<PAGE> 1
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 JUNE 30, 1998.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO
________.
COMMISSION FILE NUMBER 0-19998
WORLD ACCESS, INC.
(Exact name of Registrant as specified in its Charter)
<TABLE>
<CAPTION>
<S> <C>
DELAWARE 65-0044209
(State of Incorporation) (I.R.S. Employer Identification No.)
945 E. PACES FERRY ROAD, SUITE 2240, ATLANTA GEORGIA 30326
(Address of principal executive offices) (Zip Code)
(404) 231-2025
(Registrant's telephone number)
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
------- -------
The number of shares outstanding of the Registrant's common stock, par
value $.01 per share, at August 18, 1998 was 22,511,422.
<PAGE> 2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30 DECEMBER 31
1998 1997
------------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets
Cash and equivalents $ 57,653,355 $118,065,045
Marketable securities 3,500,000 --
Accounts receivable 41,819,028 20,263,971
Inventories 34,472,593 22,426,918
Other current assets 15,428,681 10,923,723
------------- ------------
Total Current Assets 152,873,657 171,679,657
Property and equipment 17,202,608 5,704,585
Goodwill 74,378,279 31,660,201
Other assets 24,063,136 16,238,298
------------- ------------
Total Assets $ 268,517,680 $225,282,741
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Short-term debt $ 4,408,477 $ 81,739
Accounts payable 23,086,925 9,339,588
Other accrued liabilities 12,913,105 8,508,698
------------- ------------
Total Current Liabilities 40,408,507 17,930,025
Long-term debt 115,528,565 115,263,984
Noncurrent liabilities 1,564,078 333,802
Minority interests 12,442,337 --
------------- ------------
Total Liabilities 169,943,487 133,527,811
------------- ------------
Stockholders' Equity
Common stock 218,871 193,062
Capital in excess of par value 133,286,631 84,162,478
Retained earnings (deficit) (34,931,309) 7,399,390
------------- ------------
Total Stockholders' Equity 98,574,193 91,754,930
------------- ------------
Total Liabilities and Stockholders' Equity $ 268,517,680 $225,282,741
============= ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
1
<PAGE> 3
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30
-------------------------------- -------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales of products $ 41,600,854 $ 19,444,256 $ 69,829,810 $ 34,914,306
Service revenues 5,906,224 4,571,822 13,408,313 9,353,196
------------ ------------ ------------ ------------
Total Sales 47,507,078 24,016,078 83,238,123 44,267,502
Cost of products sold 22,239,271 11,525,183 39,011,720 21,494,810
Cost of services 4,761,514 4,005,782 12,189,198 8,089,263
------------ ------------ ------------ ------------
Total Cost of Sales 27,000,785 15,530,965 51,200,918 29,584,073
------------ ------------ ------------ ------------
Gross Profit 20,506,293 8,485,113 32,037,205 14,683,429
Engineering and development 1,793,743 428,595 2,581,927 745,005
Selling, general and administrative 4,680,414 2,434,951 7,936,268 4,352,514
Amortization of goodwill 1,018,374 380,404 1,882,371 664,535
In-process research and development -- -- 50,000,000 --
Special charges -- -- 3,240,000 --
------------ ------------ ------------ ------------
Operating Income (Loss) 13,013,762 5,241,163 (33,603,361) 8,921,375
Interest and other income 701,454 225,091 1,970,738 592,277
Interest expense (1,515,576) (24,044) (3,030,489) (52,974)
------------ ------------ ------------ ------------
Income (Loss) Before Income Taxes
and Minority Interests 12,199,640 5,442,210 (34,663,112) 9,460,678
Income taxes 4,880,249 2,014,000 6,135,249 3,420,000
------------ ------------ ------------ ------------
Income (Loss) Before Minority Interests 7,319,391 3,428,210 (40,798,361) 6,040,678
Minority interests in earnings of subsidiary 848,687 -- 1,532,338 --
------------ ------------ ------------ ------------
Net Income (Loss) $ 6,470,704 $ 3,428,210 $(42,330,699) $ 6,040,678
============ ============ ============ ============
Net Income (Loss) Per Common Share:
Basic $ .31 $ .21 $ (2.13) $ .37
============ ============ ============ ============
Diluted $ .30 $ .19 $ (2.13) $ .34
============ ============ ============ ============
Weighted Average Shares Outstanding:
Basic 20,576,451 16,556,478 19,894,508 16,478,013
============ ============ ============ ============
Diluted 21,821,649 18,515,809 19,894,508 17,918,264
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE> 4
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
<TABLE>
<CAPTION>
CAPITAL IN RETAINED
COMMON EXCESS OF EARNINGS
STOCK PAR VALUE (DEFICIT) TOTAL
------------ ------------- ------------ -----------
<S> <C> <C> <C> <C>
Balance at January 1, 1998 $ 193,062 $ 84,162,478 $ 7,399,390 $91,754,930
Net loss (42,330,699) (42,330,699)
Issuance of 1,429,907 shares for NACT
acquisition 14,299 26,867,953 26,882,252
Issuance of stock options for NACT acquisition 8,359,737 8,359,737
Issuance of 633,982 shares for ATI
acquisition 6,340 6,508,200 6,514,540
Issuance of 513,728 shares for stock
options and warrants 5,138 3,074,391 3,079,529
Tax benefit from exercises of stock
options and warrants 4,222,100 4,222,100
Issuance of 3,222 shares for matching
contribution to 401K plan 32 91,772 91,804
------------ ------------- ------------ -----------
Balance at June 30, 1998 $ 218,871 $ 133,286,631 $(34,931,309) $98,574,193
============ ============= ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE> 5
WORLD ACCESS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30
--------------------------------
1998 1997
------------- ------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income (loss) $ (42,330,699) $ 6,040,678
Adjustments to reconcile net income (loss) to net cash from
(used by) operating activities:
Depreciation and amortization 3,193,828 1,105,303
Income tax benefit from stock warrants and options 4,222,100 1,200,000
Special charges 55,034,046 --
Minority interests in earnings of subsidiary 1,532,338 --
Provision for inventory reserves 143,500 243,001
Provision for bad debts 316,360 68,755
Stock contributed to employee benefit plan 91,804 43,187
Changes in operating assets and liabilities, net of effects
from businesses acquired:
Accounts receivable (13,087,624) (5,474,956)
Inventories (9,294,251) (6,170,980)
Accounts payable 9,100,656 1,859,535
Other assets and liabilities (5,970,061) (357,746)
------------- ------------
Net Cash From (Used By) Operating Activities 2,951,997 (1,443,223)
------------- ------------
Cash Flows From Investing Activities:
Acquisitions of businesses (62,084,127) (4,099,852)
Software development costs (1,830,950) --
Loan repayments by affiliate -- 582,500
Expenditures for property and equipment (5,858,706) (1,115,745)
------------- ------------
Net Cash Used By Investing Activities (69,773,783) (4,633,097)
------------- ------------
Cash Flows From Financing Activities:
Short-term debt borrowings 4,297,109 3,509,087
Proceeds from exercise of stock warrants and options 3,079,529 1,390,730
Long-term debt repayments (966,542) --
Issuance of long-term debt for capital lease -- 291,500
------------- ------------
Net Cash From Financing Activities 6,410,096 5,191,317
------------- ------------
Decrease in Cash and Equivalents (60,411,690) (885,003)
Cash and Equivalents at Beginning of Period 118,065,045 22,480,082
------------- ------------
Cash and Equivalents at End of Period $ 57,653,355 $ 21,595,079
============= ============
Supplemental Schedule of Noncash Financing and
Investing Activities:
Issuance of common stock for businesses acquired $ 33,396,792 $ 8,676,650
Issuance of stock options for businesses acquired 8,359,737
Conversion of note receivable to investment in ATI 4,484,534
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE> 6
WORLD ACCESS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the
accounts of the Company and its subsidiary companies, all of which are
wholly-owned except NACT Telecommunications, Inc. ("NACT") of which the Company
owns 67.3%. Minority interests represent the minority stockholders proportionate
share of NACT's equity. 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.
For further information, refer to the audited consolidated financial statements
and footnotes included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1997.
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 sales and expenses during the reporting
period. Actual results could differ from those estimates.
The results of operations for the three and six months ended June 30, 1998
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 1998.
NOTE 2. ACQUISITIONS
ATI Acquisition
On December 24, 1997, the Company entered into an agreement to acquire
Advanced TechCom, Inc. ("ATI"), a Wilmington, Massachusetts based designer and
manufacturer of digital microwave and millimeterwave radio systems for
voice, data and/or video applications. On January 29, 1998, the
transaction was completed in its final form whereby ATI was merged with and into
Cellular Infrastructure Supply, Inc. ("CIS"), a wholly-owned subsidiary of the
Company (the "ATI Merger").
In connection with the ATI Merger, the stockholders of ATI received
approximately $300,000 in cash and 424,932 restricted shares of the Company's
common stock valued at approximately $6.5 million. The Company's policy is to
value restricted stock issued in acquisitions at the average market price of its
common stock for the three trading days prior and the three trading days
subsequent to the date economic terms of the acquisition are announced less a
discount to reflect the lack of marketability caused by trading restrictions,
size of the share issuances and other relevant factors. A discount factor of
30% was used to value the 424,932 restricted shares, which was based on previous
sales of restricted Company common stock and independent studies regarding
discount attributable to lack of marketability. Management believes the
discount rate used to value these restricted shares was appropriate and
reasonable.
In addition to the 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 income from
ATI's operations during calendar years 1998 and 1999. Upon issuance, the 209,050
escrowed shares were valued by the Company at par value only, or $2,091. As it
becomes probable that the conditions for release from escrow will be met, the
fair market value of the shares as measured at that time will be recorded as
additional goodwill and stockholders' equity, respectively.
5
<PAGE> 7
The acquisition of ATI has been accounted for using the purchase method of
accounting. Accordingly, the results of ATI's operations have been included in
the accompanying consolidated financial statements from February 1, 1998. The
purchase price was allocated to net assets acquired and to approximately $5.4
million of purchased in-process research and development ("R&D"). The excess of
purchase price over the fair value of net assets acquired and purchased
in-process R&D, currently estimated at approximately $2.7 million, has been
recorded as goodwill and is being amortized over a 15 year period.
Purchased in-process R&D, which consisted of the value of ATI products in
the development stage that were not considered to have reached technological
feasibility as of the date of the ATI Merger, was expensed in the first quarter
of 1998 in accordance with applicable accounting rules. See Management's
Discussion and Analysis.
6
<PAGE> 8
NACT Acquisition
In the fourth quarter of 1997, the Company began a three phase acquisition
of NACT, a Provo, Utah based single-source provider of advanced
telecommunications switching platforms with integrated telephony software
applications and network telemanagement capabilities. 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 (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. These shares were valued at $18.80
per share, a 20% discount to the closing market price of Company common stock on
February 26, 1998. Management believes this valuation was appropriate and
reasonable based on the fact GST USA sold all 1,429,907 restricted shares at
$18.80 per share to an independent third party in a private transaction
completed on February 27, 1998.
In addition, the Company issued 740,543 non-qualified options to purchase
Company common stock at $11.15 per share and 106,586 non-qualified options to
purchase Company common stock at $16.25 per share in exchange for substantially
all the options held by NACT employees, which became immediately vested in
connection with the NACT Acquisition. These options had an initial fair value of
approximately $8.4 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 owned by the Company or GST USA. Pursuant to the terms of the
merger agreement, each share of NACT common stock will be converted into shares
of Company common stock having a value of $17.50 per share based on the average
of the daily closing price of Company common stock on the Nasdaq National Market
for a pre-defined period prior to the closing (the "Closing Price"), provided
that if the Closing Price is more than $25.52, then each share of NACT common
stock will be converted into 0.6857 shares of Company common stock. If the
Closing Price is less than $20.88, then the Company may elect to terminate the
agreement. The merger is subject to, among other things, the approval of the
NACT stockholders and the satisfaction of certain other customary conditions.
This merger is expected to be consummated in September 1998.
7
<PAGE> 9
The acquisition of the 67.3% majority interest in NACT has been accounted
for using the purchase method of accounting. Accordingly, the results of NACT's
operations have been included in the accompanying consolidated financial
statements from March 1, 1998. The purchase price of the majority interest in
NACT was allocated to 67.3% of the net assets acquired and purchased in-process
R&D. The excess of purchase price over 67.3% of the fair value of net assets
acquired and purchased in-process R&D, currently estimated at approximately
$42.8 million, has been recorded as goodwill and is being amortized over a 20
year period.
During the first quarter of 1998, $44.6 million of purchased in-process
R&D, which consists of 67.3% of the value of NACT products in the development
stage that are not considered to have reached technological feasibility as of
the date of the NACT Acquisition, was expensed in accordance with applicable
accounting rules. See Management's Discussion and Analysis.
8
<PAGE> 10
Pro Forma Results of Operations
On a pro forma, unaudited basis, as if the acquisitions of ATI and NACT had
occurred as of January 1, 1997, total sales, operating income, net income and
diluted net income per common share for the six months ended June 30, 1998 and
1997 would have been approximately $86.4 million and $66.9 million; $14.1
million and $7.6 million; $6.4 million and $4.1 million; and $0.30 and $0.21,
respectively. The pro forma results of operations for the six months ended June
30, 1998 would not have been materially different had the acquisitions of AIT
and NACT occurred on January 1, 1998.
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. The portion of the ATI and NACT purchase prices allocated to
purchased in-process R&D expensed in accordance with applicable accounting rules
will not recur, therefore the pro forma results have been prepared excluding
these charges.
NOTE 3. INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
JUNE 30 DECEMBER 31
1998 1997
----------- -----------
<S> <C> <C>
Switching systems, frames and related circuit boards $20,960,342 $13,445,770
Transport and access products 1,343,217 779,674
Electronic components 6,364,945 4,879,213
Pay telephone parts 1,666,120 1,332,835
Work in progress 3,747,254 1,744,368
Other finished goods 390,715 245,058
----------- -----------
$34,472,593 $22,426,918
=========== ===========
</TABLE>
NOTE 4. GOODWILL
Goodwill from acquisitions, representing the excess of purchase price
paid over the value of net assets acquired and purchased in-process R&D, was
as follows:
<TABLE>
<CAPTION>
JUNE 30 DECEMBER 31
1998 1997
------------ ------------
<S> <C> <C>
NACT $ 42,752,140 $ --
CIS 12,485,239 12,485,239
AIT 10,657,917 11,557,917
Galaxy 5,089,265 5,089,265
ATI 2,748,309 --
Other 5,034,062 5,034,062
------------ ------------
78,766,932 34,166,483
Accumulated amortization (4,388,653) (2,506,282)
------------ ------------
$ 74,378,279 $ 31,660,201
============ ============
</TABLE>
9
<PAGE> 11
Goodwill is being amortized on a straight-line basis over a 15 to 20 year
period. In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of", the Company regularly reviews the projected future cash flows
from operations of each of the acquired businesses to assess the recoverability
of goodwill. In the event that the Company deems permanent impairment of
goodwill has resulted, charges are recorded against current operations for the
impairment. No significant impairment charges have been recorded to date. See
Management's Discussion and Analysis.
NOTE 5. DEBT
The Company has a $10.0 million revolving line of credit with a large
European bank. As of June 30, 1998, the Company had borrowings of $4.3 million
outstanding under this facility. These borrowing were repaid to the bank in July
1998.
The bank agreement, which expires in March 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 and 1/4% or Libor plus 2 and 1/2%, at the option of the
Company.
NOTE 6. SPECIAL CHARGES
Special charges in the first quarter of 1998 included $6.6 million for
costs related to the consolidation of several operations and the Company's exit
from the contract manufacturing business. The Company's AIT and circuit board
repair operations have been consolidated into a new facility in Orlando,
Florida; the Company's manufacturing operations have moved from Orlando to a new
facility in Alpharetta, Georgia; and the Company's Scottsdale, Arizona
operations have been integrated into ATI's facility in Wilmington,
Massachusetts.
The special charges included $3,360,000 to cost of sales for obsolete
contract manufacturing inventories and inventories deemed obsolete or redundant
as a result of the consolidation activities. The additional charges consisted
of:
<TABLE>
<S> <C>
Severance and termination benefits..... $ 550,000
Idle facility costs.................... 1,340,000
Idle equipment costs................... 1,350,000
----------
$3,240,000
==========
</TABLE>
The consolidated program began in the first quarter of 1998 and was
completed as of June 30, 1998. No costs were included in the special charges
that are expected to derive future economic benefit to the Company. As of June
30, 1998, approximately $600,000 of accrued special charges is included in Other
current liabilities on the Company's balance sheet, which consisted primarily of
facility lease termination losses expected to be incurred. See Management's
Discussion and Analysis.
NOTE 7. EARNINGS PER SHARE
Effective in 1997, the Company adopted Statement of Financial Accounting
Standards No. 128 "Earnings per Share". The computation of basic earnings per
share is based on the weighted average number of common shares outstanding
during the period. The computation of diluted earnings per share is based on the
weighted average number of common shares outstanding plus, when their effect is
dilutive, potential common stock consisting of shares subject to stock options,
stock warrants and convertible notes. Potential common stock shares of 1,245,198
were included in computing diluted earnings per share for the three month period
ended June 30, 1998, and potential common stock shares of 1,959,331 and
1,440,251 were included in computing diluted earnings per share for the three
and six month periods ended June 30, 1997, respectively. A total of 1,203,786
shares of common stock held in escrow from certain acquisitions and a license
agreement were excluded from the earnings per share calculations for the three
months ended June 30, 1998 because the conditions for release of shares from
escrow had not been satisfied.
Common stock issued and outstanding at June 30, 1998 and 1997 was
21,887,074 and 18,159,797 shares, respectively.
NOTE 8. LEGAL PROCEEDINGS
On August 24, 1996, Aerotel, Ltd. and Aerotel U.S.A. Inc. (collectively,
"Aerotel") commenced an action against NACT and a customer of NACT in the United
States District Court, Southern District of New York, alleging that telephone
systems manufactured and sold by NACT incorporating prepaid debit card features
infringe upon Aerotel's patent which was issued in November 1987 (the "Aerotel
Patent"). Aerotel sought injunctive relief, damages in an unspecified amount and
damages of up to three times damages found for willful infringement of the
Aerotel Patent. NACT filed an answer and Counterclaim in which it denied
infringement of the Aerotel Patent and sought judgement that the Aerotel patent
is invalid and unenforceable and that Aerotel has misused its patent in
violation of antitrust laws. NACT has denied that it has committed defamation,
unfair competition and tortuous interference with prospective business
relations. In August 1997, Aerotel amended its complaint to include as
defendants GST, GST USA, and two former executive officers of NACT. The amended
pleadings seek in excess of $18.7 million in damages and allege that GST and GST
USA have infringed the Aerotel patent, aided and abetted infringement by others,
including NACT, and participated in, and aided and abetted alleged tortuous
conduct by NACT. GST, GST USA and the two former executive officers of NACT have
served answers denying all material allegations.
Under the terms of the Company's stock purchase agreement with GST, the
Company and GST have agreed to share evenly the costs of any judgement against
NACT as a result of the Aerotel litigation, including NACT's legal fees.
Subsequent to the NACT Acquisition, the Company has been actively engaged in
settlement negotiations. On July 9, 1998, the Company, GST and Aerotel entered
into a Memorandum of Understanding to settle the Aerotel litigation. As of the
date of this Report, the parties are negotiating the terms and conditions of a
final settlement agreement.
The Company currently estimates that its portion of the total settlement
costs, including legal fees, will be approximately $3.3 million. Any payment
made to Aerotel is expected to be paid through the issuance of Company common
stock. The settlement costs expected to be incurred by the Company as a result
of the Aerotel litigation have been accounted for as additional NACT purchase
price as of June 30, 1998.
Management expects a final Aerotel settlement agreement to be executed in
the near future. If a settlement does not occur, management believes that NACT
has valid defenses to the Aerotel claim. An unfavorable decision in this action,
however, could have a material adverse effect on the Company's financial
position.
10
<PAGE> 12
NOTE 9 PENDING ACQUISITIONS
Resurgens Acquisition
On February 12, 1998, the Company executed a letter of intent to
acquire Cherry Communications Incorporated, d/b/a Resurgens Communications Group
("RCG"), and Cherry Communications U.K. Limited ("Cherry U.K.", and together
with RCG, "Resurgens"). On May 12, 1998, the Company signed definitive
agreements to acquire Resurgens. The agreement to acquire RCG is subject to the
approval of the Bankruptcy Court. The transactions, which will be accounted for
under the purchase method of accounting, are currently expected to close in
September or October 1998.
Pursuant to the terms of the agreements, the creditors of RCG and the
shareholders of Cherry U.K. will receive approximately 3.7 million restricted
shares of Company common stock in the aggregate, with an estimated fair value of
approximately $90 million. In addition, the RCG creditors and Cherry U.K.
shareholders have the right to receive additional consideration of up to 7.5
million restricted shares of Company common stock over the next two and one-half
years, contingent upon the achievement of certain EBITDA levels by Resurgens
during this timeframe. The transaction is subject to, among other things,
Resurgens exceeding pre-defined levels of monthly revenues and gross margin, the
receipt of the requisite corporate and regulatory approvals, the confirmation of
RCG's Plan of Reorganization and the approval of Company stockholders.
RCG, currently operating under the protection of Chapter 11 of the
United States Bankruptcy Code, and Cherry U.K. are facilities-based providers of
international network access, commonly referred to in the industry as carriers'
carrier. In October 1997, John D. ("Jack") Phillips, a director of the Company,
entered into a series of agreements whereby, among other things, he became the
new Chairman and Chief Executive Officer of Resurgens. RCG filed for bankruptcy
protection shortly thereafter. WorldCom, Inc. ("WorldCom"), a major customer and
vendor of Resurgens, has subsequently provided Resurgens approximately $26
million of direct financial support through a debtor in possession facility and
additional financial support, primarily through trade credits.
In April 1998, the Company purchased approximately $3.6 million of
switching equipment which has been consigned to Resurgens. Upon its acquisition
of Resurgens, the Company will account for this equipment as part of its
investment in Resurgens. If the acquisition is not consummated, the Company
expects to negotiate an arms-length sale of the equipment to Resurgens or
another customer. This equipment is included in Other assets on the Company's
June 30, 1998 balance sheet.
Telco Acquisition
On June 4, 1998, the Company entered into a definitive Agreement to
merge with Telco Systems, Inc. ("Telco") (the "Merger").
11
<PAGE> 13
As a result of the Merger, each outstanding share of Telco common stock
shall be converted into the right to receive that number of shares of Company
common stock equal to the quotient of $17.00 divided by the average daily
closing price of Company common stock as reported on Nasdaq on each of the
twenty consecutive trading days ending on the second business day prior to the
date of the Merger (the "Average Closing Price"), provided that if the Average
Closing Price is more than $36.00 per share, then each share of Telco common
stock will be converted into .4722 shares of Company common stock and if the
Average Closing Price is less than $29.00 per share, then each share of Telco
common stock will be converted into .5862 shares of Company common stock. Based
on the Company's current stock price as of the date of this Report, the shares
issued in connection with the Merger will be valued at approximately $200
million.
The Merger is intended to constitute a reorganization under Section
368(a) of the Internal Revenue Code of 1986, as amended, and will be accounted
for as a purchase. The purchase price will be allocated to the net assets
acquired and to approximately $65 million of purchased in-process R&D. Purchased
in-process R&D, which consists of the value of Telco's products in the
development stage that are not considered to have reached technological
feasibility, will be expensed upon completion of the Merger.
The consummation of the Merger is subject to (i) clearance under the
Hart-Scott-Rodino Improvements Act of 1976, as amended, (ii) the approval by the
respective stockholders of the Company and Telco, (iii) the approval by the
stockholders of the Company of an increase in the authorized shares of common
stock of such corporation, and (iv) the satisfaction or waiver of customary
conditions. The Merger is expected to be consummated in September or October
1998.
NOTE 10 COMPREHENSIVE INCOME
The Company adopted Statement of Financial Accounting Standards No. 130
("SFAS 130"), "Reporting Comprehensive Income", effective January 1, 1998. For
the six months ended June 30, 1998 and 1997, respectively, comprehensive and net
income were the same for the Company.
12
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Under the Private Securities Litigation Reform Act of 1995, companies are
provided a "safe harbor" for making forward-looking statements about the
potential risks and rewards of their strategies. The Company believes that it is
in the best interest of its stockholders to use these provisions in discussing
future events in this Form 10-Q and other communications. These forward-looking
statements include the Company's plans for growth, the potential for
development, acceptance of the Company's products and other factors that could
affect the Company's future operations or financial position.
The Company's ability to achieve its goals depends on many known and
unknown risks and uncertainties, as well as changes in general economic and
business conditions. These factors could cause the anticipated performance and
results of the Company to differ materially from those described or implied in
such forward-looking statements.
Factors that could cause or contribute to such differences include the
risks and uncertainties described in the Company's SEC reports, including the
Company's Annual Report on Form 10-K, as amended, for the year ended December
31, 1997 and the Company's Registration Statement on Form S-3 (No. 333-43497).
OVERVIEW
The Company develops, manufactures and markets wireline and wireless
switching, transport and access products for the global telecommunications
markets. The products offered by the Company include those manufactured by the
Company as well as those manufactured by other telecommunications equipment
manufacturers. To support and complement its product sales, the Company also
provides its customers with a broad range of design, engineering, manufacturing,
testing, installation, repair and other value-added services.
During 1995 and 1996, the Company completed strategic and financial
restructuring programs to strengthen its management team, reposition the Company
as a provider of telecommunications products, improve its financial condition,
reduce its operating costs and position the Company for future growth. These
programs were undertaken following the significant losses incurred by the
Company in the early 1990s, primarily due to a discontinued smart pay telephone
business, and to take advantage of the significant growth opportunities within
the Company's existing customer base and related markets. In November 1994, the
Company began to rebuild its management team and change its strategic focus. The
Company strengthened its management team by appointing a new Chief Executive
Officer and by recruiting and hiring a new President and Chief Operating
Officer, Executive Vice President of Business Development and experienced
product development and manufacturing professionals. These individuals, together
with other key managers recruited into the Company, have brought significant
experience in manufacturing and marketing telecommunications equipment to the
Company.
The Company acquired five businesses during 1995 to 1997 in an effort
to broaden its line of switching, transport and access products, enhance its
product development capabilities and strengthen its technical base. Effective
May 1995, the Company acquired AIT, Inc. ("AIT"), a full service provider of
Northern Telecom switching systems, add-on frames and related circuit boards;
effective October 1995, the Company acquired Westec Communications, Inc.
("Westec"), a provider of wireless products and services primarily to the cable
television industry; effective January 1996, the Company acquired Sunrise
Sierra, Inc. ("Sunrise"), a developer and manufacturer of intelligent transport
and access products; effective January 1997, the Company acquired Cellular
Infrastructure Supply, Inc. ("CIS"), a provider of mobile network equipment and
related design, installation and technical support services to cellular, PCS and
other wireless service providers; and effective August 1997, the Company
acquired Galaxy Personal Communication Services ("Galaxy"), a RF engineering
firm that provides system design, implementation, optimization and other
value-added radio engineering and consulting services to the wireless service
markets. The markets served by CIS and Galaxy complement the Company's
traditional telephone service provider and private network operator markets.
In the first quarter of 1998, the Company acquired ATI, a manufacturer
of digital point-to-point microwave radio systems for short and long haul
applications and a majority stake in NACT, a provider of advanced
telecommunications switching platforms with integrated applications software. In
May 1998, the Company signed definitive agreements to acquire Resurgens, a
facilities-based provider of international network access, commonly referred to
in the industry as carriers' carrier. In June 1998, the Company signed a
definitive agreement to acquire Telco, a manufacturer of asynchronous fiber
optic systems and intelligent channel banks for the integrated access, high
capacity multiplexer and Frame Relay/ATM access markets. These acquisitions have
positioned the Company to offer its customers a complete telecommunications
network solution , including proprietary equipment, planning and engineering
services and access to international long distance.
13
<PAGE> 15
The Company realized significant improvements in its sales and
operating results since 1994 as a result of the acquisitions and internal growth
initiatives. The Company's total sales increased by 82.3% in 1997, 69.2% in 1996
and 97.2% in 1995. Total sales for the first six months of 1998 increased by
41.5% over the last six months of 1997. As the Company increased its product
sales from 18.2% of total sales in 1994 to 79.0% of total sales in the first six
months of 1998, its gross profit margin before special charges increased from
12.9% in 1994 to 21.1% in 1995, 29.4% in 1996, 34.6% in 1997 and 44.1% in the
first six months of 1998. As a percentage of total sales, the Company's
operating income (loss) before special charges increased from (8.5%) in 1994 to
5.0% in 1995, 14.4% in 1996, 21.0% in 1997 and 27.6% in the first six months of
1998. The Company will continue to seek further improvements in gross profit
margin over time as product offerings include more internally developed,
acquired and licensed products containing proprietary technology.
Although the Company has aggressively pursued acquisitions in recent
years, approximately 50% of the Company's total sales growth since 1994 has come
from internal growth initiatives. The Company has had considerable success in
growing businesses subsequent to their acquisition,due in part to the Company's
ability to provide working capital, an extensive base of telecommunications
customers and a broad range of support services.
Since January 1, 1995, the Company has significantly strengthened its
balance sheet through improved operating results, a $115.0 million sale of
convertible subordinated notes, a $26.2 million secondary public equity
offering, stock warrant and option exercises, and a five-year $10.0 million
credit facility. The Company has used this capital for acquisitions and to
support the working capital requirements associated with the Company's growth.
The Company's working capital and stockholders' equity have increased from $2.3
million and $1.2 million, respectively, at December 31, 1994 to $116.1 million
and $98.6 million, respectively, at June 30, 1998.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company's operating results have fluctuated significantly in the
past. As the Company 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 product 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.
The Company's sales during the first six months of 1998 included
approximately $30.0 million from its AIT and CIS subsidiaries. AIT sells new
and used Northern Telecom switching systems, add-on frames and circuit cards.
CIS sells re-engineered cellular base stations and related mobile network
equipment. These operations depend on a consistent supply of equipment to
sustain their revenue levels. Additionally, individual sales by AIT and CIS are
relatively large ($500,000 to $2.0 million), which subjects the Company to the
risk of revenue fluctuations in the event that customers adjust the timing of
their orders.
14
<PAGE> 16
RESULTS OF OPERATIONS
The following table sets forth items in the Company's Consolidated
Statements of Operations as a percentage of total revenues:
STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
-------------------- --------------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Sales of products 87.6% 81.0% 83.9% 78.9%
Service revenues 12.4 19.0 16.1 21.1
------ ------ ------ ------
Total sales 100.0 100.0 100.0 100.0
Cost of products sold 46.8 48.0 46.9 48.5
Cost of services 10.0 16.7 14.6 18.3
------ ------ ------ ------
Total cost of sales 56.8 64.7 61.5 66.8
------ ------ ------ ------
Gross profit 43.2 35.3 38.5 33.2
Engineering and development 3.8 1.8 3.1 1.7
Selling, general and administrative 9.9 10.1 9.6 9.8
Amortization of goodwill 2.1 1.6 2.3 1.5
In process research and development -- -- 60.0 --
Special charges -- -- 3.9 --
------ ------ ------ ------
Operating income (loss) 27.4 21.8 (40.4) 20.2
Interest and other income 1.5 0.9 2.4 1.3
Interest expense (3.2) -- (3.6) (0.1)
------ ------ ------ ------
Income (loss) before income taxes and minority 25.7 22.7 (41.6) 21.4
interest
Income taxes 10.3 8.4 7.4 7.8
------ ------ ------ ------
Income (loss) before minority interests 15.4 14.3 (49.0) 13.6
Minority interests in earnings of subsidiary 1.8 -- 1.8 --
------ ------ ------ ------
Net income (loss) 13.6% 14.3% 50.8% 13.6%
====== ====== ====== ======
OTHER DATA:
Gross Margin (Before Special Charges)
Products 46.5% 40.7% 44.1% 38.4%
Services 19.4 12.4 34.2 13.5
</TABLE>
15
<PAGE> 17
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
Sales. Total sales increased $23.5 million, or 97.8%, to $47.5 million
in the second quarter of 1998 from $24.0 million in the second quarter of 1997.
The percentage of product sales to total sales increased to 87.6% in the second
quarter of 1998 from 81.0% in the second quarter of 1997.
Product sales increased $22.2 million, or 113.9%, to $41.6 million in
the second quarter of 1998 from $19.4 million in the second quarter of 1997. The
increase related to sales generated by ATI and NACT which were acquired
effective February 1, 1998 and March 1, 1998, respectively, and increases in
sales of the Company's international switching product, the Compact Digital
Exchange switch ("CDX"), and it's WX-5501 line card.
Service revenues increased $1.3 million, or 29.2%, to $5.9 million in
the second quarter of 1998 from $4.6 million in the second quarter of 1997. The
increase related to additional revenues attributable to the Galaxy acquisition,
which was acquired effective July 1, 1997. This increase was offset by a decline
in electronic manufacturing revenues resulting from a strategic decision to
begin utilizing the Company's manufacturing capacity for new World Access
products rather than service outside contract manufacturing customers.
Gross Profit. Gross profit increased $12.0 million, or 141.7%, to $20.5
million in the second quarter of 1998 from $8.5 million in the second quarter of
1997. Gross profit margin increased to 43.2% in the second quarter of 1998 from
35.3% in the second quarter of 1997. The improved performance resulted from
economies of scale associated with the 97.8% increase in total sales and the
change in sales mix to products, which generally carry a higher gross profit
margin than service revenues.
Gross profit margin on products sold increased to 46.5% in the second
quarter of 1998 from 40.7% in the second quarter of 1997. The improved margins
related to the NACT and ATI sales of proprietary equipment and systems and the
increase in sales of CDX equipment, all of which generally carry margins in
excess of 45%. The Company's refurbished switching products experienced
declines in gross margin during the second quarter of 1998 primarily related to
margin pressure on sales of Northern Telecom add-on frames and related circuit
boards.
Gross profit margin on service revenues increased to 19.4% in the second
quarter of 1998 from 12.4% in the second quarter of 1997. The improvement was
due to the addition of revenues from Galaxy.
Engineering and Development. Engineering and development expenses
increased $1.4 million, or 318.5%, to $1.8 million in the second quarter of 1998
from $429,000 in the second quarter of 1997. The increase in expenses was
attributable to the acquisitions of NACT and ATI and the continued expansion of
the Company's development group during 1998. Total engineering and development
expenses increased to 3.8% of total sales in the second quarter of 1998 from
1.8% of total sales in the second quarter of 1997.
16
<PAGE> 18
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $2.3 million, or 92.2%, to $4.7 million in the
second quarter of 1998 from $2.4 million in the second quarter of 1997. The
increase related primarily to expenses associated with the operations of NACT,
ATI and Galaxy, which were acquired subsequent to the second quarter of 1997. As
a percentage of total sales, selling, general and administrative expenses
decreased to 9.9% in the second quarter of 1998 from 10.1% in the second quarter
of 1997.
Amortization of Goodwill. Amortization of goodwill increased $638,000
to $1.0 million in the second quarter of 1998 from $380,000 in the second
quarter of 1997, as a result of the goodwill acquired in connection with the
NACT, ATI, and Galaxy acquisitions and additional goodwill recorded related to
earnout performances for the CIS, AIT and Galaxy acquisitions.
AIT, CIS, Galaxy, ATI and NACT (collectively representing approximately
95% of the net goodwill of the Company)are all operating at profitability levels
in excess of management's expectations and the related risk of impairment in the
foreseeable future is believed to be low. Westec and Sunrise are operating
below management's expectations and may have difficulty achieving future sales
growth. Although management believes there has been no permanent impairment in
the value of the Westec and Sunrise goodwill to date, management will continue
to monitor closely the value of Westec and Sunrise goodwill throughout 1998 and
1999.
Operating Income. Operating income increased $7.8 million, or 148.3%,
to $13.0 million in the second quarter of 1998 from $5.2 million in the second
quarter of 1997. Operating income margin increased to 27.4% in the second
quarter of 1998 from 21.8% in the second quarter of 1997.
Interest and Other Income. Interest and other income increased
$476,000, or 211.6%, to $701,000 in the second quarter of 1998 from $225,000 in
the second quarter of 1997 due to increased invested cash balances of the
Company, resulting primarily from proceeds received from a $115.0 million
convertible note offering completed in October 1997.
Interest Expense. Interest expense increased to $1.5 million in the
second quarter of 1998 from $24,000 in the second quarter of 1997. The increase
is due to the $115.0 million convertible note offering.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
Sales. Total sales increased $38.9 million, or 88.0%, to $83.2 million
in the first six months of 1998 from $44.3 million in the first six months of
1997. The percentage of product sales to total sales increased to 83.9% in the
first six months of 1998 from 78.9% in the first six months of 1997.
Product sales increased $34.9 million, or 100.0%, to $69.8 million in
the first six months of 1998 from $34.9 million in the first six months of 1997.
The increase related to sales generated by ATI and NACT which were acquired
effective February 1, 1998 and March 1, 1998, respectively, and increases in
sales of the Company's international switching product, the Compact Digital
Exchange switch "(CDX"), and it's WX-5501 line card.
Service revenues increased $4.0 million, or 43.3%, to $13.4 million in
the first six months of 1998 from $9.4 million in the first six months of 1997.
The increase related to additional revenues attributable to the Galaxy
acquisition. This increase was offset by a decline in electronic manufacturing
revenues resulting from a strategic decision to begin utilizing the Company's
manufacturing capacity for new World Access products rather than service outside
contract manufacturing customers and in the Company's circuit board repair
business.
17
<PAGE> 19
Gross Profit. Gross profit increased $17.3 million, or 118.2%, to $32.0
million in the first six months of 1998 from $14.7 million in the first six
months of 1997. Gross profit margin increased to 38.5% in the first six months
of 1998 from 33.2% in the first six months of 1997. The improved performance
resulted from the 88.0% increase in total sales and the change in sales mix to
products, which generally carry a higher gross profit margin than service
revenues.
Gross profit margin on products sold increased to 44.1% in the first
six months of 1998 from 38.4% in the first six months of 1997. The improved
margins related to the NACT and ATI sales of proprietary equipment and systems
and the increase in sales of CDX equipment, all of which generally carry margins
in excess of 45%. The Company's refurbished switching products experienced
declines in gross margin during the first six months of 1998 primarily related
to margin pressure on sales of Northern Telecom add-on frames and related
circuit boards.
Gross profit margin on service revenues was 9.1% in the first six
months of 1998 as compared to 13.5% in the first six months of 1997. Gross
profit margin excluding the special charge was 34.2% in the first six months of
1998. The improvement was due to the addition of revenues from Galaxy, which was
acquired effective July 1, 1997.
Engineering and Development. Engineering and development expenses
increased $1.8 million, or 246.6%, to $2.6 million in the first six months of
1998 from $745,000 in the first six months of 1997. The increase in engineering
and development expenses was attributable to the acquisitions of NACT and ATI
and the continued expansion of the Company's development group during 1998.
Total engineering and development expenses increased to 3.1% of total sales in
the first six months of 1998 from 1.7% of total sales in the first six months of
1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $3.5 million, or 82.3%, to $7.9 million in the
first six months of 1998 from $4.4 million in the first six months of 1997. The
increase related primarily to expenses associated with the operations of NACT,
ATI and Galaxy, which were acquired subsequent to the second quarter of 1997. As
a percentage of total sales, selling, general and administrative expenses
decreased to 9.6% in the first six months of 1998 from 9.8% in the first six
months of 1997.
Amortization of Goodwill. Amortization of goodwill increased $1.4
million to $2.0 million in the first six months of 1998 from $592,000 in the
first six months of 1997, as a result of the goodwill acquired in connection
with the NACT, ATI, and Galaxy acquisitions and additional goodwill recorded
related to earnout performances for the CIS, AIT and Galaxy acquisitions.
Operating Income Before Special Charges. Operating income before
special charges increased $14.1 million to $23.0 million in the first six months
of 1998 from $8.9 million in the first six months of 1997. Operating income
margin before special charges increased to 27.6% in the first six months of 1998
from 20.2% in the first six months of 1997.
Interest and Other Income. Interest and other income increased $1.4
million, or 232.7%, to $2.0 million in the first six months of 1998 from
$592,000 in the first six months of 1997 due to increased invested cash balances
of the Company, resulting primarily from proceeds received from a $115.0 million
convertible note offering completed in October 1997.
Interest Expense. Interest expense increased to $3.0 million in the
first six months of 1998 from $53,000 in the first six months of 1997. The
increase is due to the $115.0 million convertible note offering.
18
<PAGE> 20
PURCHASED IN-PROCESS R&D
Special charges in the first quarter of 1998 included $50.0 million
for in-process research and development related to the first quarter 1998
acquisitions of a 67.3% interest in NACT and ATI (see Note 2 to the "Financial
Statements"). Purchased in-process research and development, which consists of
the value of NACT and ATI products in the development stage that are not
considered to have reached technological feasibility, were expensed in
accordance with applicable accounting rules. The Company expects to record an
additional in-process research and development charge of approximately $22.0
million in the third quarter of 1998 in connection with the acquisition of the
remaining 32.7% of NACT.
The Income Approach was utilized to value the acquired research and
development technologies in the NACT Acquisition. The Income Approach values
technologies by projecting the potential cash flows related to those
technologies and discounting the cash flows to their present values using a
discount rate reflective of the risk of achieving the cash flows. The projected
cash flows include estimates of the remaining costs to complete the in-process
technologies.
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 as of the date of Acquisition.
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 larger
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.
NACT had nine principal projects in the development pipeline at the
time of acquisition. Most major projects had several ongoing sub-projects (e.g.,
a hardware design project and a software design project). These projects
included significant redevelopment of some existing products and the creation of
new products. The research and development projects were at various stages of
development. Most new or redeveloped products were scheduled for release in
1998, while several others were scheduled for release in 1999. None of the
in-process projects considered in the write-off had attained technological
feasibility.
For all in-process technologies, management estimated remaining costs
to complete. These estimates were $3.3 million for 1998, and $1 million for
1999. The expected sources of funding were scheduled research and development
expenses from the operating budget of NACT provided by the operating assets and
liabilities of NACT.
The Income Approach was also used to value the acquired research and
development technologies in the ATI acquisition.
ATI develops and manufactures a series of high-performance digital
microwave/millimeter 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 as of the date of Acquisition. 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.
At the time of acquisition, ATI's primary product lines were FSK+,
Compact, and QAM. ATI's management determined the following percentages of each
product line were in-process technologies:
FSK+: 15.0% of units in development
Compact: 95.0% of units in development
QAM: 100.0% of units in development
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.
For all in-process products, management estimated remaining costs to
complete to be $3.1 million for 1998, $7.2 million for 1999, $7.6 million for
2000, $5.1 million for 2001, and $1.1 million for 2002. The expected sources of
funding were scheduled R&D expenses from the operating budget of ATI provided by
the operating assets and liabilities of ATI.
SPECIAL CHARGES
In January 1998, the Company's senior management decided that the
following actions were necessary to streamline operations and position the
Company to service anticipated sales growth:
- Close down the existing Orlando, Florida manufacturing and repair
facility. Move the manufacturing of certain World Access products to
the company's Alpharetta, Georgia manufacturing facility.
- Exit the contract manufacturing business.
- Close down four Lakeland, Florida facilities and move AIT operations to
a new facility in Orlando, Florida. Repair operations would be
integrated with AIT in this new facility.
- Close down Westee's facility in Scottsdale, Arizona and integrate its
operations into ATI's facility in Wilmington, Massachusetts.
Shortly thereafter, senior management informed the operating management
of the applicable divisions. All Orlando and Lakeland employees were informed in
January and Westee employees were informed in February (subsequent to the
closing of the ATI acquisition).
Management carefully reviewed the provisions of EITF 94-3 in
determining which costs related to the above actions should be included in a
first quarter special charge. 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.
The special charge consisted of:
<TABLE>
<S> <C>
Obsolete and redundant inventories . . . . . . . . $ 3,360,000
Severance and termination benefits . . . . . . . . 550,000
Idle facility costs. . . . . . . . . . . . . . . . 1,340,000
Idle equipment costs . . . . . . . . . . . . . . . 1,350,000
-----------
$ 6,600,000
===========
</TABLE>
Severance and termination benefits were clearly communicated up front
to the approximately 60 employees who lost their jobs as a direct result of the
consolidations. Affected employees were notified shortly after the January and
February employee meetings. Benefits were determined consistent with the
Company's severance policy of one week of pay for each full year of service
(minimum of two weeks) and continued benefits through the month severance pay is
exhausted. Approximately 10 of these employees were involuntarily terminated in
February and March, approximately 40 employees were involuntarily terminated in
April and approximately 10 employees were involuntarily terminated in June. The
Orlando and Lakeland facilities were closed in April and the Scottsdale facility
was closed in June. The actual severance and termination benefit costs incurred
by the Company were not materially different from the $550,000 recorded in the
special charge.
The idle facility and equipment portion of the special charge included
the write-off of "old Orlando", Lakeland and Scottsdale leasehold improvements,
provisions for the estimated costs to terminate idle facility and equipment
leases, the write-off of Orlando manufacturing equipment not relocated to the
company's Alpharetta facility and certain phase-down expenses associated with
the six facilities closed down. As of the date of this Report, the Company does
not expect the actual costs for these items to be materially different from
amounts recorded in the special charge.
As previously noted, all activities that resulted in the first quarter
special charge were completed by the Company as of June 30, 1998. Of the
$3,240,000 special charge, approximately $1.4 million related to assets directly
written-off of amounts charged to the reserve in the first quarter. As of June
30, 1998, the accrual for special charges was approximately $600,000, which
consisted primarily of lease termination losses expected to be incurred.
LIQUIDITY AND CAPITAL RESOURCES
Overview. Cash management is a key element of the Company's operating
philosophy and strategic plans. Acquisitions to date have been structured to
minimize the cash element of the purchase price and ensure that appropriate
levels of cash are available to support the increased product development,
marketing programs and working capital normally associated with the growth
initiatives of acquired businesses. As of June 30, 1998, the Company had $61.2
million of cash and investments and $5.7 million in borrowings available under
its credit line to support its current working capital requirements and
strategic growth initiatives.
Operating Activities. Cash provided from operating activities was $3.0
million in the first six months of 1998 as compared to cash used by operations
of $2.6 million in the first six months of 1997.
19
<PAGE> 21
Accounts receivable increased $21.5 million, or 106.4%, to $41.8
million at June 30, 1998 from $20.3 million at December 31, 1997. This was due
to the acquisitions of NACT, ATI and Galaxy and increased sales activity at the
Company (second quarter 1998 sales were $47.5 million as compared to fourth
quarter 1997 sales of $21.3 million). Average days sales outstanding at June 30,
1998, March 31, 1998 and December 31, 1997 were approximately 80 days, 90 days
and 81 days, respectively. The Company's transition into equipment sales has
caused an increase in days sales outstanding. The Company's equipment sales tend
to include longer payment terms than the historical repair and refurbishment
businesses. In addition, the Company's sales to international customers have
increased during the last twelve months. International sales generally have
payment terms of 90 to 120 days. The Company also has recently begun to enter
into long-term notes receivable with selected customers. To maximize cash flow,
the Company sells the notes where possible on either a non-recourse or recourse
basis to a third party financing institution.
Inventories increased $12.1 million, or 53.7%, to $34.5 million at June
30, 1998 from $22.4 million at December 31, 1997. This increase was due to the
acquisitions of NACT and ATI, a planned build-up of CDX switching and WX-5501
inventories related to the closure of the Company's Orlando manufacturing
facility and an increase in AIT and CIS inventories to support future orders.
The increases above were offset by the $3.4 million provision for obsolete and
redundant inventories related to the consolidation program initiated in the
first quarter of 1998 (see Special Charges).
Investing Activities. Cash used by investing activities, primarily for
the acquisitions of businesses, was $69.8 million and $4.6 million for the first
six months of 1998 and 1997, respectively.
On December 31, 1997, the Company entered into a stock purchase
agreement with GST and 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 Stock Acquisition"). On February 27, 1998 the NACT
Stock Acquisition was completed with GST USA receiving $59.7 million in cash and
1,429,907 restricted shares of the Company's common stock. These shares had an
initial fair value of approximately $26.9 million. This transaction increased
the Company's ownership of NACT to 67.3%.
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. Pursuant to the
terms of the merger agreement, each share of NACT common stock will be converted
into shares of Company common stock having a value of $17.50 per share based on
the average of the daily closing price of Company common stock on the NASDAQ
National Market for a pre-defined period prior to the closing (the "Closing
Price"), provided that if the Closing Price is more than $25.52, then each share
of NACT common stock will be converted into 0.6857 shares of Company common
stock. If the Closing Price is less than $20.88, then the Company may elect to
terminate the agreement. This merger is expected to be consummated in September
1998.
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 $6.5 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.
20
<PAGE> 22
In December 1997, the Company loaned ATI approximately $4.5 million.
ATI used $2.6 million of the proceeds to pay off its line of credit with a bank
and the remainder for working capital purposes. The note receivable from ATI is
included in Other assets on the Company's December 31, 1997 balance sheet.
During the first quarter of 1998, the note receivable was included in the
Company's purchase price of ATI.
During the first six months of 1998 and 1997, the Company invested $5.9
million and $1.1 million, respectively, in capital expenditures. The Company has
invested approximately $3.7 million during 1998 related to the establishment of
the new manufacturing facility in Alpharetta, Georgia. The remaining
expenditures during 1998 were primarily for computer network and related
communications equipment designed to upgrade the Company's management
information systems and facilitate the integration of 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. Software development costs are capitalized upon the
establishment of technological feasibility of the product. During the first six
months of 1998, the Company capitalized approximately $1.8 million of software
development costs.
Financing Activities. Cash provided from financing activities was $6.4
million and $5.4 million for the first six months of 1998 and 1997,
respectively.
On October 1, 1997, the Company sold $100.0 million in aggregate
principal amount of convertible subordinated notes (the "Notes") under Rule 144A
of the Securities Act of 1933. The Notes bear interest at the rate of 4.5% per
annum, are convertible into Company common stock at an initial price of $37.03
per share and mature on October 1, 2002. Interest on the Notes is payable on
April 1 and October 1 of each year, commencing on April 1, 1998. The Notes are
general unsecured obligations of the Company and are subordinate in right of
payment to all existing and senior indebtedness. The Company received $97.0
million from the sale of the Notes, after the initial purchasers' discount fees
of $3.0 million.
In addition to the Notes sold on October 1, 1997, the Company granted
the initial purchasers an option to purchase up to an additional $15.0 million
in Notes to cover over-allotments. On October 28, 1997, the initial purchasers
exercised the over-allotment option in full and the Company received an
additional $14.6 million, after the application of the initial purchasers'
discount fees.
The total discount fees of $3,450,000, along with approximately
$550,000 of legal, accounting, printing and other expenses (the "Debt issuance
costs") are being amortized to expense over the five year term of the Notes.
Debt issuance costs of approximately $3.4 million, net of amortization, are
included in Other assets on the Company's June 30, 1998 balance sheet.
As of June 30, 1998, the Company had borrowings of $4.3 million
outstanding under its $10.0 million revolving line of credit. Borrowings under
the Company's line of credit are secured by a first lien on substantially all
the assets of the Company. The bank agreement, which expires in March 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 1/2%,
at the option of the Company. As of the date of this Report, there were no
amounts outstanding under the Company's line of credit.
During the first six months of 1998 and 1997, the Company received
approximately $7.3 million and $2.6 million, respectively, in cash, including
related federal income tax benefits, from the exercises of incentive and
non-qualified stock options and warrants by the Company's directors and
employees.
21
<PAGE> 23
Income Taxes. As a result of the exercises of non-qualified stock
options and warrants by the Company's directors and employees, the Company has
realized a federal income tax benefit of approximately $4.2 million for the
first six months of 1998. Although this tax benefit does not have any effect on
the Company's provision for income tax expense , it represents 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.
Summary. The Company's improved operating performance and completion of
the sale of $115.0 million of Notes in 1997 has significantly enhanced its
financial strength and improved its liquidity. As of the date of this Report,
the Company has approximately $60.0 million of cash and a $10.0 million
revolving line of credit available. 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
As a result of certain computer programs being written using two
digits rather than four to define the applicable year, any of the Company's
computer systems that have date sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000 (the so-called "Year 2000
Issue"). This could result in a system failure or miscalculations causing
disruptions, including, among other things, a temporary inability to process
transactions, send invoices or engage in normal business activities.
The Company is in the process of evaluating its computer systems to
determine what modifications (if any) are necessary to make such systems
compatible with the year 2000 requirements. However, because many of the
Company's computer systems have been put into service within the last several
years, the Company does not expect any such modifications to have a material
adverse effect on the Company's consolidated results of operations, liquidity
and capital resources.
In addition, the Company is in the process of developing a plan
whereby it will review the year 2000 readiness of its customers and suppliers.
In doing so, the Company will undertake appropriate internal reviews and will
contact certain of its significant customers to assess, to the extent possible,
Year 2000 Issues related to the Company's products. In that regard, the Company
has identified that certain of its products, including the NTS 1000 billing
System available from one of the Company's subsidiary, are not year 2000
compliant. The Company is in the process of releasing new versions of such
products and making necessary modifications to existing products to address
the Year 2000 Issue. These new and revised products are expected to be available
commencing in the first quarter of 1999. The Company expects that many of its
customers will upgrade to the new products. However, there can be no assurance
that the Company's customers will upgrade to the new year 2000 compliant
products or that the modifications planned to the certain of the Company's
existing products will be successful or completed in a timely manner. The
Company will continue to evaluate its other products to determine their year
2000 compliance.
The Company intends to take all reasonable efforts to make information
on the year 2000 readiness of its products available to its customers, although
this information may not reach all customers, particularly indirect purchasers
of the Company's products. Although the Company believes that it can address
year 200 readiness issues related to its products, there may still be
disruptions and or product failures that are unforeseen.
The Company also intends to request assurances from its major
suppliers that they are addressing the Year 2000 Issue and that the products
and services procured or used by the Company will function properly or be
available without interruption in the year 2000. Nevertheless, it will be
impossible for the Company to fully assess the potential consequences if
service interruptions occur from suppliers or in infrastructure areas such as
utilities, communications, transportation, banking and government. As a result,
the Company also intends to develop a business continuity plan to minimize the
impact of such external events.
While the Company's efforts to address year 2000 issues will involve
additional costs and the time and effort of a number of Company employees, the
Company believes, based on currently available information, that it will be
able to manage its total year 2000 transition without any material adverse
effect on the Company's consolidated results of operations, liquidity and
capital resources.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable
PART II. OTHER INFORMATION
22
<PAGE> 24
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
On February 13, 1998, the Company filed a report on Form 8-K, as
amended by Amendment No. 1 thereto on Form 8-K/A filed on April 14, 1998,
announcing that on January 29, 1998 the merger of ATI with and into CIS, a
wholly-owned subsidiary of the Company was consummated.
On February 20, 1998, the Company filed a report on Form 8-K announcing
that the Company signed a letter of intent to acquire Cherry Communications
Incorporated d/b/a Resurgens Communications Group ("RCG"). On May 18, 1998, the
Company filed a report on Form 8-K announcing that the Company signed definitive
agreements to acquire RCG and Cherry Communications U.K. Limited. On July 27,
1998, the Company filed a report on Form 8-K which included the financial
statements of Resurgens and the pro forma financial statements of the Company.
On April 23, 1998, the Company filed a report on Form 8-K, as amended
by Amendment No. 1 thereto on Form 8-K/A filed on April 24, 1998, announcing
the resignation of William P. O'Reilly from the Company's Board of Directors.
On June 8, 1998, the Company filed a report on Form 8-K, announcing
that that it had entered into a definitive agreement to acquire Telco Systems,
Inc.
23
<PAGE> 25
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, Secretary
Dated: August 19, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30,
1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH UNAUDITED
CONSOLIDATED FINANCIAL STATEMENTS FILED IN THE REGISTRANTS REPORT ON FORM 10Q
FOR JUNE 30, 1998.
</LEGEND>
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<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1998
<CASH> 57,653
<SECURITIES> 3,500
<RECEIVABLES> 44,015
<ALLOWANCES> (2,196)
<INVENTORY> 34,473
<CURRENT-ASSETS> 152,874
<PP&E> 24,822
<DEPRECIATION> (7,619)
<TOTAL-ASSETS> 268,518
<CURRENT-LIABILITIES> 40,409
<BONDS> 115,000
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<COMMON> 219
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<TOTAL-LIABILITY-AND-EQUITY> 268,518
<SALES> 69,830
<TOTAL-REVENUES> 83,238
<CGS> 39,012
<TOTAL-COSTS> 51,201
<OTHER-EXPENSES> 65,641
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<INTEREST-EXPENSE> 3,030
<INCOME-PRETAX> (34,663)
<INCOME-TAX> 6,135
<INCOME-CONTINUING> (42,331)
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