U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] Quarterly report under to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended SEPTEMBER 30, 1998
[ ] Transition report under to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transitional period from _________ to _________
Commission File Number 0-24622
TELSCAPE INTERNATIONAL, INC.
(Exact name of Small Business Issuer as specified in its charter)
TEXAS 75-2433637
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification number)
2700 POST OAK BLVD., SUITE 1000, HOUSTON, TEXAS 77056
(Address of principal executive offices) (Zip Code)
Issuer's telephone number including area code -- 713/968-0968
----------------------------------------------------------------
(Former name, former address and former fiscal year if changed since last
report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act 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 [ ]
5,690,846 shares of Registrant's common stock ($.001 Par Value) were
outstanding as of November 10, 1998.
<PAGE>
Telscape International, Inc.
Table of Contents
Form 10-Q
September 30, 1998
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
As of December 31, 1997 and
September 30, 1998 (unaudited) ......................... 1
Unaudited Condensed Consolidated
Statements of Operations -
Three Months and Nine Months
Ended September 30, 1997 and 1998 ...................... 2
Unaudited Condensed Consolidated
Statements of Cash Flows - Nine Months
Ended September 30, 1997 and 1998 ...................... 3
Notes to Unaudited Condensed Consolidated
Financial Statements ................................... 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ........ 23
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ..................... 35
(a) Exhibits
(b) Reports on Form 8-K
Signatures ................................................... 36
<PAGE>
TELSCAPE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS
-----------------------------
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ................................ $ 4,734,000 $ 7,201,000
Accounts receivable, less allowance for doubtful
accounts of $200,000 and $393,000 (unaudited),
respectively ........................................... 6,276,000 14,028,000
Inventories .............................................. 4,305,000 5,287,000
Prepaid expenses and other ............................... 2,674,000 5,245,000
Deferred income taxes .................................... 517,000 334,000
------------ ------------
Total current assets .................................... 18,506,000 32,095,000
PROPERTY AND EQUIPMENT, net of accumulated
depreciation ............................................. 2,679,000 14,999,000
GOODWILL AND OTHER INTANGIBLES, net of accumulated
amortization ............................................. 17,674,000 31,699,000
OTHER ASSETS ............................................... 776,000 1,734,000
------------ ------------
Total assets ................................. $ 39,635,000 $ 80,527,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ......................................... $ 10,756,000 $ 22,050,000
Accrued expenses ......................................... 3,303,000 7,901,000
Current portion of notes payable and capital
lease obligations ...................................... 508,000 2,954,000
Convertible debentures ................................... -- 4,994,000
Deferred income taxes .................................... 270,000 328,000
------------ ------------
Total current liabilities ............................... 14,837,000 38,227,000
NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS, net
of current portion ....................................... 2,676,000 1,568,000
CONVERTIBLE SUBORDINATED DEBENTURES ........................ -- 4,929,000
MINORITY INTERESTS ......................................... 34,000 49,000
COMMITMENTS AND CONTINGENCIES .............................. -- --
SERIES B NON-VOTING PREFERRED STOCK,
$.001 par value, 380,000 and 0 shares,
respectively, authorized issued and
outstanding, mandatorily redeemable as
certain performance measures were achieved ............... -- --
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 5,000,000
shares authorized; without defined
preference rights ...................................... -- --
Series A preferred stock, $.001 par value,
1,000,000 shares authorized ............................ -- --
Common stock, $.001 par value, 25,000,000 shares
authorized; 4,104,027 and 5,681,493 issued, respectively 4,000 6,000
Additional paid-in capital ............................... 25,232,000 38,129,000
Accumulated deficit ...................................... (2,851,000) (1,490,000)
Treasury stock ........................................... (297,000) (891,000)
------------ ------------
Total stockholders' equity ...................... 22,088,000 35,754,000
------------ ------------
Total liabilities and stockholders'
equity ........................................ $ 39,635,000 $ 80,527,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES ......................... $ 12,192,000 $ 36,529,000 $ 22,134,000 $ 102,306,000
COST OF REVENUES ................. 8,455,000 29,727,000 14,449,000 86,783,000
------------- ------------- ------------- -------------
GROSS PROFIT ..................... 3,737,000 6,802,000 7,685,000 15,523,000
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES ........ 2,376,000 3,660,000 5,775,000 9,365,000
DEPRECIATION AND AMORTIZATION .... 192,000 960,000 431,000 2,218,000
------------- ------------- ------------- -------------
OPERATING INCOME ................. 1,169,000 2,182,000 1,479,000 3,940,000
OTHER INCOME (EXPENSE):
Interest income ................ 40,000 45,000 66,000 308,000
Interest expense ............... (84,000) (380,000) (110,000) (894,000)
Foreign exchange gain (loss) ... (29,000) (581,000) (2,000) (768,000)
Other, net ..................... 14,000 241,000 (280,000) 337,000
------------- ------------- ------------- -------------
Total other expense, net ... (59,000) (675,000) (326,000) (1,017,000)
------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAXES AND
MINORITY INTERESTS ............. 1,110,000 1,507,000 1,153,000 2,923,000
INCOME TAX BENEFIT (EXPENSE) ..... 79,000 (652,000) 246,000 (1,547,000)
------------- ------------- ------------- -------------
INCOME BEFORE MINORITY INTERESTS . 1,189,000 855,000 1,399,000 1,376,000
MINORITY INTERESTS IN SUBSIDIARIES 13,000 14,000 17,000 (15,000)
------------- ------------- ------------- -------------
NET INCOME ....................... $ 1,202,000 $ 869,000 $ 1,416,000 $ 1,361,000
============= ============= ============= =============
EARNINGS PER SHARE:
Basic .......................... $ 0.31 $ 0.16 $ 0.36 $ 0.28
Diluted ........................ $ 0.15 $ 0.11 $ 0.18 $ 0.17
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic .......................... 3,868,724 5,547,651 3,904,574 4,877,604
Diluted ........................ 7,857,884 8,228,284 7,777,578 7,788,139
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE>
TELSCAPE INTERNATIONAL, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
1997 1998
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................... $ 1,416,000 $ 1,361,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for doubtful accounts .............. 450,000 556,000
Depreciation and amortization ................ 431,000 2,218,000
Imputed interest on non-interest bearing
notes payable and amortization of discount
on convertible notes ....................... 68,000 212,000
Write-off of investment in operating venture . 196,000 --
Deferred income taxes ........................ (209,000) 290,000
Minority interest in subsidiaries' income
(loss) ...................................... (17,000) 15,000
Changes in assets and liabilities:
Accounts receivable ........................ (1,249,000) (5,672,000)
Inventories ................................ 96,000 (191,000)
Prepaid and other assets ................... (1,713,000) (2,579,000)
Accounts payable ........................... 5,789,000 9,490,000
Accrued expenses ........................... 682,000 991,000
------------ ------------
Net cash provided by operating activities ...... 5,940,000 6,691,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment .......... (926,000) (9,194,000)
Proceeds from asset sale leaseback ........... 119,000 --
Cash acquired in acquisition of Integracion,
net of purchase price ...................... 177,000 --
Acquisition of MSN, net of cash acquired ..... -- (2,325,000)
Acquisition of INTERLINK, net of cash acquired -- (8,250,000)
------------ ------------
Net cash used in investing activities .......... (630,000) (19,769,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations ........ (62,000) (55,000)
Payments on notes payable .................... -- (538,000)
Purchase of treasury shares .................. -- (594,000)
Borrowings on line of credit, net ............ -- 1,948,000
Proceeds from issuance of common stock ....... 15,000 --
Proceeds from exercise of options and warrants -- 4,784,000
Proceeds from issuance of convertible debt ... -- 10,000,000
------------ ------------
Net cash provided by (used in) financing
activities ................................... (47,000) 15,545,000
------------ ------------
Net increase in cash and cash equivalents ...... 5,263,000 2,467,000
------------ ------------
Cash and cash equivalents at beginning of period 495,000 4,734,000
------------ ------------
Cash and cash equivalents at end of period ..... $ 5,758,000 $ 7,201,000
============ ============
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
TELSCAPE INTERNATIONAL, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
1997 1998
------------ -------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Interest paid .............................. $ 84,000 $ 398,000
Income taxes paid .......................... 451,000 1,334,000
NON-CASH TRANSACTIONS:
Property and equipment acquired by
execution of capital lease obligation ........ 329,000 --
Issuance of common stock and promissory
notes in connection with acquisition of MSN:
Promissory Notes ....................... -- 672,000
Common Stock ........................... -- 880,000
Issuance of notes and acquisition of treasury
shares in litigation settlement :
Litigation settlement ................. (3,000) --
Treasury stock ........................ (297,000) --
Notes payable ......................... 300,000 --
Issuance of common stock and warrants in
exchange for services provided in
connection with severance agreement ........ 188,000 --
Issuance of promissory notes in connection
with the acquisition of Integracion ........ 2,555,000 --
Issuance of warrants in connection with
issuance of convertible debentures ......... -- 497,000
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
TELSCAPE INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 - FINANCIAL STATEMENTS
The accompanying unaudited condensed consolidated financial statements
include the accounts of Telscape International, Inc. and its subsidiaries
(collectively, the "Company"). The unaudited condensed consolidated financial
statements of the Company for the three and nine months ended September 30, 1997
and September 30, 1998 have been prepared without an audit pursuant to the rules
and regulations of the Securities and Exchange Commission. They do not include
all of the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments, which consist of normal recurring adjustments, considered necessary
to present fairly the financial position, results of operations and cash flows
for all periods presented have been made. Operating results for the three and
nine months ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the full year ending December 31, 1998. For
further information, refer to the consolidated financial statements and
footnotes included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1997.
MANAGEMENT'S ESTIMATES AND ASSUMPTIONS
The accompanying financial statements are prepared in conformity with
generally accepted accounting principles which require 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 reported period. The Company reviews all significant estimates
affecting the financial statements on a recurring basis and records the effect
of any necessary adjustments prior to their issuance. The actual results could
differ from those estimates.
NEW ACCOUNTING STANDARDS
Statement of Financial Accounting Standards ("SFAS") No. 130, "REPORTING
COMPREHENSIVE INCOME," establishes standards for reporting and display of
comprehensive income, its components and accumulated balances. Comprehensive
income is defined to include all changes in equity except those resulting from
investments by owners and distributions to owners. Among other disclosures, SFAS
No. 130 requires that all items that are required to be recognized under current
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. For the three months and nine months ended September 30,
1997 and 1998, respectively, comprehensive income is the same as net income.
SFAS No. 131, "DISCLOSURE ABOUT SEGMENTS OF A BUSINESS ENTERPRISE,"
establishes standards for the way that public enterprises report information
about operating segments in annual financial statements and requires reporting
of selected information about operating segments in interim financial statements
issued to the public. It also establishes standards for disclosures regarding
products and services, geographic areas and major customers. SFAS No. 131
defines operating segments as components of an enterprise about which separate
financial information is available that are evaluated regularly by the chief
operating decision makers in deciding how to allocate resources and in assessing
performance.
SFAS No. 132, "Employers' Disclosure about Pensions and other
Postretirement Benefits" standardizes the disclosure requirements for pensions
and other post-retirement benefits and requires additional information on
changes in the benefit obligations and fair values of plan assets.
5
<PAGE>
SFAS No.'s 130, 131 and 132 are effective for financial statements for the
periods beginning after December 15, 1997 and require comparative information
for earlier years to be restated. Adoption of these statements is not expected
to have a material effect on the Company's financial statement disclosures.
SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
requires companies to recognize all derivatives contracts as either assets or
liabilities in the balance sheet and to measure them at fair value. If certain
conditions are met, a derivative may be specifically designated as a hedge, the
objective of which is to match the timing of gain or loss recognition on the
hedging derivative with the recognition of (i) the changes in the fair value of
the hedged asset or liability that are attributable to the hedged risk or (ii)
the earnings effect of the hedged forecasted transaction. For a derivative not
designated as a hedging instrument, the gain or loss is recognized in income in
the period of change. SFAS No. 133 is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999.
Historically, the Company has not entered into derivatives contracts
either to hedge existing risks or for speculative purposes. Accordingly, the
Company does not expect adoption of the new standard to have a material effect
on its financial statements.
NOTE 2 - MSN ACQUISITION
Effective January 1, 1998, the Company acquired all of the outstanding
common stock of MSN Communications, Inc. ("MSN"). MSN, through its TELEFIESTA
brand, markets prepaid telephone calling cards across the United States
primarily to the Hispanic community. Under the terms of the transaction, the
Company paid the following to the shareholders of MSN: i) the sum of $3,250,000
in cash, ii) $750,000 in non-interest bearing promissory notes payable in eight
equal quarterly installments, and iii) 100,000 shares of the Company's common
stock. The acquisition was accounted for under the purchase method of
accounting. The financial position and results of operations of MSN are included
in the Company's financial statements from the effective date of the
acquisition.
The consideration paid for MSN measured at the acquisition date was
$4,880,000 and consisted of cash of $3,250,000, non-interest bearing promissory
notes with a discounted value of $672,000, common stock valued at $880,000 and
transaction costs of $78,000. The purchase price was allocated to the acquired
company's assets and liabilities based upon an estimate of fair values at the
date of acquisition and resulted in $6,091,000 of goodwill, which is being
amortized over 15 years. The balances included in the Unaudited Condensed
Consolidated Balance Sheet related to the MSN acquisition are based on
preliminary information and are subject to change when additional information
concerning final asset and liability valuations are obtained. Management does
not expect that such adjustments will be material.
NOTE 3 - INTERLINK ACQUISITION
Effective June 1, 1998, pursuant to a stock purchase agreement, the
Company through its newly-formed subsidiary Interlink Communications Holding
Co., Inc., a Delaware Corporation ("INTERLINK"), acquired all of the outstanding
shares of California Microwave Services Division, Inc., a Delaware corporation,
from California Microwave, Inc., a Delaware corporation, which operates a
teleport and network operations facility located in Mountain View, California.
The acquisition principally was accounted for under the purchase method of
accounting. The financial position and results of operations of INTERLINK are
included in the Company's financial statements from the effective date of the
acquisition.
The consideration paid for INTERLINK measured at the acquisition date was
$8,319,000 and consisted of cash of $8,154,000 and transaction costs of
$165,000. The acquisition price is subject to post-closing adjustments to the
purchase price based on changes in the closing date balance sheet. The purchase
was financed with the Deere Park Convertible Debentures and Gordon Brothers
Convertible Debentures (see Note 5). The purchase price was allocated to the
acquired company's assets and liabilities based upon an estimate of fair values
at the date of acquisition; to a non-compete agreement in the amount of
$250,000, which is being amortized over 3 years; and the remainder to goodwill,
in the amount of $3,176,000, which is being amortized over 15 years. The
balances included in the Unaudited Condensed Balance Sheet related to the
acquisition are based on preliminary information and are subject to change when
additional information concerning final asset and liability valuations are
obtained. Management does not expect that such adjustments will be material.
6
<PAGE>
NOTE 4 - EARNINGS (LOSS) PER SHARE
Following is a summary of the calculations of basic earnings per share
("basic EPS") and diluted earnings per share ("diluted EPS"):
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
1997 1998 1997 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
BASIC
Net income as reported ....... $1,202,000 $ 869,000 $1,416,000 $1,361,000
Weighted average common shares
outstanding ................. 3,868,724 5,547,651 3,904,574 4,877,604
Basic earnings per share ..... $ 0.31 $ 0.16 $ 0.36 $ 0.28
DILUTED
Net income as reported ....... $1,202,000 $ 869,000 $1,416,000 $1,361,000
Weighted average common shares
outstanding ................ 3,868,724 5,547,651 3,904,574 4,877,604
Weighted average diluted
potential common shares
outstanding:
Options ................. 1,571,849 839,684 1,504,946 913,973
Warrants ................ 2,417,311 1,840,949 2,368,058 1,996,562
Total weighted average
dilutive potential common
shares outstanding ......... 3,989,160 2,680,633 3,873,004 2,910,535
Weight average common and
dilutive potential common
shares outstanding ......... 7,857,884 8,228,284 7,777,578 7,788,139
Diluted earnings per share ... $ 0.15 $ 0.11 $ 0.18 $ 0.17
</TABLE>
Certain performance based warrants issued in connection with the Company's
acquisitions vest upon the achievement of certain operating performance
measures. In accordance with SFAS No. 128, these contingently issuable shares
are included in the calculation of diluted EPS when all the necessary conditions
were met. If all the necessary conditions have not been satisfied by the end of
the period, the number of contingently issuable shares that would have been
issued if the reporting period was the end of the contingency period are
included in the calculation as if those shares were issued at the beginning of
that period. For year-to-date calculations, contingent shares are weighted for
the interim periods in which they are included in the computation of diluted
EPS. During the third quarter, 500,000 performance based warrants vested upon
the achievement of certain operating performance measures. These contingently
issuable shares are included in the calculation of diluted EPS as if those
shares were issued July 1, 1998. Additionally, for purposes of the diluted EPS
calculations for the three months and nine months ended September 30, 1998,
there were 418,500 and 390,500 options and warrants outstanding, respectively,
which were not included in the calculation of diluted EPS as their exercise
prices were greater than the average market price of the Company's common stock
during the period and inclusion of these securities in the calculation would
result in an anti-dilutive effect.
7
<PAGE>
NOTE 5 - NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS
The Company's notes payable and capital lease obligations consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
<S> <C> <C>
Convertible Subordinated Debentures, bearing interest
at 8%, unamortized discount of $71,000, convertible
into common stock, maturing three years from closing
(see discussion below) ................................ $ -- $ 4,929,000
Convertible Debentures, bearing interest at 8%,
unamortized discount of $6,000, convertible into common
stock, maturing on May 29, 2000 (see discussion below) -- 4,994,000
Non-interest bearing promissory notes, imputed
interest at 10%, unamortized discount of
$348,000 and $228,000, respectively, issued
in connection with Integracion acquisition,
maturing at various dates through January 1, 2001 ..... 1,853,000 1,673,000
Non-interest bearing promissory note,
imputed interest at 10%, unamortized
discount of $141,000 and $ 0, respectively,
issued in connection with Integracion
acquisition, converted into 333,000 shares
of common stock in July 1998 .......................... 839,000 --
Promissory note issued to repurchase
common stock, payable in six semi-annual
installments through May 20, 2000, and
bearing interest at 6% ................................ 250,000 200,000
Capital lease obligation payable in monthly
installments of $5,413 including principal
and interest maturing June 30, 2002 ................... 242,000 187,000
Non-interest bearing promissory note,
imputed interest at 10%, unamortized
discount of $49,000, issued in connection
with MSN acquisition, payable in eight
equal quarterly installments beginning April, 1998 .... -- 514,000
Revolving credit facility maturing July 31, 1999
bearing interest at prime plus 1%, secured
by accounts receivable ................................ -- 1,948,000
----------- -----------
Total notes payable and capital leases ................ $ 3,184,000 $14,445,000
Current portion ....................................... 508,000 7,948,000
----------- -----------
Long term portion ..................................... $ 2,676,000 $ 6,497,000
=========== ===========
</TABLE>
The annual maturity of the debt indicated above for the five years
following September 30, 1998 are $144,000 in 1998, $7,910,000 in 1999, $640,000
in 2000, $5,722,000 in 2001 and $29,000 in 2002.
In May 1998, the Company issued $3,000,000 in 8% Convertible Subordinated
Debentures (the "Deere Park Convertible Debentures") maturing three years from
closing (the "First Draw") to Deere Park Capital Management, LLC, an Illinois
limited liability company ("Deere Park"). On May 28, 1998, the Company issued an
additional $1,000,000 of the Deere Park Convertible Debentures (the "Second
Draw"). On June 30, 1998, the Company issued an additional $1,000,000 of the
Deere Park Convertible Debentures (the "Third Draw"). The Deere Park Convertible
Debentures are convertible by the holder into shares of
8
<PAGE>
Common Stock at a price equal to $26 per share for the First Draw, $29 per share
for the Second Draw and $26 per share for the Third Draw, until November 1,
1998, and thereafter, at the lesser of (i) $26 per share for the First Draw, $29
per share for the Second Draw and $26 per share for the Third Draw or (ii) a
price equal to the average of the three highest of the five lowest closing
prices of the Common Stock for the 20 trading days preceding the conversion
date. If the Common Stock trades below $15 per share for the First Draw, $16.66
per share for the Second Draw and $15 for the Third Draw for three consecutive
trading days, the Company may redeem all or part of such Deere Park Convertible
Debentures at 107% of face value plus any accrued interest. The Company's
obligation to make interest payments on the Deere Park Convertible Debentures
terminates if the price of Common Stock closes for twenty consecutive trading
days at or above $30 per share for the First Draw, at or above $33.50 per share
for the Second Draw and at or above $30 per share for the Third Draw, adjusted,
without limitation, for any stock splits or combinations. In connection with the
Deere Park Convertible Debentures, Deere Park also received warrants to purchase
an aggregate of 8,952 share of Common Stock at an exercise price of $16.76 per
share (subject to adjustment for stock splits and other share adjustments) for
the First Draw, warrants to purchase an aggregate of 2,427 shares of Common
Stock at $20.60 per share (subject to adjustment for stock splits and other
share adjustments) for the Second Draw and warrants to purchase an aggregate of
6,382 shares of Common Stock at $15.67 per share (subject to adjustment for
stock splits and other share adjustments) for the Third Draw. The warrants have
a term of three years from the effectiveness of a registration statement
covering such warrants. The Deere Park Convertible Debentures are PARI PASSU in
right of payment to the Notes (see Note 9).
The Company is required to pay an exit fee in connection with any
prepayment of principal to be made under the Deere Park Convertible Debentures
(the "Deere Park Exit Fee"). The Deere Park Exit Fee varies depending upon the
date of payment, and is equal to (i) 6.6% if the payment is made within 90 days
after the closing of each respective draw, (ii) 7.2% if payment is made after 90
days and up to 180 days after the closing of each respective draw, (iii) 8.8% if
payment is made after 180 days and up to 270 days after the closing of each
respective draw and (iv) 10.0% if payment is made after 270 days after the
closing of each respective draw. The Deere Park Exit Fee is adjusted on a pro
rata basis to the extent that the prepayment is made between periods except that
a minimum Deere Park Exit Fee of 6.6% is required if the prepayment is made
prior to 90 days after closing.
In May 1998, the Company issued $5,000,000 in 8% Convertible Debentures
(the "Gordon Brothers Convertible Debentures") maturing one year from closing to
Gordon Brothers Capital, LLC, a Delaware limited liability company ("Gordon
Brothers"). The Gordon Brothers Convertible Debentures are convertible by Gordon
Brothers into shares of Common Stock at a price equal to $29.00 per share until
November 1, 1998, and thereafter, at the lesser of (i) $29.00 per share or (ii)
a price equal to the average of the three highest of the five lowest closing
prices of the Common Stock for the 20 trading days preceding the conversion
date. If the Common Stock trades below $16.66 for three consecutive trading
days, the Company may redeem all or part of such Gordon Brothers Convertible
Debentures at 107% of face value plus any accrued interest. The Company's
obligation to make interest payments on the Gordon Brothers Convertible
Debentures terminates (i) in the event the Common Stock closes, for twenty
consecutive trading days, at or above $33.50 per share, adjusted, without
limitation, for any stock splits or combinations, (ii) when a registration
statement covering the Gordon Brothers Convertible Debentures is effective and
(iii) if there exists no event of default under the Gordon Brothers Convertible
Debentures. The Gordon Brothers Convertible Debentures are secured by a pledge
of the Company's stock in Telereunion and the Company's preferred stock in
INTERLINK. In addition, the Gordon Brothers Convertible Debentures are
guaranteed by INTERLINK and such guaranty is collateralized by a security
agreement covering all of INTERLINK's assets. In connection with the Gordon
Brothers Convertible Debentures, Gordon Brothers also received warrants to
purchase an aggregate of 12,136 shares of Common Stock at an exercise price of
$20.60 per share. The warrants have a term of three years from the effectiveness
of the registration statement covering such warrants. The Gordon Brothers
Convertible Debentures are senior secured indebtedness of the Company to the
extent of the assets securing such indebtedness.
9
<PAGE>
The Company is required to pay an exit fee in connection with any
prepayment of principal to be made under the Gordon Brothers Convertible
Debentures (the "Gordon Brothers Exit Fee"). The Gordon Brothers Exit Fee varies
depending upon the date of payment, and is equal to (i) 6.5% if the payment is
made within 90 days after May 29, 1998, (ii) 13.0% if payment is made after 90
days and up to 180 days after May 29, 1998, (iii) 19.0% if payment is made after
180 days and up to 270 days after May 29, 1998 and (iv) 25.0% if payment is made
after 270 days and up to 365 days after May 29, 1998. The Gordon Brothers Exit
Fee with respect to any payment made after May 28, 1999 shall be equal to (a)
25.0% plus (b) 25.0% multiplied by the number of days elapsed from May 28, 1999
divided by 365. The Gordon Brothers Exit Fee is adjusted on a pro rata basis to
the extent that the prepayment is made between periods during the first twelve
months except that a minimum Gordon Brothers Exit Fee of 6.5% is required if the
prepayment is made prior to 90 days after closing.
A portion of the proceeds from the Deere Park Convertible Debentures and
the Gordon Brothers Convertible Debentures were allocated to the warrants issued
to the holders of such debentures. The Company estimated the fair value of the
warrants by utilizing the Black-Scholes option pricing model with the following
assumptions: dividend yield of 0%, expected volatility of 50%, risk free
interest rate of 5%, and expected lives of an average of 2 years. The resulting
discount of approximately $108,000 for the Deere Park Convertible Debentures and
the Gordon Brothers Convertible Debentures is being amortized as interest
expense over the life of the debentures.
In connection with the issuance of the Deere Park Convertible Debentures
and the Gordon Brothers Convertible Debentures, the Company issued to the
placement agent, warrants to purchase 59,340 shares of Common Stock with
exercise prices ranging from $16.76 to $20.60 per share, respectively. The
warrants have a term of two years.
Approximately $8.2 million of the proceeds from the Deere Park Convertible
Debentures and the Gordon Brothers Convertible Debentures were used to finance
the INTERLINK Acquisition and the remainder was utilized for capital investments
and general working capital purposes.
On October 26, 1998, the Company entered into agreements with the holders
of the Gordon Brothers Convertible Debentures and the Deere Park Convertible
Debentures to restructure these debentures. Under the terms of the
restructuring, Gordon Brothers agreed to fix the conversion price at $15 per
share for the term of the debenture. In return, the Company agreed to reduce the
strike price on 12,136 warrants issued in connection with the original funding
from $20.60 to $15 per share. Deere Park agreed to fix the conversion price at
$15 per share until May 1, 1999. Beyond this date, the conversion price will
revert to a "floating" price for the term of the debentures unless it is further
restructured. In return, the Company agreed to issue an additional 8,000
warrants to Deere Park at current market prices. In addition, the Company repaid
$1,000,000 of the Deere Park Convertible Debentures at 107% plus accrued
interest.
The Company estimated the fair value of all of the warrants issued to the
placement agent utilizing the Black-Scholes option pricing model with the
following assumptions: dividend yield of 0%, expected volatility of 50%, risk
free interest rate of 5%, and an expected life of 2 years. The fair value of the
warrants of approximately $390,000 is being accounted for as deferred offering
costs and amortized over the life of the Notes.
The Company renegotiated the terms of the revolving credit facility to
provide borrowings of up to $2.5 million and extended the term of the facility
to July 31, 1999. As of September 30, 1998, the Company had drawn $1.9 million
on this facility. The Company also negotiated terms with certain of its
equipment vendors which call for extended payment terms and increased credit
lines, including two lines of credit each of up to $2.0 million, with sixty day
and ninety day payment terms, respectively.
10
<PAGE>
Telscape USA and MSN have obtained a waiver under the Revolving Credit
Facility to (i) permit the Guarantee of the Notes (see Note 8) by Telscape USA
and MSN and (ii) waive the defaults under the minimum current ratio covenant.
In June 1998, members of the management team of the Company exercised
certain options and warrants resulting in approximately $1.2 million in proceeds
to the Company.
In June 1998, the Company financed the purchase of $1.4 million of
equipment by entering into an equipment lease arrangement with a financing
company which provides for monthly lease payments of $27,500, including
principal and interest, through May 31, 2003. The lease obligation is secured by
the financed equipment.
In July 1998, the Company financed the purchase of $972,000 of equipment
by entering into two equipment lease arrangements with a financing company which
provide for monthly lease payments totaling $22,100, including principal and
interest through July 6, 2003. The lease obligations are secured by the financed
equipment.
In July 1998, the Company financed the purchase of $243,000 of equipment
by entering into an equipment lease arrangement with a financing company which
provides for monthly lease payments of $6,600, including principal and interest
through July 14, 2002. The lease obligation is secured by the financed
equipment.
The Company has also received a commitment from a financing company to
fund equipment purchases of up to $6.0 million dollars through May 1999. The
financing is structured as loans maturing three years from funding at interest
rates 550 basis points above the Federal Reserve Treasury Constant Maturity Rate
(as defined). The Company expects to close this transaction in November 1998.
In July 1998, holders of the non-interest bearing convertible notes issued
in connection with the Integracion acquisition converted these notes into
333,000 shares of Common Stock.
NOTE 6 - LOSSES DUE TO ADDITIONAL PREPAID PHONE CARD SERVICES COSTS AND
BANKRUPTCY OF CUSTOMER
In May 1998, one of the Company's wholesale long distance customers filed
a petition for relief under Chapter 11 of the U.S. Bankruptcy Code.
Additionally, an affiliate of this customer provided switching services and the
Company's prepaid card platform and arranged for other carriers to provide
telecommunications services for the Company's prepaid cards. The Company had
paid the affiliate of the customer for the telecommunications services at the
time the prepaid cards were activated. After the bankruptcy, such affiliate was
unable to provide these services. Because the Company continued to provide
service to its prepaid card customers by working directly with the underlying
service providers, this resulted in the Company paying for certain of the
telecommunications services a second time. The overall impact of the bankruptcy
filing to the operating income of the Company for the second quarter 1998,
including additional prepaid card service costs, the write-off of uncollectible
receivables and the lost margin contribution from the loss of a wholesale long
distance customer, is estimated at approximately $2.0 million. This bankruptcy
is not expected to have a material impact on the Company's future operating
results.
NOTE 7 - MEXICAN CONCESSION
In June 1998, Telereunion S.A. de C.V. ("Telereunion S.A."), a Mexican
corporation and an affiliate of the Company ("Telereunion S.A."), received a
30-year, facilities-based license from the Mexican government allowing it to
construct and operate a network on which the Company can carry long distance
traffic in Mexico (the "Mexican Concession"). The Company intends to (i)
construct a combined fiber optic and microwave long distance network connecting
the United States, the Gulf region of Mexico and targeted Mexican cities (the
"Mexican Network") and (ii) acquire transmission and switching facilities for
expansion of the Company's international network.
11
<PAGE>
Under the terms of the Mexican Concession, the Company must satisfy
several conditions, including limitations on the scope and location of the
Mexican Network and minimum capital requirements with respect to Telereunion
S.A. The minimum capital requirements state that Telereunion S.A. must have
approximately $1.0 million in contributed capital upon commencement of
operations and approximately $40.0 million of invested capital upon completion
of the first 12 months of operations. The Company intends to raise the funds
necessary to meet this requirement through the Notes Offering (see Note 9). If
the Company is unable to consummate the Notes Offering, it intends to raise the
funds necessary to satisfy the capital requirements from public or private
equity or debt sources. There can be no assurance that the Company will be able
to obtain additional financing or, if obtained, that it will be able to do so on
a timely basis or on terms favorable to the Company. There also can be no
assurance that the Company will be able to comply with the conditions of the
Mexican Concession. Moreover, the failure of the Company to comply with such
terms could cause a termination of the Mexican Concession, and the Mexican
government would not be required to compensate the Company for such a
termination. Such a termination would prevent the Company from engaging in its
proposed business.
NOTE 8 - REGISTRATION STATEMENTS
In July 1998, the Company filed two Registration Statements with the
Securities and Exchange Commission for the offering and sale of (i) $125.0
million in Senior Unsecured Notes (the "Notes") due 2008 (the "Notes Offering")
and (ii) 3,400,000 shares of the Company's Common Stock (the "Equity Offering").
Due to recent market developments, the Company withdrew the Equity Offering from
the Commission on September 15, 1998.
NOTE 9 - STOCK OPTION PLANS
During June 1998, the Company adopted the "1998 Stock Option and
Appreciation Rights Plan." Pursuant to the Company's 1998 Stock Option and
Appreciation Rights Plan, the Company may grant the Company's employees,
directors and consultants non-qualified options to purchase up to 800,000 shares
of Common Stock. The maximum number of shares of Common Stock that may be
granted to any individual under this plan may not exceed 250,000 shares. The
Plan also provides for grants of SARs in connection with the grant of options
under the plan. Incentive stock options must be granted at not less than the
fair market value of the Company's Common Stock at the date of grant as
determined by the Company's Board of Directors (110% of fair market value for
stockholders owning 10% or more of the Company's Common Stock). The terms of the
options are determined by the Company's Board of Directors. Any options granted
must be exercised within ten years of the date of grant or within five years
from the date of grant for options granted to stockholders owning 10% or more of
the Company's Common Stock. Unexercised vested and unvested options terminate
immediately if the employment or service of an option holder is terminated for
cause. Unvested options terminate if the employment or service of an option
holder is terminated without cause or for disability. The Company may also grant
SARs in connection with any option, which permits cashless exercises of the
options. SARs allow an option holder to surrender an option and to receive the
difference between the exercise price of the option and the then fair market
value of the Common Stock. The Company may also make loans to any option holder
in order to permit the option holder to pay the purchase price upon exercise of
the option.
During October 1998, the Company adopted the "1998 MSN Stock Option and
Appreciation Rights Plan." Pursuant to the Company's 1998 MSN Stock Option and
Appreciation Rights Plan, the Company may grant the Company's employees,
directors and consultants non-qualified options to purchase up to 100,000 shares
of Common Stock. The maximum number of shares of Common Stock that may be
granted to any individual under this plan may not exceed 50,000 shares. The
terms of the options are determined by the Company's Board of Directors. Any
options granted must be exercised within ten years of the date of grant or
12
<PAGE>
within five years from the date of grant for options granted to stockholders
owning 10% or more of the Company's Common Stock. Unexercised vested and
unvested options terminate immediately if the employment or service of an option
holder is terminated for cause. Unvested options terminate if the employment or
service of an option holder is terminated without cause or for disability. The
Company may also grant SARs in connection with any option, which permits
cashless exercises of the options. SARs allow an option holder to surrender an
option and to receive the difference between the exercise price of the option
and the then fair market value of the Common Stock. The Company may also make
loans to any option holder in order to permit the option holder to pay the
purchase price upon exercise of the option.
NOTE 10 - WARRANTS VESTING
During the third quarter, 500,000 warrants, issued in connection with the
Telereunion acquisition, vested as a result of certain operating performance
measures being achieved. As a result, the Company recorded $5.5 million in
additional consideration, which was reflected as an increase in goodwill, in
connection with the Telereunion acquisition.
13
<PAGE>
NOTE 11 - SEGMENT INFORMATION
The Company operates in two business segments, international long distance
and systems integration services. Long distance services revenues are generated
in the United States of America. Systems integration services revenues are
generated principally in Mexico.
Revenues, operating information and identifiable assets by business
segment and location are as follows:
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
1997 1998
------------ ------------
Revenues ---
Long distance services - United States . $ 11,371,000 $ 75,899,000
Systems Integration - Mexico and other . 10,763,000 26,407,000
------------ ------------
Total revenues .............. $ 22,134,000 $102,306,000
Operating income (loss) ---
Long distance services - United States . 2,176,000 826,000
Systems Integration - Mexico and other . (697,000) 3,114,000
------------ ------------
Total operating income (loss) $ 1,479,000 $ 3,940,000
------------ ------------
Capital Expenditures ---
Long distance services - United States . $ 391,000 $ 8,298,000
Systems Integration - Mexico and other . 535,000 896,000
------------ ------------
Total capital expenditures .. $ 926,000 $ 9,194,000
Depreciation and amortization ---
Long distance services - United States . $ 77,000 $ 1,171,000
Systems Integration - Mexico and other . 354,000 1,047,000
------------ ------------
Total depreciation and
amortization ............. $ 431,000 $ 2,218,000
============ ============
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
1997 1998
------------ ------------
Identifiable assets ---
Long distance services - United States . $ 7,091,000 $ 40,849,000
Systems Integration - Mexico and other . 14,946,000 39,678,000
------------ ------------
Total identifiable assets ... $ 22,037,000 $ 80,527,000
============ ============
NOTE 12 - SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION
The Company's wholly-owned United States subsidiaries (the "Guarantors"),
will fully and unconditionally guarantee, on a senior basis, jointly and
severally, the full and prompt performance of the Company's obligations under
the Notes (See Note 5), including the payment of and interest on the Notes. The
following condensed consolidating financial statements are presented for
purposes of complying with the reporting requirements of the parent company and
subsidiaries which are guarantors under the Notes. Separate financial statements
of the Guarantors are not presented because the Company believes such statements
would not be material to investors.
14
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------ -------------- --------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ......... $ 55,000 $ 5,227,000 $ 1,919,000 $ -- $ 7,201,000
Accounts receivable, net .......... (41,000) 3,276,000 10,793,000 -- 14,028,000
Inventories ....................... (50,000) 30,000 5,307,000 -- 5,287,000
Prepaid expenses and other ........ 141,000 555,000 4,549,000 -- 5,245,000
Deferred income taxes ............. -- 109,000 225,000 -- 334,000
Intercompany receivables
(payables), net ................. 9,330,000 (1,511,000) (7,819,000) -- --
------------ ------------ ------------ ------------ ------------
Total current assets ...... 9,435,000 7,686,000 14,974,000 -- 32,095,000
Property and equipment, net ....... 244,000 5,224,000 9,531,000 -- 14,999,000
Goodwill and other intangibles, net 9,260,000 22,439,000 -- -- 31,699,000
Investments in affiliates ......... 26,986,000 -- -- (26,740,000) 246,000
Other assets ...................... 1,044,000 157,000 287,000 -- 1,488,000
------------ ------------ ------------ ------------ ------------
Total assets .............. $ 46,969,000 $ 35,506,000 $ 24,792,000 $(26,740,000) $ 80,527,000
============ ============ ============ ============ ============
LIABILITIES AND STOCKHOLDERS'
EQUITY
CURRENT LIABILITIES:
Accounts Payable .................. $ 322,000 $ 3,554,000 $ 18,174,000 $ -- $ 22,050,000
Accrued Expenses .................. 103,000 5,520,000 2,278,000 -- 7,901,000
Current portion of
note payable and
capital lease
obligations ..................... 517,000 2,437,000 -- -- 2,954,000
Current portion of
convertible debentures .......... 4,994,000 -- -- -- 4,994,000
Deferred income taxes ............. -- -- 328,000 -- 328,000
------------ ------------ ------------ ------------ ------------
Total current liabilities ..... 5,936,000 11,511,000 20,780,000 -- 38,227,000
Notes payable and
capital lease
obligations .................... 384,000 1,184,000 -- -- 1,568,000
Convertible
Debentures ..................... 4,929,000 -- -- -- 4,929,000
Minority interests ............... (34,000) 83,000 -- -- 49,000
Commitments and
contingencies .................. -- -- -- -- --
Series B Non-voting
preferred stock ................ -- -- -- -- --
STOCKHOLDERS' EQUITY
Preferred Stock .................. -- -- -- -- --
Series A preferred stock ......... -- -- -- -- --
Common stock ..................... 6,000 31,000 152,000 (183,000) 6,000
Additional paid-in
capital ........................ 38,129,000 18,190,000 3,028,000 (21,218,000) 38,129,000
Accumulated deficit .............. (1,490,000) 4,507,000 832,000 (5,339,000) (1,490,000)
Treasury stock ................... (891,000) -- -- -- (891,000)
------------ ------------ ------------ ------------ ------------
Total stockholders'
equity .................. 35,754,000 22,728,000 4,012,000 (26,740,000) 35,754,000
------------ ------------ ------------ ------------ ------------
Total liabilities and
stockholders' equity .... $ 46,969,000 $ 35,506,000 $ 24,792,000 $(26,740,000) $ 80,527,000
============ ============ ============ ============ ============
</TABLE>
15
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1997
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............. $ 3,000 $ 4,187,000 $ 544,000 $ -- $ 4,734,000
Accounts receivable, net .............. -- 1,219,000 5,057,000 -- 6,276,000
Inventories ........................... -- -- 4,305,000 -- 4,305,000
Prepaid expenses and other ............ 275,000 163,000 2,236,000 -- 2,674,000
Deferred income taxes ................. -- 517,000 -- -- 517,000
Intercompany receivables
(payables), net ..................... 2,975,000 291,000 (3,266,000) -- --
------------ ------------ ------------ ------------ ------------
Total current assets .......... 3,253,000 6,377,000 8,876,000 -- 18,506,000
Property and equipment, net ........... 296,000 396,000 1,987,000 -- 2,679,000
Goodwill and other intangibles, net ... 63,000 17,611,000 -- -- 17,674,000
Investments in affiliates ............. 19,010,000 -- -- (18,715,000) 295,000
Other assets .......................... 169,000 122,000 190,000 -- 481,000
------------ ------------ ------------ ------------ ------------
Total assets .................. $ 22,791,000 $ 24,506,000 $ 11,053,000 $(18,715,000) $ 39,635,000
============ ============ ============ ============ ============
LIABILITIES AND STOCKHOLDERS'
EQUITY
CURRENT LIABILITIES:
Accounts Payable ...................... $ 156,000 $ 343,000 $ 10,257,000 $ -- $ 10,756,000
Accrued Expenses ...................... 54,000 1,906,000 1,343,000 -- 3,303,000
Current portion of
note payable and
capital lease
obligations ......................... 208,000 300,000 -- -- 508,000
Deferred income taxes ................. -- -- 270,000 -- 270,000
------------ ------------ ------------ ------------ ------------
Total current liabilities ......... 418,000 2,549,000 11,870,000 -- 14,837,000
Notes payable and capital lease
obligations ........................ 285,000 2,391,000 -- -- 2,676,000
Minority interests ................... -- 34,000 -- -- 34,000
Commitments and contingencies ........ -- -- -- -- --
Series B Non-voting preferred stock .. -- -- -- -- --
STOCKHOLDERS' EQUITY
Preferred Stock ...................... -- -- -- -- --
Series A preferred stock ............. -- -- -- -- --
Common stock ......................... 4,000 11,000 152,000 (163,000) 4,000
Additional paid-in capital ........... 25,232,000 15,965,000 28,000 (15,993,000) 25,232,000
Accumulated deficit .................. (2,851,000) 3,556,000 (997,000) (2,559,000) (2,851,000)
Treasury stock ....................... (297,000) -- -- -- (297,000)
------------ ------------ ------------ ------------ ------------
Total stockholders'
equity ...................... 22,088,000 19,532,000 (817,000) (18,715,000) 22,088,000
------------ ------------ ------------ ------------ ------------
Total liabilities and
stockholders' equity ........ $ 22,791,000 $ 24,506,000 $ 11,053,000 $(18,715,000) $ 39,635,000
============ ============ ============ ============ ============
</TABLE>
16
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues .................................... $ -- $ 22,883,000 $ 21,371,000 $ (7,725,000) $ 36,529,000
Cost of revenues ............................ -- 20,881,000 16,571,000 (7,725,000) 29,727,000
------------ ------------ ------------ ------------ ------------
Gross profit ................................ -- 2,002,000 4,800,000 -- 6,802,000
Selling, general and
administrative expenses ................... 531,000 512,000 2,617,000 -- 3,660,000
Depreciation and
amortization .............................. 203,000 427,000 330,000 -- 960,000
------------ ------------ ------------ ------------ ------------
Operating income (loss) ..................... (734,000) 1,063,000 1,853,000 -- 2,182,000
Other income (expense):
Interest, net ............................. (289,000) (56,000) 10,000 -- (335,000)
Foreign exchange gain (loss) .............. -- -- (581,000) -- (581,000)
Other, net ................................ 173,000 11,000 57,000 -- 241,000
Equity in income of subsidiaries .......... 1,401,000 -- -- (1,401,000) --
------------ ------------ ------------ ------------ ------------
Total other income
(expense), net ...................... 1,285,000 (45,000) (514,000) (1,401,000) (675,000)
------------ ------------ ------------ ------------ ------------
Income (loss) before
income taxes and
minority interests ........................ 551,000 1,018,000 1,339,000 (1,401,000) 1,507,000
Income tax benefit (expense) ................ 285,000 (468,000) (469,000) -- (652,000)
------------ ------------ ------------ ------------ ------------
Income (loss) before
minority interests ........................ 836,000 550,000 870,000 (1,401,000) 855,000
Minority interests in
subsidiaries .............................. 33,000 (19,000) -- -- 14,000
------------ ------------ ------------ ------------ ------------
Net income (loss) ........................... $ 869,000 $ 531,000 $ 870,000 $ (1,401,000) $ 869,000
============ ============ ============ ============ ============
</TABLE>
17
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues ......................... $ -- $ 5,646,000 $ 11,293,000 $ (4,747,000) $ 12,192,000
Cost of revenues ................. 6,000 3,010,000 10,186,000 (4,747,000) 8,455,000
------------ ------------ ------------ ------------ ------------
Gross profit ..................... (6,000) 2,636,000 1,107,000 -- 3,737,000
Selling, general and
administrative expenses ........ 193,000 737,000 1,446,000 -- 2,376,000
Depreciation and amortization .... 25,000 6,000 161,000 -- 192,000
------------ ------------ ------------ ------------ ------------
Operating income (loss) .......... (224,000) 1,893,000 (500,000) -- 1,169,000
Other income (expense):
Interest, net .................. (16,000) (27,000) (1,000) -- (44,000)
Foreign exchange gain (loss) ... -- -- (29,000) -- (29,000)
Other, net ..................... -- (6,000) 20,000 -- 14,000
Equity in income of subsidiaries 1,412,000 -- -- (1,412,000) --
------------ ------------ ------------ ------------ ------------
Total other income
(expense), net ........... 1,396,000 (33,000) (10,000) (1,412,000) (59,000)
------------ ------------ ------------ ------------ ------------
Income (loss) before income
taxes and Minority interests ... 1,172,000 1,860,000 (510,000) (1,412,000) 1,110,000
Income tax benefit (expense) ..... 13,000 207,000 (141,000) -- 79,000
------------ ------------ ------------ ------------ ------------
Income (loss) before
minority interests ............. 1,185,000 2,067,000 (651,000) (1,412,000) 1,189,000
Minority interests in
subsidiaries ................... 17,000 -- (4,000) -- 13,000
------------ ------------ ------------ ------------ ------------
Net income (loss) ................ $ 1,202,000 $ 2,067,000 $ (655,000) $ (1,412,000) $ 1,202,000
============ ============ ============ ============ ============
</TABLE>
18
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues ......................... $ -- $ 72,112,000 $ 50,582,000 $ (20,388,000) $ 102,306,000
Cost of revenues ................. -- 67,013,000 40,158,000 (20,388,000) 86,783,000
------------- ------------- ------------- ------------- -------------
Gross profit ..................... -- 5,099,000 10,424,000 -- 15,523,000
Selling, general and
administrative expenses ........ 1,221,000 1,892,000 6,252,000 -- 9,365,000
Depreciation and amortization .... 482,000 1,113,000 623,000 -- 2,218,000
------------- ------------- ------------- ------------- -------------
Operating income (loss) .......... (1,703,000) 2,094,000 3,549,000 -- 3,940,000
Other income (expense):
Interest, net .................. (412,000) (126,000) (48,000) -- (586,000)
Foreign exchange gain (loss) ... -- -- (768,000) -- (768,000)
Other, net ..................... 173,000 83,000 81,000 -- 337,000
Equity in income of subsidiaries 2,780,000 -- -- (2,780,000) --
------------- ------------- ------------- ------------- -------------
Total other income
(expense), net ........... 2,541,000 (43,000) (735,000) (2,780,000) (1,017,000)
------------- ------------- ------------- ------------- -------------
Income (loss) before
income taxes and
minority interests ............. 838,000 2,051,000 2,814,000 (2,780,000) 2,923,000
Income tax benefit
(expense) ...................... 489,000 (1,051,000) (985,000) -- (1,547,000)
------------- ------------- ------------- ------------- -------------
Income (loss) before
minority interests ............. 1,327,000 1,000,000 1,829,000 (2,780,000) 1,376,000
Minority interests in
subsidiaries ................... 34,000 (49,000) -- -- (15,000)
------------- ------------- ------------- ------------- -------------
Net income (loss) ................ $ 1,361,000 $ 951,000 $ 1,829,000 $ (2,780,000) $ 1,361,000
============= ============= ============= ============= =============
</TABLE>
19
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues ......................... $ -- $ 11,371,000 $ 17,226,000 $ (6,463,000) $ 22,134,000
Cost of revenues ................. 6,000 6,777,000 14,129,000 (6,463,000) 14,449,000
------------ ------------ ------------ ------------ ------------
Gross profit ..................... (6,000) 4,594,000 3,097,000 -- 7,685,000
Selling, general and
administrative expenses ........ 832,000 1,503,000 3,440,000 -- 5,775,000
Depreciation and amortization .... 64,000 13,000 354,000 -- 431,000
------------ ------------ ------------ ------------ ------------
Operating income (loss) .......... (902,000) 3,078,000 (697,000) -- 1,479,000
Other income (expense):
Interest, net .................. (39,000) (8,000) 3,000 -- (44,000)
Foreign exchange gain (loss) ... -- -- (2,000) -- (2,000)
Other, net ..................... (324,000) (6,000) 50,000 -- (280,000)
Equity in income of subsidiaries 2,664,000 -- -- (2,664,000) --
------------ ------------ ------------ ------------ ------------
Total other income
(expense), net ........... 2,301,000 (14,000) 51,000 (2,664,000) (326,000)
------------ ------------ ------------ ------------ ------------
Income (loss) before
income taxes and
minority interests ............. 1,399,000 3,064,000 (646,000) (2,664,000) 1,153,000
Income tax benefit (expense) ..... -- 207,000 39,000 -- 246,000
------------ ------------ ------------ ------------ ------------
Income (loss) before
minority interests ............. 1,399,000 3,271,000 (607,000) (2,664,000) 1,399,000
Minority interests in
subsidiaries ................... 17,000 -- -- -- 17,000
------------ ------------ ------------ ------------ ------------
Net income (loss) ................ $ 1,416,000 $ 3,271,000 $ (607,000) $ (2,664,000) $ 1,416,000
============ ============ ============ ============ ============
</TABLE>
20
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income .................. $ 1,361,000 $ 951,000 $ 1,829,000 $ (2,780,000) $ 1,361,000
Adjustments to
reconcile net income to
net cash provided by
(used in) operating
activities:
Provision for
doubtful accounts ... -- 548,000 8,000 -- 556,000
Depreciation and
amortization ........ 482,000 1,113,000 623,000 -- 2,218,000
Imputed interest
on non-interest
bearing notes
payable and
amortization of
discount on
convertible notes ... 42,000 170,000 -- -- 212,000
Minority
interests in
subsidiaries' income (34,000) 49,000 -- -- 15,000
Equity in income
from subsidiaries .. (2,731,000) -- -- 2,780,000 49,000
Changes in
other assets and
other liabilities .. (2,090,000) 1,924,000 2,446,000 -- 2,280,000
------------ ------------ ------------ ------------ ------------
Net cash provided by
(used in) operating
activities ......... (2,970,000) 4,755,000 4,906,000 -- 6,691,000
------------ ------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchases of property
and equipment .............. -- (5,663,000) (3,531,000) -- (9,194,000)
Acquisition of MSN, net
of cash acquired ........... (2,325,000) -- -- -- (2,325,000)
Acquisition of
INTERLINK, net of
cash acquired .............. (8,250,000) -- -- -- (8,250,000)
------------ ------------ ------------ ------------ ------------
Net cash used in
investing activities (10,575,000) (5,663,000) (3,531,000) (19,769,000)
------------ ------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Payments on capital
lease obligations .......... (55,000) -- -- -- (55,000)
Payments on notes payable .... (538,000) -- -- -- (538,000)
Purchase of treasury stock ... (594,000) -- -- -- (594,000)
Borrowings on line of
credit, net ................ -- 1,948,000 -- -- 1,948,000
Proceeds from warrants
and options exercised ...... 4,784,000 -- -- -- 4,784,000
Proceeds from issuance
of convertible debt ........ 10,000,000 -- -- -- 10,000,000
------------ ------------ ------------ ------------ ------------
Net cash provided
by financing activities 13,597,000 1,948,000 -- -- 15,545,000
------------ ------------ ------------ ------------ ------------
Net increase
(decrease) in cash
and cash equivalents ... 52,000 1,040,000 1,375,000 -- 2,467,000
------------ ------------ ------------ ------------ ------------
Cash and cash
equivalents at
beginning of period ... 3,000 4,187,000 544,000 -- 4,734,000
------------ ------------ ------------ ------------ ------------
Cash and cash
equivalents at end
of period ............. $ 55,000 $ 5,227,000 $ 1,919,000 $ -- $ 7,201,000
============ ============ ============ ============ ============
</TABLE>
21
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income (loss) ........... $ 1,416,000 $ 3,271,000 $ (607,000) $(2,664,000) $ 1,416,000
Adjustments to
reconcile net income
(loss) to net cash
provided by operating
activities:
Provision for
doubtful accounts ... -- 450,000 -- -- 450,000
Depreciation and
amortization ........ 64,000 13,000 354,000 -- 431,000
Write-off
investment in
operating venture ... 196,000 -- -- -- 196,000
Minority
interests in
subsidiaries' income (13,000) (1,000) (3,000) -- (17,000)
Equity in income
from subsidiaries .. (2,664,000) -- -- 2,664,000 --
Changes in other
assets and other
liabilities ........ 799,000 1,214,000 1,451,000 -- 3,464,000
----------- ----------- ----------- ----------- -----------
Net cash provided by
operating activities (202,000) 4,947,000 1,195,000 -- 5,940,000
----------- ----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchases of property
and equipment .............. (342,000) (49,000) (535,000) -- (926,000)
Proceeds from asset sale
leaseback .................. 119,000 -- -- -- 119,000
Cash acquired in
acquisition, net of
purchase price ............. 177,000 -- -- -- 177,000
----------- ----------- ----------- ----------- -----------
Net cash used in
investing activities (46,000) (49,000) (535,000) -- (630,000)
----------- ----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Payments on capital
lease obligations .......... (62,000) -- -- -- (62,000)
Proceeds from issuance
of common stock ............ 15,000 -- -- -- 15,000
----------- ----------- ----------- ----------- -----------
Net cash provided
by financing activities (47,000) -- -- -- (47,000)
----------- ----------- ----------- ----------- -----------
Net increase
(decrease) in cash
and cash equivalents ... (295,000) 4,898,000 660,000 -- 5,263,000
----------- ----------- ----------- ----------- -----------
Cash and cash
equivalents at
beginning of period ... 300,000 55,000 140,000 -- 495,000
----------- ----------- ----------- ----------- -----------
Cash and cash
equivalents at
end of period ......... $ 5,000 $ 4,953,000 $ 800,000 $ -- $ 5,758,000
=========== =========== =========== =========== ===========
</TABLE>
22
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements in this Quarterly Report on Form 10-Q made herein that
are not historical are forward-looking within the meaning of the Private
Securities Litigation Reform Act of 1995. Such statements can be identified by
the use of forward-looking terminology such as "believes", "expects", "may",
"estimates", "will", "should", "plans", or "anticipates" or the negative thereof
or other variations thereon or comparable terminology, or by discussions of
strategy. These statements are based on numerous assumptions about future
conditions that could prove not to be accurate. Actual events, transactions and
results may materially differ from the anticipated events, transactions or
results described in such statements. Investors are cautioned that all
forward-looking statements are not guarantees of future performance and that
actual results could vary materially from those in the forward-looking
statements. Investors are also cautioned that forward-looking statements involve
risks and uncertainties including, without limitation, risks related to the
effectiveness of management's strategies and decisions, market acceptance of and
demand for the Company's products and services by customers, continued
relationships with and pricing dependence on third party suppliers, economic
conditions, results of financing efforts and regulatory approvals and
developments. This report identifies other factors that could cause such
differences. No assurance can be given that these are all of the factors that
could cause actual results to vary materially from the forward-looking
statements. Statements with respect to acquisitions and continued trends are
forward-looking and involve risks and uncertainties. Furthermore, the Company
has significant operations in Mexico, subjecting the Company to certain
political and commercial risk. The Company undertakes no obligation and does not
intend to update, revise or otherwise publicly release the result of any
revisions to these forward-looking statements that may be made to reflect future
events or circumstances.
OVERVIEW
Telscape is a rapidly-growing, emerging multinational telecommunications
carrier focused on Latin America. The Company provides international wholesale
long distance services for calls originating in the United States and
terminating in markets in Latin America. As a way to generate increased
international long distance traffic to countries it serves, the Company markets
long distance services principally to Hispanic consumers in the United States
through the distribution of prepaid cards under the TELEFIESTA(R) brand name. In
addition to these wholesale and retail international long distance services, the
Company also provides a broad range of systems integration and value-added voice
and data services to major public and private sector customers in Mexico.
Telscape intends to significantly expand its facilities-based
telecommunications and to broaden its service offerings in markets where it has
established, or expects to establish, a significant presence. In June 1998,
Telereunion S.A. de C.V. ("Telereunion S.A."), a Mexican corporation and an
affiliate of the Company, was granted a long distance concession from the
Mexican government. The concession is a 30-year, facilities-based carrier
license which allows it to construct and operate a network over which the
Company can carry long distance traffic in Mexico ("the Mexican Concession").
Assuming that the Company is able to raise the capital described in Liquidity
and Capital Resources, the Company, through Telereunion S.A., intends to
construct the Mexican Network, a combined fiber-optic and microwave long
distance network, connecting the United States, the Gulf region of Mexico and
targeted Mexican cities.
In May 1996, Telscape began to focus on providing telecommunication
services to and in Latin America. The Company acquired all of the stock of
Telereunion S.A., the owner of 97.0% of Vextro de Mexico S.A. de C.V.
("Vextro"). Vextro is a Mexico-based systems integration company, with an
emphasis on voice solutions. In September 1996, the Company expanded its
operations to include international long distance by acquiring Orion
Communications, Inc., a U.S.-based reseller of long distance services ("Orion").
In 1997, the Company expanded its systems integration service offerings by
acquiring Integracion de Redes, S.A. de C.V. ("Integracion") and N.S.I., S.A. de
C.V. ("N.S.I."), both focused on data services and based in Mexico City, Mexico.
23
<PAGE>
In January 1998, Telscape acquired MSN Communications, Inc. ("MSN"), a
leading provider of Prepaid Cards that are marketed under the TELEFIESTA(R)
brand name to Hispanic consumers residing in the United States. The MSN
acquisition enhances Telscape's international long distance business by
providing a retail platform, enhancing its ability to market additional products
and services to Hispanic customers and increasing its ability to generate
significant returns of U.S.-outbound traffic to Latin America. The Company plans
to leverage the TELEFIESTA(R) brand recognition in other Latin American
countries after obtaining the required licenses.
Effective June 1, 1998, the Company through its newly-formed subsidiary
Interlink Communications Holding Co., Inc. ("INTERLINK") acquired California
Microwave Services Division, Inc. for $8.2 million in cash, subject to
post-closing adjustments. INTERLINK provides the Company with a teleport
facility in California, thereby enhancing the Company's position as an
integrated telecommunications provider and contributing to the Company's ability
to provide satellite capacity to its targeted markets in Latin America.
In June 1998, Telereunion S.A. received the Mexican Concession. The
Company believes that the Mexican Concession will enhance its service offerings
to business customers in Mexico while allowing it to reduce its cost of
international termination in Mexico.
Telscape intends to capitalize on the deregulating markets of Latin
America by providing international long distance services to and from targeted
Latin American countries. The Company also intends to position itself as an
integrated telecommunications provider in Mexico through the construction of the
Mexican Network under its recently granted Mexican Concession. The Company
believes that owning a long distance network in Mexico, combined with an
expanding international telecommunications network, will increase the percentage
of minutes of traffic carried on-net, enable it to increase margins and
profitability and ensure quality of service on both international and domestic
long distance traffic.
REVENUES
During 1997, the Company derived its revenues principally from the
provision of systems integration and value-added services in Mexico and from the
sale of U.S. outbound international long distance services to Latin America. In
1998, with the addition of prepaid card revenues generated by recently acquired
MSN, the Company's revenue mix changed. The Company expects that this line of
business will contribute an increasing proportion of the revenues.
The Company provides systems integration services to private and public
sector customers in Mexico. Revenues are derived from the sale of equipment and
value-added services. Revenues from this business have grown significantly
through both internal growth and strategic acquisitions in 1996 and 1997. The
revenues in this line of business are subject to economic conditions in Mexico
and are expected to soften in 1999 as a result thereof.
The Company provides international long distance services to wholesale
customers. Revenues are derived from the number of minutes of use (or fraction
thereof) billed by the Company and are recorded upon completion of calls.
The Company also provides domestic and international long distance
services through the sale of prepaid cards. The Company has in the past entered
into, and may in the future enter into, arrangements with third parties whereby
these parties provide, at a fixed cost to the Company, the long distance
telecommunications services for the prepaid cards that the Company sells. The
Company recognizes revenues from the sale of prepaid cards under these
agreements at the time of shipment. In other cases, third parties provide
telecommunications services for the prepaid cards and bills the Company for such
services based on customer usage. The Company recognizes revenues from the sale
of prepaid cards under these agreements at the time of customer usage.
24
<PAGE>
In May 1998, one of the Company's wholesale long distance customers filed
a petition for relief under Chapter 11 of the U.S. Bankruptcy Code.
Additionally, an affiliate of this customer provided switching services and the
Prepaid Card platform and arranged for other carriers to provide
telecommunications services for the Prepaid Cards. The Company had paid the
affiliate of this customer for these services at the time the Prepaid Cards were
activated. Because the Company continued to provide services to its Prepaid Card
customers by working directly with the underlying service providers, this
resulted in the Company paying for certain of the telecommunications services on
the Prepaid Cards a second time. The overall impact of the bankruptcy filing to
the Company's earnings, including additional Prepaid Card services costs, the
write-off of uncollectible receivables and the lost margin contribution from the
loss of a wholesale customer, resulted in a reduction of operating income of
approximately $2.0 million in the second quarter of 1998. The lost revenues from
this customer have been replaced by replacing the minutes previously purchased
by this customer with existing or new customers at market rates.
GROSS MARGIN
The Company has enjoyed strong gross profits from its international long
distance and systems integration services to date; however, as these markets
become more competitive, the Company may experience a decline in gross profit
percentage. The effects of this potential decline are expected to be mitigated
by the Company's strategy of focusing on providing long distance services in
deregulating markets, particularly in Latin America, and on providing
value-added services, where it can enjoy higher gross profit percentages. Gross
profits as a percentage of revenues from the Company's newly-acquired Prepaid
Card business are significantly lower than those of the wholesale international
long distance and systems integration businesses. As such, overall gross profit
as a percentage of revenues has declined in the first three quarters of 1998 as
compared to fiscal 1997 and will decline as the prepaid card revenues increase
as a percentage of overall revenues.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1997
REVENUES increased from $12,192,000 in 1997 to $36,529,000 in 1998. This
increase of $24,337,000, or 200%, was due principally to the acquisition of MSN
completed in the first quarter of 1998, which provided revenues of $13.0 million
in the third quarter of 1998. Wholesale international long distance revenues
increased $4.1 million from $ 5.7 million for the three months ended September
30, 1997 to $9.8 million for the three months ended September 30, 1998. In
addition, revenues from systems integration services increased $ 4.7 million
from $6.4 million for the three months ended September 30, 1997 to $11.1 million
for the three months ended September 30, 1998. This increase in systems
integration services revenues is due to the overall growth in revenues from
these services. The acquisition of INTERLINK provided an additional $2.6 million
in revenues.
COST OF REVENUES increased from $8,455,000 in 1997 to $29,727,000 in 1998,
or $21,272,000. The 252% increase in cost of revenues was due principally to the
incremental cost of revenues associated with the acquisition of MSN, the
increase in the sale of international long distance services and systems
integration and, to a lesser extent, the incremental cost of revenues
attributable to the acquisition of INTERLINK. The cost of revenues as a
percentage of revenues increased from 69.3% to 81.4%, or 12.1%, due principally
to the higher cost of revenues as a percentage of revenues associated with the
sale of prepaid phone cards and declining margins on wholesale long distance
services.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A") increased from
$2,376,000 in 1997 to $3,660,000 in 1998, or $1,284,000. The 54% increase in
SG&A was due principally to the incremental SG&A related to the operations of
the acquisitions of MSN and INTERLINK and increased staffing at existing
operations of the systems integration business and the wholesale long distance
business to meet the additional resource requirements associated with the growth
of these operations.
25
<PAGE>
Overall SG&A as a percentage of revenues decreased from 19.5% to 10.0%, or
9.5%. This decrease was due principally to the lower SG&A expenses as a
percentage of revenues associated with MSN and to the growth in overall revenues
rapidly outpacing the growth in SG&A expenses.
DEPRECIATION AND AMORTIZATION increased from $192,000 in 1997 to $960,000
in 1998, or $768,000. This increase is due to an increase in goodwill
amortization primarily due to the vesting of performance based warrants issued
in connection with the Telereunion acquisition, which resulted in additional
goodwill being recognized on December 31, 1997 and goodwill recognized on the
MSN and INTERLINK acquisitions. All of the performance based warrants associated
with the Telereunion acquisition have vested. Consequently, there will be no
additional goodwill recorded in connection with this acquisition. In addition,
depreciation increased as a result of the Company's continuing expansion of its
international wholesale long distance network which includes purchases of
switches and other telecommunications equipment and facilities. The Company
expects depreciation expense to increase as it continues to expand its
telecommunications network.
INTEREST INCOME (EXPENSE),NET increased from ($44,000) in 1997 to
($335,000) in 1998, or ($291,000). This increase was mainly due to an increase
in the Company's level of borrowings, including notes issued in connection with
the Integracion and MSN acquisitions, and the Deere Park Convertible Debentures
and Gordon Brothers Convertible Debentures issued in connection with the
INTERLINK acquisition.
OTHER INCOME (EXPENSE) increased from $(15,000) in 1997 to $(340,000) in
1998, or $(325,000). This increase is primarily due to foreign exchange
translation losses of $581,000 resulting from the translation of financial
statements of the Company's Mexican operations.
INCOME TAX BENEFIT (EXPENSE) changed from an income tax benefit of $79,000
in 1997 to an income tax expense of $(652,000) in 1998. The tax benefit realized
in 1997 is a result of the Company's utilization of its loss carryforwards to
offset taxable income and the recognition of a portion of the deferred tax
benefits related to the Company's tax loss carryforward. The effective tax rate
for the three months ended September 30, 1998, is higher that the U.S. and
Mexico statutory rate of 34% due to permanent differences, the most significant
of which is the nondeductible nature of goodwill amortization.
NET INCOME. The Company experienced net income of $1,202,000 in 1997 as
compared to a net income of $869,000 in 1998 due to a combination of the factors
discussed above.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1997
REVENUES increased from $22,134,000 in 1997 to $102,306,000 in 1998. This
increase of $80,172,000, or 362%, was due principally to the acquisition of MSN
completed in the first quarter of 1998, which provided revenues of $45.5 million
for the nine months ended September 30, 1998. Wholesale international long
distance revenues increased $15.2 million from $ 11.4 million for the nine
months ended September 30, 1997 to $26.6 million for the nine months ended
September 30, 1998. In addition, revenues from systems integration services
increased $15.7 million from $10.7 million for the three months ended September
30, 1997 to $26.4 million for the nine months ended September 30, 1998. This
increase in systems integration services revenues is due to the acquisitions of
Integracion, and N.S.I., completed during 1997 and to the overall growth in
revenues from these services. The acquisition of INTERLINK provided an
additional $3.8 million in revenues.
COST OF REVENUES increased from $14,449,000 in 1997 to $86,783,000 in
1998, or $72,334,000. The 501% increase in cost of revenues was due principally
to the incremental cost of revenues associated with the acquisition of MSN, the
increase in the sale of international long distance services and, to a lesser
extent, the incremental cost of revenues attributable to the acquisitions of
Integracion, N.S.I and INTERLINK. The cost of revenues as a percentage of
revenues increased from 65.3% to 84.8%, or 19.5%, due principally to the higher
cost of revenues as a percentage of revenues associated with the sale of prepaid
phone cards and declining margins on wholesale long distance services. In
addition, cost of revenues was negatively impacted by the additional costs,
estimated at $766,000, incurred on the Company's prepaid card services as a
result of the bankruptcy of a customer as discussed above.
26
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A") increased from
$5,775,000 in 1997 to $9,365,000 in 1998, or $3,590,000. The 62% increase in
SG&A was due principally to the incremental SG&A related to the operations of
the acquisitions of Integracion, N.S.I., MSN and INTERLINK and, to a lesser
extent, increased staffing at existing operations of the systems integration
business and the wholesale long distance business to meet the additional
resource requirements from the growth of these operations. In addition, SG&A was
negatively impacted by the write off of receivables, approximately $541,000, due
from the customer which filed for bankruptcy as discussed above.
Overall SG&A as a percentage of revenues decreased from 26.1% to 9.2%, or
16.9%. This decrease was due principally to the lower SG&A expenses as a
percentage of revenue associated with MSN and to the growth in overall revenues
rapidly outpacing the growth in SG&A expenses. This improvement was partially
offset by the write off of receivables due from the customer which filed for
bankruptcy as discussed above.
DEPRECIATION AND AMORTIZATION increased from $431,000 in 1997 to
$2,218,000 in 1998, or $1,787,000 This increase is due to an increase in
goodwill amortization primarily due the vesting of performance based warrants
issued in connection with the Telereunion acquisition, which resulted in
additional goodwill being recognized on December 31, 1997 and in the third
quarter 1998 and goodwill recognized on the INTERLINK, MSN, Integracion and
N.S.I. acquisitions. All of the performance based warrants associated with the
Telereunion acquisition have vested. Consequently, there will be no additional
goodwill recorded in connection with this acquisition. Depreciation increased as
a result of the Company's continuing expansion of its international wholesale
long distance network which includes purchases of switches and other
telecommunications equipment and facilities. The Company expects depreciation
expense to increase as it continues to expand its telecommunications network.
INTEREST INCOME (EXPENSE),NET increased from ($44,000) in 1997 to
($586,000) in 1998, or ($542,000). This increase was mainly due to an increase
in the Company's level of borrowings, including notes issued in connection with
the Integracion and MSN acquisitions, and the Deere Park Convertible Debentures
and Gordon Brothers Convertible Debentures issued in connection with the
INTERLINK acquisition.
OTHER INCOME (EXPENSE) increased from $(282,000) in 1997 to $(431,000) in
1998, or $(149,000). In 1997 the Company wrote off its $196,000 investment in
Elterix, an operating joint venture, and incurred a litigation settlement
expense of $128,000. In addition, in 1998, the Company incurred foreign exchange
translation losses resulting from translation of financial statements of the
Company's Mexican operations.
INCOME TAX BENEFIT (EXPENSE) changed from an income tax benefit of
$246,000 in 1997 to an income tax expense of $(1,547,000) in 1998. The tax
benefit realized in 1997 is a result of the Company's utilization of its loss
carryforwards to offset taxable income and the recognition of a portion of the
deferred tax benefits related to the Company's tax loss carryforward. The
effective tax rate for the nine months ended September 30, 1998, is higher than
the U.S. and Mexico statutory rates of 34% due to permanent differences, the
most significant of which is the nondeductible nature of goodwill amortization.
NET INCOME. The Company experienced a net income of $1,416,000 in 1997 as
compared to a net income of $1,361,000 in 1998 due to a combination of the
factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $5,940,000 and $6,691,000
for the nine months ended September 30, 1997 and September 30, 1998,
respectively. The increase in net cash provided by operations in 1998 as
compared to 1997 was due primarily to an increase in accounts payable in 1998 of
$9.5 million offset by an increase of value added tax receivables of
approximately $1.8 million, an increase in accounts receivable of $5.7 million,
an increase in deferred revenues of $ 4.3 million, additional costs on the
Company's Prepaid Card services and the write off of receivables associated with
the bankruptcy of a customer.
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Net cash used in investing activities was $(630,000) and $(19,769,000) for
the nine months ended September 30, 1997 and September 30, 1998, respectively.
In the nine months ended September 30, 1998, the Company expended approximately
$9.2 million on purchases of, or deposits on, property and equipment as part of
the Company's network expansion strategy as compared to $926,000 for the nine
months ended September 30, 1997. In addition, the Company acquired MSN for $2.3
million, net of cash acquired, and INTERLINK for $8.3 million, net of cash
acquired.
Net cash provided by (used in) financing activities was $(47,000) and
$15,545,000 for the nine months ended September 30, 1997 and September 30, 1998,
respectively. In December 1997, the Company announced its intention to redeem
publicly traded warrants to purchase an aggregate of 525,000 common shares with
a 30 day notice requirement. This announcement resulted in 475,535 warrants
being exercised prior to the redemption date. The Company realized net proceeds
from these exercises of $3.7 million, of which $2.7 million was received
subsequent to year-end. The Company also raised $10.0 million from the issuance
of the Deere Park Convertible Debentures and the Gordon Brothers Convertible
Debentures. In addition, the Company drew a net $1.9 million from its revolving
credit facility. Finally, the Company realized $2.1 million in proceeds from the
exercise of options and warrants.
As of September 30, 1998, the Company had cash and cash equivalents of
$7,201,000 and negative working capital of $6,132,000. Included in working
capital is $5.0 million in Convertible Debentures which mature on May 29, 1999
and approximately $3.5 million in accounts payable related to purchases of
equipment for the Company's Network expansion which the Company intends to
finance through long term loans or lease financing agreements.
In the first three quarters of 1998, the Company continued its strategic
plans to significantly expand the Company's facilities and capacity related to
its long distance services and Prepaid Card business lines. Through September
30, 1998, the Company has expended or placed purchase orders for equipment
purchases for a total in excess of $9.0 million relating to these business
expansions. Management does not expect that cash generated from operations will
be adequate to fund these capital investments.
RECENT FINANCINGS AND SOURCES OF CAPITAL
In May 1998, the Company issued $3,000,000 in 8% Convertible Subordinated
Debentures (the "Deere Park Convertible Debentures") maturing three years from
closing (the "First Draw") to Deere Park Capital Management, LLC, an Illinois
limited liability company ("Deere Park"). On May 28, 1998, the Company issued an
additional $1,000,000 of the Deere Park Convertible Debentures (the "Second
Draw"). On June 30, 1998, the Company issued an additional $1,000,000 of the
Deere Park Convertible Debentures (the "Third Draw"). The Deere Park Convertible
Debentures are convertible by the holder into shares of Common Stock at a price
equal to $26 per share for the First Draw, $29 per share for the Second Draw and
$26 per share for the Third Draw, until November 1, 1998, and thereafter, at the
lesser of (i) $26 per share for the First Draw, $29 per share for the Second
Draw and $26 per share for the Third Draw or (ii) a price equal to the average
of the three highest of the five lowest closing prices of the Common Stock for
the 20 trading days preceding the conversion date. If the Common Stock trades
below $15 per share for the First Draw, $16.66 per share for the Second Draw and
$15 for the Third Draw for three consecutive trading days, the Company may
redeem all or part of such Deere Park Convertible Debentures at 107% of face
value plus any accrued interest. The Company's obligation to make interest
payments on the Deere Park Convertible Debentures terminates if the price of
Common Stock closes for twenty consecutive trading days at or above $30 per
share for the First Draw, at or above $33.50 per share for the Second Draw and
at or above $30 per share for the Third Draw, adjusted, without limitation, for
any stock splits or combinations. In connection
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with the Deere Park Convertible Debentures, Deere Park also received warrants to
purchase an aggregate of 8,952 share of Common Stock at an exercise price of
$16.76 per share (subject to adjustment for stock splits and other share
adjustments) for the First Draw, warrants to purchase an aggregate of 2,427
shares of Common Stock at $20.60 per share (subject to adjustment for stock
splits and other share adjustments) for the Second Draw and warrants to purchase
an aggregate of 6,382 shares of Common Stock at $15.67 per share (subject to
adjustment for stock splits and other share adjustments) for the Third Draw. The
warrants have a term of three years from the effectiveness of a registration
statement covering such warrants. The Deere Park Convertible Debentures are PARI
PASSU in right of payment to the Notes.
The Company is required to pay an exit fee in connection with any
prepayment of principal to be made under the Deere Park Convertible Debentures
(the "Deere Park Exit Fee"). The Deere Park Exit Fee varies depending upon the
date of payment, and is equal to (i) 6.6% if the payment is made within 90 days
after the closing of each respective draw, (ii) 7.2% if payment is made after 90
days and up to 180 days after the closing of each respective draw, (iii) 8.8% if
payment is made after 180 days and up to 270 days after the closing of each
respective draw and (iv) 10.0% if payment is made after 270 days after the
closing of each respective draw. The Deere Park Exit Fee is adjusted on a pro
rata basis to the extent that the prepayment is made between periods except that
a minimum Deere Park Exit Fee of 6.6% is required if the prepayment is made
prior to 90 days after closing.
In May 1998, the Company issued $5,000,000 in 8% Convertible Debentures
(the "Gordon Brothers Convertible Debentures") maturing one year from closing to
Gordon Brothers Capital, LLC, a Delaware limited liability company ("Gordon
Brothers"). The Gordon Brothers Convertible Debentures are convertible by Gordon
Brothers into shares of Common Stock at a price equal to $29.00 per share until
November 1, 1998, and thereafter, at the lesser of (i) $29.00 per share or (ii)
a price equal to the average of the three highest of the five lowest closing
prices of the Common Stock for the 20 trading days preceding the conversion
date. If the Common Stock trades below $16.66 for three consecutive trading
days, the Company may redeem all or part of such Gordon Brothers Convertible
Debentures at 107% of face value plus any accrued interest. The Company's
obligation to make interest payments on the Gordon Brothers Convertible
Debentures terminates (i) in the event the Common Stock closes, for twenty
consecutive trading days, at or above $33.50 per share, adjusted, without
limitation, for any stock splits or combinations, (ii) when a registration
statement covering the Gordon Brothers Convertible Debentures is effective and
(iii) if there exists no event of default under the Gordon Brothers Convertible
Debentures. The Gordon Brothers Convertible Debentures are secured by a pledge
of the Company's stock in Telereunion and the Company's preferred stock in
INTERLINK. In addition, the Gordon Brothers Convertible Debentures are
guaranteed by INTERLINK and such guaranty is collateralized by a security
agreement covering all of INTERLINK's assets. In connection with the Gordon
Brothers Convertible Debentures, Gordon Brothers also received warrants to
purchase an aggregate of 12,136 shares of Common Stock at an exercise price of
$20.60 per share. The warrants have a term of three years from the effectiveness
of the registration statement covering such warrants. The Gordon Brothers
Convertible Debentures are senior secured indebtedness of the Company to the
extent of the assets securing such indebtedness.
The Company is required to pay an exit fee in connection with any
prepayment of principal to be made under the Gordon Brothers Convertible
Debentures (the "Gordon Brothers Exit Fee"). The Gordon Brothers Exit Fee varies
depending upon the date of payment, and is equal to (i) 6.5% if the payment is
made within 90 days after May 29, 1998, (ii) 13.0% if payment is made after 90
days and up to 180 days after May 29, 1998, (iii) 19.0% if payment is made after
180 days and up to 270 days after May 29, 1998 and (iv) 25.0% if payment is made
after 270 days and up to 365 days after May 29, 1998. The Gordon Brothers Exit
Fee with respect to any payment made after May 28, 1999 shall be equal to (a)
25.0% plus (b) 25.0% multiplied by the number of days elapsed from May 28, 1999
divided by 365. The Gordon Brothers Exit Fee is adjusted on a pro rata basis to
the extent that the prepayment is made between periods during the first twelve
months except that a minimum Gordon Brothers Exit Fee of 6.5% is required if the
prepayment is made prior to 90 days after closing.
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A portion of the proceeds from the Deere Park Convertible Debentures and
the Gordon Brothers Convertible Debentures were allocated to the warrants issued
to the holders of such debentures. The Company estimated the fair value of the
warrants by utilizing the Black-Scholes option pricing model with the following
assumptions: dividend yield of 0%, expected volatility of 50%, risk free
interest rate of 5%, and expected lives of an average of 2 years. The resulting
discount of approximately $108,000 for the Deere Park Convertible Debentures and
the Gordon Brothers Convertible Debentures is being amortized as interest
expense over the life of the debentures.
In connection with the issuance of the Deere Park Convertible Debentures
and the Gordon Brothers Convertible Debentures, the Company issued to the
placement agent, warrants to purchase 59,340 shares of Common Stock with
exercise prices ranging from $16.76 to $20.60 per share, respectively. The
warrants have a term of two years.
Approximately $8.2 million of the proceeds from the Deere Park Convertible
Debentures and the Gordon Brothers Convertible Debentures were used to finance
the INTERLINK Acquisition and the remainder was utilized for capital investments
and general working capital purposes.
On October 26, 1998, the Company entered into agreements with the holders
of the Gordon Brothers Convertible Debentures and the Deere Park Convertible
Debentures to restructure these debentures. Under the terms of the
restructuring, Gordon Brothers agreed to fix the conversion price at $15 per
share for the term of the debenture. In return, the Company agreed to reduce the
strike price on 12,136 warrants issued in connection with the original funding
from $20.60 to $15 per share. Deere Park agreed to fix the conversion price at
$15 per share until May 1, 1999. Beyond this date, the conversion price will
revert to a "floating" price for the term of the debentures unless it is further
restructured. In return, the Company agreed to issue an additional 8,000
warrants to Deere Park at current market prices. In addition, the Company repaid
$1,000,000 of the Deere Park Convertible Debentures at 107% plus accrued
interest.
The Company estimated the fair value of all of the warrants issued to the
placement agent utilizing the Black-Scholes option pricing model with the
following assumptions: dividend yield of 0%, expected volatility of 50%, risk
free interest rate of 5%, and an expected life of 2 years. The fair value of the
warrants of approximately $390,000 is being accounted for as deferred offering
costs and amortized over the life of the Notes.
The Company renegotiated the terms of the revolving credit facility to
provide borrowings of up to $2.5 million and extended the term of the facility
to July 31, 1999. As of September 30, 1998, the Company had drawn $1.9 million
on this facility. The Company also negotiated terms with certain of its
equipment vendors which call for extended payment terms and increased credit
lines, including two lines of credit each of up to $2.0 million, with sixty day
and ninety day payment terms, respectively.
Telscape USA and MSN have obtained a waiver under the Revolving Credit
Facility to (i) permit the Guarantee of the Notes (see Note 9) by Telscape USA
and MSN and (ii) waive the defaults under the minimum current ratio covenant.
In June 1998, members of the management team of the Company exercised
certain options and warrants resulting in approximately $1.2 million in proceeds
to the Company.
In June 1998, the Company financed the purchase of $1.4 million of
equipment by entering into an equipment lease arrangement with a financing
company which provides for monthly lease payments of $27,500, including
principal and interest, through May 31, 2003. The lease obligation is secured by
the financed equipment.
In July 1998, the Company financed the purchase of $972,000 of equipment
by entering into two equipment lease arrangements with a financing company which
provide for monthly lease payments totaling $22,100, including principal and
interest through July 6, 2003. The lease obligations are secured by the financed
equipment.
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In July 1998, the Company financed the purchase of $243,000 of equipment
by entering into an equipment lease arrangement with a financing company which
provides for monthly lease payments of $6,600, including principal and interest
through July 14, 2002. The lease obligation is secured by the financed
equipment.
The Company has received a commitment from a financing company to fund
equipment purchases of up to $6.0 million dollars through May 1999. The
financing is structured as loans maturing three years from funding at interest
rates 550 basis points above the Federal Reserve Treasury Constant Maturity Rate
(as defined). The Company expects to close this transaction in November 1998.
In July 1998, holders of the non-interest bearing convertible notes issued
in connection with the Integracion acquisition converted these notes into
333,000 shares of Common Stock.
In July 1998, the Company filed two Registration Statements with the
Securities and Exchange Commission for the offering and sale of (i) $125.0
million in Senior Unsecured Notes (the "Notes") due 2008 (the "Notes Offering")
and (ii) 3,400,000 shares of the Company's Common Stock (the "Equity Offering").
Due to recent market developments, on September 15, 1998, the Company withdrew
the Equity Offering from the Commission.
The development and expansion of the Company's network facilities,
including construction of the Mexican Network, together with acquisitions and
joint ventures to enter into new markets or expand in existing markets, funding
of working capital needs and investment in the Company's management information
systems will require significant investments. The Company expects that the net
proceeds form the Notes Offering and cash flow from operations will provide the
Company with sufficient capital to fund planned capital expenditures and
anticipated losses. There can be no assurance, however, that the Company will
consummate the Notes Offering. If the Company is unable to raise funds through
the Notes Offering, there can be no assurance that the Company's business
strategy will be successful. There can be no assurance that the Company will not
need additional financing sooner than anticipated. If the Company consummates
the Notes Offering, the Company may be required to obtain additional financing
in order to repay the Notes at maturity. The need for additional financing will
depend on factors such as the rate and extent of the Company's international
expansion, increased investment in ownership rights in fiber optic cable,
increased acquisitions of new businesses, and increased sales and marketing
expenses. In addition, the amount of the Company's actual future capital
requirements also will depend upon many factors that are not within the
Company's control, including competitive conditions (particularly with respect
to the Company's ability to attract incremental traffic or acquire new
operations at favorable prices) and regulatory or other government actions. In
the event that the Company's plans or assumptions change or prove to be
inaccurate or the net proceeds of the Notes Offering, together with internally
generated funds, prove to be insufficient to fund the Company's growth and
operations, then some or all of the Company's development and expansion plans,
including with respect to the Mexican Network, could be delayed or abandoned, or
the Company could be required to seek additional financing.
The Company will seek to raise such additional capital from public or
private equity or debt sources. There can be no assurance that the Company will
be able to obtain the additional financing or, if obtained, that it will be able
to do so on a timely basis or on terms favorable to the Company. The Indenture
governing the Notes contains certain restrictive covenants that will affect, and
in many respects will significantly limit or prohibit, among other things, the
ability of the Company to incur additional indebtedness and to create liens on
its assets. If the Company is able to raise additional funds through the
incurrence of debt, and it does so, it would likely become subject to additional
restrictive financial covenants. In the event that the Company is unable to
obtain such additional capital or is unable to obtain such additional capital on
acceptable terms, the Company may be required to reduce the scope of its
expansion, which could materially adversely affect the Company's business,
results of operations and financial condition and its ability to compete.
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RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards ("SFAS") No. 130, "REPORTING
COMPREHENSIVE INCOME," establishes standards for reporting and display of
comprehensive income, its components and accumulated balances. Comprehensive
income is defined to include all changes in equity except those resulting from
investments by owners and distributions to owners. Among other disclosures, SFAS
No. 130 requires that all items that are required to be recognized under current
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. For the three months and nine months ended September 30,
1997 and 1998, respectively, comprehensive income is the same as net income.
SFAS No. 131, "DISCLOSURE ABOUT SEGMENTS OF A BUSINESS ENTERPRISE,"
establishes standards for the way that public enterprises report information
about operating segments in annual financial statements and requires reporting
of selected information about operating segments in interim financial statements
issued to the public. It also establishes standards for disclosures regarding
products and services, geographic areas and major customers. SFAS No. 131
defines operating segments as components of an enterprise about which separate
financial information is available that are evaluated regularly by the chief
operating decision makers in deciding how to allocate resources and in assessing
performance.
SFAS No. 132, "Employers' Disclosure about Pensions and other
Postretirement Benefits" standardizes the disclosure requirements for pensions
and other post-retirement benefits and requires additional information on
changes in the benefit obligations and fair values of plan assets.
SFAS No.'s 130, 131 and 132 are effective for financial statements for the
periods beginning after December 15, 1997 and require comparative information
for earlier years to be restated. Adoption of these statements is not expected
to have a material effect on the Company's financial statement disclosures.
SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
requires companies to recognize all derivatives contracts as either assets or
liabilities in the balance sheet and to measure them at fair value. If certain
conditions are met, a derivative may be specifically designated as a hedge, the
objective of which is to match the timing of gain or loss recognition on the
hedging derivative with the recognition of (i) the changes in the fair value of
the hedged asset or liability that are attributable to the hedged risk or (ii)
the earnings effect of the hedged forecasted transaction. For a derivative not
designated as a hedging instrument, the gain or loss is recognized in income in
the period of change. SFAS No. 133 is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999.
Historically, the Company has not entered into derivatives contracts
either to hedge existing risks or for speculative purposes. Accordingly, the
Company does not expect adoption of the new standard to have a material effect
on its financial statements.
UNCERTAINTIES
The Company continues to face many risks and uncertainties, including
general and specific market economic risks. The exploitation of the
opportunities presented by the Mexican market are expected to require
substantial capital. To the extent the Company's Mexican subsidiaries do not
have a positive net cash flow from its operations in 1998, it can be expected
that the Company would have to fund any shortfalls from its working capital. In
addition, any capital expenditures needed to expand the operations of the
Mexican subsidiaries would likely be funded out of the working capital of the
parent corporation. Any such fundings would reduce the funds available to
finance and expand the Company's strategy to compete in the international long
distance services business. Also, any economic crises in Mexico could result in
the need to fund any cash flow shortfalls of the Company's Mexican subsidiaries.
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As in any recently deregulated market, drastic changes and adjustments of
regulations or changes in government policies may occur from time to time that
will directly affect the Company. The Company's competitive position in the
telecommunications services and long distance markets depends heavily on the
license granted by the Mexican government. Should this permit be revoked for
whatever reason, the Company would be severely impaired or unable to provide
many of its telecommunications services. In addition, the Company relies on
other carriers to complete the transmission of certain telecommunications
services. To the extent that any of these carriers was to no longer do business
with the Company, the Company would either have to find an alternate source or
not be able to provide those services.
The international long distance market, although large and rapidly
growing, is also very competitive. The Company generates a significant amount of
its revenues from long distance services and has a significant amount of assets
deployed in foreign countries. The Company competes in this market with
companies that have greater experience and substantially greater resources, both
financial and otherwise. In addition, the Company faces certain additional risks
in competing in this market, including changes in U.S. and foreign government
regulations and telecommunications standards, dependence on strategic partners,
tariffs, taxes and other trade barriers, the potential for nationalization and
economic downturns and political instability in foreign countries. In addition,
the Company could be adversely affected by a reversal in the trend toward
deregulation of telecommunication markets. The Company will be increasingly
exposed to these risks as the Company expands its presence in this market and in
foreign countries. The Company's growth in this business is dependent on its
ability to expand its capacity through investments in additional facilities or
entering into termination arrangements with other carriers. There can be no
assurance that the Company will be successful in raising the capital required to
fund the additional facilities or to enter into such arrangements with other
carriers, in which case the Company's operations, the future growth in this
business and the ability to compete effectively against competitors with
significantly more resources could be materially adversely affected.
The prepaid phone card market represents a new market for the Company.
While the former owners of MSN are currently officers of the Company and
continue to actively manage the prepaid phone card operations, this is a rapidly
growing and very competitive market. As with international long distance
services, the Company will compete in this market with companies that have
greater experience and have substantially greater resources. In addition, the
prepaid phone card industry is subject to extensive U.S. federal and state
regulation including the imposition of various excise taxes and fees, including
the "Universal Service Fund". As with the wholesale international long distance
business, the Company's growth in this business is dependent on its ability to
expand its capacity through investments in additional facilities or entering in
partnering arrangements for outsourcing the telecommunications services related
to calls initiated on the prepaid phone cards it serves. There can be no
assurance that the Company will be successful in raising the capital required to
fund the additional facilities, or in obtaining such partnering arrangements, in
which case the Company's operations, the future growth in this business and the
ability to compete effectively against competitors with significantly more
resources could be materially adversely affected.
The Company is also pursuing a strategy of growth through selective
acquisitions. However, there can be no assurance that any acquisition will be
completed, that attractive candidates will be identified in the future, that the
Company will be successful in raising the capital to fund such acquisitions, or
that, if completed, any acquisition will be beneficial to the Company.
FOREIGN CURRENCY RISK
The general economic conditions of Mexico are greatly affected by the
fluctuations in exchange rates and inflation. The Company's foreign currency
risk is mitigated in Mexico due to the fact that many of the Company's customers
are multinational firms that transact and pay in U.S. dollars. In addition, most
of the
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customers that do pay in pesos pay at the spot exchange rate in effect at the
time of payment as opposed to the exchange rate at the time the receivable is
created. The Company's functional currency in Mexico is the U.S. dollar because
the majority of its transactions are in such currency. However, from time to
time the Company transacts in the local currency and thus faces foreign currency
risk with respect to these transactions. U.S.-originated calls will be paid in
U.S. dollars; however, the Company also expects to derive a certain portion of
its revenues from calls originated outside of the U.S. thus exposing the Company
to additional exchange rate risk. In addition, the Company pays its termination
partners in Latin America in their respective local currencies, exposing the
Company to additional exchange rate risk. The Company may choose to limit its
exposure to foreign currency risk through the purchase of forward foreign
exchange contracts or similar hedging strategies. There can be no assurance that
any foreign currency hedging strategy would be successful in avoiding
exchange-related losses.
YEAR 2000 PLANS
The year 2000 issue exists because many computer systems and applications,
including those embedded in telecommunications equipment and facilities, use two
digit rather than four digit date fields to designate the applicable year. As a
result, the systems and applications may not properly recognize the year 2000 or
process data which includes it, potentially causing data miscalculations or
inaccuracies or operations malfunctions or failures. The year 2000 is also a
leap year, which may also lead to incorrect calculations, functions or systems
failures. This issue exists for many kinds of software, including software for
mainframes, PCs and embedded systems. The Company has initiated the process of
gathering, testing, and producing information about the Company's technologies
impacted by the year 2000 transition. As part of this effort, the Company is
reviewing its network and supporting infrastructure for the telecommunications
services it provides, its operational and financial information technology
systems, and the year 2000 compliance of the Company's key vendors.
Though the year 2000 could affect the Company's internal systems,
management believes the impact will be minimal because the Company has purchased
the majority of its hardware and software systems within the last year or will
be replacing existing systems as part of a Company wide information systems
upgrade. The newer hardware and software systems generally have been engineered
to be year 2000 compliant. In addition, the Company is in the process of
building and expanding its telecommunications network, and in doing so, is
ensuring that these new systems are year 2000 compliant.
In accordance with Emerging Issues Task Force Consensus No. 96-14,
"Accounting for the Costs Associated with Modifying Computer Software for the
Year 2000," the Company will expense all costs as incurred. The extent of the
costs to ready the Company for the year 2000 transition have not been fully
determined; however, the Company does not believe that such costs will have a
material adverse impact on the Company's financial position or its results or
operations. However, if the Company in unable to ready it network and systems
for the year 2000 transition, or if its key suppliers or other companies upon
which the Company depends or with whom the Company's systems interface are not
year 2000 compliant, there could be a material adverse effect on the Company.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. See Index to Exhibits on page 37.
(b) Reports on Form 8-K.
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SIGNATURES
In accordance with the requirements of the Exchange Act, the issuer has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Telscape International, Inc.
(Registrant)
Date: November 15, 1998 By: /s/ E. SCOTT CRIST
E. Scott Crist
President and Chief Executive Officer
Date: November 15, 1998 By: /s/ TODD M. BINET
Todd M. Binet
Executive Vice President and Chief
Financial Officer (Principal Financial
and Chief Accounting Officer)
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INDEX OF EXHIBITS
EXHIBIT NO. DESCRIPTION
3.1 - Articles of Incorporation of the Registrant, as amended
(filed as Exhibit 3.1 to the Company's Registration Statement
No. 33-80542-D and incorporated herein by reference)
3.2 - Bylaws of the Registrant, as amended (filed as Exhibit
3.2 to the Company's Registration Statement No. 33-80542-D and
incorporated herein by reference)
4.1 - Form of Certificate evidencing Common Stock (filed as Exhibit
4.1 to the Company's Registration Statement No. 33-80542-D and
incorporated herein by reference)
4.2 - Form of Warrant Agreement between American Stock Transfer &
Trust Company and the Company (filed as Exhibit 4.2 to the
Company's Registration Statement No. 33-80542-D and
incorporated herein by reference)
4.3 - Form of Warrant Certificate evidencing the Warrants (filed as
Exhibit 4.3 to the Company's Registration Statement No.
33-80542-D and incorporated herein by reference)
4.4 - Securities Purchase Agreement between Deere Park Capital
Management, LLC and Telscape International, Inc. dated as of
May 1, 1998; Registration Rights Agreement dated as of May 1,
1998 between Telscape International, Inc. and Deere Park
Capital Management, LLC; Form of Convertible Subordinated
Debenture for $3,000,000 dated May 1, 1998; Form of Stock
Purchase Warrant to Purchase 8,952 shares of Common Sock of
Telscape International, Inc. dated May 1, 1998 (filed as
Exhibit 4.4 to the Company's Report on Form 10Q for the
quarter ended March 31, 1998 and incorporated herein by
reference)
4.5 - Stock Purchase Agreement dated May 18, 1998, by and among
Telscape International, Inc.; California Microwave, Inc., and
California Microwave Services Divisions, Inc. together with a
Form of Supply Agreement between California Microwave, Inc.
and California Microwave Services Division, Inc. as Exhibit B
(all filed as Exhibit 10.1 to the Company's Report on Form 8-K
dated June 9, 1998 and incorporated herein by reference)
4.6 - A Form of Convertible Subordinated Debenture in the principal
amount of $1,000,000 between Deere Park Capital Management,
LLC and Telscape International, Inc. dated as of May 28, 1998;
and a form of Stock Purchase Warrant to Purchase 2,427 shares
of Common Stock of Telscape International, Inc. dated May 28,
1998 (all filed as Exhibit 10.3 to the Company's Report on
Form 8-K dated June 9, 1998 and incorporated herein by
reference)
4.7 - Securities Purchase Agreement dated May 29, 1998 by and
between Telscape International, Inc. and Gordon Brothers
Capital, LLC ("Gordon Brothers"); together with a Form of
Convertible Debenture in the principal amount of $5,000,000
payable to Gordon Brothers attached as Exhibit A; a Form of
Stock Purchase Warrant for Gordon Brothers for 12,136 shares
of Common Stock of Telscape International, Inc. as Exhibit B;
and a Registration Rights Agreement by and between Gordon
Brothers and Telscape International, Inc. as Exhibit C (all
filed as Exhibit 10.4 to the Company's Report on Form 8-K
dated June 9, 1998 and incorporated herein by reference)
4.8 - Equity Purchase Agreement by and between Interlink
Communications Holding Co., Inc. and each of Telscape
International, Inc., E. Russell Hardy, Stephen Strohman, Monty
J. Moore, and Salvador Giblas dated as of May 18, 1998 (all
filed as Exhibit 10.5 to the Company's Report on Form 8-K
dated June 9, 1998 and incorporated herein by reference)
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4.9 - Form of Employment Agreement by and between California
Microwave Services Division, Inc. and E. Russell Hardy dated
as of May 18, 1998 (all filed as Exhibit 10.6 to the Company's
Report on Form 8-K dated June 9, 1998 and incorporated herein
by reference)
4.10 - Form of Employment Agreement by and between California
Microwave Services Division, Inc. and Stephen Strohman dated
as of May 18, 1998 (all filed as Exhibit 10.7 to the Company's
Report on Form 8-K dated June 9, 1998 and incorporated herein
by reference)
4.11 - Form of Consulting Agreement by and between California
Microwave Services Division, Inc. and Salvador Giblas dated as
of May 18, 1998 (all filed as Exhibit 10.8 to the Company's
Report on Form 8-K dated June 9, 1998 and incorporated herein
by reference)
*27.1 - Financial Data Schedule
- - -----------------
*Filed herein
38
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