity.......................... 269,496 253,188
Total liabilities and stockholders equity.... 469,449 462,693
OPERATING STATEMENT INFORMATION
(In thousands)
Three Months Ended March 31, 1999(1)
Total sales.................................... $ 121,077
Gross profit................................... 18,132
Income (loss) from continuing operations....... 2,691
Income (loss) from discontinued operations(2).. 32
Net income .................................... 2,723
- ----------
(1) No operating statement information is presented for the three months ended
March 31, 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 telcom equipment and pay
telephone refurbishment. The discontinued operations had total assets of $29.4
million and $31.1 million as of March 31, 1999 and December 31, 1998,
respectively, and total liabilities of $6.1 million and $7.8 million as of March
31, 1999 and December 31, 1998, respectively.
15
<PAGE>
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.
16
<PAGE>
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 $47.7 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.
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.
17
<PAGE>
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 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:
Three Months Ended March 31
1999 1998
-------- --------
Carrier service revenues.......................... 59.7% 2.3%
Equipment sales................................... 40.3 97.7
-------- --------
Total sales.................................... 100.0 100.0
Cost of carrier services.......................... 52.7 1.9
Cost of services network.......................... 3.9 .2
Cost of equipment sold............................ 22.3 52.1
Amortization of acquired technology............... .8 --
-------- --------
Total cost of sales............................ 79.7 54.2
-------- --------
Gross profit................................... 20.3 45.8
Research and development.......................... 3.0 3.1
Selling, general and administrative............... 9.7 11.9
Amortization of goodwill.......................... 2.2 2.7
In-process research and development............... -- 151.3
Restructuring and other charges................... -- 2.5
-------- --------
Operating income (loss)........................ 5.4 (125.7)
Interest and other income......................... .3 5.5
Interest expense.................................. (1.8) (6.2)
-------- --------
Income (loss) from continuing operations
before income taxes and minority interests..... 3.9 (126.4)
Income taxes...................................... 2.4 9.4
-------- --------
Income (loss) from continuing operations
before minority interests...................... 1.5 (135.8)
Minority interests in earnings of subsidiary...... -- 2.9
-------- --------
Income (loss) from continuing operations....... 1.5% (138.7)%
======== ========
18
<PAGE>
Three Months Ended March 31, 1999 Continuing Operations Compared to Three Months
Ended March 31, 1998 Continuing Operations
Sales. Total sales increased $120.1 million, or 513.0%, to $143.5 million
in the first quarter of 1999 from $23.4 million in the first quarter of 1998.
Carrier service revenues were $85.6 million in the first quarter of 1999 as
compared to $545,000, in the first quarter of 1998 which consisted of facilities
management services at NACT. This increase is due to revenues from Resurgens
which was acquired on December 15, 1998 and represented an increase of
approximately $9.3 million, or 12.2%, over revenues realized by Resurgens in
its fourth quarter of 1998.
Equipment sales increased $35.0 million, or 153.1% to $57.9 million in the
first quarter of 1999 from $22.9 million in the first quarter 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 $18.4 million, or 171.3%, to $29.1
million in the first quarter of 1999 from $10.7 million in the first quarter of
1998. Gross profit margin decreased to 20.3% in the first quarter of 1999 as
compared to 45.8% in the first quarter of 1998.
Carrier service gross profit increased to $4.4 million in the first quarter
of 1999 from $53,000 in the first quarter of 1998. Gross profit margin was 5.1%
in the first quarter of 1999 as compared to 9.7% in the first 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 11.6% in the first quarter of 1999 from the 11.0%
that Resurgens realized in its fourth quarter of 1998. 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 $14.0 million, or 131.6%, to $24.7
million in the first quarter of 1999 from $10.7 million in the first quarter of
1998. Gross profit margin decreased to 42.7% in the first quarter of 1999 from
46.7% in the first 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 first 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 first quarter of 1998,
resulting from large contract price negotiations which enabled CIS to obtain
significant sales growth of 84.2% over the first quarter of 1998.
Research and Development. Research and development expenses which relate
exclusively to the Equipment Group increased $3.6 million, or 494.8%, to $4.4
million in the first quarter of 1999 from $732,000 in the first quarter of 1998.
The increase in expenses was attributable to the acquisitions of Telco, NACT and
ATI. Research and development expenses increased to 7.5% of total equipment
sales in the first quarter of 1999 from 3.2% of total equipment sales in the
first quarter of 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $11.1 million, or 399.4%, to $13.9 million in
the first quarter of 1999 from $2.8 million in the first quarter 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. As a
percentage of total sales, selling, general and administrative expenses
decreased to 9.7% in the first quarter of 1999 from 11.9% in the first quarter
of 1998.
19
<PAGE>
Amortization of Goodwill. Amortization of goodwill increased $2.5 million to
$3.1 million in the first quarter of 1999 from $642,000 in the first quarter of
1998, primarily as a result of the goodwill generated in connection with the
Resurgens, Telco and NACT acquisitions.
Operating Income (Loss). Operating income increased $37.1 million to $7.7
million in the first quarter of 1999 as compared to a loss of $29.4 million in
the first quarter of 1998 due to the significant special charges recorded during
the first quarter of 1998 related to acquisitions and restructuring programs.
Operating income was 5.4% in the first quarter of 1999 as compared to (125.7%)
in the first quarter of 1998. Operating income increased $694,000, or 9.9%, in
the first quarter of 1999 from $7.0 million before special charges in the first
quarter of 1998. Operating income margin, decreased to 5.4% in the first quarter
of 1999 from 30.1% before special charges in the first quarter 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 $9.1 million, or 158.5 %, to $14.9 million in the first quarter
of 1999 from $5.8 million in the first quarter of 1998.
Interest and Other Income. Interest and other income decreased $848,000, or
66.7%, to $423,000 in the first quarter of 1999 from $1.3 million in the first
quarter of 1998 due to the reduction in invested cash balances of the Company.
Interest Expense. Interest expense increased $1.2 million to $2.6 million in
the first quarter of 1999 from $1.4 million in the first 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.
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 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 charge
was recorded for purchased in-process R&D. However, the effect of the
revaluation required the Company to reduce the first quarter 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 as of the date of the NACT Merger.
Consequently, net loss for the quarter ended March 31, 1998 of $48.8 million as
reported in the Company's Report on Form 10-Q for the three months ended March
31, 1998 is now reported as $34.2 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. These
estimates were based on several assumptions, including those summarized below.
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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.
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 4 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
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.
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The following details the activity charged to the accrual for the fourth
quarter 1998 restructuring activities during the first quarter of 1999:
Reserve Reserve
Balance 1999 Balance
At 12/31/98 Activity At 3/31/99
----------- -------- ----------
(In thousands)
Reorganize Operating Structure
Employee termination benefits....... $ 449 $ 125 $ 324
Idle facility costs................. 258 62 196
Other............................... 304 176 128
------- -------- ------
1,011 363 648
Consolidation of ATI and Telco
Employee termination benefits....... 1,175 369 806
Idle facility costs................. 577 102 475
Other............................... 300 -- 300
------- -------- ------
2,052 471 1,581
Outsource Manufacturing
Employee termination benefits....... 310 98 212
Idle facility costs................. 365 239 126
Other............................... 332 332 --
------- -------- ------
1,007 669 338
Product Line Rationalization.......... 568 228 340
------- -------- ------
Total....................... $ 4,638 $ 1,731 $2,907
======= ======== ======
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 approximately $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.
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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 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. On January 5,
1999, the Company formally announced its intention to sell these businesses.
Management expects that the sales will be completed in 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 March 31, 1999 Compared to Three Months Ended March
31,1998. Sales decreased $4.1 million, or 32.0%, to $8.2 million in the first
quarter of 1999 from $12.3 million in the first 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 4.3% in the first quarter of 1999 from 27.8%
in the first 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.
During the first quarter 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 March 31, 1999, the Company had $41.1
million of cash and equivalents and $61.7 million in borrowings available under
its credit line to support its current working capital requirements and
strategic growth initiatives.
Operating Activities. Cash used by operating activities was $9.0 million in
the first quarter of 1999 as compared to cash provided from operations of $2.5
million in the first quarter of 1998. The increased use of cash in the first
quarter of 1999 resulted from the Company's need to finance increased accounts
receivable and inventories to support its growth.
Accounts receivable increased $4.2 million, or 6.0%, to $74.7 million at
March 31, 1999 from $70.5 million at December 31, 1998. This was mainly due to
increased sales activity at the Company (first quarter 1999 total sales were
$151.7 million as compared to fourth quarter 1998 total sales of $73.6 million).
Average days sales outstanding at March 31, 1999 were approximately 45 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
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notes where possible on either a non-recourse or recourse basis to a third party
financing institution. As of March 31, 1999, the Company has a contingent
liability of approximately $17.4 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 increased $5.1 million, or 10.5%, to $53.7 million at March 31,
1999 from $48.6 million at December 31, 1998. This increase was primarily due to
the increase in CIS inventories as a result of the timing of a large equipment
purchase in the first quarter. The increase was partially offset by the first
quarter sale of $5.4 million of inventories related to the sale of the Company's
Alpharetta, Georgia manufacturing facility and the outsourcing of ATI's wireless
radios.
Investing Activities. Cash used by investing activities was $5.6 million
and $59.8 million for the first quarter 1999 and 1998, respectively.
In connection with the acquisition of 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 of April 30, 1997, the Company
determined that it was highly probable 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 highly probable that the conditions for release and
payment for the first 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.
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.
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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.
During each of the first quarters of 1999 and 1998, the Company invested
$1.9 million in capital expenditures. These expenditures in 1999 were primarily
for 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
quarter of 1999 and 1998, the Company capitalized approximately $1.2 million and
$425,000 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 $480,000
and $2.5 million for the first quarter 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 March 31,
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 $47.7 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.
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
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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 March 31, 1999.
The Company's provision for income taxes attributable to continuing
operations for the three months ended March 31, 1999 was $3.5 million or
approximately 61.6% 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. All of the Company's business units
are now engaged in identifying and 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, 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 has
been completed in most areas of the Company and is expected to be completed
before the end of June 1999. Information received from manufacturers and
suppliers is maintained in databases to monitor compliance status, and
compliance testing has been completed for most Company products.
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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 June 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.
All Transport and Access products have been determined to be Year 2000
compliant, or may be upgraded at no charge. Software required for upgrades is
presently available and may be downloaded from the internet. 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.
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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 quarter of 1999, the Company spent
approximately $340,000 in connection with Year 2000 issues and the Company has
spent a total of approximately $1.1 million since 1997 in connection with Year
2000 issues. The Telecommunications Group estimates $800,000 will be required in
1999 for upgrades to switching equipment and billing systems. The Equipment
Group estimates $1,000,000 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 $3.0 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 March 31, 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 March
31, 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.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
Following the Company's announcement in January 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. 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 in
February 1999, and a few of these cases were amended, and additional similar
complaints were filed. The 22 cases were consolidated pursuant to a court order
entered on April 28, 1999. The Company expects that an amended consolidated
complaint will be filed in May 1999. The court has deferred ruling on a pending
motion regarding the appointment of lead plaintiffs and lead counsel.
Although the 22 complaints differ in some respects, the plaintiffs,
generally, have alleged violations of the federal securities laws arising from
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 inventory and sales activities during the
fourth quarter of 1998. In general, the complaints are filed on behalf of: (a)
persons who purchased shares of the Company's common stock between October 7,
1998 and February 11, 1999; (b) shareholders of Telco who received shares of
common stock of the Company 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 common stock of the Company as a result of the Company's acquisition
of NACT that closed on October 28, 1998. Plaintiffs have requested damages in an
unspecified amount in their complaints. 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 the
Company will not sustain material liability as a result of or related to these
shareholder suits.
In addition to the proceedings described above, on March 18, 1999 plaintiffs
Craig Illausky, John Ufkes and Steven R. Mason filed an additional putative
class action complaint in the United States District Court for the Northern
District of Georgia. The Company and certain of its officers, directors and
former directors were named as defendants. The complaint is similar to the
complaints filed in the proceedings described above, alleging violations of
federal securities laws arising from misstatements of material information in
and/or omissions of material information from certain of the Company's
securities filings and other public disclosures. The Company expects to file a
motion requesting that this action be consolidated with the other pending cases.
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
"Preferred Stock") to The 1818 Fund III, L.P. The Preferred Stock ranks senior
to the Company's Common Stock with respect to dividend rights and rights on
liquidation, dissolution or winding up.
29
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits
27.1 -- Financial Data Schedule (for SEC use only).
(B) Report on Form 8-K
There were no such Reports filed during the period covered by this Report.
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.
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: May 20, 1999
30
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FORM 10-Q.
</LEGEND>
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<NAME> WORLD ACCESS, INC.
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<FISCAL-YEAR-END> DEC-31-1999
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