PROSPECTUS
910,430 SHARES
TELSCAPE INTERNATIONAL, INC.
COMMON STOCK
------------------------
This Prospectus relates to the public offer and sale, from time to time, of
up to 910,430 shares (the "Shares") of common stock, par value $.001 per share
(the "Common Stock"), of Telscape International, Inc. ("Telscape" or the
"Company"), for the account of certain selling stockholders named herein (the
"Selling Stockholders"). See "Selling Stockholders" and "Plan of
Distribution." Information concerning the Selling Stockholders may change from
time to time, which changes will be set forth in an accompanying Prospectus
Supplement.
The Common Stock is traded on the Nasdaq National Market (the "Nasdaq
NMS") under the symbol "TSCP." The closing sale price of the Common Stock
reported on the Nasdaq NMS on November 4, 1998 was $8.9375 per share.
The Company has been advised by the Selling Stockholders that the Selling
Stockholders, acting as principals for their own account, directly or through
agents, dealers or underwriters to be designated from time to time, may sell the
Shares from time to time on terms to be determined at the time of sale through
customary brokerage channels, negotiated transactions or a combination of these
methods at fixed prices that may be changed, at market prices then prevailing or
at negotiated prices then obtainable. To the extent required, the number of
Shares to be sold, the names of the Selling Stockholders, the purchase price,
the public offering price, the name of any agent, dealer or underwriter, the
amount of any offering expenses, any applicable commissions or discounts and any
other material information with respect to a particular offer will be set forth
in an accompanying Prospectus Supplement or, if appropriate, a post-effective
amendment to the Registration Statement of which this Prospectus is a part. Each
of the Selling Stockholders reserves the right to accept and, together with its
agents from time to time, to reject in whole or in part any proposed purchase of
the Shares to be made directly or through agents. Since the Shares registered
hereunder are being offered on a delayed or continuous basis pursuant to Rule
415 under the Securities Act of 1933, as amended (the "Securities Act"), the
Company cannot include herein information about the price to the public of the
Shares or the proceeds to the Selling Stockholders. The Selling Stockholders and
any brokers or dealers executing selling orders on their behalf may be deemed
"underwriters" within the meaning of the Securities Act, in which event the
usual and customary selling commissions which may be paid to the brokers or
dealers may be deemed to be underwriting commissions under the Securities Act.
The aggregate proceeds to the Selling Stockholders from the sale of the Shares
offered by the Selling Stockholders hereby will be the purchase price of such
Shares less any discounts or commissions. There can be no assurance that any or
all of the Shares registered hereunder will be sold. The Company will receive no
portion of the proceeds from the sale of the Shares offered hereby and will bear
certain expenses incident to their registration. See "Plan of Distribution."
------------------------
SEE "RISK FACTORS" BEGINNING ON PAGE 6 OF THIS PROSPECTUS FOR A DISCUSSION
OF RISK FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE
SHARES OF COMMON STOCK OFFERED HEREBY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
The date of this Prospectus is November 9, 1998.
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a registration statement on Form S-1 (the "Registration
Statement") under the Securities Act, with respect to the Shares offered
hereby. This Prospectus, which constitutes a part of the Registration Statement,
does not contain all the information set forth in the Registration Statement,
certain items of which are contained in schedules and exhibits to the
Registration Statement as permitted by the rules and regulations of the
Commission. For further information, reference is hereby made to the
Registration Statement and to the exhibits and schedules thereto. With respect
to any contract, agreement or document filed as an exhibit to the Registration
Statement, reference is made to such exhibit for a more complete description of
the matter involved, and each such statement is qualified in its entirety by
such reference. Reports, proxy and information statements and other information
filed by the Company with the Commission may be inspected and copied at
prescribed rates at the public reference facilities maintained by the Commission
at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549 and at the
following regional offices of the Commission: CitiCorp Center, 500 West Madision
Street, Suite 1400, Chicago, Illinois 60661, and 7 World Trade Center, Suite
1300, New York, New York 10048. In addition, the Commission maintains a World
Wide Web site on the Internet at http://www.sec.gov that contains reports, proxy
and information statements and other information regarding registrants that file
electronically with the Commission. In addition, reports, proxy and information
statements and other information filed by the Company with the Commission may be
reviewed through the Commission's Electronic Data Gathering Analysis and
Retrieval System, which is publicly available through the Commission's web site
(http://www.sec.gov).
The Company's Common Stock is listed on the Nasdaq NMS. The Company is
subject to the periodic reporting and informational requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in
accordance therewith, the Company files reports and other information as
required thereby with the Commission. The Company intends to furnish its
stockholders with annual reports containing audited annual financial statements
and related notes thereto and with quarterly reports for the first three
quarters of each fiscal year containing unaudited interim financial statements.
NOTE REGARDING FORWARD-LOOKING STATEMENTS
The statements contained in this Prospectus that are not historical facts
are "forward-looking statements" (as such term is defined in the Private
Securities Litigation Reform Act of 1995), which 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. Such statements include, but are not limited to,
statements under the captions "Prospectus Summary," "Risk Factors," "Use of
Proceeds," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Business" and elsewhere in this Prospectus as to the
Company's plans to implement its growth strategy, improve its financial
performance, expand its infrastructure, develop new products and services,
expand its sales force, expand its customer base and enter international
markets. In addition, from time to time, the Company or its representatives have
made or may make forward-looking statements, orally or in writing. Furthermore,
such forward-looking statements may be included in, but are not limited to,
various filings made by the Company with the Commission, or press releases or
oral statements made by or with the approval of an authorized executive officer
of the Company.
Management wishes to caution the reader that the forward-looking statements
referred to above and contained herein in this Prospectus regarding matters that
are not historical facts involve predictions. No assurance can be given that the
future results will be achieved; actual events or results may differ materially
as a result of risks facing the Company. Such risks include, but are not limited
to, changes in business conditions, changes in the telecommunications industry
and the general economy, competition, changes in service offerings, and risks
associated with the Company's limited operating history, entry into developing
markets, managing rapid growth, international operations, dependence on
effective information systems, ability to consummate acquisitions or enter into
joint ventures with companies on terms acceptable to the Company, and
development of its network, as well as regulatory developments that could cause
actual results to vary materially from the future results indicated, expressed
or implied, in such forward-looking statements. See "Risk Factors."
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PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ
IN CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND THE CONSOLIDATED
FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, APPEARING ELSEWHERE IN THIS
PROSPECTUS. AS USED IN THIS PROSPECTUS, UNLESS THE CONTEXT OTHERWISE REQUIRES,
THE TERMS THE "COMPANY" AND "TELSCAPE" REFER TO TELSCAPE INTERNATIONAL,
INC., A TEXAS CORPORATION, AND ITS SUBSIDIARIES, COLLECTIVELY.
THE COMPANY
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 telephone calling cards ("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 operations over the next 18 months 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., a Mexican
corporation and an affiliate of the Company ("Telereunion S.A."), received a
30-year, facilities-based carrier license from the Mexican government allowing
it to construct and operate a network over which the Company can carry long
distance traffic in Mexico (the "Mexican Concession"). To deliver its
services, the Company, through Telereunion S.A., intends to 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").
The Company's ability to construct the Mexican Network depends on its ability to
raise capital, and on other factors, many of which are beyond its control.
Telscape is a holding company, the principal assets of which are its
operating subsidiaries in the United States and Mexico. As a holding company,
Telscape is dependent upon dividends and distributions from its subsidiaries to
meet its cash needs. MSN Communications, Inc. ("MSN"), Telscape USA, Inc.
("Telscape USA"), Telereunion, Inc. ("Telereunion") and TSCP International,
Inc. ("TSCP International"), are wholly-owned subsidiaries of the Company, and
INTERLINK Communications, Inc. ("INTERLINK") is 90%-owned by the Company. The
Company's ownership interests in its Mexican subsidiaries are held through
Telereunion. The chart on page 44 illustrates the Company's operational
structure.
The Company believes that it is well-positioned to capitalize on the
opportunities presented by the large and growing international
telecommunications services market. According to Global Telecommunications
Traffic Statistics & Commentary 1997/98 published by TELEGEOGRAPHY in November
1997 (the "Telegeography Report"), revenues generated from the provision of
international long distance services increased to $61.3 billion in 1996 from
$23.9 billion in 1987, a compound annual growth rate of 11.0%. Management
believes that Latin American traffic, including traffic between the United
States and Latin America, will grow faster than the international
telecommunications market as a whole as a result of the (i) underlying economic
growth within Latin America, (ii) growth of regional trade as a result of free
trade initiatives such as the North American Free Trade Agreement ("NAFTA"),
Mercado Comun del Sur ("Mercosur") and the Andean Pact, (iii) deregulation and
privatization of telecommunications carriers in the region, (iv) projected
regional increases in telephone density, (v) growth in the Hispanic population
in the United States and (vi) increasing demand for bandwidth-intensive
applications. See "Business -- Industry."
Telscape intends to capitalize on the growth in the Latin American
telecommunications market by providing international long distance services to
and from targeted Latin American countries. The Company
1
<PAGE>
also intends to position itself as an integrated telecommunications provider in
Mexico by providing domestic and international long distance services over the
Mexican Network. The Company believes that expanding its owned and leased
transmission facilities in Latin America will allow it to increase the
percentage of minutes of traffic carried over its own facilities and over
transmission capacity owned or leased on a fixed cost basis ("on-net"), which
will enable it to increase margins and profitability and ensure quality of
service on both international and domestic long distance traffic. See
"Business -- Network," "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Gross Margin."
STRATEGY
The Company's objective is to become a leading provider of high quality,
competitively priced international long distance services between the United
States and Latin America, and a leading provider of international long distance
services, domestic long distance services and integrated value-added services to
customers in Mexico and other targeted countries in Latin America. The key
elements of the Company's strategy are to: (i) expand its Latin American
presence; (ii) expand its network facilities; (iii) provide an integrated suite
of service offerings; (iv) expand the scale and scope of its retail business;
(v) pursue strategic alliances, joint ventures and acquisitions; and (vi) build
brand awareness.
For a discussion of the Company's business strategy, see
"Business -- Strategy." The Company's ability to pursue its business strategy
depends on many factors, including the availability of financing, economic and
regulatory conditions in its markets and competition. There can be no assurance
that the Company's business strategy will be successful. See "Risk Factors."
RECENT DEVELOPMENTS
In July 1998, the Company filed two registration statements with the
Commission to offer 3.64 million shares of its Common Stock (the "Equity
Offering") and $125.0 million in aggregate principal amount of the Company's
Senior Notes due 2008 (the "Notes Offering"). Due to recent market
developments, on September 15, 1998, the Company withdrew the Equity Offering
from the SEC. There can be no assurance that the Company will consummate the
Notes Offering. For a detailed discussion of the Notes Offering, see "Summary
of Certain Indebtedness."
USE OF PROCEEDS
The Company will not receive any of the proceeds from the sale of the
Shares offered hereby, nor will any such proceeds be available for use by it or
for its benefit.
RISK FACTORS
An investment in the Common Stock is subject to certain risks, including
the following:
FUTURE CAPITAL NEEDS: UNCERTAINTY OF ADDITIONAL FUNDING. The development
and expansion of the Company's network facilities, 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. There can be no
assurance that the Company will consummate the Notes Offering. The Company may
seek to raise additional capital from public or private equity or debt sources.
If the Company is unable to raise funds through the Notes Offering or through
alternative sources on acceptable terms, there can be no assurance that the
Company's business strategy will be successful which could materially adversely
affect the Company's business, results of operations and financial condition and
its ability to compete.
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FUTURE NET LOSSES. The Company could incur significant net losses in the
next few years as it incurs additional costs associated with the development and
expansion of its network, including the construction of the Mexican Network, and
debt repayment obligations, including interest on the Notes. The construction of
the Mexican Network could be delayed due to factors beyond the Company's
control. The Company may experience negative cash flows in new markets it enters
until an adequate customer base and related revenues can be established.
CONSTRUCTION OF THE MEXICAN NETWORK; CONSTRUCTION COSTS. Construction of
the Mexican Network will require the Company to commit significant amounts of
capital. The failure to complete, delays in the construction of, or significant
cost overruns incurred in the construction of the Mexican Network could
adversely affect the Company's ability to increase its on-net traffic and
increase its cash flows.
COMPETITION. The telecommunications industry is and will continue to be
highly competitive. Existing telecommunications providers, many with
significantly greater resources and brand name recognition than the Company, and
new entrants will continue to compete with the Company for customers, which will
likely result in continued downward pricing pressure for the Company's services.
SUBSTANTIAL GOVERNMENT REGULATION. In each country in which it operates,
the Company is subject to substantial government regulation. Enforcement and
interpretation of the telecommunications laws in these countries are often
unclear, unpredictable or subject to influence by the incumbent telephone
carrier. The Company may, from time to time, be subject to fines, penalties,
confiscation of facilities and equipment and/or other sanctions, including being
denied the ability to offer its products and services.
SUBSTANTIAL INDEBTEDNESS. The Company will have substantial indebtedness
and will be highly leveraged after it consummates the Notes Offering. The
Company's high degree of indebtedness could affect the Company's ability to
obtain financing in the future, could limit its flexibility in planning for
changes in its business, and will require a significant portion of its cash flow
to be used for the payment of principal and interest on the Notes, limiting its
availability for use in the Company's business.
For a more complete discussion of these and other risk factors that should
be considered in evaluating an investment in the Common Stock, see "Risk
Factors."
------------------------
The Company's principal executive offices are located at 2700 Post Oak
Boulevard, Suite 1000, Houston, Texas 77056, and its telephone number is (713)
968-0968.
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SUMMARY HISTORICAL AND PRO FORMA FINANCIAL AND OTHER DATA
The summary financial and other data set forth below is qualified in its
entirety by, and should be read together with, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Pro Forma
Condensed Consolidated Financial Statements, including the Notes thereto, and
the other financial information included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
PRO FORMA SIX MONTHS
YEAR ENDED DECEMBER 31, YEAR ENDED ENDED
------------------------------- DECEMBER 31, JUNE 30,
1995 1996 1997 1997(1) 1998
--------- --------- --------- ------------ ----------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT RATIOS AND OTHER OPERATING DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
DATA(2):
Revenues........................... $ 1,108 $ 5,705 $ 36,154 $ 65,368 $ 65,777
Cost of revenues................... 619 3,041 24,396 52,018 57,056
--------- --------- --------- ------------ ----------
Gross profit....................... 489 2,664 11,758 13,350 8,721
Selling, general and administrative
expenses.......................... 1,349 4,159 8,154 9,500 5,705
Depreciation and amortization...... 48 264 622 1,157 1,258
--------- --------- --------- ------------ ----------
Operating income (loss)............ (908) (1,759) 2,982 2,693 1,758
Interest income (expense), net..... 230 15 (95) (223) (251)
Other income (expense), net........ (2) 99 (137) (123) (91)
--------- --------- --------- ------------ ----------
Income (loss) before income taxes
and minority interests............ (680) (1,645) 2,750 2,347 1,416
Income tax benefit (expense)....... -- 53 (84) 11 (895)
--------- --------- --------- ------------ ----------
Income (loss) before minority
interests......................... (680) (1,592) 2,666 2,358 521
Minority interests................. 7 (6) 6 6 (29)
--------- --------- --------- ------------ ----------
Net income (loss).................. $ (673) $ (1,598) $ 2,672 $ 2,364 $ 492
========= ========= ========= ============ ==========
EARNINGS (LOSS) PER SHARE:
Basic.............................. $ (0.36) $ (0.52) $ 0.68 $ 0.59 $ 0.11
Weighted average shares
outstanding....................... 1,890,442 3,046,594 3,903,470 4,003,470 4,534,568
Diluted(3)......................... N/A N/A $ 0.53 $ 0.45 $ 0.06
Weighted average shares outstanding
for diluted calculation........... N/A N/A 5,152,211 5,418,711 7,778,072
<CAPTION>
DECEMBER 31, AS ADJUSTED(6)
------------------------------- JUNE 30, JUNE 30,
1995 1996 1997 1998 1998
--------- --------- --------- -------- --------------
CONSOLIDATED BALANCE SHEET DATA(2):
Cash, cash equivalents and short
term investments.................. $ 3,645 $ 495 $ 4,734 $ 4,939 $118,350
Working capital.................... 4,081 1,813 3,669 (2,552) 110,859
Property and equipment, net........ 154 983 2,679 13,084 13,084
Goodwill and other intangibles,
net............................... -- 3,246 17,674 26,332 26,332
Total assets....................... 4,498 9,371 39,635 68,880 193,880
Total long-term debt............... -- -- 2,676 9,385 134,385
Total stockholders' equity......... 3,590 5,765 22,088 28,592 28,592
<CAPTION>
PRO FORMA SIX MONTHS
YEAR ENDED DECEMBER 31, YEAR ENDED ENDED
------------------------------- DECEMBER 31, JUNE 30,
1995 1996 1997 1997(1) 1998
--------- --------- --------- ------------ ----------
(UNAUDITED) (UNAUDITED)
OTHER OPERATING DATA(2):
EBITDA(4).......................... $ (860) $ (1,495) $ 3,604 $ 3,850 $ 3,016
Ratio of debt to EBITDA............ -- -- 0.88 0.83 5.12
Capital expenditures............... 46 441 1,682 5,696
Ratio of earnings to fixed
charges(5)........................ -- -- 7.07 4.93 2.51
Fixed charges in excess of
earnings(5)....................... 717 1,770 N/A N/A N/A
Cash flows provided by (used in)
operating activities.............. (817) (2,731) 4,588 5,516 441
Cash flows provided by (used in)
investing activities.............. 444 2,489 (1,799) (2,007) (16,721)
Cash flows provided by (used in)
financing activities.............. -- 564 1,450 (56) 16,035
</TABLE>
(FOOTNOTES ON FOLLOWING PAGE)
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- ------------
(1) Adjusted to give effect to the Company's acquisitions of MSN and Integracion
de Redes, S.A. de C.V. ("Integracion"), as if such transactions and events
had been consummated on January 1, 1997.
(2) The Company's historical financial statements include the operations of its
subsidiaries from their respective dates of acquisition, or inception in the
case of poolings, as follows: Telscape USA -- April 10, 1996;
Telereunion -- May 10, 1996; Integracion -- July 1, 1997; N.S.I., S.A. de
C.V. ("NSI") -- October 1, 1997; and MSN -- January 1, 1998. INTERLINK's
operations will be included beginning June 1, 1998.
(3) Diluted earnings per share for the years ended December 31, 1995 and 1996
were not provided, as inclusion of additional shares under a diluted
analysis for loss periods is inappropriate due to the anti-dilutive effect.
For purposes of diluted earnings per share, interest expense on convertible
notes assumed to have been converted into common shares was added back to
net income as follows: $42 and $84 for the historical year ended December
31, 1997 and pro forma year ended December 31, 1997, respectively.
(4) EBITDA as used in this Prospectus represents net earnings (loss) before
interest, income taxes, depreciation and amortization. The Company has
included EBITDA data because it is a measure commonly used in the
telecommunications industry and is included herein to provide additional
information with respect to the Company's ability to meet its future debt
service, capital expenditures and working capital requirements. In addition,
the Company believes that certain investors find EBITDA to be a useful tool
for measuring the ability of the Company to service its debt. EBITDA is not
a measure of financial performance determined under generally accepted
accounting principles, should not be considered as an alternative to net
income as a measure of performance or to cash flows as a measure of
liquidity, and is not necessarily comparable to similarly titled measures
presented by other companies. Funds depicted by EBITDA may not be available
for management's discretionary use due to functional and debt covenant
requirements to conserve funds for capital replacement and expansion, debt
service and other commitments and uncertainties.
(5) The ratio of earnings to fixed charges was computed by dividing earnings by
fixed charges. For this purpose, earnings consist of income from continuing
operations, before income taxes and fixed charges of the Company and its
subsidiaries. Fixed charges consist of the Company's and subsidiaries'
interest expense and the portion of rent expense representative of an
interest factor. Where the ratio indicates less than 1-to-1 coverage, the
dollar amount of the coverage deficiency is presented.
(6) As adjusted to give effect to the Notes Offering.
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RISK FACTORS
PROSPECTIVE INVESTORS SHOULD CONSIDER CAREFULLY THE RISK FACTORS SET FORTH
BELOW, AS WELL AS THE OTHER INFORMATION APPEARING IN THIS PROSPECTUS, BEFORE
MAKING AN INVESTMENT IN THE COMMON STOCK.
HOLDING COMPANY STRUCTURE; RELIANCE ON SUBSIDIARIES FOR DISTRIBUTIONS TO REPAY
NOTES
Telscape is a holding company, the principal assets of which are its
operating subsidiaries in the United States and Mexico. As a holding company,
the Company's internal sources of funds to meet its cash needs are dividends,
intercompany loans and other permitted payments from its direct and indirect
subsidiaries, as well as its own credit arrangements. Additionally, several of
the Company's subsidiaries are organized in jurisdictions outside the United
States, and the Company may not have direct control over such subsidiaries. The
ability of the Company's operating subsidiaries to pay dividends, repay
intercompany loans or make other distributions to Telscape may be restricted by,
among other things, the availability of funds, the terms of various credit
arrangements entered into by such operating subsidiaries, the terms of any
agreements the Company enters into with owners of minority interests in certain
subsidiaries, joint venture partners or entities selling assets or businesses to
the Company, as well as statutory and other legal restrictions including
restrictions on the repatriation of money from foreign jurisdictions, and any
such payments may have adverse tax consequences. The failure to pay any such
dividends, make intercompany loans or make any such other distributions would
restrict Telscape's ability to make principal and/or interest payments on the
Notes, utilize cash flow from one subsidiary to cover shortfalls in working
capital at another subsidiary, and could otherwise have a material adverse
effect upon the Company's business, financial condition and results of
operations.
Holders of secured indebtedness will have a claim on the assets of the
Company and its subsidiaries securing such indebtedness that is prior to the
claims of the holders of the Notes and will have a claim that is PARI PASSU with
the claims of the holders of the Notes to the extent such security does not
satisfy such indebtedness. As of June 30, 1998, the Company (excluding its
subsidiaries) had approximately $5.2 million of secured indebtedness, and the
Guarantors had approximately $1.9 million of secured indebtedness. The Company
has no significant assets other than the ownership interests in its subsidiaries
and it is expected that such ownership interests may be pledged in the future to
secure one or more credit facilities.
FUTURE NET LOSSES
The Company could incur significant net losses over the next few years as
it incurs additional costs associated with the development and expansion of its
network, the expansion of its marketing and sales organization and the
introduction of new telecommunications services. Furthermore, the Company's
operations in new target markets could experience negative cash flows until an
adequate customer base and related revenues have been established. In addition,
the generation of revenues from the development of the Mexican Network may be
delayed due to factors outside of the Company's control, including, but not
limited to, delays in negotiating acceptable interconnection agreements with
Telefonos de Mexico, S.A. de C.V. ("Telmex"), delays in negotiating
rights-of-way for completion of the Mexican Network and delays in construction
of the Mexican Network, any of which could have the result of decreasing the
Company's operating cash flow. See "-- Telmex Charges." The Company must
substantially increase its net cash flow in order to meet its debt service
obligations, and there can be no assurance that the Company will achieve or, if
achieved, will sustain profitability or positive cash flow from operating
activities in the future. If the Company cannot achieve and sustain operating
profitability or positive cash flow from operations, it may not be able to meet
its debt service or working capital requirements, which could have a material
adverse effect on the business, operations and financial condition of the
Company. The Company's ability to grow and generate revenues will depend, among
other things, on its ability to expand the capacity of its network. The
continued expansion, operation and development of the Company's network will
depend on, among other factors, the Company's ability to (i) attract and retain
customers and (ii) attract and retain experienced and qualified personnel. See
" -- Future Capital Needs; Uncertainty of Additional Funding," " --
Construction of the Mexican Network; Construction Costs" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
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EXPANSION AND OPERATION OF THE NETWORK
The success of the Company is largely dependent on its ability to deliver
low-cost, uninterrupted international and domestic long distance telephone
services. Any system or network failure that causes interruptions in the
Company's operations could have a material adverse effect on its business,
financial condition or results of operations. At times, the Company's switching
equipment has experienced failures, which temporarily prevented customers from
using its services. The Company's operations are dependent on its ability to
expand successfully its network and integrate new and emerging technologies and
equipment into its network, which are likely to increase the risk of system
failure and to cause strain upon the network. The Company's ability to expand
successfully into new markets is dependent on its ability to integrate its
equipment into the existing networks in those markets. The Company's ability to
enter a new market has in the past, and could in the future, be delayed by
technical specifications and other barriers to entry that exist in the market.
The Company's operations also are dependent on the Company's protection of its
hardware and other equipment from damage from natural disasters such as fires,
floods, hurricanes and earthquakes, or other sources of power loss,
telecommunications failures or similar occurrences. Significant or prolonged
network failures, or difficulties for customers in completing long distance
telephone calls, could damage the reputation of the Company and result in the
loss of customers. Such damage or losses could have a material adverse effect on
the Company's ability to obtain new subscribers and customers and retain its
existing customers, and on the Company's business, financial condition or
results of operations.
The Company's ability to increase revenues will be dependent on its ability
to expand the capacity of, and eliminate bottlenecks that may develop from time
to time on, the Company's network. The continued expansion, operation and
development of the Company's network will depend on, among other factors, the
Company's ability to: (i) obtain one or more switch sites in its targeted
markets; (ii) obtain interconnectivity to the local Public Switched Telephone
Network ("PSTN") and/or other carriers; (iii) obtain necessary licenses
permitting termination and origination of traffic; (iv) obtain access to or
ownership of transmission facilities linking a switch to other network switches;
and (v) open new offices in target markets. By expanding its network, the
Company will incur additional fixed operating costs that typically exceed,
particularly with respect to international transmission lines, the revenues
attributable to the transmission capacity funded by such costs until the Company
generates additional traffic volume for such expanded capacity. There can be no
assurance that the Company will be able to expand its network in a cost
effective manner or to operate the network efficiently.
Although the Company has not experienced significant quality problems to
date, the Company may from time to time experience general problems affecting
the quality of the voice and data transmission of some calls transmitted over
its network due to its anticipated expansion, which could result in poor quality
transmission and interruptions in service. To provide redundancy in the event of
technical difficulties with its network and to the extent the Company purchases
transit and termination capacity from other carriers, the Company relies upon
other carriers' networks. Whenever the Company is required to route traffic over
a non-primary choice carrier due to technical difficulties or capacity shortages
with its network or its primary choice carrier, those calls are more costly to
the Company and could result in lower transmission quality. Any failure by the
Company to operate, expand, manage or maintain its network properly could result
in customers diverting all or a portion of their calls to other carriers, which
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Conditions and Results of Operations."
As part of its plan to provide coverage from the United States to Mexico
and other targeted Latin American markets where fiber optic capacity cannot be
acquired or cannot be acquired on terms acceptable to the Company, Telscape
acquired satellite transmission equipment by purchasing INTERLINK. Prior to this
acquisition, the Company did not have significant experience in operating
satellite transmission facilities, and any problems that arise from the
operation or maintenance of these facilities could materially adversely affect
the Company's ability to provide telecommunications services to regions served
by such facilities. If the Company is not able to restore service quickly or to
secure redundant capacity on acceptable
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terms, the failure to maintain or operate such facilities could have a material
adverse effect on the Company's business, financial condition or results of
operations.
SUBSTANTIAL INDEBTEDNESS
The Company will have substantial indebtedness upon consummation of the
Notes Offering. As of June 30, 1998, after giving effect to the Notes Offering
and the application of the net proceeds therefrom, the Company's total
indebtedness would have been approximately $140.5 million, including $7.1
million of secured indebtedness, its stockholders' equity would have been
approximately $28.6 million and it would have had total assets of approximately
$194.0 million. For the six months ended June 30, 1998, after giving effect to
the Notes Offering and the application of the net proceeds therefrom, the
Company's earnings (as defined in Footnote 5 to Summary Historical and Pro Forma
Financial and Other Data) would have been insufficient to cover fixed charges
(including interest on the Notes) by approximately $7.3 million. This indicates
that the Company must substantially increase its net cash flow in order to meet
its debt service obligations, including interest payments on the Notes. The
Indenture governing the Notes (the "Indenture") limits the incurrence of
certain additional indebtedness by the Company and certain of its subsidiaries.
In the event of a bankruptcy, liquidation, dissolution, reorganization or
similar proceeding with respect to the Company, the holders of any secured
indebtedness will be entitled to proceed against the collateral that secures
such secured indebtedness and such collateral will not be available for
satisfaction of any amounts owed under the Notes. The Company anticipates that
it and its subsidiaries will incur substantial additional indebtedness in the
future. See the Company's Consolidated Financial Statements elsewhere in the
Prospectus, "Selected Consolidated Financial and Other Data" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The level of the Company's indebtedness could have important consequences
to holders of the Common Stock, including the following: (i) the ability of the
Company to obtain any necessary financing in the future for working capital,
capital expenditures, debt service requirements or other purposes may be
limited; (ii) a substantial portion of the Company's cash flow from operations,
if any, must be dedicated to the payment of principal and interest on the Notes
and its other indebtedness and will not be available for use in its business;
(iii) the Company's level of indebtedness could limit its flexibility in
planning for, or reacting to, changes in its business; (iv) the Company may
become more highly leveraged than some of its competitors, which may place it at
a competitive disadvantage; and (v) the Company's high degree of indebtedness
will make it more vulnerable in the event of a downturn in its business. In
addition, the degree to which the Company is leveraged could prevent it from
repurchasing all of the Notes tendered to it upon a change of control of the
Company.
The Company must substantially increase its net cash flow in order to meet
its debt service obligations, and there can be no assurance that the Company
will be able to meet such obligations. If the Company is unable to generate
sufficient cash flow or otherwise obtain funds necessary to make required
payments, or if it otherwise fails to comply with the various covenants
governing its indebtedness, it would be in default under the terms thereof,
which would permit the holders of such indebtedness to accelerate the maturity
of such indebtedness and could cause defaults under other indebtedness of the
Company.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING
Through September 1999, the Company intends to invest approximately $113.0
million for infrastructure, including approximately $98.0 million towards
construction of the Mexican Network and approximately $15.0 million to acquire
switching and transmission facilities and enhanced service platforms. This
development and expansion of the Company's network facilities, 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 from 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
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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 may 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
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.
CONSTRUCTION OF THE MEXICAN NETWORK; CONSTRUCTION COSTS
The Company's ability to build the Mexican Network is essential to its
future success. The Company has targeted the Gulf region of Mexico for the
development of the Mexican Network, including the states of Tamaulipas and
Veracruz on the eastern coast of Mexico extending into the central region via
the state of Puebla. The Company expects to complete the Mexican Network over
the course of approximately twenty-four months. There are certain risks
associated with the Mexican Network, including, among other things, (i) the
potential for cost overruns, (ii) the potential for an untimely completion of
the Mexican Network, (iii) the Company's lack of experience in developing such a
network, (iv) obtaining necessary rights of way, (v) managing effectively the
construction of the new fiber routes and (vi) the potential that a competitor
may develop a comparable network prior to the completion of the Mexican Network,
thus greatly diminishing the demand for the Company's services. In addition, the
successful construction of the Mexican Network will depend to a significant
extent on third party contractors retained by the Company. Although the Company
does not anticipate undue difficulty in acquiring the necessary rights-of-way or
in managing the network construction, no assurance can be given that such rights
will be acquired or that the construction will be completed without significant
delays, within its budget or at all. Difficulties or delays with respect to any
of the foregoing may significantly delay or prevent the completion of the
Mexican Network, which would have a material adverse effect on the Company. See
"Business -- Network -- Network Strategy" and "Business -- Network -- Network
Expansion."
PRICING PRESSURES AND RISKS OF INDUSTRY OVER-CAPACITY
Since the AT&T Corp. ("AT&T") divestiture in 1984, the long distance
transmission industry has generally been characterized by over-capacity and
declining prices. The Company believes that demand has increased over the last
several years, ameliorating the over-capacity and reducing pricing pressures.
However, the Company anticipates that prices for its services will continue to
decline. There can be no assurance that the Company's competitors, as well as
potential new entrants to the industry, will not construct new fiber optic and
other long distance transmission networks where the Company intends to construct
its Mexican Network. Because the cost of the actual fiber is a relatively small
portion of building
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new transmission lines, persons building such lines are likely to install fiber
that provides substantially more transmission capacity than will be needed over
the next several years. Further, recent technological advances have also shown
the potential to greatly expand the capacity of existing and new fiber optic
cable. The Company's cost-saving arrangements with other carriers, which may
involve the sale or lease of capacity or fibers on the Company's Mexican
Network, may result in competitors having capacity on the Company's routes along
the Mexican Network, which may in turn result in pricing pressures with respect
to traffic carried along these routes. If capacity expansion in the industry
results in capacity that exceeds overall demand in general, or along any of the
Company's routes, severe additional pricing pressure could develop. Such pricing
pressure could have a material adverse effect on the Company.
RISKS ASSOCIATED WITH ACQUISITIONS, INVESTMENTS AND STRATEGIC ALLIANCES
As part of its business strategy, the Company has entered into, and in the
future may enter into, strategic alliances with, has acquired and in the future
may acquire assets or businesses from and has made and in the future may make
investments in, companies that are complementary to its current operations. Any
such future strategic alliances, investments or acquisitions would be
accompanied by the risks commonly encountered in such transactions. Such risks
include, among other things, the difficulty of assimilating the operations and
personnel of the companies, the potential disruption of the Company's ongoing
business, costs associated with the development and integration of such
operations, the inability of management to maximize the financial and strategic
position of the Company by the successful incorporation of licensed or acquired
technology into the Company's service offerings, the maintenance of uniform
standards, controls, procedures and policies, the impairment of relationships
with employees and customers as a result of changes in management and higher
customer attrition with respect to customers obtained through acquisitions.
Financial risks involved in acquisitions include the incurrence of indebtedness
by the Company in order to finance such acquisitions and the consequent need to
service such indebtedness.
In many Latin American countries, including Mexico, the jurisdiction of
organization of Telereunion S.A., foreign investors such as the Company may be
prohibited from owning a majority interest in any local entity providing certain
telecommunications services. The result of any such laws or regulations is that
the Company may not have a controlling interest in an entity through which
substantial investments and operations of the Company are made and conducted.
Expansion through joint ventures entails similar potential risks for the
Company. The Company may not have a majority interest in or control of the board
of directors of any such local operating entity or its operations or assets.
There is also a risk that a minority or majority interest owner or the Company's
joint venture partner or partners may not have economic, business or legal
interests or goals that are consistent with those of the joint venture or the
Company. In addition, there is a risk that a minority or majority interest owner
or a joint venture partner may be unable to meet its economic or other
obligations and that the Company may be required to fulfill those obligations.
Depending on the value and nature of the consideration paid by the Company
for acquisitions, such acquisitions may materially adversely affect the
Company's liquidity. In making acquisitions in the future, the Company
anticipates that it may compete for acquisitions with other companies, some of
which are larger and have greater financial resources than the Company. There
can be no assurance that the Company will be successful in consummating
acquisitions, thereby limiting the Company's ability to grow. The Indenture
limits the ability of the Company and its subsidiaries to incur indebtedness to
finance acquisitions. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
CERTAIN FACTORS RELATING TO MEXICO
ADVERSE MEXICAN ECONOMIC CONDITIONS AND GOVERNMENT POLICIES. A significant
portion of the Company's assets and revenues are and will be located in Mexico.
In addition, substantially all of the proceeds from the Notes Offering are to be
invested in the development of the Mexican Network. The Company's business is
affected by prevailing conditions in the Mexican economy and is, to a
significant extent, vulnerable to economic downturns and changes in government
policies. The Mexican government has exercised and continues to exercise
significant influence over many aspects of the Mexican economy.
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Accordingly, actions taken or policies established by legislative, executive or
judicial authorities in Mexico that affect the economy of Mexico could have
material adverse effects on private sector entities in general and on the
Company in particular. There can be no assurance that future economic, political
or diplomatic developments in or affecting Mexico will not impair the Company's
business, results of operations, financial condition, liquidity (including the
ability to obtain financing) or prospects, or materially adversely affect the
market price of the Company's securities (including the shares of Common Stock)
or the ability of the Company to meet its obligations. See " -- Risks
Associated with International Operations; Currency Fluctuations."
EXCHANGE RATES. From December 1994 through December 1996, Mexico
experienced an economic crisis characterized by exchange rate instability, a
devaluation of the peso, high inflation, high domestic interest rates, negative
economic growth (on a cumulative basis), a reduction of international capital
flows to both the private and public sectors, reduced consumer purchasing power
and high unemployment. This crisis or any future crisis of a similar nature,
including the devaluation of the peso, could have a material adverse effect on
the Company's financial position and results of operations. Additionally, any
future devaluation of the peso against the U.S. dollar could materially
adversely affect the ability of the Company to service its dollar-denominated
liabilities.
The value of the peso has been subject to significant fluctuations with
respect to the U.S. dollar in the past and may be subject to significant
fluctuations in the future. The following table summarizes the value of the peso
against the U.S. dollar at the beginning and end of the periods indicated.
TIME PERIOD PESOS PER U.S. DOLLAR % CHANGE DURING PERIOD
- ------------------------ --------------------- ----------------------
1/1/94 - 12/31/94 3.11 - 4.94 58.8%
1/1/95 - 12/31/95 4.94 - 7.68 55.5
1/1/96 - 12/31/96 7.68 - 7.85 2.2
1/1/97 - 12/31/97 7.85 - 8.08 2.9
1/1/98 - 8/31/98 8.08 - 9.96 23.3
Exchange rate fluctuations could have a material adverse effect on the
Company's business and its ability to service its dollar-denominated
liabilities.
Substantially all of the Company's indebtedness is denominated in U.S.
dollars. In addition, the Company generally purchases equipment for capital
improvements in U.S. dollars. The Company believes that less than 10% of the
Company's revenues are currently transacted in pesos. Declines in the value of
the peso relative to other currencies will increase the costs in pesos to the
Company of this indebtedness and will result in foreign exchange losses and
increases in the peso cost of the Company's capital expenditures. In 1993, 1994,
1995, 1996 and 1997 and the six months ended June 30, 1998, the Company
experienced net foreign exchange losses (gains) of $(14,000), $(18,000), $2,000,
($161,000), $126,000 and $187,000, respectively, as a result of the effect of
the peso devaluation.
The Company may in the future incur additional non-peso-denominated
indebtedness. As a result of its plan to construct the Mexican Network, the
Company anticipates that it will generate additional peso-denominated
receivables in the future from the provision of domestic and international long
distance services originating in Mexico. As the Company's peso-denominated
revenues increase, the Company's foreign exchange risk will also increase. The
Company does not currently hedge against the risk of exchange rate fluctuations.
EXCHANGE CONTROLS. In recent years, the Mexican economy has suffered
balance of payment deficits and shortages in foreign exchange reserves. While
the Mexican government does not currently restrict the ability of Mexican or
foreign persons or entities to convert pesos to dollars or to transfer dollars
outside Mexico, no assurance can be given that the Mexican government will not
institute a restrictive exchange control policy in the future. Any such
restrictive exchange control policy would materially adversely affect the
Company's ability to convert pesos into dollars and could also have a material
adverse effect on the Company's business and financial condition and its ability
to service its dollar denominated liabilities.
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DEVELOPMENTS IN OTHER EMERGING MARKET COUNTRIES. Prices of securities of
companies with significant Mexican operations may be, to varying degrees,
influenced by economic and market conditions in other emerging market countries.
Although economic conditions are different in each country, investors' reactions
to developments in one country may have effects on the prices of securities of
issuers in other countries, including Mexico. There can be no assurance that the
Company's securities (including the Common Stock) would not be materially
adversely affected by events in emerging market countries or that such events
would not affect the price of the Common Stock.
MANAGEMENT OF GROWTH
The Company's strategy of continuing its growth and expansion has placed,
and is expected to continue to place, a significant strain on the Company's
management, operational and financial resources and increased demands on its
systems and controls. The Company is continuing to develop its network by adding
switches, cable and satellite facilities and expanding its operations within
Latin America when business and regulatory conditions warrant. In order to
manage its growth effectively, the Company must continue to implement and
improve its operational and financial systems and controls, purchase and utilize
other transmission facilities, and expand, train and manage its employee base.
Inaccuracies in the Company's forecasts of traffic could result in insufficient
or excessive transmission facilities and disproportionate fixed expenses. There
can be no assurance that the Company will be able to develop a facilities-based
network or expand within its target markets at the rate presently planned by the
Company, or that the existing regulatory barriers to such expansion will be
reduced or eliminated. As the Company proceeds with its development, there will
be additional demands on the Company's customer support, billings systems and
support, sales and marketing and administrative resources and network
infrastructure. There can be no assurance that the Company's operating and
financial control systems and infrastructure will be adequate to maintain and
effectively manage future growth. The failure to continue to upgrade the
administrative, operating and financial control systems or the emergence of
unexpected expansion difficulties could materially adversely affect the
Company's business, results of operations and financial condition. See " --
Dependence on Effective Management Information Systems."
DEPENDENCE ON EFFECTIVE MANAGEMENT INFORMATION SYSTEMS
The Company is dependent upon its information systems and switching
equipment to provide service to its customers, manage its network, collect
billing information and perform other vital functions. The Company is
particularly dependent upon its maintenance of an effective billing and
collection system, especially with respect to its Prepaid Card and wholesale
long distance businesses because of the high transaction volumes associated with
such businesses. The Company may experience technical difficulties with its
hardware or software which could materially adversely affect the Company's
business, financial condition or results of operations. See " -- Impact of the
Year 2000 Issue" and "Business -- Network."
COMPETITION
COMPETITION WITH PROVIDERS THAT HAVE GREATER RESOURCES THAN THE
COMPANY. The international and national telecommunications industry is highly
competitive and subject to rapid change precipitated by advances in technology
and regulation. Many of the Company's competitors are significantly larger, have
substantially greater financial, technical and marketing resources, larger
networks and a broader portfolio of services than the Company. Additionally,
many competitors have strong name recognition and "brand" loyalty,
long-standing relationships with the Company's target customers, and economies
of scale which can result in a lower relative cost structure for transmission
and related costs. These competitors include, among others, AT&T, MCI WorldCom,
Inc. ("MCI WorldCom") and Sprint Communications, Inc. ("Sprint"), which
provide long distance services in the United States: Telmex, Concessionaires,
and other registered value-added services providers in Mexico; as well as Post
Telegraph and Telephone operators ("PTTs") and emerging competitors in other
Latin American markets where the Company seeks to compete.
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The Company anticipates that it will encounter additional competition as a
result of the formation of global alliances among large telecommunications
providers. Recent examples of such alliances include AT&T's alliance with
Unisource, known as "Uniworld;" Cable & Wireless Plc's recent alliance with
Italy's STET/Telecom Italia to serve international customers with a primary
focus on the Latin American and European regions; WorldCom, Inc.'s
("WorldCom") recent merger with MCI Communications, Inc. ("MCI"), and
subsequent alliance with Telefonica de Espana; and Sprint Communications, Inc.'s
("Sprint") alliance with Deutsche Telekom and France Telecom, known as
"Global One," and the joint venture between Sprint and Telmex. Consolidation
in the telecommunications industry may create even larger competitors with
greater financial and other resources. The effect of the aforementioned or other
similar mergers and alliances could create increased competition in the
telecommunications services market and potentially reduce the number of
customers that purchase wholesale international long distance services from the
Company.
COMPETITION WITH PREPAID CARD PROVIDERS. In the Prepaid Card business, the
Company currently competes with all of the first tier telecommunications
carriers as well as emerging multinational carriers such as PT-1 Communications,
Inc. ("PT-1"), SmarTalk Teleservices, Inc. ("SmarTalk"), RSL Communications,
Ltd. ("RSL") and IDT Corporation ("IDT"), many of which have greater
financial resources than the Company. Because certain of the Company's current
competitors also are or could be the Company's customers, the Company's business
would be materially adversely affected to the extent that a significant number
of such customers limit or cease doing business with the Company for competitive
or other reasons.
COMPETITION FROM PRICE SENSITIVITY AND FROM DEREGULATION. International
telecommunications providers such as the Company compete on the basis of price,
customer service, transmission quality, breadth of service offerings and
value-added services, and the Company's carrier and Prepaid Card customers are
especially price sensitive. Many of the Company's larger competitors enjoy
economies of scale that can result in a lower cost structure for termination and
network costs, which could cause significant pricing pressures within the
international communications industry. Many of the Company's smaller competitors
have the flexibility to change pricing strategies and introduce new service
offerings quickly. In recent years, prices for international and other
telecommunications services have decreased substantially, and are expected to
continue to decrease, in most of the markets in which the Company currently
competes or intends to compete. The intensity of such competition has recently
increased, and the Company expects that such competition will continue to
intensify as the number of new entrants increases as a result of the new
competitive opportunities created by the U.S. Telecommunications Act of 1996
(the "1996 Telecommunications Act"), implementation by the Federal
Communications Commission ("FCC") of the U.S. commitment to the World Trade
Organization ("WTO"), and privatization, deregulation and changes in
legislation and regulation in various of the Company's foreign target markets.
The Company believes that competition in all of its markets is likely to
increase and that competition in non-U.S. markets is likely to become more
similar to competition in the U.S. market over time as such non-U.S. markets
continue to experience deregulatory influences. In each of the countries where
the Company markets or intends to market its services, the Company competes
primarily on the basis of price (particularly with respect to its sales to other
carriers), and also on the basis of customer service and its ability to provide
a variety of telecommunications products and services. There can be no assurance
that the Company will be able to compete successfully in the future. The Company
anticipates that deregulation and increased competition will result in
decreasing customer prices for telecommunications services. The Company believes
that the effects of such decreases will be at least partially offset by
increased telecommunications usage and decreased costs, but there can be no
assurance that this will be the case. To the extent this is not the case, there
could be a material adverse effect on the Company's margins and profits, and the
Company's business, financial condition and results of operations could be
materially and adversely affected. There can be no assurance that the Company
will be able to compete successfully in the future, or that such intense
competition will not have a material adverse effect on the Company's business,
financial condition and results of operations.
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COMPETITION IN MEXICO. In Mexico, the regulatory authorities have granted
concessions to 15 companies, including Telmex and Telereunion S.A., to construct
and operate public, long distance telecommunications networks in Mexico
("Concessionaires"). Some of these new competitive entrants have as their
partners major U.S. telecommunications providers including AT&T (Alestra, S.A.
de C.V. ("Alestra")), MCI (Avantel, S.A. de C.V. ("Avantel")) and Bell
Atlantic Corp. (Iusatel, S.A. de C.V. ("Iusatel")). In addition, the
regulatory authorities in Mexico have granted national concessions to provide
local exchange services to several telecommunications providers, including
Telmex and Telinor, S.A. de C.V. ("Telinor"), Megacable Comunicaciones de
Mexico, S.A. de C.V. ("Megacable"), Amaritel, S.A. de C.V. ("Amaritel"),
Union Telefonica Nacional, S.A. de C.V. ("Unitel"), MetroNet S.A. de C.V.
("MetroNet") and Red de Servicios de Telecommunicaciones, S.A. de C.V. ("Red
de Servicios") and several of Mexico's long distance Concessionaires. With
regard to the provision of services in Mexico, the Company competes or will
compete in Mexico with numerous other systems integration, value-added services,
and voice and data services providers, some of which focus their efforts on the
same customers targeted by the Company. In addition to these competitors, recent
and pending deregulation in Mexico may encourage new entrants.
Moreover, while the recently completed WTO Agreement (as defined) could
create opportunities for the Company to enter new foreign markets,
implementation of the WTO Agreement by the United States and other countries
could result in new competition from PTTs previously banned or limited from
providing services in the United States. For example, the joint venture between
Sprint and Telmex has applied to the FCC to enter the United States market and
to provide resold international switched services between the United States and
Mexico. Such application was approved subject to various conditions. Although
certain parties requested that the FCC reconsider its decision, the request was
denied. Increased competition in the United States, Mexico, and other Latin
American countries as a result of the foregoing, and other competitive
developments, including entry by Internet service providers into the
long-distance market, could have a material adverse effect on the Company's
business, financial condition and results of operations.
COMPETITION WITH PTTS; FOREIGN REGULATORY HURDLES. The Company's success
depends upon its ability to compete with a variety of other telecommunications
providers in each of its markets, including the respective PTT in each country
in which the Company operates. The Company believes that PTTs generally have
certain competitive advantages due to their control over local connectivity and
close ties with national regulatory authorities. The Company also believes that,
in certain instances, some regulators have shown a reluctance to adopt policies
and grant regulatory approvals that would result in increased competition for
the local PTT. If a PTT were to successfully pressure national regulators to
prevent the Company from providing its services, the Company could be denied
regulatory approval in certain jurisdictions in which its services would
otherwise be permitted, thereby requiring the Company to seek judicial or other
legal enforcement of its right to provide services or to abandon its proposed
operations. Any delay in obtaining approval, or failure to obtain approval,
could have a material adverse effect on the Company's business, financial
condition and results of operations. If the Company encounters anti-competitive
behavior or if national regulatory authorities fail to adopt or implement
procompetitive policies or safeguards in countries in which the Company operates
or intends to operate or if the PTT in any country in which the Company operates
uses its competitive advantages to the fullest extent, the Company's business,
financial condition and results of operations could be materially adversely
affected. See "Business -- Competition" and "Business -- Regulation."
RISKS RELATED TO THE MEXICAN CONCESSION
The terms of the Mexican Concession are subject to regulation by the
Mexican government. There can be no assurance that additional concessions to
provide services similar to those expected to be provided by the Company will
not be granted to additional competitors, or that the value of the Mexican
Concession will not otherwise be affected by government action. The Mexican
government also has authority to temporarily seize all assets related to the
Mexican Concession in the event of natural disaster, war, significant public
disturbance or threats to internal peace and for other reasons of economic or
public order. In addition, the
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Mexican government has the statutory right to expropriate any concession and
claim all assets related thereto for reasons of public interest. Mexican law
provides for compensation in connection with losses and damages related to
temporary seizure or expropriation. However, there can be no assurance as to the
adequacy or timing of compensation obtained in any such case.
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. 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 and would likely prevent the
Company from having the ability to repay the Notes.
SUBSTANTIAL GOVERNMENT REGULATION
GENERAL. The global telecommunications industry is subject to substantial
government regulation, which may frequently change and which varies from country
to country, with enforcement and interpretation often unpredictable and/or
subject to influence by the local PTT. The Company has pursued and expects to
continue to pursue an aggressive strategy of providing its services to the
maximum extent it believes to be permissible under applicable laws and
regulations, which may result in the Company (i) providing services or using
transmission methods that are found to violate the laws or regulations of those
countries where it operates or plans to operate, (ii) losing, failing or being
unable to obtain approvals or make filings subsequently found to be required
under such laws or regulations, or (iii) being subject to fines, penalties, the
confiscation of facilities and equipment or other sanctions, including being
denied the ability to offer its products and services.
If the Company's interpretation of applicable laws and regulations proves
incorrect, or if the Company is subject to fines, penalties or other sanctions
as a result, or if the Company is unable to provide services or utilize
transmission methods which it presently provides or utilizes or intends to
provide or utilize, these events may have a material adverse effect on the
Company's business, financial condition and results of operations. Additionally,
there can be no assurance that future regulatory, judicial or legislative
changes in any or all of the markets in which the Company operates or intends to
operate will not have a material adverse effect on the Company's business,
financial condition or results of operations. See "Business -- Regulation."
DEPENDENCE ON MANAGEMENT AND OTHER KEY PERSONNEL
The Company's success depends in significant part upon the continued
service of its senior management personnel and certain other employees with
longstanding industry relationships and technical knowledge of the Company's
operations including, in particular, E. Scott Crist, the Company's President and
Chief Executive Officer, and Manuel Landa, the Company's Chairman of the Board.
The Company does not maintain any "key person" life insurance. The Company has
entered into employment agreements with all of its key members of management.
The Company's future success also depends on its ability to attract, train,
retain and motivate highly skilled personnel. Competition for qualified,
high-level telecommunications personnel is intense and there can be no assurance
that the Company will be successful in attracting and retaining such personnel.
In particular, the Company is seeking to expand its middle-management personnel
in certain target markets, where the number of available qualified managers is
extremely limited. The loss of the services of one or
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<PAGE>
more of the Company's key personnel, or the failure to attract and retain
additional key personnel, could have a material adverse effect on the Company's
business, operating results and financial condition. See "Management."
DEPENDENCE ON DISTRIBUTORS
The Company is dependent on distributors, particularly with respect to
sales of its TELEFIESTA(R) Prepaid Cards for international long distance
telecommunications services in the United States. Most of the Company's
distributors also sell services or products of other companies. Accordingly,
there can be no assurance that these distributors will devote sufficient efforts
to promoting and selling the Company's services, or that the Company will be
able to find capable distributors in the new markets into which it is entering.
The failure of these distributors to effectively distribute the Company's
TELEFIESTA(R) Prepaid Cards would substantially impair the Company's ability to
generate revenues from the sales of these cards, which could have a material
adverse effect on the Company's business, financial condition or results of
operations.
RISKS ASSOCIATED WITH COLLECTION OF RECEIVABLES; FRAUD
The Company expends considerable resources to collect receivables from
customers who fail to make payments in a timely manner. While the Company
continually seeks to minimize bad debt, and at times requires collateral to
support accounts receivable from certain customers, the Company's experience
indicates that a certain portion of past due accounts receivable will never be
collected and that such bad debt is a necessary cost of conducting business. As
of June 30, 1998, the Company reserved approximately $375,000 for accounts
receivable that are estimated to be uncollectible. In June 1998, one of the
Company's significant wholesale customers filed a petition for relief under
Chapter 11 of the U.S. Bankruptcy Code. As a result, the Company has reserved
approximately $540,000 for accounts receivable that are expected to be
uncollectible from this customer. There can be no assurance that, with regard to
any particular time period or periods or any particular geographic location or
locations, uncollectible receivables will not rise significantly above
historical or anticipated levels. Any significant increase in uncollectible
receivables could have a material adverse effect on the Company's business,
financial condition or results of operations. See "-- Dependence on Service
Providers for Prepaid Card Services."
The telecommunications industry has historically incurred losses due to
fraud. Although the Company has implemented anti-fraud measures in order to
control losses relating to fraudulent practices, there can be no assurance that
the Company will be able to control fraud effectively when operating in the
international or domestic telecommunications arena. The Company's failure to
control fraud effectively could have a material adverse effect on its business,
financial condition or results of operations. See "Business -- Customers,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Revenues" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview."
DEPENDENCE ON OPERATING AGREEMENTS WITH FOREIGN OPERATORS
The Company's wholesale long distance business is substantially dependent
on its ability to enter into: (i) operating agreements with PTTs in countries
that have yet to become deregulated so the Company can terminate traffic in, and
receive return traffic from, such countries; (ii) operating agreements with PTTs
and emerging carriers in foreign countries whose telecommunications markets have
deregulated so it can terminate traffic in such countries; and (iii)
interconnection agreements with the PTT in each of the countries where the
Company has operating facilities so it can terminate traffic in such countries.
The Company believes that it would not be able to serve its customers at
competitive prices without such operating or interconnection agreements.
Termination of such operating agreements by certain of the Company's foreign
carriers or PTTs would have a material adverse effect on the Company's business.
Moreover, there can be no assurance that the Company will be able to enter into
additional operating or interconnection agreements in the future. The failure to
enter into additional agreements could limit the Company's ability to increase
its revenues on a profitable basis. See "Business -- Network."
In many Latin American countries, including Mexico, the jurisdiction of
organization of Telereunion S.A., foreign investors such as the Company may be
prohibited from owning a majority interest in any local entity providing certain
telecommunications services. The result of any such laws or regulations is that
the
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Company may not have a controlling interest in an entity through which
substantial investments and operations of the Company are made and conducted.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS; CURRENCY FLUCTUATIONS
A significant portion of the Company's operations, employees and assets are
located in Mexico. Additionally, expansion into international markets,
particularly in Latin America, is a key component of the Company's growth
strategy.
In many international markets, the PTT controls access to the local
networks, enjoys better brand name recognition and customer loyalty and
possesses significant operational economies, including a larger backbone network
and operating agreements with other PTTs. Moreover, PTTs generally have certain
competitive advantages due to their close ties with national regulatory
authorities, which have, in certain instances, shown reluctance to adopt
policies and grant regulatory approvals that would result in increased
competition for the local PTT. Pursuit of international growth opportunities may
require significant investments for extended periods of time before returns, if
any, on such investments are realized. Obtaining licenses in certain target
countries may require the Company to commit significant financial resources,
which investments may not yield positive net returns in such markets for
extended periods of time or ever. In addition, there can be no assurance that
the Company will be able to obtain the permits and licenses required for it to
operate, obtain access to local transmission facilities or markets or sell and
deliver competitive services in these markets.
In addition to the uncertainty as to the Company's ability to expand its
international presence, there are certain risks associated with conducting
business internationally that could have a material adverse effect on the
Company's international operations, including its strategy to open additional
offices in foreign countries and its ability to repatriate net income from
foreign markets. Such risks may include unexpected changes in regulatory
requirements, value-added tax, tariffs, customs, duties and other trade
barriers, difficulties in staffing and managing foreign operations, problems in
collecting accounts receivable, political risks, fluctuations in currency
exchange rates, foreign exchange controls which restrict or prohibit
repatriation of funds, technology export and import restrictions or
prohibitions, delays from customs brokers or government agencies, seasonal
reductions in business activity during the summer months in certain parts of the
world and potentially adverse tax consequences resulting from operating in
multiple jurisdictions with different tax laws. Although the Company's sales to
date have generally been denominated in U.S. dollars, some of the Company's
recent contracts are denominated in foreign currencies, and the value of the
U.S. dollar in relation to foreign currencies may also materially adversely
affect the Company's sales to international customers as well as the cost of
procuring, installing and maintaining equipment abroad. To the extent the
Company expands its international operations or begins to denominate prices in
foreign currencies, the Company will be exposed to increased risks of currency
fluctuation. The Company does not currently hedge against the risk of exchange
rate fluctuation, but may in the future choose to limit its exposure to foreign
currency risk through the purchase of forward foreign exchange contracts or
similar hedging strategies. However, there can be no assurance that any foreign
currency hedging strategy would be successful in avoiding exchange-related
losses. In addition, the Company's business could be materially adversely
affected by a reversal in the current trend toward deregulation of
telecommunications carriers. In certain countries, into which the Company may
choose to expand in the future, the Company may need to enter into a joint
venture or other strategic relationship with one or more third parties (possibly
with a PTT or other dominant carrier) in order to enter the market and/or
conduct its operations successfully. There can be no assurance that such factors
will not have a material adverse effect on the Company's future operations and,
consequently, on the Company's business, results of operations and financial
condition, or that the Company will not have to modify its current business
practices. In addition, there can be no assurance that laws or administrative
practices relating to taxation, foreign exchange or other matters of countries
within which the Company operates will not change. Any such change could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "-- Certain Factors Relating to Mexico."
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DEPENDENCE ON FACILITIES-BASED CARRIERS
Telephone calls made by the Company's customers are transmitted primarily
over lines that the Company leases from facilities-based long distance carriers,
many of which are, or may become, competitors of the Company. The Company's
ability to maintain and expand its business is dependent upon whether the
Company continues to maintain favorable relationships with the facilities-based
carriers from which the Company leases transmission lines. Although the Company
believes that its relationships with carriers generally are satisfactory, the
deterioration or termination of the Company's relationships with one or more of
these carriers could have a material adverse effect upon the Company's cost
structure, service quality, network diversity, results of operations and
financial condition.
At present, a significant amount of the transmission capacity used by the
Company is obtained on a per-call (or usage) basis, subjecting the Company to
the possibility of unanticipated price increases and service cancellations.
Currently, usage rates generally are less than the rates the Company charges its
customers for connecting calls through these lines. Due to increased
competition, the Company may be forced to reduce the rates it charges to its
customers, which may result in the Company experiencing reduced or, in certain
circumstances, negative margins for some services. As its traffic volume
increases between particular international markets, the Company expects to cease
using variable usage arrangements and enter into fixed monthly or longer-term
leasing arrangements, subject to regulatory constraints. If the Company enters
into fixed-cost lease arrangements and incorrectly projects traffic volume in a
particular geographic area, the Company may not generate sufficient additional
revenue to offset the higher fixed costs. Moreover, certain vendors from which
the Company leases transmission lines, including Regional Bell Operating
Companies ("RBOCs") and other Local Exchange Carriers ("LECs") in the United
States, currently are subject to tariff controls and other price constraints
which in the future may be changed. Regulatory proposals are pending that may
affect the prices charged by the RBOCs and other LECs to the Company, which
could have a material adverse effect on the Company's margins, business,
financial condition and results of operations. If the tariff controls are lifted
as a result of the Detariffing Order (as defined), the Company will need to
negotiate contracts with these vendors, which could result in substantial legal
and administrative expense and a different cost structure for the Company's
services. See "-- Substantial Government Regulation" and
"Business -- Regulation."
DEPENDENCE ON SERVICE PROVIDERS FOR PREPAID CARD SERVICES
The Company has entered into service agreements with certain providers to
provide the Prepaid Card switching platform and the telecommunications services
related to the Prepaid Cards it markets and sells under the TELEFIESTA(R) brand
name. The Company intends to install its own Prepaid Card switching platform in
Houston, Texas, utilizing a Nortel DMS-250 switching platform. In addition, the
Company intends to use a portion of the net proceeds from the Notes Offering to
expand the Company's network facilities, including approximately $6.0 million
toward the deployment or purchase of Prepaid Card switching platforms in high
volume gateway cities such as Houston, New York, Chicago, San Francisco and Los
Angeles. There can be no assurance that the Prepaid Card switching platforms
will be completed on a timely basis, if at all. Until it installs platforms
sufficient to service its Prepaid Card business, the Company will continue to
utilize third parties to provide platforms for its Prepaid Card services. The
deterioration or termination of the Company's relationships with its platform
service providers could have a material adverse effect upon the Company's
revenue growth, cost structure, service quality, brand name recognition, network
diversity, results of operations and financial condition.
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. For the five
months ended May 31, 1998, this customer accounted for approximately 26% of the
Company's wholesale revenues and 7% of the Company's overall revenues.
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 the customer for the telecommunications services at the time the
Prepaid Cards were activated. 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 Company's
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earnings, including additional Prepaid Card services cost, 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 by approximately
$2.0 million in the second quarter of 1998. This bankruptcy is not expected to
have a material impact on the Company's operating results for the third quarter
of 1998. The lost revenues from this customer have been replaced by replacing
the minutes previously purchased by this customer with minutes from existing or
new customers at market rates.
RAPID TECHNOLOGICAL DEVELOPMENT
The markets that the Company services are characterized by rapidly changing
technology, evolving industry standards, emerging competition and the frequent
introduction of new services, software and other products. The Company's success
is dependent in part upon its ability to enhance existing products, software and
services and to develop new products, software and services that meet changing
customer requirements on a timely and cost-effective basis. There can be no
assurance that the Company can successfully identify new opportunities and
develop and bring new products, software and services to market in a timely and
cost effective manner, or that products, software, services or technologies
developed by others will not render the Company's products, software, services
or technologies non-competitive or obsolete. In addition, there can be no
assurance that products, software or service developments or enhancements
introduced by the Company will achieve or sustain market acceptance or that they
will effectively address the compatibility and interoperability issues raised by
technological changes or new industry standards.
NEW AND UNCERTAIN MARKETS
Many of the overseas markets in which the Company currently markets or
intends to market telecommunications services are undergoing dramatic changes as
a result of privatization and deregulation. As a result of privatization and
deregulation, a new competitive environment is emerging in which major telephone
companies, media companies and utilities are entering the telecommunications
market and forming new alliances which are radically changing the landscape of
international and domestic telephone services. Open markets for
telecommunications services are expected to evolve in other parts of the world
as well. While the Company is focused on exploiting the imbalances brought about
by deregulation, the Company frequently enters new markets and is unable to
predict how the regulatory environments of such markets will evolve. There can
be no assurance that changes in the marketplace and new strategic alliances
among companies with greater resources than the Company will not materially
adversely affect the Company's ability to continue its efforts to increase its
overseas telecommunications customer base and its traffic volume, or its ability
to recover the cost of building out its international telecommunications
switching and transmission infrastructure.
CUSTOMER CONCENTRATION
The Company is dependent upon several key customers with respect to its
international wholesale business. One of the Company's customers accounted for
approximately 28% of its overall revenues for the year ended December 31, 1997.
For the six months ended June 30, 1998, no single customer accounted for over
10% of the Company's overall revenues. The Company could lose a significant
customer for many reasons, including the entrance into the market of significant
new competitors with lower rates than the Company, downward pressure on the
overall costs of transmitting international calls, transmission quality
problems, changes in U.S. or foreign regulations or unexpected increases in the
Company's cost structure as a result of expenses related to installing a global
network or otherwise. Recently, a wholesale customer of the Company that
accounted for approximately 26% of the Company's wholesale long distance
revenues for the five months ended May 31, 1998, filed a petition for relief
under Chapter 11 of the U.S. Bankruptcy Code. The Company has reserved
approximately $540,000 for accounts receivable that are expected to be
uncollectible from this customer. An affiliate of such customer provided
services for the Company's Prepaid Cards. See " -- Dependence on Service
Providers for Prepaid Card Services." Reserving for these receivables and the
loss of wholesale carrier revenues and gross margin contribution from this
customer negatively impacted the Company's earnings and EBITDA for the quarter
ended June 30, 1998 and will negatively impact the Company's earnings and EBITDA
for the fiscal year ending December 31, 1998. The
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Company seeks to mitigate the risk of customer concentration by expanding its
wholesale customer base. However, there can be no assurance that the Company
will be able to attract and retain new wholesale customers or that such
customers will not experience similar financial difficulties, default on their
payment obligations or choose to route their traffic through a carrier other
than Telscape, any of which would have a material adverse effect on the
Company's business and results of operations. See "-- Risks Associated with
Collection of Receivables; Fraud."
RISK OF DEFAULT UNDER EXISTING AGREEMENTS
Certain of the Company's subsidiaries have entered into financing
agreements with an equipment lessor. These agreements permit the lessor, upon
the occurrence of certain events of default, to accelerate the entire unpaid
balance of amounts loaned to those subsidiaries for the purchase of switching
equipment and to foreclose on the equipment securing such obligations.
Accordingly, any failure by these subsidiaries to make payments when due on such
loans or to comply with certain affirmative and negative covenants set forth in
the agreements could materially adversely affect the Company's business,
financial condition and results of operation as well as its ability to provide
services through the use of these switches. For a more detailed discussion of
these agreements, see "Summary of Certain Indebtedness -- Equipment Leases."
On July 27, 1998, the Company obtained a waiver from Southwest Bank of
Texas, N.A. under the Company's Revolving Credit Facility (as defined) to (i)
permit the Guarantee of the Notes by Telscape USA and MSN and (ii) waive
defaults under the minimum current ratio, minimum tangible net worth and
prohibition on quarterly loss covenants. If the Company remains in default under
the Revolving Credit Facility or defaults on covenants provided for in future
financing arrangements, and the Company is unable to obtain a waiver for such
defaults, the lenders could terminate such financing arrangements. The
termination of one or more of the Company's financing arrangements could have a
material adverse effect on the Company's working capital, ability to expand its
business or ability to execute its business plan. In addition, it is an event of
default under the Notes if the Company defaults on a financing obligation that
causes the acceleration of an amount in excess of $5.0 million.
COVENANTS
Upon consummation of the Notes Offering, the Indenture will contain
numerous financial and operating covenants that will limit the discretion of the
Company's management with respect to certain business matters. These covenants
will place significant restrictions on, among other things, the ability of the
Company to incur additional indebtedness, to create liens or other encumbrances,
to make certain payments and investments, and to sell or otherwise dispose of
assets and merge or consolidate with other entities. A failure to comply with
the obligations contained in the Indenture could result in an event of default
under the Indenture, which could result in acceleration of the Notes and the
acceleration of debt under other instruments evidencing indebtedness that may
contain cross-acceleration or cross-default provisions.
PROPRIETARY RIGHTS
The Company relies on a combination of patent, copyright, trademark and
trade secret laws and contractual restrictions to establish and protect its
technology and trade names. The Company believes that "Telscape" and the
"TELEFIESTA"(R) Prepaid Cards, as well as the names and logos associated with
other of its services and products have achieved significant brand awareness
among its targeted markets, and the Company intends to protect and defend its
name, servicemarks and trademarks in the United States and internationally. The
Company has achieved registration for the "TELEFIESTA"(R) mark and has filed for
protection of the "Telscape" name and logo, and Telereunion S.A., has a national
trademark registration in Mexico for "TELEREUNION." There can be no assurance
that the Company's trademark applications will result in any trademark
registrations. There can be no assurance that the steps taken by the Company
will be adequate to prevent misappropriation of its technology or other
proprietary rights, or that the Company's competitors will not independently
develop technologies that are substantially equivalent or superior to the
Company's technology.
The Company is not aware of any third party challenges to the validity of
its trademarks, trademark applications, or of any claim by a third party of
trademark infringement with respect to its products, marks,
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registrations or applications for registration. There can be no assurance that
the Company's efforts to protect its proprietary rights in the United States or
other countries will be successful. There can be no assurance that challenges or
claims will not be asserted in the future, or that the Company will have
sufficient funds to withstand such challenges or claims, regardless of their
merit. There can be no assurance that, if registered, any trademark will be held
valid and enforceable if challenged. The Company's inability to protect its
proprietary rights or continue to use its marks could have a material adverse
effect on the Company's operations. In addition, there can be no assurance that
licenses for any intellectual property that might be required in connection with
the Company's development of its services or products would be available on
reasonable terms if at all.
Although the Company does not believe that its products infringe the
proprietary rights of any third parties, and no third parties have asserted
patent infringement or other such claims against the Company, there can be no
assurance that third parties will not assert such claims against the Company in
the future or that any such claims will not be successful. The Company is aware
that patents have been recently granted to others based on fundamental
technologies in the communications, multimedia and Internet telephony areas and
patents may be issued which relate to fundamental technologies incorporated in
the Company's services and products. Because patent applications in the United
States are not publicly disclosed until the relevant patent is issued,
applications may have been filed which, if issued as patents, could relate to
the Company's services and products. The Company could incur substantial costs
and diversion of management resources in defending or pursuing any claims
relating to proprietary rights, which could have a material adverse effect on
the Company's business, financial condition or results of operations.
Furthermore, parties making such claims could secure a judgment awarding
substantial damages, as well as injunctive or other equitable relief which could
effectively block the Company's ability to provide services or products in the
United States or other countries. Such a judgment could have a material adverse
effect on the Company's business, financial condition or results of operations.
CONTROL BY PRINCIPAL STOCKHOLDERS
As of October 8, 1998, the officers and directors of the Company
beneficially owned approximately 57.5% of the Company's Common Stock on a fully
diluted basis. The Company's officers and directors are likely to continue to
exercise control or substantial influence over the Company's affairs, business
and election of members of the Company's Board of Directors. See "Principal and
Selling Stockholders."
RISKS RELATING TO A CHANGE OF CONTROL
Upon a change of control of the Company, holders of the Notes will have the
right to require the Company to repurchase all or any part of such holders'
Notes at a price equal to 101% of the aggregate principal amount thereof, plus
accrued and unpaid interest to the date of repurchase. Restrictions in the
Indenture governing the Notes may make more difficult or discourage a takeover
of the Company, whether favored or opposed by the management of the Company.
There can be no assurance that the Company would have sufficient financial
resources available to satisfy all of its obligations under the Notes (including
its obligation to repurchase the Notes at 101% of the aggregate principal amount
thereof) in the event of a change of control of the Company. The Company's
failure to purchase the Notes would result in a default under the Indenture,
which could have material adverse consequences for the Company.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 issue is the result of computer programs having been written
using two digits rather than four to define the applicable year, resulting in
date-sensitive software having the potential to recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities. In anticipation of the year 2000,
management has developed a plan to review software that was internally developed
or externally purchased or licensed, and also to review with its key vendors and
service providers their software, for compliance with Year 2000 processing
requirements. If the systems of other companies on whose services 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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USE OF PROCEEDS
The Company will not receive any of the proceeds from the sale of the
Shares offered hereby, nor will any such proceeds be available for use by it or
for its benefit.
DIVIDEND POLICY
The Company has paid no cash dividends since 1996. The Company currently
intends to retain all future earnings for use in the operation of its business
and, therefore, does not anticipate paying any cash dividends in the foreseeable
future. The declaration and payment in the future of any cash dividends will be
at the discretion of the Company's Board of Directors and will depend upon,
among other things, the earnings, capital requirements and financial position of
the Company, existing and/or future loan covenants and general economic
conditions. In addition, the Indenture governing the Notes will place
limitations on the Company's ability to pay dividends or make any other
distributions on the Common Stock. In addition, the Company's ability to pay
dividends may be adversely affected if, in the future, the Mexican government
were to impose restrictions on the Company's ability to repatriate profits. See
"Risk Factors -- Certain Factors Relating to Mexico."
PRICE RANGE OF COMMON STOCK
The Company's Common Stock traded on the NASDAQ Small Cap Market under the
symbol "PTMC" from August 10, 1994 until June 28, 1996, when it began trading
under the symbol "TSCP." The Company's Common Stock began trading on the
Nasdaq NMS on July 31, 1998. The following table sets forth, for the periods
indicated, the range of the high and low closing sales prices for the Common
Stock (i) as reported by the NASDAQ Small Cap Market, Inc. for periods prior to
July 31, 1998 and (ii) as reported by the Nasdaq NMS for periods beginning July
31, 1998.
HIGH LOW
--------- ---------
1996
First Quarter........................ $ 4.500 $ 2.500
Second Quarter....................... 6.875 3.000
Third Quarter........................ 7.125 3.875
Fourth Quarter....................... 4.875 3.125
1997
First Quarter........................ 3.750 2.000
Second Quarter....................... 4.250 2.625
Third Quarter........................ 10.75 3.688
Fourth Quarter....................... 15.25 7.500
1998
First Quarter........................ 17.625 8.25
Second Quarter....................... 23.1875 14.125
Third Quarter (through November 4,
1998).............................. 16.375 7.00
As of November 4, 1998, there were approximately 90 holders of record of
the Company's Common Stock.
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CAPITALIZATION
The following table sets forth Telscape's capitalization as of June 30,
1998 (i) on an actual basis and (ii) on an as adjusted basis giving effect to
the issuance and sale by the Company of $125.0 million of % Senior Notes due
2008 in the Notes Offering and the application of the estimated net proceeds
therefrom.
AS OF JUNE 30, 1998
--------------------------
AS ADJUSTED
ACTUAL NOTES OFFERING
------- ---------------
(DOLLARS IN THOUSANDS)
Cash and cash equivalents............ $ 4,939 $ 118,350
Short-term debt and current
maturities of long-term
obligations........................ 5,906 5,906
Long-term debt (less current
portion):
% Senior Notes due 2008.... -- 125,000
Notes payable and capital lease
obligations, net of current
portion....................... 4,463 4,463
Deere Park Convertible
Debentures.................... 4,922 4,922
Total long-term
debt............... 9,385 134,385
Series B non-voting,
non-participating preferred stock,
par value $.001 per share, 380,000
shares authorized, no shares issued
and outstanding.................... -- --
Stockholders' equity:
Preferred stock, par value $.001
per share, 5,000,000 shares
authorized; without defined
preference rights............. -- --
Series A preferred stock, par
value $.001 per share,
1,000,000 shares authorized... -- --
Common stock, par value $.001
per share, 25,000,000 shares
authorized, 5,248,636 and
8,067,548 shares issued and
outstanding................... 5 5
Additional paid-in capital...... 31,575 31,575
Accumulated deficit............. (2,359) (2,359)
Treasury Stock.................. (629) (629)
------- ---------------
Total stockholders'
equity.................. 28,592 28,592
------- ---------------
Total capitalization....... $37,977 $ 162,977
======= ===============
23
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following Unaudited Pro Forma Condensed Consolidated Statements of
Operations set forth the historical statements of operations of the Company for
the year ended December 31, 1997, as adjusted for the acquisitions of MSN and
Integracion, and the related transactions and events described in the notes
thereto, as if such transactions and events had been consummated on January 1,
1997.
Management believes that the assumptions used provide a reasonable basis on
which to present such Unaudited Pro Forma Condensed Consolidated Financial
Statements. The Unaudited Pro Forma Condensed Consolidated Financial Statements
should be read in conjunction with the historical Financial Statements and notes
thereto included elsewhere in this Prospectus and "Management's Discussion and
Analysis of Financial Condition and Results of Operations." The Unaudited Pro
Forma Consolidated Financial Statements are provided for informational purposes
only and should not be construed to be indicative of the Company's results of
operations or financial condition had the acquisitions of MSN and Integracion
and the transactions and events described above been consummated on the dates
assumed, may not reflect the results of operations or financial condition which
would have resulted had MSN and Integracion been operated as an integrated part
of the Company during such period, and are not necessarily indicative of the
Company's future results of operations or financial condition.
24
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
INTEGRACION
MSN (SIX MONTHS PRO FORMA
(YEAR ENDED ENDED ADJUSTMENTS
TELSCAPE DECEMBER 31, JUNE 30, (SEE NOTE
(HISTORICAL) 1997) 1997) 2) PRO FORMA
------------ ------------ ------------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<S> <C> <C> <C> <C> <C>
Revenues............................. $ 36,154 $ 24,568 $ 4,646 $ -- $65,368
Cost of revenues..................... 24,396 24,241 3,381 -- 52,018
------------ ------------ ------------- ----------- ---------
Gross profit......................... 11,758 327 1,265 -- 13,350
Selling, general and administrative
expenses........................... 8,154 1,246 524 (424)(2a) 9,500
------------ ------------ ------------- ----------- ---------
Operating income (loss) before
depreciation and
amortization................... 3,604 (919) 741 424 3,850
Depreciation and amortization........ 622 35 22 478(2b) 1,157
------------ ------------ ------------- ----------- ---------
Operating income (loss).......... 2,982 (954) 719 (54) 2,693
Interest income (expense), net....... (95) 33 (161)(2c) (223)
Other income (expense)............... (137) (3) 17 -- (123)
------------ ------------ ------------- ----------- ---------
Income (loss) before income
taxes.......................... 2,750 (957) 769 (215) 2,347
Provision for income taxes........... (84) -- (290) 385(2d) 11
------------ ------------ ------------- ----------- ---------
Income (loss) before minority
interests...................... 2,666 (957) 479 170 2,358
Minority interests................... 6 -- -- -- 6
------------ ------------ ------------- ----------- ---------
Net income (loss)................ $ 2,672 $ (957) $ 479 $ 170 $ 2,364
============ ============ ============= =========== =========
Earnings per share (note 2e):
Basic............................ $ 0.68 $ 0.59
Diluted.......................... $ 0.53 $ 0.44
</TABLE>
The accompanying notes are an integral part of these unaudited pro forma
condensed consolidated financial statements.
25
<PAGE>
1) GENERAL:
The unaudited pro forma condensed consolidated statements of operations of
the Company for the year ended December 31, 1997 reflect the Company's
historical statement of operations adjusted to include the operations of: (i)
MSN, acquired effective January 1, 1998, and (ii) Integracion, acquired
effective July 1, 1997, as if each of those acquisitions were consummated
effective January 1, 1997.
The pro forma financial information is not necessarily indicative of the
results that would have occurred had such transactions actually taken place at
the beginning of the periods specified nor does such information purport to
project the Company's financial position or results of operations for any future
date or period.
Effective July 1, 1997, pursuant to a stock purchase agreement, the Company
acquired all of the outstanding shares of Integracion. Integracion is a systems
integrator engaged in the distribution and sale of data and network equipment
and also provides value-added services in network integration in Mexico.
Under the terms of the transaction, the Company paid the following
aggregate consideration to the selling shareholders of Integracion: i) $130,000
in cash, ii) $2,201,000 in non-interest bearing promissory notes maturing at
various dates through January 1, 2001, iii) $999,000 in non-interest bearing
convertible notes maturing on September 1, 1999, which are convertible into
333,000 shares of common stock of the Company at a price of $3.00 per share,
representing the quoted market price of the Company's common stock on the date
of the transaction; iv) warrants for the purchase of up to 100,000 shares of
common stock of the Company based on Integracion meeting certain performance
requirements and v) a covenant by the Purchasers to pay $280,000 in the event
that Integracion meets certain performance requirements over the cumulative
period beginning January 1, 1997 and ending December 31, 2000. The acquisition
was accounted for under the purchase method of accounting.
The consideration paid for Integracion measured at the acquisition date was
$2,745,000 and consisted of cash of $130,000, promissory notes with a discounted
value of $2,555,000 and transaction costs of $60,000. 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 $1,756,000 of
goodwill, which is being amortized over 15 years. The purchase price of the
acquisition has been allocated as follows:
FAIR
VALUE
------------
Cash................................. $ 130,000
Promissory Notes (discounted
value)............................. 1,759,000
Convertible Notes (discounted
value)............................. 796,000
Transaction Costs.................... 60,000
------------
Total consideration............. 2,745,000
Cash................................. 307,000
Accounts receivable.................. 1,996,000
Inventories.......................... 330,000
Other assets......................... 165,000
Accounts payable and accrued
liabilities........................ (1,686,000)
Other liabilities.................... (123,000)
------------
Fair value of net assets
acquired....................... 989,000
------------
Goodwill............................. $ 1,756,000
============
During the year ended December 31, 1997, certain of the operating
performance measures were met resulting in 80,000 warrants vesting. The
remaining 20,000 warrants were forfeited. As a result, $422,000 in additional
contingent consideration and the related goodwill was recognized on the
acquisition of Integracion at December 31, 1997.
Effective January 1, 1998, the Company acquired all of the outstanding
common stock of MSN. MSN, through its TELEFIESTA(R) brand, markets Prepaid Cards
across the United States primarily to the Hispanic community. Under the terms of
the transaction, the Company paid the following aggregate consideration to the
shareholders of MSN: i) $3,250,000 in cash, ii) $750,000 in non-interest bearing
promissory notes
26
<PAGE>
payable in eight equal quarterly installments, and iii) 100,000 shares of the
Company's common stock. In addition, the two selling shareholders of MSN were
each granted 50,000 options to purchase the Company's common stock at $11.00 per
share. The acquisition was accounted for under the purchase method of
accounting.
The consideration paid for MSN measured at the acquisition date was
$4,880,000 and consisted of cash of $3,250,000, $750,000 aggregate principal
amount of 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 purchase
price of the acquisition has been allocated as follows:
FAIR
VALUE
--------------
Cash................................. $ 3,250,000
Promissory Notes (discounted
value)............................. 672,000
Common Stock......................... 880,000
Transaction Costs.................... 78,000
--------------
Purchase consideration.......... 4,880,000
Cash................................. 977,000
Accounts receivable.................. 1,042,000
Other assets......................... 90,000
Accounts payable and accrued
liabilities........................ (1,323,000)
Deferred revenue..................... (1,997,000)
--------------
Excess of liabilities assumed
over fair value of net assets
acquired....................... (1,211,000)
--------------
Goodwill............................. 6,091,000
==============
The amounts recorded on 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 expects that this
final determination will be completed by the end of the calendar year and does
not expect that such adjustments will be material.
2) PRO FORMA CONSOLIDATING STATEMENT OF OPERATIONS ADJUSTMENTS FOR THE YEAR
ENDED DECEMBER 31, 1997
a) Reflects the reduction in salaries and bonuses earned by officers of
MSN which exceeds the amounts to which they have agreed prospectively.
b) Reflects the amortization of goodwill and depreciation expense,
resulting from the step-up in assets and recognition of goodwill on the
MSN and Integracion acquisitions, for the period from January 1, 1997
to the effective date of the respective acquisition.
c) Reflects interest expense on the promissory notes issued to the sellers
in connection with the acquisition of Integracion and MSN, for the
period from January 1, 1997 to the effective date of the respective
acquisition.
d) Reflects the income tax benefit on MSN as if MSN were a C-corporation
from January 1, 1997. MSN was an S-corporation when it was acquired by
the Company. Additionally, reflects the income tax effect of the pro
forma adjustments described in items a) through c) above.
e) Reflects the 100,000 shares of Common Stock issued as part of the
consideration paid for MSN and reflects an adjustment to net income for
common stockholders relating to interest expense on convertible notes
issued as part of the consideration paid for Integracion, as if such
Common Stock and convertible notes were issued on January 1, 1997.
27
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The following table sets forth certain consolidated financial information
for the Company for (i) the years ended December 31, 1993, 1994, 1995, 1996 and
1997, which have been derived from the Company's audited consolidated financial
statements and notes thereto, which in the case of the Consolidated Statement of
Operations and Consolidated Statement of Cash Flows for each of the three years
ended December 31, 1995, 1996 and 1997 and the Consolidated Balance Sheet Data
for each of the two years ended December 31, 1996 and 1997 are included
elsewhere in this Prospectus and (ii) for the six months ended June 30, 1997 and
1998. The selected consolidated financial data for the six months ended June 30,
1997 and 1998 have been derived from the unaudited consolidated financial
statements of the Company that have been prepared on the same basis as the
audited consolidated financial statements and, in the opinion of management,
include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the results of operations for the periods
presented. The following financial information should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations", the Company's consolidated financial statements and notes
thereto appearing elsewhere herein, and in the Company's Form 10-K for the year
ended December 31, 1994 and is qualified in its entirety by the other financial
information appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------------------- --------------------
1993 1994 1995 1996 1997 1997 1998
--------- --------- --------- --------- --------- --------- ---------
(UNAUDITED)
(IN THOUSANDS, EXCEPT RATIOS AND PER SHARE INFORMATION)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
DATA(1):
Revenues........................... $ 1,722 $ 972 $ 1,108 $ 5,705 $ 36,154 $ 9,941 $ 65,777
Cost of revenues................... 887 439 619 3,041 24,396 5,994 57,056
--------- --------- --------- --------- --------- --------- ---------
Gross profit....................... 835 533 489 2,664 11,758 3,947 8,721
Selling, general and administrative
expenses.......................... 1,470 1,032 1,349 4,159 8,154 3,339 5,705
--------- --------- --------- --------- --------- --------- ---------
Operating income (loss) before
depreciation and amortization..... (635) (499) (860) (1,495) 3,604 309 1,758
Depreciation and amortization...... 23 36 48 264 622 339 1,258
--------- --------- --------- --------- --------- --------- ---------
Operating income (loss)............ (658) (535) (908) (1,759) 2,982 309 1,758
Interest income (expense), net..... (84) 23 230 15 (95) -- (251)
Other income (expense), net........ (14) (18) (2) 99 (137) (366) (91)
--------- --------- --------- --------- --------- --------- ---------
Income (loss) before income taxes
and minority interests............ (756) (530) (680) (1,645) 2,750 43 1,416
Income tax benefit (expense)....... -- -- -- 53 (84) 167 (895)
--------- --------- --------- --------- --------- --------- ---------
Income (loss) before minority
interests......................... (756) (530) (680) (1,592) 2,666 210 521
Minority interests................. 360 (18) 7 (6) 6 4 (29)
--------- --------- --------- --------- --------- --------- ---------
Net income (loss).................. $ (396) $ (548) $ (673) $ (1,598) $ 2,672 $ 214 $ 492
========= ========= ========= ========= ========= ========= =========
EARNINGS (LOSS) PER SHARE:
Basic.............................. $ (0.81) $ (0.44) $ (0.36) $ (0.52) $ 0.68 $ 0.05 $ 0.11
Weighted average shares
outstanding....................... 491,303 1,254,689 1,890,442 3,046,594 3,903,470 3,921,878 4,534,568
Diluted(2)......................... N/A N/A N/A N/A $ 0.53 $ 0.05 $ 0.06
Weighted average shares outstanding
for diluted calculation........... N/A N/A N/A N/A 5,152,211 3,998,660 7,778,072
(FOOTNOTES ON FOLLOWING PAGE)
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------- JUNE 30,
1993 1994 1995 1996 1997 1998
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA(1):
Cash, cash equivalents and short term
investments........................ $ 98 $ 4,509 $ 3,645 $ 495 $ 4,734 $ 4,939
Working capital...................... (777) 4,817 4,081 1,813 3,669 (2,552)
Property and equipment, net.......... 168 156 154 983 2,679 13,084
Goodwill and other intangibles,
net................................ -- -- -- 3,246 17,674 26,322
Total assets......................... 521 5,335 4,498 9,371 39,635 68,880
Total long-term debt................. 445 -- -- -- 2,676 9,385
Total stockholders' equity
(deficit).......................... (812) 4,446 3,590 5,765 22,088 28,592
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------------------- --------------------
1993 1994 1995 1996 1997 1997 1998
--------- --------- --------- --------- --------- --------- ---------
(UNAUDITED)
OTHER OPERATING DATA(1):
EBITDA(3).......................... $ (635) $ (499) $ (860) $ (1,495) $ 3,604 $ 548 $ 3,016
Ratio of debt to EBITDA............ -- -- -- -- 0.88 -- 5.12
Capital expenditures............... 22 24 46 441 1,682 667 5,696
Ratio of earnings to fixed
charges(4)........................ -- -- -- -- 7.07 1.22 2.51
Fixed charges in excess of
earnings(4)....................... 534 649 717 1,770 N/A N/A N/A
Cash flows provided by (used in)
operating activities.............. (44) (1,035) (817) (2,731) 4,588 3,395 441
Cash flows provided by (used in)
investing activities.............. (22) (3,971) 444 2,489 (1,799) (667) (16,721)
Cash flows provided by (used in)
financing activities.............. (244) (670) -- 564 1,450 (43) 16,035
</TABLE>
- ------------
(1) The Company's historical financial statements include the operations of its
subsidiaries from their respective effective dates of acquisition, or
inception in the case of poolings, as follows: Telscape USA, -- April 10,
1996, Telereunion S.A. -- May 10, 1996; Integracion -- July 1, 1997;
N.S.I. -- October 1, 1997; and MSN -- January 1, 1998. INTERLINK'S
operations will be included beginning June 1, 1998.
(2) Diluted earnings per share for the years ended December 31, 1993, 1994,
1995, and 1996 and the three months ended March 31, 1997 were not provided
as inclusion of additional shares under a diluted analysis for loss periods
is inappropriate due to the anti-dilutive effect. For purposes of diluted
earnings per share, interest expense of $42 on convertible notes assumed to
have been converted into common shares was added back to net income for the
historical year ended December 31, 1997.
(3) EBITDA as used in this Prospectus represents net earnings (loss) before
interest, income taxes, depreciation and amortization. The Company has
included EBITDA data because it is a measure commonly used in the
telecommunications industry and is included herein to provide additional
information with respect to the Company's ability to meet its future debt
service, capital expenditures and working capital requirements. In addition,
the Company believes that certain investors find EBITDA to be a useful tool
for measuring the ability of the Company to service its debt. EBITDA is not
a measure of financial performance determined under generally accepted
accounting principles, should not be considered as an alternative to net
income as a measure of performance or to cash flows as a measure of
liquidity, and is not necessarily comparable to similarly titled measures
presented by other companies. Funds depicted by EBITDA may not be available
for management's discretionary use due to functional and debt covenant
requirements to conserve funds for capital replacement and expansion, debt
service and other commitments and uncertainties.
(4) The ratio of earnings to fixed charges was computed by dividing earnings by
fixed charges. For this purpose, earnings consist of income from continuing
operations, before income taxes and fixed charges of the Company and its
subsidiaries. Fixed charges consist of the Company's and subsidiaries'
interest expense and the portion of rent expense representative of an
interest factor. Where the ratio indicates less than 1-to-1 coverage, the
dollar amount of the coverage deficiency is presented.
29
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH
THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO CONTAINED ELSEWHERE IN
THIS PROSPECTUS. CERTAIN INFORMATION CONTAINED BELOW AND ELSEWHERE IN THIS
PROSPECTUS, INCLUDING INFORMATION WITH RESPECT TO THE COMPANY'S PLANS AND
STRATEGY FOR ITS BUSINESS, ARE FORWARD-LOOKING STATEMENTS. SEE "NOTE REGARDING
FORWARD-LOOKING STATEMENTS."
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 operations over the next 18 months 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. received the Mexican
Concession, a 30-year, facilities-based carrier license from the Mexican
government allowing it to construct and operate a network over which the Company
can carry long distance traffic in Mexico. To deliver its services, 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. See "Risk
Factors -- Construction of the Mexican Network; Construction Costs,"
"Business -- Services" and "Business -- Network."
The Company's objectives in constructing the Mexican Network are to: (i)
provide on-net capacity to allow growth in its long distance services business;
(ii) increase profitability and lower its costs for switched services by
reducing its off-net capacity expenses; and (iii) use the expanded network as a
platform to support advanced, bandwidth-intensive data and media applications.
The Company estimates that the aggregate cost of constructing the Mexican
Network will be approximately $98.0 million. The principal components of such
cost are expected to be: (i) fiber optic cable and microwave, between 25% and
30% of total construction costs; (ii) engineering and construction, between 58%
and 63% of total construction costs; (iii) electronics, approximately 8% of
total construction costs; and (iv) acquiring rights-of-way, approximately 4% of
total construction costs. The Company will seek to acquire rights-of-way from
railroads, highway commissions, pipeline owners, utility companies and others.
See "Risk Factors -- Construction of the Mexican Network; Construction Costs,"
"Business -- Services" and "Business -- Network."
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, 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 and
N.S.I., both focused on data services and based in Mexico City, Mexico.
In January 1998, Telscape acquired 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 Mexico, El Salvador and other Latin American countries after
obtaining the required licenses.
30
<PAGE>
In May 1998, the Company acquired CMSD for $8.2 million in cash, subject to
post-closing adjustments. The CMSD Acquisition provides the Company with a
teleport facility in California, thereby enhancing the Company's position as an
integrated telecommunications provider and assuring 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 from the
SCT. 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. See "Business -- Network."
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
the first two quarters of 1998, with the addition of Prepaid Card revenues
generated by recently acquired MSN, the Company's revenue mix changed.
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 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. For
the year ended December 31, 1997, one wholesale customer, Communications
Distributors, Inc., accounted for approximately 28% of the Company's overall
revenues. For the six months ended June 30, 1998, no single customer represented
greater than 10% of the Company's revenues.
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 based on customer usage. The
Company recognizes revenues from the sale of Prepaid Cards under these
agreements at the time of customer usage.
In May 1998, one of the Company's wholesale long distance customers filed a
petition for relief under Chapter 11 of the Bankruptcy Code. For the five months
ended May 31, 1998, this customer accounted for approximately 26% of the
Company's wholesale long distance revenues and 7% of the Company's overall
revenues. 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 service to its Prepaid Card
customers by working directly with the underlying service providers, this
resulted in the Company's paying for certain of the telecommunication 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 contributions 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. This bankruptcy is not
expected to have a material impact to the operating results for the third
quarter of 1998. The lost revenues
31
<PAGE>
from this customer have been replaced by replacing the minutes previously
purchased by this customer with existing and 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 quarter of 1998 and may
continue to decline to the extent that Prepaid Card revenues increase as a
percentage of overall revenues.
The following table sets forth for the periods indicated certain financial
data as a percentage of revenues:
PERCENTAGE OF REVENUES
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
------------------------------- --------------------
1995 1996 1997 1997 1998
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues............................. 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues..................... 55.9 53.3 67.5 60.3 86.7
Gross profit......................... 44.1 46.7 32.5 39.7 13.3
Selling, general and administrative
expenses........................... 121.7 72.9 22.6 34.2 8.7
Depreciation and amortization........ 4.3 4.6 1.7 2.4 1.9
Operating income (loss).............. (81.9) (30.8) 8.2 (3.1) 2.7
Other income (expense)............... 20.6 2.0 (0.6) (2.7) (0.5)
Income (loss) before income taxes and
minority interest.................. (61.3) (28.8) 7.6 0.4 2.2
Income tax benefit (expense)......... 0.0 0.9 (0.2) 1.7 (1.4)
Income (loss) before minority
interests.......................... (61.3) (27.9) 7.4 2.1 0.8
Minority interests in subsidiaries... 0.6 (0.1) 0.0 0.0 0.0
Net income (loss).................... (60.7) (28.0) 7.4 2.1 0.8
</TABLE>
RESULTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO THE SIX MONTHS ENDED
JUNE 30, 1997
REVENUES increased from $9.9 million in 1997 to $65.8 million in 1998. This
increase of $55.8 million, or 562%, was due principally to the acquisition of
MSN completed in the first quarter of 1998, which provided total revenues of
$32.4 million. Wholesale international long distance revenues increased $11.1
million from $5.7 million for the six months ended June 30, 1997 to $16.8
million for the six months ended June 30, 1998. In addition, revenues from
systems integration services increased $11.1 million from $4.3 million for the
six months ended June 30, 1997 to $15.4 million for the six months ended June
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 $1.2 million in revenues.
COST OF REVENUES increased from $6.0 million in 1997 to $51.1 million in
1998, or $51.1 million. The 852% 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 60.3% to 86.7%, or 26.4%, due
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principally to the higher cost of revenues as a percentage of revenues
associated with the sale of Prepaid Cards. 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.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A") increased from $3.4
million in 1997 to $5.7 million in 1998, or $2.3 million. The 67.8% increase in
SG&A was due principally to the incremental SG&A related to the operations 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 34.2% to 8.7%, or
25.5%. 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 $239,000 in 1997 to $1.3
million in 1998, or $1.0 million. 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 INTERLINK, MSN, Integracion and N.S.I. acquisitions.
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) decreased from ($0) in 1997 to ($251,000) in
1998, or ($251,000). This decrease 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), NET decreased from ($266,000) in 1997 to ($91,000),
or ($175,000). 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, the Company incurred a foreign exchange translation loss
of $187,000 for the six months ended June 30, 1998 as compared to a gain of
$27,000 for the six months ended June 30, 1997. The loss in 1998 was primarily
due to translation of financial statements of the Company's Mexican operations.
INCOME TAX BENEFIT (EXPENSE) changed from an income tax benefit of $167,000
in 1997 to an income tax expense of ($895,000) 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 six months ended June 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 (LOSS) increased from $214,000 for the six months ended June 30,
1997 to $492,000 for the six months ended June 30, 1998 due to a combination of
the factors discussed above.
FOR THE YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31,
1996
REVENUES increased from $5.7 million in 1996 to $36.2 million in 1997. This
increase of $30.5 million, or 535%, was due principally to the significant
growth in the Company's international long distance business and, to a lesser
extent, the acquisitions of Telereunion, Integracion and NSI. The Company's
revenues from international long distance services grew $16.8 million from
$640,000 in 1996 to $17.4 million, or 2,625%. Revenues from systems integration
services and equipment sales increased $13.7 million from $5.1 million to $18.8
million, or 269%. Although some of the growth is attributable to the
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effect of including Telereunion for a full year in 1997, Telereunion also
experienced growth in revenues in 1997.
COST OF REVENUES increased from $3.0 million in 1996 to $24.4 million in
1997, or $21.4 million. The increase in cost of revenues was due principally to
the incremental cost of revenues associated with the significant growth in the
international long distance business and, to a lesser extent, the incremental
cost of revenues associated with the acquisitions of Telereunion, Integracion
and NSI. The cost of revenues as a percentage of revenues increased from 53.3%
to 67.5%, or 14.2%. The increase in cost of revenues as a percentage of revenues
was due principally to a significant change in the Company's product mix. During
1997, the Company's decline in the margins earned in the systems integration
businesses in Mexico and Poland were offset by higher margins earned in the
international long distance services business.
SG&A increased from $4.2 million in 1996 to $8.2 million in 1997. The
increase in SG&A was due principally to the incremental SG&A associated with the
acquisitions of Telereunion, Integracion and NSI and, to a lesser extent, the
additional administrative staff added to handle the significant growth in the
international long distance business. In 1996, the Company also incurred certain
non-recurring expenses of approximately $350,000 relating to non-cash
compensation expense that was recorded in 1996 in compliance with "FAS 123:
Accounting for Stock-Based Compensation," approximately $100,000 in fees
associated with the Company's merger with Orion (which, upon consummation of the
merger, was renamed Telscape USA) (the "Telscape USA Acquisition"), and
approximately $146,000 in consulting fees. These consulting fees were paid under
agreements which have been terminated.
Overall SG&A as a percentage of revenues decreased from 72.9% to 22.6%, or
50.3%. This decrease was due principally to the significant growth in revenues
in each of the Company's core businesses while containing costs.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
from $264,000 in 1996 to $622,000 in 1997, or $358,000. This increase was due to
an increase in goodwill amortization primarily due to the Integracion and N.S.I.
acquisitions completed during 1997 and a full year's amortization of goodwill in
1997 associated with the Telereunion acquisition.
INTEREST INCOME (EXPENSE), NET decreased from $15,000 in 1996 to ($95,000)
in 1997, or ($110,000). This decrease was mainly attributable to interest
expense relating to notes issued in connection with the Integracion acquisition.
OTHER INCOME (EXPENSE), NET decreased from $99,000 in 1996 to ($137,000) in
1997, or $236,000. The decrease in other income was due principally to the
Company recognizing a foreign exchange loss of ($126,000), primarily as a result
of translation of the financial statements of the Polish operations as compared
to a foreign exchange gain of $161,000, primarily as a result of translation of
the financial statements of the Mexican operations, in 1996. The Company also
wrote off its investment in a joint venture in Poland, realizing a loss of
$196,000 and incurring certain litigation settlement expenses of $128,000.
INCOME TAX BENEFIT (EXPENSE) decreased from a benefit of $53,000 in 1996 to
($84,000) in 1997. This decrease is primarily due to tax expense from the
Company's Mexican operations offset by a benefit realized from a reversal of
valuation allowances on U.S. Federal net operating losses.
NET INCOME (LOSS) increased from ($1.6) million in 1996 to $2.7 million in
1997. The change in net income was due to a combination of the factors discussed
above.
FOR YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUES increased from $1.1 million in 1995 to $5.7 million in 1996. This
increase of $4.6 million, or 418%, was due principally to the acquisition of
Telereunion and, to a lesser extent, the Telscape USA Acquisition. Revenues for
the Polish operations increased only slightly from $1.11 million in 1995 to
$1.14 million in 1996.
COST OF REVENUES increased from $619,000 in 1995 to $3.0 million in 1996,
or $2.4 million. The increase in cost of revenues was due principally to the
incremental cost of revenues attributable to the acquisition of Telereunion and,
to a lesser extent, the Telscape USA Acquisition. This increase was offset
partially by a decrease of $121,000 in the Polish operations. The cost of
revenues as a percentage of
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revenues decreased from 55.9% to 53.3%, or 2.6%. The decrease in cost of
revenues as a percentage of revenues was due principally to the improvements in
the Polish operations and the addition of higher margin sales from the Telscape
USA Acquisition.
SG&A increased from $1.4 million in 1995 to $4.2 million in 1996, or $2.8
million. The increase in SG&A was due principally to the incremental SG&A
attributable to the acquisition of Telereunion and, to a lesser extent, the
Telscape USA Acquisition. The Company also incurred certain non-recurring
expenses of approximately $596,000. These expenses included approximately
$350,000 of non-cash compensation expense that was recorded in 1996 in
compliance with "FAS 123: Accounting for Stock-Based Compensation,"
approximately $100,000 in fees associated with the Telscape USA Acquisition, and
approximately $146,000 in consulting fees. These consulting fees were paid under
agreements which have been terminated. In addition, the Company had an increase
in certain recurring non-cash expenses, such as approximately $77,000 in
depreciation and approximately $140,000 for the amortization of goodwill
associated with the Telereunion acquisition.
On approximately the same revenues, SG&A for the Polish operations
decreased by $84,000 due principally to a reduction in work force. Overall SG&A
as a percentage of revenues decreased from 121.7% to 72.9%, or 48.8%. This
decrease was due principally to the lower SG&A as a percentage of revenues
associated with Telereunion and, to a lesser extent, efficiency improvements in
the Polish operations. These improvements were offset by the non-recurring
expenses and additional recurring expenses described above.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
from $48,000 in 1995 to $264,000 in 1996, or $216,000. This increase was due to
an increase in goodwill amortization related to the Telereunion acquisition and
the incremental depreciation expense associated with those operations.
INTEREST INCOME (EXPENSE), NET decreased from $230,000 in 1995 to $15,000
in 1996, or $215,000. This decrease was mainly due to a reduction in cash and
cash equivalent balances in 1996 as compared to 1995.
OTHER INCOME (EXPENSE), NET increased from ($2,000) in 1995 to $99,000 in
1996, or $101,000. The increase in other income was due principally to the
recognition of a $63,000 loss in connection with the forfeiture of an earnest
money deposit for an aborted acquisition attempt. This loss was offset by an
increase in the Company's foreign exchange gain of approximately $160,000,
primarily from translation of the financial statements of the Company's Polish
operations.
INCOME TAX BENEFIT (EXPENSE) increased from no provision in 1995 to a tax
benefit of $53,000 in 1996, resulting primarily from the increase in deferred
tax assets in Vextro.
NET INCOME (LOSS) decreased from ($673,000) in 1995 to ($1.6) million in
1996. The decrease in net income was due to a combination of the factors
discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $3,395,000 and $441,000 for
the six months ended June 30, 1997 and June 30, 1998, respectively. The decrease
in net cash provided by operations in 1998 as compared to 1997 was due primarily
to an increase of value added tax receivables of approximately $2.1 million,
additional costs associated with the Company's Prepaid Card services and the
write off of receivables associated with the bankruptcy of a customer.
Net cash used in investing activities was ($667,000) and ($16,271,000) for
the six months ended June 30, 1997 and June 30, 1998, respectively. In the six
months ended June 30, 1998, the Company expended approximately $5.7 million on
purchases of, or deposits on, property and equipment as part of the Company's
network expansion strategy. 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 ($43,000) and
$16,035,000 for the six months ended June 30, 1997 and June 30, 1998,
respectively. In December 1997, the Company announced its intention to redeem
publicly traded warrants to purchase an aggregate of 525,000 shares of Common
Stock. 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
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subsequent to year-end. The Company raised $10.0 million from the issuance of
Deere Park Convertible Debentures (as defined) and Gordon Brothers Convertible
Debentures (as defined). In addition, the Company realized $2.2 million in
proceeds from the exercise of options and warrants.
As of June 30, 1998, the Company had cash and cash equivalents of
$4,939,000 and negative working capital of $2,522,000. Included in current
liabilities is $5.0 million in Deere Park Convertible Debentures which mature on
May 29, 1999.
In the first and second quarter 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
June 30, 1998, the Company has expended or placed purchase orders for equipment
purchases for a total in excess of $9.0 million. Management does not expect that
cash generated from operations will be adequate to find these capital
investments.
RECENT FINANCINGS AND SOURCES OF CAPITAL
From January 1, 1998 through July 15, 1998 the Company raised a total of
approximately $15.0 million, through various financing and capital raising
transactions, as described below:
On May 1, 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 in the event the holder elects to
convert. 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 shares of Common Stock at an
exercise price of $16.76 per share for the First Draw, (subject to adjustment
for stock splits and other share adjustments) warrants to purchase an aggregate
of 2,427 shares of Common Stock at $20.60 per share for the Second Draw (subject
to adjustment for stock splits and other share adjustments) and warrants to
purchase an aggregate of 6,382 shares of Common Stock at $15.67 per share for
the Third Draw (subject to adjustment for stock splits and other share
adjustments). 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.
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On May 29, 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 in the
event the holder elects to convert. 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 a 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.
Approximately $8.2 million of the proceeds from the Deere Park Convertible
Debentures and the Gordon Brothers Convertible Debentures were used to finance
the CMSD 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.
Under the terms of the restructuring, 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 agreed to repay $1,000,000 of the Deere Park Convertible
Debentures at 107% plus accrued interest.
On March 12, 1998, the Company entered into the Revolving Credit Facility
with a commercial bank which provided for borrowings up to $1.3 million subject
to adequate levels of eligible accounts receivable. Borrowings are secured by
the accounts receivable of Telscape USA and MSN. This facility provides that
borrowings will bear interest at floating rates of prime plus 1% and expires in
six months. On May 19, 1998, the Company renegotiated the terms of the Revolving
Credit Facility to provide for borrowings of up
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to $2.5 million and extended the term of the facility to June 30, 1999. As of
June 30, 1998, the Company had drawn $1.9 million on this facility. The Company
has 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 60 day and 90 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 by Telscape USA and MSN and
(ii) waive the defaults under the minimum current ratio, minimize tangible net
worth and prohibition on quarterly loss covenants.
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.
On July 6, 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 of $22,100, including principal and interest
through July 6, 2003. The lease obligations are secured by the financed
equipment.
On July 14, 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.
In July 1998, the Company 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. The Company expects to close this transaction in September 1998.
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. 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 and would likely prevent the
Company from having the ability to repay the Notes.
The Company intends to finance its growth and additional capital
investments required for its planned facility expansions through cash generated
from operations, additional financing through commercial lenders, additional
lease financing and the sale of debt and equity securities (or a combination of
both). There can be no assurance that the cash generated from operations will be
sufficient or that the Company will be able to obtain additional financing on
commercially reasonable terms, if at all. Additional funding through the
incurrence of debt or sale of additional equity (or a combination of both) may
be required to meet the Company's growth plans, although there can be no
assurance that such additional funds can be obtained on acceptable terms, if at
all. If necessary funds are not available, the Company's business and results of
operations and the future expansion of its business could be materially
adversely affected.
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ESCROW AGREEMENT
Pursuant to the Texas Securities Act of 1957, the Texas State Securities
Commissioner has the discretion to require that an issuer offering and selling
securities to the residents of Texas in a public offering deposit certain
outstanding securities in escrow. In that regard, certain former officers and
directors of the Company, as well as two other individuals (collectively, the
"Escrow Shareholders"), are parties to a Stock Escrow Agreement (the "Escrow
Agreement") dated August 8, 1994. The Escrow Agreement was required by the
Texas State Securities Commissioner as a condition to the registration of
securities in Texas in connection with the Company's initial public offering.
The Escrow Agreement provides that a total of 415,503 shares of Common Stock
("Escrow Shares") and 55,779 shares of Common Stock issuable upon the exercise
of options ("Escrow Options") be held in escrow for a period of not less than
two years and not more than ten years. The terms of the Escrow Agreement provide
further that Escrow Shares and Escrow Options may be released from escrow
provided certain performance requirements of the Company ("Performance
Requirements") are met. For instance, if the Common Stock trades at a price per
share of at least $11.81 for at least ninety (90) consecutive trading days then
the Escrow Shares and Escrow Options are automatically released from escrow.
During the first quarter of 1998, the Company and the Escrow Shareholders
entered into agreements, which resulted in (i) the early termination of the
Escrow Agreement in July 1998, (ii) the repurchase by the Company of certain of
the Escrow Shares at a significant discount to market and (iii) the resolution
of a disagreement with certain of the Escrow Shareholders concerning the
validity of the Escrow Options. The agreements called for the Escrow
Shareholders to sell a total of 101,417 Escrow Shares to the Company for
$985,580, or $9.72 per share, of which 25% was paid by the Company upon
execution of the agreements and 75% was scheduled to be paid on July 6, 1998. In
addition, the Escrow Shareholders signed a lock-up agreement (the "Escrow
Lock-Up"), ending on July 6, 1998, for any Escrow Shares which were not sold to
the Company; provided, however, that if any of the Performance Requirements were
met during the Escrow Lock-Up, the Escrow Lock-Up would terminate automatically.
Finally, certain of the Escrow Shareholders agreed to the termination of
approximately 40,000 of the Escrow Options, which had an exercise price of $0.80
per share. On May 1, 1998, the Company agreed to reduce the number of Escrow
Shares required to be sold to the Company, resulting in a reduction in the total
number of Escrow Shares being repurchased to 86,417 Escrow Shares for total
consideration of $873,000, or $10.10 per share.
On July 6, 1998, the Company assigned the rights to purchase 80,257 of the
Escrow Shares to Preferred Capital Markets, Inc. ("Preferred"). In return for
the assignment, Preferred reimbursed the Company for the 25% down payment in an
amount of $276,000 and paid the Company $449,000 for the assignment. The Company
has no further obligations in connection with the Escrow Shares.
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 pay in United States dollars. In addition, most of
the 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 United States
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. United
States-originated calls will be paid in United States dollars; however, the
Company also expects to derive a certain portion of its revenues from calls
originated outside of the United States, thus 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.
The Company does not currently hedge against the risk of foreign exchange
rate fluctuations.
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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 system
failure. 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 of
operations. However, if the Company is unable to ready its 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.
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
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.
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. 130 and No. 131 are effective for financial statements for the
periods beginning after December 15, 1997 and require comparative information
for earlier years to be restated. The Company does not believe this statement
will have a material impact on its financial statements.
SFAS No. 132, "EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER
POSTRETIREMENT BENEFITS." The new standard 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. The statement is effective for financial statements for periods
beginning after December 15, 1997 and requires comparative information for
earlier years to be restated. Adoption of SFAS 132 is 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
40
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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 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.
41
<PAGE>
BUSINESS
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 operations over the next 18 months 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. received the Mexican
Concession, a 30-year, facilities-based carrier license from the Mexican
government allowing it to construct and operate a network over which the Company
can carry long distance traffic in Mexico. To deliver its services, the Company,
through Telereunion S.A., intends to construct the Mexican Network, a 4,025
kilometer combined fiber-optic and microwave long distance network, connecting
the United States, the Gulf region of Mexico and targeted Mexican cities.
The Company believes that it is well-positioned to capitalize on the
opportunities presented by the large and growing international
telecommunications services market. According to the Telegeography Report,
revenues generated from the provision of international long distance services
increased to $61.3 billion in 1996 from $23.9 billion in 1987, a compound annual
growth rate of 11.0%. Management believes that Latin American traffic, including
traffic between the United States and Latin America, will grow faster than the
international telecommunications market as a whole as a result of the (i)
underlying economic growth within Latin America, (ii) growth of regional trade
as a result of free trade initiatives such as NAFTA, Mercosur and the Andean
Pact, (iii) deregulation and privatization of telecommunications carriers in the
region, (iv) projected regional increases in telephone density, (v) growth in
the Hispanic population in the United States and (vi) increasing demand for
bandwidth-intensive applications. See "-- Industry."
Telscape intends to capitalize on the growth in the Latin American
telecommunications market 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 by providing
domestic and international long distance services over the Mexican Network. The
Company believes that expanding its owned and leased transmission facilities in
Latin America will allow it to increase the percentage of minutes of traffic
carried on-net, which will enable it to increase margins and profitability and
ensure quality of service on both international and domestic long distance
traffic. See "Risk Factors -- Construction of the Mexican Network; Construction
Costs," "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Overview" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Gross Margin."
HISTORY
The Company was founded in 1992 with the objective of becoming a
significant participant in the emerging Eastern European telecommunications
equipment market through its 90% interest in Digital Telecommunications
Systems/ZWUT, a Polish limited liability company. In May 1996 the Company began
shifting its strategic focus to the provision of telecommunications services in
Latin America. Revenues from the Company's operations in Poland during 1997
represented less than 5% of the Company's revenues. In November 1996, the
Company's name was changed from "Polish Telephones and Microwave Corporation"
to "Telscape International, Inc." to more accurately reflect the Company's
overall strategy. This shift in strategic focus was completed in December 1997
with the sale of the Company's Polish subsidiary.
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<PAGE>
In May 1996, the Company acquired all of the stock of Telereunion, a 97%
owner of Vextro de Mexico S. A. de C.V. ("Vextro"). Vextro is a systems
integration company, with an emphasis on voice solutions, based in Mexico. In
September 1996, Orion Communications, Inc., a U.S.-based reseller of long
distance services ("Orion"), was merged into Telscape USA, a subsidiary of the
Company. The management capabilities that came with the Orion merger enabled the
Company to expand its strategy to include international long distance.
In July 1997, the Company acquired Integracion of Mexico City, Mexico, a
data and network integrator. The acquisition of Integracion marked the Company's
entry into the fast growing data and network market. In October 1997, the
Company acquired N.S.I. also of Mexico City, Mexico, also a data and network
integrator. Management of the Company believes that these acquisitions, coupled
with Vextro, strategically position the Company in Mexico to address the
technological convergence of data, voice and video transmission. The Company is
one of the three largest systems integrators in Mexico.
In January 1998, the Company added to its international long distance
operations the business of MSN, a leading provider of Prepaid Cards targeted at
Hispanic communities in the United States. The transaction adds a well-known
brand name, TELEFIESTA, and a retail distribution platform to the Company's
business mix, and the Company intends to utilize that brand name in certain
Latin American countries as regulations and licenses permit.
In June 1998, the Company, through its newly-formed subsidiary INTERLINK,
acquired California Microwave Services Division, Inc. 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.
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<PAGE>
The following chart illustrates the operational structure of the Company.
<TABLE>
<CAPTION>
<S> <C>
------------------------------
| Telscape International, Inc. |
| Texas Corporation |
------------------------------
|
---------------------------------------------------------------------------------------------
| | | | |
| | | | |
----------------------------- ------------------------ ----------------------- | ------------------------------
| MSN Communications, Inc. | | Telscape USA, Inc. | | Telereunion, Inc. | | |INTERLINK Communications, Inc.|
| California Corporation | | Texas Corporation | | Delaware Corporation | | | Delaware Corporation |
| (Prepaid Cards) | | (U.S. Domestic Long | ----------------------- | | (U.S. Satellite Teleport) |
----------------------------- | Distance Wholesaler) | | | ------------------------------
------------------------ | |
| |
| |
| ------------------------------
| | TSCP International, Inc. |
| | Texas Corporation |
| | (International Long Distance |
| | Wholesaler) |
| ------------------------------
|
--------------------------------------------------------------------------------------------------
| | | |
| | | |
------------------------------- ----------------------------------- ---------------------- |
| Vextro de Mexico, S.A. de C.V.| | Integracion de Redes, S.A. de C.V.| | N.S.I.,S.A. de C.V. | ---------------------------
| Mexican Corporation | | Mexican Corporation | | Mexican Corporation | | Telereunion International,|
| (Systems Integration) | | (Systems Integration) | | (Systems Integration)| | S.A. de C.V. |
------------------------------- ----------------------------------- ---------------------- | Mexican Corporation |
| (Mexico Concession |
| Operations) |
---------------------------
|
|
|
|
--------------------------
| Telereunion, S.A. de C.V.|
| Mexican Corporation |
| (Concessionaire) |
--------------------------
</TABLE>
INDUSTRY
OVERVIEW
The international telecommunications industry is undergoing a period of
fundamental change that has resulted, and is expected to continue to result, in
significant growth in international telecommunications traffic and revenues.
According to the World Telecommunication Development Report 1996/97 published by
the ITU on February 20, 1997 (the "ITU Report"), the 1998 revenue of the
global telecommunications industry is projected to exceed $1 trillion. According
to the Telegeography Report, revenues generated from the provision of
international long distance services increased to $61.3 billion in 1996 from
$23.9 billion in 1987, a compound annual growth rate of 11.0%. Management
believes that Latin American traffic, including traffic between the United
States and Latin America, will continue to grow faster than the international
telecommunications market as a whole as a result of (i) underlying economic
growth within Latin America, (ii) growth of regional trade as a result of free
trade initiatives such as NAFTA, Mercosur and the Andean Pact, (iii)
deregulation and privatization of telecommunications carriers in the region,
(iv) projected regional increases in telephone density and (v) increasing demand
for bandwidth-intensive applications.
The Company believes that numerous factors have driven the growth in demand
for international telecommunications products and services. Those factors
include: (i) the globalization of the world's economies and the worldwide trend
toward deregulation of the telecommunications sector, (ii) declining prices and
a wider selection of products and services driven by greater competition
resulting from deregulation, (iii) increased telephone accessibility resulting
from technological advances and greater investment in telecommunications
infrastructure, including deployment of wireless networks, (iv) increased
international business and leisure travel and (v) growth of computerized
transmission of voice and data
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information. These trends have sharply increased the use of, and reliance upon,
telecommunications products and services throughout the world. The Company
expects these trends to continue for the foreseeable future.
The growth in the use of telecommunications services and the rapidly
changing international telecommunications market have created a significant
opportunity for carriers such as the Company, that can offer high quality, low
cost comprehensive telecommunications products, systems and services. The
Company believes that a high percentage of the world's businesses and
residential consumers continue to be subject to high prices with poor quality
and lack of availability of service which have been characteristic of many PTTs.
Demand for improved service and lower prices has created opportunities for
private companies to compete in the international telecommunications market and
has spurred a broadening of products and services. New technologies have
contributed to improved quality and increased transmission capacity and speed.
The Company therefore believes that recent and on-going deregulation and
increasing access to telecommunications facilities in emerging markets will
bring a high level of growth in the demand for telecommunications services
outside the United States, particularly in Latin America.
By eroding the traditional monopolies held by PTTs, many of which are or
were wholly or partially government owned, deregulation is providing U.S.-based
providers the opportunity to negotiate more favorable agreements with both the
traditional PTTs and emerging foreign providers. In addition, deregulation in
certain foreign countries is enabling U.S.-based providers to establish local
switching and transmission facilities in order to terminate their own traffic
and begin to carry international long distance traffic originating in those
countries. Deregulation, privatization, the expansion of the resale market and
other trends influencing the international telecommunications market are
resulting in decreased termination costs, a proliferation of routing options and
increased competition.
Advances in technology have created multiple ways for telecommunications
carriers to provide customer access to their networks and services. Overall,
these changes have resulted in a trend towards bypassing traditional
international long distance operating agreements as international long distance
companies seek to operate more efficiently. In markets that have not deregulated
or are in the process of implementing deregulation, international long distance
carriers have used advances in technology to develop innovative alternative
methods to meet customer demand.
Recent legislation and an agreement among numerous countries are expected
to lead to increased liberalization of the majority of the world's
telecommunication markets. Specifically, the WTO Agreement created a framework
under which 69 countries committed to liberalize their telecommunications laws
to permit increased competition and, in most cases, foreign ownership in their
telecommunications markets, beginning in 1998; the 1996 Telecommunications Act
established a framework for increasing competition in the U.S.
telecommunications services market; and the European Union's Services Directive
abolished exclusive rights for the provision of voice telephony services
throughout the European Union ("EU") and the local PSTN of any member country
of the EU by January 1, 1998.
The Company believes that these initiatives, as well as other proposed
legislation and agreements, will provide increased opportunities for emerging
competitive carriers such as Telscape to provide telecommunications services in
targeted markets. Deregulation has encouraged competition, which in turn has
prompted carriers to offer a wider selection of services and reduce prices. The
Company's projections for substantially increased international minutes of use
and revenue are based in part on its belief that reduced pricing as a result of
deregulation and competition will result in a substantial increase in the demand
for telecommunications services in most markets.
LATIN AMERICA. The telecommunications market in Latin America is
undergoing a period of deregulation, privatization, increased competition and
rapid growth. According to the Telegeography Report, growth in the demand for
telecommunications services across Latin America in 1995-1996 increased at a
rate of 13.6%, which has been faster than the global average and substantially
faster than the increased demand in Europe and Africa.
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The Company seeks to focus on the opportunities created by deregulation and
market growth in the rapidly changing international telecommunications markets
in Latin America. Countries in the Latin American region generally are
experiencing a solid period of economic, business and infrastructure growth,
reduced inflation, and economic and political stability. Substantial
opportunities exist for providers of telecommunications equipment, system
integration, value-added services, and voice and data services as Latin American
countries move toward privatization and greater liberalization of their
telecommunications markets.
The Company believes that the small- to medium-sized business segment is
the target market in many countries in Latin America for value-added services
such as teleconferencing, advanced facsimile, advanced phone, unified messaging,
frame relay and Asynchronous Transfer Mode ("ATM"). Unlike larger businesses
which have the resources and traffic volume to support the internal development
of a wide range of value-added services, developing and maintaining such
services is not economical for smaller businesses. Accordingly, to meet these
needs smaller businesses may either purchase such services or outsource their
telecommunications services to third parties specializing in such services, such
as the Company. The Company believes that its experience and expertise in
providing these services will enable it to compete in this market.
The Company believes that it is well-positioned to capitalize on these
opportunities by providing high quality, low-cost comprehensive
telecommunications services. As a rule, Latin American countries have extremely
low telephone density, and the markets have been subject to characteristically
inefficient, poor-quality service, as well as the unavailability of new and
innovative systems and services. In addition, the Latin American markets in
which the Company is offering services or in which it seeks to compete generally
are characterized by a lack of fiber optic cable capacity. Existing
satellite-based capacity offers limited capability to meet the increasing demand
for bandwidth-intensive applications in the Company's targeted countries in the
region. There exists a critical and growing demand for the type of high-quality,
innovative systems, products and services that the Company is currently
providing and seeks to provide in expanding in its current markets and
exploiting the opportunities in new markets throughout Latin America.
The Company believes that the Latin American region is poised for growth in
telecommunications usage based on the political and economic changes in many
Latin American countries that have modernized their economies, increased
transparency in business and governmental practice and sustained strong economic
growth. In addition, telecommunications growth will be spurred as a result of
the recent and ongoing privatizations by many Latin American governments of
their previously state-owned telecommunications monopolies, as well as ongoing
liberalization of the regulatory frameworks in many countries in the region to
promote competition in telecommunications services.
MEXICO. The market for telecommunications services in Mexico is undergoing
rapid expansion. According to the TeleGeography Report, the volume of
telecommunication traffic to Mexico increased 14.6% in 1995 and 16.2% in 1996.
The 1996 traffic along the U.S.-Mexico route accounted for 12.5% of the U.S.
international market and 86.6% of the Mexican international telecommunications
market. According to a report issued by the FCC's Common Carrier Bureau in June
1997, revenues for sales on the U.S.-Mexico route exceeded $1.7 billion in 1995.
As a result of legislation enacted in 1995, Mexico began the process of
opening its telecommunications market to competition. National and international
long distance services were opened to competition in August 1996, subject to the
issuance of individual concessions. Pure switched international resale is not
allowed in Mexico to date. Value-added services are fully open to competition
and subject to a simple registration process.
The Company believes that it is well-positioned to take advantage of the
growing demand for telecommunications services between the United States and
Mexico. The Company currently provides a full range of systems integration and
value-added services to major public and private customers. Additionally, in
June 1998, Telereunion S.A. received the Mexican Concession from the SCT,
allowing it to originate and terminate domestic and international long distance
services in Mexico.
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<PAGE>
OTHER LATIN AMERICAN MARKETS. The Company seeks to focus on the
opportunities created by deregulation of telecommunications services in other
telecommunications markets in Latin America. Latin American markets have
undergone rapid expansion as a result of regional and global deregulation.
Countries within Latin America have different national regulatory schemes
and are in varying stages of deregulation. The requirements for the Company to
obtain the necessary approvals to offer value-added services and various other
telecommunications services, including voice telephony, vary from country to
country. Specifically, the Company has recently obtained the authority to
provide inbound and outbound international long distance as well as certain
other telecommunications services in El Salvador.
STRATEGY
The Company's objective is to become a leading provider of high quality,
competitively priced international long distance services between the United
States and Latin America, and a leading provider of international long distance
services, domestic long distance services and of integrated value-added services
to customers in Mexico and other targeted countries in Latin America. The key
elements of the Company's strategy are to:
o EXPAND LATIN AMERICAN PRESENCE. The Company seeks to expand its Latin
American presence in order to capitalize on the relatively high growth
of traffic between the United States and Latin America. The Company
believes that management's international telecommunications expertise,
combined with Telscape's established reputation and extensive
operations in Mexico, will enable the Company to identify and
capitalize on the increasing deregulation in targeted Latin American
markets.
o EXPAND NETWORK FACILITIES. The Company intends to expand its network
by acquiring switching and transmission facilities, state-of-the-art
ATM technologies and additional fiber optic and satellite transmission
capacity for the provision of international and domestic voice, video
and data services. Therefore, Telscape intends to invest approximately
$113.0 million for infrastructure, including approximately $ 98.0
million towards construction of the Mexican Network and approximately
$15.0 million to acquire switching and transmission facilities and
enhanced service platforms. The Company's objectives in making these
investments are to: (i) provide on-net capacity to allow growth in its
long distance services business; (ii) increase profitability for
switched services by reducing the amount of the Company's traffic
terminated by other long distance carriers pursuant to resale
arrangements; and (iii) use the expanded network as a platform to
support advanced, bandwidth-intensive data and media applications.
o PROVIDE AN INTEGRATED SUITE OF SERVICE OFFERINGS. The Company seeks
to provide its commercial customers in Mexico with a comprehensive
suite of telecommunications services, including international and
domestic long distance services, systems integration, call centers,
conference calling, Internet access and other broadband data services.
The Company believes that providing multiple service offerings
improves customer retention and the profitability of individual
customer relationships. Management believes that Telscape is one of
the few companies to offer a wide array of high quality and
competitively priced telecommunications services to commercial
customers in Mexico, and expects to pursue opportunities to provide
similar services as it expands into other Latin American markets.
o EXPAND SCALE AND SCOPE OF RETAIL BUSINESS. Management believes that
the acquisition of MSN, a leading provider of Prepaid Cards, positions
the Company for expanded growth in the retail sector of the
international telecommunications market. The Company intends to expand
its retail business through the deployment or purchase of switching
platforms in high-volume gateway cities such as Houston, New York,
Chicago, San Francisco and Los Angeles, which will be capable of
managing local and 800 Prepaid Card traffic. The Company believes that
these state-of-the-art programmable switches will provide the Company
with the advanced technology necessary to handle the anticipated
growth in this rapidly expanding market.
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o PURSUE STRATEGIC ALLIANCES, JOINT VENTURES AND ACQUISITIONS. The
Company continues to pursue strategic alliances, joint ventures and
acquisitions to expand its business, increase its customer base, add
network and circuit capacity, enter additional markets and develop new
products and services. The Company seeks to acquire interests in
companies that have network facilities, service offerings or
technologies that complement those of the Company. Since 1996, the
Company has completed six acquisitions, including a U.S.-based
provider of satellite telecommunications services with access to
satellites covering Central and South America, a U.S.-based Prepaid
Card provider focused on Hispanic consumers in the United States and
Latin American markets, three data and systems integration businesses
in Mexico and a U.S.-based reseller of long distance services. See
"Risk Factors -- Risks Associated with Acquisitions, Investments and
Strategic Alliances."
o BUILD BRAND AWARENESS. The Company seeks to build brand awareness of
its TELEFIESTA(R) and TELEREUNION brands. Management believes that it
will be able to continue building customer awareness of its
TELEFIESTA(R) brand name through sales of its TELEFIESTA(R) Prepaid
Cards to its U.S. customers as it opens new international long
distance markets throughout Latin America. In addition, the Company
intends to distribute its TELEFIESTA(R) Prepaid Cards in targeted
Latin American countries as continued deregulation and market
conditions permit. Management also intends to continue building
customer awareness of its systems integration and value-added services
through the TELEREUNION brand name, which it plans to leverage as it
commences international and domestic long distance services in Mexico.
SERVICES
Telscape provides its customers with long distance services and systems
integration solutions, including value-added voice and data services. Financial
information about the Company's business segments for each of the three years
ended December 31, 1995, 1996 and 1997 and the six months ended June 30, 1997
and 1998 are disclosed in the Notes to the Consolidated Financial
Statements -- Footnote 9. Segment Information.
LONG DISTANCE SERVICES
INTERNATIONAL WHOLESALE SERVICES. The Company provides its wholesale
carrier services to other carriers in the United States. In offering these
services, the Company leverages the rates that it is able to obtain through (i)
its extensive relationships in the long distance telecommunications industry;
(ii) its ability to generate a high volume of long distance traffic to targeted
Latin American countries; and (iii) the advantageous rates negotiated with
competitive carriers in targeted Latin American countries. The Company believes
that its understanding of the rapidly changing conditions of the
telecommunications industry in many Latin American markets distinguishes it from
many U.S.-based emerging international carriers and allows the Company to
compete in Latin American markets with first tier carriers. By developing the
Mexican Network, the Company expects to increase the amount of wholesale
international traffic it carries on-net. For the six months ended June 30, 1998,
the Company generated revenues from its wholesale carrier services business of
$16.8 million, representing 26% of the Company's consolidated revenues.
PREPAID CARDS. The Company sells Prepaid Cards under the TELEFIESTA(R)
brand name, providing access to more than 200 countries and territories. The
Company's Prepaid Cards are marketed primarily to Hispanic communities in the
United States that generate high levels of international traffic to targeted
Latin American countries where the Company has favorable termination agreements.
The Company's TELEFIESTA(R) Prepaid Cards are sold through distributors to over
20,000 independent retail outlets in 100 cities throughout the United States.
The Company believes that the TELEFIESTA(R) Prepaid Cards offer competitive
rates to selected Latin American and other international markets. For the six
months ended June 30, 1998, the Company generated revenues from its Prepaid Card
business of $32.4 million, representing 49% of the Company's consolidated
revenues.
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SYSTEMS INTEGRATION
The Company provides a full range of voice, video and data systems
integration solutions and audio, data and video conferencing services and
enhanced facsimile services to business customers in Mexico, including
multi-national Fortune 500 companies. The Company has also provided call center
services to the U.S. Embassy in Mexico since the fourth quarter of 1997.
Systems integration involves the identification of customer needs, the
development of customized solutions, the installation of telecommunications
equipment and the integration of such equipment with the client's
telecommunications and information systems, post-sales services such as
maintenance contracts, outsourcing and network management and monitoring
services. Although the Company expects that systems integration revenues will
not increase as rapidly as those from the Company's other lines of business, it
will remain an important part of the Company's strategy to introduce commercial
customers to the Company's other telecommunications services. For the six months
ended June 30, 1998, the Company generated revenues of $15.4 million from
systems integration services, representing 23% of the Company's consolidated
revenues.
Since 1992, the Company has been one of five distributors in Mexico of
Nortel telecommunications equipment. The Company also distributes voice and
teleconferencing products manufactured by Polycom, Centigram and VTEL, and
distributes, installs and maintains data and networking equipment manufactured
by 3Com Corporation, Nortel and Newbridge Networks, ADC Kentrox and Cisco.
As traditional telecommunications services become more of a commodity,
Telscape believes that value-added services will become an increasingly
important component of the Company's service offerings. The Company believes it
can leverage its systems integration expertise to provide outsourced network
management services, allowing the Company to offer a single-source, turn-key
solution to its private and public commercial customers. For the six months
ended June 30, 1998, the Company generated revenues from its value-added
services of less than 5% of the Company's consolidated revenues.
The Company anticipates that traditional long distance and local exchange
services will increasingly involve sophisticated, application-oriented services
such as audio, data and video conferencing, enhanced facsimile, telemarketing,
interactive voice response ("IVR"), help-desk, advanced Internet and other
content and service intensive value-added services. The Company has provided
value-added services in Mexico since 1995, giving it both technical and
marketing experience needed to compete in the value-added services market.
The Company's expanding presence in value-added telecommunications services
resulted in an outsourcing contract, signed in the third quarter of 1997, with
the U.S. Embassy in Mexico City. The contract is through the fourth quarter of
1998 when the U.S. government has the option to renew the contract for up to
four additional one-year terms. The system is designed to automate the delivery
of visa applications and enables callers to request visa information from either
a live operator or from an automated touch-tone system. The Company began
implementing the system in December 1997 and management believes the early
results are very positive. The number of calls the Company handles has increased
from an average of approximately 1,000 calls per day during December 1997 to an
average of approximately 4,300 calls per day during June 1998. In connection
with this contract, the Company established a call center in Mexico City, which
the Company believes will serve as a platform for additional growth.
NETWORK
The Company currently manages its own telecommunications network and also
utilizes the transmission capacity of several carriers. The Company believes
that increasing the percentage of traffic it carries on-net will enable it to
increase margins and profitability and ensure quality. In addition, the
Company's use of multiple carriers increases cost efficiencies by establishing
additional routing capability and enabling the Company to obtain sufficient
capacity to support its rapid growth.
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NETWORK STRATEGY
The Company's network is comprised of leased, partitioned and owned
switches, fixed cost point-to-point fiber optic cable leases and leased
satellite capacity to provide connectivity for many Central and South American
cities. The Company intends to expand its network primarily by using traditional
circuit-based technology, acquiring additional satellite and fiber optic
transmission capacity and installing switching equipment in targeted U.S. and
Latin American markets. In countries in which the Company currently operates
without a switch and in each new market the Company enters, the Company intends
to install switching facilities and integrate them into its network to improve
the Company's overall cost structure. The Company expects that it will be able
to realize significant cost savings by routing an increasing portion of its
Mexican domestic long distance and international traffic on-net.
In the near future, the Company intends, to the extent technically
possible, to further develop its network by employing state-of-the-art ATM
technologies, giving it the flexibility to transmit packetized voice, data and
video signals over its network. The Company believes that using ATM technology
in its network construction gives it a competitive advantage over carriers using
the traditional, time division multiplexing technology that will eventually need
to be replaced to accommodate the increased demands for data and video
transmission capacity.
The Company intends to market certain domestic long distance services
directly to customers in the Gulf region of Mexico primarily through the
development of the Mexican Network. The Company's Mexican Network will support
multiple lines of international and domestic national telephone services in
Mexico, as well as provide Telscape with an essential element for its plan to
become a significant market force in Mexico by securing for the Company control
over its bandwidth and quality transmission requirements. The Company has
targeted the Gulf region of Mexico for these services because (i) the region
currently lacks extensive telecommunications infrastructure, (ii) other major
competitors of the Company have not targeted the region for development, (iii)
there is a developed business community with a high potential for long distance
usage in the region, (iv) the region is sufficiently populated to permit the
efficient use of new infrastructure and (v) the region is in close proximity to
the United States. The Company believes that this focused approach to building a
network is superior to constructing a nationwide network.
INTERNATIONAL ORIGINATION AND TERMINATION FACILITIES
SWITCHING FACILITIES. The Company owns and operates a Nortel DMS-250,
state-of-the-art digital switch consisting of approximately 9,000 ports in
Houston, Texas. The Company has selected Nortel as its primary switch vendor and
has installed public switched network architecture to manage one of its Prepaid
Card platforms. The Company currently operates additional switching platforms in
Houston, Texas, and six Latin American countries and anticipates installing
switches in four other Latin American countries during 1998. The Company also
currently partitions a switch in New York.
As part of the Company's strategy to expand its Prepaid Card operations, it
plans to install or purchase additional Prepaid Card switching platforms in
selected cities in North America. These switches will be capable of managing
local and 800 Prepaid Card traffic in high-volume gateway cities such as
Houston, New York, Chicago, San Francisco and Los Angeles.
SATELLITE FACILITIES. The Company operates, or will operate in the near
term, earth stations in several markets in Central and South America. In
connection with the CMSD Acquisition, the Company acquired a teleport facility
in Mountain View, California. The Company believes that this acquisition
enhances its position as an integrated telecommunications provider. INTERLINK
has agreements with satellite providers to its targeted markets in Latin
America, which generally provide for cancellation upon 30 days notice by either
party. By the end of 1998, the Company anticipates operating earth stations in
several other major cities of Central and South America.
The earth stations are either owned by Telscape or the Company has access
to the earth stations pursuant to contractual arrangements with local operators.
Telscape's strategy is to create a platform that enables the near-term
implementation of value added services such as Internet access, data
transmission, fax and video and call centers, where market and regulatory
conditions permit.
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NETWORK CAPACITY. The Company purchases transmission services on a per
minute basis and leases transmission capacity on a fixed cost basis from a
variety of local and long distance carriers. The Company is currently expanding
its leased on-net capacity in an attempt to lower costs in its largest
distribution areas. The Company obtains private line capacity from approximately
six local, domestic and international carriers, including MCI, WorldCom and IXC.
The Company's agreements with these carriers fix the private line cost for a
minimum of one year. The Company's agreements with its carriers provide that
some international per minute rates may fluctuate with rate change notice
periods varying from five days to one month. The variable nature of the cost of
services and many of the Company's contracts and agreements subject the Company
to the possibility of unanticipated cost increases and the loss of
cost-effective routing alternatives.
TELECOMMUNICATIONS NETWORK MANAGEMENT AND INFORMATION SYSTEMS. The
Company's network management and information systems enable it to (i)
economically and efficiently route traffic over the Company's network and the
networks of other carriers, (ii) offer reliable services with high call
completion rates and voice quality and (iii) manage an advanced voice, data and
video multi-service platform. The Company believes that these systems,
particularly their ability to provide flexible, high quality service to
international destinations, provide it with a competitive advantage relative to
many other providers of telecommunications services. The Company monitors its
network and initiates changes to its overall switch network and traffic routing
where appropriate to optimize routing and minimize costs. Because a substantial
portion of the traffic carried by the Company terminates internationally and
call completions vary by carrier, the Company monitors the call completion
efficiencies of its suppliers. The Company intends to continue configuring large
portions of its network with Common Channel Signaling System 7 ("SS7"). SS7
reduces voice call setup and connect time delays and provides additional
technical capabilities and efficiencies for call routing and network
engineering.
NETWORK OPERATIONS CENTER. The Company is developing a network operations
center ("NOC") in Mexico City, Mexico, which will be used to monitor and
control all switches and other transmission equipment used in its network. The
NOC is expected to operate seven days a week, 24 hours per day, 365 days a year.
The Company plans to use a portion of the net proceeds of the Offerings to
install a new NOC in Houston, Texas, and to upgrade the existing Mexico City
NOC. Each of the NOCs will be capable of monitoring and controlling the network
in most regions.
NETWORK EXPANSION
MEXICAN NETWORK. The Company plans to develop the Mexican Network
consisting of a fiber optic cable and microwave transmission facilities network
in the Gulf region of Mexico. The Mexican Network will provide connectivity from
Reynosa to Coatzacoalcos and Minatitlan, and through Puebla to Mexico City. The
Company will seek to acquire rights-of-way from railroads, highway commissions,
pipeline owners, utility companies and others. The Company intends to lease
from, and exchange capacity with, other long distance providers to connect with
the central (Mexico City, Guanajuato and Guadalajara) and northeast (Monterrey)
regions of Mexico, and to install a switching facility in Mexico City and at the
U.S./Mexico border. The Gulf region of Mexico contains approximately 38.0% of
the population of Mexico. The Company believes that more than half of the
domestic business long distance traffic and nearly half of the domestic
residential long distance traffic originates in the region that will be serviced
by the Mexican Network. Portions of the Mexican Network will be located near
Petroleos Mexicanos ("Pemex") operations, the largest user of
telecommunications services in Mexico. Pemex is a systems integration customer
of the Company.
The Mexican Network has been designed to accommodate the increasing demand
of bandwidth. The fiber optic component constitutes two cables of twenty-four
optical strands each. The Company anticipates that two strands will be used in
the first five years of operation, leaving a considerable reserve for future
expansions or dark fiber capacity available for lease to other carriers. The
bandwidth of the fiber optic multiplexors to be utilized during the first five
years is 155Mbps, equal to 2,268 high quality (64 kbps) voice channels or 76
E1s. The Company believes that the additional fiber capacity will be used to
support emerging bandwidth-intensive data and multimedia applications.
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The optical transmission capacity can be expanded on an as-needed basis, by
several methods which include the utilization of compression techniques, ATM
technology, higher capacity multiplexor substitution and Dense Wavelength
Division Multiplexing ("DWDM") technologies. The bandwidth considerations for
the microwave section of the long haul transmission media have been limited by
the actual mid-term projected demand in each specific city; however, this
transmission capacity can be grown gradually by increasing bandwidth in radio
equipment or by substituting radios with fiber optic facilities on a case-by-
case basis.
The Company believes that owning a network will enable the Company to
significantly reduce expenditures for leasing off-net capacity because the new
fiber routes: (i) could carry much of the traffic that would otherwise be
transmitted off-net, and (ii) may enable the Company to exchange its fiber
capacity for other carriers' network capacity.
OBJECTIVES. The Company's objectives in constructing the Mexican Network
are to: (i) provide on-net capacity to allow growth in its long distance
services business; (ii) increase profitability for switched services by reducing
its off-net capacity expenses; and (iii) use the expanded network as a platform
to support advanced, bandwidth-intensive data and media applications.
CONSTRUCTION AND COST. The Company plans to complete the Mexican Network
in two phases along the following routes (which are subject to change depending
on the availability of certain cost-saving arrangements and the ability to
minimize construction costs and maximize the benefits from the routes to be
constructed):
(i) PHASE I. The Company anticipates that the first phase of
construction will involve the installation of a central node with an
international teleport in Mexico City and fiber optic cable up the eastern
Mexican coast to connect with the Company's U.S. network. During Phase I,
the Company intends to lease from other carriers transmission capacity
connecting the Company's network to Monterrey and Guadalajara. The Company
estimates that this phase will cost approximately $95.0 million to
complete.
(ii) PHASE II. The Company anticipates that the second phase of
construction will involve connecting its network, primarily by means of
microwave, to medium and smaller sized cities in the Gulf of Mexico region.
The Company estimates that this phase will cost approximately $3.0 million
to complete.
The Company anticipates that Phase I will begin in the first quarter of
1999 and will be completed in approximately 12-14 months, and Phase II will be
completed approximately six to eight months thereafter.
The Company estimates the aggregate cost of the Mexican Network will be
$98.0 million. The principal components of such cost are expected to be: (i)
fiber optic cable and microwave, between 25% and 30% of total construction
costs; (ii) engineering and construction, between 52% and 58% of total
construction costs; (iii) electronics, approximately 8% of total construction
costs; and (iv) rights-of-way, approximately 4% of total construction costs. The
Company will seek to acquire rights-of-way from railroads, highway commissions,
pipeline owners, utility companies and others.
FUNDING THE NETWORK EXPANSION. Although the Company estimates the
aggregate cost of the Mexican Network to be approximately $98.0 million, it will
seek to realize significant cost savings and/or lower the aggregate cost by: (i)
adding additional fibers to the network and selling such fibers to other
carriers; (ii) exchanging excess fibers or capacity on the Company's expanded
network for excess fibers or capacity on the other carriers' networks; and (iii)
obtaining the right to install Company-owned fibers in new fiber optic routes
being constructed by other carriers along the proposed network routes in
exchange for the Company sharing construction costs with the other carrier,
allowing the other carrier to use excess Company fiber elsewhere in the
Company's network or allowing the other carriers to add its own fibers to
segments of the network.
For a discussion of the risks associated with the Mexican Network, see
"Risk Factors -- Expansion and Operation of the Network," "Risk
Factors -- Construction of the Mexican Network; Construction Costs" and "Risk
Factors -- Substantial Indebtedness."
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SALES, MARKETING AND DISTRIBUTION
LONG DISTANCE SERVICES
INTERNATIONAL WHOLESALE SERVICES. The Company's carrier resale department
markets its international outbound switched and dedicated services on a
wholesale basis to other telecommunications companies through a direct sales
effort. At September 25, 1998, the Company had approximately 19 wholesale
carrier agreements in place. To provide a more complete package of international
rates to its customers, the Company intends to establish strategic relationships
with entities that have gateways to international destinations. When
appropriate, the Company will establish in-country relationships for the
termination of international long distance. For a discussion of the risks
associated with customer concentration in the Company's wholesale services, see
"Risk Factors -- Customer Concentration" and "Summary -- Recent
Developments."
PREPAID CARDS. The Company markets its Prepaid Cards under the
TELEFIESTA(R) brand name. The Company's TELEFIESTA(R) Prepaid Cards are sold
through distributors to over 20,000 independent retail outlets in 100 cities
throughout the United States. The Company has focused on building a substantial
network of wholesale distributors that sell to sub-distributors and directly to
retail outlets. The sub-distributors generally sell only to retail outlets.
The Company targets heavily populated metropolitan areas in the United
States with substantial Hispanic populations that generate significant
international calling volume. Many of the Company's distributors are members of
such ethnic communities or otherwise have personal or business relationships in
such communities. In developing relationships with distributors, the Company
also focuses on expansion into new geographic and metropolitan areas with
substantial Hispanic populations. The Company believes that the success of its
Prepaid Cards has created significant brand loyalty and encourages distributors
and retail outlets to actively market the Company's products. The Company
regularly provides distributors and retail outlets with point of purchase
advertising and explanatory materials. The Company frequently adds new Prepaid
Card products to its service offerings, and adjusts its pricing for particular
traffic segments in order to target certain customer groups, respond to
competitive pressures and otherwise increase market share.
For a discussion of the risks associated with the Company's Prepaid Cards,
see "Risk Factors -- Dependence on Service Providers for Prepaid Card
Services" and "Summary -- Recent Developments."
SYSTEMS INTEGRATION
To serve the complex needs of its customers, the Company has formed a team
of sales and technical personnel that combines strong sales capabilities with
specialized technical expertise in product-specific areas such as PBX, voice
processing, Internet, video conferencing and ATM and frame relay networks.
Management believes that this sales approach allows the Company to provide
innovative solutions to complex systems integration projects.
In Mexico, the Company promotes its systems integration sales through a
combination of advertising, trade shows, direct mail and telemarketing. The
Company has historically utilized its own direct sales force but has recently
developed a dealer network to broaden its distribution channel. The Company's
product managers focus on cultivating relationships with one or more vendors and
with coordinating sales efforts for their specific product lines.
The Company markets its value-added telecommunications services through
advertising in trade magazines, telemarketing, direct mail and attending trade
shows. The Company believes that its systems integration service base provides
an excellent platform for the follow-up sales of advanced telecommunications
services, since many of the Company's customers have developed confidence in the
Company's ability to implement complex projects.
The Company's direct sales effort begins with understanding the customer's
business. Sales personnel then identify potential areas where the Company's
value-added services could improve the customer's business, suggesting specific
services, customizing those services to meet the customer's specific needs,
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implementing value-added solutions and monitoring the results and potential
changes in the customer's needs.
CUSTOMERS
LONG DISTANCE SERVICES
INTERNATIONAL WHOLESALE SERVICES. The Company's wholesale customers are
primarily other international carriers that seek termination services in one or
more Latin American countries. During the six months ended June 30, 1998, no
single customer represented more than 10% of the Company's overall revenues. See
"Risk Factors -- Customer Concentration."
PREPAID CARDS. The Company markets its Prepaid Cards primarily to Hispanic
communities in the United States that generate high levels of international
traffic to targeted Latin American countries where the Company has favorable
termination agreements. The Company sells its Prepaid Cards through a network of
distributors, who distribute the Prepaid Cards to over 20,000 independent retail
outlets in 100 cities throughout the United States. During the six months ended
June 30, 1998, no single distributor represented more than 10% of the Company's
overall revenues. See "Risk Factors -- Dependence on Distributors."
SYSTEMS INTEGRATION
The Company performs substantially all of its systems integration services
for customers located in Mexico. During the six months ended June 30, 1998, no
single customer represented more than 10% of the Company's overall revenues.
CUSTOMER SUPPORT AND BILLING
Telscape believes that reliable, sophisticated and flexible billing and
information systems are essential to its ability to remain competitive in the
global telecommunications market. Accordingly, the Company has invested
substantial resources in an IBM AS-400 platform for rating and billing services.
The Company is also developing and implementing proprietary management
information systems, as well as other commercially available software packages.
The Company's billing system enables the Company to (i) accurately analyze
its network traffic, revenues and margins by customer and by route on a daily
basis; (ii) validate carrier settlements; and (iii) monitor least cost routing
of customer traffic. These reports produce efficiencies by reducing the need for
monitoring by the Company's employees. The Company believes that the accuracy
and efficiency of its management information systems provide it with a
significant strategic advantage over other emerging carriers.
COMPETITION
The international and national telecommunications industry is highly
competitive, is subject to rapid change precipitated by advances in technology
and deregulation and is significantly influenced by the pricing and marketing
decisions of larger industry participants. The Company's success depends upon
its ability to compete with a variety of other telecommunications providers in
each of its markets, including the respective PTT in each country in which the
Company operates. Other competitors of the Company include large,
facilities-based, multinational carriers and smaller facilities-based wholesale
long distance service providers in the United States and overseas that have
emerged as a result of deregulation, switched-based resellers of international
long distance services, providers of systems integration and/or value-added
services, Prepaid Card providers and global alliances among some of the world's
largest telecommunications carriers. The Company anticipates that it will
encounter additional competition as a result of the formation of global
alliances among large telecommunications providers. Recent examples of such
alliances include AT&T's alliance with Unisource, known as "Uniworld;" Cable &
Wireless Plc's recent alliance with Italy's STET/Telecom Italia to serve
international customers with a primary focus on the Latin American and European
regions; WorldCom's recent merger with MCI, and subsequent alliance with
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Telefonica de Espana; and Sprint's alliance with Deutsche Telekom and France
Telecom, known as "Global One", and the joint venture between Sprint and
Telmex. Consolidation in the telecommunications industry may create even larger
competitors with greater financial and other resources. The effect of the
aforementioned or other similar mergers and alliances could create increased
competition in the telecommunications services market and potentially reduce the
number of customers that purchase wholesale international long distance services
from the Company. In the Prepaid Card business, the Company currently competes
with all of the first tier telecommunications carriers as well as emerging
multinational carriers such as SmarTalk, RSL and IDT, many of which have greater
financial resources than the Company. Because certain of the Company's current
competitors also are or could be the Company's customers, the Company's business
would be materially adversely affected to the extent that a significant number
of such customers limit or cease doing business with the Company for competitive
or other reasons.
International telecommunications providers such as the Company compete on
the basis of price, customer service, transmission quality, breadth of service
offerings and value-added services, and the Company's carrier and Prepaid Card
customers are especially price sensitive. In addition, many of the Company's
competitors enjoy economies of scale that can result in a lower cost structure
for termination and network costs, which could cause significant pricing
pressures within the international communications industry. In recent years,
prices for international and other telecommunications services have decreased
substantially, and are expected to continue to decrease, in most of the markets
in which the Company currently competes or intends to compete. The intensity of
such competition has recently increased, and the Company expects that such
competition will continue to intensify as the number of new entrants increases
as a result of the new competitive opportunities created by the 1996
Telecommunications Act, implementation by the FCC of the U.S. commitment to the
WTO, and privatization, deregulation and changes in legislation and regulation
in various of the Company's foreign target markets. There can be no assurance
that the Company will be able to compete successfully in the future, or that
such intense competition will not have a material adverse effect on the
Company's business, financial condition and results of operations.
Many of the Company's competitors are significantly larger, have
substantially greater financial, technical and marketing resources, larger
networks and a broader portfolio of services than the Company. Additionally,
many competitors have strong name recognition and "brand" loyalty,
long-standing relationships with the Company's target customers, and economies
of scale which can result in a lower relative cost structure for transmission
and related costs. These competitors include, among others, AT&T, Sprint, and
MCI WorldCom, which provide long distance services in the U.S.; Telmex,
Concessionaries, and other registered value-added services providers in Mexico;
as well as PTTs and emerging competitors in other Latin American markets where
the Company seeks to compete. In Mexico, the regulatory authorities have granted
concessions to 15 companies, including Telmex and Telereunion S.A., to construct
and operate public, long distance telecomunications networks in Mexico. Some of
these new competitive entrants have as their partners, major U.S.
telecommunications providers including AT&T (Alestra), MCI WorldCom (Avantel),
Bell Atlantic (Iusatel). In addition, the regulatory authorities in Mexico have
granted concessions to several competitive local exchange providers, such as
Telinor, Megacable, Amaritel, Unitel, MetroNet, and Red de Servicios and several
of Mexico's long distance Concessionaires. With regard to the provision of
services in Mexico, the Company competes or will compete in Mexico with numerous
other systems integration, value-added services, and voice and data services
providers, some of which focus their efforts on the same customers targeted by
the Company. In addition to these competitors, recent and pending deregulation
in Mexico and various other Latin American countries may encourage new entrants.
Moreover, while the recently completed WTO Agreement could create opportunities
for the Company to enter new foreign markets, implementation of the accord by
the United States and other countries could result in new competition from PTTs
previously banned or limited from providing services in the United States. For
example, the joint venture between Sprint and Telmex has applied to the FCC for
authority to enter the U.S. market and to provide resold international switched
services between the United States and Mexico. Such application was approved
subject to various conditions, but certain parties requested that the FCC
reconsider its decision. The FCC's decision on reconsideration is currently
pending. Increased competition in such countries as a result of the foregoing,
and other competitive developments, including entry by
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Internet service providers into the long-distance market, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company believes that PTTs generally have certain competitive
advantages due to their control over local connectivity and close ties with
national regulatory authorities. The Company also believes that, in certain
instances, some regulators have shown a reluctance to adopt policies and grant
regulatory approvals that would result in increased competition for the local
PTT. If a PTT were to successfully pressure national regulators to prevent the
Company from providing its services, the Company could be denied regulatory
approval in certain jurisdictions in which its services would otherwise be
permitted, thereby requiring the Company to seek judicial or other legal
enforcement of its right to provide services or to abandon its proposed market
entry. Any delay in obtaining approval, or failure to obtain approval, could
have a material adverse effect on the Company's business, financial condition
and results of operations. If the Company encounters anti-competitive behavior
in countries in which it operates or intends to operate or if the PTT in any
country in which the Company operates uses its competitive advantages to the
fullest extent, the Company's business, financial condition and results of
operations could be materially adversely affected.
REGULATION
GENERAL. The global telecommunications industry is subject to
international treaties and agreements, and to laws and regulations which vary
from country to country. Enforcement and interpretation of these treaties,
agreements, laws and regulations can be unpredictable and are often subject to
informal views of government officials and ministries that regulate
telecommunications in each country. In certain countries, including certain of
the Company's target Latin American markets, such government officials and
ministries may be subject to influence by the local PTT. To the best knowledge
of management, the Company is in compliance with all rules, regulations and laws
applicable to the Company except where non compliance is unlikely to have a
material adverse effect on the Company.
The Company has pursued and expects to continue to pursue a strategy of
providing its services to the maximum extent it believes to be permissible under
applicable laws and regulations. To the extent that the interpretation or
enforcement of applicable laws and regulations is uncertain or unclear, the
Company's aggressive strategy may result in the Company (i) providing services
or using transmission methods that are found to violate the laws or regulations
of those countries where it operates or plans to operate or (ii) failing to
obtain approvals or make filings subsequently found to be required under such
laws or regulations. If the Company's interpretation of applicable laws and
regulations proves incorrect, it could lose, or be unable to obtain, regulatory
approvals necessary to provide certain of its services or to use certain of its
transmission methods, or to lose its investments in that country. There can be
no assurance that the Company will not be subject to fines, penalties or other
sanctions, including being denied the ability to offer its products and
services, as a result of violations regardless of whether such violations are
knowing or willful and regardless of whether such violations are corrected. To
the Company's knowledge, it is not currently subject to any material regulatory
inquiry or investigation.
In numerous countries where the Company operates or plans to operate, local
laws or regulations limit the ability of telecommunication companies to provide
telecommunications services in competition with state-owned or state-sanctioned
monopoly carriers. There can be no assurance that future regulatory, judicial,
legislative or political considerations will permit the Company to offer all or
any of its products and services in such countries, that regulators or third
parties will not raise material issues regarding the Company's compliance with
applicable laws or regulations, or that such regulatory, judicial, legislative
or political decisions will not have a material adverse effect on the Company.
If the Company is unable to provide the services which it presently provides or
intends to provide or to use its existing or contemplated transmission methods
due to its inability to obtain or retain the requisite governmental approvals
for such services or transmission methods or because it is subjected to adverse
regulatory inquiry, investigation or action, or for any other reason related to
regulatory compliance or lack thereof, such developments could have a material
adverse effect on the Company's business, financial condition and results of
operations.
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On February 15, 1997, the United States and 68 other countries signed the
WTO Agreement, agreeing to open their respective telecommunications markets to
competition and foreign ownership and to adopt regulatory measures to protect
market entrants against anticompetitive behavior by dominant telephone
companies. Although the Company believes that the WTO Agreement could provide
the Company with significant opportunities to compete in markets that were not
previously accessible, reduce its costs and provide more reliable services, it
could also provide similar opportunities to the Company's competitors. There can
be no assurance that the pro-competitive effects of the WTO Agreement will not
have a material adverse effect on the Company's business, financial condition
and results of operations or that members of the WTO will implement the terms of
the WTO Agreement.
UNITED STATES. In the United States, to the extent that the Company offers
services as a carrier, the provision of the Company's services is subject to the
provisions of the Communications Act, the 1996 Telecommunications Act and the
regulations of the FCC thereunder. There can be no assurance that future
regulatory, judicial and legislative changes will not have a material adverse
effect on the Company's business, financial condition and results of operations.
Moreover, to the extent that the interpretation or enforcement of applicable
laws and regulations is uncertain or unclear, the Company's aggressive strategy
may result in the Company (i) providing services or using transmission methods
that are found to violate the Communications Act or FCC regulations or (ii)
failing to obtain approvals or make filings subsequently found to be required
under such laws or regulations. If the Company's interpretation of applicable
laws and regulations proves incorrect, it could lose, or be unable to obtain,
regulatory approvals necessary to provide certain of its services or to use
certain of its transmission methods. There can be no assurance that the Company
will not be subject to fines, penalties or other sanctions as a result of
violations regardless of whether such violations are knowing or willful and
regardless of whether such violations are corrected. There can be no assurance
that if the Company's interpretation of applicable laws and regulations proves
incorrect and/or if the Company is subject to fines, penalties or other
sanctions as a result, that these events will not have a material adverse effect
on the Company's business, financial condition and results of operations.
U.S. INTERNATIONAL LONG DISTANCE SERVICES. To the extent the Company
offers services as a carrier, it is subject to FCC rules requiring authorization
from the FCC prior to leasing international capacity, acquiring international
facilities, and/or purchasing switched minutes, and initiating international
service between the United States and foreign points, as well as to FCC rules
which also regulate the manner in which the Company's international services may
be provided, including the circumstances under which the Company may provide
international switched services by using private lines or routing traffic
through third countries. FCC rules also require prior authorization before
transferring control of or assigning FCC authorizations, and impose various
reporting and filing requirements on companies providing international services
under an FCC authorization. In order to offer international long distance
services, the Company is also required to file and has filed with the FCC a
tariff containing the rates, terms and conditions applicable to its
international telecommunications services. MSN has filed a tariff with respect
to international services. The Company has a continuing obligation to ensure
that the tariffs accurately reflect the terms and conditions associated with its
service offerings. The Company is also required to file certain carrier to
carrier agreements with the FCC. The FCC also requires carriers such as the
Company to report any affiliations, as defined by the FCC, with foreign
carriers. The FCC may also impose restrictions on affiliations with certain
foreign telecommunications companies. Failure to comply with the FCC's rules
could result in fines, penalties or forfeiture of the Company's FCC
authorizations, each of which could have a material adverse effect on the
Company business, financial condition and results of operations.
THE FCC'S PRIVATE LINE RESALE POLICY. The FCC's private line resale policy
currently prohibits a carrier from reselling international private leased
circuits to provide switched services (known as "ISR") to or from a country
unless the FCC has designated that country as one that affords U.S. carriers
equivalent opportunities to engage in similar activities in that country or that
the country is a member of the WTO and the local PTT offers U.S. carriers
settlement rates at or below the FCC-prescribed benchmark for terminating the
U.S. carriers' traffic. Thus far, the FCC has found that Australia, Austria,
Belgium, Canada, Denmark, France, Germany, Italy, Japan, Luxembourg, The
Netherlands, New Zealand, Norway, Sweden,
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Switzerland and the United Kingdom meet this standard. In separate proceedings,
the FCC issued, on August 6, 1998, a proposed rulemaking that could provide
opportunities to allow ISR on additional routes. There can be no assurance,
however, that the FCC or any other country's regulatory authority will change
their policies in a way that would have a beneficial impact on the Company or
that would not have a material adverse effect on the Company's business,
financial condition and results of operations. Furthermore, it is possible,
although not likely, that the FCC could take the view that certain arrangements
by which the Company provides international services do not comply with the
existing Private Line Resale Policy. If the FCC, on its own motion or in
response to a challenge filed by a third party, determines that such
arrangements do not comply with FCC rules, among other measures, it may issue a
cease and desist order, impose fines on the Company or, in extreme
circumstances, revoke or suspend its FCC authorizations.
THE FCC'S POLICIES ON TRANSIT AND REFILE. The FCC is currently considering
the 1995 Request to limit or prohibit the practice whereby a carrier routes,
through its facilities in a third country, traffic originating from one country
and destined for another country. The FCC has permitted transiting. Under
certain arrangements referred to as "refiling," the carrier in the destination
country does not consent to receiving traffic from the originating country and
does not realize the traffic it receives from the third country is actually
originating from a different country. The FCC to date has made no pronouncement
as to whether refiling arrangements are inconsistent with U.S. or ITU
regulations, although it is considering these issues in connection with the 1995
Request. The Company believes that it is possible, although not likely, that the
FCC will determine that refiling violates U.S. and/or international law, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
INTERNATIONAL SETTLEMENTS POLICY. The ISP establishes the framework
governing U.S. carriers' relationships with their foreign correspondents.
Specifically, the ISP governs the settlements between U.S. carriers and their
foreign correspondents of the cost of terminating traffic over each other's
networks and prevents foreign carriers from discriminating among U.S. carriers
in bilateral accounting rate negotiations. The ISP requires: (1) the equal
division of accounting rates; (2) non-discriminatory treatment of U.S. carriers;
and (3) proportionate return of inbound traffic. The FCC recently enacted
certain changes in its rules designed to permit alternative arrangements outside
of its ISP as a means of encouraging competition and achieving lower, cost-based
accounting rates as foreign markets deregulate. Specifically, the FCC has
decided to allow U.S. carriers, subject to certain competitive safeguards, to
propose methods to pay for international call termination that deviate from
traditional bilateral accounting rates and the ISP. The FCC has also established
lower ceilings ("benchmarks") for the rates that U.S. carriers can pay foreign
carriers for the termination of international services. Moreover, the FCC
recently changed its rules to implement the WTO Agreement, in part by allowing
U.S. carriers, under certain circumstances, to accept special concessions from
foreign carriers. Furthermore, on August 6, 1998, the FCC released a proposed
order that could substantially eliminate the necessity of compliance with the
ISP for arrangements with non-dominant carriers in WTO member countries. While
these rule changes provide the Company with more flexibility to respond more
rapidly to changes in the global telecommunications market, they also provide
similar flexibility to the Company's competitors.
U.S. DOMESTIC LONG DISTANCE SERVICES. The Company's ability to provide
domestic long distance service in the United States is subject to regulation by
the FCC and relevant state PSCs that regulate the offering of interstate and
intrastate telecommunications services, respectively. No formal authority is
required for the offering of interstate services. The Company, however, is
required by the FCC to file tariffs listing the rates, terms and conditions of
domestic long distance services provided. MSN has a tariff with respect to
domestic long distance services on file. The FCC adopted the October 29, 1996
Order (the "Detariffing Order") eliminating the requirement that non-dominant
interstate carriers, such as the Company, maintain FCC tariffs. However, on
February 13, 1997, the U.S. Court of Appeals for the DC Circuit stayed the
Detariffing Order, pending judicial review of the order. No final decision has
been rendered on the appeal.
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Prior to the initiation of intrastate service, depending on the state, the
Company generally must obtain certification from or register with the relevant
state PSC. Providers of intrastate services may also be required to file tariffs
or rate schedules, and may be subject to certain reporting obligations with the
relevant PSC. Telscape USA has obtained the authorizations or has registered
with state regulatory authorities in 40 states. MSN has certification in eight
states, plus pending applications in two additional states. The Company has not
yet filed tariffs in the states that require tariffs to be filed, because the
Company is not currently offering intrastate interexchange service in any state.
For the same reason, the Company has not filed any reports with state PSCs.
Failure to comply with state law and/or the rules, regulations and policies of
the PSCs may result in challenges by third parties, and/or actions by the PSCs
including conditioning, modifying or revoking state authorization to provide
telecommunications services within the respective state and/or subject the
provider to fines and penalties.
In addition, the FCC has adopted certain measures to implement the 1996
Telecommunications Act that will impose new regulatory requirements, including
the requirement that the Company contribute some portion of its
telecommunications revenues to a "universal service fund" designated to fund
affordable telephone service for consumers, schools, libraries and rural health
care providers. These contributions became payable beginning in 1998 for all
interexchange carriers. The contribution percentages for 1998 equal
approximately 3.15% of interstate and international gross end user
telecommunications revenues for the high cost and low income fund, and
approximately 0.75% of intrastate, interstate and international gross end user
telecommunications revenues for the schools, libraries and health care fund. The
Company cannot predict the amount of universal service fund contributions for
1999, or thereafter, until the FCC issues contribution factors for such periods.
To date, the Company has not made any contributions to the universal service
fund because it provides its wholesale long distance services to other carriers
who are responsible for these contributions. In the future, the Company may be
required to make such contributions as it establishes its own platform for its
Prepaid Card services.
MEXICO. In June 1998, Telereunion S.A. received a 30-year facilities-based
carrier license from the SCT, allowing it to originate and terminate long
distance services and to provide data and other value-added services in Mexico.
The FTL opened the local and long distance telecommunications service markets to
competition and imposed varying levels of regulation on Mexican
telecommunications providers. Pursuant to the FTL, the SCT and the COFETEL
implement the provisions of the FTL. The FTL imposes regulations on public
carriers. Facilities-based public carriers, those that use the radio spectrum,
satellite links or any form of land-based cables to provide telecommunications
services, must obtain concessions prior to providing service. Concessionaires
may also resell the facilities and services of other Concessionaires. Vendors
(resellers) of telecommunications services may not own their own facilities but
need only obtain a permit to provide service. Although the FTL provides for the
existence of resellers, the Mexican government has not issued the implementing
rules and regulations to allow their entry into the market. Consequently,
Mexican law does not currently permit pure switched international resale.
Carriers wishing to offer value-added services need only register with the
COFETEL's Telecommunications Registry.
In addition to the FTL, the Mexican Long Distance International Rules (the
"International Rules") establish the specific regulatory framework that
governs international long distance services. Among other matters, the
International Rules (i) mandate uniform accounting rate and proportionate return
for three years for all international traffic; (ii) require Concessionaires to
obtain additional specific authorization to install and operate international
gateways; (iii) implicitly prohibit ISR for three years; and (iv) regulate
international correspondent agreements, which must reflect the uniform
accounting rate and proportionate return rules. The International Rules prohibit
all telecommunications operators, except those Concessionaires that have
obtained the specific authorization from the COFETEL, to install and operate
international gateway switches. Those Concessionaires that have not received
such specific authorization, as well as any other companies that provide
telecommunications services, such as providers of value-added services, cellular
concessionaires and paging service providers cannot directly transmit
international switched traffic. To date, the SCT and the COFETEL have granted 15
companies, including Telmex and Telereunion S.A., concessions for the
installation, operation and exploitation of long distance public
telecommunications networks, of which eight have received authorization to
install and operate international gateway facilities.
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In addition, the SCT and the COFETEL have granted eight concessions for local
switched services as well as numerous registrations for value added services.
Pursuant to the Foreign Investment Law and the Telecom Law, concessions for
public telecommunication networks may only be granted to Mexican citizens or
Mexican companies. Foreign investors may own minority interests in
Concessionaires, but may not own more than 49% of the voting ownership interest
of the company except for companies that provide cellular service. NAFTA removed
certain Mexican restrictions on foreign investment and U.S. companies may now
maintain 100% ownership interests in companies that provide value-added services
in Mexico. Pursuant to Mexican law, only Mexican citizens or companies
incorporated and domiciled in Mexico can register as providers of value-added
services.
The Company, through its Mexican subsidiaries, is currently registered with
the COFETEL as a value-added services provider. In June 1998, Telereunion S.A.
received the Mexican Concession, a 30-year, facilities-based carrier license
from the SCT, allowing it to construct and operate a network on which the
Company can carry long distance traffic in Mexico.
TELMEX CHARGES. In connection with the liberalization of the Mexican
telecommunications market, the Mexican government, through the Secretaria de
Comunicaciones y Transportes (the "SCT") and the Comision Federal de
Telecommunicaciones (the "COFETEL"), has granted concessions to 15
Concessionaires, including Telmex and Telereunion, S.A., to construct and
operate public, long distance telecommunications networks in Mexico. The SCT
authorized Telmex to charge each of the Concessionaires, upon interconnection
with the Telmex system, a portion of the infrastructure cost incurred by Telmex
to upgrade its system to allow interconnection (the "Common Cost Charges"), as
well as interconnection and access costs (the "Additional Charges"). The
Mexican regulatory authorities were requiring the Concessionaires to pay Telmex
an interconnection rate equal to $.057 cents per minute and an additional access
fee equivalent to 58% of the settlement rate on every incoming international
call, in addition to other high access fees for routing calls through Telmex's
network. An independent third-party had estimated the aggregate amount of the
Common Cost Charges to be approximately $422.0 million, which excluded the cost
of administering and operating such upgrades, which remained subject to
determination by another independent third party. The Mexican regulatory
authorities accepted such estimate in a ruling dated May 28, 1997, which was
challenged by Telmex and three of the Concessionaires already interconnected
with Telmex (Alestra, Avantel and Miditel) in administrative proceedings before
the SCT and the courts. Specifically, Telmex requested an increase in the Common
Cost Charges and full payment in a single installment, and the three
Concessionaires were seeking a reduction in the Common Cost Charges and payment
on an installation, as well as a reduction in the Additional Charges.
On August 24, 1998, the SCT announced that Telmex and four of the six
Concessionaires interconnected to Telmex (Alestra, Protel, Iusatel, and
Marcatel) reached an agreement regarding the Common Cost Charges and the
Additional Charges. The new agreement reduces the interconnection rate charged
by Telmex by 52% to $.027 cents per minute, eliminates the 58% access fee on
incoming international calls and reduces other access fees charged by Telmex for
routing calls over its network. The agreement also provides that the
Concessionaires must pay Telmex $703.4 million as Common Cost Charges, which
includes the cost of administering and operating the upgrades done by Telmex to
its network, which had not been determined in the May 28, 1997 ruling by the
SCT, plus 12% annual interest. The $703.4 million will be paid in two manners:
(i) a first lump sum payment by the Concessionaires (excluding Telmex and
Telnor) equal to 15% of the Common Cost Charges on December 31, 1998, and (ii)
recurring payments by each Concessionaire based on their pro rata use of
Telmex's network, which will be charged at an interconnection rate of $.053
cents per minute. The total Common Cost Charges must be paid by the year 2004.
Any additional Concessionaires that interconnect with Telmex in the future, such
as the Company, will have to pay their proportionate share of the 15% initial
payment to those Concessionaires that have already paid it, plus the $.053 cents
per minute to Telmex. Two Concessionaires (Avantel and Miditel) refused to form
part of the agreement and therefore are continuing their legal challenge against
Telmex. These two Concessionaires will have to individually negotiate the terms
of interconnection with Telmex, provided that if they cannot reach an agreement
with Telmex within 60 days, the COFETEL may intervene
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and mandate the applicable terms of interconnection. Should the Company decide
not to form part of the agreement, it will also have to individually negotiate
interconnection terms with Telmex.
OTHER LATIN AMERICAN MARKETS. The Company's provision of services
elsewhere in Latin America is subject to the developing laws and regulations
governing the competitive provision of telecommunications services in each Latin
American country in which it provides or seeks to provide services. Each such
Latin American country in which the Company currently conducts or intends to
conduct business has a different national regulatory scheme. Historically, Latin
American countries have prohibited Voice Telephony except by the PTT. The
available opportunities and the requirements for the Company to obtain necessary
approvals to offer value-added services, systems integration, or the full range
of telecommunications services, including Voice Telephony, vary considerably
from country to country. The Company currently plans to provide a limited range
of services in certain Latin American countries, as permitted by regulatory
conditions in those markets, and to expand its operations as these markets
implement liberalization to permit competition in the full range of
telecommunications services. The nature, extent and timing of the opportunity
for the Company to compete in these markets will be determined, in part, by the
actions taken by the governments in these countries to implement competition and
the response of incumbent carriers to these efforts. There can be no assurance
that any of these countries will implement competition in the near future or at
all, that the Company will be able to take advantage of any such liberalization
in a timely manner, or that the Company's operations in any such country will be
successful. There can be no assurance that the Company has received all
necessary approvals, filed applications for such approvals, received comfort
letters or obtained all necessary licenses from the applicable regulatory
authorities to offer telecommunications services in the Latin American countries
where it currently provides services or those in which it seeks to provide
services in the future, or that it will do so in the future. The Company's
failure to obtain, or retain necessary approvals could have a material adverse
effect on the Company's business, financial condition and results of operations.
Liberalization in Latin America is proceeding rapidly and the Company seeks
to keep pace with competition even where PTTs retain a legally mandated monopoly
on Voice Telephony. The Company is currently offering or plans to offer certain
systems integration, enhanced services, or value-added services in a number of
Latin America countries where the PTT retains the legally mandated monopoly on
Voice Telephony. While the Company believes that it will not be found to be
offering Voice Telephony in these countries prior to the expiration of the PTT's
monopoly on such services, the Company has received no assurance from the
respective PTTs or from the respective regulating authorities that this will be
the case. It is possible that the Company could be fined, or that the Company's
facilities or equipment could be confiscated, or that the Company would not be
allowed to provide specific services in these countries, among other sanctions,
if the Company were found to be providing Voice Telephony before the date in
which the PTT's monopoly on Voice Telephony ceases. Such actions could have a
material adverse impact on the Company's business, financial condition and
results of operations.
Moreover, the Company may be incorrect in its assumption that (i) each
Latin American country will abolish, on a timely basis, the respective PTT's
monopoly to provide Voice Telephony within and between other countries, (ii)
deregulation will continue to occur and (iii) the Company will be allowed to
continue to provide and to expand its services in the Latin American countries.
There can be no assurance that any or all of the Latin American countries will
not adopt laws or regulatory requirements that will adversely affect the
Company. Additionally, there can be no assurance that future regulatory,
judicial or legislative changes in any or all of the Latin American will not
have a material adverse effect on the Company or that regulators or third
parties will not raise material issues with regard to the Company's compliance
with applicable laws or regulations. If the Company is unable to provide the
services it is presently providing or intends to provide or to use its existing
or contemplated transmission methods due to its inability to receive or retain
formal or informal approvals for such services or transmission methods, or for
any other reason related to regulatory compliance or the lack thereof, such
events could have a material adverse effect on the Company's business, financial
condition and results of operations.
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INTELLECTUAL PROPERTY
The Company uses the names "Telscape International" and "Telscape" as its
primary business names, and has filed for federal trademark protection for the
"Telscape" name and distinctive logo. These filings are pending, and the Company
has no assurance that they will be granted. The Company owns a federal trademark
registration for the "TELEFIESTA"(R) Prepaid Cards. Telereunion S.A. has a
national trademark registration in Mexico for "TELEREUNION." The Company regards
its trademarks, servicemarks, tradenames and logos as valuable assets and
believes they have value in the marketing of its products and services. The
Company intends to protect and defend its name, servicemarks and trademarks in
the United States and internationally. See "Risk Factors -- Proprietary Rights."
EMPLOYEES
As of September 22, 1998, the Company had 387 full-time employees, with 314
residing in Mexico and 73 residing in the United States. Of the total employees,
there are six in product development, 58 in sales and marketing, 52 in general
and administrative and 271 in operations, engineering and manufacturing and
assembly. None of the Company's employees are subject to a collective bargaining
agreement, and the Company has not experienced any work stoppage. The Company
believes that its relations with its employees are good.
PROPERTIES
The Company's international headquarters are located in Houston, Texas,
where the Company leases approximately 5,700 square feet of an office building.
The Company also leases additional facilities in Houston, Texas totaling 9,800
square feet relating to its Prepaid Card operations and to house
telecommunications equipment relating to its long distance services operations.
The Company leases facilities in Mexico City, Guadalajara and Tijuana, totaling
approximately 34,000 square feet and consisting of office and warehousing
facilities. The Company leases facilities in Sunnyvale and Mountain View,
California totalling 69,524 square feet.
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MANAGEMENT
OFFICERS, DIRECTORS AND OTHER KEY EMPLOYEES
The officers, directors and other key employees of the Company, and their
ages, as of October 20, 1998, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------- --- ---------------------------------------------------------
<S> <C>
E. Scott Crist....................... 34 Director; President; Chief Executive Officer
Manuel Landa......................... 37 Director; Chairman of the Board; Executive Vice President
of Operations; Chief Executive Officer of Telereunion;
President of Vextro
Todd M. Binet(1)..................... 34 Director; Executive Vice President; Secretary; Treasurer;
Chief Financial Officer
Oscar Garcia......................... 37 Director; Vice President of Telereunion; Vice President
of Operations of Vextro
Ricardo Orea......................... 37 Director; Vice President of Telereunion; Vice President
of Sales and Marketing of Vextro
Stuart Newman........................ 42 President of MSN
Bryan T. Emerson..................... 37 Vice President of International Business
Jose Luis Apan....................... 36 Director of Marketing of Telereunion
Carlos de Lara....................... 38 Chief Technology Officer
E. Russell Hardy..................... 58 Chief Executive Officer of INTERLINK
Marco A. Castilla.................... 32 Vice President of International Affairs and Corporate
Counsel
Jesse E. Morris...................... 30 Corporate Controller; Assistant Treasurer
Darrel O. Kirkland(1)(2)............. 57 Director
Enrique Orihuela(1)(2)............... 51 Director
Jack M. Fields, Jr................... 46 Director
</TABLE>
- ------------
(1) Member of the Audit Committee of the Board of Directors.
(2) Member of the Compensation Committee of the Board of Directors.
E. SCOTT CRIST has served as President and Chief Executive Officer of the
Company since July 1996. Prior to joining the Company, Mr. Crist was a founder
of Orion Communications, Inc., a reseller of long distance and Internet access
services, where he served as President from June 1996 to July 1996. He was also
President and Chief Executive Officer for Matrix Telecom, a long-distance
company which ranked #7 on THE INC. MAGAZINE list of the 500 fastest growing
private companies, from September 1995 through June 1996. He also founded in May
1993, DNS Communications ("DNS"), a long-distance reseller. He served as DNS's
Chief Executive Officer from its inception until DNS's merger with Matrix
Telecom. From March 1991 to January 1993 he served as Vice President of
Acquisitions for Trammell Crow Group, where he specialized in U.S. capital
market transactions. Mr. Crist has an M.B.A. from the J.L. Kellogg School at
Northwestern University, and received a B.S. MAGNA CUM LAUDE in Electrical
Engineering with an emphasis on telecommunications design from North Carolina
State University.
MANUEL LANDA has served as the Company's Chairman of the Board and as a
member of the Board of Directors since May 1996. Mr. Landa co-founded
Telereunion, has served as President of Vextro since 1989, and has served as
Chief Executive Officer and a Director of Telereunion since August 1995. From
1986 until he joined Telereunion, Mr. Landa served as Export Sales Manager for
Condumex, the largest Mexican manufacturer of electrical products with exports
to the United States, Canada, Latin America and Europe. While at Condumex, Mr.
Landa also served as Plant Manager, in which capacity he directed the Insulating
Materials Division. Prior to joining Condumex, Mr. Landa worked in the consumer
and industrial electronics business of Philips, a Dutch company, where he served
as Design Engineer for its Industrial Audio-Video Division. Mr. Landa also
worked for IPESA, a Mexican construction and engineering firm, on projects in
the petrochemical, industrial and touristic sectors of Mexico. Mr. Landa
received a degree in
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Electronic and Communications Engineering from La Salle University in Mexico
City, where he graduated MAGNA CUM LAUDE. He also has a diploma in Total Quality
Management from the Instituto Tecnologico de Estudios Superiores Monterrey.
TODD M. BINET has served as the Company's Executive Vice President and
Chief Financial Officer since January 1997, and as a member of the Board of
Directors since March 1997. Mr. Binet has over 10 years of business and
management experience. Prior to joining the Company, he served as an officer and
director of St. James Capital Corp., the general partner to St. James Capital
Partners, a merchant banking fund, from January 1996 to December 1996. Prior to
his service with St. James, from July 1992 to December 1995, Mr. Binet served as
Treasurer and Corporate Counsel for Alamo Group Inc., an international company
listed on the New York Stock Exchange ("NYSE"). Mr. Binet received a B.B.A. in
finance from Southern Methodist University and graduated CUM LAUDE. He also
received an M.B.A. from the Wharton School of Business and holds a J.D. from the
University of Pennsylvania. Mr. Binet also holds a license to practice law in
the state of Texas, although the license is currently inactive.
OSCAR GARCIA has served as a member of the Board of Directors of the
Company since May 1996. Mr. Garcia co-founded Vextro and Telereunion, has served
as Vextro's Vice President of Operations since 1988 and as a Vice President of
Telereunion since August 1995. From 1987 until he co-founded Vextro, Mr. Garcia
served as Engineering Manager for Infosistemas, which at that time was the
exclusive AT&T telephone equipment distributor in Mexico. Prior to that, Mr.
Garcia was Sales Support Manager for Macrotel de Mexico S.A. de C.V., a
subsidiary of Macrotel, Inc., a Florida telephone key systems company with
exports to Mexico and Latin America. Before that, Mr. Garcia held the position
of design engineer for the R&D department of GTE, at that time the leading U.S.
telecommunications company involved in PBX and KSU manufacturing in Mexico. Mr.
Garcia holds an undergraduate degree in Electronic and Communications
Engineering from La Salle University in Mexico City, a diploma in Marketing from
La Salle University and a degree in Business Administration from Berkley
University in Mexico City.
RICARDO OREA has served as a member of the Board of Directors of the
Company since May 1996. Mr. Orea co-founded Vextro and Telereunion, has served
as Vextro's Vice President of Sales and Marketing since 1988 and as a Vice
President of Telereunion since August 1995. Prior to joining Vextro, Mr. Orea
was Electronic Control Systems Plant Manager for Asea Brown Boveri, a Swedish
electrical control and switchgear equipment manufacturer. Before that, Mr. Orea
worked for GTE in its Purchasing and Logistics Department as System Integrator
and Supplier Development Manager. Earlier, he was Technical Service Manager for
MISA, a Mexican computer mainframes and telecommunications maintenance service
company which served major financial accounts and universities. Mr. Orea
received an undergraduate degree in Electronic and Communications Engineering
from La Salle University in Mexico City and has a diploma in Business
Administration from Berkley University in Mexico City.
STUART NEWMAN has served as President of MSN since it was founded in 1996.
Mr. Newman first entered the telecommunications industry in 1979 at Amtel
Consulting, where he was responsible for certain Fortune 500 customers in Texas.
He helped corporate clients establish networks and was involved in auditing
billing systems. From 1994 to 1996, Mr. Newman served as Executive Vice
President for Carribbean Telephone & Telegraph, Inc., a switch based provider of
long distance services. In 1992 Mr. Newman founded New West Telecom, Inc., one
of the nation's first Prepaid Card companies.
BRYAN T. EMERSON has served as the Company's Vice President of
International Business since joining the Company in August 1996. From December
1993 to March 1995, Mr. Emerson served as International Sales Manager for C & L
Communications, Inc., a NYSE company, where he was responsible for distributing
telecommunications equipment in Mexico, Spain and Japan. From May 1992 to
December 1993, Mr. Emerson served as Vice President of Marketing for ISDN de
Mexico, S.A. de C.V. He also served as a Product Manager for WilTel, where he
specialized in developing such products as original switched, 800, conference
calling, voice mail, and travel and domestic card services for domestic and
international services. Mr. Emerson was also responsible for identifying and
signing distributor contracts between WilTel and companies in Mexico and
Guatemala. Mr. Emerson received a B.A. from Hamilton College and graduated CUM
LAUDE. He also received an M.B.A. from Rice University.
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JOSE LUIS APAN has served as the Company's Director of Marketing since July
1, 1996. Prior to joining the Company, he was co-founder and Chief Executive
Officer of Integracion from 1992 to 1997. From 1986 until he founded
Integracion, Mr. Apan served as Regional Telecommunications Manager for Hewlett-
Packard Latin America where he was responsible for the installation and
operation of the Voice, Data and Video Digital Network for the Latin America
Region. Mr. Apan has an MBA from the Instituto Tecnologico Autonomo de Mexico
and holds an undergraduate degree in Chemical Engineering from the Universidad
Iberoamericana in Mexico City. Mr. Apan is also a Registered Communications
Distribution Designer from the Building Institute of Construction Industry in
Tampa, Florida.
CARLOS DE LARA has served as the Company's Technology Officer since
October, 1997. Prior to joining the Company, he was Chief Operating Officer of
NSI which he co-founded in 1994. While at NSI he was instrumental in obtaining
several large systems integration contracts with Pemex, Elektra, Banco Mexicano,
Banco Union and obtained recognition for the Company as Best Integrator from
3Com and the Best New Integrator in Latin America from Newbridge Networks, Inc.,
both in 1996. Prior to founding NSI, he served from June 1992 as Division
Vice-President with Serpcco where he developed Serpcco's network integration
business unit. Mr. De Lara was also academic coordinator from 1992 to 1993 at
the Universidad Anahuac, where he founded the postgraduate program for computer
networking and telecommunications, believed to be the first such program in
Mexico and which received official recognition from the Ministry of Education of
Mexico. From 1995 to 1996, Mr. De Lara served as a specialist in data and packet
networks at the Mexican Institute for Communications serving under Dr. Enrique
Melrose, then Research Director, who is now Technical Commissioner at the
COFETEL. Mr. De Lara holds an undergraduate degree in Industrial Engineering
from Universidad Anahuac in Mexico City.
E. RUSSELL HARDY has served as Chief Executive Officer of INTERLINK since
it was founded in May 1998. Prior to joining the Company, Mr. Hardy worked for
28 years in various capacities at California Microwave, Inc, serving as
President of its Services Division for the last 13 years. While serving at
California Microwave, Inc., Mr. Hardy served in various capacities in the
Satellite Communications Division, Defense Products Division and the
Telecommunications Division. Mr. Hardy has a Bachelor of Science in Electrical
Engineering from the University of California at Berkeley and a Master of
Science in Electrical Engineering from San Jose State University.
MARCO A. CASTILLA has served as Vice President of International Affairs and
Corporate Counsel since July 1998. Prior to joining the Company, Mr. Castilla
worked as Foreign Legal Advisor at Swidler Berlin Shereff Friedman, LLP
("Swidler"). At Swidler, Mr. Castilla practiced in the telecommunications
group, representing and advising U.S. and international telecommunications
companies in their entry into newly competitive markets, including with respect
to regulatory and transactional matters, and in structuring their foreign
operations. From December 1995 to September 1996, Mr. Castilla worked as a
Foreign Associate at the international law firm Rogers & Wells in Washington
D.C. From June 1995 to early December 1995 Mr. Castilla worked as Research
Assistant at Harvard Law School. From January 1992 to June 1994, Mr. Castilla
served as Regional Legal Advisor for the United Nations High Commissioner for
Refugees (UNHCR) Regional Office in Mexico. Mr. Castilla received an L.L.M. from
Harvard Law School and a J.D. with honors from the Universidad Iberoamericana in
Mexico City.
JESSE E. MORRIS has served as Corporate Controller since joining the
Company in October 1997. Prior to joining the Company Mr. Morris worked from
January 1992 until October 1997 with Arthur Andersen LLP, a multi-national
accounting and consulting professional services firm, where he last served as
Experienced Audit Manager. Mr. Morris received his B.B.A. in Accounting and
Finance and his Masters in Professional Accountancy from the University of
Texas. Mr. Morris is a Certified Public Accountant with the State of Texas.
DARREL O. KIRKLAND has served as a member of the Board of Directors of the
Company since March 1996. Mr. Kirkland has served as a principal consultant with
Kirkland & Associates, a management consulting firm specializing in
telecommunications since 1992. A registered Professional Engineer, Mr. Kirkland
has many years of experience in long distance, microwave, wireless, fiber and
local transmission services. He has held general management and marketing
positions with MCI Air Signal, CPI Microwave,
65
<PAGE>
and Discovery Communications. Current and recent clients include MCI, Skytel,
IXC Communications, Prime Cable and Winstar Wireless. Mr. Kirkland received a
B.B.A. from the University of Texas and an M.S. in Industrial Engineering from
the University of Houston.
ENRIQUE ORIHUELA has served as a member of the Board of Directors of the
Company since March 1998. Mr. Orihuela is a founder and an owner of the Andean
Satellite System ("ANDESAT"). Since 1997, he has served as a member of the
Board of Directors of ANDESAT. ANDESAT is a multinational corporation
constituted by members of the five Andean countries: Venezuela, Colombia,
Ecuador, Peru and Bolivia. Mr. Orihuela has been responsible for negotiations
with Satmex, the Mexican satellite operator, for the space in C Band to be used
by ANDESAT until its planned year 2000 satellite launch. He has also conducted
negotiations with Nahuelsat, the Argentinian satellite operator, for the Ku Band
to be used by ANDESAT for the same purpose. In 1991, Mr. Orihuela founded Vector
Communication Network Corp., a Florida-based satellite services provider, and
has served as its President since that time. Mr. Orihuela studied at the
University La Molina in the field of computers and communications.
JACK M. FIELDS, JR. will serve as director upon the completion of the Notes
Offering. Mr. Fields served as a U.S. Congressman representing Texas' 8th
Congressional District in the United States House of Representatives from 1981
to 1997, retiring as chairman of the House Telecommunications and Finance
subcommittee. Under his leadership, Congress enacted the 1996 Telecommunications
Act. Mr. Fields served on the Telecommunications and Finance Subcommittee from
1985 until his retirement. During his years of service, the subcommittee
maintained jurisdiction over interstate and international telecommunications,
the Federal Communications Commission, as well as the telephone, cellular, cable
and broadcast industries. In addition, the subcommittee maintained jurisdiction
over the Securities and Exchange Commission, including the activities of
investment bankers, stock brokers, investment advisors, stock exchanges and the
mutual fund industry. After retiring in 1997, Mr. Fields founded two companies;
Texana Global, Inc. an international trading corporation, and Twenty-First
Century Group, Inc., a Washington, D.C.-based governmental affairs and strategic
planning company. Mr. Fields earned his B.A. and his J.D. degrees from Baylor
University in Waco, Texas. Mr. Fields currently serves on the boards of AIM
Management Group, Inc. and Administaff, Inc., as well as the Houston
Metropolitan Study Group.
EMPLOYMENT AGREEMENTS
The Company entered into an employment agreement with Mr. Crist, effective
August 1, 1996, pursuant to which Mr. Crist serves as President and Chief
Executive Officer of the Company. The agreement expires on August 1, 1999,
unless the Company terminates Mr. Crist for cause prior to that time. The
agreement provides for Mr. Crist to receive annual compensation of $95,000 and
options to purchase 350,000 shares of Common Stock at $4.50 per share. One-third
of the options vest each year commencing August 1, 1997, and all options
automatically vest if the price of the Company's Common Stock exceeds $13.00 per
share for 20 consecutive trading days. In addition, Mr. Crist is entitled to a
bonus, which will be determined by the Board of Directors based on his and the
Company's performance.
In connection with its acquisition of Telereunion, the Company entered into
employment agreements with Messrs. Landa, Garcia and Orea, effective as of May
14, 1996. The employment agreements provide that Mr. Landa will serve as
President and Chief Executive Officer of Telereunion and that Messrs. Garcia and
Orea will each serve as a vice president of Telereunion. Each employment
agreement terminates on May 14, 1999, unless Telereunion terminates the officer
for cause prior to that time. Each of Messrs. Landa, Garcia and Orea are
entitled to receive annual compensation equal to $80,000.
On January 13, 1997, the Company entered into an employment agreement with
Mr. Binet pursuant to which Mr. Binet serves as Executive Vice President and
Chief Financial Officer of the Company. The agreement terminates on January 13,
2000, unless the Company terminates Mr. Binet for cause prior to that time. Mr.
Binet is entitled to a minimum annual compensation of $70,000 and a bonus based
on his and the Company's performance. Mr. Binet's minimum annual compensation is
adjusted to the extent that Mr. Binet receives a raise in annual salary. In
addition, Mr. Binet was granted an option in January 1997 to purchase 250,000
shares of Common Stock, consisting of 166,667 at $4.00 per share and 83,333 at
$3.25
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<PAGE>
per share. The options vest over a three year period, on a quarterly basis,
after the first year. The options are immediately exercisable in the event there
is a change in control of the Company that results in Mr. Binet no longer
serving as Executive Vice President and Chief Financial Officer of the surviving
company.
STOCK OPTION PLANS
1993 STOCK OPTION PLAN
Under the terms of its 1993 Stock Option Plan, the Company may grant to
employees, directors and consultants of the Company and its subsidiaries,
incentive and non-qualified stock options to purchase up to 218,145 shares of
Common Stock. Options must be granted at not less than the fair market value of
the 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
Common Stock) for incentive stock options and at not less than 85% of the fair
market value for non-qualified stock options. Options granted under this plan
may be for a term of up to 10 years (5 years for options granted to stockholders
owning 10% or more of the Company's Common Stock), as determined by the Board of
Directors.
1994 DIRECTORS' STOCK OPTION PLAN
Under the terms of its 1994 Directors Stock Option Plan, the Company may
grant non-qualified options to purchase up to 31,163 shares of Common Stock to
directors of the Company or directors of any majority-owned subsidiary of the
Company who are not salaried employees. Options may be granted under the plan
until June 1, 2004, at prices not less than the fair market value of the
Company's Common Stock at the date of grant, and must be exercisable within 10
years of the date of grant. Upon a change of control of the Company, all granted
but unvested options under the plan will vest immediately.
TELEREUNION 1995 STOCK OPTION PLAN
The Company assumed Telereunion's Stock Option Plan in connection with the
acquisition of Telereunion. Under the terms of this plan, the Company may grant
non-qualified options to employees, directors and consultants of the Company.
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) for incentive stock options, and at not less than 85% of
the fair market value for non-qualified stock options. The terms of the options
are determined by the Company's Board of Directors. Any options granted must be
exercised within 10 years of the date of grant.
1996 STOCK OPTION AND APPRECIATION RIGHTS PLAN
Pursuant to the Company's 1996 Stock Option and Appreciation Rights Plan,
the Company may grant the Company's employees, directors and consultants
non-qualified options to purchase up to 1,200,000 shares of Common Stock. The
plan also provides for grants of stock appreciation rights ("SARs") in
connection with the grant of options under the plan. 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) for
incentive stock options. 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 options 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 in return, 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.
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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. 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.
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 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.
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SUMMARY COMPENSATION TABLE
The following table sets forth certain summary information concerning
compensation for services in all capacities awarded to, earned by or paid to,
the Company's Chief Executive Officer and each of the four other most highly
compensated executive officers of the Company, whose aggregate cash and cash
equivalent compensation exceeded $100,000 (collectively, the "Named
Officers"), with respect to the fiscal year ended December 31, 1997.
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
-------------
PAYOUTS
-------------
ANNUAL COMPENSATION(1) SECURITIES
NAME AND --------------------------- UNDERLYING
PRINCIPAL BONUS OPTIONS/
POSITION(2) YEAR SALARY($) ($)(3) SARS(#)
- ------------------------------------- ---- ---------- ------- -------------
<S> <C> <C> <C>
E. Scott Crist 1997 $ 87,308 $75,000 --
President and Chief Executive Officer 1996 $ 14,423 -- 350,000
Manuel Landa 1997 $ 80,000 $75,000 --
Chairman, Executive Vice President of 1996 $ 33,000 -- 75,000
Operations and Chief Executive
Officer of Telereunion and President
of Vextro
Oscar Garcia 1997 $ 80,000 $50,000 --
Vice President of Telereunion, Vice 1996 $ 33,000 -- 75,000
President of Operations of Vextro
Ricardo Orea 1997 $ 80,000 $50,000 --
Vice President of Telereunion, Vice 1996 $ 33,000 -- 75,000
President of Sales and Marketing of
Vextro
Todd M. Binet 1997 $74,346 $50,000 250,000
Executive Vice President, Secretary, 1996 -- -- --
Treasurer and Chief Financial Officer
</TABLE>
- ------------
(1) Each of the Company's officers received perquisites and other personal
benefits in addition to salary and bonuses. The aggregate amount of such
perquisites and other personal benefits, however, does not exceed the lesser
of $50,000 or 10 percent of the total of the annual salary and bonus
reported for any of the Named Officers for each of the reported years.
(2) The following summarizes each executive's employment commencement dates: Mr.
Crist, August, 1996; Mr. Landa, May, 1996; Mr. Garcia, May, 1996; Mr. Orea,
May, 1996; Mr. Binet, January, 1997. Compensation information is provided
for each Named Officer from the employment commencement date.
(3) Represents annual bonus award earned for the fiscal year noted, even though
such bonus was paid in the following fiscal year.
EXECUTIVE COMPENSATION
The following is the report of the Compensation Committee of the Board of
Directors for compensation paid to executive officers of the Company during
fiscal year 1997.
REPORT ON EXECUTIVE COMPENSATION
During 1997, the compensation of the executive officers was administered
and determined directly by the Board of Directors. In March 1997, the Company
established a Compensation Committee of the Board which is comprised of Mr.
Kirkland, a non-employee director, and Mr. Crist and Mr. Landa, two employee
directors, and it is responsible for administering the Company's executive
compensation programs and policies. As of April 24, 1998, the Compensation
Committee consists of Mr. Kirkland and Mr. Orihuela, two non-employee directors.
The Company's executive compensation programs are designed to attract, motivate
and retain the executive talent needed to optimize stockholder value in a
competitive environment. The programs are intended to support the goal of
increasing stockholder value while facilitating the business strategies and
long-range plans of the Company.
The following is the Board of Directors' report addressing the compensation
of the Company's executive officers for fiscal 1997.
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<PAGE>
COMPENSATION POLICY AND PHILOSOPHY
The Company's executive compensation policy is designed to establish an
appropriate relationship between executive pay and the Company's annual
performance, its long term growth objectives and its ability to attract and
retain qualified executive officers. The Company's policy is based on the belief
that the interests of the executives should be closely aligned with the
Company's stockholders. The Board attempts to achieve these goals by integrating
annual base salaries with (i) annual incentive bonuses based on corporate
performance, based on the achievement of specified performance objectives set
forth in the Company's financial plan for such fiscal year, and based on
individual performance, and (ii) stock options through the Company's stock
option plans. The Board's philosophy is to review salaries paid to executive
officers with comparable responsibilities in comparable businesses and offer
salaries to its executives which are in the lower range of those offered by such
comparable businesses. In addition, the components of each executive officer's
compensation is weighted to the bonus and option components. This results in a
meaningful portion of each executive's compensation being placed at-risk and
linked to the accomplishment of specific results that are expected to lead to
the creation of value for the Company's stockholders from both the short-term
performance and long term success of the Company. The Board considers all
elements of compensation and the compensation policy when determining individual
components of pay.
The Board believes that leadership and motivation of the Company's
employees are critical to achieving the objectives of the Company. The Board is
responsible for ensuring that its executive officers are compensated in a way
that furthers the Company's business strategies and which aligns their interests
with those of the stockholders. To support this philosophy, the following
principles provide a framework for executive compensation: (i) offer
compensation opportunities that attract the best talent to the Company; (ii)
motivate individuals to perform at their highest levels; (iii) reward
outstanding achievement; (iv) retain those with leadership abilities and skills
necessary for building long-term stockholder value; (v) maintain a significant
portion of executives' total compensation at risk, tied to both the annual and
long-term financial performance of the Company and the creation of incremental
stockholder value; and (iv) encourage executives to manage from the perspective
of owners with an equity stake in the Company.
EXECUTIVE COMPENSATION COMPONENTS
As discussed below, the Company's executive compensation package is
primarily comprised of three components: base salary, annual incentive bonuses
and stock options.
BASE SALARY. For fiscal 1997, the Board approved the base salaries of the
Named Officers based on (i) salaries paid to executive officers with comparable
responsibilities employed by companies with comparable businesses, (ii)
performance and accomplishment of the Company in fiscal 1997 which is the most
important factor, and (iii) individual performance reviews for fiscal 1997 for
most executive officers. The Board's philosophy is to review salaries paid to
executive officers with comparable responsibilities in comparable businesses and
offer salaries to its executives which are in the lower range of those offered
by such comparable businesses. In addition, the components of each executive
officer's compensation is weighted to the bonus and option components. This
results in a meaningful portion of each executive's compensation being placed
at-risk and linked to the accomplishment of specific results that are expected
to lead to the creation of value for the Company's stockholders from both the
short-term performance and long term success of the Company. The Board reviews
executive officer salaries annually and exercises its judgement based on all the
factors described above in making its decision, subject to the terms of such
officer's employment agreement. No specific formula is applied to determine the
weight of each criteria.
ANNUAL INCENTIVE BONUSES. Annual incentive bonuses for the Named Officers
are based upon the following criteria: (i) the Company's financial performance
for the current fiscal year, (ii) the furthering of the Company's strategic
position in the marketplace, and (iii) individual merit. The Company paid
incentive bonuses to the Named Executive Officers as depicted in the Summary
Compensation Table.
LONG TERM INCENTIVE COMPENSATION. Stock options encourage and reward
effective management which results in long-term corporate financial success, as
measured by stock price appreciation. The Board believes that option grants
afford a desirable long-term compensation method because they closely ally the
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<PAGE>
interests of management with stockholder value and that grants of stock options
are the best way to motivate executive officers to improve long-term stock
market performance. The vesting provisions of options granted under the
Company's stock option plans are designed to encourage longevity of employment
with the Company and generally extend over a three year period.
COMPENSATION OF CHIEF EXECUTIVE OFFICER
The Board believes that E. Scott Crist, the Company's Chief Executive
Officer, provides valuable services to the Company and that his compensation
should therefore be competitive with that paid to executives at comparable
companies. In addition, the Board believes that an important component of his
compensation should be based on Company performance. Mr. Crist's annual base
salary for fiscal 1997 was $95,000. The factors which the Board considered in
setting his annual base salary were his individual performance and pay practices
of peer companies relating to executives of similar responsibility.
Additionally, Mr. Crist received an annual incentive bonus of $75,000 which was
determined by the Board after considering the Company's performance in fiscal
year 1997 in relation to the Company's financial plans for 1997 as well as Mr.
Crist's individual performance.
INTERNAL REVENUE CODE SECTION 162(M)
Under Section 162(m) of the Internal Revenue Code (the "Code"), the
amount of compensation paid to certain executives that is deductible with
respect to the Company's corporate taxes is limited to $1,000,000 annually, if
certain requirements of section 162(m) are not met. It is the current policy of
the Board to maximize, to the extent reasonably possible, the Company's ability
to obtain a corporate tax deduction for compensation paid to executive officers
of the Company to the extent consistent with the best interests of the Company
and its stockholders.
The Compensation Committee
Darrel O. Kirkland
E. Scott Crist
Manuel Landa
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<PAGE>
OPTION GRANTS
The following table sets forth certain information with respect to options
granted during the last fiscal year to the Named Officers.
OPTION/SAR GRANTS IN LAST FISCAL YEAR (1997)
<TABLE>
<CAPTION>
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/SARS
UNDERLYING GRANTED TO FAIR MARKET
OPTIONS/SARS EMPLOYEES IN EXERCISE VALUE AT DATE
NAME GRANTED(#) FISCAL YEAR PRICE($/SH) EXPIRATION DATE OF GRANT(1)
- ------------------------------------- ------------ ------------ ----------- ----------------- -------------
<S> <C> <C> <C> <C> <C>
E. Scott Crist....................... -- -- -- -- --
Manuel Landa......................... -- -- -- -- --
Oscar Garcia......................... -- -- -- -- --
Ricardo Orea......................... -- -- -- -- --
Todd M. Binet........................ 83,333 15% $3.25 January 13, 2007 $ 89,264
166,667 30% $4.00 January 13, 2007 $ 219,730
</TABLE>
- ------------
(1) The calculation of fair market value was performed utilizing the
Black-Scholes model utilizing the following assumptions: expected volatility
of 75%, risk-free rate of return of 5.6%, dividend yield of 0%, and expected
life of 10 years.
AGGREGATE OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION/SAR VALUES
The following table sets forth certain information with respect to options
exercised during fiscal 1997 by the Named Officers and with respect to
unexercised options held by such persons at the end of fiscal 1997.
<TABLE>
<CAPTION>
VALUE OF
UNEXERCISED
IN-THE-
MONEY
OPTIONS/SARS
NUMBER OF SECURITIES AT FISCAL
UNDERLYING UNEXERCISED AT YEAR
SHARES FISCAL YEAR END(#) END($)(1)
ACQUIRED ON VALUE ----------------------------- ------------
NAME EXERCISE(#) REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE
- ------------------------------------- ----------- -------- ----------- ------------- ------------
<S> <C> <C> <C>
E. Scott Crist....................... -- -- 116,667 233,333 $393,750
Manuel Landa......................... -- -- 100,000 -- $388,125
Oscar Garcia......................... -- -- 100,000 -- $388,125
Ricardo Orea......................... -- -- 100,000 -- $388,125
Todd M. Binet........................ -- -- -- 250,000 --
</TABLE>
NAME UNEXERCISABLE
- ------------------------------------- --------------
E. Scott Crist....................... $ 787,500
Manuel Landa......................... --
Oscar Garcia......................... --
Ricardo Orea......................... --
Todd M. Binet........................ $1,031,250
- ------------
(1) The calculations of the value of unexercised options are based on the
difference between the closing price of $7.875 per share of Common Stock on
NASDAQ Small Cap Market on December 31, 1997, and the exercise price of each
option, multiplied by the number of shares covered by the option.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During the fiscal year ended December 31, 1997, E. Scott Crist and Manuel
Landa, each an executive officer of the Company, served as members of the
Company's Board of Directors Compensation Committee. The Compensation Committee
establishes compensation and incentives for the Company's executive officers and
administers the Company's incentive compensation and benefit plans, including
Mr. Crist's and Mr. Landa's compensation. Darrell Kirkland, a non-employee
director, also served on the Compensation Committee.
DIRECTOR COMPENSATION
The Company reimburses all directors for the ordinary and necessary
expenses that they incur in attending meetings of the Board of Directors or a
committee of the Board of Directors on which they serve. Directors who are not
also employees of the Company receive $500 for each meeting of the Board of
Directors that they attend. Directors of the Company are eligible to participate
in the Company's 1998 Stock Option and Appreciation Rights Plan, 1996 Stock
Option and Appreciation Rights Plan and 1994 Directors Stock Option Plan.
Non-employee directors may receive an annual grant of options to purchase
up to 10,000 shares of the Company's Common Stock.
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<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Vector Communications Network Corp ("Vector"), of which Enrique Orihuela,
a director of the Company, is President, provides the Company with satellite
communication services under various one year contracts through April 1999. The
Company paid Vector a total of $215,000 for these services in fiscal year 1997
and $568,000 through June of 1998.
Manuel Landa, Oscar Garcia and Ricardo Orea, each a director of the
Company, together own 3% of the voting shares of Vextro and 18% of the voting
interests and 2% of the economic interests of Telereunion S.A.
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of October 8, 1998, by (i) each
person known by the Company to beneficially own five percent or more of any
class of the Company's capital stock, (ii) each director of the Company, (iii)
each Named Officer and (iv) all directors and executive officers of the Company
as a group. All information with respect to beneficial ownership has been
furnished to the Company by the respective shareholders of the Company. Unless
otherwise noted, the persons listed below have sole voting and investment power
with respect to such shares.
PERCENTAGE
NUMBER OF SHARES BENEFICIALLY
NAME AND ADDRESS BENEFICIALLY OWNED OWNED
- ------------------------------------- ------------------- ------------
E. Scott Crist....................... 1,311,450(1) 14.6%
2700 Post Oak Boulevard, Suite 1000
Houston, Texas 77056
Manuel Landa......................... 1,149,091(3)(4) 12.8%
Moras No. 430
Col. Del Valle, Del Benito Juarez
03100 Mexico, D.F.
Ricardo Orea......................... 1,148,022(2)(3) 12.8%
Moras No. 430
Col. Del Valle, Del Benito Juarez
03100 Mexico, D.F.
Oscar Garcia......................... 1,142,022(3)(5) 12.7%
Moras No. 430
Col. Del Valle, Del Benito Juarez
03100 Mexico, D.F.
Todd M. Binet........................ 389,207(6) 4.3%
2700 Post Oak Boulevard, Suite 1000
Houston, Texas 77056
Darrel Kirkland...................... * (7) *
803 Forest View
Austin, TX 78746
Enrique Orihuela..................... -- (8) --
13000 S.W. 133rd Court
Miami, FL 33186
All directors and executive
officers as a group (7 persons).... 5,155,532(9) 57.5%
(FOOTNOTES ON NEXT PAGE)
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- ------------
* Less than 1%
(1) Includes shares of Common Stock issuable upon exercise of the Series A
Common Stock Warrant which have vested and are exercisable with respect to
rights to purchase 300,000 shares of Common Stock held by Delaware
Guaranteed Trust Co. F/B/O Mr. Crist. The Series A Common Stock Warrant
lapses on May 16, 2003. Also, included are the shares of Common Stock
issuable upon exercise of a Series B Common Stock Warrant representing the
right to purchase 49,000 shares of Common Stock at $2.19 per share held by
Delaware Guarantee & Trust Co. F/B/O Mr. Crist. The Series B Common Stock
Warrant is currently exercisable and expires on May 16, 2003. Includes
options to purchase 327,778 shares of Common Stock at $4.50 per share which
are presently exercisable. Excludes options to purchase 40,000 shares of
Common Stock at $19.66 per share as such options are not exercisable within
60 days of this table. Reference is also made to the Schedule 13D filed
with the Commission by Mr. Crist on July 17, 1998, as amended.
(2) Includes shares of Common Stock issuable upon exercise of the Series A
Common Stock Warrant which have vested and become exercisable with respect
to rights to purchase 247,208 shares of Common Stock at $2.19 per share
owned by Mr. Orea, as well as rights to purchase 326,883 shares of Common
Stock held by Cloud International, L.L.C. ("Cloud"). Mr. Orea is the
beneficial owner of Cloud. The Series A Common Stock Warrant lapses on May
16, 2003. Reference is also made to the Schedule 13D filed with the
Commission by Mr. Orea on July 30, 1998, as amended.
(3) Includes options to purchase 25,000 and 75,000 shares of Common Stock at
$1.35 and $4.875 per share, respectively, all of which options are
presently exercisable. Excludes options to purchase 40,000 shares of Common
Stock at $17.88 per share as such options are not exercisable within 60
days of this table.
(4) Includes shares of Common Stock issuable upon exercise of a Series A Common
Stock Warrant which have vested and become exercisable with respect to
rights to purchase 247,208 shares of Common Stock at $2.19 per share owned
by Mr. Landa, as well as rights to purchase 325,814 shares of Common Stock
held by Forest International, L.L.C. ("Forest"). Mr. Landa is the
beneficial owner of Forest. The Series A Common Stock Warrant lapses on May
16, 2003. Reference is also made to the Schedule 13D filed with the
Commission by Mr. Landa on July 29, 1998, as amended.
(5) Includes shares of Common Stock issuable upon exercise of the Series A
Common Stock Warrant which have vested and become exercisable with respect
to rights to purchase 241,208 shares of Common Stock at $2.19 per share
owned by Mr. Garcia, as well as rights to purchase 325,814 shares of Common
Stock held by Sky International, L.L.C. ("Sky"). Mr. Garcia is the
beneficial owner of Sky. The Series A Common Stock Warrant lapses on May
16, 2003. Reference is also made to the Schedule 13D filed with the
Commission by Mr. Garcia on July 27, 1998, as amended.
(6) Includes shares of Common Stock issuable upon exercise of the Series A
Common Stock Warrant which have vested and become exercisable with respect
to rights to purchase 59,000 shares of Common Stock at $2.19 per share.
Also, included are shares of Common Stock issuable upon exercise of a
Series B Common Stock Warrant representing the right to purchase 25,000
shares of Common Stock at $2.19 per share. The Series A Common Stock
Warrant and the Series B Common Stock Warrant both expire on May 16, 2003.
Includes options to purchase 48,610 shares of Common Stock at $3.25 per
share and options to purchase 97,222 shares of Common Stock at $4.00 per
share, all of which are presently exercisable. Excludes options to purchase
34,723 shares of Common Stock at $3.25 per share and 69,445 shares of
Common Stock at $4.00 per share as such options are not exercisable within
sixty (60) days of this table. Excludes 10,000 Series A Warrants and 10,000
Series B Warrants which are held in trust for the benefit of Mr. Binet's
two minor children. Mr. Binet disclaims beneficial ownership of these
shares. Excludes options to purchase 50,000 shares of Common Stock at
$17.88 per share as such options are not exercisable within 60 days of this
table. The options to purchase 50,000 shares of Common Stock vest
immediately upon the successful consummation of one of the Offerings.
(7) Includes options to purchase 10,000 shares of Common Stock at $3.75 per
share, all of which options are presently exercisable. Excludes options to
purchase 10,000 shares of Common Stock at $9.00 per share as such options
are not exercisable within 60 days of this table.
(8) Excludes options to purchase 10,000 shares of Common Stock at $13.50 per
share as such options are not exercisable within 60 days of this table.
(9) Includes options and warrants to purchase 2,232,135 shares of Common Stock,
all of which are exercisable within sixty (60) days of the date of this
table.
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DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 25,000,000 shares
of Common Stock, par value $0.001 per share, 5,000,000 shares of Preferred
Stock, $0.001 par value $0.001 per share, and 1,000,000 shares of Series A
Preferred Stock, par value $0.0001 per share.
COMMON STOCK
As of October 8, 1998, there were 5,566,327 shares of Common Stock
outstanding that were held of record by approximately 96 stockholders, excluding
options and warrants to purchase a total of 2,701,117 shares of Common Stock,
which by their terms are currently exercisable within 60 days of the date of
this filing.
The holders of Common Stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding Preferred Stock, the holders of Common Stock are
entitled to receive ratably such dividends, if any, as may be declared from time
to time by the Board of Directors out of funds legally available therefor. See
"Dividend Policy." In the event of the liquidation, dissolution, or winding up
of the Company, the holders of Common Stock are entitled to share ratably in all
assets remaining after payment of liabilities, subject to prior distribution
rights of Preferred Stock, if any, then outstanding. The Common Stock has no
preemptive or conversion rights or other subscription rights. There are no
redemption or sinking fund provisions applicable to the Common Stock. All
outstanding shares of Common Stock are fully paid and nonassessable.
PREFERRED STOCK
The Board of Directors has the authority to issue up to 5,000,000 shares of
Preferred Stock in one or more series and to fix the rights, preferences,
privileges and restrictions thereof, including dividend rights, dividend rates,
conversion rights, voting rights, terms of redemption, redemption prices,
liquidation preferences and the number of shares constituting any series or the
designation of such series, without further vote or action by the stockholders.
The issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of the Company without further action by the
stockholders and may adversely affect the voting and other rights of the holders
of Common Stock. The issuance of Preferred Stock with voting and conversion
rights may adversely affect the voting power of the holders of Common Stock,
including the loss of voting control to others. At present, there is no
Preferred Stock outstanding and the Company has no plans to issue any Preferred
Stock.
SERIES A PREFERRED STOCK
The Board of Directors has the authority to issue up to 1,000,000 shares of
Series A Preferred Stock in one or more series which shall (1) participate
equally with each share of Common Stock in all dividends, (2) be redeemable, in
whole or in part, at the option of the Company, (3) be convertible, at the
option of the holder of record, into one fully paid and non-assessable share of
Common Stock, (4) be entitled to one vote for each share of Series A Preferred
Stock with the same voting rights as if each such share were one share of Common
Stock, and (5) in the event of any liquidation, dissolution or winding up of the
affairs of the Company, whether voluntary or otherwise, after payment of the
liabilities of the Company, entitle the holder thereof to receive, prior to any
payments to the holders of Common Stock, out of the remaining net assets of the
Company, an amount in cash equal to all other shares of Series A Preferred
Stock, but not more than the amount of consideration originally paid for such
shares. At present the Company has no plans to issue any of the Series A
Preferred Stock.
WARRANTS
In connection with the issuance of the Deere Park Convertible Debentures,
the Company issued warrants to purchase an aggregate of 8,952 shares of Common
Stock at an exercise price of $16.76 per share for the First Draw, warrants to
purchase an aggregate of 2,427 shares of Common Stock at $20.60 per share for
the Second Draw and warrants to purchase an aggregate of 6,382 shares of Common
Stock at $15.67 per share for the Third Draw. The warrants have a term of three
years from the effectiveness of a registration statement covering such warrants.
See "Summary of Certain Indebtedness -- Convertible Debentures."
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In connection with the issuance of the Gordon Brothers Convertible
Debentures, the Company issued 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. See "Summary of Certain Indebtedness -- Convertible
Debentures."
Also 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 65,722 shares of Common Stock with
exercise prices ranging from $15.81 to $20.00 per share, respectively. The
warrants have a term of two years from the effectiveness of the registration
statement covering such warrants.
On October 26, 1998, the Company issued 8,000 additional warrants to the
holders of the Deere Park Convertible Debentures at an exercise price of $8.50
and a term of three years from the effectiveness of the registration statement
covering such warrants.
ANTI-TAKEOVER EFFECTS OF PROVISIONS OF THE CERTIFICATE OF INCORPORATION, BYLAWS
AND TEXAS LAW
CERTIFICATE OF INCORPORATION AND BYLAWS
The Company's Amended and Restated Certificate of Incorporation provides
that the members of the Board of Directors are elected annually or as otherwise
provided by resolution. Provisions of the Bylaws and the Amended and Restated
Certificate of Incorporation provide that the stockholders may amend the Bylaws
or certain provisions of the Amended and Restated Certificate of Incorporation
only with the affirmative vote of 67% of the Company's Capital Stock. These
provisions of the Amended and Restated Certificate of Incorporation and Bylaws
could discourage potential acquisition proposals and could delay or prevent a
change in control of the Company. These provisions are intended to enhance the
likelihood of continuity and stability in the composition of the Board of
Directors and in the policies formulated by the Board of Directors and to
discourage certain types of transactions that may involve an actual or
threatened change of control of the Company. The provisions are designed to
reduce the vulnerability of the Company to an unsolicited acquisition proposal.
The provisions also are intended to discourage certain tactics that may be used
in proxy fights. However, such provisions could have the effect of discouraging
others from making tender offers for the Company's shares and, as a consequence,
also may inhibit fluctuations in the market price of the Company's shares that
could result from actual or rumored takeover attempts. Such provisions also may
have the effect of preventing changes in the management of the Company.
TEXAS BUSINESS COMBINATION LAW
The Company is subject to Part 13 of the Texas Business Corporation Act
("Part 13"), which subject to certain exceptions, prohibits a Texas
corporation from engaging in any business combination with any affiliated
shareholder, or any affiliate or associate of the affiliated shareholder, for a
period of three years following the date that such shareholder became an
affiliated shareholder, unless (i) the business combination or the purchase or
acquisition of shares made by the affiliated shareholder on the affiliated
shareholder's share acquisition date is approved by the board of directors of
the issuing public corporation before the affiliated shareholder's share
acquisition date; or (ii) the business combination is approved, by the
affirmative vote of the holders of at least two-thirds of the outstanding voting
shares of the issuing public corporation not beneficially owned by the
affiliated shareholder or an affiliate or associate of the affiliated
shareholder, at a meeting of shareholders and not by written consent, duly
called for that purpose not less than six months after the affiliated
shareholder's share acquisition date.
Part 13 defines business combination to include:
(a) any merger, share exchange, or conversion of an issuing public
corporation or a subsidiary with:
(i) an affiliated shareholder;
(ii) a foreign or domestic corporation or other entity that is, or
after the merger, share exchange, or conversion would be, an affiliate
or associate of the affiliated shareholder; or
(iii) another domestic or foreign corporation or other entity, if
the merger, share exchange, or conversion is caused by an affiliated
shareholder, or an affiliate or associate of an affiliated
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shareholder, and as a result of the merger, share exchange, or
conversion Part 13 does not apply to the surviving corporation or other
entity;
(b) a sale, lease, exchange, mortgage, pledge, transfer, or other
disposition, in one transaction or a series of transactions, including an
allocation of assets pursuant to a merger, to or with the affiliated
shareholder, or an affiliate or associate of the affiliated shareholder, of
assets of the issuing public corporation or any subsidiary that:
(i) have an aggregate market value equal to 10 percent or more of
the aggregate market value of all the assets, determined on a
consolidated basis, of the issuing public corporation;
(ii) have an aggregate market value equal to 10 percent or more of
the aggregate market value of all the outstanding common stock of the
issuing public corporation; or
(iii) represent 10 percent or more of the earning power or net
income, determined on a consolidated basis, of the issuing public
corporation;
(c) the issuance or transfer by an issuing public corporation or a
subsidiary to an affiliated shareholder or an affiliate or associate of the
affiliated shareholder, in one transaction or a series of transactions, of
shares of the issuing public corporation or a subsidiary, except by the
exercise of warrants or rights to purchase shares of the issuing public
corporation offered, or a share dividend paid, pro rata to all shareholders
of the issuing public corporation after the affiliated shareholder's share
acquisition date;
(d) the adoption of a plan or proposal for the liquidation or
dissolution of an issuing public corporation proposed by, or pursuant to
any agreement, arrangement, or understanding, whether or not in writing,
with an affiliated shareholder or an affiliate or associate of the
affiliated shareholder;
(e) a reclassification of securities, including a reverse share split
or a share splitup, share dividend, or other distribution of shares, a
recapitalization of the issuing public corporation, a merger of the issuing
public corporation with a subsidiary or pursuant to which the assets and
liabilities of the issuing public corporation are allocated among two or
more surviving or new domestic or foreign corporations or other entities,
or any other transaction whether or not with, into, or otherwise involving
the affiliated shareholder, proposed by, or pursuant to an agreement,
arrangement, or understanding, whether or not in writing, with an
affiliated shareholder or an affiliate or associate of the affiliated
shareholder that has the effect, directly or indirectly, of increasing the
proportionate ownership percentage of the outstanding shares of a class or
series of voting shares or securities convertible into voting shares of the
issuing public corporation that is beneficially owned by the affiliated
shareholder or an affiliate or associate of the affiliated shareholder,
except as a result of immaterial changes due to fractional share
adjustments; or
(f) the direct or indirect receipt by an affiliated shareholder or an
affiliate or associate of the affiliated shareholder of the benefit of a
loan, advance, guarantee, pledge, or other financial assistance or a tax
credit or other tax advantage provided by or through the issuing public
corporation, except proportionately as a shareholder of the issuing public
corporation.
Part 13 defines an affiliated shareholder as a person, other than the
issuing public corporation or a wholly owned subsidiary of the issuing public
corporation, that is the beneficial owner of 20 percent or more of the
outstanding voting shares of the issuing public corporation or that, within the
preceding three-year period, was the beneficial owner of 20 percent or more of
the then outstanding voting shares of the issuing public corporation. For the
purpose of determining whether a person is an affiliated shareholder, the number
of voting shares of the issuing public corporation considered outstanding
includes shares considered beneficially owned by that person under Subdivision
(3) of Part 13, but does not include other unissued voting shares of the issuing
public corporation that may be issuable pursuant to an agreement, arrangement,
or understanding, or on exercise of conversion rights, warrants, or options, or
otherwise.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is American Stock
Transfer, 40 Wall Street, 46th Floor, New York, NY 10005 (718) 921-8275.
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SUMMARY OF CERTAIN INDEBTEDNESS
SENIOR NOTES DUE 2008
The Company will offer $125.0 million of Notes. The Notes will be issued
pursuant to the Indenture between the Company and
[ ]as trustee, dated , 1998. The
Notes mature in 2008 and bear interest, payable semiannually, at % per annum.
The Notes will be fully and unconditionally guaranteed by all of the Company's
wholly-owned U.S. subsidiaries. The Indenture does not provide for a sinking
fund. The Notes are subject to redemption at any time on or after ,
2003, at the option of the Company, in whole or in part, in integral multiples
of $1,000 principal amount at declining redemption prices set forth in the
Indenture. Notwithstanding the foregoing, at any time, or from time to time, on
or prior to 2001, the Company may, at its option, redeem up to 35%
of the aggregate principal amount of the Notes originally issued with the net
proceeds of any Public Equity Offerings (as defined in the Indenture) at % of
the principal amount thereof.
As of June 30, 1998, after giving effect to the Notes Offering, the Company
would have had approximately $136.1 million of senior indebtedness outstanding,
of which $5.2 million would have been secured. As of June 30, 1998, the
Guarantors would have had approximately $4.8 million (exclusive of the
Guarantees of the Notes) of senior indebtedness outstanding, of which $1.9
million would have been secured. As of June 30, 1998, all of the Company's and
the Guarantors' indebtedness would have ranked PARI PASSU with or would have
been effectively senior to the Notes and the Guarantees, respectively.
Upon a Change of Control (as defined in the Indenture) of the Company, or
in the event of Asset Sales (as defined in the Indenture) in certain
circumstances, the Company is required by the terms of the Indenture to make an
offer to purchase the outstanding Notes at a purchase price equal to 101% or
100%, respectively, or the principal amount thereof plus accrued and unpaid
interest thereon.
The indebtedness of the Company evidenced by the Notes ranks PARI PASSU in
right of payment with all other existing and future unsubordinated senior
indebtedness of the Company and senior in right of payment to all existing and
future obligations of the Company expressly subordinated in right of payment to
the Notes. The Indenture contains a number of covenants restricting the
operations of the Company and its Restricted Subsidiaries (as defined in the
Indenture), including those restricting (i) the incurrence of indebtedness; (ii)
the making of restricted payments (in the form of the declaration or payment of
certain dividends or distributions, the purchase, redemption or other
acquisition of any capital stock of the Company, the voluntary prepayment of
PARI PASSU or subordinated indebtedness and the making of certain investments,
loans and advances) unless no Default or Event of Default (each, as defined in
the Indenture) exists, its leverage ratio does not exceed 5.5 to 1.0 and such
restricted payments do not exceed the basket, as determined by the Indenture;
(iii) transactions with stockholders and affiliates; (iv) the incurrence of
liens; (v) sale-leaseback transactions; issuances and sales of capital stock of
subsidiaries; the incurrence of guarantees by subsidiaries; (vi) dividend and
other payment restrictions affecting subsidiaries; (vii) consolidation, merger
or sale of substantially all of the Company's assets; (viii) and requiring the
purchase of Notes, at the option of the holder, upon the occurrence of a Change
of Control and certain Asset Sales.
The events of default under the Indenture include provisions that are
typical of senior debt financing, including a cross-acceleration to a default by
the Company or any Restricted Subsidiary on any indebtedness that has an
aggregate principal amount in excess of certain levels. Upon the occurrence of
such an event of default, the trustee or the holders of not less than 25% in
principal amount at maturity of the outstanding Notes may immediately accelerate
the maturity of all the Notes as provided in the Notes Indenture.
CONVERTIBLE DEBENTURES
On May 1, 1998, the Company issued $3,000,000 in Deere Park Convertible
Debentures maturing three years from closing (the "First Draw"). 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
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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 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 $15.00 per share for the First
Draw, $16.66 per share for the Second Draw and $15 per share 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 in the event the holder elects to convert. The Company's obligations 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 (i)
an aggregate of 8,952 shares of Common Stock at an exercise price of $16.76 per
share for the First Draw (subject to adjustment for stock splits and other share
adjustments), (ii) an aggregate of 2,427 shares of Common Stock at $20.60 per
share for the Second Draw (subject to adjustment for stock splits and other
share adjustments) and (iii) an aggregate of 6,382 shares of Common Stock at
$15.67 per share for the Third Draw (subject to adjustment for stock splits and
other share adjustments). The warrants have a term of three years from the
effectiveness of a registration statement covering such warrants. The Deere Park
Convertible Debentures will be PARI PASSUin 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.
On May 29, 1998, the Company issued $5,000,000 in Gordon Brothers
Convertible Debentures maturing one year from closing. The Gordon Brothers
Convertible Debentures are convertible by the holders into shares of the
Company's common stock at a price equal to $29 per share for the first six
months following closing, and thereafter, at the lesser of (i) $29 per share or
(ii) a price equal to the average of the three highest of the five lowest
closing prices of the Company's common stock for the 20 trading days preceding
the conversion date. However, should the common stock trade below $16.66 for
three consecutive trading days, the Company may elect to redeem all or part of
such Gordon Brothers Convertible Debentures at 107% of face value plus accrued
interest in the event the holder elects to convert. In the event that the
Company's common stock closes above $33.50 per share, adjusted, without
limitation, for any stock splits or combinations, the Company's obligation to
make interest payments on the Gordon Brothers Convertible Debentures are
terminated. In connection with the Gordon Brothers Convertible Debentures, the
holders also received warrants to purchase an aggregate of 12,136 shares of the
Company's common stock at an exercise price of $20.60 per share. The warrants
have a term of three years. In addition, the Company is required to file a
registration statement with the Securities and Exchange Commission to register
the shares of common stock issuable upon the conversion of the Gordon Brothers
Convertible Debentures or the exercise of the warrants.
The Company is required to pay an exit fee in connection with any principal
payment to be made under the Gordon Brothers Convertible Debenture (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
majority of the proceeds from the
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Deere Park Convertible Debentures and the Gordon Brothers Convertible Debentures
were utilized to fund the CMSD Acquisition.
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.
Under the terms of the restructuring, 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 agreed to repay $1,000,000 of the Deere Park Convertible
Debentures at 107% plus accrued interest.
REVOLVING LINE OF CREDIT
On March 12, 1998, the Company guaranteed a revolving credit facility with
Southwest Bank of Texas N.A., which permits Telscape USA to borrow up to
$1,250,000 subject to adequate levels of eligible accounts receivable (the
"Revolving Credit Facility"). Borrowings under the credit facility are secured
by the accounts receivable of Telscape USA and MSN (collectively, the
"Borrowers"). This facility provides that borrowings will bear interest at
floating rates of prime plus 1% and expires on June 30, 1999. On May 19, 1998,
the Company renegotiated the terms of the revolving credit facility to provide
for borrowings of up to $2,500,000 and extended the term of the facility to
thirteen months. As of June 30, 1998, the Company had $1.9 million in borrowings
outstanding under this facility. The credit facility requires Telscape USA to
comply with certain financial covenants and to maintain certain financial
ratios. The credit facility also restricts Telscape USA's ability, without the
prior written consent of the lender, to incur additional indebtedness or any
obligation as surety or guarantor. The credit facility contains typical event of
default provisions, including provisions which provide for default upon (i) the
Borrowers defaulting on any other agreements with the lender (cross-default),
(ii) the Borrowers failing to provide a perfected security interest (defective
collateralization) and (iii) upon the Borrowers becoming insolvent.
Telscape USA and MSN have obtained a waiver under the Revolving Credit
Facility to (i) permit Telscape USA and MSN to Guarantee the Notes and (ii)
waive defaults under the minimum current ratio, minimize tangible net worth and
prohibition on quarterly loss covenants. Because the Revolving Credit Facility
prohibits Telscape USA from guaranteeing any indebtedness, the Company obtained
a waiver for the Guarantee of the Notes in anticipation of filing the
Registration Statement relating to the Notes Offering. As a result of one of the
Company's wholesale customers filing a petition for bankruptcy in May 1998,
which resulted in the Company losing wholesale long distance revenues and
incurring increased Prepaid Card service costs, the Company obtained a waiver
relating to its default under the various financial covenants.
EQUIPMENT LEASES
On February 28, 1997, Telscape USA entered into an equipment financing
agreement at a rate of 10.75% per annum in connection with its acquisition of
switching equipment, which agreement provided for monthly lease payments of
principal and interest totaling $11,200, through February 28, 2000. On June 1,
1998, the Company entered into a second equipment financing agreement with the
same financing company for the purchase of a Nortel DMS-250 switching platform
and related equipment at a total cost of $1.4 million, which provides for
monthly lease payments of principal and interest totalling $27,500, through June
1, 2003. In connection with the signing of the second agreement, the first
agreement was refinanced to provide for monthly lease payments of $5,400,
through June 1, 2003. The lease obligations are secured by equipment.
On July 6, 1998, the Company financed the purchase of $972,000 in equipment
by entering into two equipment lease arrangements with a financing company which
provide for monthly lease payments of
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$22,100, including principal and interest through July 6, 2003. The lease
obligations are secured by the financed equipment.
On July 14, 1998, the Company financed the purchase of $243,000 in
equipment by entering into a equipment lease arrangement with a financing
company which provide for monthly lease payments of $6,600, including principal
and interest through July 14, 2002. The lease obligations are secured by the
financed equipment.
INTEGRACION NOTES
In connection with the Company's acquisition of Integracion, the Company
issued to the selling shareholders: (i) an aggregate of $2,201,000 in
non-interest bearing promissory notes maturing at various dates through January
1, 2001, and (ii) an aggregate of $999,000 in non-interest bearing convertible
notes maturing on September 1, 1999, which are convertible into 333,000 shares
of common stock of the Company at a price of $3.00 per share, representing the
quoted market price of the Company's common stock on the date of the
transaction. As of July 27, 1998, $1,901,000 of the non-interest bearing
promissory notes were outstanding. On July 23, 1998, the non-interest bearing
convertible notes were converted into 333,000 shares of Common Stock.
MSN NOTES
In connection with the MSN acquisition, the Company issued to selling
shareholders an aggregate of $750,000 in non-interest bearing promissory notes
payable in eight equal quarterly installments, beginning March 23, 1998.
COMMON STOCK REPURCHASE NOTE
In connection with a suit filed by the estate of a former shareholder, in
May 1997 the Company entered into a compromise and settlement agreement.
Pursuant to the agreement, the Company agreed to repurchase all of the 83,359
shares of Company common stock owned by the plaintiffs for total consideration
of $425,000, which was comprised of $125,000 and a three year $300,000
promissory note bearing interest at 6%, payable in six semi-annual installments
through May 20, 2000.
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UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
FOR NON-U.S. HOLDERS OF COMMON STOCK
GENERAL. The following discussion concerns the material United States
federal income and estate tax consequences of the ownership and disposition of
shares of Common Stock applicable to Non-U.S. Holders of such shares of Common
Stock. In general, a "Non-U.S. Holder" is any holder other than (i) a citizen
or resident, as specifically defined for U.S. federal income and estate tax
purposes, of the United States, (ii) a corporation, partnership or any entity
treated as a corporation or partnership for U.S. federal income tax purposes
created or organized in the United States or under the laws of the United States
or of any State thereof, or (iii) an estate or trust whose income is includible
in gross income for United States federal income tax purposes regardless of its
source. The discussion is based on current law, which is subject to change
retroactively or prospectively and is for general information only. The
discussion does not address all aspects of United States federal income and
estate taxation and does not address any aspects of state, local or foreign tax
laws. The discussion does not consider any specific facts or circumstances that
may apply to a particular Non-U.S. Holder. Accordingly, prospective investors
are urged to consult their tax advisors regarding the current and possible
future United States federal, state, local and non-U.S. income and other tax
consequences of holding and disposing of shares of Common Stock.
DIVIDENDS. In general, dividends paid to a Non-U.S. Holder will be subject
to United States withholding tax at a 30% rate (or a lower rate as may be
specified by an applicable tax treaty) unless the dividends are (i) effectively
connected with a trade or business carried on by the Non-U.S. Holder within the
United States, and (ii) if a tax treaty applies, attributable to a United States
permanent establishment maintained by the Non-U.S. Holder. Dividends effectively
connected with such a trade or business or, if a tax treaty applies,
attributable to such permanent establishment will generally not be subject to
withholding (if the Non-U.S. Holder files certain forms annually with the payor
of the dividend) but will generally be subject to United States federal income
tax on a net income basis at regular graduated individual or corporate rates. In
the case of a Non-U.S. Holder that is a corporation, such effectively connected
income also may be subject to the branch profits tax (which is generally imposed
on a foreign corporation on the deemed repartriation from the United States of
effectively connected earnings and profits) at a 30% rate or such lower rate as
may be specified by an applicable income tax treaty. The branch profits tax may
not apply if the recipient is a qualified resident of certain countries with
which the United States has an income tax treaty.
To determine the applicability of a tax treaty providing for a lower rate
of withholding, dividends paid to an address in a foreign country are presumed
under current Treasury Regulations to be paid to a resident of that country,
unless the payor has definite knowledge that such presumption is not warranted
or an applicable tax treaty (or United States Treasury Regulations thereunder)
requires some other method for determining a Non-U.S. Holder's residence. For
dividends payments after December 31, 1999, however, under the recently
finalized Treasury regulations (the "Final Withholding Tax Regulations"), a
Non-U.S. Holder is required to provide a valid form W-8 (or other applicable
form, as prescribed by the Internal Revenue Service (the "IRS")) to the
Company in order to receive the benefit of a reduced treaty rate or to be
treated as a U.S. individual or corporation with respect to their effectively
connected U.S. income. Under current regulations, the Company must report
annually to the IRS and to each Non-U.S. Holder the amount of dividends paid to,
and the tax withheld with respect to, each Non-U.S. Holder. These reporting
requirements apply regardless of whether withholding was reduced or eliminated
by applicable tax treaty. Copies of these information returns also may be made
available under the provisions of a specific treaty or agreement with the tax
authorities of the country in which the Non-U.S. Holder resides.
A Non-U.S. Holder that is eligible for a reduced rate of United States
withholding tax pursuant to an income tax treaty may obtain a refund of any
excess amounts currently withheld by filing an appropriate claim for refund with
the IRS.
SALE OF COMMON STOCK. Generally, a Non-U.S. Holder will not be subject to
United States federal income tax on any gain realized upon the sale or other
disposition of such holder's shares of Common Stock unless (i) the gain is
effectively connected with a trade or business carried on by the Non-U.S. Holder
82
<PAGE>
within the United States and, if a tax treaty applies, the gain is attributable
to a permanent establishment maintained by the Non-U.S. Holder in the United
States; (ii) the Non-U.S. Holder is an individual who holds the shares of Common
Stock as a capital asset and is present in the United States for 183 days or
more in the taxable year of the disposition, and either (a) such Non-U.S. Holder
has a "tax home" (as specifically defined for U.S. federal income tax
purposes) in the United States (unless the gain from disposition is attributable
to an office or other fixed place of business maintained by such non-U.S. Holder
in a foreign country and a foreign tax equal to at least 10% of such gain has
been paid to a foreign country), or (b) the gain from the disposition is
attributable to an office or other fixed place of business maintained by such
Non-U.S. Holder in the United States; (iii) the Non-U.S. Holder is subject to
tax pursuant to the provisions of U.S. tax law applicable to certain United
States expatriates, or (iv) the Company is or has been during certain periods a
"U.S. real property holding corporation" for U.S. federal income tax purposes
(which the Company does not believe that it has been, currently is or is likely
to become) and, assuming that the Common Stock is deemed for tax purposes to be
"regularly traded on an established securities market," the Non-U.S. Holder
held, at any time during the five-year period ending on the date of disposition
(or such shorter period that such shares were held), directly or indirectly,
more than five percent of the Common Stock.
ESTATE TAX. Shares of Common Stock owned or treated as owned by an
individual who is not a citizen or resident (as specifically defined for United
States federal estate tax purposes) of the United States at the time of death
will be includible in the individual's gross estate for United States federal
estate tax purposes, unless an applicable tax treaty provides otherwise, and may
be subject to United States federal estate tax.
BACKUP WITHHOLDING AND INFORMATION REPORTING. As a general rule, under
current United States federal income tax law, backup withholding tax (which
generally is a withholding tax imposed at the rate of 31% on certain payments to
persons that fail to furnish the information required under the U.S. information
reporting requirements) and information reporting requirements apply to the
actual and constructive payments of dividends. The United States backup
withholding tax and information reporting requirements generally, under current
regulations, will not apply to dividends paid on Common Stock to a Non-U.S.
Holder at an address outside the United States that are either subject to the
30% withholding discussed above or that are not so subject because a tax treaty
applies that reduces or eliminates such 30% withholding, unless the payer has
knowledge that the payee is a U.S. person. Backup withholding and information
reporting generally will apply to dividends paid to addresses inside the United
States on shares of Common Stock to beneficial owners that are not recipients
that are entitled to an exemption, as discussed above and that fail to provide
in the manner required certain identifying information.
The payment of the proceeds from the disposition of shares of Common Stock
to or through the United States office of a broker will be subject to
information reporting and backup withholding unless the holder, under penalties
of perjury, certifies, among other things, its status as a Non-U.S. Holder, or
otherwise establishes an exemption. Generally, the payment of the proceeds from
the disposition of shares of Common Stock to or through a non-U.S. office of a
non-U.S. broker will not be subject to backup withholding and will not be
subject to information reporting. In the case of the payment of proceeds from
the disposition of shares of Common Stock to or through a non-U.S. office of a
broker that is a U.S. person or a "U.S.-related person," existing regulations
require (i) backup withholding if the broker has actual knowledge that the owner
is not a Non-U.S. Holder, and (ii) information reporting on the payment unless
the broker receives a statement from the owner, signed under penalties of
perjury, certifying, among other things, its status as a Non-U.S. Holder, or the
broker has documentary evidence in its files that the owner is a Non-U.S. Holder
and the broker has no actual knowledge to the contrary. For this purpose, a
"U.S.-related person" is (i) a "controlled foreign corporation" for United
States federal income tax purposes or (ii) a foreign person 50% or more of whose
gross income from all sources for the three-year period ending with the close of
its taxable year preceding the payment (or for such part of the period that the
broker has been in existence) is derived from activities that are effectively
connected with the conduct of a United States trade or business.
83
<PAGE>
In general, the Final Withholding Tax Regulations do not significantly
alter the current substantive backup withholding and information reporting
requirements but unify current certification procedures and clarify reliance
standards. Under the Final Withholding Tax Regulations, special rules apply
which permit the shifting of primary responsibility for withholding to certain
financial intermediaries acting on behalf of beneficial owners. A holder of
Common Stock should consult with its tax advisor regarding the application of
the backup withholding rules to its particular situation, the availability of an
exemption therefrom, the procedure for obtaining such an exemption, if
available, and the impact of the Final Withholding Tax Regulations on payments
made with respect to Common Stock after December 31, 1999.
Backup withholding is not an additional tax. Any amounts withheld from a
payment to a Non-U.S. Holder under the backup withholding rules will be allowed
as a credit against such holder's United States federal income tax liability, if
any, and provided that such holder furnishes the IRS with the information
entitling such holder to an exemption from or reduced rate of withholding, such
holder would be entitled to a refund.
THE FEDERAL INCOME TAX SUMMARY SET FORTH ABOVE IS INCLUDED FOR GENERAL
INFORMATION ONLY AND MAY NOT BE APPLICABLE DEPENDING UPON A HOLDER'S PARTICULAR
SITUATION. PROSPECTIVE PURCHASERS OF THE COMMON STOCK ARE URGED TO CONSULT THEIR
OWN TAX ADVISORS AS TO THE PRECISE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX
CONSEQUENCES OF ACQUIRING, OWNING AND DISPOSING OF THE COMMON STOCK.
84
<PAGE>
SELLING STOCKHOLDERS
The following table sets forth the name of each Selling Stockholder, the
aggregate number of Shares of Common Stock beneficially owned by each Selling
Stockholder as of the date hereof and the aggregate number of Shares of Common
Stock that each Selling Stockholder may offer and sell pursuant to this
Prospectus. Because the Selling Stockholders may sell all or a portion of the
Shares at any time and from time to time after the date hereof, no estimate can
be made of the number of shares of Common Stock that each Selling Stockholder
may retain upon completion of the offering pursuant to this Prospectus.
Information concerning the Selling Stockholders may change from time to time
and, to the extent required, will be set forth in an accompanying Prospectus
Supplement or, if appropriate, a post-effective amendment to the Registration
Statement of which this Prospectus is a part. To the Company's knowledge, none
of the Selling Stockholders has, or has had within the last three years, any
material relationship with the Company except as set forth elsewhere in this
Prospectus. The following table and the disclosure concerning material
relationships between the Selling Stockholders and the Company is based upon
information furnished to the Company by or on behalf of the Selling
Stockholders.
<TABLE>
<CAPTION>
NUMBER OF SHARES NUMBER OF SHARES
NAME OF SELLING STOCKHOLDER OWNED BEFORE OFFERING(1) BEING REGISTERED
- ------------------------------------- ------------------------- -----------------
<S> <C> <C>
Deere Park Capital Management, LLC... 352,452(2) 352,452(2)
Gordon Brothers Capital, LLC......... 312,256(3) 312,256(3)
Coast Partners Securities, Inc....... 155,000(4) 155,000(4)
Preferred Capital Markets, Inc....... 146,722(5) 65,722(5)
Thomas M. Swartwood.................. 20,000(6) 19,000(6)
Glenn S. Cushman..................... 6,000(7) 6,000(7)
Jack M. Fields, Jr................... 4,717 4,717
---------- -----------------
Total........................... 989,147 907,147
</TABLE>
- ------------
(1) Information set forth in the table regarding the Selling Stockholders is
provided to the best knowledge of the Company based on information furnished
to the Company by each Selling Stockholder and/or available to the Company
through its stock ledgers or inquiries to brokers.
(2) Includes 334,691 shares of Common Stock issuable upon exercise of Deere Park
Convertible Debentures and 17,761 shares of Common Stock issuable upon
exercise of Warrants that have vested.
(3) Includes 300,120 shares of Common Stock issuable upon exercise of Gordon
Brothers Convertible Debentures and 12,136 shares of Common Stock issuable
upon exercise of Warrants that have vested.
(4) Includes 155,000 shares of Common Stock issuable upon exercise of Warrants
that may be exercisable within 60 days of this filing.
(5) Includes 65,722 shares of Common Stock issuable upon exercise of Warrants
that have vested.
(6) Includes 19,000 shares of Common Stock issuable upon exercise of Warrants
that have vested.
(7) Includes 6,000 shares of Common Stock issuable upon exercise of Common Stock
Warrants that have vested.
PLAN OF DISTRIBUTION
The Selling Stockholders may sell all or a portion of the Shares offered
hereby from time to time while the Registration Statement of which this
Prospectus is a part remains effective. The Company has been advised by the
Selling Stockholders that the Shares may be sold on terms to be determined at
the time of such sale through customary brokerage channels, negotiated
transactions or a combination of these methods, at fixed prices that may be
changed, at market prices then prevailing or at negotiated prices then
obtainable. There is no assurance that the Selling Stockholders will sell any or
all of the Shares offered hereby. Each of the Selling Stockholders reserves the
right to accept and, together with its agents from time to time, to reject in
whole or in part any proposed purchase of the Shares to be made directly or
through agents. The Company will receive no portion of the proceeds from the
sale of the Shares offered hereby. The aggregate
85
<PAGE>
proceeds to the Selling Stockholders from the sale of the Shares offered hereby
will be the purchase price of such Shares less any discounts or commissions.
The Company has been advised by the Selling Stockholders that the Selling
Stockholders, acting as principals for their own account, may sell Shares from
time to time directly to purchasers or through agents, dealers or underwriters
to be designated by the Selling Stockholders from time to time who may receive
compensation in the form of underwriting discounts, commissions or concessions
from the Selling Stockholders and the purchasers of the Shares for whom they may
act as agent. The Selling Stockholders and any agents, broker-dealers or
underwriters that participate with the Selling Stockholders in the distribution
of the Shares may be deemed to be "underwriters" within the meaning of the
Securities Act, in which event any discounts, commissions or concessions
received by such broker-dealers, agents or underwriters and any profit on the
resale of the Shares purchased by them may be deemed to be underwriting
discounts or commissions under the Securities Act.
A Selling Stockholder may elect to engage a broker or dealer to effect
sales of the Shares in one or more of the following transactions: (a) block
trades in which the broker or dealer so engaged will attempt to sell the Shares
as agent but may position and resell a portion of the block as principal to
facilitate the transaction, (b) purchases by a broker or dealer as principal and
resale by such broker or dealer for its account pursuant to this Prospectus and
(c) ordinary brokerage transactions and transactions in which the broker
solicits purchasers. In effecting sales, brokers and dealers engaged by a
Selling Stockholder may arrange for other brokers or dealers to participate.
Broker-dealers may agree with the Selling Stockholders to sell a specified
number of such Shares at a stipulated price, and, to the extent such
broker-dealer is unable to do so acting as agent for a Selling Stockholder, to
purchase as principal any unsold Shares at the price required to fulfill the
broker-dealer commitment to such Selling Stockholder. Broker-dealers who acquire
Shares as principal may thereafter resell such Shares from time to time in
transactions (which may involve crosses and block transactions and sales to and
through other broker-dealers, including transactions of the nature described
above) in the over-the-counter market or otherwise at prices and on terms then
prevailing at the time of sale, at prices then related to the then-current
market price or in negotiated transactions and, in connection with such resales,
may pay to or receive from the purchasers of such Shares commissions as
described above. To the extent required, the number of Shares to be sold, the
names of the Selling Stockholders, the purchase price, the public offering
price, the name of any agent, dealer or underwriter, the amount of any offering
expenses, any applicable commissions or discounts and any other material
information with respect to a particular offer will be set forth in an
accompanying Prospectus Supplement or, if appropriate, a post-effective
amendment to the Registration Statement of which this Prospectus is a part.
The Shares originally issued by the Company contained legends as to their
restricted transferability. These legends will not be necessary with respect to
any Shares sold pursuant to, and during the effectiveness of, the Registration
Statement of which this Prospectus is a part. Upon the transfer by the Selling
Stockholders of any of the Shares, new certificates representing such Shares
will be issued to the transferee, free of any such legends.
Under the Exchange Act, any person engaged in the distribution of the
Shares may not simultaneously bid for or purchase securities of the same class
for a period of at least two business days prior to the commencement of such
distribution. In addition, and without limiting the foregoing, the Selling
Stockholders will be subject to applicable provisions of the Exchange Act and
the rules and regulations thereunder, including without limitation the rules
contained in Regulation M, in connection with the transactions in the Shares
during the effectiveness of the Registration Statement of which this Prospectus
is a part. The foregoing may affect the marketability of the Common Stock and
any market making activities with respect to the Common Stock.
To comply with the securities laws of certain states, if applicable, the
Shares will be sold in such states only through registered or licensed brokers
or dealers. In addition, in certain states the Shares may not be offered or sold
unless they have been registered or qualified for sale in such state or an
exemption from the registration or qualification requirement is available and is
complied with.
86
<PAGE>
Each of the Selling Stockholders has certain registration rights with
respect to the Shares owned by such Selling Stockholder. Notwithstanding such
rights, the Company has voluntarily filed the Registration Statement of which
this Prospectus is a part. The Company is required to maintain the effectiveness
of such Registration Statement until such time as all the Shares have been sold
pursuant hereto or are no longer outstanding. The Company will bear all expenses
relating to this registration, other than underwriting discounts and commissions
and fees and disbursements of counsel to the Selling Stockholders.
LEGAL MATTERS
Certain legal matters in connection with the Shares offered hereby will be
passed upon for the Company by Swidler Berlin Shereff Friedman, LLP, Washington,
D.C. and Gardere Wynne Sewell & Riggs, LLP, Houston, Texas.
EXPERTS
The consolidated financial statements as of December 31, 1996 and 1997 and
for each of the two years ended December 31, 1997, included in this Prospectus
have been audited by BDO Seidman, LLP, independent certified public accountants,
to the extent and for the periods set forth in their reports appearing elsewhere
herein, and are included in reliance upon such reports given upon the authority
of said firm as experts in auditing and accounting. The consolidated financial
statements of the Company for the year ended December 31, 1995, appearing in
this Prospectus have been audited by Hoffman, McBryde & Co., P.C., independent
auditors, as set forth in their report thereon appearing elsewhere herein, and
are included in reliance upon such report given upon the authority of such firm
as experts in accounting and auditing.
The financial statements of MSN as of and for the year ended December 31,
1997, appearing in the Prospectus have been audited by BDO Seidman, LLP,
independent certified public accountants, to the extent and for the periods set
forth in their report appearing elsewhere herein, and are included in reliance
upon such report given upon the authority of said firm as experts in auditing
and accounting.
The financial statements of Integracion for the year ended December 31,
1996, appearing in this Prospectus have been audited by De Las Fuentes, De La
Mora Y Valdivia, S.C, independent certified public accountants in Mexico as set
forth in their report thereon appearing elsewhere herein, and are included in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
87
<PAGE>
INDEX TO FINANCIAL STATEMENTS
PAGE
---------
CONSOLIDATED FINANCIAL STATEMENTS OF
TELSCAPE INTERNATIONAL, INC.:
Reports of Independent Certified
Public Accountants............. F-2
Consolidated Balance
Sheets -- As of December 31,
1996 and 1997 and
June 30, 1998 (unaudited)..... F-4
Consolidated Statements of
Operations -- For the years
ended December 31, 1995, 1996
and 1997 and the Six Months
Ended June 30, 1997 and 1998
(unaudited).................... F-5
Consolidated Statements of
Stockholders' Equity -- For the
years ended December 31, 1995,
1996 and 1997 and the Six
Months Ended June 30, 1998
(unaudited).................... F-6
Consolidated Statements of Cash
Flows -- For the years ended
December 31, 1995, 1996 and
1997 and the Six Months Ended
June 30, 1997 and 1998
(unaudited).................... F-7
Notes to Consolidated Financial
Statements..................... F-9
FINANCIAL STATEMENTS OF INTEGRACION
DE REDES, S.A. de C.V.
Report of Independent
Auditors....................... F-48
Statements of Operations -- For
the year ended December 31,
1996 and Six Months Ended June
30, 1997 (unaudited)........... F-49
Statements of Changes in
Financial Position -- For the
year ended December 31, 1996
and the Six Months Ended June
30, 1997 (unaudited)........... F-50
Notes to the Financial
Statements..................... F-51
FINANCIAL STATEMENTS OF MSN
COMMUNICATIONS, INC.
Report of Independent Certified
Public Accountants............. F-54
Balance Sheet -- As of December
31, 1997....................... F-55
Statement of Operations and
Accumulated Deficit -- For the
year ended December 31, 1997... F-56
Statement of Cash Flows -- For
the year ended December 31,
1997........................... F-57
Notes to the Financial
Statements..................... F-58
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Telscape International, Inc.
Houston, Texas
We have audited the accompanying consolidated balance sheets of Telscape
International, Inc. and subsidiaries (formerly Polish Telephones and Microwave
Corporation) as of December 31, 1996 and 1997, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Telscape
International, Inc. and subsidiaries at December 31, 1996 and 1997, and the
results of its operations and its cash flows for the years then ended, in
conformity with generally accepted accounting principles.
BDO SEIDMAN, LLP
Houston, Texas
March 9, 1998
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Polish Telephones and Microwave Corporation
We have audited the accompanying consolidated statements of operations,
stockholders' equity, and cash flows of Polish Telephones and Microwave
Corporation and subsidiaries for the year ended December 31, 1995. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated results of operations
and cash flows of Polish Telephones and Microwave Corporation and subsidiaries
for the year ended December 31, 1995, in conformity with generally accepted
accounting principles.
Hoffman, McBryde & Co., P.C.
Dallas, Texas
March 27, 1996
F-3
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------ JUNE 30,
1996 1997 1998
-------------- -------------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents....... $ 495,000 $ 4,734,000 $ 4,939,000
Accounts receivable, less
allowance for doubtful
accounts of $57,000, $200,000,
and $215,000 (unaudited),
respectively.................. 2,035,000 6,276,000 12,841,000
Inventories..................... 2,045,000 4,305,000 3,803,000
Prepaid expenses and other...... 90,000 2,674,000 6,458,000
Deferred income taxes........... -- 517,000 334,000
-------------- -------------- -----------
Total current assets....... 4,665,000 18,506,000 28,375,000
Property and equipment, net of
accumulated depreciation........... 983,000 2,679,000 13,084,000
Goodwill and other intangibles, net
of accumulated amortization........ 3,246,000 17,674,000 26,332,000
Deferred income taxes................ 192,000 77,000 --
Investment in affiliates............. -- 295,000 --
Other assets......................... 285,000 404,000 1,089,000
-------------- -------------- -----------
Total assets............... $ 9,371,000 $ 39,635,000 $68,880,000
============== ============== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................ $ 1,756,000 $ 10,756,000 $17,694,000
Accrued expenses................ 724,000 3,303,000 6,799,000
Current portion of notes payable
and capital lease
obligations................... -- 508,000 993,000
Convertible debentures.......... -- -- 4,913,000
Deferred income taxes........... 372,000 270,000 441,000
-------------- -------------- -----------
Total current
liabilities............. 2,852,000 14,837,000 30,840,000
Notes payable and capital lease
obligations........................ -- 2,676,000 4,463,000
Convertible subordinated
debentures......................... -- -- 4,922,000
Minority interests................... 754,000 34,000 63,000
Commitments and contingencies (Note
7)
Series B Non-voting preferred stock,
$.001 par value, 380,000 shares
authorized and no shares issued and
outstanding, mandatorily redeemable
upon achievement of certain
performance measures............... -- -- --
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;
3,935,969, 4,104,027 and
4,667,548, respectively issued
and outstanding,
respectively.................. 4,000 4,000 5,000
Additional paid-in capital...... 11,884,000 25,232,000 31,575,000
Capital subscriptions
receivable.................... (600,000) -- --
Accumulated deficit............. (5,523,000) (2,851,000) (2,359,000)
Treasury stock.................. -- (297,000) (629,000)
-------------- -------------- -----------
Total stockholders'
equity.................. 5,765,000 22,088,000 28,592,000
-------------- -------------- -----------
Total liabilities and
stockholders' equity.... $ 9,371,000 $ 39,635,000 $68,880,000
============== ============== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------------------- ------------------------------
1995 1996 1997 1997 1998
------------ -------------- -------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues............................. $ 1,108,000 $ 5,705,000 $ 36,154,000 $ 9,941,000 $ 65,777,000
Cost of revenues..................... 619,000 3,041,000 24,396,000 5,994,000 57,056,000
------------ -------------- -------------- -------------- --------------
Gross profit......................... 489,000 2,664,000 11,758,000 3,947,000 8,721,000
Selling, general and administrative
expenses........................... 1,349,000 4,159,000 8,154,000 3,399,000 5,705,000
Depreciation and amortization........ 48,000 264,000 622,000 239,000 1,258,000
------------ -------------- -------------- -------------- --------------
Operating income (loss).............. (908,000) (1,759,000) 2,982,000 309,000 1,758,000
Other income (expense):
Interest income................. 232,000 143,000 171,000 26,000 91,000
Interest expense................ (2,000) (128,000) (266,000) (26,000) (342,000)
Foreign exchange gain (loss).... (2,000) 161,000 (126,000) 27,000 (187,000)
Other, net...................... -- (62,000) (11,000) (293,000) 96,000
------------ -------------- -------------- -------------- --------------
Total other income
(expense), net.......... 228,000 114,000 (232,000) (266,000) (342,000)
------------ -------------- -------------- -------------- --------------
Income (loss) before income taxes and
minority interests................. (680,000) (1,645,000) 2,750,000 43,000 1,416,000
Income tax benefit (expense)......... -- 53,000 (84,000) 167,000 (895,000)
------------ -------------- -------------- -------------- --------------
Income (loss) before minority
interests.......................... (680,000) (1,592,000) 2,666,000 210,000 521,000
Minority interests in subsidiaries... 7,000 (6,000) 6,000 4,000 (29,000)
------------ -------------- -------------- -------------- --------------
Net income (loss).................... $ (673,000) $ (1,598,000) $ 2,672,000 $ 214,000 $ 492,000
============ ============== ============== ============== ==============
Earnings (loss) per share:
Basic........................... $ (0.36) $ (0.52) $ 0.68 $ 0.05 $ 0.11
Diluted(1)...................... n/a n/a $ 0.53 0.05 $ 0.06
Weighted average shares outstanding:
Basic........................... 1,890,442 3,046,594 3,903,470 3,921,878 4,534,568
Diluted(1)...................... n/a n/a 5,152,211 3,998,660 7,778,072
</TABLE>
- ------------
(1) Inclusion of additional shares under a diluted analysis is inappropriate due
to the anti-dilutive effect
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK CAPITAL
------------------ ADDITIONAL SUBSCRIPTIONS ACCUMULATED TREASURY
SHARES AMOUNT PAID-IN CAPITAL RECEIVABLE DEFICIT STOCK
-------- ------- ---------------- -------------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994........... 1,890,442 $2,000 $8,113,000 $ (600,000) $(3,069,000) $ --
Reclassification of accumulated
losses acquired from minority
interest in subsidiary............. -- -- -- -- (183,000) --
Net loss............................. -- -- -- -- (673,000) --
--------- ------- ---------------- -------------- ------------ ---------
Balance, December 31, 1995........... 1,890,442 2,000 8,113,000 (600,000) (3,925,000) --
Issuance of stock in acquisition of
subsidiary......................... 1,605,000 1,000 2,856,000 -- -- --
Issuance of stock in connection with
merger............................. 400,000 1,000 525,000 -- -- --
Issuance of stock in connection with
stock options exercised............ 40,527 -- 38,000 -- -- --
Compensation related to warrants
granted............................ -- -- 352,000 -- -- --
Net loss............................. -- -- -- -- (1,598,000) --
--------- ------- ---------------- -------------- ------------ ---------
Balance, December 31, 1996........... 3,935,969 4,000 11,884,000 (600,000) (5,523,000) --
Issuance of stock in connection with
warrants and options exercised..... 148,058 -- 1,004,000 -- -- --
Compensation related to common stock
and warrants granted............... 20,000 -- 188,000 -- -- --
Repurchase of treasury shares........ -- -- -- -- -- (297,000)
Release of stock in escrow........... -- -- -- 600,000 -- --
Additional consideration recognized
upon vesting of warrants........... -- -- 12,156,000 -- -- --
Net income........................... -- -- -- -- 2,672,000 --
--------- ------- ---------------- -------------- ------------ ---------
Balance, December, 1997.............. 4,104,027 4,000 25,232,000 -- (2,851,000) (297,000)
Issuance of stock in connection with
warrants and options exercised
(unaudited)........................ 1,044,609 1,000 5,463,000 -- -- --
Issuance of stock in connection with
acquisition (unaudited)............ 100,000 -- 880,000 -- -- --
Repurchase of treasury shares
(unaudited)........................ -- -- -- -- -- (332,000)
Net income (unaudited)............... -- -- -- -- 492,000 --
-------- ------- ---------------- -------------- ------------ ---------
Balance, June 30, 1998 (unaudited)... 5,248,636 $5,000 $31,575,000 $ -- $(2,359,000) $(629,000)
========= ======= ================ ============== ============ =========
</TABLE>
TOTAL
STOCKHOLDERS'
EQUITY
-------------
Balance, December 31, 1994........... $ 4,446,000
Reclassification of accumulated
losses acquired from minority
interest in subsidiary............. (183,000)
Net loss............................. (673,000)
-------------
Balance, December 31, 1995........... 3,590,000
Issuance of stock in acquisition of
subsidiary......................... 2,857,000
Issuance of stock in connection with
merger............................. 526,000
Issuance of stock in connection with
stock options exercised............ 38,000
Compensation related to warrants
granted............................ 352,000
Net loss............................. (1,598,000)
-------------
Balance, December 31, 1996........... 5,765,000
Issuance of stock in connection with
warrants and options exercised..... 1,004,000
Compensation related to common stock
and warrants granted............... 188,000
Repurchase of treasury shares........ (297,000)
Release of stock in escrow........... 600,000
Additional consideration recognized
upon vesting of warrants........... 12,156,000
Net income........................... 2,672,000
-------------
Balance, December, 1997.............. 22,088,000
Issuance of stock in connection with
warrants and options exercised
(unaudited)........................ 5,464,000
Issuance of stock in connection with
acquisition (unaudited)............ 880,000
Repurchase of treasury shares
(unaudited)........................ (332,000)
Net income (unaudited)............... 492,000
-------------
Balance, June 30, 1998 (unaudited)... $28,592,000
=============
The accompanying notes are integral part of these financial statements.
F-6
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------- --------------------------
1995 1996 1997 1997 1998
------------- ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................ $ (673,000) $ (1,598,000) $ 2,672,000 $ 214,000 $ 492,000
Adjustments to reconcile net
income (loss) to net cash
provided by (used in) operating
activities:
Provision for doubtful
accounts....................... 9,000 277,000 254,000 556,000
Depreciation and amortization.... 48,000 264,000 622,000 239,000 1,258,000
Provision for inventory
obsolescence................... -- 55,000 53,000 -- --
Write-off investment in operating
venture........................ -- -- 196,000 196,000 --
Deferred income tax benefit...... -- (112,000) (1,566,000) -- 422,000
Interest amortized on discounted
investments.................... (64,000) (8,000) -- -- --
Imputed interest on non-interest
bearing notes payable.......... -- -- 136,000 -- 142,000
Minority interest in
subsidiaries' income (loss).... (7,000) 6,000 (6,000) (4,000) 29,000
Equity in income from
unconsolidated subsidiary...... -- -- -- -- 49,000
Decrease in minority interests
for credits utilized........... 55,000 53,000 -- -- --
Changes in assets and
liabilities:
Accounts receivable......... 75,000 (952,000) (1,623,000) (183,000) (4,957,000)
Inventories................. 15,000 (720,000) (2,359,000) 337,000 1,292,000
Prepaid and other assets.... (117,000) 35,000 (2,634,000) (461,000) (3,210,000)
Accounts payable............ (114,000) (124,000) 6,954,000 3,145,000 4,007,000
Accrued liabilities......... (35,000) 361,000 1,866,000 (342,000) 361,000
------------- ------------ ------------ ------------ ------------
Net cash provided by (used
in) operating
activities................ (817,000) (2,731,000) 4,588,000 3,395,000 441,000
------------- ------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term
investments.................... (10,944,000) (4,899,000) -- -- --
Redemption of short-term
investments.................... 11,500,000 8,378,000 -- -- --
Purchases of property and
equipment...................... (46,000) (441,000) (1,682,000) (667,000) (5,696,000)
Acquisition of Telereunion, net
of cash acquired............... -- (353,000) -- -- --
Acquisition of Integracion, net
of cash acquired............... -- -- 117,000 -- --
Acquisition of N.S.I., net of
cash acquired.................. -- -- (49,000) -- --
Acquisition of MSN, net of cash
acquired....................... -- -- -- -- (2,325,000)
Acquisition of INTERLINK, net of
cash acquired.................. -- -- -- -- (8,250,000)
Investment in BCH Holdings....... -- -- (185,000) -- --
Purchase of minority interest.... (63,000) -- -- -- --
Investment in joint venture...... (3,000) (196,000) -- -- --
------------- ------------ ------------ ------------ ------------
Net cash provided by (used in)
investing activities........... 444,000 2,489,000 (1,799,000) (667,000) (16,271,000)
------------- ------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease
obligations.................... -- -- (104,000) (45,000) (46,000)
Payments on notes payable........ -- -- (50,000) -- (444,000)
Proceeds from capital
subscriptions.................. -- -- 600,000 -- --
Purchase of treasury shares...... -- -- -- -- (332,000)
Issuance of common stock......... -- 564,000 -- -- --
Borrowings on line of credit,
net............................ -- -- -- -- 1,948,000
Proceeds from warrants and
options exercised.............. -- -- 1,004,000 2,000 4,909,000
Proceeds from issuance of
convertible debts.............. -- -- -- -- 10,000,000
------------- ------------ ------------ ------------ ------------
Net cash provided by (used in)
financing activities........... -- 564,000 1,450,000 (43,000) 16,035,000
------------- ------------ ------------ ------------ ------------
Net increase (decrease) in cash
and cash equivalents........... (373,000) 322,000 4,239,000 2,685,000 205,000
------------- ------------ ------------ ------------ ------------
Cash and cash equivalents at
beginning of year.............. 546,000 173,000 495,000 495,000 4,734,000
------------- ------------ ------------ ------------ ------------
Cash and cash equivalents at end
of year........................ $ 173,000 $ 495,000 $ 4,734,000 $ 3,180,000 $ 4,939,000
============= ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-7
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------------- ----------------------
1995 1996 1997 1997 1998
--------- -------------- ------------ ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Supplemental disclosure of cash flow
information:
Interest paid................... $ 2,000 $ 176,000 $ 121,000 $ 8,000 $ 105,000
Taxes paid...................... -- 80,000 505,000 214,000 600,000
Non-cash transactions:
Property and equipment acquired by
execution of capital lease
obligation......................... 329,000 329,000
Issuance of notes and acquisition of
treasury shares in litigation
settlement:
Litigation settlement........... (3,000) (3,000)
Treasury stock.................. (297,000) (297,000)
Notes payable................... 300,000 300,000
Issuance of preferred and common
stock in exchange for shares of
common stock in connection with
reverse triangular merger:
Excess of cost over net assets
acquired...................... 2,857,000
Common stock.................... (2,000)
Preferred stock................. --
Additional paid-in capital...... (2,855,000)
Issuance of promissory notes in
connection with the acquisition of
Integracion........................ 2,555,000
Issuance of common stock and warrants
in exchange for services provided
or in connection with severance
agreement.......................... 352,000 188,000 188,000
Reduction of subsidiary stock
subscription receivable in exchange
for credits on equipment........... 55,000 53,000
Additional contingent consideration
recorded:
2,175,000 warrants issued in
connection with Telereunion and
Integracion acquisitions vesting
upon achievement of certain
operating performance measures..... 12,156,000
Accrual of redemption of 380,000
shares of Series B preferred stock
to be redeemed based upon
achievement of certain operating
performance measures............... 380,000
Issuance of common stock and
promissory notes in connection with
the acquisition of MSN
Communications
Common Stock.................... 880,000
Promissory Notes................ 672,000
Issuance of warrants in
connection with issuance of
convertible debentures........ 537,000
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-8
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)
1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Telscape International, Inc. (collectively with its subsidiaries, the
"Company") is an emerging, fully-integrated telecommunications company. The
Company supplies U.S.-originated international long distance services on a
wholesale and retail basis, via switched and dedicated networks, with an
emphasis on Latin America. In addition, the Company provides a full range of
systems integration and value-added telecom services in Mexico to major public
and private sector customers.
Through its Telscape USA, Inc. ("Telscape USA") subsidiary, the Company
is a facilities-based long distance telecommunications services company
providing international long distance services for calls originating in the
United States and terminating in other countries, primarily in Latin America.
Through its Mexican subsidiaries, Vextro de Mexico, S.A. de C.V.
("Vextro"), Integracion de Redes, S.A. de C.V. ("Integracion"), and N.S.I.
de S.A. de C.V. ("N.S.I."), the Company is engaged in the distribution and
sale of voice, data and networking equipment and provides value-added services
in network integration. Each of these Mexican entities is owned principally by
Telereunion, Inc. ("Telereunion"), a wholly-owned subsidiary of the Company.
Through its newly-acquired subsidiary, MSN Communications, Inc. ("MSN"),
the Company is engaged in the distribution and sale of prepaid phone cards
across the United States, targeted mainly at the Hispanic community.
SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and all wholly and majority owned subsidiaries. The Company records minority
interests expense, which represents the portion of majority owned subsidiaries
attributable to minority owners. Investments in affiliates in which the Company
owns a 20% to 50% ownership interest, and in which the Company exercises
significant influence over operating and financial policies, are accounted for
by the equity method. Investments of less than 20% ownership are recorded at
cost, which does not exceed the estimated net realizable value of such
investments. All significant intercompany transactions and balances have been
eliminated in consolidation.
INTERIM FINANCIAL STATEMENTS
The consolidated financial statements at June 30, 1998 and for the six
months ended June 30, 1997 and 1998 are unaudited. In the opinion of Management,
the unaudited consolidated financial statements at June 30, 1998 and for the six
months ended June 30, 1997 and 1998, include all normal recurring adjustments
necessary for a fair presentation of the financial position and results of
operations for such periods. Results of operations for the interim periods are
not necessarily indicative of results to be expected for the full year.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to current
year presentation.
MANAGEMENT'S ESTIMATES AND ASSUMPTIONS
The accompanying financial statements are prepared in conformity with
generally accepted accounting principles which requires management to make
estimates and assumptions that effect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. 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.
REVENUE RECOGNITION
The Company recognizes revenue from long distance telecommunications
services at the time of customer usage. Revenue from sales of equipment are
recognized at time of shipment. Revenue from data and network integration
value-added services are recognized when services are performed. In certain
cases,
F-9
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Company has entered into arrangements with third parties whereby these
parties provide long distance telecommunication services for prepaid phone cards
sold at a fixed cost. As the earnings process is complete at time of shipment
under these arrangements, the Company recognizes revenues (and cost of revenues)
from the sale of cards at the time of shipment of its cards. In other cases, the
Company has entered into arrangements with third parties whereby these parties
provide the long distance telecommunications services for prepaid phone cards
and bills the Company for these services as the cards are utilized. As the
earnings process is complete when the cards are utilized under these
arrangements, the Company recognizes revenues (and cost of revenues) from the
sale of cards at the time the cards are utilized and the costs measured. Under
both arrangements, there are no rights of return once cards are sold.
CASH AND CASH EQUIVALENTS
The Company considers cash in banks and short-term investments with
original maturities of three months or less as cash and cash equivalents.
FINANCIAL INSTRUMENTS
The Company follows the guidance of Statement of Financial Accounting
Standards No. 107, "DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS," which
requires the disclosures of the fair value of financial instruments; however,
this information does not represent the aggregate net fair value of the Company.
Some of the information used to determine fair value is subjective and
judgmental in nature; therefore, fair value estimates, especially for less
marketable securities may vary. The amounts actually realized or paid upon
settlement or maturity could be significantly different.
Unless quoted market price indicates otherwise, the fair values of cash and
cash equivalents, short-term investments, escrowed deposits and investments
(certificates of deposit) generally approximate market value because of the
short maturity of these instruments. The Company's notes payable and capital
lease obligations also approximate market value as the underlying borrowing
rates are similar to other financial instruments with similar maturities and
terms.
INVENTORIES
Inventories consist principally of telecommunications equipment acquired
from manufacturers for distribution and are stated at the lower of cost
(first-in, first-out) or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. The cost of major renewals and
betterments is capitalized; repairs and maintenance costs are expensed when
incurred. Upon retirement or sale, the cost of the assets disposed of and the
related accumulated depreciation are removed from the accounts, with any
resultant gain or loss being reflected in the Consolidated Statement of
Operations. Depreciation of property and equipment for financial reporting
purposes is computed using the straight-line method over the estimated useful
lives of the assets. Leasehold improvements and capital leases are amortized
over the lesser of the life of the lease or the useful life of the asset. For
income tax purposes, accelerated methods of depreciation are used. The following
is a summary of the Company's property and equipment and their estimated useful
lives:
AS OF DECEMBER 31, ESTIMATED
-------------------------- USEFUL LIVES
1996 1997 (YEARS)
------------ ------------ ------------
Computer equipment and software...... $ 314,000 $ 569,000 3
Telecommunications equipment......... 467,000 1,184,000 5-7
Office equipment..................... 271,000 380,000 5-7
Leasehold improvements............... 196,000 230,000 7
Transportation equipment............. 157,000 295,000 5
Call center equipment................ -- 705,000 5
------------ ------------
1,405,000 3,363,000
Less, accumulated depreciation....... (422,000) (684,000)
------------ ------------
$ 983,000 $ 2,679,000
============ ============
F-10
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
GOODWILL AND INTANGIBLES
The major classes of intangible assets are summarized below:
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF AMORTIZATION
---------------------------- JUNE 30, PERIOD
1996 1997 1998 (YEARS)
------------ -------------- -------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Goodwill............................. $ 3,312,000 $ 18,037,000 $ 27,570,000 15
Organization costs................... 73,000 73,000 73,000 5
Less, accumulated amortization....... (139,000) (436,000) (1,311,000)
------------ -------------- --------------
$ 3,246,000 $ 17,674,000 $ 26,332,000
============ ============== ==============
</TABLE>
Intangible assets are amortized using the straight-line method for periods
noted above.
Goodwill is recognized for the excess of the purchase price of the various
business combinations over the estimated fair value of the identifiable net
tangible and intangible assets acquired. In connection with certain of the
Company's acquisitions, the Company issued performance-based warrants. The
Company records such contingent consideration at the time the contingency is
resolved and the consideration becomes issuable or when the outcome of the
contingency is determinable beyond a reasonable doubt. During the year ended
December 31, 1997, 2,095,000 warrants, issued in connection with the Telereunion
acquisition, vested as a result of certain operating performance measures being
achieved. In addition, 380,000 shares of preferred stock were mandatorily
redeemable at December 31, 1997 at $1.00 per share based upon the Company
meeting certain operating performance measures. The preferred shares were
redeemed in the first quarter of 1998. As a result, the Company recorded
$12,114,000 in additional consideration in connection with the Telereunion
acquisition. During the year ended December 31, 1997, 80,000 warrants, issued in
connection with the Integracion acquisition, vested as a result of certain
operating performance measures being achieved. The Company recorded $422,000 in
additional consideration in connection with the Integracion acquisition.
Effective January 1, 1998, the Company acquired MSN resulting in $6,063,000 in
goodwill being recorded (Unaudited). See Note 2 for further discussion regarding
the Company's acquisitions. Realization of long-lived assets, including
goodwill, is periodically assessed by the management of the Company utilizing
the guidance of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed of. Accordingly, in the event that
facts and circumstances indicate that property and equipment, and intangible or
other assets may be impaired, an evaluation of recoverability would be
performed. If an evaluation is required, the estimated future undiscounted cash
flows associated with the asset are compared to the asset's carrying amount to
determine if a write-down to market value is necessary. In management's opinion,
there is no impairment of such assets at December 31, 1997 or at June 30, 1998.
WARRANTY RESERVES
The Company generally provides its systems integration customers a warranty
on each sale of equipment and related products and accrues warranty expense at
the time of sale based upon actual claims history. Actual warranty costs
incurred are charged against such accrual when paid.
PREPAID EXPENSES AND OTHER CURRENT ASSETS:
Prepaid expenses and other current assets include the following:
AS OF DECEMBER 31,
-----------------------
1996 1997
--------- ------------
Value-added taxes receivable......... $ -- $ 1,749,000
Deposits............................. 14,000 448,000
Prepaid insurance and other
expenses........................... 13,000 197,000
Other................................ 63,000 280,000
--------- ------------
$ 90,000 $ 2,674,000
========= ============
F-11
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ACCRUED EXPENSES:
Accrued expenses include the following:
AS OF DECEMBER 31,
------------------------
1996 1997
---------- ------------
Customer prepayments................. $ 406,000 $ 799,000
Accrued carrier costs................ -- 560,000
Accrued wages........................ 15,000 579,000
Taxes payable........................ 146,000 509,000
Preferred stock redemption payable... -- 380,000
Other................................ 157,000 476,000
---------- ------------
$ 724,000 $ 3,303,000
========== ============
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The Company has determined that the U.S. dollar is the functional currency
for its operations outside the U.S. As such, gains and losses resulting from the
translation of financial statements of such operations are included in the
Consolidated Statements of Operations.
INCOME TAXES
Income taxes are calculated using the liability method specified by
Statement of Financial Accounting Standards ("SFAS") No. 109, "ACCOUNTING FOR
INCOME TAXES." Under this method, deferred tax assets and liabilities are
determined based on differences between the financial reporting and income tax
bases of assets and liabilities and are measured using the enacted tax rates and
laws that will be in effect when differences are expected to reverse. A
valuation allowance is used to reduce deferred tax assets to the amount that is
more likely than not to be realized.
EARNINGS (LOSS) PER SHARE
In February 1997, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 128, Earnings Per Share. SFAS No. 128 is effective for the year
ended December 31, 1997. SFAS No. 128 simplifies the standards required under
current accounting rules for computing earning per share and replaces the
presentation of primary earnings per share and fully diluted earnings per share
with a presentation of basic earnings per share ("basic EPS") and diluted
earnings per share ("diluted EPS"). Following is a summary of the
calculations:
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEAR ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------------------ --------------------------
1995 1996 1997 1997 1998
------------ -------------- ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
BASIC
Net income (loss) as reported........ $ (673,000) $ (1,598,000) $ 2,672,000 $ 214,000 $ 492,000
Weighted average common shares
outstanding........................ 1,890,442 3,046,594 3,903,470 3,921,878 4,534,568
Basic earnings (loss) per share...... $ (0.36) $ (0.52) $ 0.68 $ 0.05 $ 0.11
</TABLE>
(TABLE CONTINUED ON FOLLOWING PAGE)
F-12
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEAR ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------------------ --------------------------
1995 1996 1997 1997 1998
------------ -------------- ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
DILUTED
Net income (loss) as reported........ $ (673,000) $ (1,598,000) $ 2,672,000 $ 214,000 $ 492,000
Interest expense on convertible
debt............................... -- -- 42,000 -- --
------------ -------------- ------------ ------------ ------------
Net income (loss) applicable to
common stockholders................ $ (673,000) $ (1,598,000) $ 2,714,000 $ 214,000 $ 492,000
Weighted average common shares
outstanding........................ 1,890,442 3,046,594 3,903,470 3,921,878 4,534,568
Weighted average dilutive potential
common shares outstanding:
Options......................... 91,773 74,775 430,969 69,471 956,241
Warrants........................ -- 39,867 651,272 7,311 2,287,263
Convertible debt................ -- -- 166,500 -- --
------------ -------------- ------------ ------------ ------------
Total weighted average dilutive
potential common shares
outstanding........................ 91,773 114,642 1,248,741 76,782 3,243,504
Weighted average common and dilutive
potential common shares
outstanding........................ 1,982,215 3,161,236 5,152,211 3,998,660 7,778,072
Diluted net income (loss) per
share.............................. $ (0.34) $ (0.51) $ 0.53 $ 0.05 $ 0.06
</TABLE>
Diluted EPS for the years ended December 31, 1995 and 1996, was not
disclosed on the Consolidated Statement of Operations as the effect is
anti-dilutive. Certain performance based warrants vested at December 31, 1997
upon the achievement of certain operating performance measures (See Note 2). In
accordance with SFAS 128, these contingently issuable shares were 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.
Accordingly, 1,000,000 warrants were included in the calculation of diluted EPS
for the year ended December 31, 1997 as if those shares were issued on July 1,
1997 and 1,175,000 warrants were included as if those shares were issued on
October 1, 1997. At December 31, 1996, December 31, 1997, June 30, 1997 and June
30, 1998, there were 2,695,000, 500,000, 2,695,000 and 500,000 performance based
warrants, respectively, which had not vested which were not included in the
calculation of diluted EPS. Additionally, 525,000, 525,000, 666,270, 556,164 and
17,000 options and warrants outstanding at December 31, 1995, 1996, 1997, June
30, 1997 and 1998, respectively, 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.
NEW 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
F-13
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 years ended December 31, 1995,
1996, 1997 and the six months ended June 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. The statement
is effective for financial statements for periods beginning after December 15,
1997 and requires comparative information for earlier years to be restated.
SFAS Nos. 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.
2. MERGERS AND ACQUISITIONS
TELEREUNION ACQUISITION
On May 17, 1996, the Company acquired all of the outstanding common stock
of Telereunion, which had previously acquired a 97% ownership of Vextro in a
triangular reverse acquisition, accounted for as a purchase. Vextro is engaged
in the distribution and sale of voice, data and networking equipment and
provides value-added telecommunications services and network integration
services in Mexico. In late 1994, Vextro was issued a license to provide
value-added telecommunications services by the Mexican Secretaria de
Comunicaciones y Transportes ("SCT"). The license grants Vextro the right for
an unspecified term to provide these services throughout Mexico involving the
use of data, facsimile and voice transmissions, and the resulting embedded
international and long distance traffic generated.
Under the terms of the acquisition, the Company issued to the shareholders
of Telereunion 1,605,000 shares of common stock of the Company, 380,000 shares
of non-voting, non-participatory Series B preferred stock and warrants to
purchase up to 2,595,000 additional common shares at $2.19 per share. The
warrants vest and become exercisable upon Vextro meeting certain operating
performance measures and
F-14
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
expire seven years after closing. The preferred stock was mandatorily redeemable
at $380,000 in the aggregate upon the Company meeting certain operating
performance measures. In addition, the Company converted and amended certain
non-qualified options outstanding under the Telereunion 1995 Stock Option and
Appreciation Rights Plan to provide for the right to acquire an aggregate of
216,618 shares of common stock of the Company at an exercise price of $1.35 per
share. The acquisition was accounted for under the purchase method of
accounting. The operations of Telereunion and Vextro have been included in the
Company's financial statements since the date of acquisition.
The consideration paid for Telereunion measured at the acquisition date was
$3,210,000, net of cash received of approximately $132,000, and consisted of
common stock valued at $2,722,000, 216,618 stock options valued at $135,000 and
transaction costs of $485,000. 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 $3,312,000 of goodwill, which is being
amortized over 15 years. During the year ended December 31, 1997, certain of the
operating performance measures were met resulting in 2,095,000 warrants vesting
and the 380,000 preferred shares being mandatorily redeemable at $1.00 per
share. The preferred shares were redeemed in the first quarter of 1998. As a
result, $12,114,000 in additional contingent consideration and the related
goodwill was recognized relating to the acquisition of Telereunion at December
31, 1997.
ORION MERGER
On July 26, 1996, the Company entered into an Agreement and Plan of Merger,
pursuant to which the Company acquired on September 5, 1996, all of the
outstanding common stock of Orion Communications, Inc. ("Orion"), a Texas
corporation in exchange for 400,000 shares of its common stock. Orion was a
reseller of U.S. domestic long distance services. This transaction has been
accounted for under the pooling-of-interests method and, accordingly, the
accompanying consolidated statements of operations include the results of the
operations of Orion since its inception on April 10, 1996. At the time of the
merger, the name of Orion was changed to Telscape USA, Inc. Expenses of $102,500
related to the merger with Orion were charged to expense during 1996.
INTEGRACION ACQUISITION
Effective July 1, 1997, pursuant to a stock purchase agreement, the Company
acquired all of the outstanding shares of Integracion. Integracion is a systems
integrator engaged in the distribution and sale of data and network equipment
and also provides value-added services in network integration in Mexico.
Under the terms of the transaction, the Company paid the following to the
selling shareholders of Integracion: i) the sum of $130,000 in cash, ii) an
aggregate of $2,201,000 in non-interest bearing promissory notes maturing at
various dates through January 1, 2001, iii) an aggregate of $999,000 in non-
interest bearing convertible notes maturing on September 1, 1999, which are
convertible into 333,000 shares of common stock of the Company at a price of
$3.00 per share, representing the quoted market price of the Company's common
stock on the date of the transaction, iv) warrants for the purchase of up to
100,000 shares of common stock of the Company based on Integracion meeting
certain performance requirements and v) a covenant by the Purchasers to pay
$280,000 in the event that Integracion meets certain performance requirements
over the cumulative periods beginning January 1, 1997 and ending December 31,
2000. The acquisition was accounted for under the purchase method of accounting.
The financial position and results of operations of Integracion have been
included in the Company's consolidated financial statements since the effective
date of the acquisition.
The consideration paid for Integracion measured at the acquisition date was
$2,745,000 and consisted of cash of $130,000, promissory notes with a discounted
value of $2,555,000 and transaction costs of $60,000. The purchase price was
allocated to the acquired company's assets and liabilities based upon an
F-15
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
estimate of fair values at the date of acquisition and resulted in $1,756,000 of
goodwill, which is being amortized over 15 years. The purchase price of the
acquisition has been allocated as follows:
FAIR
VALUE
--------------
Cash................................. $ 130,000
Promissory Notes (discounted
value)............................. 1,759,000
Convertible Notes (discounted
value)............................. 796,000
Transaction Costs.................... 60,000
--------------
Total consideration............. 2,745,000
Cash................................. 307,000
Accounts receivable.................. 1,996,000
Inventories.......................... 330,000
Other assets......................... 165,000
Accounts payable and accrued
liabilities........................ (1,686,000)
Other liabilities.................... (123,000)
--------------
Fair value of net assets
acquired...................... 989,000
--------------
Goodwill............................. $ 1,756,000
==============
During the year ended December 31, 1997, certain of the operating
performance measures were met resulting in 80,000 warrants vesting. The
remaining 20,000 warrants were forfeited. As a result, $422,000 in additional
contingent consideration and the related goodwill was recognized on the
acquisition of Integracion at December 31, 1997.
N.S.I. ACQUISITION
On October 1, 1997, pursuant to a stock purchase agreement, the Company
acquired all of the outstanding shares of N.S.I. N.S.I. is a systems integrator
engaged in the distribution and sale of data and network equipment and also
provides value-added services in network integration in Mexico.
Under the terms of the acquisition, the Company paid cash of $1,000 to the
shareholders of N.S.I. and agreed to guarantee the repayment of approximately
$260,000 of N.S.I. debt to one of the sellers. 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 $430,000 of goodwill, which is
being amortized over 15 years. The acquisition was accounted for under the
purchase method of accounting. The financial position and results of operations
of N.S.I. have been included in the Company's consolidated financial statements
since the effective date of the acquisition.
MSN ACQUISITION
Effective January 1, 1998, the Company acquired all of the outstanding
common stock of 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. In
addition, the two selling shareholders were each granted 50,000 options to
purchase the Company's common stock at $11.00 per share. 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
F-16
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 (unaudited). The purchase price
of the acquisition has been allocated as follows:
FAIR
VALUE
--------------
Cash................................. $ 3,250,000
Promissory Notes (discounted
value)............................. 672,000
Common Stock......................... 880,000
Transaction Costs.................... 78,000
--------------
Purchase consideration.......... 4,880,000
Cash................................. 977,000
Accounts receivable.................. 1,042,000
Other assets......................... 90,000
Accounts payable and accrued
liabilities........................ (1,323,000)
Deferred revenue..................... (1,997,000)
--------------
Excess of liabilities assumed
over fair value of net assets
acquired....................... (1,211,000)
--------------
Goodwill............................. $ 6,091,000
==============
The following presents the unaudited pro forma results of operations of the
Company for the year ended December 31, 1996 and 1997, as if the acquisitions of
Telereunion, Integracion, N.S.I. and MSN had occurred on January 1, 1996:
FOR THE YEAR ENDED DECEMBER 31,
------------------------------
1996 1997
-------------- --------------
(UNAUDITED)
Pro forma revenues................... $ 15,662,000 $ 68,776,000
Pro forma operating income........... (2,158,000) 2,189,000
Pro forma net income (loss).......... (2,171,000) 2,041,000
Pro forma basic net income (loss) per
share.............................. $ (0.71) $ 0.51
Pro forma diluted net income (loss)
per share(1)....................... n/a $ 0.39
- ------------
(1) Inclusion of additional shares under a diluted analysis for 1996 is
inappropriate due to the anti-dilutive effect.
The unaudited pro forma consolidated financial statements of Telereunion,
Integracion, N.S.I. and MSN have been prepared as if the business combinations
had been consummated as of January 1, 1996. The information is not necessarily
indicative of the results of operations and financial position of the Company as
they may be in the future or as they might have been had the business
combinations been consummated as of January 1, 1996.
The balances included in the Consolidated Balance Sheets related to the
current year acquisitions 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. In addition, changes in the balances recorded where contingent
consideration was issued are subject to change as those contingencies are
resolved. In certain cases, the contingent consideration is payable in equity
securities where valuation of those securities is not determined until the
respective contingency is resolved. As such, it is not possible to compute the
amount that could be recorded in the future. In such cases, the amount of
contingent consideration recorded in the future may be significant. As of
December 31, 1997, there were 500,000 warrants issued in connection with the
Telereunion acquisition, which are subject to vesting upon the meeting of
certain operating performance measures. If such operating
F-17
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
performance measures were met and the warrants were valued as of December 31,
1997, $2,906,000 in additional consideration and related goodwill would have
been recognized.
DTS/ZWUT
Digital Communications Systems/Zaklady Wytworcze Urzadzen Telefonicznych
("DTS/ZWUT"), a Polish limited liability company, was a 90%-owned subsidiary
of the Company. DTS/ZWUT manufactures and markets telephone switching equipment
in Poland. On December 12, 1997, the Company exchanged its 90% interest in
DTS/ZWUT for a 31% interest in BCH Holding Company, Inc. ("BCH"), a Nevada
corporation with a full service telecommunications operation based in Warsaw,
Poland. As a result of this transaction, the Company's investment in BCH will be
accounted for under the equity method. The Company recorded its investment in
BCH at the Company's estimate of its fair value at the time of the exchange with
no gain or loss recognized on the exchange.
3. CONCENTRATION OF RISK
CONCENTRATION OF RISK - MEXICO
The devaluation of the Mexican peso in late 1994 caused Mexico to
experience an economic crisis characterized by exchange rate instability,
increased inflation, high domestic interest rates, reduced consumer purchasing
power and high unemployment. Consequently, the Mexican government has exercised,
and continues to exercise, significant influence over the Mexican economy.
Accordingly, Mexican governmental actions could have a significant effect on
Mexican companies, including the Company's customers, and overall market
conditions.
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 pay in U.S.
dollars. In addition, most of the 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. Nevertheless, significant adverse effects
from any material devaluation in the Mexican peso could result in an adverse
effect on the Company's operations.
SIGNIFICANT CUSTOMERS
The Company's credit risks primarily consist of accounts receivable from
its customers, many of which are located in Mexico. Management performs ongoing
credit valuations of its customers and provides allowances for credit losses
when necessary.
Major customers are those that individually account for more than 10
percent of the Company's total revenues. For the year ended December 31, 1997,
one customer accounted for 28% of the Company's total revenues and 56% of the
Company's long distance services revenues. For the years ended December 31, 1996
and 1995, and for the six months ended June 30, 1998, no customer represented
greater than 10% of revenues.
F-18
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS
The Company's notes payable and capital lease obligations consist of the
following:
AS OF DECEMBER 31, AS OF JUNE 30,
----------------------- ---------------
1996 1997 1998
--------- ------------ ---------------
(UNAUDITED)
Convertible Subordinated Debentures,
bearing interest at 8%, convertible
into common stock, maturing three
years from closing (see Note 13)... $ -- $ -- $ 4,922,000
Convertible Debentures bearing
interest at 8%, convertible into
common stock, maturing on May 39,
2000 (see Note 13)................. -- -- 4,913,000
Non-interest bearing promissory
notes, imputed interest at 10%,
unamortized discount of $348,000
and $308,000, respectively, issued
in connection with Integracion
acquisition, maturing at various
dates through January 1, 2001 (See
Note 2)............................ -- 1,853,000 1,633,000
Non-interest bearing promissory note,
imputed interest at 10%,
unamortized discount of $141,000
and $120,000, respectively, issued
in connection with Integracion
acquisition, convertible into
333,000 shares of common stock, and
maturing on September 1, 1999 (See
Note 2)............................ -- 839,000 881,000
Promissory note issued to repurchase
common stock, payable in six
semi-annual installments through
May 20, 2000, and bearing interest
at 6% (See Note 7)................. -- 250,000 200,000
Capital lease obligation payable in
monthly installments of $11,000
including principal and interest
maturing February 28, 2000......... -- 242,000 196,000
Non-interest bearing promissory note,
imputed interest at 10%,
unamortized discount of $78,000,
issued in connection with MSN
acquisition, payable in eight equal
quarterly installments beginning
April 23, 1998..................... -- -- 598,000
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 15,291,000
Current portion...................... -- 508,000 5,906,000
--------- ------------ ---------------
Long-term portion.................... $ -- $ 2,676,000 $ 9,385,000
========= ============ ===============
The annual maturities of the debt indicated above for the five years
following June 30, 1998, are $198,000 in 1998, $8,825,000 in 1999, $629,000 in
2000, $5,775,000 in 2001 and $29,000 in 2002.
On February 28, 1997, the Company entered into a lease obligation which
provided for monthly lease payments of $11,200 including principal and interest
through February 28, 2000.
On March 12, 1998, the Company entered into a revolving credit facility
with a commercial bank which provides for borrowings up to $1,250,000 subject to
adequate levels of eligible accounts receivable. Borrowings are secured by the
accounts receivable of the Company's Telscape USA and MSN subsidiaries. This
facility provides that borrowings will bear interest at floating rates of prime
plus 1% and expires in six months.
F-19
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. A significant difference
relates to the treatment of inventories under the Mexican Tax Law. Under this
law, the cost of sales for financial statement purposes is not deductible for
income tax purposes. Instead, inventory purchases are deductible for income tax
purposes in the year the purchases are made.
Significant components of the Company's deferred tax liabilities and assets
at December 31, 1996 and 1997 are as follows:
<TABLE>
<CAPTION>
1996 1997
-------------------------- --------------------------
UNITED STATES FOREIGN UNITED STATES FOREIGN
------------- --------- ------------- ---------
<S> <C> <C> <C> <C>
CURRENT:
Operating loss carryforwards and tax
credits............................ $ -- $ -- $ 189,000 $ 152,000
Accrued carrier costs................ -- -- 191,000 --
Accrued wages........................ -- -- 52,000 --
Other accrued liabilities............ -- -- 34,000 --
Allowance for doubtful accounts...... 13,000 6,000 51,000 10,000
Inventories.......................... -- (516,000) -- (704,000)
Customer prepayments................. -- 138,000 -- 272,000
Valuation allowance.................. (13,000) -- -- --
------------- --------- ------------- ---------
Net current deferred tax asset
(liability)........................ $ -- $(372,000) $ 517,000 $(270,000)
============= ========= ============= =========
LONG-TERM:
Operating loss carryforwards and tax
credits............................ $ 1,079,000 $ 172,000 $ -- $ --
Basis differences in assets.......... 18,000 13,000 6,000 58,000
Accrued employee benefits............ 120,000 7,000 -- 13,000
Valuation allowance.................. (1,217,000) -- -- --
------------- --------- ------------- ---------
Net long term deferred tax asset..... $ -- $ 192,000 $ 6,000 $ 71,000
============= ========= ============= =========
</TABLE>
The Company records valuation allowances based upon judgments as to the
future realization of deferred tax benefits supported by demonstrated trends in
the Company's operating results. At December 31, 1996, the Company had recorded
a valuation allowance equal to its deferred tax assets. At December 31, 1997, no
valuation allowance was recorded.
Significant components of the provision (benefit) for income taxes are as
follows:
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
------------ ------------ --------------
Current:
Federal....................... $ -- $ -- $ 1,146,000
Foreign....................... -- 58,000 504,000
------------ ------------ --------------
Total current............ -- 58,000 1,650,000
Deferred:
Federal....................... -- -- (1,545,000)
Foreign....................... -- (111,000) (21,000)
------------ ------------ --------------
Total deferred........... -- (111,000) (1,566,000)
------------ ------------ --------------
Total provision
(benefit)........ $ -- $ (53,000) $ 84,000
============ ============ ==============
F-20
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a reconciliation of income taxes calculated at the United
States federal statutory rate to the income tax provision (benefit):
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
Provision for income taxes at U.S.
statutory rate..................... (34)% (34)% 34%
Non-deductible amortization of
intangible assets.................. 3 7
Non-deductible litigation loss....... 2
Other items, net..................... (3) 4
Effect of utilization of net
operating loss carryforwards, tax
credits and reversal of valuation
allowance.......................... 34 31 (44)
--------- --------- ---------
Income tax provision
(benefit)............... -- (3)% 3%
========= ========= =========
At December 31, 1997, the Company had available for US federal income tax
purposes unused net operating loss carryforwards of approximately $368,000 which
may provide future tax benefits and which will expire in years 2005 through
2011. Additionally, as of December 31, 1997, the Company had approximately
$65,000 in alternative minimum tax credits which can be utilized to offset
future tax liabilities.
In accordance with Mexican Tax Law, companies may carryforward an income
tax loss for ten years. Also, in accordance with Mexican Tax Law, a company is
subject to income taxes based upon the greater of 34% of taxable income and 1.8%
of net assets, as defined in the tax law. Any tax on assets paid is recoverable
and can be carried forward for ten years in the event a company begins paying
taxes on income. At December 31, 1996, the Company had available for Mexican
income tax purposes operating loss carryforwards of approximately $328,000 which
expire in 2007 and net asset taxes credits of approximately $40,000 which expire
in 2007.
6. STOCK OPTIONS AND WARRANTS
STOCK OPTIONS
1993 STOCK OPTION PLAN
Under the terms of its 1993 Stock Option Plan, the Company may grant
incentive and non-qualified stock options to purchase up to 218,145 shares of
its common stock to the Company's employees, directors or consultants. 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) for incentive stock options, or not less than 85% of the fair
market value for non-qualified stock options. Options granted under this plan
may be for a term of up to 10 years (5 years for incentive stock options granted
to stockholders owning 10% or more of the Company's common stock) and are
exercisable as determined by the Board of Directors.
1994 DIRECTORS STOCK OPTION PLAN
Effective June 1, 1994, the Company adopted the 1994 Directors Stock Option
Plan, which provides that the Company may grant non-qualified options to
directors of the Company or any majority-owned subsidiary who are not salaried
employees to purchase up to 31,163 shares of its common stock. Options must be
granted by June 1, 2004, at prices not less than the fair market value of the
Company's common stock at the date of grant and must be exercised within ten
years of the date of grant. Upon a change of control of the Company, all granted
but unvested options under the plan will vest immediately.
F-21
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
TELEREUNION 1995 STOCK OPTION PLAN
As stated in Note 2, the Company assumed Telereunion's Stock Option Plan in
connection with the acquisition of Telereunion. Under the terms of this Plan,
the Company may grant non-qualified or incentive stock options to employees,
directors and consultants. 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) for incentive stock options,
or not less than 85% of the fair market value for non-qualified stock options.
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 (5 years
for incentive stock options granted to stockholders owning 10% or more of the
Company's common stock).
1996 STOCK OPTION AND APPRECIATION RIGHTS PLAN
During 1996, the Company adopted the 1996 Stock Option and Appreciation
Rights Plan, which provides that the Company may grant non-qualified or
incentive stock options to purchase up to 1,200,000 shares of its common stock
to the Company's employees, directors or consultants. The plan also provides for
grants of stock appreciation rights in connection with the grant of options
under the plan. 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) for incentive stock options, or not
less than 85% of the fair market value for non-qualified stock options. 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 (5 years
for incentive stock options granted to stockholders owning 10% or more of the
Company's common stock).
A summary of the Company's fixed option plans as of December 31, 1995, 1996
and 1997 is presented below:
<TABLE>
<CAPTION>
TOTAL WTD. AVG.
1993 PLAN 1994 PLAN 1995 PLAN 1996 PLAN ALL PLANS EXER. PRICE
--------- --------- --------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at January 1,
1995............................... 64,440 -- -- -- 64,440 $0.80
Options granted...................... 58,000 30,000 -- -- 88,000 2.23
Options exercised.................... (4,000) -- -- -- (4,000) 2.25
Options cancelled.................... -- -- -- -- -- --
--------- --------- --------- --------- ---------
Options outstanding at December 31,
1995............................... 118,440 30,000 -- -- 148,440 1.61
Max. shares exercisable.............. 118,440 30,000 -- -- 148,440 1.61
Options granted...................... -- 10,000 216,618 1,190,809 1,417,427 3.62
Options exercised.................... -- -- -- -- -- --
Options cancelled.................... (32,408) (30,000) (141,618) -- (204,026) 1.39
--------- --------- --------- --------- ---------
Options outstanding at December 31,
1996............................... 86,032 10,000 75,000 1,190,809 1,361,841 3.95
Max. shares exercisable.............. 86,032 10,000 75,000 225,000 396,032 3.49
Options granted...................... -- -- -- 525,000 525,000 5.73
Options exercised.................... (15,828) -- -- (10,000) (25,828) 1.87
Options cancelled.................... -- -- -- (505,809) (505,809) 3.91
--------- --------- --------- --------- ---------
Options outstanding at December 31,
1997............................... 70,204 10,000 75,000 1,200,000 1,355,204 4.76
========= ========= ========= ========= =========
Max. shares exercisable.............. 70,204 10,000 75,000 393,333 548,537 3.89
</TABLE>
SFAS 123 requires the Company to provide pro forma information regarding
net income (loss) applicable to common stockholders and income (loss) per share
as if compensation cost for the Company's stock options granted had been
determined in accordance with the fair value based method prescribed in that
Statement. The Company estimates the fair value of each stock option at the
grant date by using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in 1995, 1996 and 1997: dividend
yield of 0% for all years; expected volatility ranging from 20% to 33%, 80%
F-22
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to 85%, and 80% to 90%; risk-free interest rates ranging from 5.92% to 6.78%,
6.15% to 6.41%, and 5.65% to 5.80%; and expected lives ranging from 7.75 to 9.33
years, 1.33 to 9.87 years, and 7.25 to 9.91 years, respectively.
Under the accounting provisions of SFAS No. 123, the Company's net income
(loss) applicable to common stockholders and income (loss) per share would have
been revised to the pro forma amounts indicated below:
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
------------ -------------- ------------
Net income (loss):
As reported................... $ (673,000) $ (1,598,000) $ 2,672,000
Pro Forma..................... $ (738,000) $ (3,096,000) $ 1,955,000
Net income (loss) per share:
Basic
As reported................... $ (.36) $ (.52) $ .68
Pro Forma..................... $ (.39) $ (1.02) $ .50
Diluted
As reported................... n/a n/a $ .53
Pro Forma..................... n/a n/a $ .38
F-23
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
WARRANTS
Following is a description of the Company's warrants outstanding at
December 31, 1997:
#
DESCRIPTION OF WARRANTS: OUTSTANDING
- ------------------------------------- -----------
Series A Warrants (unregistered)
issued in connection with the
Company's acquisition of
Telereunion on May 17, 1996,
exercisable at $2.19 at stated
percentages only upon the Company
achieving certain operating
performance measures or fully
vesting upon the Company
maintaining a $12 share price for
90 consecutive trading days;
expiration date of May 16, 2003,
2,000,000 of which vested at
December 31, 1997 (See Note 2)..... 2,500,000
Series B Warrants (unregistered)
issued in connection with the
Company's acquisition of
Telereunion on May 17, 1996,
currently exercisable at $2.19 as
certain operating performance
measures were achieved during the
year ended December 31, 1997,
expiration date May 16, 2003 (See
Note 2)............................ 95,000
Registered warrants (NASDAQ) issued
in connection with the IPO
exercisable at any time at $8 per
share prior to expiration on August
10, 1998........................... 393,770
Warrants (unregistered) issued to IPO
underwriters exercisable at any
time at $8.10 prior to expiration
on August 10, 1999................. 105,000
Warrants (unregistered) issued on
February 29, 1996, in connection
with former officer's severance
agreement exercisable at any time
at $2.94 prior to expiration on
February 28, 2001.................. 150,000
Warrants (unregistered) issued in
connection with the Company's
acquisition of Telereunion on May
17, 1996, exercisable at any time
at $2.19 prior to expiration on May
16, 2001........................... 78,191
Warrants (unregistered) issued on
April 30, 1997, in connection with
former officer's severance
agreement exercisable at any time
at $3.88 - $5.00 prior to
expiration on April 30, 1999....... 25,000
Warrants (unregistered) issued in
connection with the Company's
acquisition of Integracion
effective July 1, 1997, currently
exercisable at $3.00 as certain
operating performance measures were
achieved during the year ended
December 31, 1997, expiration date
of July 1, 2003 (See Note 2)....... 80,000
-----------
Total warrants.................. 3,426,961
===========
The IPO warrants were redeemable at the Company's option at any time with
30 days written notice at a redemption price of $0.20 per share. During the
fourth quarter 1997, the Company exercised its redemption privileges. As a
result, 475,535 warrants were exercised, including 131,230 warrants as of
December 31, 1997, resulting in net proceeds to the Company of approximately
$3,804,000, of which $989,000 was received prior to December 31, 1997.
F-24
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
The Company is obligated under certain long-term non-cancelable lease
agreements for office and warehouse space as follows:
AMOUNT
------------
1998................................. $ 449,000
1999................................. 564,000
2000................................. 585,000
2001................................. 626,000
2002................................. 655,000
------------
$ 2,879,000
============
Total rent expense under leases was $131,000 and $229,000, respectively,
for the years ended December 31, 1996 and 1997.
At December 31, 1997, the Company has employment agreements with six
officers, which expire in 1999. Future minimum commitments under these
agreements, excluding incentive bonuses or stock options, as of December 31,
1997, are as follows:
AMOUNT
----------
1998................................. $ 410,000
1999................................. 221,000
----------
$ 631,000
==========
Vextro is required to pay a license fee quarterly to the Mexican government
equal to five percent of its revenues from value-added telecommunications
services. Under the license, Vextro is free to set its service rates without
government approval; however, Vextro's rate schedule must be filed with the SCT.
On December 16, 1997, the Company entered into a purchase agreement with an
equipment manufacturer whereby it agreed to purchase a telecommunications switch
for a total cost of $1,060,000. No amounts had been funded pursuant to this
commitment as of December 31, 1997. On March 16, 1998, the Company entered into
a second purchase agreement with the same manufacturer to expand the capacity of
the telecommunication switch for an incremental cost of $854,000. As of March
1998, the Company had placed orders for additional telecommunications equipment
of over $1.8 million.
CONTINGENCIES
The Company has been named in two lawsuits filed by former employees and
consultants of the Company seeking damages in the aggregate in excess of
$1,000,000. The Company denies these allegations and intends to vigorously
defend against these allegations, although there can be no assurance as to the
successful defense of this matter. The Company believes that the results of this
litigation will not have a materially adverse effect on the Company's financial
condition.
The Company was a defendant in a suit filed on November 8, 1997 by the
estate of a former shareholder. Effective May 23, 1997, the Company entered into
a compromise and settlement agreement with respect to this lawsuit. Pursuant to
the agreement, the Company agreed to repurchase all of the 83,359 shares of
Company common stock owned by the plaintiffs for total consideration of
$425,000, which was comprised of $125,000 and a three year $300,000 promissory
note bearing interest at 6%. In return for this consideration, the plaintiffs
have agreed to release the Company and the other defendant from any and all
claims in connection with the lawsuit. The Company recorded a loss on the
settlement of $128,000, which represents the excess of the consideration paid
over the trading value of the stock on the date of settlement.
F-25
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ESCROW AGREEMENT
Pursuant to the Texas Securities Act of 1957, the Texas State Securities
Commissioner has the discretion to require that an issuer offering and selling
securities to the residents of Texas in a public offering deposit certain
outstanding securities in escrow. In that regard, certain former officers and
directors of the Company, including Gary Panno, Kris Murthy, and Dal Berry, as
well as three other individuals (collectively, the "Shareholders"), are
parties to a Stock Escrow Agreement (the "Escrow Agreement") dated August 8,
1994. The Escrow Agreement was required by the Texas State Securities
Commissioner as a condition to the registration of securities in Texas in
connection with the Company's IPO. The Escrow Agreement provides that a total of
415,503 shares of Common Stock ("Shares") and 55,779 shares of Common Stock
issuable upon the exercise of options ("Options") be held in escrow for a
period of not less than two years and not more than ten years. The terms of the
Escrow Agreement provide further that Shares and Options held in escrow may be
released provided certain performance requirements of the Company ("Performance
Requirements") are met. For instance, if the Company's common stock trades at a
price per share of at least $11.81 for at least ninety (90) consecutive trading
days then the Shares and Options are automatically released from escrow.
During the first quarter of 1998, the Company and the Shareholders entered
into a series of agreements, which will result in the early termination of the
Escrow Agreement in the second quarter of 1998, the repurchase by the Company of
certain of the Shares at a significant discount to market and the resolution of
a disagreement with certain of the Shareholders concerning the validity of the
Options. The agreements call for the Shareholders to sell a total of 101,417
Shares to the Company for $986,000 or $9.72 per share to be paid 25% upon
closing and 75% within ninety (90) days. Closing is expected to take place
during the first half of April 1998. In addition, the Shareholders agreed to
sign a ninety (90) day lock-up ("Lock-Up"), commencing on the closing date,
for any Shares which were not sold to the Company; provided, however, that
should any of the Performance Requirements be met during the Lock-Up, the Lock-
Up will terminate automatically. Finally, certain of the Shareholders agreed to
the termination of approximately 40,000 of the Options, which had an exercise
price of $0.80 per share.
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 system
failure. 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
F-26
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 of operations. However, if the Company is unable to
ready its 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.
8. CAPITAL SUBSCRIPTIONS RECEIVABLE
On December 15, 1993, the Company executed stock purchase agreements with
two individuals and a company that entitled each holder to purchase 125,000
shares of the Company's common stock at $2 per share. In accordance with the
terms of the stock purchase agreements, each holder paid $50,000 of the purchase
price and received 25,000 shares; the remaining 100,000 shares were held in
escrow until the balance for each holder of $200,000 is paid in full by the
holder, which is due December 15, 1998. During 1997, the remaining balance of
the purchase price was paid to the Company resulting in the shares being
released from escrow.
9. SEGMENT INFORMATION
The Company operates in two business segments, international long distance
and systems integration services. Long distance services operations are
conducted in the United States of America. Systems integration services are
performed in Mexico and Poland.
F-27
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Revenues, operating information and identifiable assets by business segment
and location are as follows:
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED
FOR THE YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------------------- ------------------------------
1995 1996 1997 1997 1998
------------ -------------- -------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues --
Long distance services (United
States)....................... $ -- $ 1,213,000 $ 17,390,000 $ 5,669,000 $ 50,435,000
Systems Integration:
Mexico..................... -- 3,350,000 18,030,000 3,895,000 15,342,000
Poland..................... 1,108,000 1,142,000 734,000 377,000 --
------------ -------------- -------------- -------------- --------------
Total revenues........ $ 1,108,000 $ 5,705,000 $ 36,154,000 $ 9,941,000 $ 65,777,000
Operating income (loss) --
Long distance services (United
States)....................... $ -- $ (1,933,000) $ 2,428,000 $ 404,000 $ 787,000
Systems Integration:
Mexico..................... -- 129,000 768,000 (57,000) 971,000
Poland..................... (908,000) 45,000 (214,000) (38,000) --
------------ -------------- -------------- -------------- --------------
Total operating income
(loss)............. $ (908,000) $ (1,759,000) $ 2,982,000 $ 309,000 $ 1,758,000
------------ -------------- -------------- -------------- --------------
Capital Expenditures --
Long distance services (United
States)....................... $ -- $ 23,000 $ 383,000 $ 572,000 $ 2,909,000
Systems Integration:
Mexico..................... 46,000 418,000 1,260,000 87,000 2,787,000
Poland..................... -- -- 39,000 8,000 --
------------ -------------- -------------- -------------- --------------
Total capital
expenditures....... $ 46,000 $ 441,000 $ 1,682,000 $ 667,000 $ 5,696,000
Depreciation and
amortization --
Long distance services (United
States)....................... $ 1,000 $ 141,000 $ 369,000 $ 46,000 $ 479,000
Systems Integration:
Mexico..................... -- 74,000 204,000 181,000 779,000
Poland..................... 47,000 49,000 49,000 12,000 --
------------ -------------- -------------- -------------- --------------
Total depreciation
and amortization... $ 48,000 $ 264,000 $ 622,000 $ 239,000 $ 1,258,000
============ ============== ============== ============== ==============
<CAPTION>
AS OF DECEMBER 31, AS OF JUNE 30,
-------------------------------------------- ------------------------------
1995 1996 1997 1997 1998
------------ -------------- -------------- -------------- --------------
(UNAUDITED)
Identifiable assets --
Long distance services (United
States)....................... $ -- $ 4,136,000 $ 6,612,000 $ 4,776,000 $ 34,072,000
Systems Integration:
Mexico..................... -- 4,165,000 32,013,000 7,102,000 34,808,000
Poland..................... 4,498,000 1,070,000 1,010,000 1,020,000 --
------------ -------------- -------------- -------------- --------------
Total identifiable
assets............. $ 4,498,000 $ 9,371,000 $ 39,635,000 $ 12,898,000 $ 68,880,000
============ ============== ============== ============== ==============
</TABLE>
F-28
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. INVESTMENT IN OPERATING VENTURES
During 1996, the Company invested $196,000 for a 7.21% interest in a
venture with Elterix, a Polish company developing a private network for 70,000
telephone lines. During 1997, this venture lost its license to provide such
services. Accordingly, the Company realized a loss equal to its investment in
1997.
11. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION
The Company's wholly-owned United States subsidiaries (the "Guarantors"),
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 13), 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.
F-29
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING BALANCE SHEET -- JUNE 30, 1998
<TABLE>
<CAPTION>
TELSCAPE GUARANTOR NON-GUARANTOR
INTERNATIONAL, INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------------- ------------ -------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........ $ (201,000) $ 4,272,000 $ 868,000 $ -- $ 4,939,000
Accounts receivable, net......... 335,000 1,898,000 10,608,000 -- 12,841,000
Inventories...................... (50,000) 43,000 3,810,000 -- 3,803,000
Prepaid expenses and other....... 166,000 1,551,000 4,741,000 -- 6,458,000
Deferred income taxes............ -- 263,000 71,000 -- 334,000
Intercompany receivables
(payables), net................ 9,546,000 (732,000) (8,814,000) -- --
-------------------- ------------ -------------- ------------ ------------
Total current assets........ 9,796,000 7,295,000 11,284,000 -- 28,375,000
Property and equipment, net...... 262,000 3,795,000 9,027,000 -- 13,084,000
Goodwill and other intangibles,
net............................ 9,348,000 16,984,000 -- -- 26,332,000
Investments in affiliates........ 19,987,000 -- -- (19,741,000) 246,000
Other assets..................... 659,000 164,000 20,000 -- 843,000
-------------------- ------------ -------------- ------------ ------------
Total assets................ $40,052,000 $28,238,000 $20,331,000 $(19,741,000) $68,880,000
==================== ============ ============== ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts Payable................. $ 304,000 $ 2,600,000 $14,790,000 $ -- $17,694,000
Accrued Expenses................. 327,000 4,394,000 2,078,000 -- 6,799,000
Current portion of notes payable
and capital lease
obligations.................... 515,000 478,000 -- -- 993,000
Current portion of convertible
debentures..................... 4,913,000 -- -- -- 4,913,000
Deferred income taxes............ -- -- 441,000 -- 441,000
-------------------- ------------ -------------- ------------ ------------
Total current liabilities... 6,059,000 7,472,000 17,309,000 -- 30,840,000
-------------------- ------------ -------------- ------------ ------------
Convertible Debentures........... 4,922,000 -- -- -- 4,922,000
Notes payable and capital lease
obligations.................... 479,000 3,984,000 -- -- 4,463,000
Minority interests............... -- 63,000 -- -- 63,000
Commitments and contingencies
(Note 6)....................... -- -- -- -- --
Series B Non-voting preferred
stock.......................... -- -- -- -- --
STOCKHOLDERS' EQUITY
Preferred Stock.................. -- -- -- -- --
Series A preferred stock......... -- -- -- -- --
Common stock..................... 5,000 31,000 152,000 (183,000) 5,000
Additional paid-in capital....... 31,575,000 12,712,000 3,028,000 (15,740,000) 31,575,000
Accumulated deficit.............. (2,359,000) 3,976,000 (158,000) (3,818,000) (2,359,000)
Treasury stock................... (629,000) -- -- -- (629,000)
-------------------- ------------ -------------- ------------ ------------
Total stockholders'
equity.................... 28,592,000 16,719,000 3,022,000 (19,741,000) 28,592,000
-------------------- ------------ -------------- ------------ ------------
Total liabilities and
stockholders' equity...... $40,052,000 $28,238,000 $20,331,000 $(19,741,000) $68,880,000
==================== ============ ============== ============ ============
</TABLE>
F-30
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING BALANCE SHEET -- DECEMBER 31, 1997
<TABLE>
<CAPTION>
TELSCAPE GUARANTOR NON-GUARANTOR
INTERNATIONAL, INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------------- ------------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........ $ 3,000 $ 4,272,000 $ 459,000 $ -- $ 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................ 2,975,000 206,000 (3,181,000) -- --
------------------- ------------- -------------- ------------- -------------
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
Deferred income taxes............ -- 7,000 70,000 -- 77,000
Investments in subsidiaries and
affiliates..................... 19,010,000 -- -- (18,715,000) 295,000
Other assets 169,000 115,000 120,000 -- 404,000
------------------- ------------- -------------- ------------- -------------
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 notes 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
(Note 7)....................... -- -- -- -- --
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>
F-31
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING BALANCE SHEET -- DECEMBER 31, 1996
<TABLE>
<CAPTION>
TELSCAPE GUARANTOR NON-GUARANTOR
INTERNATIONAL, INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------------- ------------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........ $ 300,000 $ 55,000 $ 140,000 $ -- $ 495,000
Accounts receivable, net......... -- 342,000 1,693,000 -- 2,035,000
Inventories...................... 4,000 -- 2,041,000 -- 2,045,000
Prepaid expenses and other....... 31,000 -- 59,000 -- 90,000
Intercompany receivables
(payables), net................ 1,413,000 (161,000) (1,252,000) -- --
------------------- ------------- -------------- ------------- -------------
Total current assets........ 1,748,000 236,000 2,681,000 -- 4,665,000
Property and equipment, net...... 1,000 22,000 960,000 -- 983,000
Goodwill and other intangibles,
net............................ 3,246,000 -- -- 3,246,000
Deferred income taxes............ -- -- 192,000 -- 192,000
Investments in subsidiaries and
affiliates..................... 4,584,000 83,000 -- (4,667,000) --
Other assets..................... 196,000 72,000 17,000 -- 285,000
------------------- ------------- -------------- ------------- -------------
Total assets................ $ 6,529,000 $3,659,000 $3,850,000 $(4,667,000) $ 9,371,000
=================== ============= ============== ============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................. $ 14,000 $ 217,000 $1,525,000 $ -- $ 1,756,000
Accrued expenses................. 4,000 40,000 680,000 -- 724,000
Current portion of notes payable
and capital lease
obligations.................... -- -- -- --
Deferred income taxes............ -- -- 372,000 -- 372,000
------------------- ------------- -------------- ------------- -------------
Total current liabilities... 18,000 257,000 2,577,000 -- 2,852,000
Minority interests............... 746,000 8,000 -- -- 754,000
Commitments and contingencies
(Note 7)....................... -- -- -- -- --
Series B Non-voting preferred
stock.......................... -- -- -- -- --
STOCKHOLDERS' EQUITY.................
Preferred Stock.................. -- -- -- -- --
Series A preferred stock......... -- -- -- -- --
Common stock..................... 4,000 11,000 100,000 (111,000) 4,000
Additional paid-in capital....... 11,884,000 3,827,000 2,735,000 (6,562,000) 11,884,000
Capital subscriptions
receivable..................... (600,000) -- -- -- (600,000)
Accumulated deficit.............. (5,523,000) (444,000) (1,562,000) 2,006,000 (5,523,000)
Treasury stock................... --
------------------- ------------- -------------- ------------- -------------
Total stockholders'
equity.................... 5,765,000 3,394,000 1,273,000 (4,667,000) 5,765,000
------------------- ------------- -------------- ------------- -------------
Total liabilities and
stockholders' equity...... $ 6,529,000 $3,659,000 $3,850,000 $(4,667,000) $ 9,371,000
=================== ============= ============== ============= =============
</TABLE>
F-32
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS -- SIX MONTHS ENDED JUNE 30,
1998
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL, GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues............................. $ -- $49,229,000 $29,211,000 $(12,663,000) $65,777,000
Cost of Revenues..................... -- 46,133,000 23,586,000 (12,663,000) 57,056,000
-------------- ------------ ------------ ------------ ------------
Gross profit......................... -- 3,096,000 5,625,000 -- 8,721,000
Selling, general and administrative
expenses............................ 690,000 1,380,000 3,635,000 -- 5,705,000
Depreciation and amortization........ 279,000 686,000 293,000 -- 1,258,000
-------------- ------------ ------------ ------------ ------------
Operating income (loss).............. (969,000) 1,030,000 1,697,000 -- 1,758,000
Other income (expense):
Interest, net...................... (123,000) (70,000) (58,000) -- (251,000)
Foreign exchange gain (loss)....... -- -- (187,000) -- (187,000)
Other, net......................... -- 72,000 24,000 -- 96,000
Equity in income of subsidiaries... 1,259,000 -- -- (1,259,000) --
-------------- ------------ ------------ ------------ ------------
Total other income (expense),
net............................. 1,136,000 2,000 (221,000) (1,259,000) (342,000)
-------------- ------------ ------------ ------------ ------------
Income (loss) before income taxes and
minority interests.................. 167,000 1,032,000 1,476,000 (1,259,000) 1,416,000
Income tax benefit (expense)......... 325,000 (583,000) (637,000) -- (895,000)
-------------- ------------ ------------ ------------ ------------
Income (loss) before minority
interests........................... 492,000 449,000 839,000 (1,259,000) 521,000
Minority interests in subsidiaries... -- (29,000) -- -- (29,000)
-------------- ------------ ------------ ------------ ------------
Net income (loss).................... $ 492,000 $ 420,000 $ 839,000 $ (1,259,000) $ 492,000
============== ============ ============ ============ ============
</TABLE>
F-33
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS -- SIX MONTHS ENDED JUNE 30,
1997
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL, GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues............................. $ -- $5,725,000 $5,932,000 $(1,716,000) $9,941,000
Cost of Revenues..................... -- 3,767,000 3,943,000 (1,716,000) 5,994,000
-------------- ------------ ------------ ------------ ------------
Gross profit......................... -- 1,958,000 1,989,000 -- 3,947,000
Selling, general and administrative
expenses........................... 639,000 766,000 1,994,000 -- 3,399,000
Depreciation and amortization........ 29,000 112,000 98,000 -- 239,000
-------------- ------------ ------------ ------------ ------------
Operating income (loss).............. (668,000) 1,080,000 (103,000) -- 309,000
Other income (expense):
Interest, net...................... (23,000) 19,000 4,000 -- --
Foreign exchange gain (loss)....... -- -- 27,000 -- 27,000
Other, net......................... (324,000) -- 31,000 -- (293,000)
Equity in income of subsidiaries... 1,433,000 -- -- (1,433,000) --
-------------- ------------ ------------ ------------ ------------
Total other income (expense),
net............................ 1,086,000 19,000 62,000 (1,433,000) (266,000)
-------------- ------------ ------------ ------------ ------------
Income (loss) before income taxes and
Minority interests................. 418,000 1,099,000 (41,000) (1,433,000) 43,000
Income tax benefit (expense)......... (204,000) 411,000 (40,000) -- 167,000
-------------- ------------ ------------ ------------ ------------
Income (loss) before minority
interests.......................... 214,000 1,510,000 (81,000) (1,433,000) 210,000
Minority interests in subsidiaries... -- 1,000 3,000 -- 4,000
-------------- ------------ ------------ ------------ ------------
Net income (loss).................... $ 214,000 $1,511,000 $ (78,000) $(1,433,000) $ 214,000
============== ============ ============ ============ ============
</TABLE>
F-34
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS -- YEAR ENDED
DECEMBER 31, 1997
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL, GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues............................. $ -- $17,390,000 $30,033,000 $(11,269,000) $36,154,000
Cost of Revenues..................... -- 12,281,000 23,384,000 (11,269,000) 24,396,000
-------------- ------------ ------------ ------------ ------------
Gross profit......................... -- 5,109,000 6,649,000 -- 11,758,000
Selling, general and administrative
expenses............................ 1,116,000 1,620,000 5,418,000 -- 8,154,000
Depreciation and amortization........ 68,000 301,000 253,000 -- 622,000
-------------- ------------ ------------ ------------ ------------
Operating income (loss).............. (1,184,000) 3,188,000 978,000 -- 2,982,000
Other income (expense)
Interest, net...................... (52,000) (26,000) (17,000) -- (95,000)
Foreign exchange gain (loss)....... -- -- (126,000) -- (126,000)
Other, net......................... (278,000) 54,000 213,000 -- (11,000)
Equity in income of subsidiaries... 4,565,000 -- -- (4,565,000) --
-------------- ------------ ------------ ------------ ------------
Total other income (expense),
net........................... 4,235,000 28,000 70,000 (4,565,000) (232,000)
-------------- ------------ ------------ ------------ ------------
Income (loss) before income taxes and
minority interests................. 3,051,000 3,216,000 1,048,000 (4,565,000) 2,750,000
Income tax benefit (expense)......... (405,000) 804,000 (483,000) -- (84,000)
-------------- ------------ ------------ ------------ ------------
Income (loss) before minority
interests........................... 2,646,000 4,020,000 565,000 (4,565,000) 2,666,000
Minority interests in subsidiaries... 26,000 (20,000) -- -- 6,000
-------------- ------------ ------------ ------------ ------------
Net income (loss).................... $2,672,000 $ 4,000,000 $ 565,000 $ (4,565,000) $ 2,672,000
============== ============ ============ ============ ============
</TABLE>
F-35
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS -- YEAR ENDED
DECEMBER 31, 1996
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL, GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues............................. $ -- $1,213,000 $6,900,000 $(2,408,000) $ 5,705,000
Cost of Revenues..................... -- 817,000 4,632,000 (2,408,000) 3,041,000
-------------- ------------ ------------ ----------- ------------
Gross profit......................... -- 396,000 2,268,000 -- 2,664,000
Selling, general and administrative
expenses............................ 1,462,000 844,000 1,853,000 -- 4,159,000
Depreciation and amortization........ 1,000 140,000 123,000 -- 264,000
-------------- ------------ ------------ ----------- ------------
Operating income (loss).............. (1,463,000) (588,000) 292,000 -- (1,759,000)
Other income (expense):
Interest, net...................... 103,000 6,000 (94,000) -- 15,000
Foreign exchange gain (loss)....... -- -- 161,000 -- 161,000
Other, net......................... (63,000) 1,000 -- -- (62,000)
Equity in income of subsidiaries... (177,000) -- -- 177,000 --
-------------- ------------ ------------ ----------- ------------
Total other income (expense),
net............................. (137,000) 7,000 67,000 177,000 114,000
Income (loss) before income taxes and
minority interests................. (1,600,000) (581,000) 359,000 177,000 (1,645,000)
-------------- ------------ ------------ ----------- ------------
Income tax benefit (expense)......... -- -- 53,000 -- 53,000
-------------- ------------ ------------ ----------- ------------
Income (loss) before minority
interests........................... (1,600,000) (581,000) 412,000 177,000 (1,592,000)
Minority interests in subsidiaries... 2,000 (8,000) -- -- (6,000)
-------------- ------------ ------------ ----------- ------------
Net income (loss).................... $(1,598,000) $ (589,000) $ 412,000 $ 177,000 $(1,598,000)
============== ============ ============ =========== ============
</TABLE>
F-36
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS -- YEAR ENDED
DECEMBER 31, 1995
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL, GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues............................. $ -- $ -- $ 1,108,000 $ -- $ 1,108,000
Cost of Revenues..................... -- -- 619,000 -- 619,000
-------------- ------------ ------------ ----------- ------------
Gross profit......................... -- -- 489,000 -- 489,000
Selling, general and administrative
expenses............................ 712,000 -- 637,000 -- 1,349,000
Depreciation and amortization........ 1,000 -- 47,000 -- 48,000
-------------- ------------ ------------ ----------- ------------
Operating income (loss).............. (713,000) -- (195,000) -- (908,000)
Other income (expense):
Interest, net...................... 217,000 -- 13,000 -- 230,000
Foreign exchange gain (loss)....... -- -- (2,000) -- (2,000)
Other, net......................... -- -- -- -- --
Equity in income (loss) of
subsidiaries...................... (184,000) -- -- 184,000 --
-------------- ------------ ------------ ----------- ------------
Total other income (expense),
net........................... 33,000 -- 11,000 184,000 228,000
-------------- ------------ ------------ ----------- ------------
Income (loss) before income taxes and
minority interests.................. (680,000) -- (184,000) 184,000 (680,000)
Income tax benefit (expense)......... -- -- -- -- --
-------------- ------------ ------------ ----------- ------------
Income (loss) before minority
interests........................... (680,000) -- (184,000) 184,000 (680,000)
Minority interests in subsidiaries... 7,000 -- -- -- 7,000
-------------- ------------ ------------ ----------- ------------
Net income (loss).................... $ (673,000) $ -- $ (184,000) $ 184,000 $ (673,000)
============== ============ ============ =========== ============
</TABLE>
F-37
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS -- SIX MONTHS ENDED JUNE 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 (loss).................. $ 492,000 $ 420,000 $ 839,000 $(1,259,000) $ 492,000
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Provision for doubtful
accounts.................... -- 548,000 8,000 -- 556,000
Depreciation and
amortization................ 279,000 686,000 293,000 -- 1,258,000
Imputed interest on
non-interest bearing notes
payable..................... 20,000 122,000 -- -- 142,000
Minority interests in
subsidiaries' income........ -- 29,000 -- -- 29,000
Equity in income from
subsidiaries................ (1,210,000) -- -- 1,259,000 49,000
Changes in current assets and
current liabilities......... (3,296,000) (760,000) 1,971,000 -- (2,085,000)
-------------- ------------- ------------- ------------- -------------
Net cash provided by (used in)
operating activities........ (3,715,000) (1,045,000) 3,111,000 -- 441,000
-------------- ------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and
equipment........................ -- (2,909,000) (2,787,000) -- (5,696,000)
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) (2,909,000) (2,787,000) -- (16,271,000)
-------------- ------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease
obligations...................... (46,000) -- -- -- (46,000)
Payments on notes payable.......... (444,000) -- -- -- (444,000)
Purchase of treasury stock......... (332,000) -- -- -- (332,000)
Borrowings on line of credit,
net.............................. -- 1,948,000 -- -- 1,948,000
Proceeds from warrants and options
exercised........................ 4,909,000 -- -- -- 4,909,000
Proceeds from issuance of
convertible debt................. 10,000,000 -- -- -- 10,000,000
-------------- ------------- ------------- ------------- -------------
Net cash provided by financing
activities.................. 14,087,000 1,948,000 -- -- 16,035,000
-------------- ------------- ------------- ------------- -------------
Net increase (decrease) in cash
and cash equivalents........ (204,000) 85,000 324,000 -- 205,000
-------------- ------------- ------------- ------------- -------------
Cash and cash equivalents at
beginning of year........... 3,000 4,272,000 459,000 -- 4,734,000
-------------- ------------- ------------- ------------- -------------
Cash and cash equivalents at
end of period............... $ (201,000) $ 4,357,000 $ 783,000 $ -- $ 4,939,000
============== ============= ============= ============= =============
</TABLE>
F-38
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS -- SIX MONTHS ENDED JUNE 30,
1997
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL, GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------ ------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C> <C> <C>
Net income (loss).................. $ 214,000 $1,511,000 $(78,000) $(1,433,000) $ 214,000
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Provision for doubtful
accounts.................... -- 243,000 11,000 -- 254,000
Depreciation and
amortization................ 29,000 112,000 98,000 -- 239,000
Write-off investment in
operating venture........... 196,000 -- -- -- 196,000
Minority interests in
subsidiaries' (income)...... -- (1,000) (3,000) -- (4,000)
Equity in income from
subsidiaries................ (1,433,000) -- -- 1,433,000 --
Changes in other assets and
other liabilities........... 1,078,000 1,079,000 339,000 -- 2,496,000
-------------- ------------ ------------ ------------ ------------
Net cash provided by
operating activities...... 84,000 2,944,000 367,000 -- 3,395,000
-------------- ------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and
equipment........................ (336,000) (236,000) (95,000) -- (667,000)
-------------- ------------ ------------ ------------ ------------
Net cash used in investing
activities..................... (336,000) (236,000) (95,000) -- (667,000)
-------------- ------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease
obligations...................... (45,000) -- -- -- (45,000)
Proceeds from warrants and
options exercised.............. 2,000 -- -- -- 2,000
-------------- ------------ ------------ ------------ ------------
Net cash provided by financing
activities..................... (43,000) -- -- -- (43,000)
-------------- ------------ ------------ ------------ ------------
Net increase (decrease) in cash
and cash equivalents........... (295,000) 2,708,000 272,000 -- 2,685,000
-------------- ------------ ------------ ------------ ------------
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 $2,763,000 $412,000 $ -- $3,180,000
============== ============ ============ ============ ============
</TABLE>
F-39
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS -- YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL, GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBISIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................. $ 2,672,000 $ 4,000,000 $ 565,000 $(4,565,000) $ 2,672,000
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Provision for doubtful
accounts.................... -- 200,000 77,000 -- 277,000
Depreciation and
amortization................ 68,000 301,000 253,000 -- 622,000
Provision for inventory
obsolescence................ -- -- 53,000 -- 53,000
Write-off investment in
operating venture........... 196,000 -- -- -- 196,000
Deferred income tax benefit.... -- (409,000) (1,157,000) -- (1,566,000)
Imputed interest on
non-interest bearing notes
payable..................... -- 136,000 -- -- 136,000
Minority interests in
subsidiaries' income
(loss)...................... (26,000) 20,000 -- -- (6,000)
Equity in income from
subsidiaries................ (4,565,000) -- -- 4,565,000 --
Changes in current assets and
current liabilities......... 101,000 276,000 1,827,000 -- 2,204,000
-------------- ------------- ------------- ------------ ------------
Net cash provided by (used
in) operating activities.. (1,554,000) 4,524,000 1,618,000 -- 4,588,000
-------------- ------------- ------------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and
equipment........................ (8,000) (375,000) (1,299,000) -- (1,682,000)
Acquisition of Integracion, net of
cash acquired.................... -- 117,000 -- -- 117,000
Acquisition of N.S.I., net of cash
acquired......................... -- (49,000) -- -- (49,000)
Investment in BCH Holdings......... (185,000) -- -- -- (185,000)
-------------- ------------- ------------- ------------ ------------
Net cash used in investing
activities.................. (193,000) (307,000) (1,299,000) -- (1,799,000)
-------------- ------------- ------------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease
obligations...................... (104,000) -- -- -- (104,000)
Payments on notes payable.......... (50,000) -- -- -- (50,000)
Proceeds from capital
subscriptions.................... 600,000 -- -- -- 600,000
Proceeds from warrants and options
exercised........................ 1,004,000 -- -- -- 1,004,000
-------------- ------------- ------------- ------------ ------------
Net cash provided by financing
activities.................. 1,450,000 -- -- -- 1,450,000
-------------- ------------- ------------- ------------ ------------
Net increase (decrease) in cash
and cash equivalents........ (297,000) 4,217,000 319,000 -- 4,239,000
-------------- ------------- ------------- ------------ ------------
Cash and cash equivalents at
beginning of year........... 300,000 55,000 140,000 -- 495,000
-------------- ------------- ------------- ------------ ------------
Cash and cash equivalents at
end of year................. $ 3,000 $ 4,272,000 $ 459,000 $ -- $ 4,734,000
============== ============= ============= ============ ============
</TABLE>
F-40
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS -- YEAR ENDED
DECEMBER 31, 1996
<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).................. $(1,598,000) $(589,000) $ 412,000 $ 177,000 $(1,598,000)
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Provision for doubtful
accounts.................... -- -- 9,000 -- 9,000
Depreciation and
amortization................ 1,000 140,000 123,000 -- 264,000
Provision for inventory
obsolescence................ -- -- 55,000 -- 55,000
Deferred income tax benefit.... -- -- (112,000) -- (112,000)
Interest amortized on
discounted investments...... (8,000) -- -- -- (8,000)
Minority interests in
subsidiaries' income
(loss)...................... (2,000) 8,000 -- -- 6,000
Equity in income of
subsidiary.................. 177,000 -- -- (177,000) --
Decrease in minority interests
for credits utilized........ -- -- 53,000 -- 53,000
Changes in current assets and
current liabilities......... (1,272,000) (45,000) (83,000) -- (1,400,000)
-------------- ------------- ------------ ------------- -------------
Net cash provided by (used in)
operating activities........ (2,702,000) (486,000) 457,000 -- (2,731,000)
-------------- ------------- ------------ ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term
investments...................... (4,899,000) -- -- -- (4,899,000)
Redemption of short-term
investments...................... 8,378,000 -- -- -- 8,378,000
Purchases of property and
equipment........................ -- (23,000) (418,000) -- (441,000)
Acquisition of Telereunion, net of
cash acquired.................... (353,000) -- -- -- (353,000)
Investment in joint venture........ (196,000) -- -- -- (196,000)
-------------- ------------- ------------ ------------- -------------
Net cash provided by (used in)
investing activities............. 2,930,000 (23,000) (418,000) -- 2,489,000
-------------- ------------- ------------ ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock........... -- 564,000 -- -- 564,000
-------------- ------------- ------------ ------------- -------------
Net cash provided by financing
activities....................... -- 564,000 -- -- 564,000
-------------- ------------- ------------ ------------- -------------
Net increase in cash and cash
equivalents...................... 228,000 55,000 39,000 -- 322,000
-------------- ------------- ------------ ------------- -------------
Cash and cash equivalents at
beginning of year................ 72,000 -- 101,000 -- 173,000
-------------- ------------- ------------ ------------- -------------
Cash and cash equivalents at end of
year............................. $ 300,000 $ 55,000 $ 140,000 $ -- $ 495,000
============== ============= ============ ============= =============
</TABLE>
F-41
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS -- YEAR ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL, GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBISIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................. $ (673,000) $ -- $ (184,000) $ 184,000 $ (673,000)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and
amortization................ 1,000 -- 47,000 -- 48,000
Interest amortized on
discounted investments...... (64,000) -- -- -- (64,000)
Equity in income of
subsidiaries................ 184,000 -- -- (184,000) --
Minority interests in
subsidiaries' income
(loss)...................... (7,000) -- -- -- (7,000)
Decrease in minority interests
for credits utilized........ 55,000 -- -- -- 55,000
Changes in current assets and
current liabilities......... (31,000) -- (145,000) -- (176,000)
-------------- ------------ ------------ ------------ ------------
Net cash used in operating
activities.................. (535,000) -- (282,000) -- (817,000)
-------------- ------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term
investments...................... (10,944,000) -- -- -- (10,944,000)
Redemption of short-term
investments...................... 11,500,000 -- -- -- 11,500,000
Purchases of property and
equipment........................ -- -- (46,000) -- (46,000)
Purchase of minority interests..... (63,000) -- -- -- (63,000)
Investment in joint venture........ (3,000) -- -- -- (3,000)
-------------- ------------ ------------ ------------ ------------
Net cash provided by (used in)
investing activities........ 490,000 -- (46,000) -- 444,000
-------------- ------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash provided by financing
activities.................. -- -- -- -- --
-------------- ------------ ------------ ------------ ------------
Net decrease in cash and cash
equivalents................. (45,000) -- (328,000) -- (373,000)
-------------- ------------ ------------ ------------ ------------
Cash and cash equivalents at
beginning of year........... 117,000 -- 429,000 -- 546,000
-------------- ------------ ------------ ------------ ------------
Cash and cash equivalents at
end of year................. $ 72,000 $ -- $ 101,000 $ -- $ 173,000
============== ============ ============ ============ ============
</TABLE>
F-42
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. QUARTERLY INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH YEAR
------------ ------------ ------------ ------------ --------------
<S> <C> <C> <C> <C> <C>
1996
Revenues............................. $ 509,000 $ 841,000 $ 1,474,000 $ 2,881,000 $ 5,705,000
Operating loss....................... (210,000) (265,000) (362,000) (921,000) (1,759,000)
Income (loss) before taxes and
minority interests................. (174,000) (186,000) (287,000) (998,000) (1,645,000)
Net loss............................. (181,000) (207,000) (299,000) (911,000) (1,598,000)
Basic EPS............................ $ (0.10) $ (.07) $ (0.08) $ (0.23) $ (0.52)
FIRST SECOND THIRD FOURTH YEAR
------------ ------------ -------------- -------------- --------------
1997
Revenues............................. $ 3,771,000 $ 6,170,000 $ 12,193,000 $ 14,020,000 $ 36,154,000
Operating income (loss).............. (386,000) 696,000 1,169,000 1,503,000 2,982,000
Income (loss) before taxes and
minority interests................. (359,000) 402,000 1,110,000 1,597,000 2,750,000
Net income (loss).................... (324,000) 538,000 1,202,000 1,256,000 2,672,000
Basic EPS............................ $ (0.08) $ 0.14 $ 0.31 $ 0.32 $ 0.68
Diluted EPS(1)....................... n/a $ 0.13 $ 0.22 $ 0.18 $ 0.53
</TABLE>
- ------------
(1) Inclusion of additional shares under a diluted analysis for loss period is
inappropriate due to the anti-dilutive effect.
13. SUBSEQUENT EVENTS (UNAUDITED)
In May 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.
Under the terms of the agreement, Interlink paid cash of $8,154,000,
subject to post-closing adjustments to the purchase price based on changes in
the closing date balance sheet. The purchase was financed with the Convertible
Deere Park Debentures and Gordon Brothers Convertible Debentures.
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
F-43
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 shares 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
F-44
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 a 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 $180,000 for the Deere Park Convertible Debentures and
the Gordon Brothers Convertible Debentures will be 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.
The Company estimated the fair value of the warrants 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.
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.
Under the terms of the restructuring, 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 agreed to repay $1,000,000 of the Deere Park Convertible
Debentures at 107% plus accrued interest.
The Company renegotiated the terms of the revolving credit facility to
provide for borrowings of up to $2.5 million and extended the term of the
facility to July 31, 1999. As of June 30, 1998, the Company had drawn $1.9
million on this facility. The Company has 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 by Telscape USA and MSN and
(ii) waive the defaults under the minimum current ratio, minimize tangible net
worth and prohibition on quarterly loss covenants.
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.
F-45
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 of $22,100, including principal and interest
through July 6, 2003. The lease obligation 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.
In July 1998, the Company 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 September 1998.
In May 1998, one of the Company's wholesale long distance customers filed
for petition for relief under Chapter 11 of the Bankruptcy Code. For the five
months ended May 31, 1998, this customer accounted for approximately 26% of the
Company's wholesale long distance revenues and 7% of the Company's overall
revenues. 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 service to its Prepaid Card
customers by working directly with the underlying carriers, this resulted in the
Company's paying for certain of the telecommunication 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 contributions from
the loss of a wholesale customer, is expected to result in a reduction of
operating income of approximately $2.5 million to $3.0 million in the second
quarter of 1998. This bankruptcy is not expected to have a material impact to
the operating results for the third quarter of 1998.
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.
F-46
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company may also make loans to any option holder in order in order to permit
the option holder to pay the purchase price upon exercise of the option.
On May 1, 1998, the Company agreed to reduce the number of Escrow Shares
required to be sold to the Company, resulting in a reduction in the total number
of Escrow Shares being repurchased to 86,417 Escrow Shares for total
consideration of $873,000, or $10.10 per share. In July 1998, the Company
assigned the rights to purchase 80,257 of the Escrow Shares to Preferred Capital
Markets, Inc. ("Preferred"). In return for the assignment, Preferred paid the
Company $449,000. The Company has no further obligations in connection with the
Escrow Shares.
On July 23, 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 May 1998, Telereunion, S.A. de C.V., 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 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 4,025 kilometer 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.
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. 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 and would likely prevent the
Company from having the ability to repay the Notes.
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 due 2008 and (ii) 3,400,000 shares of the
Company's Common Stock. The consummation of each respective offering is not a
condition precedent to the consummation of the other offering.
F-47
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Integracion de Redes, S.A. de C.V.:
We have audited the accompanying statements of operations and changes in
financial position for the year ended December 31, 1996 of Integracion de Redes,
S.A. de C.V., all expressed in Mexican pesos. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We have conducted our audit in accordance with auditing standards generally
accepted in Mexico, which are substantially the same as those followed in the
United States of America. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall presentation of
the financial statements. We believe that our audit provides a reasonable basis
for our opinion.
As disclosed in Note 1, the financial statements referred to above have
been restated from amounts previously presented to reflect the constant
purchasing power of the Mexican peso at June 30, 1997.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations and changes in financial
position for the year ended December 31, 1996 of Integracion de Redes, S.A. de
C.V., in conformity with generally accepted accounting principles in Mexico.
Accounting principles generally accepted in Mexico vary in certain
important respects from accounting principles generally accepted in the United
States. The application of the latter would have affected the determination of
net income expressed in Mexican pesos for the year ended December 31, 1996 to
the extent summarized in Note 5 to the financial statements.
De Las Fuentes, De La Mora y Valdivia, S.C.
Mexico City
September 6, 1997
F-48
<PAGE>
INTEGRACION DE REDES, S.A. DE C.V.
STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1996
AND THE SIX MONTHS ENDED JUNE 30, 1997 (UNAUDITED)
MEXICAN PESOS (PS) WITH PURCHASING POWER AS OF JUNE 30, 1997 AND U.S. DOLLARS($)
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, 1996 JUNE 30, 1996 JUNE 30, 1997
-------------------------- -------------------------- --------------------------
(NOTE 5) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net sales............................... Ps30,476,000 $ 3,830,000 Ps10,759,000 $ 1,352,000 Ps37,236,000 $ 4,679,000
Cost of sales........................... 20,516,000 2,578,000 6,799,000 854,000 27,552,000 3,462,000
------------- ----------- ------------- ----------- ------------- -----------
Gross profit............................ 9,960,000 1,252,000 3,960,000 498,000 9,684,000 1,217,000
Selling, general and administrative
expenses................................ 6,384,000 802,000 2,332,000 293,000 3,939,000 495,000
------------- ----------- ------------- ----------- ------------- -----------
Operating income........................ 3,576,000 450,000 1,628,000 205,000 5,745,000 722,000
Comprehensive financing expense
(income):
Interest income..................... (505,000) (63,000) -- -- (263,000) (33,000)
(Gain) loss on net monetary
position.......................... (29,000) (4,000) (17,000) (2,000) 223,000 28,000
Loss (gain) on foreign currency
exchange, net..................... 705,000 89,000 (50,000) (6,000) (64,000) (8,000)
------------- ----------- ------------- ----------- ------------- -----------
171,000 22,000 (67,000) (8,000) (104,000) (13,000)
------------- ----------- ------------- ----------- ------------- -----------
Other (income) expense, net............. 26,000 3,000 -- -- (9,000) (1,000)
------------- ----------- ------------- ----------- ------------- -----------
Income before provision for income
taxes................................... 3,379,000 425,000 1,695,000 213,000 5,858,000 736,000
Provision for income taxes.............. 329,000 41,000 163,000 20,000 2,548,000 320,000
------------- ----------- ------------- ----------- ------------- -----------
Net income.............................. Ps 3,050,000 $ 384,000 Ps 1,532,000 $ 193,000 Ps 3,310,000 $ 416,000
============= =========== ============= =========== ============= ===========
Net income per share.................... Ps 6,100 $ 768 Ps 3,064 $ 386 Ps 6,620 $ 832
============= =========== ============= =========== ============= ===========
Average common shares outstanding....... 500 500 500 500 500 500
============= =========== ============= =========== ============= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-49
<PAGE>
INTEGRACION DE REDES, S.A. DE C.V.
STATEMENTS OF CHANGES IN FINANCIAL POSITION
FOR THE YEAR ENDED DECEMBER 31, 1996
AND THE SIX MONTHS ENDED JUNE 30, 1997 (UNAUDITED)
MEXICAN PESOS (PS) WITH PURCHASING POWER AS OF JUNE 30, 1997 AND U.S DOLLARS ($)
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, 1996 JUNE 30, 1996 JUNE 30, 1997
------------------------ ------------------------- ---------------------------
(NOTE 5) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
--------- ------------- --------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS:
Net income....................... Ps3,050,000 $ 384,000 Ps1,532,000 $ 193,000 Ps3,310,000 $ 416,000
Depreciation and amortization.... 238,000 29,000 73,000 9,000 160,000 20,000
Net change in accounts
receivable,
inventories, accounts payable
and other...................... (186,000) (23,000) (1,670,000) (210,000) (3,592,000) (451,000)
------------ --------- ------------- --------- ------------ -----------
Funds provided by (used in)
operations..................... 3,102,000 390,000 (65,000) (8,000) (122,000) (15,000)
------------ --------- ------------- --------- ------------ -----------
FINANCING:
Dividends paid................... -- -- -- -- (1,430,000) (180,000)
Recognition of the effects of
inflation...................... (889,000) (112,000) (889,000) (112,000) -- --
------------ --------- ------------- --------- ------------ -----------
Funds used by financing
activities..................... (889,000) (112,000) (889,000) (112,000) (1,430,000) (180,000)
------------ --------- ------------- --------- ------------ -----------
INVESTMENT:
Acquisition of equipment......... (638,000) (80,000) (196,000) (25,000) (183,000) (23,000)
------------ --------- ------------- --------- ------------ -----------
Funds used by investment
activities..................... (638,000) (80,000) (196,000) (25,000) (183,000) (23,000)
------------ --------- ------------- --------- ------------ -----------
Increase (decrease) in cash and cash
equivalents........................ 1,575,000 198,000 (1,150,000) (145,000) (1,735,000) (218,000)
Cash and cash equivalents at
beginning of year.................. 2,539,000 319,000 3,232,000 406,000 4,114,000 517,000
------------ --------- ------------- --------- ------------ -----------
Cash and cash equivalents at end of
year............................... Ps4,114,000 $ 517,000 Ps2,022,000 $ 261,000 Ps2,379,000 $ 299,000
============ ========= ============= ========= ============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-50
<PAGE>
INTEGRACION DE REDES, S.A. DE C.V.
NOTES TO THE FINANCIAL STATEMENTS
MEXICAN PESOS (PS) WITH PURCHASING POWER AS OF JUNE 30, 1997 AND U.S. DOLLARS
($)
NOTE 1 THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES:
Integracion de Redes, S.A. de C.V. (the "Company") is a Mexican
corporation engaged in the distribution and sale of voice, data and networking
equipment and provides value-added services in network integracion.
REVENUE RECOGNITION
Revenue from data and network integration value-added services are
recognized when services are performed.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company's management did not consider an allowance for doubtful
accounts necessary since the Company's history shows a minimum percentage of
uncollectible accounts.
INVENTORIES
Inventories consist principally of telecommunications equipment acquired
from manufacturers for distribution and are stated at the lower of cost
(first-in, first-out) or market.
EMPLOYEE PROFIT SHARING
Salaries and other labor related benefits are taxed at 2%. The Company has
2,000 Mexican pesos in employee profit sharing payable at December 31, 1996.
EARNINGS PER SHARE OF COMMON STOCK
Earnings per share of common stock have been computed by dividing the
results applicable to common shareholders by the weighted average number of
shares outstanding, after giving retroactive effect to the stock split and
subscription price adjustment disclosed in Note 11. The Company does not have
effects from potential dilution of securities.
INFLATION ACCOUNTING
The accompanying financial statements as of December 31, 1996 have been
prepared in accordance with the stipulations of Bulletin B-10 "Recognition of
the Effects of Inflation on Financial Information", as amended, issued by the
Mexican Institute of Public Accountants, A.C. Therefore, these statements are
expressed in Mexican pesos with purchasing power as of June 30, 1997, as
determined by applying factors derived from the National Consumer Price Index
(NCPI) published by Banco de Mexico in accordance with Mexican GAAP.
The accounts affected by the recognition of inflation include inventories,
income statement accounts, property and equipment and stockholders' equity.
INTERIM FINANCIAL STATEMENTS
The financial statements at June 30, 1997 and for the six months ended June
30, 1997 are unaudited. In the opinion of management, the unaudited financial
statements at June 30, 1997 and for the six months ended June 30, 1997, include
all normal recurring adjustments necessary for a fair presentation of the
results of operations and changes in financial position for such period. Results
of operations for the interim periods are not necessarily indicative of results
to be expected for the full year.
MANAGEMENT'S ESTIMATES AND ASSUMPTIONS
The accompanying financial statements are prepared in conformity with
generally accepted accounting principles in Mexico which requires management to
make estimates and assumptions that effect the
F-51
<PAGE>
INTEGRACION DE REDES, S.A. DE C.V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. 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.
NOTE 2 PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and is restated to reflect
inflation derived from the NCPI and utilizing the purchase date as the base
year. The cost of major renewals and betterments is capitalized; repairs and
maintenance costs are expensed when incurred. Upon retirement or sale, the cost
of the assets disposed of and the related accumulated depreciation are removed
from the accounts, with any resultant gain or loss being reflected in the
statement of operations. Depreciation of property and equipment for financial
reporting purposes is computed using the straight-line method over the estimated
useful lives of the assets. Leasehold improvements and capital leases are
amortized over the lesser of the life of the lease or the useful life of the
asset.
NOTE 3 FOREIGN SUPPLIERS
As of December 31, 1996 the Company owed Northern Telecom, a U.S. Company,
$36,000 U.S. dollars.
NOTE 4 DIVIDENDS
Dividend distributions are subject to income tax charged to the Company
when the distributions are not made from net taxable income in retained earnings
as defined in Mexican tax law.
NOTE 5 SIGNIFICANT DIFFERENCES BETWEEN MEXICAN AND U.S. GAAP
The financial statements of the Company are presented on the basis of
accounting principles generally accepted in Mexico (Mexican GAAP).
Except for inflation accounting, Mexican GAAP are, in general terms,
similar to the accounting principles generally accepted in the United States (US
GAAP). However, there are other areas in which Mexican accounting standards and
practices differ from the requirements of US GAAP.
The principal differences between Mexican GAAP and US GAAP applicable to
the Company are as follows:
RECOGNITION OF THE EFFECTS OF INFLATION ON FINANCIAL INFORMATION:
The provisions of Bulletin B-10, as amended, relating to the recognition of
the effects of inflation in the financial statements, have no counterparts under
US GAAP. However, as Mexican GAAP includes the effects of inflation in the
primary financial statements, the US Securities and Exchange Commission does not
require the reversal of the restatement of the financial statements to recognize
the effects of inflation.
DEFERRED INCOME TAXES:
Under Mexican GAAP, deferred income taxes and compulsory profit sharing to
employees are provided on the liability method only for non-recurring and
identifiable book and tax differences that are expected to reverse over a
definite period of time. Under US GAAP, deferred taxes are recognized for the
tax consequences of all temporary differences, both recurring and nonrecurring,
between the financial statement carrying amounts and the tax basis of existing
assets and liabilities.
F-52
<PAGE>
INTEGRACION DE REDES, S.A. DE C.V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
CONVENIENCE STATEMENTS:
The US dollar amounts, denoted by the symbol $, shown in the financial
statements have been included solely for the convenience of the reader and were
translated from Mexican pesos at the rate quoted by Bank of Mexico for June 30,
1997 of 7.9577 pesos per US dollar. Such translation should not be construed as
a representation that the Mexican peso amounts have been or could be converted
into US dollars at this or any other rate.
STATEMENT OF CHANGES IN FINANCIAL POSITION:
Under Mexican GAAP, the Company presents statements of changes in financial
position in constant Mexican pesos. This presentation identifies the generation
and application of resources representing differences between beginning and
ending financial statement balances in constant Mexican pesos.
The changes in the financial statement balances included in this statement
constitute cash flow activity stated in constant Mexican pesos (including
monetary gains which are considered cash gains in the financial statements
presented in constant Mexican pesos.)
PERSONNEL COMPENSATION AND SENIORITY PREMIUMS:
Under Mexican GAAP, vacation expense is recognized when taken rather than
in the period it is earned by the employee, as is required under U.S. GAAP.
The Company has no pension plan. Seniority premiums are established based
upon actuarial studies, which is similar in concept to the U.S. GAAP criteria of
SFAS 87, "Employees' Accounting for Pensions".
NOTE 6 SUBSEQUENT EVENTS (UNAUDITED)
Effective July 1, 1997, pursuant to a stock purchase agreement, all the
outstanding shares of the Company were sold. Under the terms of the transaction,
the selling shareholders received the following: i) the sum of $130,000 in cash,
ii) an aggregate of $2,201,000 in non-interest bearing promissory notes maturing
at various dates through January 1, 2001, iii) an aggregate of $999,000 in
non-interest bearing convertible notes maturing on September 1, 1999, which are
convertible into 333,000 shares of common stock of the acquiring company at a
price of $3.00 per share, representing the quoted market price of the acquiring
company common stock on the date of the transaction, iv) warrants for the
purchase of up to 100,000 shares of common stock of the acquiring company based
on the Company meeting certain performance requirements and v) a covenant by the
Purchasers to pay $280,000 in the event that the Company meets certain
performance requirements over the cumulative periods beginning January 1, 1997
and ending December 31, 2000. During the year ended December 1, 1997, certain
performance requirements were met resulting in 80,000 warrants vesting. In
addition in July 1998, holders of the convertible notes converted these notes
into 333,000 shares of common stock of the acquiring company.
F-53
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders of
MSN Communications, Inc.
We have audited the accompanying balance sheet of MSN Communications, Inc.
as of December 31, 1997, and the related statements of operations and
accumulated deficit and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statements presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above presents fairly,
in all material respects, the financial position of MSN Communications, Inc., at
December 31, 1997, and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
BDO SEIDMAN, LLP
Houston, Texas
March 6, 1998
F-54
<PAGE>
MSN COMMUNICATIONS, INC.
BALANCE SHEET
DECEMBER 31,
1997
------------
ASSETS
Current Assets:
Cash............................ $ 977,000
Accounts receivable............. 1,042,000
Inventories..................... 14,000
Prepaid expenses and other...... 19,000
------------
Total current assets....... 2,052,000
Property and equipment, less
accumulated depreciation....... 6,000
Other assets.................... 52,000
------------
Total assets............... $ 2,110,000
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable................ $ 940,000
Deferred revenue................ 1,997,000
Excise tax payable.............. 283,000
Commissions Payable............. 100,000
------------
Total current
liabilities............... 3,320,000
------------
Commitments and Contingencies
Stockholders' deficit:
Common stock, no par; 100,000
shares authorized, 10,000
shares issued and
outstanding.................... 20,000
Accumulated deficit........... (1,230,000)
------------
Total stockholders'
deficit................... (1,210,000)
------------
Total liabilities and
stockholders' deficit..... $ 2,110,000
============
See accompanying notes to financial statements.
F-55
<PAGE>
MSN COMMUNICATIONS, INC.
STATEMENT OF OPERATIONS AND ACCUMULATED DEFICIT
YEAR ENDED
DECEMBER 31,
1997
------------
Revenues............................. $ 24,568,000
Cost of revenues..................... 24,241,000
------------
Gross profit......................... 327,000
Selling, general and administrative
expenses........................... 1,246,000
Depreciation and amortization........ 35,000
------------
Operating loss....................... (954,000)
Other expense:
Interest expense................ (1,000)
Other........................... (2,000)
------------
Total other expense, net... (3,000)
------------
Net Loss............................. $ (957,000)
------------
Accumulated Deficit, beginning of
year............................... (273,000)
------------
Accumulated Deficit, end of year..... $ (1,230,000)
============
Loss per share
Basic........................... $ (95.75)
Diluted......................... n/a
Weighted average shares outstanding:
Basic........................... 10,000
Diluted......................... n/a
See accompanying notes to financial statements.
F-56
<PAGE>
MSN COMMUNICATIONS, INC.
STATEMENT OF CASH FLOWS
YEAR ENDED
DECEMBER 31,
1997
------------
Cash Flows From Operating Activities:
Net loss........................ $ (957,000)
Adjustments to reconcile net
loss to net cash provided by
operating activities:
Bad debt expense........... 13,000
Depreciation and
amortization.............. 35,000
Changes in assets and
liabilities:
Accounts receivable... (1,007,000)
Inventories........... (14,000)
Prepaid expenses and
other assets......... 5,000
Accounts payable...... 988,000
Deferred revenue...... 1,497,000
Excise tax payable.... 283,000
Commissions payable... 100,000
------------
Net cash
provided by
operating
activities..... 943,000
Net Cash Flows Used In Investing
Activities:
Purchases of fixed assets....... (25,000)
Net Cash Flows Used In Financing
Activities:
Repayment of related party
debt........................... (56,000)
------------
Net increase in cash................. 862,000
Cash at beginning of year............ 115,000
------------
Cash at end of year.................. $ 977,000
============
Supplemental Cash Flow Disclosures:
Interest paid................... $ 5,000
============
See accompanying notes to financial statements.
F-57
<PAGE>
MSN COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 -- THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
MSN Communications, Inc. ("the Company") was incorporated in the state of
California on May 6, 1996. The Company's operations consist of sales of
international and domestic long distance telecommunications services, primarily
through the marketing of prepaid phone cards. The Company targets mainly the
Hispanic community and markets its cards to a network of distributors who sell
the cards in over one hundred cities throughout the United States. The Company's
primary markets are located in Texas, California, and Illinois.
SIGNIFICANT ACCOUNTING POLICIES
FEDERAL INCOME TAX
The stockholders of the Company elected to be taxed under the "S"
Corporation provision of the Internal Revenue Code, whereby the Company's
operating results are reported in the individual tax returns of the
stockholders. Therefore, no provision has been made for federal income taxes in
the financial statements. Ordinarily presented in connection with the
acquisition of an S-corporation by an SEC reporting entity, see Note 7, proforma
disclosures to reflect the Company's results of operations as if the Company was
a C corporation for federal income tax purposes are not necessary as the Company
operated at a loss for the year. A valuation allowance would have been recorded
on deferred tax assets resulting from net operating loss carryforwards resulting
in a net income tax provision of zero.
MANAGEMENT'S ESTIMATES AND ASSUMPTIONS
The accompanying financial statements are prepared in conformity with
generally accepted accounting principles which requires management to make
estimates and assumptions that effect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. 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.
REVENUE RECOGNITION AND DEFERRED REVENUE
The Company recognizes revenue from long distance telecommunications
services at the time of customer usage. The Company recognizes deferred revenue
as its prepaid phone cards are shipped. The primary costs associated with
revenue-producing activities are carrier costs for transport of traffic
generated by use of the prepaid phone cards. The Company has entered into an
arrangement with a third party whereby this party provides the long distance
telecommunications services for the cards the Company sells at a fixed cost. The
Company recognizes revenues from the sale of cards under this agreement at time
of shipment.
ANALYSIS FOR IMPAIRMENT
In accordance with SFAS 121, "ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED
ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF," management reviews
long-lived assets for impairment whenever events or changes in circumstances
indicate the carrying amount of an asset may not be fully recoverable.
EARNINGS (LOSS) PER SHARE
In February 1997, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 128, Earnings Per Share. SFAS 128 is effective for the year
ended December 31, 1997. SFAS 128 simplifies the standards required under
current accounting rules for computing earning per share and replaces the
F-58
<PAGE>
MSN COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
presentation of primary earnings per share and fully diluted earnings per share
with a presentation of basic earnings per share ("basic EPS") and diluted
earnings per share ("diluted EPS"). A diluted earnings per share presentation
is not required because MSN has not issued any dilutive potential securities.
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards 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
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.
Statement of Financial Accounting Standards 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 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 130 and 131 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 are not expected to
have a material affect on the Company's financial statement disclosures.
NOTE 2 -- PROPERTY AND EQUIPMENT
Major classes of property and equipment at December 31, together with their
estimated useful lives, consisted of the following:
ESTIMATED
USEFUL LIVES
AMOUNT (YEARS)
-------- ------------
Equipment............................ $ 27,000 5
Furniture and fixtures............... 1,000 7
--------
28,000
Less accumulated depreciation........ (22,000)
--------
Net property and equipment........... $ 6,000
========
NOTE 3 -- OTHER ASSETS
Other Assets consists of capitalized organizational costs and design costs.
These costs are being amortized over 5 years utilizing the straight line method.
At December 31, 1997, organizational costs totaled $36,000, net of accumulated
amortization of $14,500 and design costs totaled $16,000, net of accumulated
amortization of $4,000. For the year ended December 31, 1997, amortization
expense for the year ended December 31, 1997 totaled $16,000.
NOTE 4 -- CONCENTRATION OF CREDIT RISK
At December 31, 1997, the Company's cash in a financial institution
exceeded the federally insured deposit limit by $857,000. The Company's credit
risks primarily consist of accounts receivable from its distributors. Management
performs ongoing credit valuations of its distributors and provides allowances
for
F-59
<PAGE>
MSN COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
credit losses when necessary. Significant customers are those that represent
greater than 10% of the Company's revenue. For the year ended December 31, 1997,
three customers represented 21%, 20% and 13% of the Company's revenues,
respectively. At December 31, 1997, the outstanding receivables from these
customers were $233,000, $374,000 and $236,000, respectively.
NOTE 5 -- RELATED PARTY TRANSACTIONS
During the year ended December 31, 1997, the Company paid commissions to
its two shareholders totaling $388,000. At December 31, 1997, an additional
$100,000 of commissions were accrued.
During the year ended December 31, 1997, the Company repaid notes payable
and accrued interest to shareholders totaling $52,000 and $5,000, respectively.
NOTE 6 -- COMMITMENTS AND CONTINGENCIES
The Company leases certain automobiles and office space under
noncancellable operating leases. Future minimum rental payments follow:
YEAR ENDED
DECEMBER 31, AMOUNT
------------- -------
1998............................... $35,000
1999............................... 34,000
2000............................... 26,000
-------
Total.............................. $95,000
=======
For the year ended December 31, 1997, rent expense totalled approximately
$50,000.
The Company is subject to regulation by various government agencies and
jurisdictions and believes it is in compliance with all applicable laws and
regulations. However, implementation and interpretation of the
Telecommunications Act of 1996 (the Act) is ongoing and subject to litigation by
various Federal and state agencies and courts. As a result, the impact of the
Act on the Company is not yet completely determinable and future interpretations
and rulings may impact the financial position and results of operations of the
Company.
The taxation of prepaid phone cards is evolving and is not specifically
addressed by many of the states in which the Company does business. While the
Company believes it has adequately provided for any such excise taxes it may
ultimately be required to pay, certain states may enact legislation which
specifically provide for taxation of such cards or may interpret current laws in
a manner resulting in additional tax liabilities.
During the fourth quarter 1997, the Internal Revenue Service issued a
ruling stating that sellers of prepaid phone cards are subject to a 3% federal
excise tax on the gross amount of cards sold. The Company accrued $283,000
relating to excise taxes for cards sold from the date of the ruling.
NOTE 7 -- SUBSEQUENT EVENTS
On January 22, 1998, the shareholders of the Company entered into a
transaction whereby they sold all of the Company's outstanding stock to Telscape
International, Inc. ("Telscape") in exchange for $3,250,000 in cash, $750,000
in non-interest bearing promissory notes, and 100,000 shares of stock in the
acquiring company. The sale became effective as of January 1, 1998.
In May 1998, one of Telscape's wholesale long distance customers filed for
petition for relief under Chapter 11 of the Bankruptcy Code. An affiliate of
this customer provided switching services, the Prepaid Card platform and
arranged for other carriers to provide telecommunications services for the
Company. Because the Company had paid the affiliate of this customer for these
services at the time the Prepaid Cards
F-60
<PAGE>
MSN COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
were activated, this resulted in the Company's paying for certain of the
telecommunication services on the Prepaid Cards a second time. The overall
impact of the bankruptcy filing to Telscape's earnings, including additional
Prepaid Card services costs, the write-off of uncollectible receivables and the
lost margin contributions from the loss of a wholesale customer, is expected to
result in a reduction of Telscape's operating income of approximately $2.5
million to $3.0 million in the second quarter of 1998. This bankruptcy is not
expected to have a material impact to Telscape's or the Company's operating
results for the third quarter of 1998.
F-61
<PAGE>
NO DEALER, SALESPERSON, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THE OFFER
CONTAINED HEREIN OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL
OR THE SOLICITATION OF ANY OFFER TO BUY ANY SECURITY OTHER THAN THOSE TO WHICH
IT RELATES, NOR DOES IT CONSTITUTE AN OFFER TO SELL, OR THE SOLICITATION OF AN
OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF NOR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
PAGE
----
Prospectus Summary................... 1
Risk Factors......................... 6
Use of Proceeds...................... 22
Dividend Policy...................... 22
Price Range of Common Stock.......... 22
Capitalization....................... 23
Unaudited Pro Forma Condensed
Consolidated Financial
Statements......................... 24
Selected Consolidated Financial and
Other Data......................... 28
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 30
Business............................. 42
Management........................... 63
Certain Relationships and Related
Transactions....................... 73
Principal Stockholders............... 73
Description of Capital Stock......... 75
Summary of Certain Indebtedness...... 78
United States Federal Income Tax
Considerations for Non-U.S. Holders
of Common Stock.................... 82
Selling Stockholders................. 85
Plan of Distribution................. 85
Legal Matters........................ 87
Experts.............................. 87
Index to Financial Statements........ F-1
910,430 SHARES
TELSCAPE
INTERNATIONAL, INC.
COMMON STOCK
----------------------
PROSPECTUS
----------------------
November 9, 1998
