AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 30, 1998
REGISTRATION STATEMENT NO.
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
TELSCAPE INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C> <C> <C>
2700 POST OAK BLVD.,
SUITE 1000
HOUSTON, TEXAS 77056
TEXAS 4813 75-2433637 (713) 968-0968
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER (ADDRESS, INCLUDING ZIP
JURISDICTION OF INDUSTRIAL IDENTIFICATION NUMBER) CODE, AND TELEPHONE
INCORPORATION OR CLASSIFICATION CODE NUMBER, INCLUDING AREA
ORGANIZATION) NUMBER) CODE, OF REGISTRANT'S
PRINCIPAL EXECUTIVE
OFFICES)
</TABLE>
MSN COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C> <C> <C>
230 SECOND ST., SUITE 102
ENCINITAS, CALIFORNIA
92024
CALIFORNIA 4813 33-0707658 (760) 635-1886
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER (ADDRESS, INCLUDING ZIP
JURISDICTION OF INDUSTRIAL IDENTIFICATION NUMBER) CODE, AND TELEPHONE
INCORPORATION OR CLASSIFICATION CODE NUMBER, INCLUDING AREA
ORGANIZATION) NUMBER) CODE, OF REGISTRANT'S
PRINCIPAL EXECUTIVE
OFFICES)
</TABLE>
COPY TO:
TELSCAPE USA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C> <C> <C>
2700 POST OAK BLVD.,
SUITE 1000
HOUSTON, TEXAS 77056
TEXAS 4813 76-049907 (713) 968-0968
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER (ADDRESS, INCLUDING ZIP
JURISDICTION OF INDUSTRIAL IDENTIFICATION NUMBER) CODE, AND TELEPHONE
INCORPORATION OR CLASSIFICATION CODE NUMBER, INCLUDING AREA
ORGANIZATION) NUMBER) CODE, OF REGISTRANT'S
PRINCIPAL EXECUTIVE
OFFICES)
</TABLE>
TELEREUNION, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
COPY TO:
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<S> <C> <C> <C>
2700 POST OAK BLVD.,
SUITE 1000
HOUSTON, TEXAS 77056
DELAWARE 4813 76-0467511 (713) 968-0968
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER (ADDRESS, INCLUDING ZIP
JURISDICTION OF INDUSTRIAL IDENTIFICATION NUMBER) CODE, AND TELEPHONE
INCORPORATION OR CLASSIFICATION CODE NUMBER, INCLUDING AREA
ORGANIZATION) NUMBER) CODE, OF REGISTRANT'S
PRINCIPAL EXECUTIVE
OFFICES)
TSCP INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
2700 POST OAK BLVD.,
SUITE 1000
HOUSTON, TEXAS 77056
TEXAS 4813 76-0577773 (713) 968-0968
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER (ADDRESS, INCLUDING ZIP
JURISDICTION OF INDUSTRIAL IDENTIFICATION NUMBER) CODE, AND TELEPHONE
INCORPORATION OR CLASSIFICATION CODE NUMBER, INCLUDING AREA
ORGANIZATION) NUMBER) CODE, OF REGISTRANT'S
PRINCIPAL EXECUTIVE
OFFICES)
</TABLE>
TODD M. BINET
CHIEF FINANCIAL OFFICER
TELSCAPE INTERNATIONAL, INC.
2700 POST OAK BOULEVARD, SUITE 1000
HOUSTON, TEXAS 77056
(713) 968-0968
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
COPIES TO:
MORRIS F. DEFEO, JR., ESQ. WILLIAM B. GANNETT, ESQ.
SWIDLER & BERLIN, CHARTERED CAHILL GORDON & REINDEL
3000 K STREET, N.W., SUITE 300 80 PINE STREET
WASHINGTON, D.C. 20007 NEW YORK, NEW YORK 10005
(202) 424-7500 (212) 701-3000
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon
as practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(e)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: [ ]
------------------------
CALCULATION OF REGISTRATION FEE
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- -----------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF AGGREGATE AGGREGATE OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED OFFERING PRICE PRICE PER NOTE REGISTRATION FEE
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Senior Notes due 2008........... $125,000,000 $1,000 $36,875
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
</TABLE>
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
================================================================================
<PAGE>
******************************************************************************
* *
* INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A *
* REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED *
* WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT *
* BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE *
* REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT *
* CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR *
* SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH *
* OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR *
* QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. *
* *
******************************************************************************
SUBJECT TO COMPLETION, DATED JULY 30, 1998
PROSPECTUS
[LOGO]
$125,000,000
TELSCAPE INTERNATIONAL, INC.
% SENIOR NOTES DUE 2008
------------------------
Telscape International, Inc., a Texas corporation ( the "Company"), is
hereby offering (the "Notes Offering") $125.0 million aggregate principal
amount of its % Senior Notes due 2008 (the "Notes"). Concurrently with this
Notes Offering, the Company intends to offer 3.4 million shares of common stock,
$.001 par value per share (the "Common Stock"), of the Company, representing
an estimated $47.6 million in gross proceeds (assuming no exercise of the
Underwriters' over-allotment option and assuming a price of $14.00 per share),
by a separate registration statement and prospectus (the "Equity Offering,"
and together with this Notes Offering, the "Offerings"). The consummation of
the Equity Offering is not a condition precedent to the consummation of this
Notes Offering. The Notes will mature on , 2008 and will bear
interest at the rate of % per annum. Interest on the Notes will be payable
semi-annually on and of each year commencing , 1999.
The Notes will be redeemable, in whole or in part, at the option of the
Company on or after , 2003, at the redemption prices set forth herein,
plus accrued and unpaid interest to the date of redemption. In addition, at any
time 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 cash proceeds of one or more Public Equity Offerings (as defined), at a
redemption price equal to % of the aggregate principal amount thereof, plus
accrued and unpaid interest, if any, to the date of redemption; PROVIDED,
HOWEVER, that after giving effect to any such redemption, at least 65% of the
aggregate principal amount of the Notes originally issued remains outstanding.
In the event of a Change of Control (as defined), each holder of the Notes
will have the right to require the Company to repurchase such holder's Notes at
a price equal to 101% of the aggregate principal amount thereof, plus accrued
and unpaid interest, if any, to the date of purchase. In addition, the Company
will be obligated to offer to repurchase the Notes at 100% of the aggregate
principal amount thereof, plus accrued and unpaid interest, if any, to the date
of purchase in the event of certain Asset Sales (as defined). See "Description
of the Notes."
The Notes will be general unsecured obligations of the Company and will be
PARI PASSU in right of payment to existing and future senior unsecured
indebtedness of the Company. The Notes will be effectively subordinated to all
secured indebtedness of the Company and its subsidiaries to the extent of the
assets securing such indebtedness. The Notes will be unconditionally guaranteed
(the "Guarantees") by all of the Company's wholly-owned U.S. subsidiaries (the
"Guarantors"). The Guarantees will be general unsecured obligations of the
Guarantors and will be PARI PASSU in right of payment to all existing and future
senior unsecured indebtedness of each Guarantor. The Guarantees will be
subordinated to secured indebtedness of the Guarantors to the extent of the
assets securing such indebtedness. As of March 31, 1998, after giving effect to
the Notes Offering, the Company would have had approximately $126.2 million of
senior indebtedness outstanding, of which $0.2 million would have been secured,
and the Guarantors would have had approximately $3.2 million (exclusive of the
Guarantees of the Notes) of senior indebtedness outstanding, of which $0.7
million would have been secured.
There is no existing market for the Notes, and there can be no assurance as
to the liquidity of any market that may develop for the Notes, the ability of
the holders of the Notes to sell such Notes or the price at which such holders
would be able to sell their Notes. The Company does not intend to apply for
listing of the Notes on any securities exchange. See "Risk Factors -- Absence
of Public Market."
------------------------
SEE "RISK FACTORS," BEGINNING ON PAGE 8, FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED IN EVALUATING AN INVESTMENT IN THE NOTES.
------------------------
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.
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PRICE PROCEEDS
TO UNDERWRITING TO THE
PUBLIC(1) DISCOUNTS(2) COMPANY(3)
- -------------------------------------------------------------------------------------------------------------------
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Per Note................................ % % %
- -------------------------------------------------------------------------------------------------------------------
Total................................... $ $ $
==================================================================================================================
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(1) Plus accrued interest, if any, from the date of original issuance of the
Notes.
(2) The Company and the Guarantors have agreed to idemnify the Underwriters (as
defined) against certain liabilities, including liabilities under the
Securities Act of 1933, as amended (the "Securities Act"). See
"Underwriting."
(3) Before deducting expenses of the Notes Offering payable by the Company
estimated at $ .
------------------------
The Notes are being offered, subject to prior sale, when, as and if
delivered to and accepted by BT Alex. Brown Incorporated and Lehman Brothers
Inc. (the "Underwriters"), and subject to approval of certain legal matters by
counsel for the Underwriters and certain other conditions. It is expected that
delivery of the Notes will be made in New York, New York on or about ,
1998.
BT ALEX. BROWN LEHMAN BROTHERS
------------------------
The date of this Prospectus is , 1998.
<PAGE>
CERTAIN PERSONS PARTICIPATING IN THIS NOTES OFFERING MAY ENGAGE IN
TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE
NOTES. SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION WITH THE
NOTES OFFERING, MAY BID FOR AND PURCHASE NOTES IN THE OPEN MARKET AND MAY IMPOSE
PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
------------------------
i
<PAGE>
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 Securities and Exchange Commission
(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."
ii
<PAGE>
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 under the TELEFIESTA
(Registered Trademark) 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 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").
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 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."
1
<PAGE>
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:
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
Asynchronous Transfer Mode ("ATM") technologies and additional fiber
optic and satellite transmission capacity for the provision of
international and domestic voice, video and data services. In the next
18 months, Telscape intends to invest approximately $152.0 million for
infrastructure, including approximately $137.0 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 Communications, Inc. ("MSN"), a leading
provider of prepaid telephone calling cards ("Prepaid Cards"),
positions the Company for expanded growth in the retail sector of the
international telecommunications market. The Company intends to deploy
or purchase 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.
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
2
<PAGE>
data and systems integration businesses in Mexico and a U.S.-based
reseller of long distance services. See "-- Recent Developments" and
"Risk Factors -- Risks Associated with Acquisitions, Investments and
Strategic Alliances."
o BUILD BRAND AWARENESS. The Company seeks to build brand awareness of
its TELEFIESTA (Registered Trademark) and TELEREUNION brands.
Management believes that it will be able to continue building customer
awareness of its TELEFIESTA (Registered Trademark) brand name through
sales of its TELEFIESTA (Registered Trademark) Prepaid Cards to its
United States customers as it opens new international long distance
markets throughout Latin America. In addition, the Company intends to
distribute its TELEFIESTA (Registered Trademark) 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.
RECENT DEVELOPMENTS
In June 1998, Telereunion S.A. received the Mexican Concession, allowing it
to construct and operate a network over which the Company can carry long
distance traffic in Mexico. The Company, through certain of its Mexican
subsidiaries, has been authorized to provide data and other value-added services
in Mexico. Telereunion S.A. is an affiliate of the Company in which the Company
owns approximately 65% of the economic interests and 49% of the voting
interests. In addition, three directors of the Company own an additional 18% of
the voting interests and 2% of the economic interests in Telereunion S.A.,
resulting in the Company and such directors together controlling 67% of the
economic interests and voting interests of Telereunion S.A. Under Mexican law,
foreign investors may own more than a majority of the economic interests in a
Concessionaire (as defined) but may not own more than 49% of the voting
ownership of any Concessionaire. The Company believes that the Mexican
Concession will allow it to enhance service offerings to business customers in
Mexico while reducing its cost of terminating international traffic in Mexico.
In May 1998, the Company acquired California Microwave Services Division,
Inc. ("CMSD"), a subsidiary of California Microwave, Inc., for $8.2 million in
cash subject to certain post-closing adjustments (the "CMSD Acquisition"). As
part of the CMSD Acquisition, the Company formed INTERLINK Communications, Inc.
("INTERLINK") to acquire CMSD. The primary asset of INTERLINK is a teleport
facility in Mountain View, California. The Company believes that the CMSD
Acquisition enhances its position as an integrated telecommunications provider
and helps assure satellite capacity in its targeted markets in Latin America.
In May 1998, the Company issued $4.0 million in Deere Park Convertible
Debentures (as defined) and $5.0 million in Gordon Brothers Convertible
Debentures (as defined). In June 1998, the Company issued an additional $1.0
million in Deere Park Convertible Debentures. Approximately $8.2 million of the
proceeds from the Deere Park Convertible Debentures and the Gordon Brothers
Convertible Debentures was used in connection with the CMSD Acquisition, and the
remainder was used for capital investments and general working capital purposes.
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 long distance revenues and 7% of the Company's overall
revenues. Additionally, an affiliate of the customer provided switching services
and the Company's Prepaid Card platform and arranged for other carriers to
provide telecommunications services for the Company's Prepaid Cards. The Company
had paid the affiliate of the customer for the telecommunications services at
the time the Prepaid Cards were activated. 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 earnings, including additional Prepaid Card
service costs, the write-off
3
<PAGE>
of uncollectible receivables and the lost margin contribution from the loss of a
wholesale long distance 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 adverse
impact to the Company's operating results for the third quarter of 1998 and the
lost revenues from this customer have been replaced.
In March 1998, the Company acquired a license and access code from the
government of El Salvador to provide inbound and outbound international long
distance and certain other telecommunications services.
In January 1998, Telscape acquired MSN, a leading provider of Prepaid Cards
that are marketed under the TELEFIESTA (Registered Trademark) brand name
primarily to Hispanic consumers residing in the United States. The acquisition
enhances Telscape's long distance business profile by establishing a retail
platform for its international long distance services and enhancing its ability
to market additional products and services to Hispanic customers.
THE EQUITY OFFERING
Concurrently with this Notes Offering, the Company intends to offer 3.4
million shares of Common Stock, representing an estimated $47.6 million in gross
proceeds based on a price per share of $14.00 and certain stockholders of the
Company ("Selling Stockholders") intend to offer 240,000 shares of Common
Stock pursuant to a separate registration statement and prospectus. The Company
has granted the Underwriters a 30-day option to purchase up to 546,000
additional shares of Common Stock from the Company on the same terms and
conditions, solely to cover over-allotments, if any. The consummation of the
Equity Offering is not a condition precedent to the consummation of the Notes
Offering, and the consummation of the Notes Offering is not a condition
precedent to the consummation of the Equity Offering.
------------------------
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.
4
<PAGE>
THE NOTES OFFERING
SECURITIES OFFERED....................... $125.0 million in aggregate principal
amount of % Senior Notes due 2008.
ISSUER................................... Telscape International, Inc.
GUARANTORS............................... All of the Company's wholly-owned
U.S. subsidiaries (the "Guarantors")
MATURITY DATE............................ , 2008.
INTEREST PAYMENT DATES................... Interest on the Notes will accrue
from the date of issuance and will be
payable semi-annually on and of
each year, commencing , 1999.
GUARANTEES............................... The Notes will be guaranteed on an
unsecured senior basis (the
"Guarantees") by the Guarantors.
RANKING.................................. The Notes will be general unsecured
senior obligations of the Company and
will be PARI PASSU in right of
payment to existing and future senior
unsecured indebtedness of the
Company. The Notes will also be
effectively subordinated to all
secured indebtedness of the Company
and its subsidiaries to the extent of
the assets securing such indebted-
ness. As of March 31, 1998, after
giving effect to the Notes Offering,
the Company would have had
approximately $126.2 million of
senior indebtedness outstanding, of
which $0.2 million would have been
secured. The Guarantees will be
general unsecured obligations of the
Guarantors and will be PARI PASSU in
right of payment to all existing and
future senior unsecured indebtedness
of the Guarantors. The Guarantees
will also be effectively subordinated
to all secured indebtedness of the
Guarantors to the extent of the
assets securing such indebtedness. As
of March 31, 1998, after giving
effect to the Notes Offering, the
Guarantors would have had
approximately $3.2 million (exclusive
of the Guarantees of the Notes) of
senior indebtedness outstanding, of
which $0.7 million would have been
secured. Subsequent to March 31,
1998, the Company and certain
Guarantors incurred approximately
$11.2 million in additional senior
indebtedness, of which $6.2 million
is secured.
OPTIONAL REDEMPTION...................... The Notes will be redeemable, in
whole or in part, at the option of
the Company on or after , 2003, at
the redemption prices set forth
herein, plus accrued and unpaid
interest to the date of redemption.
In addition, at any 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 cash proceeds of one or more
Public Equity Offerings (as defined),
at a redemption price equal to %
of the aggregate principal amount of
the Notes to be redeemed plus accrued
and unpaid interest to the date of
redemption; PROVIDED, HOWEVER, that,
after giving effect to any such
redemption, at least 65% of the
aggregate principal amount of the
Notes originally issued remains
outstanding.
CHANGE OF CONTROL........................ Upon a Change of Control (as
defined), each holder will have the
right, subject to certain conditions,
to require the Company to repurchase
such holder's Notes at a price equal
to 101% of the aggregate principal
amount thereof plus accrued and
unpaid interest to the date of
repurchase.
5
<PAGE>
CERTAIN COVENANTS........................ The Indenture governing the Notes
(the "Indenture") will contain
certain covenants that limit the
ability of the Company and its
subsidiaries to, among other things,
incur additional indebtedness, pay
dividends or make investments and
certain other restricted payments,
consummate certain asset sales, enter
into certain transactions with af-
filiates, incur liens, impose
restrictions on the ability of a
subsidiary to pay dividends or make
certain payments to the Company and
its subsidiaries, merge or
consolidate with any other person or
sell, assign, transfer, lease, convey
or otherwise dispose of all or
substantially all of the assets of
the Company. In addition, under
certain circumstances, the Company
will be required to offer to purchase
the Notes, in whole or in part, at a
purchase price equal to 100% of the
aggregate principal amount thereof
plus accrued and unpaid interest, if
any, to the date of repurchase, with
the proceeds of certain Asset Sales
(as defined). All of such covenants
are subject to significant
qualifications and exceptions.
THE EQUITY OFFERING...................... Concurrently with the Notes Offering,
the Company intends to offer 3.4
million shares of Common Stock,
representing an estimated $47.6
million in gross proceeds, and the
Selling Stockholders intend to offer
240,000 shares of Common Stock, all
pursuant to a separate registration
statement and prospectus. The Company
has granted the Underwriters a 30-day
option to purchase up to 546,000
additional shares of Common Stock
from the Company on the same terms
and conditions, solely to cover
over-allotments, if any. The
consummation of the Equity Offering
is not a condition precedent to the
consummation of this Notes Offering.
For additional information regarding the Notes, see "Description of the
Notes."
USE OF PROCEEDS
The net proceeds from the Notes Offering and the Equity Offering, if
consummated, are estimated to be approximately $119.6 million and $43.9 million
($51.5 million from the Equity Offering if the Underwriters' over-allotment
option is exercised in full), assuming a price of $14.00 per share,
respectively, after deducting discounts, commissions and expenses payable by the
Company. The Company intends to use the net proceeds from the Offerings as
follows: (i) approximately $137.0 million to complete the first two phases of
the Mexican Network; (ii) approximately $15.0 million to acquire international
switching and transmission facilities; and (iii) the balance to pursue joint
ventures, strategic alliances or acquisitions and for working capital and other
general corporate purposes.
Completion of the first two phases of the Mexican Network will provide the
Company with a fully functional network. The Company intends to undertake the
third phase of the Mexican Network, which it estimates will cost approximately
$18.0 million, if justified by demand. The Company intends to fund the third
phase of the Mexican Network with cash flow from existing operations, increased
cash flow resulting from reduced off-net capacity costs as segments of the
Mexican Network become operational and increased cash flow resulting from the
development of the switched-products business.
The Notes Offering is not conditioned upon the consummation of the Equity
Offering. If the Equity Offering is not consummated, the Company will need to
find additional sources of capital to replace the funding that would have been
provided by the Equity Offering.
RISK FACTORS
See "Risk Factors" for a discussion of certain factors that should be
considered in evaluating an investment in the Notes.
6
<PAGE>
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 THREE MONTHS
YEAR ENDED DECEMBER 31, YEAR ENDED ENDED
------------------------------- DECEMBER 31, MARCH 31,
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 $ 33,399
Cost of revenues................... 619 3,041 24,396 52,018 28,334
--------- --------- --------- ------------ ------------
Gross profit....................... 489 2,664 11,758 13,350 5,065
Selling, general and administrative
expenses.......................... 1,349 4,159 8,154 9,500 2,277
--------- --------- --------- ------------ ------------
Operating income (loss) before
depreciation and amortization..... (860) (1,495) 3,604 3,850 2,788
Depreciation and amortization...... 48 264 622 1,157 569
--------- --------- --------- ------------ ------------
Operating income (loss)............ (908) (1,759) 2,982 2,693 2,219
Interest income (expense), net..... 230 15 (95) (223) (56)
Other income (expense), net........ (2) 99 (137) (123) (74)
--------- --------- --------- ------------ ------------
Income (loss) before income taxes
and minority interests............ (680) (1,645) 2,750 2,347 2,089
Income tax benefit (expense)....... -- 53 (84) 11 (963)
--------- --------- --------- ------------ ------------
Income (loss) before minority
interests......................... (680) (1,592) 2,666 2,358 1,126
Minority interests................. 7 (6) 6 6 (12)
--------- --------- --------- ------------ ------------
Net income (loss).................. $ (673) $ (1,598) $ 2,672 $ 2,364 $ 1,114
========= ========= ========= ============ ============
EARNINGS (LOSS) PER SHARE:
Basic.............................. $ (0.36) $ (0.52) $ 0.68 $ 0.59 $ 0.25
Weighted average shares
outstanding....................... 1,890,442 3,046,594 3,903,470 4,003,470 4,371,464
Diluted(3)......................... N/A N/A $ 0.53 $ 0.45 $ 0.15
Weighted average shares outstanding
for diluted calculation........... N/A N/A 5,152,211 5,418,711 7,779,177
OTHER OPERATING DATA(2):
EBITDA(4).......................... (860) (1,495) 3,604 3,850 2,788
Ratio of debt to EBITDA............ -- -- 0.88 0.83 1.54
Capital expenditures............... 46 441 1,682 3,642
Ratio of earnings to fixed
charges(5)........................ -- -- 9.03 5.66 18.39
<CAPTION>
DECEMBER 31, AS ADJUSTED(6) AS ADJUSTED(7)
------------------------------- MARCH 31, MARCH 31, MARCH 31,
1995 1996 1997 1998 1998 1998
--------- --------- --------- --------- -------------- --------------
CONSOLIDATED BALANCE SHEET DATA(2):
Cash, cash equivalents and short
term investments.................. $ 3,645 $ 495 $ 4,734 $ 2,882 $122,521 $166,413
Working capital.................... 4,081 1,813 3,669 426 120,065 163,957
Property and equipment, net........ 154 983 2,679 5,344 5,344 5,344
Goodwill and other intangibles,
net............................... -- 3,246 17,674 23,324 23,324 23,324
Total assets....................... 4,498 9,371 39,635 47,940 172,940 216,832
Total long-term debt............... -- -- 2,676 2,548 127,548 127,548
Total stockholders' equity......... 3,590 5,765 22,088 27,203 27,203 71,095
- ------------
</TABLE>
(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, Inc. -- April 10, 1996;
Telereunion, Inc.("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, $84 and $21 for the historical year ended
December 31, 1997, pro forma year ended December 31, 1997 and historical
three months ended March 31, 1998, respectively.
(4) EBITDA represents net earnings (loss) before interest, income taxes,
depreciation and amortization. While EBITDA should not be construed as a
substitute for operating income or a better indicator of liquidity than cash
flow from operating activities, which are determined in accordance with
generally accepted accounting principles, it is included herein to provide
additional information with respect to the ability of the Company 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 necessarily a measure of the Company's
ability to fund cash needs.
(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. For the years ended December 31, 1995 and 1996, earnings
were inadequate to cover fixed charges by $724 and $1,817, respectively.
(6) As adjusted to give effect to the Notes Offering. Subsequent to March 31,
1998, the Company incurred additional indebtedness in the aggregate
principal amount of $11.2 million. See "Summary of Other Indebtedness."
(7) As adjusted to give effect to the Notes Offering and the Equity Offering
(assuming no exercise of the Underwriters' over-allotment option and
assuming a price of $14.00 per share). See also Note (6).
7
<PAGE>
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 NOTES.
SUBSTANTIAL INDEBTEDNESS
The Company will have substantial indebtedness after the Notes Offering. As
of March 31, 1998, after giving effect to the Offerings and the application of
the net proceeds therefrom, the Company's total indebtedness would have been
approximately $129.3 million, including $0.9 million of secured indebtedness,
its stockholders' equity would have been approximately $71.1 million and it
would have had total assets of approximately $216.8 million. Subsequent to March
31, 1998, the Company incurred additional indebtedness in the aggregate
principal amount of $11.2 million (excluding operating leases), including $5.0
million in Deere Park Convertible Debentures, $5.0 million in Gordon Brothers
Convertible Debentures and $1.2 million under the Revolving Credit Facility (as
defined). For the three months ended March 31, 1998, after giving effect to the
Offerings and the application of the net proceeds therefrom, the Company's
EBITDA would have been insufficient to cover fixed charges (including interest
on the Notes) by approximately $1.2 million. 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," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Description of the Notes."
The level of the Company's indebtedness could have important consequences
to holders of the Notes, including the following: (i) the debt service
requirements of any additional indebtedness could make it more difficult for the
Company to make payments of interest on the Notes; (ii) 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; (iii) 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;
(iv) the Company's level of indebtedness could limit its flexibility in planning
for, or reacting to, changes in its business; (v) the Company may become more
highly leveraged than some of its competitors, which may place it at a
competitive disadvantage; and (vi) the Company's high degree of indebtedness
will make it more vulnerable in the event of a downturn in its business.
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, including its obligations under the
Notes. 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. Such defaults could result in
a default on the Notes and could delay or preclude payments of interest or
principal thereon.
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, including
payment of expenses and principal and interest on the Notes, 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
8
<PAGE>
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 March 31, 1998, the Company (excluding its
subsidiaries) had approximately $0.2 million of secured indebtedness, and the
Guarantors had approximately $0.7 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, delays in construction of
the Mexican Network and any increase in or the acceleration of the payment
schedule for the Company's portion of the Common Cost Charges (as defined)
payable to Telmex in connection with its activities as a Concessionaire, 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, including its obligations on the
Notes, 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 (including its obligations with
respect to the Notes), 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."
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
9
<PAGE>
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 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.
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
10
<PAGE>
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
"Use of Proceeds," "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 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
11
<PAGE>
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" and
"Description of the Notes -- Certain Covenants."
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 Offerings 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. 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 Notes) 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, including the Notes.
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 12 MONTHS 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 - 6/30/98 8.08 - 9.04 11.9
Exchange rate fluctuations could have a material adverse effect on the
Company's business and its ability to service its dollar-denominated
liabilities, including the Notes.
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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 three months ended March 31, 1998, the Company
experienced net foreign exchange losses (gains) of $(14,000), $(18,000), $2,000,
($161,000), $126,000 and $122,000, 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 for purposes of making payments
to holders of the Notes, 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.
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 Notes) would not be materially adversely
affected by events in emerging market countries or that such events would not
affect the price of the Notes.
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."
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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's management information systems and switching
equipment are subject to hardware defects and software bugs, the existence of
which may be outside of the Company's control. 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
The international and national telecommunications industry is highly
competitive and subject to rapid change precipitated by advances in technology
and regulation. 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 Post Telegraph & Telephone operator ("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, Inc.'s ("WorldCom") proposed 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. 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.
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 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
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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, MCI, Sprint,
and WorldCom which provide long distance services in the United States; Telmex,
Concessionaires, 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 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 Telecomunicaciones S.A. de C.V. ("Red de
Servicios") and several of Mexico's long distance Concessionaires, including
Telmex and Telinor. 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 (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, but certain parties
requested that the FCC reconsider its decision. The FCC's decision on
reconsideration is currently pending. 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.
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."
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The telecommunications industry is intensely competitive and is
significantly influenced by the pricing and marketing decisions of the larger
industry participants. In the United States, the industry has relatively limited
barriers to entry with numerous entities competing for the same customers.
Customers frequently change telecommunications providers in response to the
offering of lower rates or promotional incentives by competitors. 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 financial
profits, and the Company's business, financial condition and results of
operations could be materially and adversely affected.
The telecommunications industry is in a period of rapid technological
evolution, marked by the introduction of new product and service offerings. The
Company is unable to predict which of many possible future product and service
offerings will be important to maintain its competitive position or what
expenditures will be required to develop and provide such products and services.
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 has 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 by the Concessionaires and handle the increased traffic
expected to result from interconnection (the "Common Cost Charges"), as well
as interconnection and access costs (the "Additional Charges"). An independent
third-party has estimated the aggregate amount of the Common Cost Charges to be
approximately $422.0 million, and the Mexican regulatory authorities accepted
such estimate. The Company estimates that, based on its business plan, its
proportionate share of the Common Cost Charges will total approximately $30.0
million for the first seven years of operation following interconnection. These
Common Cost Charges will likely be lower during the initial years of operation
but will increase in subsequent years as the Company's use of Telmex's network
increases. In addition, the Mexican regulatory authorities currently require the
Concessionaires to pay Telmex approximately 58% of the settlement rate on every
incoming international call, in addition to a high access fee for routing calls
through Telmex's network. Telmex and three of the Concessionaires already
interconnected with Telmex (Alestra, Miditel and Avantel) have initiated
administrative proceedings before the SCT in which Telmex is requesting an
increase in the Common Cost Charges and full payment in a single installment,
and the three Concessionaires are seeking a reduction in the Common Cost Charges
and payment on an installment basis over a period of time as well as a reduction
in the Additional Charges. Resolution of these actions is still pending and any
determination will apply to the Company. There can be no assurance that the
Concessionaires will not be required to pay these or other higher charges to
Telmex in the future, whether in a single or several installments. In addition,
the U.S. partners of Alestra and Avantel have also objected to delays in
reducing Telmex's high basic rate charged for incoming international calls, now
at 37.5 cents per minute on average. Any increase in Common Cost Charges or
Additional Charges or a requirement that the Company pay its portion of the
Common Cost Charges in a single payment, whether pursuant to the current
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administrative proceedings or otherwise, could materially adversely affect the
Company's business, financial condition and results of operations, as well as
its ability to satisfy its obligations (including with respect to the Notes).
See "-- Substantial Indebtedness."
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 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. There can be no assurances that the Company will be able to comply
with such terms. 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
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.
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
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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 the lack thereof, such developments could have a
material adverse effect on the Company's business, financial condition and
results of operations.
On February 15, 1997, the United States and 68 other members of the WTO
agreed 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 (the "WTO
Agreement"). 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
Communications Act of 1934, as amended (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.
UNITED STATES 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. 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.
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As noted above, the FCC imposes on entities authorized to provide
telecommunications services prior approval requirements for "transfers of
control," including pro forma transfers. These prior approval requirements may
delay, prevent or deter a change in control of the Company.
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, Japan, Luxembourg, The Netherlands,
New Zealand, Norway, Sweden, Switzerland and the United Kingdom meet this
standard. In separate proceedings, the FCC is considering applications to engage
in ISR between the United States and other countries, including Chile and
Mexico. 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
a 1995 request (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 third
country calling where all countries involved consent to the routing arrangements
(referred to as "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 International Telecommunications
Union ("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 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. 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.
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UNITED STATES DOMESTIC LONG DISTANCE SERVICES. The Company provides
domestic long distance service in the United States as a result of its Prepaid
Card business. The Company's ability to provide domestic long distance service
in the United States is subject to regulation by the FCC and relevant state
Public Service Commissions ("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 and its
subsidiary, MSN, however, are required by the FCC to file tariffs listing the
rates, terms and conditions of domestic long distance services provided. MSN has
a tariff on file with respect to domestic long distance services. The FCC
adopted an order on October 29, 1996 (the "October 29, 1996 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 October 29, 1996 Order, pending judicial
review of the order. No final decision has been rendered on the appeal.
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 has obtained the authorizations or has registered with
state regulatory authorities in approximately 40 states. MSN has certification
in eight states, plus pending applications in two additional states. 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 and the first and
second quarters of 1999 equal approximately 3.19% and 3.14%, respectively, of
interstate and international gross end user telecommunications revenues for the
high cost and low income fund, and approximately 0.72% and 0.76%, respectively,
of intrastate, interstate and international gross end user telecommunications
revenues for the schools and libraries and health care fund. The Company cannot
predict the amount of universal service fund contributions for the remaining
quarters of 1999, or thereafter, until the FCC issues contribution factors for
such periods.
MEXICO. The Mexican government enacted a new Federal Telecommunications
Law in 1995 (the "FTL") that opened the local and long distance
telecommunications service markets to competition and imposed varying levels of
regulation on Mexican telecommunications providers. The SCT and the COFETEL
oversee the implementation of the FTL. The FTL imposes regulations only on
carriers that provide commercial telecommunications services to the public
("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. 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. Companies wishing to offer
value-added services need only register with the COFETEL's Telecommunications
Registry.
In addition to the FTL, the Mexican International Long Distance 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
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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. Concessionaires
that have not received authorization from the COFETEL, as well as value-added
services providers, cellular concessionaires and paging service providers,
cannot directly transmit international switched traffic. To date, the SCT and
the COFETEL have granted concessions to 15 companies, including Telmex and
Telereunion S.A., 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. In
addition, the SCT and the COFETEL have granted eight concessions for local
switched services as well as numerous registrations for value added services.
To the extent that the regulatory framework in Mexico continues to evolve,
the interpretation or enforcement of applicable laws and regulations is
uncertain or unclear.
Pursuant to the Foreign Investment Law of 1993 ("Foreign Investment Law")
and the FTL, concessions for public telecommunication networks may only be
granted to Mexican citizens or Mexican companies. Foreign investors may own
majority economic interests in Concessionaires but may not own more than 49.0%
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 is registered with the COFETEL as a value-added services
provider through its Mexican subsidiaries. In June 1998, Telereunion S.A.
received the Mexican Concession, a 30-year, facilities-based carrier license
from the COFETEL and the SCT, allowing it to construct and operate a network on
which the Company can carry long distance traffic in Mexico. In addition, the
Company, through certain of its Mexican subsidiaries, is authorized to provide
data and other value-added services in Mexico.
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 the direct transport and switching of speech
in real-time between switched network termination points ("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, 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 American countries where the PTT retains the legally mandated monopoly on
Voice
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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 materially 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 markets in
which the Company operates or intends to operate 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. 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 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 (Registered Trademark) 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 (Registered Trademark) 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.
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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 March 31, 1998, the Company reserved approximately $215,000 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."
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING
The development and expansion of the Company's network facilities,
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 Offerings 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 not need additional financing sooner than anticipated. In
addition, 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 Offerings, 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
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Company's business, results of operations and financial condition, its ability
to compete and its ability to meet its obligations on the Notes.
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 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
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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."
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. To the extent these variable
costs increase, the Company may experience 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. 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
(Registered Trademark) 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 Offerings to expand the Company's network facilities,
including the
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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 earnings, including additional Prepaid Card services
costs, the write-off of uncollectible receivables and the lost margin
contribution from the loss of a wholesale customer, 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 Company's operating results for the third quarter of 1998, and the
lost revenues from this customer have been replaced.
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.
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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.
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." The Company expects that
reserving for these receivables and the loss of wholesale carrier revenues and
gross margin contribution from this customer will negatively affect the
Company's earnings and EBITDA for the quarter ended June 30, 1998 and the fiscal
year ending December 31, 1998. The 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 LEASE AGREEMENTS; DEPENDENCE ON KEY SUPPLIERS
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 Other Indebtedness -- Equipment Leases."
COVENANTS
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. See "Description of the Notes -- Certain Covenants." 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" (Registered Trademark) 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"
(Registered Trademark) 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.
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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, 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 July 21, 1998, the officers and directors of the Company beneficially
owned approximately 59.3% of the Company's Common Stock on a fully diluted
basis. Upon consummation of the Equity Offering, such officers and directors
will beneficially own approximately 41.4% of the Company's Common Stock on a
fully diluted basis (assuming no exercise of the Underwriters' over-allotment
option). Accordingly, 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 Stockholders."
RISKS RELATING TO A CHANGE OF CONTROL
Upon a Change of Control (as defined) 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. There can be no assurance
that the Company would have sufficient financial resources available to satisfy
all of its obligations under the Notes in the event of a Change of Control. 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 and
the holders of the Notes. See "Description of the Notes -- Change of Control."
The definition of "Change of Control" in the Indenture includes a sale, lease,
exchange or other transfer of "all or substantially all" of the assets of the
Company and its subsidiaries taken as a whole to a person or a group of persons.
There is no clearly established meaning for the phrase "all or substantially
all" in the context of an indenture. Because there is no precise established
definition of this phrase, the ability of a holder of the Notes to require the
Company to repurchase such Notes as a result of a sale, lease, exchange or other
transfer of all or substantially all of the Company's assets to a person or
group of persons may be uncertain.
FRAUDULENT CONVEYANCE CONSIDERATIONS; AVOIDANCE OF GUARANTEES
Various fraudulent conveyance laws have been enacted for the protection of
creditors and may be utilized by a court to subordinate or avoid the Notes or
any Guarantee in favor of other existing or future creditors of the Company or a
Guarantor.
28
<PAGE>
The incurrence by the Company of the Notes is subject to review under
relevant federal and state fraudulent conveyance laws in a bankruptcy case or a
lawsuit by or on behalf of unpaid creditors of the Company or a representative
of such creditors, such as a trustee or the Company as debtor-in-possession.
Under such laws, if a court were to find that, at the time the Notes were
issued, either (i) the Company issued the Notes with the intent of hindering,
delaying or defrauding creditors, or (ii) the Company received less than a
reasonably equivalent value or fair consideration for issuing the Notes and the
Company (a) was insolvent or rendered insolvent by reason of the issuance of the
Notes, (b) was engaged in business or a transaction, or was about to engage in
business or a transaction for which any property remaining with the Company
after issuance of the Notes constituted an unreasonably small amount of capital,
(c) intended to incur, or believed that it would incur, debts beyond its ability
to pay as they matured or (d) was a defendant in an action for money damages or
had a judgment for money damages docketed against it (if, in either case, after
final judgment, the judgment is unsatisfied), such court could void the
Company's obligations under the Notes and direct the repayment of any amounts
paid thereunder by the Company to a fund for the benefit of the Company's
creditors, or take other action detrimental to the holders of the Notes. Such
other action could include subordinating the Notes to claims of existing or
future creditors of the Company.
Similarly, indebtedness under the Guarantees of the Notes also may be
subject to review under relevant federal and state fraudulent conveyance laws in
a bankruptcy of a Guarantor or in a lawsuit brought by or on behalf of creditors
of a Guarantor under the same standards described above. Pursuant to the terms
of the Guarantees, the liability of each Guarantor is limited to the maximum
amount of indebtedness permitted, at the time of the grant of such Guarantee, to
be incurred in compliance with fraudulent conveyance or similar laws.
To the extent any Guarantee was avoided as a fraudulent conveyance, limited
as described above or held unenforceable for any other reason, holders of the
Notes would, to such extent, cease to have a claim in respect of such Guarantee
and, to such extent, would be creditors solely of the Company and any Guarantor
whose Guarantee was not avoided, limited or held unenforceable. In such event,
the claims of the holders of the Notes against the issuer of an avoided, limited
or unenforceable Guarantee would be subject to the prior payment of all
liabilities of such Guarantor. There can be no assurance that, after providing
for all prior claims, there would be sufficient assets to satisfy the claims of
the holders of the Notes.
ABSENCE OF PUBLIC MARKET
The Notes are a new issue of securities which have no established trading
market. The Underwriters have advised the Company that they intend to make a
market in the Notes after the consummation of the Notes Offering; however, the
Underwriters are not obligated to do so, and any such market-making, if
commenced, may be terminated at any time without notice. No assurances can be
given as to the liquidity of the trading market, if any, that may develop for
the Notes.
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.
29
<PAGE>
USE OF PROCEEDS
The net proceeds from the Notes Offering and the Equity Offering, if
consummated, are estimated to be approximately $119.6 million and $43.9 million
($51.5 million from the Equity Offering if the Underwriters' over-allotment
option is exercised in full), assuming a price of $14.00 per share,
respectively, after deducting discounts, commissions and expenses payable by the
Company. The Company intends to use the net proceeds from the Offerings as
follows: (i) approximately $137.0 million to complete the first two phases of
the Mexican Network; (ii) approximately $15.0 million to acquire international
switching and transmission facilities; and (iii) the balance to pursue joint
ventures, strategic alliances or acquisitions and for working capital and other
general corporate purposes.
Completion of the first two phases of the Mexican Network will provide the
Company with a fully functional network. The Company intends to undertake the
third phase of the Mexican Network, which it estimates will cost approximately
$18.0 million, if justified by demand. The Company intends to fund the third
phase of the Mexican Network with cash flow from existing operations, increased
cash flow resulting from reduced off-net capacity costs as segments of the
network become operational and increased cash flow resulting from the
development of the switched-products business.
Prior to the application of the net proceeds of the Offerings as described
above, the Company may use such proceeds to reduce short-term borrowings and
will otherwise invest such funds in high quality, liquid short-term obligations.
The Notes Offering is not conditioned upon the consummation of the Equity
Offering. If the Equity Offering is not consummated, the Company will need to
find additional sources of capital to replace the funding that would have been
provided by the Equity Offering.
30
<PAGE>
CAPITALIZATION
The following table sets forth Telscape's capitalization as of March 31,
1998 (i) on an actual basis, (ii) on an as adjusted basis giving effect to the
sale of the Notes offered hereby and the application of the estimated net
proceeds therefrom and (iii) on an as adjusted basis giving effect to the sale
of the Notes offered hereby and the issuance and sale by the Company of 3.4
million shares of Common Stock in the Equity Offering representing an estimated
$47.6 million, assuming a price of $14.00 per share, in gross proceeds and the
application of the estimated net proceeds from the Offerings. See "Use of
Proceeds."
<TABLE>
<CAPTION>
AS OF MARCH 31, 1998
---------------------------------------------
AS ADJUSTED AS ADJUSTED
ACTUAL NOTES OFFERING(1) OFFERINGS(2)
------- ----------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents............ $ 2,882 $ 122,521 $ 166,413
Current maturities of long-term
obligations........................ 1,747 1,747 1,747
Long-term debt (less current
portion):
% Senior Notes due 2008.... -- 125,000 125,000
Notes payable and capital lease
obligations, net of current
portion....................... 2,548 2,548 2,548
------- ----------------- -------------
Total long-term
debt(3)............ 2,548 127,548 127,548
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, 4,667,548 and
8,067,548 shares issued and
outstanding................... 5 5 8
Additional paid-in capital...... 29,310 29,310 73,199
Accumulated deficit............. (1,737) (1,737) (1,737)
Treasury Stock.................. (375) (375) (375)
------- ----------------- -------------
Total stockholders'
equity.................. 27,203 27,203 71,095
------- ----------------- -------------
Total capitalization....... $29,751 $ 154,751 $ 198,643
======= ================= =============
</TABLE>
- ------------
(1) As adjusted to give effect to the Notes Offering.
(2) As adjusted to give effect to the Notes Offering and the Equity Offering
(excluding the Underwriter's over-allotment option).
(3) Excludes $11.2 million in additional indebtedness which the Company incurred
subsequent to March 31, 1998. See "Summary of Other Indebtedness."
31
<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.
32
<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.
33
<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 unaudited pro forma condensed consolidated financial statements and the
notes thereto are based upon available information and certain estimates and
assumptions related to the accounting for the acquisition of MSN that are
subject to final determination. 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.
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.
34
<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 three months ended March 31, 1997
and 1998. The selected consolidated financial data for the three months ended
March 31, 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>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
--------------------------------------------------------- ----------------------------
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 $ 3,771 $ 33,399
Cost of revenues................... 887 439 619 3,041 24,396 2,525 28,334
--------- --------- --------- --------- ------------ ------------ ------------
Gross profit....................... 835 533 489 2,664 11,758 1,246 5,065
Selling, general and administrative
expenses.......................... 1,470 1,032 1,349 4,159 8,154 1,478 2,277
--------- --------- --------- --------- ------------ ------------ ------------
Operating income (loss) before
depreciation and amortization..... (635) (499) (860) (1,495) 3,604 (232) 2,788
Depreciation and amortization...... 23 36 48 264 622 154 569
--------- --------- --------- --------- ------------ ------------ ------------
Operating income (loss)............ (658) (535) (908) (1,759) 2,982 (386) 2,219
Interest income (expense), net..... (84) 23 230 15 (95) (3) (56)
Other income (expense), net........ (14) (18) (2) 99 (137) 29 (74)
--------- --------- --------- --------- ------------ ------------ ------------
Income (loss) before income taxes
and minority interests............ (756) (530) (680) (1,645) 2,750 (360) 2,089
Income tax benefit (expense)....... -- -- -- 53 (84) 32 (963)
--------- --------- --------- --------- ------------ ------------ ------------
Income (loss) before minority
interests......................... (756) (530) (680) (1,592) 2,666 (328) 1,126
Minority interests................. 360 (18) 7 (6) 6 4 (12)
--------- --------- --------- --------- ------------ ------------ ------------
Net income (loss).................. $ (396) $ (548) $ (673) $ (1,598) $ 2,672 $ (324) $ 1,114
========= ========= ========= ========= ============ ============ ============
EARNINGS (LOSS) PER SHARE:
Basic.............................. $ (0.81) $ (0.44) $ (0.36) $ (0.52) $ 0.68 $ (0.08) $ 0.25
Weighted average shares
outstanding....................... 491,303 1,254,689 1,890,442 3,046,594 3,903,470 3,935,969 4,371,464
Diluted(2)......................... N/A N/A N/A N/A $ 0.53 N/A $ 0.15
Weighted average shares outstanding
for diluted calculation........... N/A N/A N/A N/A 5,152,211 N/A 7,779,177
OTHER OPERATING DATA(1):
EBITDA(3).......................... (635) (499) (860) (1,495) 3,604 (232) 2,788
Ratio of debt to EBITDA............ -- -- -- -- 0.88 -- 1.54
Capital expenditures............... 22 24 46 441 1,682 394 3,642
Ratio of earnings to fixed
charges(4)........................ -- -- -- -- 9.03 -- 18.39
</TABLE>
(FOOTNOTES ON FOLLOWING PAGE)
35
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
DECEMBER 31,
----------------------------------------------------- MARCH 31,
1993 1994 1995 1996 1997 1998
--------- --------- --------- --------- --------- ---------
CONSOLIDATED BALANCE SHEET DATA(1):
Cash, cash equivalents and short term
investments........................ $ 98 $ 4,509 $ 3,645 $ 495 $ 4,734 $ 2,882
Working capital...................... (777) 4,817 4,081 1,813 3,669 426
Property and equipment, net.......... 168 156 154 983 2,679 5,344
Goodwill and other intangibles,
net................................ -- -- -- 3,246 17,674 23,324
Total assets......................... 521 5,335 4,498 9,371 39,635 47,940
Total long-term debt................. 445 -- -- -- 2,676 2,548
Total stockholders' equity
(deficit).......................... (812) 4,446 3,590 5,765 22,088 27,203
</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 on convertible notes assumed to have
been converted into common shares was added back to net income as follows:
$42 and $21 for the historical year ended December 31, 1997 and the
historical three months ended March 31, 1998, respectively.
(3) EBITDA represents net earnings (loss) before interest, income taxes,
depreciation and amortization. While EBITDA should not be construed as a
substitute for operating income or a better indicator of liquidity than cash
flow from operating activities, which are determined in accordance with
generally accepted accounting principles, it is included herein to provide
additional information with respect to the ability of the Company 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 necessarily a measure of the Company's
ability to fund cash needs.
(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. For the years ended December 31, 1993, 1994, 1995 and 1996,
and the three months ended March 31, 1997, earnings were insufficient to
cover fixed charges by $894, $631, $724, $1,817 and $387, respectively.
36
<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 (Registered
Trademark) 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. 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 (Registered Trademark) 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 (Registered Trademark) brand recognition in Mexico, El Salvador and
other Latin American countries after obtaining the required licenses.
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
37
<PAGE>
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 quarter 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.
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
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 services to its Prepaid Card
customers by working directly with the underlying service providers, this
resulted in the Company 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 contribution 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, and the lost revenues from this customer
have been replaced.
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
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<PAGE>
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 THREE MONTHS
DECEMBER 31, ENDED MARCH 31,
------------------------------- --------------------
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 67.0 84.8
Gross profit......................... 44.1 46.7 32.5 33.0 15.2
Selling, general and administrative
expenses........................... 121.7 72.9 22.6 39.2 6.9
Operating income (loss) before
depreciation
and amortization................... (77.6) (26.2) 9.9 (6.2) 8.3
Depreciation and amortization........ 4.3 4.6 1.7 4.0 1.7
Operating income (loss).............. (81.9) (30.8) 8.2 (10.2) 6.6
Other income (expense)............... 20.6 2.0 (0.6) 0.7 (0.4)
Income (loss) before income taxes and
minority interest.................. (61.3) (28.8) 7.6 (9.5) 6.2
Income tax benefit (expense)......... 0.0 0.9 (0.2) 0.9 (2.9)
Income (loss) before minority
interests.......................... (61.3) (27.9) 7.4 (8.6) 3.3
Minority interests in subsidiaries... 0.6 (0.1) 0.0 0.0 0.0
Net income (loss).................... (60.7) (28.0) 7.4 (8.6) 3.3
</TABLE>
RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THE THREE MONTHS
ENDED MARCH 31, 1997
REVENUES increased from $3.8 million in 1997 to $33.4 million in 1998. This
increase of $29.6 million, or 779%, was due principally to the acquisition of
MSN completed in the first quarter of 1998, increased revenues of wholesale
international long distance and, to a lesser extent, the acquisitions of
Integracion and NSI completed in the third and fourth quarters of 1997,
respectively. In addition, revenues from Vextro for the three months ended March
31, 1998 doubled those for the three months ended March 31, 1997.
COST OF REVENUES increased from $2.5 million in 1997 to $28.3 million in
1998, or $25.8 million. The 1032% 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 and NSI. In addition, cost of revenues increased due
to the higher sales generated at Vextro. Cost of revenues as a percentage of
revenues increased from 67.0% to 84.8%, or 17.8%, due principally to the higher
cost of revenues as a percentage of revenues associated with the sale of Prepaid
Cards.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A") increased from $1.5
million in 1997 to $2.3 million in 1998, or $799,000. The 53% increase in SG&A
was due principally to the incremental SG&A related to the operations of
Integracion, NSI and MSN and, to a lesser extent, increased staffing at existing
operations of Vextro and the wholesale long distance business to meet the
additional resource requirements from the growth of these operations.
Overall, SG&A as a percentage of revenues decreased from 39.2% to 6.9%, or
32.3%. This decrease was due principally to the growth in overall revenues
rapidly outpacing the growth in operating expenses and to the lower SG&A as a
percentage of revenues required to support MSN's operations.
DEPRECIATION AND AMORTIZATION increased from $154,000 in 1997 to $569,000
in 1998, or $415,000. This increase was due to an increase in goodwill
amortization primarily as a result of (1) the vesting of performance-based
warrants issued in connection with the Telereunion acquisition, which resulted
in
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<PAGE>
additional goodwill being recognized on December 31, 1997; (2) goodwill
recognized on the MSN acquisition completed effective January 1, 1998; and (3)
goodwill recognized on the Integracion and N.S.I. acquisitions completed during
1997.
INTEREST INCOME (EXPENSE), NET decreased from $(3,000) in 1997 to $(56,000)
in 1998, or $53,000. This decrease was mainly due to additional interest expense
on notes issued in connection with the Integracion and MSN acquisitions.
OTHER INCOME (EXPENSE), NET decreased from $29,000 in 1997 to $(74,000) in
1998, or $103,000. This decrease was due to a foreign exchange loss in 1998 as
compared to a foreign exchange gain in 1997.
INCOME TAX BENEFIT (EXPENSE) changed from an income tax benefit of $32,000
in 1997 to an income tax expense of $(963,000) in 1998. The Company's overall
effective tax rate for the three months ended March 31, 1998, was 12% over the
statutory rate in the U.S. and Mexico, primarily due to the non-deductible
nature of goodwill amortization.
NET INCOME (LOSS). The Company experienced a net loss of $(324,000) in
1997 as compared to net income of $1.1 million in 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 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.
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<PAGE>
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 the Polish operations as compared to a foreign exchange gain of $161,000,
primarily from 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 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
41
<PAGE>
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.
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 $1.0 million and $626,000 for
the three months ended March 31, 1997 and March 31, 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 receivable of approximately $1.0
million and a decrease in deferred revenues of $2.0 million. In the fourth
quarter of 1997, MSN entered into an arrangement with a third party whereby the
third party provided the telecommunications services related to the Prepaid
Cards sold by MSN at a fixed cost to MSN. Prior to this arrangement, MSN
arranged for the telecommunication services itself and would recognize the
revenues associated with these telecommunications services as the Prepaid Cards
were utilized. As a result, at December 31, 1997, MSN had recorded $2.0 million
in deferred revenues related to the receipt of monies related to sales of
Prepaid Cards in the fourth quarter of 1997. Such Prepaid Cards were utilized in
the first quarter of 1998, and the costs associated with these services were
paid by MSN in the first quarter of 1998. Under the new arrangement with the
third party, revenues are recognized at time of shipment and the costs paid to
the third party are paid shortly thereafter.
Net cash used in investing activities was $(394,000) and $(6.0 million) for
the three months ended March 31, 1997 and March 31, 1998, respectively. In the
first quarter of 1998, the Company expended approximately $3.6 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.
Net cash provided by (used in) financing activities was ($18,000) and $3.5
million for the three months ended March 31, 1997 and March 31, 1998,
respectively. In December 1997, the Company announced its intention to redeem
publicly traded warrants to purchase an aggregate of 525,000 common shares with
a 30 day notice requirement. This announcement resulted in 475,535 warrants
being exercised prior to the redemption date. The Company realized net proceeds
from these exercises of $3.7 million, of which $2.7 million was received
subsequent to year-end.
As of March 31, 1998, the Company had cash and cash equivalents of $2.9
million and positive working capital of $426,000. In January 1998, the Company
completed the acquisition of MSN by issuing to the sellers $3.3 million in cash,
$750,000 in non-interest bearing promissory notes and 100,000 shares of common
stock. This acquisition utilized the majority of the funds realized from the
warrant exercises.
In the first 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 relating to these business expansions.
Management does not expect that cash generated from operations will be adequate
to fund these capital investments.
42
<PAGE>
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, 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. 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) 6.9% 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 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
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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 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 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.
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).
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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.
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
45
<PAGE>
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.
YEAR 2000 PLANS
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. 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 Company does not believe that such costs will have a
material impact on the financial results of 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 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.
46
<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 (Registered
Trademark) 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."
47
<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
industry's projections for substantially increased international minutes of use
and revenue by 2000 are based in part on the 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 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.
50
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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. In the next 18 months, Telscape intends to invest
approximately $152.0 million for infrastructure, including
approximately $137.0 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 deploy
or purchase 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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<PAGE>
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
"-- Recent Developments" and "Risk Factors -- Risks Associated with
Acquisitions, Investments and Strategic Alliances."
o BUILD BRAND AWARENESS. The Company seeks to build brand awareness of
its TELEFIESTA (Registered Trademark) and TELEREUNION brands.
Management believes that it will be able to continue building customer
awareness of its TELEFIESTA (Registered Trademark) brand name through
sales of its TELEFIESTA (Registered Trademark) 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 (Registered Trademark) 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 three months ended March 31, 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 three months ended March 31,
1998, the Company generated revenues from its wholesale carrier services
business of $7.6 million, representing 23% of the Company's consolidated
revenues.
PREPAID CARDS. The Company sells Prepaid Cards under the TELEFIESTA
(Registered Trademark) 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 (Registered Trademark) 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 (Registered Trademark) Prepaid Cards offer competitive rates to
selected Latin American and other international markets. For the three months
ended March 31, 1998, the Company generated revenues from its Prepaid Card
business of $18.1 million, representing 54% 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 three
months ended March 31, 1998, the Company generated revenues of $7.7 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 three months
ended March 31, 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 term 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, and helps
assure satellite capacity to its targeted markets in Latin America. 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. See "Use of Proceeds." 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 2,225 km of fiber optic cable and 1,800 km of microwave
transmission facilities 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 three 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 $134.0 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.
(iii) PHASE III. The Company anticipates that the third phase of
construction will involve the installation of fiber optic cable to
Coatzacoalcos, with supporting microwave connectivity to nearby cities. The
Company estimates that this phase will cost approximately $18.0 million to
complete.
The Company anticipates that Phase I will begin in the fourth quarter of
1998 and will be completed in approximately 12-14 months, Phase II will be
completed approximately six to eight months thereafter and Phase III
approximately six months after the completion of Phase II.
The Company estimates the aggregate cost of the three phases of the Mexican
Network will be $155.0 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 three phases of the Mexican Network to be approximately
$155.0 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
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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.
The Company intends to use $137.0 million of the proceeds from the
Offerings to fund construction of Phases I and II of the Mexican Network.
Completion of the first two phases of the Mexican Network will provide the
Company with a fully functioning network. The Company intends to undertake Phase
III, which it estimates will cost $18.0 million, if justified by demand. The
Company expects to fund the construction costs of Phase III with cash flow from
its existing operations, increased cash flow resulting from reduced off-net
capacity costs as segments of the network become operational and increased cash
flow resulting from the development of the switched-products business.
If the Company is unable to fund the remaining construction costs with cash
flow from operations, or to make arrangements to reduce the cost of constructing
the Mexican Network the Company may seek to obtain additional funds from the
sale of equity securities or, subject to the terms of the Indenture, from
additional borrowings, or may seek to complete construction of the Mexican
Network more slowly than originally planned. The Company would delay the
construction of Phase III until sufficient funds are raised.
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."
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 July 15, 1998, the Company had approximately 17 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
(Registered Trademark) brand name. The Company's TELEFIESTA (Registered
Trademark) 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."
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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,
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)
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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 proposed merger with MCI, and subsequent alliance with
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, 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, MCI, Sprint,
and WorldCom which provide long distance services in the U.S.; Telmex,
Concessionaries, and other
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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 (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 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.
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
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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.
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
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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, Japan, Luxembourg, The Netherlands,
New Zealand, Norway, Sweden, Switzerland and the United Kingdom meet this
standard. In separate proceedings, the FCC is considering applications to engage
in ISR between the United States and other countries, including Chile and
Mexico. 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
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WTO Agreement, in part by allowing U.S. carriers, under certain circumstances,
to accept special concessions from foreign carriers. 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 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 October 29, 1996 Order, pending
judicial review of the order. No final decision has been rendered on the appeal.
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 and the first and
second quarters of 1999 equal approximately 3.19% and 3.14%, respectively, of
interstate and international gross end user telecommunications revenues for the
high cost and low income fund, and approximately 0.72% and 0.76%, respectively,
of intrastate, interstate and international gross end user telecommunications
revenues for the schools, libraries and healthcare fund. The Company cannot
predict the amount of universal service fund contributions for the remaining
quarters of 1999, or thereafter, until the FCC issues contribution factors for
such periods.
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
implemented the provisions of the FTL until recently, when all authority to
establish telecommunications policy in Mexico was given to COFETEL. 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.
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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. 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.
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.
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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.
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" (Registered Trademark) Prepaid
Cards. Telereunion S.A. has a national trademark registration in Mexico for
"Telereunion." The Company's affiliate that recently received the Mexican
Concession. 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."
LEGAL PROCEEDINGS
CHARLES CLAPSADDLE AND TELECOM CONSULTING SERVICES, INC. V. TELSCAPE
INTERNATIONAL, INC. AND E. SCOTT CRIST. On or about November 25, 1997, a
lawsuit was filed against the Company and E. Scott Crist, Chief Executive
Officer and a Director of the Company. The lawsuit is styled case number CIV 97
1504 BB; Charles Clapsaddle and Telecom Consulting Service, Inc. v. Telscape
International, Inc. and E. Scott Crist and has been brought in the U.S. District
Court in the District of New Mexico. The plaintiffs are seeking a declaratory
judgment with respect to option rights allegedly held by plaintiffs. In
addition, the plaintiffs are seeking claims of relief for unjust enrichment,
breach of an agreement, federal securities fraud, Texas blue sky securities
fraud, fraud in a stock transaction and common law fraud. Plaintiffs are seeking
actual damages in excess of $250,000 and consequential damages, exemplary and
punitive damages and attorney fees. The Company and E. Scott Crist deny these
allegations and intend to vigorously defend against these allegations, although
there can be no assurance as to the successful defense of this matter. In
addition, whether or not the Company was to prevail in this litigation, such
litigation is time consuming and costly. This lawsuit is currently under court
ordered mediation.
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ROBERT E. CHAMBERLAIN, JR. V. TELSCAPE INTERNATIONAL, INC. AND E. SCOTT
CRIST. On or about October 28, 1997, a lawsuit was filed against the Company
and Mr. Crist. The lawsuit is styled case number 97-53582 Robert Chamberlain,
Jr. v. Telscape International, Inc. and E. Scott Crist and is pending in the
270th Judicial District of Harris County, Texas. As to the Company, plaintiffs
allege breach of contract, fraud, fraudulent concealment, violation of Texas
blue sky law and violation of Texas Business and Commercial Code. As to Mr.
Crist, plaintiffs allege tortious interference, fraud, fraudulent concealment,
violation of Texas blue sky law and violation of Texas Business and Commercial
Code. Plaintiffs are seeking actual damages in excess of $800,000, exemplary and
punitive damages and attorneys fees. The Company and Mr. Crist deny these
allegations and intend to vigorously defend against these allegations, although
there can be no assurance as to the successful defense of this matter. In
addition, whether or not the Company was to prevail in this litigation, such
litigation is time consuming and costly. This lawsuit is currently under court
ordered mediation.
EMPLOYEES
As of June 22, 1998, the Company had 386 full-time employees, with 314
residing in Mexico and 72 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 270 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 July 1, 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)..................... 33 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
- ------------
</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 Electronic and Communications Engineering from La Salle
University in Mexico City, where he graduated
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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 cofounded 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 developd 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
Communications, Inc. 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, Chartered. At Swidler &
Berlin, Mr. Castilla practiced in the telecommunications group, representing and
advising several 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. At Rogers & Wells, Mr.
Castilla devoted most of his practice to capital market financing, project
financing and mergers and acquisitions. Mr. Castilla holds law degrees from
Harvard Law School (L.L.M.) and with honors from the Universidad Iberoamericana
in Mexico City (J.D.). Mr. Castilla is a member of the Inter-American Bar
Association and the Harvard International Law Society.
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 is a principal consultant with Kirkland &
Associates, a management consulting firm specializing in telecommunications. 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
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management and marketing positions with MCI Air Signal, CPI Microwave, 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.
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 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
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<PAGE>
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.
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
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<PAGE>
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.
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 $100,000 (collectively, the "Named
Officers"), with respect to the fiscal year ended December 31, 1997.
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
-----------------------------
PAYOUTS
AWARDS -------------
ANNUAL COMPENSATION(1) ------------ SECURITIES
NAME AND ----------------------------- RESTRICTED UNDERLYING
PRINCIPAL BONUS STOCK OPTIONS/
POSITION(2) YEAR SALARY($) ($)(3) AWARDS($)(4) 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.
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The following is the Board of Directors' report addressing the compensation
of the Company's executive officers for fiscal 1997.
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 Officers as depicted in the Summary Compensation
Table.
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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
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> <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 the Company's 1994 Directors Stock
Option Plan.
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<PAGE>
Non-employee directors may receive an annual grant of options to purchase
up to 10,000 shares of the Company's Common Stock.
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 Garcid 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 July 1, 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....................... 1,310,250(1) 15.1%
2700 Post Oak Boulevard, Suite 1000
Houston, Texas 77056
Ricardo Orea......................... 1,155,167(2)(3) 13.3%
Moras No. 430
Col. Del Valle, Del Benito Juarez
03100 Mexico, D.F.
Manuel Landa......................... 1,155,166(3)(4) 13.3%
Moras No. 430
Col. Del Valle, Del Benito Juarez
03100 Mexico, D.F.
Oscar Garcia......................... 1,149,167(3)(5) 13.3%
Moras No. 430
Col. Del Valle, Del Benito Juarez
03100 Mexico, D.F.
Todd M. Binet........................ 358,374(6) 4.1%
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).... 5,138,124(9) 59.3%
(FOOTNOTES ON NEXT PAGE)
76
<PAGE>
- ------------
* 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. Also includes shares of Common Stock
issuable upon exercise of the Series A Common Stock Warrant representing
the right to purchase 9,050 shares of Common Stock at $2.19 per share owned
directly by 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 332,959 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 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 332,958 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 332,959 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
for rights to purchase 49,000 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 41,666 shares of Common Stock at $3.25 per
share and options to purchase 83,333 shares of Common Stock at $4.00 per
share, all of which are presently exercisable. Excludes options to purchase
41,667 shares of Common Stock at $3.25 per share and 83,334 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 2,929,327 shares of Common Stock,
all of which are exercisable within sixty (60) days of the date of this
table.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the closing of the Equity Offering, the authorized capital stock of
the Company will consist 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 per share, and
1,000,000 shares of Series A Preferred Stock, par value $0.001 per share.
COMMON STOCK
As of July 21, 1998, there were 5,304,393 shares of Common Stock
outstanding that were held of record by approximately 98 stockholders. Upon
consummation of the Equity Offering, a total of 8,704,393 shares of Common Stock
will be outstanding (assuming no exercise of the Underwriters' over-allotment
option under the Equity Offering and assuming no exercise of outstanding options
after July 14, 1998).
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, and the
shares of Common Stock to be issued upon completion of the Equity Offering will
be 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.
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 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
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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 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
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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.
REGISTRATION RIGHTS
Holders of warrants exercisable into approximately 296,619 shares of Common
Stock are entitled to certain rights with respect to the registration of such
shares under the Securities Act. Under the terms of the agreements between the
Company and the holders of such registrable securities, such holders are
entitled to require the Company to file a registration statement under the
Securities Act (at the Company's expense) with respect to their shares of Common
Stock, and the Company is required to use its best efforts to effect such
registration. Further, holders may require the Company to file additional
registration statements on Form S-3 or otherwise acceptable form at the
Company's expense. All of these registration rights are subject to certain
conditions and limitations, among them the right of the underwriters of an
offering to limit the number of shares included in such registration and the
right of the Company not to effect a requested registration within six months
following an offering of the Company's securities, including the offering made
hereby.
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 OTHER INDEBTEDNESS
CONVERTIBLE DEBENTURES
On May 1, 1998, the Company issued $3,000,000 in Deere Park Convertible
Subordinated 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 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, (ii) an aggregate of 2,427 shares of Common Stock at
$20.60 per share for the Second Draw and (iii) 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. The Deere Park Convertible Debentures will be 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 varies depending upon the date of payment, and is equal
to (i) 6.9% 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.
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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 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
Deere Park Convertible Debentures and the Gordon Brothers Convertible Debentures
were utilized to fund the CMSD Acquisition.
REVOLVING LINE OF CREDIT
On March 12, 1998, the Company guaranteed a revolving credit facility with
a commercial bank 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. 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 to $2,500,000 and extended the term of
the facility to thirteen months. 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 cross-default, defective collateralization and the
occurrence of insolvency events.
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.
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 $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 an 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
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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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DESCRIPTION OF THE NOTES
The Notes will be issued under an indenture (the "Indenture"), to be
dated as of , 1998 by and among the Company, the Guarantors and
[NAME OF TRUSTEE], as Trustee (the "Trustee"). The following summary of
certain provisions of the Indenture does not purport to be complete and is
subject to, and is qualified in its entirety by reference to, the Trust
Indenture Act of 1939, as amended (the "TIA"), and to all of the provisions of
the Indenture (a copy of which has been filed as an exhibit to the Registration
Statement of which this Prospectus is a part), including the definitions of
certain terms therein and those terms made a part of the Indenture by reference
to the TIA as in effect on the date of the Indenture. The definitions of certain
capitalized terms used in the following summary are set forth below under
"-- Certain Definitions." For purposes of this section, references to "the
Company" include only the Company and not its Subsidiaries.
The Notes will be issued in fully registered form only, without coupons, in
denominations of $1,000 and integral multiples thereof. Initially, the Trustee
will act as Paying Agent and Registrar for the Notes. The Notes may be presented
for registration or transfer and exchange at the offices of the Registrar, which
initially will be the Trustee's corporate trust office. The Company may change
any Paying Agent and Registrar without notice to holders of the Notes (the
"Holders"). The Company will pay principal (and premium, if any) on the Notes
at the Trustee's corporate office in New York, New York. At the Company's
option, interest may be paid at the Trustee's corporate trust office or by check
mailed to the registered address of Holders. Any Notes that remain outstanding
after the completion of the Exchange Offer, together with the Exchange Notes
issued in connection with the Exchange Offer, will be treated as a single class
of securities under the Indenture.
RANKING
The Notes and the Guarantees will be general unsecured obligations of the
Company and the Guarantors, respectively, and will rank senior in right of
payment to all future unsecured Indebtedness of the Company and the Guarantors,
respectively, that is, by its terms or by the terms of the agreement or
instrument governing such Indebtedness, expressly subordinated in right of
payment to the Notes and the Guarantees and PARI PASSU in right of payment with
all existing and future unsecured liabilities of the Company and the Guarantors
that are not so subordinated. The Notes will be effectively subordinated to all
secured Indebtedness of the Company, including Indebtedness under the Credit
Facilities, to the extent of the assets securing such Indebtedness.
PRINCIPAL, MATURITY AND INTEREST
The Notes are limited in aggregate principal amount to $125.0 million and
will mature on , 2008. Interest on the Notes will accrue at the
rate of % per annum and will be payable semi-annually in arrears on each
and commencing , 1999, to the persons who are
registered Holders at the close of business on the and ,
respectively, immediately preceding the applicable interest payment date.
Interest on the Notes will accrue from the most recent interest payment date to
which interest has been paid or, if no interest has been paid, from and
including the date of issuance. Interest will be computed on the basis of a
360-day year of twelve 30-day months.
The Notes will not be entitled to the benefit of any mandatory sinking
fund.
REDEMPTION
OPTIONAL REDEMPTION. The Notes will be redeemable, at the Company's
option, in whole at any time or in part from time to time, on and after
, 2003, upon not less than 30 nor more than 60 days' notice, at the
following redemption prices (expressed as percentages of the principal amount at
maturity thereof) if redeemed during the twelve-month period commencing on
of the year set forth below, plus, in each case, accrued and unpaid
interest thereon, if any, to the date of redemption:
YEAR PERCENTAGE
- ---------------------------------------- ----------
2003.................................... %
2004.................................... %
2005.................................... %
2006 and thereafter..................... 100.000%
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OPTIONAL REDEMPTION UPON PUBLIC EQUITY OFFERINGS. At any time, or from
time to time, on or prior to , 2001, the Company may, at its
option, use the net cash proceeds of one or more Public Equity Offerings (as
defined below) to redeem up to 35% of the aggregate principal amount of the
Notes originally issued at a redemption price equal to % of the principal
amount of the Notes to be redeemed plus accrued and unpaid interest, if any, to
the date of redemption; PROVIDED that at least 65% of the principal amount of
Notes originally issued remains outstanding immediately after any such
redemption (excluding any Notes owned by the Company or any of its Affiliates).
In order to effect the foregoing redemption with the proceeds of any Public
Equity Offering, the Company shall make such redemption not more than 120 days
after the consummation of any such Public Equity Offering.
As used in the preceding paragraph, "Public Equity Offering" means an
underwritten public offering of Qualified Capital Stock of the Company pursuant
to a registration statement filed with the Commission in accordance with the
Securities Act.
SELECTION AND NOTICE OF REDEMPTION
In the event that less than all of the Notes are to be redeemed at any
time, selection of such Notes for redemption will be made by the Trustee in
compliance with the requirements of the principal national securities exchange,
if any, on which such Notes are listed or, if such Notes are not then listed on
a national securities exchange, on a PRO RATA basis, by lot or by such method as
the Trustee shall deem fair and appropriate; PROVIDED, HOWEVER, that no Notes of
a principal amount of $1,000 or less shall be redeemed in part; PROVIDED,
FURTHER, that if a partial redemption is made with the proceeds of a Public
Equity Offering, selection of the Notes or portions thereof for redemption shall
be made by the Trustee only on a PRO RATA basis or on as nearly a PRO RATA basis
as is practicable (subject to procedures of The Depository Trust Company),
unless such method is otherwise prohibited. Notice of redemption shall be mailed
by first-class mail at least 30 but not more than 60 days before the redemption
date to each Holder of Notes to be redeemed at its registered address. If any
Note is to be redeemed in part only, the notice of redemption that relates to
such Note shall state the portion of the principal amount thereof to be
redeemed. A new Note in a principal amount equal to the unredeemed portion
thereof will be issued in the name of the Holder thereof upon cancellation of
the original Note. On and after the redemption date, interest will cease to
accrue on Notes or portions thereof called for redemption as long as the Company
has deposited with the Paying Agent funds in satisfaction of the applicable
redemption price pursuant to the Indenture.
GUARANTEES
Each Guarantor unconditionally guarantees, on a senior basis, jointly and
severally, to each Holder and the Trustee, the full and prompt performance of
the Company's obligations under the Indenture and the Notes, including the
payment of principal of and interest on the Notes. The obligations of each
Guarantor are limited to the maximum amount which, after giving effect to all
other contingent and fixed liabilities of such Guarantor and after giving effect
to any collections from or payments made by or on behalf of any other Guarantor
in respect of the obligations of such other Guarantor under its Guarantee or
pursuant to its contribution obligations under the Indenture, will result in the
obligations of such Guarantor under the Guarantee not constituting a fraudulent
conveyance or fraudulent transfer under federal or state law, in the case of
domestic Guarantors, or any applicable foreign law, in the case of foreign
Guarantors. Each Guarantor that makes a payment or distribution under a
Guarantee shall be entitled to a contribution from each other Guarantor in an
amount PRO RATA, based on the net assets of each Guarantor determined in
accordance with GAAP.
Each Guarantor may consolidate with or merge into or sell its assets to the
Company or to another Guarantor that is a Wholly Owned Restricted Subsidiary
without limitation, or with other Persons upon the terms and conditions set
forth in the Indenture. See "-- Certain Covenants -- Merger, Consolidation and
Sale of Assets." In the event that either all of the Capital Stock of a
Guarantor is sold by the Company or one of the Restricted Subsidiaries (whether
by merger, stock purchase or otherwise) or all or substantially all of the
assets of a Guarantor are sold by such Guarantor and such sale complies with the
provisions set forth in "-- Certain Covenants -- Limitation on Asset Sales"
and "-- Change of Control" and any other applicable provisions in the
Indenture, the Guarantor's Guarantee will be released.
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CHANGE OF CONTROL
The Indenture will provide that upon the occurrence of a Change of Control,
each Holder will have the right to require that the Company purchase all or a
portion of such Holder's Notes pursuant to the offer described below (the
"Change of Control Offer"), at a purchase price equal to 101% of the aggregate
principal amount thereof plus accrued interest to the date of purchase.
Within 30 days following the date upon which any Change of Control occurs,
the Company must send, by first-class mail, a notice to each Holder, with a copy
to the Trustee, which notice shall govern the terms of the Change of Control
Offer. Such notice shall state, among other things, the purchase date, which
must be no earlier than 30 days nor later than 60 days from the date such notice
is mailed, other than as may be required by law (the "Change of Control Payment
Date"). Holders electing to have a Note purchased pursuant to a Change of
Control Offer will be required to surrender the Note, with the form entitled
"Option of Holder to Elect Purchase" on the reverse of the Note completed, to
the Paying Agent at the address specified in the notice prior to the close of
business on the third business day prior to the Change of Control Payment Date.
If a Change of Control Offer is made, there can be no assurance that the
Company will have available funds sufficient to pay the Change of Control
purchase price for all the Notes that might be delivered by Holders seeking to
accept the Change of Control Offer. In the event the Company is required to
purchase outstanding Notes pursuant to a Change of Control Offer, the Company
expects that it would seek third party financing to the extent it does not have
available funds to meet its purchase obligations. However, there can be no
assurance that the Company would be able to obtain such financing.
Neither the Board of Directors of the Company nor the Trustee may waive the
covenant relating to a Holder's right to redemption upon a Change of Control.
Restrictions in the Indenture described herein on the ability of the Company and
its Restricted Group Members to incur additional Indebtedness, to grant Liens on
its property, to make Restricted Payments and to make Asset Sales may also make
more difficult or discourage a takeover of the Company, whether favored or
opposed by the management of the Company. Consummation of any such transaction
in certain circumstances may require redemption or repurchase of the Notes, and
there can be no assurance that the Company or the acquiring party will have
sufficient financial resources to effect such redemption or repurchase. Such
restrictions and the restrictions on transactions with Affiliates may, in
certain circumstances, make more difficult or discourage any leveraged buyout of
the Company or any of its Restricted Group Members by the management of the
Company. While such restrictions cover a wide variety of arrangements which have
traditionally been used to effect highly leveraged transactions, the Indenture
may not afford the Holders of Notes protection in all circumstances from the
adverse aspects of a highly leveraged transaction, reorganization,
restructuring, merger or similar transaction.
The Company will comply with the requirements of Rule 14e-1 under the
Exchange Act and any other securities laws and regulations thereunder to the
extent such laws and regulations are applicable in connection with the
repurchase of Notes pursuant to a Change of Control Offer. To the extent that
the provisions of any securities laws or regulations conflict with the "Change
of Control" provisions of the Indenture, the Company shall comply with the
applicable securities laws and regulations and shall not be deemed to have
breached its obligations under the "Change of Control" provisions of the
Indenture by virtue thereof.
The Company shall not be required to make a Change of Control Offer upon a
Change of Control if a third party makes a Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements
applicable to a Change of Control Offer made by the Company and purchases all
Notes validly tendered and not withdrawn under such Change of Control Offer.
CERTAIN COVENANTS
The Indenture will contain, among others, the following covenants:
LIMITATION ON INCURRENCE OF ADDITIONAL INDEBTEDNESS. The Company will not,
and will not permit any of its Restricted Group Members to, directly or
indirectly, create, incur, assume, guarantee, acquire, become liable,
contingently or otherwise, with respect to, or otherwise become responsible for
payment of (collectively, "incur") any Indebtedness (other than Permitted
Indebtedness); PROVIDED, HOWEVER, that if no
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Default or Event of Default shall have occurred and be continuing at the time of
or as a consequence of the incurrence of any such Indebtedness, the Company and
its Restricted Group Members may incur Indebtedness if on the date of the
incurrence of such Indebtedness, after giving effect to the incurrence thereof,
the Leverage Ratio of the Company would be less than or equal to 5.5 to 1.0. For
purposes of determining any particular amount of Indebtedness under this
"Limitation on Incurrence of Additional Indebtedness" covenant, guarantees,
Liens or obligations with respect to letters of credit supporting Indebtedness
otherwise included in the determination of such particular amount shall not be
included; PROVIDED, HOWEVER, that the foregoing shall not in any way be deemed
to limit the provision of " -- Limitation on Issuances of Guarantees of
Indebtedness by Restricted Subsidiaries."
LIMITATION ON RESTRICTED PAYMENTS. The Company will not, and will not
cause or permit any of its Restricted Group Members to, directly or indirectly,
(a) declare or pay any dividend or make any distribution (other than dividends
or distributions payable in Qualified Capital Stock of the Company or any
Restricted Group Member or in options, warrants or other rights to acquire
Qualified Capital Stock) on or in respect of shares of the Company's or any
Restricted Group Member's Capital Stock to holders of such Capital Stock, (b)
purchase, redeem or otherwise acquire or retire for value any Capital Stock of
the Company or any warrants, rights or options to purchase or acquire shares of
any class of such Capital Stock, (c) make any principal payment on, purchase,
defease, redeem, prepay, decrease or otherwise acquire or retire for value,
prior to any scheduled final maturity, scheduled repayment or scheduled sinking
fund payment, any Indebtedness of the Company or any of the Restricted Group
Members that is subordinate or junior in right of payment to the Notes or the
Guarantees, as the case may be, or (d) make any Investment (other than Permitted
Investments) (each of the foregoing actions set forth in clauses (a), (b), (c)
and (d) being referred to as a "Restricted Payment"), unless, at the time of
such Restricted Payment or immediately after giving effect thereto, (i) no
Default or Event of Default shall have occurred and be continuing and (ii) if
the Company is able to incur at least $1.00 of additional Indebtedness (other
than Permitted Indebtedness) in compliance with the Leverage Ratio under the
"Limitation on Incurrence of Additional Indebtedness" covenant, the aggregate
amount of Restricted Payments (including such proposed Restricted Payment) made
subsequent to the Issue Date (the amount expended for such purposes, if other
than in cash, being the fair market value of such property as determined
reasonably and in good faith by the Board of Directors of the Company) shall not
exceed the sum of: (1) 100% of the Cumulative Operating Cash Flow less 150% of
cumulative Adjusted Fixed Charges determined for the period (treated as one
accounting period) commencing on the first day of the fiscal quarter in which
the Issue Date occurs and ending on the last day of the most recent fiscal
quarter immediately preceding the date of such Restricted Payment; plus (2) 100%
of the aggregate net cash proceeds received by the Company from any Person
(other than a Restricted Group Member) from the issuance and sale subsequent to
the Issue Date of Qualified Capital Stock of the Company minus the aggregate
amount of Restricted Payments made pursuant to clause (iii) below; plus (3)
without duplication of any amounts included in clause (ii)(2) above, 100% of the
aggregate net cash proceeds from the issuance and sale (other than to a
Restricted Group Member) of debt securities of the Company that have been
converted into or exchanged for Qualified Capital Stock (excluding, in the case
of clauses (ii)(2) and (3), any net cash proceeds from a Public Equity Offering
to the extent used to redeem the Notes in compliance with the provisions set
forth under "Redemption -- Optional Redemption Upon Public Equity Offerings");
plus (4) in the case of the disposition or repayment of any Investment that was
treated as a Restricted Payment made after the Issue Date, an amount (to the
extent not included in the computation of Cumulative Operating Cash Flow) equal
to the lesser of: (x) the return in cash of capital with respect to such
Investment and (y) the amount of such Investment that was treated as a
Restricted Payment, in either case, less the cost of the disposition of such
Investment and net of taxes; plus (5) so long as the Designation thereof was
treated as a Restricted Payment made after the Issue Date, with respect to any
Unrestricted Group Member that has been redesignated as a Restricted Group
Member after the Issue Date in accordance with " -- Designation of Unrestricted
Group Members," the Company's proportionate interest in an amount equal to the
excess of (x) the total assets of such Restricted Group Member, valued on an
aggregate basis at fair market value, over (y) the total liabilities of such
Restricted Group Member, determined in each case in accordance with GAAP (and
provided that such amount shall not in any case exceed the Designation Amount
with respect to such Restricted Group Member upon its Designation); minus (6)
with respect to each Restricted Group Member which has been
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designated as an Unrestricted Group Member after the Issue Date in accordance
with "-- Designation of Unrestricted Group Members," the greater of (x) $0 and
(y) the Designation Amount thereof (measured as of the date of Designation).
Notwithstanding the foregoing, the provisions set forth in the immediately
preceding paragraph do not prohibit: (1) the payment of any dividend within 60
days after the date of declaration of such dividend if the dividend would have
been permitted on the date of declaration; (2) if no Default or Event of Default
shall have occurred and be continuing, the repurchase, redemption or other
acquisition of any shares of Capital Stock of the Company, either (i) solely in
exchange for shares of Qualified Capital Stock of the Company or (ii) through
the application of net proceeds of a substantially concurrent (x) sale for cash
(other than to a Subsidiary of the Company) of shares of Qualified Capital Stock
of the Company or (y) capital contribution to the Company; (3) if no Default or
Event of Default shall have occurred and be continuing, the acquisition of any
Indebtedness of the Company that is subordinate or junior in right of payment to
the Notes either (i) solely in exchange for shares of Qualified Capital Stock of
the Company, or (ii) in exchange for or through the application of net proceeds
of a substantially concurrent capital contribution or sale for cash (other than
to a Restricted Group Member) of (A) shares of Qualified Capital Stock of the
Company or (B) Refinancing Indebtedness; (4) so long as no Default or Event of
Default shall have occurred and be continuing, repurchases by the Company of
Common Stock of the Company from directors, officers or employees of the Company
or any of its Restricted Group Members or their authorized representatives upon
the death, disability or termination of employment of such directors, officers
or employees, in an aggregate amount not to exceed $1.0 million in any fiscal
year; PROVIDED, HOWEVER, that any unused amount may be used only in the next
succeeding fiscal year; and (5) payments or distributions to dissenting
stockholders in accordance with applicable law, pursuant to or in connection
with a consolidation, merger or transfer of assets that complies with the
provisions of the Indenture applicable to mergers, consolidations and transfers
of all or substantially all of the property and assets of the Company. In
determining the aggregate amount of Restricted Payments made subsequent to the
Issue Date in accordance with clause (ii) of the immediately preceding
paragraph, amounts expended pursuant to clauses (1), (2)(ii) and (4) shall be
included in such calculation.
Not later than the date of making any Restricted Payment, the Company shall
deliver to the Trustee an officers' certificate stating that such Restricted
Payment complies with the Indenture and setting forth in reasonable detail the
basis upon which the required calculations were computed, which calculations may
be based upon the Company's latest available internal quarterly financial
statements.
LIMITATION ON ASSET SALES. The Company will not, and will not permit any
of its Restricted Group Members to, consummate an Asset Sale unless (i) the
Company or the applicable Restricted Group Member, as the case may be, receives
consideration at the time of such Asset Sale at least equal to the fair market
value of the assets sold or otherwise disposed of (as determined in good faith
by the Company's Board of Directors), (ii) at least 80% of the consideration
received by the Company or the Restricted Group Member, as the case may be, from
such Asset Sale shall be in the form of cash or Cash Equivalents and is received
at the time of such disposition; PROVIDED, that any notes or other obligations
received by the Company or any Restricted Group Member from the transferee
thereof that are converted by the Company or such Restricted Group Member into
cash or Cash Equivalents (to the extent of the cash or Cash Equivalents
received) within 90 days following the closing of such Asset Sale, will be
deemed to be cash for purposes of this provision; and (iii) upon the
consummation of an Asset Sale, the Company shall apply, or cause such Restricted
Group Member to apply, the Net Cash Proceeds relating to such Asset Sale within
365 days of receipt thereof either (A) to prepay any indebtedness under the
Credit Facilities (with a permanent reduction of commitments thereunder), (B) to
make an investment in properties and assets that replace the properties and
assets that were the subject of such Asset Sale or in properties and assets that
will be used in the business of the Company and its Restricted Group Members as
existing on the Issue Date or in businesses reasonably related thereto or, in
either such case, in a company having property and assets of a nature or type,
or engaged in a Telecommunications Business ("Replacement Assets"), or (C) a
combination of prepayment and investment permitted by the foregoing clauses
(iii)(A) and (iii)(B). On the 366th day after an Asset Sale or such earlier
date, if any, as the Board of Directors of the Company or of such Restricted
Group Member determines not to apply the Net Cash Proceeds relating to such
Asset Sale as set
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forth in clauses (iii)(A), (iii)(B) and (iii)(C) of the next preceding sentence
(each, a "Net Proceeds Offer Trigger Date"), such aggregate amount of Net Cash
Proceeds which have not been applied on or before such Net Proceeds Offer
Trigger Date as permitted in clauses (iii)(A), (iii)(B) and (iii)(C) of the next
preceding sentence (each a "Net Proceeds Offer Amount") shall be applied by
the Company or such Restricted Group Member to make an offer to purchase (the
"Net Proceeds Offer") on a date (the "Net Proceeds Offer Payment Date") not
less than 30 nor more than 60 days following the applicable Net Proceeds Offer
Trigger Date, from all Holders on a PRO RATA basis, that amount of Notes equal
to the Net Proceeds Offer Amount at a price equal to 100% of the principal
amount of the Notes to be purchased, plus accrued and unpaid interest thereon,
if any, to the date of purchase; PROVIDED, HOWEVER, that if at any time any
non-cash consideration received by the Company or any Restricted Group Member,
as the case may be, in connection with any Asset Sale is converted into or sold
or otherwise disposed of for cash (other than interest received with respect to
any such non-cash consideration), then such conversion or disposition shall be
deemed to constitute an Asset Sale hereunder and the Net Cash Proceeds thereof
shall be applied in accordance with this covenant. The Company may defer the Net
Proceeds Offer until there is an aggregate unutilized Net Proceeds Offer Amount
equal to or in excess of $10.0 million resulting from one or more Asset Sales
(at which time, the entire unutilized Net Proceeds Offer Amount, and not just
the amount in excess of $10.0 million shall be applied as required pursuant to
this paragraph). To the extent that any Net Proceeds Offer Amount remains after
consummation of a Net Proceeds Offer, the Company may use such Net Proceeds
Offer Amount for any purpose not otherwise prohibited by the Indenture. Upon
completion of such offer to purchase, the amount of the Net Proceeds Offer
Amount shall be reset at zero.
In the event of the transfer of substantially all (but not all) of the
property and assets of the Company and its Restricted Group Members as an
entirety to a Person in a transaction permitted under "-- Merger, Consolidation
and Sale of Assets," the successor corporation shall be deemed to have sold the
properties and assets of the Company and its Restricted Group Members not so
transferred for purposes of this covenant, and shall comply with the provisions
of this covenant with respect to such deemed sale as if it were an Asset Sale.
In addition, the fair market value of such properties and assets of the Company
or its Restricted Group Members deemed to be sold shall be deemed to be Net Cash
Proceeds for purposes of this covenant.
Each Net Proceeds Offer will be mailed to the record Holders as shown on
the register of Holders within 30 days following the Net Proceeds Offer Trigger
Date, with a copy to the Trustee, and shall comply with the procedures set forth
in the Indenture. Upon receiving notice of the Net Proceeds Offer, Holders may
elect to tender their Notes in whole or in part in integral multiples of $1,000
in exchange for cash. To the extent Holders properly tender Notes in an amount
exceeding the Net Proceeds Offer Amount, Notes of tendering Holders will be
purchased on a PRO RATA basis (based on amounts tendered). A Net Proceeds Offer
shall remain open for a period of 20 business days or such longer period as may
be required by law.
The Company will comply with the requirements of Rule 14e-1 under the
Exchange Act and any other securities laws and regulations thereunder to the
extent such laws and regulations are applicable in connection with the
repurchase of Notes pursuant to a Net Proceeds Offer. To the extent that the
provisions of any securities laws or regulations conflict with the "Asset
Sale" provisions of the Indenture, the Company shall comply with the applicable
securities laws and regulations and shall not be deemed to have breached its
obligations under the "Asset Sale" provisions of the Indenture by virtue
thereof.
LIMITATION ON DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING RESTRICTED
GROUP MEMBERS. The Company will not, and will not cause or permit any of its
Restricted Group Members to, directly or indirectly, create or otherwise cause
or permit to exist or become effective any encumbrance or restriction on the
ability of any Restricted Group Member to (a) pay dividends or make any other
distributions on or in respect of its Capital Stock; (b) make loans or advances
or to pay any Indebtedness or other obligation owed to the Company or any other
Restricted Group Member; or (c) transfer any of its property or assets to the
Company or any other Restricted Group Member, except for such encumbrances or
restrictions existing under or by reason of: (1) applicable law; (2) the
Indenture; (3) customary non-assignment provisions of any contract or any lease
governing a leasehold interest of any Restricted Group Member; (4) any
instrument governing Acquired Indebtedness, which encumbrance or restriction is
not applicable to any Person, or the properties or assets of any Person, other
than the Person or the properties or assets of the
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Person so acquired; (5) agreements existing on the Issue Date to the extent and
in the manner such agreements are in effect on the Issue Date; (6) in the case
of clause (c) of this covenant, (A) customary restrictions regarding the
subletting, assignment or transfer of any property or asset that is, or is
subject to, a lease, purchase mortgage obligation, license, conveyance or
contract or similar property or asset, (B) any transfer of, agreement to
transfer, option or right with respect to, or Lien on, any property or assets of
the Company or any Restricted Group Member not otherwise prohibited by the
Indenture or (C) encumbrances or restrictions arising or agreed to in the
ordinary course of business, not relating to any Indebtedness, and that do not,
individually or in the aggregate, detract from the value of property or assets
of the Company or any Restricted Group Member in any manner material to the
Company or any Restricted Group Member; (7) with respect to a Restricted Group
Member and imposed pursuant to an agreement that has been entered into for the
sale or disposition of all or substantially all of the Capital Stock of, or
property and assets of, such Restricted Group Member; or (8) an agreement
governing Indebtedness incurred to Refinance the Indebtedness issued, assumed or
incurred pursuant to an agreement referred to in clause (2), (4) or (5) above;
PROVIDED, HOWEVER, that the provisions relating to such encumbrance or
restriction contained in any such Indebtedness are no less favorable to the
Company in any material respect as determined by the Board of Directors of the
Company in their reasonable and good faith judgment than the provisions relating
to such encumbrance or restriction contained in agreements referred to in such
clause (2), (4) or (5). Nothing contained in this "Limitation on Dividend and
Other Payment Restrictions Affecting Restricted Group Members" covenant shall
prevent the Company or any Restricted Group Member from creating, incurring,
assuming or suffering to exist any Liens otherwise permitted in the "Limitation
on Liens" covenant.
DESIGNATION OF UNRESTRICTED GROUP MEMBERS. (a) The Company may designate
any Restricted Group Member as an "Unrestricted Group Member" under the
Indenture (a "Designation") only if:
(i) no Default shall have occurred and be continuing at the time of
or after giving effect to such Designation;
(ii) at the time of and after giving effect to such Designation, the
Company could incur $1.00 of additional Indebtedness under the first
paragraph of "-- Limitation on Incurrence of Indebtedness"; and
(iii) the Company would be permitted to make an Investment (other
than a Permitted Investment) at the time of Designation (assuming the
effectiveness of such Designation) pursuant to the first paragraph of
"-- Limitation on Restricted Payments" in an amount (the "Designation
Amount") equal to the fair market value of the Company's proportionate
interest in the net worth of such Restricted Group Member on such date.
All Subsidiaries of Unrestricted Group Members shall be Unrestricted Group
Members.
The Company shall not, and shall not cause or permit any Restricted Group
Member to, directly or indirectly, at any time (x) provide credit support for,
subject any of its properties or assets (other than the Capital Stock of any
Unrestricted Group Member) to the satisfaction of, or guarantee, any
Indebtedness of any Unrestricted Group Member (including any undertaking,
agreement or instrument evidencing such Indebtedness), (y) be liable for any
Indebtedness of any Unrestricted Group Member or (z) be liable for any
Indebtedness which provides that the holder thereof may (upon notice, lapse of
time or both) declare a default thereon or cause the payment thereof to be
accelerated or payable prior to its final scheduled maturity upon the occurrence
of a default with respect to any Indebtedness of any Unrestricted Group Member.
(b) The Company may revoke any Designation of a Restricted Group
Member as an Unrestricted Group Member (a "Revocation") only if:
(i) no Default shall have occurred and be continuing at the time of
and after giving effect to such Revocation; and
(ii) all Liens and Indebtedness of such Unrestricted Group Member
outstanding immediately following such Revocation would, if incurred at
such time, have been permitted to be incurred for all purposes of the
Indenture.
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All Designations and Revocations must be evidenced by resolutions of the
Board of Directors of the Company, delivered to the Trustee certifying
compliance with the foregoing provisions.
ADDITIONAL GUARANTEES. (a) If the Company or any of the domestic Wholly
Owned Restricted Subsidiaries transfers or causes to be transferred, in one
transaction or a series of related transactions, any property to any Wholly
Owned Restricted Subsidiary that is not a Guarantor, or if the Company or any of
the domestic Wholly Owned Restricted Subsidiaries shall organize, acquire or
otherwise invest in another Wholly Owned Restricted Subsidiary that is not a
Guarantor, or
(b) if the Company permits any Restricted Group Member, other than any
Guarantor on the Issue Date or any Person who becomes a Guarantor pursuant to
clause (a) above, directly or indirectly, by way of the pledge of any
intercompany note or otherwise, to assume, guarantee or in any other manner
become liable with respect to any Indebtedness of the Company or any other
Restricted Group Member;
then such transferee or acquired or other Restricted Group Member shall (i)
execute and deliver to the Trustee a supplemental indenture in form reasonably
satisfactory to the Trustee pursuant to which such Restricted Group Member shall
unconditionally guarantee all of the Company's obligations under the Notes and
the Indenture on the terms set forth in the Indenture and (ii) deliver to the
Trustee an opinion of counsel stating that such supplemental indenture has been
duly authorized, executed and delivered by such Restricted Group Member and
constitutes a legal, valid, binding and enforceable obligation of such
Restricted Group Member. Thereafter, such Restricted Group Member shall be a
Guarantor for all purposes of the Indenture.
LIMITATION ON THE ISSUANCE AND SALE OF CAPITAL STOCK OF RESTRICTED GROUP
MEMBERS. The Company shall not sell, and shall not cause or permit any
Restricted Group Member, directly or indirectly, to issue or sell, any Capital
Stock of a Restricted Group Member, except (i) to the Company or a Restricted
Group Member; (ii) for directors' qualifying shares or shares of Capital Stock
to foreign nationals mandated by applicable law; (iii) if, immediately after
giving effect to such issuance or sale, such Restricted Group Member would no
longer constitute a Restricted Group Member; (iv) in the case of issuance of
Capital Stock by a non-Wholly Owned Restricted Subsidiary if, after giving
effect to such issuance, the Company maintains its direct or indirect percentage
of beneficial and economic ownership of such non-Wholly Owned Restricted
Subsidiary or (v) up to a 10.5% beneficial ownership interest in INTERLINK
Communications, Inc. to Russell Hardy, Stephen Strohman, Salvador Giblas and/or
Monty J. Moore.
LIMITATION ON LIENS. The Company will not, and will not cause or permit
any of its Restricted Group Members to, directly or indirectly, create, incur,
assume or permit or suffer to exist any Liens of any kind against or upon any
property or assets of the Company or any of its Restricted Group Members whether
owned on the Issue Date or acquired after the Issue Date, or any proceeds
therefrom, or assign or otherwise convey any right to receive income or profits
therefrom unless (i) in the case of Liens securing Indebtedness that is
expressly subordinate or junior in right of payment to the Notes, the Notes are
secured by a Lien on such property, assets or proceeds that is senior in
priority to such Liens and (ii) in all other cases, the Notes are equally and
ratably secured, except for (A) Liens existing as of the Issue Date to the
extent and in the manner such Liens are in effect on the Issue Date; (B) Liens
securing Indebtedness under the Credit Facilities; (C) Liens securing the Notes;
(D) Liens of the Company or a Wholly Owned Restricted Subsidiary of the Company
on assets of any Restricted Group Member; (E) Liens securing Refinancing
Indebtedness which is incurred to Refinance any Indebtedness which has been
secured by a Lien permitted under the Indenture and which has been incurred in
accordance with the provisions of the Indenture; PROVIDED, HOWEVER, that such
Liens (a) are no less favorable to the Holders and are not more favorable to the
lienholders with respect to such Liens than the Liens in respect of the
Indebtedness being Refinanced and (b) do not extend to or cover any property or
assets of the Company or any of its Restricted Group Members not securing the
Indebtedness so Refinanced; and (F) Permitted Liens.
MERGER, CONSOLIDATION AND SALE OF ASSETS. The Company will not, in a
single transaction or series of related transactions, consolidate or merge with
or into any Person, or sell, assign, transfer, lease, convey or otherwise
dispose of (or cause or permit any Restricted Group Member to sell, assign,
transfer, lease, convey or otherwise dispose of) all or substantially all of the
assets of the Company and the Company's Restricted Group Members whether as an
entirety or substantially as an entirety to any Person unless: (i) either (1)
the Company shall be the surviving or continuing corporation or (2) the Person
(if other than the
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Company) formed by such consolidation or into which the Company is merged or the
Person which acquires by sale, assignment, transfer, lease, conveyance or other
disposition the properties and assets of the Company and of the Company's
Restricted Group Members substantially as an entirety (the "Surviving Entity")
(x) shall be a corporation organized and validly existing under the laws of the
United States or any State thereof or the District of Columbia and (y) shall
expressly assume, by supplemental indenture (in form and substance satisfactory
to the Trustee) executed and delivered to the Trustee, the due and punctual
payment of the principal of, and premium, if any, and interest on all of the
Notes and the performance of every covenant of the Notes and the Indenture on
the part of the Company to be performed or observed; (ii) immediately after
giving effect to such transaction and the assumption contemplated by clause
(i)(2)(y) above (including giving effect to any Indebtedness and Acquired
Indebtedness incurred or anticipated to be incurred in connection with or in
respect of such transaction), the Leverage Ratio of the Company or such
Surviving Entity, as the case may be, would be less than the Leverage Ratio of
the Company immediately prior to such transaction; (iii) immediately before and
immediately after giving effect to such transaction and the assumption
contemplated by clause (i)(2)(y) above (including, without limitation, giving
effect to any Indebtedness and Acquired Indebtedness incurred or anticipated to
be incurred and any Lien granted in connection with or in respect of the
transaction), no Default or Event of Default shall have occurred or be
continuing; and (iv) the Company or the Surviving Entity shall have delivered to
the Trustee an officers' certificate and an opinion of counsel, each stating
that such consolidation, merger, sale, assignment, transfer, lease, conveyance
or other disposition and, if a supplemental indenture is required in connection
with such transaction, such supplemental indenture comply with the applicable
provisions of the Indenture and that all conditions precedent in the Indenture
relating to such transaction have been satisfied.
For purposes of the foregoing, the transfer (by lease, assignment, sale or
otherwise, in a single transaction or series of transactions) of all or
substantially all of the properties or assets of one or more Restricted Group
Members of the Company the Capital Stock of which constitutes all or
substantially all of the properties and assets of the Company, shall be deemed
to be the transfer of all or substantially all of the properties and assets of
the Company.
Each Guarantor (other than any Guarantor whose Guarantee is to be released
in accordance with the terms of the Guarantee and the Indenture in connection
with any transaction complying with the provisions of "-- Limitation on Asset
Sales") will not, and the Company will not cause or permit any Guarantor to,
consolidate with or merge with or into or sell, assign, transfer, lease, convey
or otherwise dispose of all or substantially all of its assets to any Person
(other than a merger of the Company with any Guarantor or a merger of
Guarantors) unless: (i) the entity formed by or surviving any such consolidation
or merger (if other than the Guarantor) or to which such sale, lease, conveyance
or other disposition shall have been made is a corporation organized and validly
existing under the laws of the United States or any state thereof or the
District of Columbia or an entity organized and validly existing under the laws
of the foreign jurisdiction in which such Guarantor is organized; (ii) such
entity assumes by supplemental indenture all of the obligations of such
Guarantor under such Guarantee; and (iii) immediately after giving effect to
such transaction, no Default or Event of Default shall have occurred and be
continuing.
The Indenture will provide that upon any consolidation, combination or
merger or any transfer of all or substantially all of the assets of the Company
or any Guarantor in accordance with the foregoing, in which the Company or such
Guarantor is not the continuing corporation, the successor Person formed by such
consolidation or into which the Company or such Guarantor is merged or to which
such conveyance, lease or transfer is made shall succeed to, and be substituted
for, and may exercise every right and power of, the Company or such Guarantor
under the Indenture, the Notes or the Guarantee, as the case may be, with the
same effect as if such surviving entity had been named as such.
LIMITATIONS ON TRANSACTIONS WITH AFFILIATES. (a) The Company will not, and
will not permit any of its Restricted Group Members to, directly or indirectly,
enter into or permit to exist any transaction or series of related transactions
(including, without limitation, the purchase, sale, lease or exchange of any
property or the rendering of any service) with, or for the benefit of, any of
its Affiliates (each an "Affiliate Transaction"), other than (x) Affiliate
Transactions permitted under paragraph (b) below and (y) Affiliate Transactions
on terms that are no less favorable than those that might reasonably have been
obtained in a comparable transaction at such time on an arm's-length basis from
a Person that is not an Affiliate of the
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Company or such Restricted Group Member. All Affiliate Transactions (and each
series of related Affiliate Transactions which are similar or part of a common
plan) involving aggregate payments or other property with a fair market value in
excess of $2.0 million shall be approved by the Board of Directors of the
Company or such Restricted Group Member, as the case may be, such approval to be
evidenced by a Board Resolution stating that such Board of Directors has
determined that such transaction complies with the foregoing provisions. If the
Company or any Restricted Group Member enters into an Affiliate Transaction (or
a series of related Affiliate Transactions related to a common plan) that
involves an aggregate fair market value of more than $10.0 million, the Company
or such Restricted Group Member, as the case may be, shall, prior to the
consummation thereof, obtain a favorable opinion as to the fairness of such
transaction or series of related transactions to the Company or the relevant
Restricted Group Member, as the case may be, from a financial point of view,
from an Independent Financial Advisor and file the same with the Trustee.
(b) The restrictions set forth in clause (a) shall not apply to (i)
reasonable fees and compensation paid to and indemnity provided on behalf of,
officers, directors, employees or consultants of the Company or any Restricted
Group Member as determined in good faith by the Company's Board of Directors or
senior management; (ii) loans and advances to officers and employees of the
Company and its Restricted Group Members not exceeding $1.0 million outstanding
at any time; (iii) transactions exclusively between or among the Company and any
of its Restricted Group Members or exclusively between or among such Restricted
Group Members, provided such transactions are not otherwise prohibited by the
Indenture; (iv) any agreement as in effect as of the Issue Date or any amendment
thereto or any transaction contemplated thereby (including pursuant to any
amendment thereto) in any replacement agreement thereto so long as any such
amendment or replacement agreement is not more disadvantageous to the Holders in
any material respect than the original agreement as in effect on the Issue Date;
and (v) Restricted Payments permitted by the Indenture.
CONDUCT OF BUSINESS. The Company and its Restricted Group Members will not
engage in any businesses which are not the same, similar or reasonably related
to the businesses in which the Company and its Restricted Group Members are
engaged on the Issue Date.
REPORTS TO HOLDERS. The Indenture will provide that the Company will
deliver to the Trustee within 15 days after the filing of the same with the
Commission, copies of the quarterly and annual reports and of the information,
documents and other reports, if any, which the Company is required to file with
the Commission pursuant to Section 13 or 15(d) of the Exchange Act. The
Indenture further provides that, notwithstanding that the Company may not be
subject to the reporting requirements of Section 13 or 15(d) of the Exchange
Act, the Company will file with the Commission, to the extent permitted, and
provide the Trustee and Holders with such annual reports and such information,
documents and other reports specified in Sections 13 and 15(d) of the Exchange
Act. The Company will also comply with the other provisions of TIA 314(a).
EVENTS OF DEFAULT
The following events are defined in the Indenture as "Events of Default":
(i) the failure to pay interest on any Notes when the same becomes
due and payable and the default continues for a period of 30 days;
(ii) the failure to pay the principal of any Notes, when the same
becomes due and payable, at maturity, upon redemption or otherwise
(including the failure to make a payment to purchase Notes tendered
pursuant to a Change of Control Offer or a Net Proceeds Offer);
(iii) a default in the observance or performance of any other
covenant or agreement contained in the Indenture which default continues
for a period of 30 days after the Company receives written notice
specifying the default (and demanding that such default be remedied) from
the Trustee or the Holders of at least 25% of the outstanding principal
amount of the Notes (except in the case of a default with respect to the
"Merger, Consolidation and Sale of Assets" covenant, which will
constitute an Event of Default with such notice requirement but without
such passage of time requirement);
(iv) the failure to pay at final maturity (giving effect to any
applicable grace periods and any extensions thereof) the principal amount
of any Indebtedness of the Company or any Restricted Group
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Member, or the acceleration of the final stated maturity of any such
Indebtedness if the aggregate principal amount of such Indebtedness,
together with the principal amount of any other such Indebtedness in
default for failure to pay principal at final maturity or which has been
accelerated, aggregates $5.0 million or more at any time; PROVIDED that
such Indebtedness has not been discharged in full or such acceleration has
not been rescinded or annulled;
(v) one or more judgments representing obligations in an aggregate
amount in excess of $5.0 million shall have been rendered against the
Company or any of its Restricted Group Members and such judgments remain
undischarged, unpaid or unstayed for a period of 60 days after such
judgment or judgments become final and non-appealable; or
(vi) certain events of bankruptcy affecting the Company or any of its
Significant Restricted Group Members.
If an Event of Default (other than an Event of Default specified in clause
(vi) above) shall occur and be continuing, the Trustee or the Holders of at
least 25% in principal amount of outstanding Notes may declare the principal of
and accrued interest on all the Notes to be due and payable by notice in writing
to the Company and the Trustee specifying the respective Event of Default and
that it is a "notice of acceleration" (the "Acceleration Notice"), and the
same shall become immediately due and payable. If an Event of Default specified
in clause (vi) above occurs and is continuing, then all unpaid principal of, and
premium, if any, and accrued and unpaid interest on all of the outstanding Notes
shall IPSO FACTO become and be immediately due and payable without any
declaration or other act on the part of the Trustee or any Holder.
The Indenture will provide that, at any time after a declaration of
acceleration with respect to the Notes as described in the preceding paragraph,
the Holders of a majority in principal amount of the Notes may rescind and
cancel such declaration and its consequences (i) if the rescission would not
conflict with any judgment or decree, (ii) if all existing Events of Default
have been cured or waived except nonpayment of principal or interest that has
become due solely because of the acceleration, (iii) to the extent the payment
of such interest is lawful, interest on overdue installments of interest and
overdue principal, which has become due otherwise than by such declaration of
acceleration, has been paid, (iv) if the Company has paid the Trustee its
reasonable compensation and reimbursed the Trustee for its expenses,
disbursements and advances and (v) in the event of the cure or waiver of an
Event of Default of the type described in clause (vi) of the description above
of Events of Default, the Trustee shall have received an officers' certificate
and an opinion of counsel that such Event of Default has been cured or waived.
No such rescission shall affect any subsequent Default or impair any right
consequent thereto.
The Holders of a majority in principal amount of the Notes may waive any
existing Default or Event of Default under the Indenture, and its consequences,
except a default in the payment of the principal of or interest on any Notes.
Holders of the Notes may not enforce the Indenture or the Notes except as
provided in the Indenture and under the TIA. Subject to the provisions of the
Indenture relating to the duties of the Trustee, the Trustee is under no
obligation to exercise any of its rights or powers under the Indenture at the
request, order or direction of any of the Holders, unless such Holders have
offered to the Trustee reasonable indemnity. Subject to all provisions of the
Indenture and applicable law, the Holders of a majority in aggregate principal
amount of the then outstanding Notes have the right to direct the time, method
and place of conducting any proceeding for any remedy available to the Trustee
or exercising any trust or power conferred on the Trustee.
Under the Indenture, the Company is required to provide an officers'
certificate to the Trustee promptly upon any such officer obtaining knowledge of
any Default or Event of Default (provided that such officers shall provide such
certification at least annually whether or not they know of any Default or Event
of Default) that has occurred and, if applicable, describe such Default or Event
of Default and the status thereof.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have its
obligations and the corresponding obligations of the Guarantors discharged with
respect to the outstanding Notes ("Legal Defeasance"). Such Legal Defeasance
means that the Company shall be deemed to have paid and discharged the entire
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indebtedness represented by the outstanding Notes, except for (i) the rights of
Holders to receive payments in respect of the principal of, premium, if any, and
interest on the Notes when such payments are due, (ii) the Company's obligations
with respect to the Notes concerning issuing temporary Notes, registration of
Notes, mutilated, destroyed, lost or stolen Notes and the maintenance of an
office or agency for payments, (iii) the rights, powers, trust, duties and
immunities of the Trustee and the Company's obligations in connection therewith
and (iv) the Legal Defeasance provisions of the Indenture. In addition, the
Company may, at its option and at any time, elect to have the obligations of the
Company and the Guarantors released with respect to certain covenants that are
described in the Indenture ("Covenant Defeasance") and thereafter any omission
to comply with such obligations shall not constitute a Default or Event of
Default with respect to the Notes. In the event Covenant Defeasance occurs,
certain events (not including non-payment, bankruptcy, receivership,
reorganization and insolvency events) described under "Events of Default" will
no longer constitute an Event of Default with respect to the Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance, (i)
the Company must irrevocably deposit with the Trustee, in trust, for the benefit
of the Holders cash in U.S. dollars, non-callable U.S. government obligations,
or a combination thereof, in such amounts as will be sufficient, in the opinion
of a nationally recognized firm of independent public accountants, to pay the
principal of, premium, if any, and interest on the Notes on the stated date for
payment thereof or on the applicable redemption date, as the case may be; (ii)
in the case of Legal Defeasance, the Company shall have delivered to the Trustee
an opinion of counsel in the United States reasonably acceptable to the Trustee
confirming that (A) the Company has received from, or there has been published
by, the Internal Revenue Service a ruling or (B) since the date of the
Indenture, there has been a change in the applicable federal income tax law, in
either case to the effect that, and based thereon such opinion of counsel shall
confirm that, the Holders will not recognize income, gain or loss for federal
income tax purposes as a result of such Legal Defeasance and will be subject to
federal income tax on the same amounts, in the same manner and at the same times
as would have been the case if such Legal Defeasance had not occurred; (iii) in
the case of Covenant Defeasance, the Company shall have delivered to the Trustee
an opinion of counsel in the United States reasonably acceptable to the Trustee
confirming that the Holders will not recognize income, gain or loss for federal
income tax purposes as a result of such Covenant Defeasance and will be subject
to federal income tax on the same amounts, in the same manner and at the same
times as would have been the case if such Covenant Defeasance had not occurred;
(iv) no Default or Event of Default shall have occurred and be continuing on the
date of such deposit or insofar as Events of Default from bankruptcy or
insolvency events are concerned, at any time in the period ending on the 91st
day after the date of deposit; (v) such Legal Defeasance or Covenant Defeasance
shall not result in a breach or violation of, or constitute a default under the
Indenture or any other material agreement or instrument to which the Company or
any of its Restricted Group Members is a party or by which the Company or any of
its Restricted Group Members is bound; (vi) the Company shall have delivered to
the Trustee an officers' certificate stating that the deposit was not made by
the Company with the intent of preferring the Holders over any other creditors
of the Company or with the intent of defeating, hindering, delaying or
defrauding any other creditors of the Company or others; (vii) the Company shall
have delivered to the Trustee an officers' certificate and an opinion of
counsel, each stating that all conditions precedent provided for or relating to
the Legal Defeasance or the Covenant Defeasance have been complied with; (viii)
the Company shall have delivered to the Trustee an opinion of counsel to the
effect that after the 91st day following the deposit, the trust funds will not
be subject to the effect of any applicable bankruptcy, insolvency,
reorganization or similar laws affecting creditors' rights generally; and (ix)
certain other customary conditions precedent are satisfied. Notwithstanding the
foregoing, the opinion of counsel required by clause (ii) above with respect to
a Legal Defeasance need not be delivered if all Notes not theretofore delivered
to the Trustee for cancellation (x) have become due and payable or (y) will
become due an payable on the maturity date within one year under arrangements
satisfactory to the Trustee for the giving of notice of redemption by the
Trustee in the name, and at the expense, of the Company.
SATISFACTION AND DISCHARGE
The Indenture will be discharged and will cease to be of further effect
(except as to surviving rights or registration of transfer or exchange of the
Notes, as expressly provided for in the Indenture) as to all
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outstanding Notes when (i) either (a) all the Notes theretofore authenticated
and delivered (except lost, stolen or destroyed Notes which have been replaced
or paid and Notes for whose payment money has theretofore been deposited in
trust or segregated and held in trust by the Company and thereafter repaid to
the Company or discharged from such trust) have been delivered to the Trustee
for cancellation or (b) all Notes not theretofore delivered to the Trustee for
cancellation have become due and payable and the Company has irrevocably
deposited or caused to be deposited with the Trustee funds in an amount
sufficient to pay and discharge the entire Indebtedness on the Notes not
theretofore delivered to the Trustee for cancellation, for principal of,
premium, if any, and interest on the Notes to the date of deposit together with
irrevocable instructions from the Company directing the Trustee to apply such
funds to the payment thereof at maturity or redemption, as the case may be; (ii)
the Company has paid all other sums payable under the Indenture by the Company;
and (iii) the Company has delivered to the Trustee an officers' certificate and
an opinion of counsel stating that all conditions precedent under the Indenture
relating to the satisfaction and discharge of the Indenture have been complied
with.
MODIFICATION OF THE INDENTURE
From time to time, the Company, the Guarantors and the Trustee, without the
consent of the Holders, may amend the Indenture for certain specified purposes,
including curing ambiguities, defects or inconsistencies, so long as such change
does not, in the opinion of the Trustee, adversely affect the rights of any of
the Holders in any material respect. In formulating its opinion on such matters,
the Trustee will be entitled to rely on such evidence as it deems appropriate,
including, without limitation, solely on an opinion of counsel. Other
modifications and amendments of the Indenture may be made with the consent of
the Holders of a majority in principal amount of the then outstanding Notes
issued under the Indenture, except that, without the consent of each Holder
affected thereby, no amendment may: (i) reduce the amount of Notes whose Holders
must consent to an amendment; (ii) reduce the rate of or change or have the
effect of changing the time for payment of interest, including defaulted
interest, on any Notes; (iii) reduce the principal of or change or have the
effect of changing the fixed maturity of any Notes, or change the date on which
any Notes may be subject to redemption or repurchase, or reduce the redemption
or repurchase price therefor; (iv) make any Notes payable in money other than
that stated in the Notes; (v) make any change in provisions of the Indenture
protecting the right of each Holder to receive payment of principal of and
interest on such Note on or after the due date thereof or to bring suit to
enforce such payment, or permitting Holders of a majority in principal amount of
Notes to waive Defaults or Events of Default; (vi) amend, change or modify in
any material respect the obligation of the Company to make and consummate a
Change of Control Offer in the event of a Change of Control or make and
consummate a Net Proceeds Offer with respect to any Asset Sale that has been
consummated or modify any of the provisions or definitions with respect thereto;
or (vii) release any Guarantor from any of its obligations under its Guarantee
or the Indenture other than in accordance with the terms of the Indenture.
GOVERNING LAW
The Indenture will provide that it and the Notes and the Guarantees will be
governed by, and construed in accordance with, the laws of the State of New York
but without giving effect to applicable principles of conflicts of law to the
extent that the application of the law of another jurisdiction would be required
thereby.
THE TRUSTEE
The Indenture will provide that, except during the continuance of an Event
of Default, the Trustee will perform only such duties as are specifically set
forth in the Indenture. During the existence of an Event of Default, the Trustee
will exercise such rights and powers vested in it by the Indenture, and use the
same degree of care and skill in its exercise as a prudent man would exercise or
use under the circumstances in the conduct of his own affairs.
The Indenture and the provisions of the TIA contain certain limitations on
the rights of the Trustee, should it become a creditor of the Company, to obtain
payments of claims in certain cases or to realize on certain property received
in respect of any such claim as security or otherwise. Subject to the TIA, the
Trustee will be permitted to engage in other transactions; PROVIDED that if the
Trustee acquires any conflicting interest as described in the TIA, it must
eliminate such conflict or resign.
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CERTAIN DEFINITIONS
Set forth below is a summary of certain of the defined terms used in the
Indenture. Reference is made to the Indenture for the full definition of all
such terms, as well as any other terms used herein for which no definition is
provided.
"ACQUIRED INDEBTEDNESS" means Indebtedness of a Person or any of its
Subsidiaries existing at the time such Person becomes a Restricted Group Member
or at the time it merges or consolidates with the Company or any of its
Restricted Group Members or assumed in connection with the acquisition of assets
from such Person and in each case not incurred by such Person in connection
with, or in anticipation or contemplation of, such Person becoming a Restricted
Group Member or such acquisition, merger or consolidation; PROVIDED that
Indebtedness of such Person which is redeemed, defeased, retired or otherwise
repaid at the time of or immediately upon the consummation of the transactions
by which such Person becomes a Restricted Group Member or such Acquisition shall
not be considered as Indebtedness.
"ACQUISITION" means (a) an Investment by the Company or any Restricted
Group Member in any other Person pursuant to which such Person shall become a
Restricted Group Member or any Restricted Group Member, or shall be merged with
or into the Company or any Restricted Group Member, or (b) the acquisition by
the Company or any Restricted Group Member of the assets of any Person (other
than a Restricted Group Member) which constitute all or substantially all of the
assets of such Person or comprises any division or line of business of such
Person or any other properties or assets of such Person other than in the
ordinary course of business.
"ADJUSTED FIXED CHARGES" means, with respect to any Person for any
period, the sum, without duplication, of (i) Consolidated Interest Expense, plus
(ii) the amount of all dividend payments on any series of Preferred Stock of
such Person (other than dividends paid in Qualified Capital Stock) paid, accrued
or scheduled to be paid or accrued during such period.
"ADJUSTED INTEREST EXPENSE" means, with respect to any Person for any
period, the sum of, without duplication: (i) the aggregate of the interest
expense of such Person and its Restricted Group Members for such period
determined in accordance with GAAP, including without limitation, (a) any
amortization of debt discount and amortization or write-off of deferred
financing costs, (b) the net costs under Interest Swap Obligations, (c) all
capitalized interest and (d) the interest portion of any deferred payment
obligation; and (ii) the interest component of Capitalized Lease Obligations
paid, accrued and/or scheduled to be paid or accrued by such Person and its
Restricted Group Members during such period as determined on a consolidated
basis in accordance with GAAP, excluding, however, with respect to any
Restricted Group Member, that proportion thereof that corresponds to the
percentage ownership interest in the outstanding Capital Stock of such
Restricted Group Member not owned on the last day of such period, directly or
indirectly, by the Company.
"ADJUSTED INCOME TAX EXPENSE" means, with respect to any period, the
provision for federal, state, local and foreign income taxes payable by the
Company and its Restricted Group Members for such period as determined on a
consolidated basis in accordance with GAAP, excluding, however, with respect to
any Restricted Group Member, that proportion thereof that corresponds to the
percentage ownership interest in the outstanding Capital Stock of such
Restricted Group Member not owned on the last day of such period, directly or
indirectly, by the Company.
"ADJUSTED NET INCOME" means, with respect to any period, the net income
of the Company and the Restricted Group Members for such period determined in
accordance with GAAP, adjusted, to the extent included in calculating such net
income, by excluding, without duplication, (a) all extraordinary gains or losses
for such period, (b) all gains or losses from the sales or other dispositions of
assets out of the ordinary course of business (net of taxes, fees and expenses
relating to the transaction giving rise thereto) for such period; (c) that
portion of such net income derived from or in respect of investments in Persons
other than Restricted Group Members, except to the extent actually received in
cash by the Company or any Restricted Group Member (subject, in the case of any
Restricted Group Member, to the provisions of clause (f) of this definition);
(d) the portion of such net income (or loss) allocable to minority interests in
any Person (other than a Restricted Group Member) for such period, except to the
extent the Company's allocation portion of such Person's net income for such
period is actually received in cash by the Company or any Restricted Group
Member (subject, in the case of any Restricted Subsidiary, to the provisions of
clause (f) of this
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definition); (e) the net income (or loss) of any other Person combined with the
Company or any Restricted Group Member on a "pooling of interests" basis
attributable to any period prior to the date of combination; (f) the net income
of any Restricted Group Member to the extent that the declaration of dividends
or similar distributions by that Restricted Group Member of that income is not
at the time (regardless of any waiver) permitted, directly or indirectly, by
operation of the terms of its charter or any agreement, instrument, judgment,
decree, order, statute, rule or governmental regulations applicable to that
Restricted Group Member or the holders of its Capital Stock; and (g) to the
extent not otherwise excluded in accordance with GAAP, the net income (or loss)
of any Restricted Group Member in an amount that corresponds to the percentage
ownership interest in the income of such Restricted Group Member not owned on
the last day of such period, directly or indirectly, by the Company.
"ADJUSTED OPERATING CASH FLOW" means, with respect to any period,
Adjusted Net Income for such period increased (without duplication), to the
extent deducted in calculating such Adjusted Net Income, by (a) Adjusted Income
Tax Expense for such period; (b) Adjusted Fixed Charges for such period; and (c)
depreciation, amortization and any other non-cash items for such period (other
than any non-cash item to the extent that it requires the accrual of, or a
reserve for, cash charges for any future period) of the Company and the
Restricted Group Members, including, without limitation, amortization of
capitalized debt issuance costs for such period, all of the foregoing determined
in accordance with GAAP minus non-cash items to the extent they increase
Adjusted Net Income (including the partial or entire reversal of reserves taken
in prior periods) for such period. In calculating Adjusted Operating Cash Flow,
for each Restricted Group Member, the addition to Adjusted Net Income for such
Restricted Group Member of the items set forth in clause (c) of the previous
sentence shall exclude that proportion thereof that corresponds to the
percentage ownership interest in the outstanding Capital Stock of such
Restricted Group Member not owned on the last day of such period, directly or
indirectly, by the Company.
"AFFILIATE" means, with respect to any specified Person, any other Person
who directly or indirectly through one or more intermediaries controls, or is
controlled by, or is under common control with, such specified Person. The term
"control" means the possession, directly or indirectly, of the power to direct
or cause the direction of the management and policies of a Person, whether
through the ownership of voting securities, by contract or otherwise; and the
terms "controlling" and "controlled" have meanings correlative of the
foregoing.
"ASSET SALE" means any direct or indirect sale, issuance, conveyance,
transfer, lease (other than operating leases entered into in the ordinary course
of business), assignment or other transfer for value by the Company or any of
its Restricted Group Members (including any Sale and Leaseback Transaction) to
any Person other than the Company or a Restricted Group Member of (a) any
Capital Stock of any Restricted Group Member (other than in respect of any
directors' qualifying shares or investments by foreign nationals mandated by
applicable law); or (b) any other property or assets of the Company or any
Restricted Group Member other than in the ordinary course of business; PROVIDED,
HOWEVER, that Asset Sales shall not include (i) a transaction or series of
related transactions for which the Company or its Restricted Group Members
receive aggregate consideration of less than $500,000 and (ii) the sale, lease,
conveyance, disposition or other transfer of all or substantially all of the
assets of the Company as permitted under "Merger, Consolidation and Sale of
Assets."
"BOARD OF DIRECTORS" means, as to any Person, the board of directors (or
the equivalent thereof) of such Person or any duly authorized committee thereof.
"BOARD RESOLUTION" means, with respect to any Person, a copy of a
resolution certified by the Secretary or an Assistant Secretary of such Person
to have been duly adopted by the Board of Directors of such Person and to be in
full force and effect on the date of such certification, and delivered to the
Trustee.
"CAPITALIZED LEASE OBLIGATION" means, as to any Person, the obligations
of such Person under a lease that are required to be classified and accounted
for as capital lease obligations under GAAP and, for purposes of this
definition, the amount of such obligations at any date shall be the capitalized
amount of such obligations at such date, determined in accordance with GAAP.
"CAPITAL STOCK" means (i) with respect to any Person that is a
corporation, any and all shares, interests, participations or other equivalents
(however designated and whether or not voting) of corporate
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stock, including each class of Common Stock and Preferred Stock of such Person
and (ii) with respect to any Person that is not a corporation, any and all
partnership or other equity interests of such Person.
"CASH EQUIVALENTS" means (i) marketable direct obligations issued by, or
unconditionally guaranteed by, the United States Government or issued by any
agency thereof and backed by the full faith and credit of the United States, in
each case maturing within one year from the date of acquisition thereof; (ii)
marketable direct obligations issued by any state of the United States of
America or any political subdivision of any such state or any public
instrumentality thereof maturing within one year from the date of acquisition
thereof and, at the time of acquisition, having one of the two highest ratings
obtainable from either Standard & Poor's Corporation ("S&P") or Moody's
Investors Service, Inc. ("Moody's"); (iii) commercial paper maturing no more
than one year from the date of creation thereof and, at the time of acquisition,
having a rating of at least A-1 from S&P or at least P-1 from Moody's; (iv)
certificates of deposit or bankers' acceptances maturing within one year from
the date of acquisition thereof issued by any bank organized under the laws of
the United States of America or any state thereof or the District of Columbia or
any U.S. branch of a foreign bank having at the date of acquisition thereof
combined capital and surplus of not less than $250,000,000; (v) repurchase
obligations with a term of not more than seven days for underlying securities of
the types described in clause (i) above entered into with any bank meeting the
qualifications specified in clause (iv) above; and (vi) investments in money
market funds which invest substantially all their assets in securities of the
types described in clauses (i) through (v) above.
"CHANGE OF CONTROL" means the occurrence of one or more of the following
events: (i) any sale, lease, exchange or other transfer (in one transaction or a
series of related transactions) of all or substantially all of the assets of the
Company to any Person or group of related Persons for purposes of Section 13(d)
of the Exchange Act (a "Group"), together with any Affiliates thereof (whether
or not otherwise in compliance with the provisions of the Indenture) other than
to the Permitted Holders; (ii) the approval by the holders of Capital Stock of
the Company of any plan or proposal for the liquidation or dissolution of the
Company, as the case may be (whether or not otherwise in compliance with the
provisions of the Indenture); (iii) any Person or Group (other than the
Permitted Holders), together with any Affiliate thereof, shall become the record
owner or the beneficial owner (other than any Person described in clause (d)(2)
of Rule 13d-3 of the Exchange Act) of more than 50% of the aggregate voting
power or economic interest of the Capital Stock of the Company; or (iv) the
replacement of a majority of the Board of Directors of the Company over a two-
year period from the directors who constituted the Board of Directors of the
Company, at the beginning of such period, and such replacement shall not have
been approved by a vote of at least a majority of the Board of Directors of the
Company, then still in office who either were members of such Board of Directors
at the beginning of such period or whose election as a member of such Board of
Directors was previously so approved.
"COMMON STOCK" of any Person means any and all shares, interests or other
participations in, and other equivalents (however designated and whether voting
or non-voting) of such Person's common stock, whether outstanding on the Issue
Date or issued after the Issue Date, and includes, without limitation, all
series and classes of such common stock.
"CONSOLIDATED NET WORTH" of any Person means the consolidated
stockholders' equity of such Person, determined on a consolidated basis in
accordance with GAAP, less (without duplication) amounts attributable to (x)
Disqualified Capital Stock of such Person and its Subsidiaries or (y)
Unrestricted Subsidiaries.
"CREDIT FACILITIES" means one or more credit facilities evidenced by one
or more credit agreements, together with the related documents thereto
(including, without limitation, any guarantee agreements and security
documents), in each case as such agreements may be amended (including any
amendment and restatement thereof), supplemented or otherwise modified from time
to time, including any agreement extending the maturity of, refinancing,
replacing or otherwise restructuring (including increasing the amount of
available borrowings thereunder (PROVIDED that such increase in borrowings is
permitted by the "Limitation on Incurrence of Additional Indebtedness"
covenant above) or adding Restricted Group Member of the Company as additional
borrowers or guarantors thereunder) all or any portion of the Indebtedness under
such agreements or any successor or replacement agreement and whether by the
same or any other agent, lender or group of lenders.
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"CUMULATIVE OPERATING CASH FLOW" means, as at any date of determination,
the positive cumulative Adjusted Operating Cash Flow realized during the period
commencing on the first day of the fiscal quarter in which the Issue Date occurs
and ending on the last day of the most recent fiscal quarter immediately
preceding the date of determination for which consolidated financial information
of the Company is available or, if such cumulative Adjusted Operating Cash Flow
for such period is negative, the negative amount by which cumulative Adjusted
Operating Cash Flow is less than zero.
"CURRENCY AGREEMENT" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement designed to protect the
Company or any Restricted Group Member against fluctuations in currency (or
currency units) values.
"DEFAULT" means an event or condition the occurrence of which is, or with
the lapse of time or the giving of notice or both would be, an Event of Default.
"DESIGNATION" has the meaning set forth in "-- Certain
Covenants -- Designation of Unrestricted Group Members."
"DESIGNATION AMOUNT" has the meaning set forth in "-- Certain
Covenants -- Designation of Unrestricted Group Members."
"DISQUALIFIED CAPITAL STOCK" means that portion of any Capital Stock
which, by its terms (or by the terms of any security into which it is
convertible or for which it is exchangeable), or upon the happening of any
event, matures or is mandatorily redeemable, pursuant to a sinking fund
obligation or otherwise, or is redeemable at the sole option of the holder
thereof on or prior to the final maturity date of the Notes.
"EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended, or
any successor statute or statutes.
"EXISTING JOINT VENTURE" means each of Telereunion S.A. [any others] and
[its/their] respective successor(s) thereto.
"FAIR MARKET VALUE" means, with respect to any asset or property, the
price (after taking into account any liabilities relating to such assets) which
could be negotiated in an arm's-length, free market transaction, for cash,
between a willing seller and a willing and able buyer, neither of whom is under
undue pressure or compulsion to complete the transaction. Fair market value
shall be determined by the Board of Directors of the Company acting reasonably
and in good faith and shall be evidenced by a Board Resolution of the Board of
Directors of the Company delivered to the Trustee.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as may be approved by a significant segment of the accounting
profession of the United States, which are in effect as of the Issue Date.
"GUARANTOR" means each of the Company's U.S. Wholly Owned Restricted
Subsidiaries as of the Issue Date and each of the Company's Restricted Group
Members that in the future executes a supplemental indenture in which such
Restricted Group Member agrees to be bound by the terms of the Indenture as a
Guarantor; PROVIDED, HOWEVER, that any Person constituting a Guarantor shall
cease to constitute a Guarantor when its Guarantee is released in accordance
with the terms of the Indenture.
"INDEBTEDNESS" means with respect to any Person, without duplication, (i)
all Obligations of such Person for borrowed money, (ii) all Obligations of such
Person evidenced by bonds, debentures, notes or other similar instruments, (iii)
all Capitalized Lease Obligations of such Person as lessee, (iv) all Obligations
of such Person issued or assumed as the deferred purchase price of property, all
conditional sale obligations and all Obligations under any title retention
agreement (but excluding trade accounts payable and other accrued liabilities
arising in the ordinary course of business that are not overdue by 90 days or
more or are being contested in good faith by appropriate proceedings promptly
instituted and diligently conducted), (v) all Obligations for the reimbursement
of any obligor on any letter of credit, banker's acceptance or similar credit
transaction, (vi) guarantees and other contingent obligations in respect of
Indebtedness referred to in clauses (i) through (v) above and clause (viii)
below, (vii) all Obligations of any other Person of the type referred to in
clauses (i) through (vi) which are secured by any lien on any property or asset
of such Person, the amount of such Obligation being deemed to be the lesser of
the fair market
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value of such property or asset or the amount of the Obligation so secured,
(viii) all Obligations under currency agreements and interest swap agreements of
such Person and (ix) all Disqualified Capital Stock issued by such Person with
the amount of Indebtedness represented by such Disqualified Capital Stock being
equal to the greater of its voluntary or involuntary liquidation preference and
its maximum fixed repurchase price, but excluding accrued dividends, if any. For
purposes hereof, the "maximum fixed repurchase price" of any Disqualified
Capital Stock which does not have a fixed repurchase price shall be calculated
in accordance with the terms of such Disqualified Capital Stock as if such
Disqualified Capital Stock were purchased on any date on which Indebtedness
shall be required to be determined pursuant to the Indenture, and if such price
is based upon, or measured by, the fair market value of such Disqualified
Capital Stock, such fair market value shall be determined reasonably and in good
faith by the Board of Directors of the issuer of such Disqualified Capital
Stock. For purposes of the covenant described above under the caption
"Limitation on Incurrence of Additional Indebtedness," in determining the
principal amount of any Indebtedness to be incurred by the Company or any
Restricted Group Member or which is outstanding at any date, the principal
amount of any Indebtedness which provides that an amount less than the principal
amount thereof shall be due upon any declaration of acceleration thereof shall
be the accreted value thereof at the date of determination.
"INDEPENDENT FINANCIAL ADVISOR" means a firm (i) which does not, and
whose directors, officers and employees or Affiliates do not, have a direct or
indirect financial interest in the Company and (ii) which, in the judgment of
the Board of Directors of the Company, is otherwise independent and qualified to
perform the task for which it is to be engaged.
"INTEREST SWAP OBLIGATIONS" means the obligations of any Person pursuant
to any arrangement with any other Person, whereby, directly or indirectly, such
Person is entitled to receive from time to time periodic payments calculated by
applying either a floating or a fixed rate of interest on a stated notional
amount in exchange for periodic payments made by such other Person calculated by
applying a fixed or a floating rate of interest on the same notional amount and
shall include, without limitation, interest rate swaps, caps, floors, collars
and similar agreements.
"INVESTMENT" means, with respect to any Person, any direct or indirect
loan or other extension of credit (including, without limitation, a guarantee
but excluding advances to customers in the ordinary course of business that are,
in conformity with GAAP, recorded as accounts receivable on the balance sheet of
the Company or any of its Restricted Group Members) or capital contribution to
(by means of any transfer of cash or other property to others or any payment for
property or services for the account or use of others), or any purchase or
acquisition by such Person of any Capital Stock, bonds, notes, debentures or
other securities or evidences of Indebtedness issued by, any Person. For the
purposes of the "Limitation on Restricted Payments" covenant, (i)
"Investment" shall include and be valued at the fair market value of the net
assets of any Restricted Group Member at the time that such Restricted Group
Member is designated an Unrestricted Group Member and shall exclude the fair
market value of the net assets of any Unrestricted Group Member at the time that
such Unrestricted Group Member is designated a Restricted Group Member and (ii)
the amount of any Investment shall be the original cost of such Investment plus
the cost of all additional Investments by the Company or any of its Restricted
Group Members, without any adjustments for increases or decreases in value, or
write-ups, write-downs or write-offs with respect to such Investment, reduced by
the payment of dividends or distributions in connection with such Investment or
any other amounts received in respect of such Investment; PROVIDED that no such
payment of dividends or distributions or receipt of any such other amounts shall
reduce the amount of any Investment if such payment of dividends or
distributions or receipt of any such amounts would be included in Adjusted Net
Income. If the Company or any Restricted Group Member sells or otherwise
disposes of any Common Stock of any direct or indirect Restricted Group Member
such that, after giving effect to any such sale or disposition, the Company's
Board of Directors deems that such Person is no longer a Restricted Affiliate,
the Company shall be deemed to have made an Investment on the date of any such
sale or disposition equal to the fair market value of the Common Stock of such
Restricted Group Member not sold or disposed of.
"ISSUE DATE" means the date of original issuance of the Notes.
"LEVERAGE RATIO" means the ratio of (a) the Total Indebtedness as of the
date of calculation (the "Determination Date") to (b) two times the Adjusted
Operating Cash Flow for the latest two fiscal quarters
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for which financial information is available immediately preceding such
Determination Date (the "Measurement Period"). For purposes of calculating
Adjusted Operating Cash Flow for the Measurement Period immediately prior to the
relevant Determination Date, (I) any Person that is a Restricted Group Member on
the Determination Date (or would become a Restricted Group Member on such
Determination Date in connection with the transaction that requires the
determination of such Adjusted Operating Cash Flow) will be deemed to have been
a Restricted Group Member at all times during such Measurement Period, (II) any
Person that is not a Restricted Group Member on such Determination Date (or
would cease to be a Restricted Group Member on such Determination Date in
connection with the transaction that requires the determination of such Adjusted
Operating Cash Flow) will be deemed not to have been a Restricted Group Member
at any time during such Measurement Period, and (III) if the Company or any
Restricted Group Member shall have in any manner (x) acquired (through an
Acquisition or the commencement of activities constituting such operating
business) or (y) disposed of (by way of an Asset Sale or the termination or
discontinuance of activities constituting such operating business) any operating
business during such Measurement Period or after the end of such period and on
or prior to such Determination Date, such calculation will be made on a PRO
FORMA basis in accordance with GAAP as if, in the case of an Acquisition or the
commencement of activities constituting such operating business, all such
transactions had been consummated on the first day of such Measurement Period
and, in the case of an Asset Sale or termination or discontinuance of activities
constituting such operating business, all such transactions had been consummated
prior to the first day of such Measurement Period (it being understood that in
calculating Adjusted Operating Cash Flow the exclusions set forth in clauses (a)
through (f) of the definition of Adjusted Net Income shall apply to an acquired
Person as if it were a Restricted Group Member).
"LIEN" means any lien, mortgage, deed of trust, pledge, security
interest, charge or encumbrance of any kind (including any conditional sale or
other title retention agreement, any lease in the nature thereof and any
agreement to give any security interest).
"MEXICAN NETWORK" means the approximately 4,025 kilometer combined fiber
optic and microwave long distance network connecting the United States, the Gulf
region of Mexico and certain Mexican cities to be constructed by Telereunion
S.A.
"NET CASH PROCEEDS" means, with respect to any Asset Sale, the proceeds
in the form of cash or Cash Equivalents including payments in respect of
deferred payment obligations when received in the form of cash or Cash
Equivalents (other than the portion of any such deferred payment constituting
interest) and proceeds from the conversion of other property received when
converted to cash or Cash Equivalents received by the Company or any of its
Restricted Group Members from such Asset Sale net of (a) reasonable
out-of-pocket expenses and fees relating to such Asset Sale (including, without
limitation, legal, accounting and investment banking fees and sales
commissions), (b) taxes paid or payable as a result of such Asset Sale without
regard to the consolidated results of operations of the Company and its
Restricted Group Members, taken as a whole, after taking into account any
reduction in consolidated tax liability due to available tax credits or
deductions and any tax sharing arrangements, (c) repayment of Indebtedness that
is required to be repaid in connection with such Asset Sale, (d) appropriate
amounts to be provided by the Company or any Restricted Group Member, as the
case may be, as a reserve, in accordance with GAAP, against any liabilities
associated with such Asset Sale and retained by the Company or any Restricted
Group Member, as the case may be, after such Asset Sale, including, without
limitation, pension and other post-employment benefit liabilities, liabilities
related to environmental matters and liabilities under any indemnification
obligations associated with such Asset Sale and (e) with respect to Asset Sales
by any Restricted Group Members, the portion of such cash payments attributable
to persons holding a minority interest in such Restricted Group Member.
"NON-SUBSIDIARY AFFILIATE," of any specified Person, means any other
Person in which an Investment in the Capital Stock of such Person has been made
by such specified Person other than a direct or indirect Subsidiary of such
specified Person.
"OBLIGATIONS" means all obligations for principal, premium, interest,
penalties, fees, indemnifications, reimbursements, damages and other liabilities
payable under the documentation governing any Indebtedness.
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"PERMITTED HOLDERS" means E. Scott Crist, Manuel Landa, Todd M. Binet,
Oscar Garcia, Ricardo Orea, Bryan T. Emerson and Jose Luis Apan.
"PERMITTED INDEBTEDNESS" means, without duplication, each of the
following:
(i) Indebtedness under the Notes, the Guarantees and the Indenture;
(ii) Indebtedness incurred pursuant to the Credit Facilities in an
aggregate principal amount at any time outstanding not to exceed the
greater of (A) $ 20.0 million (as permanently reduced from time to time in
accordance with the terms thereof) or (B) 80% of accounts receivable (net
of reserves for uncollectible accounts receivable) reflected on the
Company's balance sheet at such time;
(iii) other Indebtedness of the Company and its Restricted Group
Members outstanding on the Issue Date reduced by the amount of any
scheduled amortization payments or mandatory prepayments when actually paid
or permanent reductions thereon;
(iv) Indebtedness (other than Acquired Indebtedness) of the Company
and its Restricted Group Members incurred to finance the cost (including
the cost of design, construction, development acquisition, installation or
integration) of equipment used in the Telecommunications Business or
ownership rights with respect to indefeasible rights of use, minimum
assignable ownership units or minimum investment units (or similar
ownership interests) in transnational fiber optic cable or other
transmission facilities, in each case purchased or leased by the Company or
any Restricted Group Member after the Issue Date, and Refinancings thereof;
(v) (x) Indebtedness of the Company in an aggregate amount
outstanding at any time not to exceed 2.00 times the net cash proceeds
received after the Issue Date by the Company from the issuance and sale of
its Qualified Capital Stock (other than to a Restricted Group Member) less
the amount of any net cash proceeds used to make Restricted Payments in
accordance with the "Limitation on Restricted Payments" covenant and (y)
Indebtedness of the Company or Acquired Indebtedness of a Restricted Group
Member in an aggregate amount outstanding at any one time not to exceed
1.50 times the fair market value of Common Stock of the Company issued as
consideration in a Telecommunications Acquisition; PROVIDED, HOWEVER, that
any Indebtedness Incurred under this clause (v) shall have a Weighted
Average Life to Maturity greater than the Weighted Average Life to Maturity
of the Notes and shall not require repayment or redemption (including
pursuant to any required offer to purchase) prior to the maturity date of
the Notes (other than a redemption upon a Change of Control of the Company
pursuant to provisions similar to those under " -- Change of Control");
(vi) Indebtedness of the Company and its Restricted Group Members
under Currency Agreements to the extent relating to (x) Indebtedness of the
Company or any Restricted Group Member and/or (y) obligations to purchase
assets, properties or services incurred in the ordinary course of business
of the Company or any Restricted Group Member and/or (z) accounts
receivable denominated in currencies other than U.S. dollars; PROVIDED,
HOWEVER, that such Currency Agreements do not increase the Indebtedness or
other obligations of the Company and the Restricted Group Members
outstanding other than as a result of fluctuations in foreign currency
exchange rates or by reason of fees, indemnities or compensation payable
thereunder;
(vii) Interest Swap Obligations of the Company covering Indebtedness
of the Company or any of its Restricted Group Members and Interest Swap
Obligations of any Restricted Group Member covering Indebtedness of such
Restricted Group Member; PROVIDED, HOWEVER, that such Interest Swap
Obligations are entered into to protect the Company and its Restricted
Group Members from fluctuations in interest rates on Indebtedness incurred
in accordance with the Indenture to the extent the notional principal
amount of such Interest Swap Obligation does not exceed the principal
amount of the Indebtedness to which such Interest Swap Obligation relates;
(viii) Indebtedness of the Company and/or any Restricted Group Member
(a) in respect of performance bonds of the Company or any Restricted Group
Member or surety or appeal bonds or letters of credit supporting trade
payables provided by the Company or any Restricted Group Member incurred in
the ordinary course of business and on ordinary business terms in
connection with the construction, ownership, maintenance or operation of a
Telecommunications Business; and (b) arising
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from agreements providing for indemnification, adjustment of purchase price
or similar obligations, or from guarantees or letters of credit, surety
bonds or performance bonds securing any of the aforementioned obligations
of the Company or any of its Restricted Group Members pursuant to such
agreements, in each case incurred in connection with the disposition of any
business, assets or Restricted Group Member (other than guarantees of
Indebtedness incurred by any Person acquiring all or any portion of such
business, assets or Restricted Group Member for the purpose of financing
such acquisition), in a principal amount not to exceed the gross proceeds
actually received by the Company or any Restricted Group Member in
connection with such disposition;
(ix) Indebtedness of a Restricted Group Member to the Company or to a
Restricted Group Member for so long as such Indebtedness is held by the
Company or a Restricted Group Member, in each case subject to no Lien held
by a Person other than the Company or a Restricted Group Member; PROVIDED
that if as of any date any Person other than the Company or a Restricted
Group Member owns or holds any such Indebtedness or holds a Lien in respect
of such Indebtedness, such date shall be deemed the incurrence of
Indebtedness not constituting Permitted Indebtedness under this clause (ix)
by the issuer of such Indebtedness;
(x) Indebtedness of the Company to a Restricted Group Member for so
long as such Indebtedness is held by a Restricted Group Member, in each
case subject to no Lien; PROVIDED that (a) any such Indebtedness of the
Company to any Restricted Group Member is unsecured and subordinated,
pursuant to a written agreement, to the Company's obligations under the
Indenture and the Notes and (b) if as of any date any Person other than a
Restricted Group Member owns or holds any such Indebtedness or any Person
holds a Lien in respect of such Indebtedness, such date shall be deemed the
incurrence of Indebtedness not constituting Permitted Indebtedness under
this clause (x) by the Company;
(xi) Indebtedness arising from the honoring by a bank or other
financial institution of a check, draft or similar instrument inadvertently
(except in the case of daylight overdrafts) drawn against insufficient
funds in the ordinary course of business; PROVIDED, HOWEVER, that such
Indebtedness is extinguished within two business days of incurrence;
(xii) Indebtedness of the Company or any of its Restricted Group
Members represented by letters of credit for the account of the Company or
such Restricted Group Member, as the case may be, in order to provide
security for workers' compensation claims, payment obligations in
connection with self-insurance or similar requirements in the ordinary
course of business;
(xiii) Indebtedness represented by Capitalized Lease Obligations of
the Company and its Restricted Group Members incurred in the ordinary
course of business not to exceed $ 2.5 million at any one time outstanding;
(xiv) Indebtedness of the Company, to the extent that the net
proceeds thereof are promptly used to repurchase the Notes tendered in a
Change of Control Offer;
(xv) Refinancing Indebtedness; and
(xvi) additional Indebtedness of the Company and its Restricted Group
Members in an aggregate principal amount not to exceed $10.0 million at any
one time outstanding.
For purposes of determining compliance with the "Limitation on
Indebtedness" covenant, in the event that an item of Indebtedness meets the
criteria of more than one of the types of Indebtedness described in the above
clauses, the Company, in its sole discretion may, at the time of such
incurrence, (i) classify such item of Indebtedness under and comply with the
foregoing clauses of this covenant (or any of such definitions), as applicable,
(ii) classify and divide such item of Indebtedness into more than one of such
clauses (or definitions), as applicable, and (iii) elect to comply with such
clauses (or definitions), as applicable, in any order.
"PERMITTED INVESTMENTS" means (i) Investments by the Company or any
Restricted Group Member in any Person that is or will become immediately after
such Investment a Restricted Group Member or that will merge or consolidate into
the Company or a Restricted Group Member, (ii) Investments in the Company by any
Restricted Group Member; PROVIDED that any Indebtedness evidencing such
Investment is unsecured and subordinated, pursuant to a written agreement, to
the Company's obligations under the Notes
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and the Indenture; (iii) investments in cash and Cash Equivalents; (iv) loans
and advances to employees and officers of the Company and its Restricted Group
Members in the ordinary course of business for bona fide business purposes not
in excess of $1.0 million at any one time outstanding; (v) Currency Agreements
and Interest Swap Obligations entered into in the ordinary course of the
Company's or its Restricted Group Members' businesses and otherwise in
compliance with the Indenture; (vi) Investments in any Person up to $20.0
million at any one time outstanding; (vii) Investments in securities of trade
creditors or customers received pursuant to any plan of reorganization or
similar arrangement upon the bankruptcy or insolvency of such trade creditors or
customers; (viii) Investments made by the Company or its Restricted Group
Members as a result of consideration received in connection with an Asset Sale
made in compliance with the "Limitation on Asset Sales" covenant; (ix)
payroll, travel and similar advances in the ordinary course of business to cover
matters that will be at the time of such advances, ultimately treated as
expenses in accordance with GAAP; (x) Investments in evidences of Indebtedness,
securities or other property of trade creditors or customers received pursuant
to any plan of reorganization or similar arrangement upon the bankruptcy or
insolvency of such trade creditors or customers; (xi) repurchases or redemptions
by the Company of Capital Stock from officers and other employees of the Company
or any of its Restricted Group Members or their authorized representatives upon
the death, disability or termination of employment of such individuals, in an
aggregate amount not exceeding $1.0 million in any calendar year and $3.0
million from the Issue Date and (xii) Investments by the Company or any
Restricted Group Member in any Restricted Group Member in connection with the
construction, operation and maintenance of the Mexican Network up to $155.0
million.
"PERMITTED LIENS" means the following types of Liens:
(i) Liens for taxes, assessments or governmental charges or claims
either (a) not delinquent or (b) contested in good faith by appropriate
proceedings and as to which the Company or its Restricted Group Members
shall have set aside on its books such reserves as may be required pursuant
to GAAP;
(ii) statutory Liens of landlords and Liens of carriers,
warehousemen, mechanics, suppliers, materialmen, repairmen and other Liens
imposed by law incurred in the ordinary course of business for sums not yet
delinquent or being contested in good faith, if such reserve or other
appropriate provision, if any, as shall be required by GAAP shall have been
made in respect thereof;
(iii) Liens incurred or deposits made in the ordinary course of
business in connection with workers' compensation, unemployment insurance
and other types of social security, including any Lien securing letters of
credit issued in the ordinary course of business consistent with past
practice in connection therewith, or to secure the performance of tenders,
statutory obligations, surety and appeal bonds, bids, leases, government
contracts, performance and return-of-money bonds and other similar
obligations (exclusive of obligations for the payment of borrowed money);
(iv) judgment Liens not giving rise to an Event of Default so long as
such Lien is adequately bonded and any appropriate legal proceedings which
may have been duly initiated for the review of such judgment shall not have
been finally terminated or the period within which such proceedings may be
initiated shall not have expired;
(v) easements, rights-of-way, municipal and zoning restrictions and
other similar charges or encumbrances in respect of real property not
interfering in any material respect with the ordinary conduct of the
business of the Company or any of its Restricted Group Members;
(vi) any interest or title of a lessor under any Capitalized Lease
Obligation; PROVIDED that such Liens do not extend to any property or
assets which is not leased property subject to such Capitalized Lease
Obligation;
(vii) purchase money Liens to finance property or assets of the
Company or any Restricted Group Member acquired in the ordinary course of
business; PROVIDED, HOWEVER, that (A) the related purchase money
indebtedness shall not exceed the cost of such property or assets and shall
not be secured by any property or assets of the Company or any Restricted
Group Member other than the property and assets so acquired and (B) the
Lien securing such Indebtedness shall (x) exist at the time of such
acquisition or (y) be created within 180 days of such acquisition;
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(viii) Liens upon specific items of inventory or other goods and
proceeds of any Person securing such Person's obligations in respect of
bankers' acceptances issued or created for the account of such Person to
facilitate the purchase, shipment or storage of such inventory or other
goods;
(ix) Liens securing reimbursement obligations with respect to
commercial letters of credit which encumber documents and other property
relating to such letters of credit and products and proceeds thereof;
(x) Liens encumbering deposits made to secure obligations arising
from statutory, regulatory, contractual, or warranty requirements of the
Company or any of its Restricted Group Members, including rights of offset
and set-off;
(xi) Liens securing Interest Swap Obligations, which Interest Swap
Obligations relate to Indebtedness that is otherwise permitted under the
Indenture;
(xii) Liens securing Capitalized Lease Obligations permitted pursuant
to clause (xiii) of the definition of "Permitted Indebtedness";
(xiii) Liens securing Indebtedness under Currency Agreements;
(xiv) Liens securing Acquired Indebtedness incurred in accordance
with the "Limitation on Incurrence of Additional Indebtedness" covenant;
PROVIDED that (A) such Liens secured such Acquired Indebtedness at the time
of and prior to the incurrence of such Acquired Indebtedness by the Company
or a Restricted Group Member and were not granted in connection with, or in
anticipation of, the incurrence of such Acquired Indebtedness by the
Company or a Restricted Group Member and (B) such Liens do not extend to or
cover any property or assets of the Company or of any of its Restricted
Group Members other than the property or assets that secured the Acquired
Indebtedness prior to the time such Indebtedness became Acquired
Indebtedness of the Company or a Restricted Group Member and are no more
favorable to the lienholders than those securing the Acquired Indebtedness
prior to the incurrence of such Acquired Indebtedness by the Company or a
Restricted Group Member;
(xv) Liens in favor of the Company or any Restricted Group Member;
(xvi) Liens in favor of customs and revenue authorities arising as a
matter of law to secure payment of customs duties in connection with the
importation of goods;
(xvii) Liens existing on the Issue Date or securing the Notes or any
Guarantee of the Notes; and
(xviii) Liens arising out of conditional sale, title retention,
consignment or similar arrangements for the sale of goods entered into by
the Company or any of its Restricted Group Members in the ordinary course
of business in accordance with the past practices of the Company and its
Restricted Group Members prior to the Issue Date.
"PERSON" means an individual, partnership, corporation, unincorporated
organization, trust or joint venture, or a governmental agency or political
subdivision thereof.
"PREFERRED STOCK" of any Person means any Capital Stock of such Person
that has preferential rights to any other Capital Stock of such Person with
respect to dividends or redemptions or upon liquidation.
"QUALIFIED CAPITAL STOCK" means any Capital Stock that is not
Disqualified Capital Stock.
"REFINANCE" means, in respect of any security or Indebtedness, to
refinance, modify, extend, renew, refund, repay, prepay, redeem, defease or
retire, or to issue a security or Indebtedness in exchange or replacement for,
such security or Indebtedness in whole or in part. "Refinanced" and
"Refinancing" shall have correlative meanings.
"REFINANCING INDEBTEDNESS" means any Refinancing by the Company or any
Restricted Group Member of Indebtedness incurred in accordance with the
"Limitation on Incurrence of Additional Indebtedness" covenant (other than
pursuant to clause (ii), (iv), (v), (vi), (vii), (viii), (ix), (x), (xi), (xii),
(xiii) or (xvi) of the definition of Permitted Indebtedness), in each case that
does not (1) result in an increase in the aggregate principal amount of
Indebtedness of such Person as of the date of such proposed Refinancing (plus
the amount of any premium required to be paid under the terms of the instrument
governing such Indebtedness, accrued interest and the amount of reasonable fees
and expenses incurred by the Company in connection with such Refinancing) or (2)
create Indebtedness with (A) a Weighted Average
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Life to Maturity that is less than the Weighted Average Life to Maturity of the
Indebtedness being Refinanced or (B) a final maturity earlier than the final
maturity of the Indebtedness being Refinanced; PROVIDED that (x) if such
Indebtedness being Refinanced is Indebtedness of the Company, then such
Refinancing Indebtedness shall be Indebtedness solely of the Company and (y) if
such Indebtedness being Refinanced is subordinate or junior to the Notes, then
such Refinancing Indebtedness shall be subordinate to the Notes at least to the
same extent and in the same manner as the Indebtedness being Refinanced.
"RESTRICTED AFFILIATE" means any direct or indirect Non-Subsidiary
Affiliate of the Company or a Restricted Subsidiary of the Company that has been
designated by the Board of Directors of the Company as a Restricted Affiliate
based on a determination by the Board of Directors that the Company has,
directly or indirectly, the requisite control over such Non-Subsidiary Affiliate
to prevent it from incurring Indebtedness, or taking any other action at any
time, in contravention of any of the provisions of the Indenture that are
applicable to Restricted Affiliates; PROVIDED, HOWEVER, that immediately after
giving effect to such designation (i) the Liens and Indebtedness of such
Non-Subsidiary Affiliate outstanding immediately after such designation would,
if incurred at such time, have been permitted to be incurred for all purposes of
the Indenture; and (ii) a Default or Event of Default shall not have occurred
and be continuing. The Company shall deliver an officers' certificate to the
Trustee upon designating any Non-Subsidiary Affiliate as a Restricted Affiliate.
As of the Issue Date, every Exisiting Joint Venture is a Restricted Affiliate.
"RESTRICTED GROUP MEMBERS" means collectively, each Restricted Subsidiary
of the Company, each Restricted Affiliate and each Restricted Subsidiary of a
Restricted Affiliate.
"RESTRICTED SUBSIDIARY" of any Person means any Subsidiary of such Person
which at the time of determination is not an Unrestricted Subsidiary.
"SALE AND LEASEBACK TRANSACTION" means any direct or indirect arrangement
with any Person or to which any such Person is a party, providing for the
leasing to the Company or a Restricted Group Member any property, whether owned
by the Company or any Restricted Group Member at the Issue Date or later
acquired, which has been or is to be sold or transferred by the Company or such
Restricted Group Member to such Person or to any other Person from whom funds
have been or are to be advanced by such Person on the security of such Property.
"SIGNIFICANT RESTRICTED GROUP MEMBER", with respect to any Person, means
any Restricted Group Member of such Person that satisfies the criteria for a
"significant subsidiary" set forth in Rule 1.02(w) of Regulation S-X under the
Securities Act.
"SUBSIDIARY", with respect to any Person, means (i) any corporation of
which the outstanding Capital Stock having at least a majority of the votes
entitled to be cast in the election of directors under ordinary circumstances
shall at the time be owned, directly or indirectly, by such Person or (ii) any
other Person of which at least a majority of the voting interest under ordinary
circumstances is at the time, directly or indirectly, owned by such Person.
"TELECOMMUNICATIONS ACQUISITION" means an Acquisition of properties or
assets to be used in a Telecommunications Business or of the Capital Stock of
any Person that becomes a Restricted Group Member; PROVIDED, HOWEVER, that such
Person's properties and assets shall consist principally of properties or assets
that will be used in a Telecommunications Business.
"TELECOMMUNICATIONS BUSINESS" means any business of owning, constructing,
financing or operating a voice, data or other communications services system,
including any business conducted by the Company or any Restricted Group Member
on the Issue Date.
"TELEREUNION S.A." means Telereunion S.A. de C.V., a company organized
under the laws of Mexico.
"TOTAL INDEBTEDNESS" means, as at any date of determination, an amount
equal to the aggregate amount of all Indebtedness of the Company and the
Restricted Group Members outstanding as of such date of determination, after
giving effect to any incurrence of Indebtedness and the application of the
proceeds therefrom giving rise to such determination.
"UNRESTRICTED SUBSIDIARY" means any Subsidiary of the Company designated
as such pursuant to "Certain Covenants -- Designation of Unrestricted
Subsidiaries."
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"WEIGHTED AVERAGE LIFE TO MATURITY" means, when applied to any
Indebtedness at any date, the number of years obtained by dividing (a) the then
outstanding aggregate principal amount of such Indebtedness into (b) the sum of
the total of the products obtained by multiplying (i) the amount of each then
remaining installment, sinking fund, serial maturity or other required payment
of principal, including payment at final maturity, in respect thereof, by (ii)
the number of years (calculated to the nearest one-twelfth) which will elapse
between such date and the making of such payment.
"WHOLLY OWNED RESTRICTED SUBSIDIARY" of any Person means any Restricted
Group Member of such Person of which all the outstanding voting securities
(other than in the case of a foreign Restricted Group Member, directors'
qualifying shares or an immaterial amount of shares required to be owned by
other Persons pursuant to applicable law) are owned by such Person or any Wholly
Owned Restricted Subsidiary of such Person.
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes the principal U.S. federal income tax
consequences of the purchase, ownership and disposition of the Notes. This
summary is based on the Internal Revenue Code of 1986, as amended (the
"Code"), final, temporary, and proposed Treasury regulations promulgated
thereunder, administrative pronouncements and rulings, and judicial decisions,
changes to any of which subsequent to the date hereof may affect the tax
consequences described herein, possibly with retroactive effect.
This summary discusses only Notes held as capital assets within the meaning
of Code section 1221. It does not discuss all of the tax consequences that may
be relevant to a Holder in light of the Holder's particular circumstances or to
Holders subject to special rules, such as certain financial institutions, banks,
insurance companies, regulated investment companies, dealers in securities or
foreign currencies, persons holding Notes as part of a straddle or hedging
transaction, or U.S. Holders whose functional currency (as defined in Code
section 985) is not the U.S. dollar. Persons considering purchasing Notes should
consult their own tax advisors concerning the application of U.S. federal tax
laws to their particular situations as well as any tax consequences arising
under the laws of any state, local or foreign taxing jurisdiction.
As used in this summary, the term "U.S. Holder" means the beneficial
owner of a Note that is, for United States federal income tax purposes, (i) a
citizen or resident of the United States (including certain former citizens and
former long-term residents); (ii) a corporation, partnership or other entity
created or organized in or under the laws of the United States or of any
political subdivision thereof; or a partnership treated as a U.S. person under
applicable Treasury regulations; (iii) an estate the income of which is subject
to U.S. federal income taxation regardless of its source; or (iv) a trust with
respect to the administration of which a court within the United States is able
to exercise primary supervision and one or more U.S. fiduciaries have the
authority to control all substantial decisions of the trust. As used in this
summary, the term "Non-U.S. Holder" means a beneficial owner of a Note that is
not a U.S. Holder.
TAX CONSEQUENCES TO U.S. HOLDERS
PAYMENTS OF INTEREST. Interest paid or accrued on the Notes will be
taxable to U.S. Holders as ordinary interest income. Interest will be included
in U.S. Holders' income at the time such payments are accrued or are received in
accordance with the U.S. Holder's method of accounting for U.S. federal income
taxes. It is not anticipated that the Notes will be issued with "original issue
discount" ("OID") within the meaning of Code section 1273.
Failure of the Company to file or cause to be declared effective an
Exchange Offer Registration Statement or Shelf Registration Statement, or to
consummate the Exchange Offer (as described under "Description of
Notes -- Exchange Offer and Registration Rights"), will cause additional
interest to accrue on the Notes as Liquidated Damages. At present, the Company
believes the likelihood is remote that additional interest will become payable
on the Notes under such circumstances. Accordingly, pursuant to applicable
Treasury regulations, the Company will not take such additional interest into
account in determining the yield on the Notes for OID purposes. If, contrary to
the Company's expectations, additional interest becomes payable as a result of
the Company's failure either to register the Notes or to consummate the Exchange
Offer, then U.S. Holders should include the additional interest in income as
paid or accrued in accordance with their regular method of tax accounting. It is
possible, however, that the Internal Revenue Service ("IRS") might require all
U.S. Holders to report such additional interest on an accrual basis as OID. U.S.
Holders must generally include OID in gross income for federal income tax
purposes on an annual basis under a constant yield method (as defined in the
Code). As a result, U.S. Holders may be required to include OID in income in
advance of the receipt of cash attributable to the stated interest.
MARKET DISCOUNT. If a Holder purchases a Note at a market discount (as
described below), the Holder will be required to treat any principal payments
on, or any gain realized on the sale, exchange, retirement or maturity of, such
Note as ordinary income to the extent of the accrued market discount (not
previously included in income) at the time of such payment or disposition. In
addition, a U.S. Holder who purchases a Note with market discount may be
required to defer the deduction of all or a portion of the interest paid or
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accrued on any indebtedness incurred or continued to purchase or carry such Note
until the maturity of the Note or its earlier disposition in a taxable
transaction.
In general, market discount is the amount by which the Note's "adjusted
issue price" exceeds the U.S. Holder's tax basis in the Note immediately after
the Note is acquired, unless such difference is less than a specified de minimis
amount. The "adjusted issue price" of a Note at the beginning of any accrual
period is equal to its issue price increased by the accrued OID, if any, for
each prior accrual period (determined without regard to the amortization of any
acquisition premium) and reduced by any payments made on such Note on or before
the first day of the accrual period other than qualified stated interest (as
defined in Code section 1273). Market discount is considered to accrue ratably,
unless the U.S. Holder elects to accrue market discount under the "constant
interest method" described under the original issue discount rules contained in
the Code and Treasury Regulations. This election, once made, is irrevocable and
applies only to the Notes for which it is made. A U.S. Holder also may elect to
include market discount in income currently as it accrues, in which case the
rules described above regarding the deferral of interest deductions will not
apply. This election, once made, applies to all market discount obligations
acquired on or after the first day of the first taxable year to which the
election applies and may not be revoked without the consent of the IRS.
Generally, if a Note with market discount is transferred in certain non-taxable
transactions, the market discount will be transferred to the property received
in exchange for the Note; however, under certain limited circumstances, the
market discount will be includible as ordinary income as if such Note had been
sold at its fair market value.
AMORTIZABLE BOND PREMIUM. In general, if a U.S. Holder of a Note purchases
the Note at a premium (I.E., an amount in excess of the amount payable upon the
maturity thereof), such excess will be treated as "amortizable bond premium."
In such case, a U.S. Holder may elect, under Code section 171, to offset
interest income with the amortizable bond premium as it is amortized under a
constant-yield method (as defined in the Code). The U.S. Holder's tax basis in
the Note then decreases by the amount of the amortizable bond premium used to
offset interest income. An election under Code section 171 is available only if
a Note is held as a capital asset. U.S. Holders should consult their own tax
advisors regarding special rules that apply for determining the amount and
method of amortizing bond premium with respect to the Notes that may be redeemed
prior to maturity.
SALE, EXCHANGE OR RETIREMENT OF THE NOTES. Upon the sale, exchange or
retirement of a Note, a U.S. Holder generally will recognize taxable gain or
loss equal to the difference between the amount realized on the sale, exchange
or retirement and such U.S. Holder's adjusted tax basis in the Note. For these
purposes, the amount realized does not include any amount attributable to
accrued interest on the Note which has not previously been included in income.
Such amounts are treated as payments of interest. See "-- Payments of
Interest" above. A U.S. Holder's adjusted tax basis in a Note generally will
equal the U.S. Holder's cost of acquiring the Note increased by the amount of
any market discount previously included in the U.S. Holder's income with respect
to the Note, and reduced by any amortized bond premium, principal payments, and
the amount of any other payments except payments of qualified stated interest.
Gain or loss realized on the sale, retirement or other disposition
(including redemption) of a Note will be capital gain or loss if the Note is a
capital asset in the hands of the U.S. Holder (except that any portion of such
gain attributable to market discount will be ordinary income). For certain
non-corporate U.S. Holders (including individuals), the maximum rate of tax on
net capital gains is 20 percent for capital assets held for more than 12 months.
Gain on the sale of capital assets held for one year or less is subject to U.S.
federal income tax at ordinary income tax rates. Certain limitations exist on
the deductibility of capital losses by both corporations and individual
taxpayers. U.S. Holders should consult their own tax advisors with respect to
applicable rates and holding periods and netting rules for capital losses.
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TAX CONSEQUENCES TO NON-U.S. HOLDERS
INCOME AND WITHHOLDING TAX. Under present U.S. federal tax law, and
subject to the discussion below concerning backup withholding:
(a) under the so-called portfolio interest exemption, payments of
interest on the Notes by the Company or any paying agent to any Non-U.S.
Holder will not be subject to the 30 percent U.S. federal withholding tax
otherwise applicable, provided that (i) such Non-U.S. Holder does not own,
actually or constructively, 10 percent or more of the total combined voting
power of all classes of stock of the Company entitled to vote, is not a
controlled foreign corporation related, directly or indirectly, to the
Company through stock ownership, and is not a bank receiving interest
described in Code section 881(c)(3)(A); and (ii) the requirements set forth
in Code section 871(h) or Code section 881(c) have been fulfilled with
respect to the beneficial owner, as discussed below; and
(b) a Non-U.S. Holder of a Note will not be subject to U.S. federal
income tax on gain realized on the sale, exchange or other disposition of
such Note, unless (i) such Non-U.S. Holder is an individual who is present
in the U.S. for 183 days or more in the taxable year of disposition, and
either (A) such individual has a "tax home" (as defined in Code section
911(d)(3)) in the U.S. (unless such gain is attributable to a fixed place
of business in a foreign country maintained by such individual and has been
subject to foreign tax of at least 10 percent) or (B) the gain is
attributable to an office or other fixed place of business maintained by
such individual in the U.S. or (ii) such gain is effectively connected with
the conduct by such Non-U.S. Holder of a trade or business in the U.S.,
and, if a tax treaty applies, the gain is attributable to a U.S. permanent
establishment maintained by the Non-U.S. Holder.
Code section 871(h) and Code section 881(c) require that, in order to
obtain the portfolio interest exemption from withholding tax described in
paragraph (a) above, either (i) the beneficial owner of a Note must certify to
the Company or its agent, under penalties of perjury, that it is a Non-U.S.
Holder and provide a completed IRS Form W-8 ("Certificate of Foreign Status")
or (ii) a securities clearing organization, bank or other financial institution
that holds customers' securities in the ordinary course of its trade or business
(a "Financial Institution") and that is holding the Note on behalf of such
beneficial owner certifies to the Company or its agent, under penalties of
perjury, that it has received a Certificate of Foreign Status from the
beneficial owner (or from another Financial Institution) and furnishes the
Company/agent with a copy thereof. For payments made after December 31, 1999,
the payment must be "reliably associated" (within the meaning of Treasury
regulations) with a Certificate of Foreign Status.
If a Non-U.S. Holder of a Note is engaged in a trade or business in the
U.S., and if interest on the Note or gain realized on its sale, exchange or
other disposition is effectively connected with the conduct of such trade or
business, such Non-U.S. Holder will be able to claim an exemption from U.S.
withholding taxes by providing the Company with a properly executed IRS Form
4224 (after December 31, 1999, subject to certain transition rules, IRS Form
W-8). Such Non-U.S. Holder, although exempt from the withholding tax discussed
in the preceding paragraph, will generally be subject to regular U.S. income tax
on such effectively connected income in the same manner as if it were a U.S.
Holder. See TAX CONSEQUENCES TO U.S. HOLDERS above. In addition, if such
Non-U.S. Holder is a foreign corporation, it may be subject to a branch profits
tax equal to 30 percent (or such lower rate provided by an applicable treaty) of
its effectively connected earnings and profits for the taxable year, subject to
certain adjustments.
Even if the portfolio interest exemption described above is inapplicable to
a particular Non-U.S. Holder, such holder may be eligible for an exemption from
or reduced rate of withholding tax under an applicable income tax treaty. In
order to obtain such an exemption or rate reduction, such Non-U.S. Holder must
provide the Company or its agent with a properly completed IRS Form 1001 (after
December 31, 1999, subject to certain transition rules, IRS Form W-8) in the
year in which payment occurs or in either of the two proceeding years,
describing such exemption or reduced rate.
A Non-U.S. Holder that is required to submit a certification on Form 1001,
4224 or W-8 to avoid the imposition of U.S. withholding taxes or to obtain a
reduced rate with respect to a payment on a Note is
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required to submit such certification to the Company or its agent as soon as
practicable after the Non-U.S. Holder acquires such Note (or a beneficial
interest therein) and to update such forms as required by the IRS. If the
Company or its agent does not physically receive such certification by the date
that is 10 days prior to a payment date on the Note, then the Company and/or its
agent may treat such certification as ineffective with respect to any payment to
such Non-U.S. Holder on such payment date and may withhold tax from such
payment.
Under Code section 2105(b), a Note held by an individual who is not a
citizen or resident of the U.S. at the time of his death will not be subject to
U.S. federal estate tax as a result of such individual's death, provided that
the individual does not own, actually or constructively, 10 percent or more of
the total combined voting power of all classes of stock of the Company entitled
to vote and, at the time of such individual's death, payments with respect to
such Note would not have been effectively connected to the conduct by such
individual of a trade or business in the U.S.
BACKUP WITHHOLDING AND INFORMATION REPORTING
U.S. HOLDERS. In general, under current U.S. federal tax law, payments to
a U.S. Holder of (a) principal, premium (if any) and interest on a Note and (b)
the proceeds of sales or other dispositions of Notes before maturity will be
subject to U.S. information reporting requirements. Such payments to
noncorporate U.S. Holders may be subject to backup withholding at a rate of 31
percent if such U.S. Holder fails to furnish its Taxpayer Identification Number
("TIN"), which, for an individual, would be his Social Security Number, and/or
certain other information in the required manner. The amount of any backup
withholding from a payment to a U.S. Holder will be allowed as a credit against
such U.S. Holder's U.S. federal income tax liability and may entitle such U.S.
Holder to a refund, provided that the required information is furnished to the
IRS. U.S. Holders should consult their own tax advisors regarding the
qualification for exemption from backup withholding and the procedure for
obtaining such an exemption, if applicable.
NON-U.S. HOLDERS. In general, there is no U.S. information reporting
requirement or backup withholding tax on payments to Non-U.S. Holders who
provide the appropriate certification described above regarding qualification
for the portfolio interest exemption from U.S. federal income tax for payments
of interest on the Notes.
Payment by the Company of principal on the Notes or payment by a U.S.
office of a broker of the proceeds of a sale of Notes is subject to both backup
withholding and information reporting unless the beneficial owner provides a
completed IRS Form W-8 which certifies under penalties of perjury that such
owner is a Non-U.S. Holder who meets all the requirements for exemption from
U.S. federal income tax on any gain from the sale, exchange or retirement of the
Notes.
In general, backup withholding and information reporting will not apply to
a payment of the gross proceeds of a sale of the Notes effected at a foreign
office of a broker. If, however, such a broker is, for U.S. federal income tax
purposes, a U.S. person, a controlled foreign corporation, or a foreign person
50 percent or more of whose gross income for certain periods is derived from
activities that are effectively connected with the conduct of a trade or
business in the U.S., such payments will not be subject to backup withholding,
but will be subject to information reporting unless (i) such broker has
documentary evidence in its records that the beneficial owner is a Non-U.S.
Holder and certain other considerations are met; or (ii) the beneficial owner
otherwise establishes an exemption, provided such broker does not have actual
knowledge that the payee is a U.S. person. Non-U.S. Holders should consult their
own tax advisors regarding the application of these rules to their particular
situations, the availability of an exemption therefrom, and the procedure for
obtaining such an exemption, if applicable.
Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules will be allowed as a credit against Non-U.S. Holder's
U.S. federal income tax liability and may entitle such Holder to a refund,
provided the required information is furnished to the IRS.
On October 6, 1997, the Treasury Department issued final rules with respect
to withholding tax on income paid to Non-U.S. Holders and related matters (the
"New Withholding Regulations"). The New
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Withholding Regulations will generally be effective for payments made after
December 31, 1999, subject to certain transition rules. The New Withholding
Regulations modify the requirements imposed on a Non-U.S. Holder and certain
intermediaries for establishing the recipient's status as a Non-U.S. Holder
eligible for exemption from withholding and backup withholding. In particular,
the New Withholding Regulations impose more stringent conditions on the ability
of financial intermediaries acting for a Non-U.S. Holder to provide
certifications on behalf of the Non-U.S. Holder, which may include entering into
an agreement with the IRS to audit certain documentation with respect to such
certifications. Non-U.S. Holders that are subject to withholding are urged to
consult their own tax advisors with respect to the New Withholding Regulations.
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 NOTES 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 NOTES.
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UNDERWRITING
Subject to the terms and conditions set forth in the Underwriting Agreement
(the "Underwriting Agreement") between the Company, the Guarantors and the
Underwriters, the Company has agreed to sell to the Underwriters, and the
Underwriters have agreed, severally, to purchase from the Company, all of the
Notes.
The Underwriting Agreement provides that the obligation of the Underwriters
to pay for and accept delivery of the Notes is subject to the approval of
certain legal matters by counsel and to various other conditions. The nature of
each Underwriter's obligation is such that each is committed to purchase the
aggregate principal amount of Notes set forth opposite its name if any are
purchased.
PRINCIPAL AMOUNT
UNDERWRITERS OF NOTES
- ------------------------------------- -----------------
BT Alex. Brown Incorporated.......... $
Lehman Brothers Inc..................
-----------------
Total........................... $ 125,000,000
=================
The Underwriters propose to offer the Notes directly to the public at the
public offering price set forth on the cover page hereof, and to certain dealers
at such price less a concession not in excess of % of the principal amount of
the Notes offered hereby. After the public offering of the Notes offered hereby,
the public offering price and other selling terms may be changed.
The Underwriting Agreement provides that the Company and the Guarantors
will indemnify the Underwriters against certain liabilities, including
liabilities under the Securities Act, and will contribute to payments that the
Underwriters may be required to make in respect thereof.
The Company does not intend to apply for listing of the Notes on a national
securities exchange. The Company has been advised by the Underwriters that they
presently intend to make a market in the Notes, and any such market making may
be discontinued at any time in the sole discretion of the Underwriters. After
the public offering of the Notes offered hereby, there can be no assurances that
an active public market for the Notes will develop.
Upon consummation of the Notes Offering and/or the Equity Offering, the
Company will pay $1.0 million and will issue 155,000 warrants to a financial
advisor.
In connection with the Notes Offering, certain persons participating in the
Notes Offering may engage in transactions that stabilize, maintain or otherwise
affect the price of the Notes. Specifically, the Underwriters may bid for and
purchase Notes in the open markets to stabilize the price of the Notes. The
Underwriters may also over-allot the Notes Offering, creating a syndicate short
position, and may bid for and purchase Notes in the open market to cover the
syndicate short position. In addition, the Underwriters may bid for and purchase
the Notes in market making transactions and impose penalty bids. These
activities may stabilize or maintain the market price of the Notes above market
levels that may otherwise prevail. The Underwriters are not required to engage
in these activities, and may end these activities at any time.
LEGAL MATTERS
The validity of the Notes offered hereby are being passed upon for the
Company by Swidler & Berlin, Chartered, Washington, D.C. Certain legal matters
relating to the Notes are being passed upon for the Underwriters by Cahill
Gordon & Reindel (a partnership including a professional corporation), New York,
New York.
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
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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 elswhere herein, and are included in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
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 Notes 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.
Statements made in this Prospectus as to the contents of any contract, agreement
or other document referred to are not necessarily complete. 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.
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.
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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
March 31, 1998 (unaudited).... F-4
Consolidated Statements of
Operations -- For the years
ended December 31, 1995, 1996
and 1997 and the Three Months
Ended March 31, 1997 and 1998
(unaudited).................... F-5
Consolidated Statements of
Stockholders' Equity -- For the
years ended December 31, 1995,
1996 and 1997 and the Three
Months Ended March 31, 1998
(unaudited).................... F-6
Consolidated Statements of Cash
Flows -- For the years ended
December 31, 1995, 1996 and
1997 and the Three Months Ended
March 31, 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-45
Statements of Operations -- For
the year ended December 31,
1996 and Six Months Ended June
30, 1997 (unaudited)........... F-46
Statements of Changes in
Financial Position -- For the
year ended December 31, 1996
and the Six Months Ended June
30, 1997 (unaudited)........... F-47
Notes to the Financial
Statements..................... F-48
FINANCIAL STATEMENTS OF MSN
COMMUNICATIONS, INC.
Report of Independent Certified
Public Accountants............. F-51
Balance Sheet -- As of December
31, 1997....................... F-52
Statement of Operations and
Accumulated Deficit -- For the
year ended
December 31, 1997............. F-53
Statement of Cash Flows -- For
the year ended December 31,
1997........................... F-54
Notes to the Financial
Statements..................... F-55
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,
------------------------------ MARCH 31,
1996 1997 1998
-------------- -------------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents....... $ 495,000 $ 4,734,000 $ 2,882,000
Accounts receivable, less
allowance for doubtful
accounts of $57,000, $200,000,
and $215,000 (unaudited),
respectively.................. 2,035,000 6,276,000 7,346,000
Inventories..................... 2,045,000 4,305,000 3,113,000
Prepaid expenses and other...... 90,000 2,674,000 4,917,000
Deferred income taxes........... -- 517,000 311,000
-------------- -------------- -----------
Total current assets....... 4,665,000 18,506,000 18,569,000
Property and equipment, net of
accumulated depreciation........... 983,000 2,679,000 5,344,000
Goodwill and other intangibles, net
of accumulated amortization........ 3,246,000 17,674,000 23,324,000
Deferred income taxes................ 192,000 77,000 74,000
Investment in affiliates............. -- 295,000 295,00
Other assets......................... 285,000 404,000 334,000
-------------- -------------- -----------
Total assets............... $ 9,371,000 $ 39,635,000 $47,940,000
============== ============== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................ $ 1,756,000 $ 10,756,000 $13,583,000
Accrued expenses................ 724,000 3,303,000 2,397,000
Current portion of notes payable
and capital lease
obligations................... -- 508,000 1,747,000
Deferred income taxes........... 372,000 270,000 416,000
-------------- -------------- -----------
Total current
liabilities............. 2,852,000 14,837,000 18,143,000
Notes payable and capital lease
obligations........................ -- 2,676,000 2,548,000
Minority interests................... 754,000 34,000 46,000
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 29,310,000
Capital subscriptions
receivable.................... (600,000) -- --
Accumulated deficit............. (5,523,000) (2,851,000) (1,737,000)
Treasury stock.................. -- (297,000) (375,000)
-------------- -------------- -----------
Total stockholders'
equity.................. 5,765,000 22,088,000 27,203,000
-------------- -------------- -----------
Total liabilities and
stockholders' equity.... $ 9,371,000 $ 39,635,000 $47,940,000
============== ============== ===========
</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>
THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
-------------------------------------------- ------------------------------
1995 1996 1997 1997 1998
------------ -------------- -------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues............................. $ 1,108,000 $ 5,705,000 $ 36,154,000 $ 3,771,000 $ 33,399,000
Cost of revenues..................... 619,000 3,041,000 24,396,000 2,525,000 28,334,000
------------ -------------- -------------- -------------- --------------
Gross profit......................... 489,000 2,664,000 11,758,000 1,246,000 5,065,000
Selling, general and administrative
expenses........................... 1,349,000 4,159,000 8,154,000 1,478,000 2,277,000
------------ -------------- -------------- -------------- --------------
Operating income (loss) before
depreciation and amortization...... (860,000) (1,495,000) 3,604,000 (232,000) 2,788,000
Depreciation and amortization........ 48,000 264,000 622,000 154,000 569,000
------------ -------------- -------------- -------------- --------------
Operating income (loss).............. (908,000) (1,759,000) 2,982,000 (386,000) 2,219,000
Other income (expense):
Interest income................. 232,000 143,000 171,000 5,000 37,000
Interest expense................ (2,000) (128,000) (266,000) (8,000) (93,000)
Foreign exchange gain (loss).... (2,000) 161,000 (126,000) 7,000 (122,000)
Other, net...................... -- (62,000) (11,000) 22,000 48,000
------------ -------------- -------------- -------------- --------------
Total other income
(expense), net.......... 228,000 114,000 (232,000) 26,000 (130,000)
------------ -------------- -------------- -------------- --------------
Income (loss) before income taxes and
minority interests................. (680,000) (1,645,000) 2,750,000 (360,000) 2,089,000
Income tax benefit (expense)......... -- 53,000 (84,000) 32,000 (963,000)
------------ -------------- -------------- -------------- --------------
Income (loss) before minority
interests.......................... (680,000) (1,592,000) 2,666,000 (328,000) 1,126,000
Minority interests in subsidiaries... 7,000 (6,000) 6,000 4,000 (12,000)
------------ -------------- -------------- -------------- --------------
Net income (loss).................... $ (673,000) $ (1,598,000) $ 2,672,000 $ (324,000) $ 1,114,000
============ ============== ============== ============== ==============
Earnings (loss) per share:
Basic........................... $ (0.36) $ (0.52) $ 0.68 $ (0.08) $ 0.25
Diluted(1)...................... n/a n/a $ 0.53 n/a $ 0.15
Weighted average shares outstanding:
Basic........................... 1,890,442 3,046,594 3,903,470 3,935,969 4,371,464
Diluted(1)...................... n/a n/a 5,152,211 n/a 7,779,177
</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)........................ 463,521 1,000 3,198,000 -- -- --
Issuance of stock in connection with
acquisition (unaudited)............ 100,000 -- 880,000 -- -- --
Repurchase of treasury shares
(unaudited)........................ -- -- -- -- -- (78,000)
Net income (unaudited)............... -- -- -- -- 1,114,000 --
-------- ------- ---------------- -------------- ------------ ---------
Balance, March 31, 1998
(unaudited)........................ 4,667,548 $5,000 $29,310,000 $ -- $(1,737,000) $(375,000)
======== ======= ================ ============== ============ =========
</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)........................ 3,199,000
Issuance of stock in connection with
acquisition (unaudited)............ 880,000
Repurchase of treasury shares
(unaudited)........................ (78,000)
Net income (unaudited)............... 1,114,000
-------------
Balance, March 31, 1998
(unaudited)........................ $27,203,000
=============
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>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------------- --------------------------
1995 1996 1997 1997 1998
------------- ------------ ------------ ------------ ------------
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C> <C> <C>
Net income (loss)................ $ (673,000) $ (1,598,000) $ 2,672,000 $ (324,000) $ 1,114,000
Adjustments to reconcile net
income (loss) to net cash
provided by (used in) operating
activities:
Provision for doubtful
accounts....................... 9,000 277,000 22,000 15,000
Depreciation and amortization.... 48,000 264,000 622,000 154,000 569,000
Provision for inventory
obsolescence................... -- 55,000 53,000 -- --
Write-off investment in operating
venture........................ -- -- 196,000 -- --
Deferred income tax benefit...... -- (112,000) (1,566,000) (88,000) 355,000
Interest amortized on discounted
investments.................... (64,000) (8,000) -- -- --
Imputed interest on non-interest
bearing notes payable.......... -- -- 136,000 -- 71,000
Minority interest in
subsidiaries' income (loss).... (7,000) 6,000 (6,000) (4,000) 12,000
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) (98,000) (44,000)
Inventories................. 15,000 (720,000) (2,359,000) 459,000 1,207,000
Prepaid and other assets.... (117,000) 35,000 (2,634,000) (248,000) (1,267,000)
Accounts payable............ (114,000) (124,000) 6,954,000 1,265,000 1,880,000
Deferred revenues........... -- -- -- -- (1,997,000)
Accrued liabilities......... (35,000) 361,000 1,866,000 (90,000) (1,289,000)
------------- ------------ ------------ ------------ ------------
Net cash provided by (used
in) operating
activities................ (817,000) (2,731,000) 4,588,000 1,048,000 626,000
------------- ------------ ------------ ------------ ------------
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) (394,000) (3,642,000)
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)
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) (394,000) (5,967,000)
------------- ------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease
obligations.................... -- -- (104,000) (18,000) (26,000)
Payments on notes payable........ -- -- (50,000) -- (300,000)
Proceeds from capital
subscriptions.................. -- -- 600,000 -- --
Purchase of treasury shares...... -- -- -- -- (78,000)
Issuance of common stock......... -- 564,000 -- -- --
Borrowings on line of credit..... -- -- -- -- 694,000
Proceeds from warrants and
options exercised.............. -- -- 1,004,000 -- 3,199,000
------------- ------------ ------------ ------------ ------------
Net cash provided by (used in)
financing activities........... -- 564,000 1,450,000 (18,000) 3,489,000
------------- ------------ ------------ ------------ ------------
Net increase (decrease) in cash
and cash equivalents........... (373,000) 322,000 4,239,000 636,000 (1,852,000)
------------- ------------ ------------ ------------ ------------
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 $ 1,131,000 $ 2,882,000
============= ============ ============ ============ ============
</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>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
--------------------------------------- ----------------------
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 $ 10,000
Taxes paid...................... -- 80,000 505,000 -- 339,000
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)
Treasury stock.................. (297,000)
Notes payable................... 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
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
</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 March 31, 1998 and for the three
months ended March 31, 1997 and 1998 are unaudited. In the opinion of
Management, the unaudited consolidated financial statements at March 31, 1998
and for the three months ended March 31, 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
F-9
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and network integration value-added services are recognized when services are
performed. In certain cases, 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. The Company recognizes
revenues (and cost of revenues) from the sale of cards under these agreements 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. The Company recognizes revenues (and
cost of revenues) from the sale of cards under these agreements at the time the
cards are utilized.
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
---------------------------- MARCH 31, PERIOD
1996 1997 1998 (YEARS)
------------ -------------- -------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Goodwill............................. $ 3,312,000 $ 18,037,000 $ 24,111,000 15
Organization costs................... 73,000 73,000 73,000 5
Less, accumulated amortization....... (139,000) (436,000) (860,000)
------------ -------------- --------------
$ 3,246,000 $ 17,674,000 $ 23,324,000
============ ============== ==============
</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 based on the
current and expected future profitability and net cash flows of acquired
companies and their contribution to the overall operations of the Company. In
management's opinion, there is no impairment of such assets at December 31,
1997.
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 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
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 THREE MONTHS
FOR THE YEAR ENDED DECEMBER 31, ENDED MARCH 31,
------------------------------------------ --------------------------
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 $ (324,000) $ 1,114,000
Weighted average common shares
outstanding........................ 1,890,442 3,046,594 3,903,470 3,935,969 4,371,464
Basic earnings (loss) per share...... $ (0.36) $ (0.52) $ 0.68 (0.08) $ 0.25
</TABLE>
(TABLE CONTINUED ON FOLLOWING PAGE)
F-12
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
FOR THE YEAR ENDED DECEMBER 31, ENDED MARCH 31,
------------------------------------------ --------------------------
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 $ (324,000) $ 1,114,000
Interest expense on convertible
debt............................... -- -- 42,000 -- 21,000
------------ -------------- ------------ ------------ ------------
Net income (loss) applicable to
common stockholders................ $ (673,000) $ (1,598,000) $ 2,714,000 $ (324,000) $ 1,135,000
Weighted average common shares
outstanding........................ 1,890,442 3,046,594 3,903,470 3,935,969 4,371,464
Weighted average dilutive potential
common shares outstanding.......... 91,773 114,642 1,248,741 73,304 3,407,713
Weighted average common and dilutive
potential common shares
outstanding........................ 1,982,215 3,161,236 5,152,211 4,009,273 7,779,177
Diluted earnings (loss) per share.... $ (0.34) $ (0.51) $ 0.53 $ (0.08) $ 0.15
</TABLE>
Diluted EPS for the years ended December 31, 1995 and 1996, and for the
three months ended March 31, 1997 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, March 31, 1997 and March 31, 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, March 31, 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 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
F-13
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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 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 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 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 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.
F-14
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
estimate of fair values at the date of acquisition and resulted in $1,756,000 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
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.
F-15
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
$4,852,000 and consisted of cash of $3,250,000, non-interest bearing promissory
notes with a discounted value of $672,000, common stock valued at $880,000 and
transaction costs of $50,000. 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 $6,063,000 of goodwill, which is being
amortized over 15 years (unaudited).
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.
F-16
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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.
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, no customer represented greater than 10% of revenues.
F-17
<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 MARCH 31,
----------------------- ---------------
1996 1997 1998
--------- ------------ ---------------
(UNAUDITED)
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 $ 1,592,000
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)............................ -- 839,000 860,000
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)................. -- 250,000 250,000
Capital lease obligation payable in
monthly installments of $11,000
including principal and interest
maturing February 28, 2000......... -- 242,000 217,000
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..................... -- -- 682,000
Revolving credit facility maturing
September 30, 1998 bearing interest
at prime plus 1%, secured by
accounts receivable................ -- -- 694,000
--------- ------------ ---------------
Total notes payable and capital
leases............................. -- 3,184,000 4,295,000
Current portion...................... -- 508,000 1,747,000
--------- ------------ ---------------
Long-term portion.................... $ -- $ 2,676,000 $ 2,548,000
========= ============ ===============
The annual maturities of the debt indicated above for the five years
following December 31, 1997, are $508,000 in 1998, $1,429,000 in 1999, $565,000
in 2000 and $682,000 in 2001.
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.
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.
F-18
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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-19
<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-20
<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>
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-21
<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 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-22
<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-23
<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-24
<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
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. 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 Company does not believe that such costs will have a
material impact on the financial results of 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-25
<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 MONTHS ENDED
FOR THE YEAR ENDED DECEMBER 31, MARCH 31,
-------------------------------------------- ------------------------------
1995 1996 1997 1997 1998
------------ -------------- -------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues --
Long distance services (United
States)....................... $ -- $ 1,213,000 $ 17,390,000 $ 1,597,000 $ 26,039,000
Systems Integration:
Mexico..................... -- 3,350,000 18,030,000 1,961,000 7,360,000
Poland..................... 1,108,000 1,142,000 734,000 213,000 --
------------ -------------- -------------- -------------- --------------
Total revenues........ $ 1,108,000 $ 5,705,000 $ 36,154,000 $ 3,771,000 $ 33,399,000
Operating income (loss) --
Long distance services (United
States)....................... $ -- $ (1,933,000) $ 2,428,000 $ 182,000 $ 2,271,000
Systems Integration:
Mexico..................... -- 129,000 768,000 (237,000) 1,371,000
Poland..................... (908,000) 45,000 (214,000) (331,000) --
------------ -------------- -------------- -------------- --------------
Total operating income
(loss)............. $ (908,000) $ (1,759,000) $ 2,982,000 $ (386,000) $ 2,219,000
------------ -------------- -------------- -------------- --------------
Capital Expenditures --
Long distance services (United
States)....................... $ -- $ 23,000 $ 383,000 $ 3,000 $ 2,549,000
Systems Integration:
Mexico..................... 46,000 418,000 1,260,000 379,000 1,093,000
Poland..................... -- -- 39,000 12,000 --
------------ -------------- -------------- -------------- --------------
Total capital
expenditures....... $ 46,000 $ 441,000 $ 1,682,000 $ 394,000 $ 3,642,000
Depreciation and
amortization --
Long distance services (United
States)....................... $ 1,000 $ 141,000 $ 369,000 $ 61,000 $ 476,000
Systems Integration:
Mexico..................... -- 74,000 204,000 12,000 93,000
Poland..................... 47,000 49,000 49,000 81,000 --
------------ -------------- -------------- -------------- --------------
Total depreciation
and amortization... $ 48,000 $ 264,000 $ 622,000 $ 154,000 $ 569,000
============ ============== ============== ============== ==============
<CAPTION>
AS OF DECEMBER 31, AS OF MARCH 31,
-------------------------------------------- ------------------------------
1995 1996 1997 1997 1998
------------ -------------- -------------- -------------- --------------
(UNAUDITED)
Identifiable assets --
Long distance services (United
States)....................... $ -- $ 4,136,000 $ 6,612,000 $ 1,505,000 $ 8,053,000
Systems Integration:
Mexico..................... -- 4,165,000 32,013,000 5,336,000 39,887,000
Poland..................... 4,498,000 1,070,000 1,010,000 3,633,000 --
------------ -------------- -------------- -------------- --------------
Total identifiable
assets............. $ 4,498,000 $ 9,371,000 $ 39,635,000 $ 10,474,000 $ 47,940,000
============ ============== ============== ============== ==============
</TABLE>
F-26
<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 obligations under the Notes (See Note 13), are
unconditionally guaranteed by all of the Company's wholly-owned United States
subsidiaries (the "Guarantors"). 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.
F-27
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING BALANCE SHEET -- MARCH 31, 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........ $ 26,000 $ 2,497,000 $ 359,000 $ -- $ 2,882,000
Accounts receivable, net......... -- 2,092,000 5,254,000 -- 7,346,000
Inventories...................... -- 88,000 3,025,000 -- 3,113,000
Prepaid expenses and other....... 178,000 1,111,000 3,628,000 -- 4,917,000
Deferred income taxes............ -- 311,000 -- -- 311,000
Intercompany receivables
(payables), net................ 1,312,000 2,219,000 (3,531,000) -- --
-------------------- ------------ -------------- ------------ ------------
Total current assets........ 1,516,000 8,318,000 8,735,000 -- 18,569,000
Property and equipment, net...... 279,000 2,077,000 2,988,000 -- 5,344,000
Goodwill and other intangibles,
net............................ 6,017,000 17,307,000 -- -- 23,324,000
Deferred income taxes............ -- 4,000 70,000 -- 74,000
Investments in affiliates........ 20,487,000 -- -- (20,192,000) 295,000
Other assets..................... 107,000 67,000 160,000 -- 334,000
-------------------- ------------ -------------- ------------ ------------
Total assets................... $28,406,000 $27,773,000 $ 11,953,000 $(20,192,000) $47,940,000
==================== ============ ============== ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................. $ 55,000 $ 2,321,000 $ 11,207,000 $ -- $13,583,000
Accrued expenses................. -- 1,704,000 693,000 -- 2,397,000
Current portion of notes payable
and capital lease
obligations.................... 586,000 1,161,000 -- -- 1,747,000
Deferred income taxes............ -- -- 416,000 -- 416,000
-------------------- ------------ -------------- ------------ ------------
Total current liabilities... 641,000 5,186,000 12,316,000 -- 18,143,000
Notes payable and capital lease
obligations.................... 562,000 1,986,000 -- -- 2,548,000
Minority interests............... -- 46,000 -- -- 46,000
Commitments and contingencies
(Note 7)....................... -- -- -- -- --
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....... 29,310,000 15,965,000 28,000 (15,993,000) 29,310,000
Accumulated deficit.............. (1,737,000) 4,559,000 (543,000) (4,016,000) (1,737,000)
Treasury stock................... (375,000) -- -- -- (375,000)
-------------------- ------------ -------------- ------------ ------------
Total stockholders'
equity.................... 27,203,000 20,555,000 (363,000) (20,192,000) 27,203,000
-------------------- ------------ -------------- ------------ ------------
Total liabilities and
stockholders' equity...... $28,406,000 $27,773,000 $ 11,953,000 $(20,192,000) $47,940,000
==================== ============ ============== ============ ============
</TABLE>
F-28
<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-29
<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 $4,667,000 $(4,667,000) $ 9,371,000
=================== ============= ============== ============= =============
</TABLE>
F-30
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS -- MARCH 31, 1998
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL, GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues............................. $ -- $26,039,000 $12,692,000 $(5,332,000) $33,399,000
Cost of Revenues -- 23,401,000 10,265,000 (5,332,000) 28,334,000
-------------- ------------ ------------ ----------- ------------
Gross profit......................... -- 2,638,000 2,427,000 -- 5,065,000
Selling, general and administrative
expenses............................ 316,000 517,000 1,444,000 -- 2,277,000
-------------- ------------ ------------ ----------- ------------
Operating income (loss) before
depreciation and amortization....... (316,000) 2,121,000 983,000 -- 2,788,000
Depreciation and amortization........ 127,000 349,000 93,000 -- 569,000
-------------- ------------ ------------ ----------- ------------
Operating income (loss).............. (443,000) 1,772,000 890,000 -- 2,219,000
Other income (expense):
Interest, net...................... (21,000) (39,000) 4,000 -- (56,000)
Foreign exchange gain (loss)....... -- -- (122,000) -- (122,000)
Other, net......................... -- 34,000 14,000 -- 48,000
Equity in income of subsidiaries... 1,457,000 -- -- (1,457,000) --
-------------- ------------ ------------ ----------- ------------
Total other income (expense),
net............................. 1,436,000 (5,000) (104,000) (1,457,000) (130,000)
-------------- ------------ ------------ ----------- ------------
Income (loss) before income taxes and
minority interests.................. 993,000 1,767,000 786,000 (1,457,000) 2,089,000
Income tax benefit (expense)......... 121,000 (752,000) (332,000) -- (963,000)
-------------- ------------ ------------ ----------- ------------
Income (loss) before minority
interests........................... 1,114,000 1,015,000 454,000 (1,457,000) 1,126,000
Minority interests in subsidiaries... -- (12,000) -- -- (12,000)
-------------- ------------ ------------ ----------- ------------
Net income (loss).................... $1,114,000 $ 1,003,000 $ 454,000 $(1,457,000) $ 1,114,000
============== ============ ============ =========== ============
</TABLE>
F-31
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS -- MARCH 31, 1997
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL, GUARANTOR GUARANTOR ELIMINA-
INC. SUBSIDIARIES SUBSIDIARIES TIONS CONSOLIDATED
-------------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Revenues............................. $ -- $1,595,000 $2,879,000 $(703,000) $3,771,000
Cost of Revenues..................... -- 1,172,000 2,056,000 (703,000) 2,525,000
-------------- ------------ ------------ ----------- ------------
Gross profit......................... -- 423,000 823,000 -- 1,246,000
Selling, general and administrative
expenses........................... 324,000 239,000 915,000 -- 1,478,000
-------------- ------------ ------------ ----------- ------------
Operating income (loss) before
depreciation and amortization...... (324,000) 184,000 (92,000) -- (232,000)
Depreciation and amortization........ 13,000 48,000 93,000 -- 154,000
-------------- ------------ ------------ ----------- ------------
Operating income (loss).............. (337,000) 136,000 (185,000) -- (386,000)
Other income (expense):
Interest, net...................... (6,000) 2,000 1,000 -- (3,000)
Foreign exchange gain (loss)....... -- -- 7,000 -- 7,000
Other, net......................... -- -- 22,000 -- 22,000
Equity income of subsidiaries...... 19,000 -- -- (19,000) --
-------------- ------------ ------------ ----------- ------------
Total other income (expense),
net............................ 13,000 2,000 30,000 (19,000) 26,000
-------------- ------------ ------------ ----------- ------------
Income (loss) before income taxes and
minority interests................. (324,000) 138,000 (155,000) (19,000) (360,000)
Income tax benefit (expense)......... -- -- 32,000 -- 32,000
-------------- ------------ ------------ ----------- ------------
Income (loss) before minority
interests.......................... (324,000) 138,000 (123,000) (19,000) (328,000)
Minority interests in subsidiaries... -- 4,000 -- -- 4,000
-------------- ------------ ------------ ----------- ------------
Net income (loss).................... $ (324,000) $ 142,000 $ (123,000) $ (19,000) $ (324,000)
============== ============ ============ =========== ============
</TABLE>
F-32
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS -- 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
-------------- ------------ ------------ ------------ ------------
Operating income (loss) before
depreciation
and amortization................... (1,116,000) 3,489,000 1,231,000 -- 3,604,000
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-33
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS -- 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
-------------- ------------ ------------ ----------- ------------
Operating income (loss) before
depreciation and amortization...... (1,462,000) (448,000) 415,000 -- (1,495,000)
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-34
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS -- 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
-------------- ------------ ------------ ----------- ------------
Operating income (loss) before
depreciation and amortization....... (712,000) -- (148,000) -- (860,000)
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-35
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS -- MARCH 31, 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).................. $1,114,000 $ 1,003,000 $ 454,000 $(1,457,000) $ 1,114,000
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Provision for doubtful
accounts.................... -- 15,000 -- -- 15,000
Depreciation and
amortization................ 127,000 349,000 93,000 -- 569,000
Provision for inventory
obsolence................... -- -- -- -- --
Write-off investment in
operating venture........... -- -- -- -- --
Deferred income tax benefit.... (208,000) 59,000 504,000 -- 355,000
Imputed interest on
non-interest bearing notes
payable..................... -- 71,000 -- -- 71,000
Minority interests in
subsidiaries' income........ 12,000 -- -- -- 12,000
Equity in income from
subsidiaries................ (1,457,000) -- -- 1,457,000 --
Changes in current assets and
current liabilities......... 368,000 (2,098,000) 220,000 -- (1,510,000)
-------------- ------------- ------------- ------------- -------------
Net cash provided by (used in)
operating activities........ (447,000) (198,000) 1,271,000 -- 626,000
-------------- ------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and
equipment........................ -- (2,271,000) (1,371,000) -- (3,642,000)
Acquisition of MSN, net of cash
acquired......................... (2,325,000) -- -- -- (2,325,000)
-------------- ------------- ------------- ------------- -------------
Net cash used in investing
activities.................. (2,325,000) (2,271,000) (1,371,000) -- (5,967,000)
-------------- ------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease
obligations...................... (26,000) -- -- -- (26,000)
Payments on notes payable.......... (300,000) -- -- -- (300,000)
Borrowings on line of credit....... -- 694,000 -- -- 694,000
Purchase of treasury stock......... (78,000) -- -- -- (78,000)
Proceeds from warrants and options
exercised........................ 3,199,000 -- -- -- 3,199,000
-------------- ------------- ------------- ------------- -------------
Net cash provided by financing
activities.................. 2,795,000 694,000 -- -- 3,489,000
-------------- ------------- ------------- ------------- -------------
Net increase (decrease) in cash
and cash equivalents........ 23,000 (1,775,000) (100,000) -- (1,852,000)
-------------- ------------- ------------- ------------- -------------
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 year................. $ 26,000 $ 2,497,000 $ 359,000 $ -- $ 2,882,000
============== ============= ============= ============= =============
</TABLE>
F-36
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS -- MARCH 31, 1997
<TABLE>
<CAPTION>
TELSCAPE NON-
INTERNATIONAL, GUARANTOR GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................. $ (324,000) $ 142,000 $(123,000) $ (19,000) $(324,000)
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Provision for doubtful
accounts.................... -- -- 22,000 -- 22,000
Depreciation and
amortization................ 13,000 48,000 93,000 -- 154,000
Deferred income tax benefit.... (88,000) (88,000)
Minority interests in
subsidiaries' (income)...... -- (4,000) -- -- (4,000)
Equity in income of
subsidiaries................ (19,000) -- -- 19,000 --
Changes in current assets and
current liabilities......... 62,000 604,000 622,000 -- 1,288,000
-------------- ------------- ------------- ------------- -------------
Net cash provided by (used
in) operating activities.. (268,000) 790,000 526,000 -- 1,048,000
-------------- ------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and
equipment........................ (3,000) (391,000) (394,000)
-------------- ------------- ------------- ------------- -------------
Net cash used in investing
activities..................... (3,000) -- (391,000) -- (394,000)
-------------- ------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease
obligations...................... (18,000) (18,000)
-------------- ------------- ------------- ------------- -------------
Net cash used in financing
activities..................... (18,000) -- -- -- (18,000)
-------------- ------------- ------------- ------------- -------------
Net increase (decrease) in cash
and cash equivalents........... (289,000) 790,000 135,000 -- 636,000
-------------- ------------- ------------- ------------- -------------
Cash and cash equivalents at
beginning of year.............. 300,000 55,000 140,000 495,000
-------------- ------------- ------------- ------------- -------------
Cash and cash equivalents at end
of year........................ $ 11,000 $ 845,000 $ 275,000 $ -- $1,131,000
============== ============= ============= ============= =============
</TABLE>
F-37
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS -- 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-38
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS -- 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-39
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS -- 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-40
<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) (920,000) (1,758,000)
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 2,751,000
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-41
<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 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. 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) 6.9% if the payment is made within 90 days
after the closing of each respective draw, (ii) 7.2% if payment is made after 90
days and up to 180 days after the closing of each respective draw, (iii) 8.8% if
payment is made after 180 days and up to 270 days after the closing of each
respective draw and (iv) 10.0% if payment is made after 270 days after the
closing of each respective draw. The Deere Park Exit Fee is adjusted on a pro
rata basis to the extent that the prepayment is made between periods except that
a minimum Deere Park Exit Fee of 6.6% is required if the prepayment is made
prior to 90 days after closing.
In May 1998, the Company issued $5,000,000 in 8% Convertible Debentures
(the "Gordon Brothers Convertible Debentures") maturing one year from closing
to Gordon Brothers Capital, LLC, a Delaware limited liability company ("Gordon
Brothers"). The Gordon Brothers Convertible Debentures are convertible by
Gordon Brothers into shares of Common Stock at a price equal to $29.00 per share
until November 1, 1998, and thereafter, at the lesser of (i) $29.00 per share or
(ii) a price equal to the average of the three highest of the five lowest
closing prices of the Common Stock for the 20 trading days preceding the
conversion date. If the Common Stock trades below $16.66 for three consecutive
trading days, the Company may redeem all or part of such Gordon Brothers
Convertible Debentures at 107% of face value plus any accrued interest. The
Company's obligation to make interest payments on the Gordon Brothers
Convertible Debentures terminates (i) in the event the Common Stock closes, for
twenty consecutive trading days, at or above $33.50 per share, adjusted, without
limitation, for any stock splits or combinations, (ii) when a registration
statement covering the Gordon Brothers Convertible Debentures is effective and
(iii) if there exists no event of default under the Gordon Brothers Convertible
Debentures. The Gordon Brothers Convertible Debentures are secured by a pledge
of the Company's stock in Telereunion and the Company's preferred stock in
INTERLINK. In addition, the Gordon Brothers Convertible Debentures are
guaranteed by INTERLINK and such guaranty is collateralized by a security
agreement covering all of INTERLINK's assets. In connection with the Gordon
Brothers Convertible Debentures, Gordon Brothers also received warrants to
purchase an aggregate of 12,136 shares of Common Stock at an exercise price of
$20.60 per share. The warrants have a term of three years from the effectiveness
of the registration statement covering such warrants. The Gordon Brothers
Convertible Debentures are senior secured indebtedness of the Company to the
extent of the assets securing such indebtedness.
The Company is required to pay an exit fee in connection with any
prepayment of principal to be made under the Gordon Brothers Convertible
Debentures (the "Gordon Brothers Exit Fee"). The Gordon Brothers Exit Fee
varies depending upon the date of payment, and is equal to (i) 6.5% if the
payment is made within 90 days after May 29, 1998, (ii) 13.0% if payment is made
after 90 days and up to 180 days after May 29, 1998, (iii) 19.0% if payment is
made after 180 days and up to 270 days after May 29, 1998 and (iv) 25.0% if
payment is made after 270 days and up to 365 days after May 29, 1998. The Gordon
Brothers Exit Fee with respect to any payment made after May 28, 1999 shall be
equal to (a) 25.0% plus (b) 25.0% multiplied by the number of days elapsed from
May 28, 1999 divided by 365. The Gordon Brothers
F-42
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
In connection with the issuance of the Deere Park Convertible Debentures
and the Gordon Brothers Convertible Debentures, the Company issued to the
holders warrants to purchase 59,340 shares of Common Stock with exercise prices
ranging from $16.76 to $20.60 per share, respectively. The warrants have a term
of two years.
Approximately $8.2 million of the proceeds from the Deere Park Convertible
Debentures and the Gordon Brothers Convertible Debentures were used to finance
the INTERLINK Acquisition and the remainder was utilized for capital investments
and general working capital purposes.
In May 1998, 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 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 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.
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 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
F-43
<PAGE>
TELSCAPE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. 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.
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-44
<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 6 to the financial statements.
De Las Fuentes, De La Mora y Valdivia, S.C.
Mexico City
September 6, 1997
F-45
<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>
SIX MONTHS ENDED JUNE 30,
YEAR ENDED DECEMBER 31, 1996 1997
----------------------------- ---------------------------
(NOTE 5) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net sales............................... Ps30,476,000 $ 3,830,000 Ps37,236,000 $ 4,679,000
Cost of sales........................... 20,516,000 2,578,000 27,552,000 3,462,000
--------------- ------------ ----------- -----------
Gross profit............................ 9,960,000 1,252,000 9,684,000 1,217,000
Selling, general and administrative
expenses................................ 6,384,000 802,000 3,939,000 495,000
--------------- ------------ ----------- -----------
Operating income........................ 3,576,000 450,000 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) 223,000 28,000
Loss (gain) on foreign currency
exchange, net.................... 705,000 89,000 (64,000) (8,000)
--------------- ------------ ----------- -----------
171,000 22,000 (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 5,858,000 736,000
Provision for income taxes.............. 329,000 41,000 2,548,000 320,000
--------------- ------------ ----------- -----------
Net income.............................. Ps 3,050,000 $ 384,000 Ps 3,310,000 $ 416,000
=============== ============ =========== ===========
Net income per share.................... Ps 6,099.87 $ 766.54 Ps 6,619.28 $ 831.81
=============== ============ =========== ===========
Average common shares outstanding....... 500 500 500 500
=============== ============ =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-46
<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 DECEMBER 31, SIX MONTHS ENDED JUNE 30,
1996 1997
-------------------------- -----------------------------
(NOTE 5) (UNAUDITED) (UNAUDITED)
--------- -------------- -----------
<S> <C> <C> <C> <C>
OPERATIONS:
Net income...................... Ps3,050,000 $ 384,000 Ps3,310,000 $ 416,000
Depreciation and amortization... 238,000 29,000 160,000 20,000
Net change in accounts
receivable,
inventories, accounts payable
and other..................... (186,000) (23,000) (3,592,000) (451,000)
-------------- --------- -------------- -----------
Funds provided by (used in)
operations.................... 3,102,000 390,000 (122,000) (15,000)
-------------- --------- -------------- -----------
FINANCING:
Dividends paid.................. -- -- (1,430,000) (180,000)
Recognition of the effects of
inflation..................... (889,000) (112,000) -- --
-------------- --------- -------------- -----------
Funds used by financing
activities.................... (889,000) (112,000) (1,430,000) (180,000)
-------------- --------- -------------- -----------
INVESTMENT:
Acquisition of equipment........ (638,000) (80,000) (183,000) (23,000)
-------------- --------- -------------- -----------
Funds used by investment
activities.................... (638,000) (80,000) (183,000) (23,000
-------------- --------- -------------- -----------
Increase (decrease) in cash and cash
equivalents........................ 1,575,000 198,000 (1,735,000) (218,000)
Cash and cash equivalents at
beginning of year.................. 2,539,000 319,000 4,114,000 517,000
-------------- --------- -------------- -----------
Cash and cash equivalents at end of
year............................... Ps4,114,000 $ 517,000 Ps2,379,000 $ 299,000
============== ========= ============== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-47
<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-48
<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-49
<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, vaction 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 7 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-50
<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-51
<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................... (1,230,000)
------------
Total liabilities and
stockholders' deficit..... $ 2,110,000
============
See accompanying notes to financial statements.
F-52
<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
------------
Operating loss before depreciation
and amortization................... (919,000)
------------
Depreciation and amortization
operating loss..................... 35,000
------------
(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-53
<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-54
<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-55
<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-56
<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-57
<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-58
<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 OR THE UNDERWRITERS. 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......................... 8
Use of Proceeds...................... 30
Capitalization....................... 31
Unaudited Pro Forma Condensed
Consolidated Financial
Statements......................... 32
Selected Consolidated Financial and
Other Data......................... 35
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 37
Business............................. 47
Management........................... 67
Certain Relationships and Related
Transactions....................... 76
Description of Capital Stock......... 78
Summary of Other Indebtedness........ 81
Description of the Notes............. 84
Certain United States Federal Income
Tax Considerations................. 109
Underwriting......................... 114
Legal Matters........................ 114
Experts.............................. 114
Available information................ 115
Index to Financial Statements........ F-1
----------------------
PROSPECTUS
----------------------
$125,000,000
[LOGO]
TELSCAPE
INTERNATIONAL, INC.
% SENIOR NOTES DUE 2008
BT ALEX. BROWN
LEHMAN BROTHERS
, 1998
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The table below sets forth the expenses to be incurred by the Company in
connection with the issuance and distribution of the securities registered for
offer and sale hereby, other than underwriting discounts and commissions. All
amounts shown represent estimates except the Securities Act registration fee and
the NASD filing fee.
Registration fee under the Securities
Act of 1933........................ $ 36,875
Printing expenses.................... *
Registrar and Transfer Agent's fees
and expenses....................... *
Accountants' fees and expenses....... *
Legal fees and expenses (not
including Blue Sky)................ *
Financial Advisor fees............... *
Blue Sky fees and expenses........... *
Miscellaneous........................ *
---------
Total................................ $ *
- ------------
* To be completed by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Company's By-Laws provide that the Company shall indemnify and advance
expenses to the directors, officers, employees, agents of the Company or any
other persons serving at the request of the Company in such capacities in a
manner and to the maximum extent permitted by applicable state or federal law.
The Company's Articles of Incorporation provide that Company shall
indemnify any person who was or is a party or is threatened to be made a party
to any threatened, pending or completed action, suit or proceeding, whether
civil, criminal, administrative, arbitrative, or investigative, any appeal in
such an action, suit, or proceeding, and any inquiry or investigation that could
lead to such an action, suit, or proceeding (whether or not by or in the right
of the Company), by reason of the fact that he is or was a director or officer
of the Company, or is or was serving at the request of the Company as a director
or officer, against all judgments, penalties (including excise and similar
taxes), fines, settlements, and reasonable expenses (including attorneys' fees
and court costs) actually and reasonably incurred by him in connection with such
action, suit or proceeding to the fullest extent permitted by any applicable
law, and such indemnity shall inure to the benefit of the heirs, executors and
administrators of any such person so indemnified. The right to indemnification
under the Company's Articles of Incorporation is a contract right and shall
include, with respect to directors and officers, the right to be paid by the
Company the expenses incurred in defending any such proceeding in advance of its
disposition; PROVIDED, HOWEVER, that, the payment of such expenses incurred by a
director or officer in advance of the final disposition of a proceeding shall be
made only upon delivery to the Company of (i) a written affirmation by such
director or officer of his good faith belief that he has met the standard of
conduct necessary for indemnification under the Company's Articles of
Incorporation or otherwise and (ii) a written undertaking by or on behalf of
such director or officer to repay all amounts so advanced if it shall ultimately
be determined that such director or officer is not entitled to be indemnified
under the Company's Articles of Incorporation or otherwise. The indemnification
and advancement of expenses provided by, or granted pursuant to, the Company's
Articles of Incorporation shall not be deemed exclusive of any right to which
those seeking indemnification or advancement of expenses may be entitled under
any law, by-law, agreement, vote of shareholders or disinterested directors or
otherwise, both as to action in his official capacity and as to action in
another capacity while holding such office.
II-1
<PAGE>
Persons who are not directors or officers of the Company may be similarly
indemnified in respect of such service to the extent authorized at any time by
the Board of Directors of the Company. The Company may purchase and maintain
liability insurance or make other arrangements for such obligations to the
extent permitted by the Texas Business Corporation Act.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
The following paragraphs describe all offers and sales of securities by the
Company within the last three years which were not registered under the
Securities Act of 1933, as amended, other than securities issued in connection
with stock reclassifications, stock dividends or stock splits:
On February 29, 1996, in connection with a former officer's severance
agreement, the Company issued warrants to purchase 150,000 shares of common
stock exercisable at $2.94 per share, which expire on February 29, 2001.
On May 17, 1996, as part of the consideration paid for Telereunion, Inc.
("Telereunion"), the Company issued to the shareholders of Telereunion
1,605,000 shares of common stock of the Company, 380,000 shares of the Company's
non-voting, non-participatory Series B preferred stock and warrants to purchase
up to 2,595,000 additional shares of common stock at $2.19 per share. The
warrants vest and become exercisable upon Vextro de Mexico S.A. de C.V. meeting
certain operating performance measures and expire on May 16, 2003. The shares of
Series B preferred stock were mandatorily redeemable for $380,000 in the
aggregate upon the Company meeting certain operating performance measures.
During the year ended December 31, 1997, the Company met certain of the
operating performance measures, which resulted in 2,095,000 warrants vesting and
the Company redeeming 380,000 preferred shares. In June 1998, because the
Company met certain of the operating performance measures, the remaining
warrants vested. Also in connection with the Telereunion acquisition, the
Company issued to financial advisors, warrants to purchase 79,191 shares of
common stock at $2.19 per share. The warrants expire on May 16, 2001.
On September 5, 1996, the Company acquired all of the outstanding common
stock of Orion Communications, Inc., a Texas corporation ("Orion"), and issued
to the shareholders of Orion 400,000 shares of the Company's common stock in a
transaction accounted for under the pooling-of-interests method. At the time of
the merger, the name of Orion was changed to Telscape USA, Inc.
Effective July 1, 1997, in connection with the Integracion acquisition, the
Company issued warrants to purchase 100,000 shares of common stock exercisable
at $3.00 per warrant, which expire on July 1, 2003. The warrants vesting is
contingent upon Integracion meeting certain performance requirements. During the
year ended December 31, 1997, certain of the operating performance requirements
were met, resulting in 80,000 warrants vesting.
Effective January 1, 1998, as part of the consideration paid for MSN, the
Company issued 100,000 shares of the Company's common stock to the selling
shareholders of MSN.
On May 1, 1998 and May 28, 1998, the Company issued $3,000,000 and
$1,000,000, respectively, in 8% Convertible Subordinated Debentures (the "Deere
Park Convertible Debentures") maturing three years from closing to Deere Park
Capital Management, LLC ("Deere Park"). On June 30, 1998, the Company issued
an additional $1,000,000 in Deere Park Convertible Debentures to Deere Park on
similar terms. In connection with the Deere Park Convertible Debentures, Deere
Park also received warrants to purchase an aggregate of 8,952 shares of the
Company's common stock at an exercise price of $16.76 per share, warrants to
purchase 2,427 shares of the Company's common stock at $20.60 per share and
warrants to purchase an aggregate of 6,382 shares of common stock at $15.67 per
share. The warrants have a term of three years from the effectiveness of a
registration statement covering such warrants.
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, L.L.C. ("Gordon Brothers"). In connection with the
Gordon Brothers Convertible Debentures, Gordon Brothers 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 from
the effectiveness of a
II-2
<PAGE>
registration statement covering such warrants. See "Summary of Other
Indebtedness" in the Prospectus included in this Registration Statement for a
description of the terms of the Deere Park Convertible Debentures and the Gordon
Brothers Convertible Debentures.
In connection with the issuance of the Deere Park Convertible Debentures
and the Gordon Brothers Convertible Debentures, the Company issued to Preferred
Capital Markets, Inc., as a placement agent fee, warrants to purchase 41,136 and
15,334 shares of common stock exercisable at $20.00 and $17.88, respectively,
per share expiring in two years from the date the shares underlying the warrants
are registered.
Each issuance of securities described above was made in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act as a
transaction by an issuer not involving any public offering. Appropriate legends
were affixed to the share certificates issued in such transactions. All
recipients had adequate access, through their relationships with the Company, to
information about the Company.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(A) Exhibits:
EXHIBIT
NUMBER DESCRIPTION
- -------------------------------------------------------------
*1.1 -- Form of Underwriting Agreement
between the Company, BT Alex. Brown
Incorporated and Lehman Brothers Inc.
3.1 -- Articles of Incorporation of the
Company, as amended (Incorporated
herein by reference to Exhibit 3.1 to
the Company's Registration Statement
No. 33-80542-D)
3.2 -- Bylaws of the Company, as amended
(Incorporated herein by reference to
Exhibit 3.2 to the Company's
Registration Statement No.
33-80542-D)
4.1 -- Form of Certificate evidencing Common
Stock (Incorporated herein by
reference to Exhibit 4.1 to the
Company's Registration Statement No.
33-80542-D)
4.2 -- Form of Warrant Agreement between
American Stock Transfer & Trust
Company and the Company (Incorporated
herein by reference to Exhibit 4.2 to
the Company's Registration Statement
No. 33-80542-D)
4.3 -- Form of Warrant Certificate
evidencing the Warrants (Incorporated
herein by reference to Exhibit 4.3 to
the Company's Registration Statement
No. 33-80542-D)
4.4 -- Form of Statement of the
establishment of the Series B
non-voting, nonparticipating
Preferred Stock (Incorporated herein
by reference to the Company's Report
on Form 10-QSB for the quarter ended
March 31, 1996)
*4.5 -- Form of Indenture for % Senior
Notes due 2008.
*5.1 -- Form of Opinion of Swidler & Berlin,
Chartered regarding legality
*8.1 -- Opinion regarding tax matters
10.1 -- Form of Warrant Agreement
(Incorporated herein by reference to
Exhibit 10.8 to the Company's
Registration Statement No.
33-80542-D)
10.2 -- Warrant Agreement between the Company
and S.P. Krishna Murthy (Incorporated
herein by reference to Exhibit 10.13
to the Company's Report on Form
10-KSB for the year ended December
31, 1995)
10.3 -- Form of Series A Common Stock Warrant
(Incorporated herein by reference to
Exhibit 10.4 to the Company's Report
on Form 10-QSB for the quarter ended
March 31, 1996)
II-3
<PAGE>
10.4 -- Form of Series B Common Stock Warrant
(Incorporated herein by reference to
Exhibit 10.5 to the Company's Report
on Form 10-QSB for the quarter ended
March 31, 1996)
10.5 -- Form of Employment Agreement for
Manuel Landa, Ricardo Orea Gudino and
Oscar Garcia Mora (Incorporated
herein by reference to Exhibit 10.6
to the Company's Report on Form
10-QSB for the quarter ended March
31, 1996)
10.6 -- Form of Non-Qualified Stock Option
Certificate and Agreement, as
amended, for Manuel Landa, Ricardo
Orea Gudino and Oscar Garcia Mora
(Incorporated herein by reference to
Exhibit 10.7 to the Company's Report
on Form 10-QSB for the quarter ended
March 31, 1996)
10.7 -- Form of Series A Common Stock Warrant
dated May 17, 1996 between the
Company and Manuel Landa, Ricardo
Orea Gudino, Oscar Garcia Mora and
Christopher Efird (Incorporated
herein by reference to Exhibit 10.1
to the Company's Report on Form 8-K
dated June 3, 1996)
10.8 -- Employment Agreement for E. Scott
Crist (Incorporated herein by
reference to Exhibit 10.1 to the
Company's Report on Form 10-QSB for
the quarter ended September 30, 1996)
10.9 -- Employment agreement for Todd M.
Binet (Incorporated herein by
reference to Exhibit 10.29 to the
Company's Report on Form 10-KSB for
the year ended December 31, 1996)
10.10 -- Form of Promissory Note dated July 1,
1997, between Telereunion and Jose
Luis Apan Wong, Raul de la Parra
Zavala and Alejandro Apan Wong
(Incorporated herein by reference to
Exhibit 10.4 to the Company's Current
Report on Form 8-K dated August 5,
1997)
10.11 -- Form of Convertible Promissory Note
dated July 1, 1997, between the
Company and Telereunion and Jose Luis
Apan Wong, Raul de la Parra Zavala
and Alejandro Apan Wong (Incorporated
herein by reference to Exhibit 10.4
to the Company's Current Report on
Form 8-K dated August 5, 1997)
10.12 -- Form of Common Stock Warrant dated
July 1, 1997, between the Company and
Jose Luis Apan Wong, Raul de la Parra
Zavala and Alejandro Apan Wong
(Incorporated herein by reference to
Exhibit 10.4 to the Company's Current
Report on Form 8-K dated August 5,
1997)
10.13 -- Stock Purchase Agreement dated July
1, 1997, by and among the Company,
Telscape USA, Telereunion and Jose
Luis Apan Wong, Raul de la Parra
Zavala and Alejandro Apan Wong
(Incorporated herein by reference to
Exhibit 10.4 to the Company's Current
Report on Form 8-K dated August 5,
1997)
10.14 -- Stock Purchase Agreement dated
October 1, 1997, by and among
Telscape USA, Inc., Telereunion, Inc.
and Jose Martin Pena Nunez, Carlos
Joaquin De Lara Y Campos, Jorge Pena
Nunez, Martha Teresita Martin Del
Campo Gutierrez (Incorporated herein
by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K
dated October 15, 1997)
10.15 -- Stock Purchase Agreement dated
January 22, 1998, by and among the
Company; MSN Communications, Inc.;
Stuart Newman; and Michael Newman,
together with Form of Promissory Note
dated January 23, 1998 in the
principal amount of $375,000 payable
to Stuart Newman attached as Exhibit
B-1 and Form of Promissory Note dated
January 23, 1998 in the principal
amount of $375,000 payable to Michael
Newman attached as Exhibit B-2
(Incorporated herein by reference to
Exhibit 10.1 to the Company's Current
Report on Form 8-K dated February 6,
1998)
10.16 -- Stock Purchase Agreement dated May
18, 1998, by and among Telscape
Interna-
tional, Inc.; California Microwave,
Inc., and California Microwave
Services Divisions, Inc. together
with a Form of Supply Agreement
between California Microwave, Inc.
and California Microwave Services
Division, Inc. as Exhibit B
(Incorporated herein by reference to
Exhibit 10.1 to the Company's Current
Report on Form 8-K dated June 9,
1998)
II-4
<PAGE>
10.17 -- Securities Purchase Agreement between
Deere Park Capital Management, LLC
and Telscape International, Inc.
dated as of May 1, 1998; Registration
Rights Agreement dated as of May 1,
1998 between Telscape International,
Inc. and Deere Park Capital
Management, LLC; Form of Convertible
Subordinated Debenture for $3,000,000
dated May 1, 1998; Form of Stock
Purchase Warrant to Purchase 8,952
shares of Common Stock of Telscape
International, Inc. dated May 12,
1998, (all filed as Exhibit 4.4 to
the Company's Report on Form 10-Q for
the quarter ended March 31, 1998 and
incorporated herein by reference)
10.18 -- Form of Convertible Subordinated
Debenture in the principal amount of
$1,000,000 between Deere Park Capital
Management, LLC and Telscape Interna-
tional, Inc. dated as of May 28,
1998; and a form of Stock Purchase
Warrant to Purchase 2,427 shares of
Common Stock of Telscape
International, Inc. dated May 28,
1998 (Incorporated herein by
reference to Exhibit 10.3 to the
Company's Current Report on Form 8-K
dated June 9, 1998)
10.19 -- Securities Purchase Agreement dated
May 29, 1998 by and between Telscape
International, Inc. and Gordon
Brothers Capital, LLC; together with
a Form of Convertible Debenture in
the principal amount of $5,000,000
payable to Gordon Brothers Capital,
LLC attached as Exhibit A; a Form of
Stock Purchase Warrant for Gordon
Brothers Capital, LLC, for 12,136
shares of Common Stock of Telscape
International, Inc. attached as
Exhibit B; and a Registration Rights
Agreement by and between Gordon
Brothers Capital, LLC and Telscape
International, Inc. attached as
Exhibit C (Incorporated herein by
reference to Exhibit 10.4 to the
Company's Current Report on Form 8-K
dated June 9, 1998)
10.20 -- Equity Purchase Agreement by and
between Interlink Communications
Holding Co., Inc. and each of
Telscape International, Inc., E.
Russell Hardy, Stephen Strohman,
Monty J. Moore, and Salvador Giblas
dated as of May 18, 1998
(Incorporated herein by reference to
Exhibit 10.5 to the Company's Current
Report on Form 8-K dated June 9,
1998)
10.21 -- Form of Employment Agreement by and
between California Microwave Services
Division, Inc. and E. Russell Hardy
dated as of May 18, 1998
(Incorporated herein by reference to
Exhibit 10.6 to the Company's Current
Report on Form 8-K dated June 9,
1998)
10.22 -- Form of Employment Agreement by and
between California Microwave Services
Division, Inc. and Stephen Strohman
dated as of May 18, 1998
(Incorporated herein by reference to
Exhibit 10.7 to the Company's Current
Report on Form 8-K dated June 9,
1998)
10.23 -- Form of Employment Agreement by and
between California Microwave Services
Division, Inc. and Monty J. Moore
dated as of May 18, 1998
(Incorporated herein by reference to
Exhibit 10.8 to the Company's Current
Report on Form 8-K dated June 9,
1998)
10.24 -- Form of Consulting Agreement by and
between California Microwave Services
Division, Inc. and Salvador Giblas
dated as of May 18, 1998
(Incorporated herein by reference to
Exhibit 10.9 to the Company's Current
Report on Form 8-K dated June 9,
1998)
16.1 -- Letter regarding change in certifying
accountant (Hoffman, McBryde & Co.,
P.C.) (Incorporated herein by
reference to Exhibit 1.1 to the
Company's Report on Form 8-KA dated
November 6, 1996)
*21.1 -- Subsidiaries of the registrant
23.1 -- Consent of BDO Seidman, LLP
23.2 -- Consent of Hoffman, McBryde & Co.,
P.C.
23.3 -- Consent of De Las Fuentes, De La Mora
y Valdivia, S.C;
24.1 -- Power of Attorney
II-5
<PAGE>
*99.1 -- Form of Letter of Transmittal
*99.2 -- Form of Notice of Guaranteed Delivery
*99.3 -- Form of Letter to Brokers, Dealers,
Commercial Banks, Trust Companies and
Other Nominees
*99.4 -- Form of Letter to Clients
*99.5 -- Guides for Certification of Taxpayer
Identification Number on Form W-9
- ------------
* To be filed by Amendment
(B). FINANCIAL STATEMENT SCHEDULES. Valuation and Qualifying Accounts. All
other schedules are omitted either because they are not applicable or are not
material, or the information presented therein is contained in the Financial
Statements or notes thereto.
ITEM 17. UNDERTAKINGS
(a) (1) For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus
filed as part of this registration statement in reliance upon
Rule 430A and contained in a form of prospectus filed by the
registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the
Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of
such securities at that time shall be deemed to be the initial
bona fide offering thereof.
(b) The undersigned Registrant hereby undertakes to file an application
for the purpose of determining the eligibility of the Trustee to act under
subsection (a) of Section 310 of the Trust Indenture Act in accordance with the
rules and regulations prescribed by the Commission under Section 305(b)(2) of
the Act.
(c) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the foregoing provisions, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
II-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Houston, State of Texas,
on the 28th day of July 1998.
Telscape International, Inc.
By: /s/ E. SCOTT CRIST
E. SCOTT CRIST,
CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the date indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
/s/E. SCOTT CRIST Chief Executive Officer (Principal July 28, 1998
E. SCOTT CRIST Executive Officer and Director)
Director July 28, 1998
MANUEL LANDA
/s/OSCAR GARCIA Director July 28, 1998
OSCAR GARCIA
/s/RICARDO OREA Director July 28, 1998
RICARDO OREA
/s/DARREL O. KIRKLAND Director July 28, 1998
DARREL O. KIRKLAND
Director July 28, 1998
ENRIQUE ORIHUELA
/s/TODD M. BINET Chief Financial Officer, Secretary, July 28, 1998
TODD M. BINET Treasurer and Director (Principal
Financial and Accounting Officer)
</TABLE>
II-7
<PAGE>
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
*1.1 -- Form of Underwriting Agreement
between the Company, BT Alex. Brown
Incorporated and Lehman Brothers Inc.
3.1 -- Articles of Incorporation of the
Company, as amended (Incorporated
herein by reference to Exhibit 3.1 to
the Company's Registration Statement
No. 33-80542-D)
3.2 -- Bylaws of the Company, as amended
(Incorporated herein by reference to
Exhibit 3.2 to the Company's
Registration Statement No.
33-80542-D)
4.1 -- Form of Certificate evidencing Common
Stock (Incorporated herein by
reference to Exhibit 4.1 to the
Company's Registration Statement No.
33-80542-D)
4.2 -- Form of Warrant Agreement between
American Stock Transfer & Trust
Company and the Company (Incorporated
herein by reference to Exhibit 4.2 to
the Company's Registration Statement
No. 33-80542-D)
4.3 -- Form of Warrant Certificate
evidencing the Warrants (Incorporated
herein by reference to Exhibit 4.3 to
the Company's Registration Statement
No. 33-80542-D)
4.4 -- Form of Statement of the
establishment of the Series B
non-voting, nonparticipating
Preferred Stock (Incorporated herein
by reference to the Company's Report
on Form 10-QSB for the quarter ended
March 31, 1996)
*4.5 -- Form of Indenture for % Senior
Notes due 2008
*5.1 -- Form of Opinion of Swidler & Berlin,
Chartered regarding legality
10.1 -- Form of Warrant Agreement
(Incorporated herein by reference to
Exhibit 10.8 to the Company's
Registration Statement No.
33-80542-D)
10.2 -- Warrant Agreement between the Company
and S.P. Krishna Murthy (Incorporated
herein by reference to Exhibit 10.13
to the Company's Report on Form
10-KSB for the year ended December
31, 1995)
10.3 -- Form of Series A Common Stock Warrant
(Incorporated herein by reference to
Exhibit 10.4 to the Company's Report
on Form 10-QSB for the quarter ended
March 31, 1996)
10.4 -- Form of Series B Common Stock Warrant
(Incorporated herein by reference to
Exhibit 10.5 to the Company's Report
on Form 10-QSB for the quarter ended
March 31, 1996)
10.5 -- Form of Employment Agreement for
Manuel Landa, Ricardo Orea Gudino and
Oscar Garcia Mora (Incorporated
herein by reference to Exhibit 10.6
to the Company's Report on Form
10-QSB for the quarter ended March
31, 1996)
10.6 -- Form of Non-Qualified Stock Option
Certificate and Agreement, as
amended, for Manuel Landa, Ricardo
Orea Gudino and Oscar Garcia Mora
(Incorporated herein by reference to
Exhibit 10.7 to the Company's Report
on Form 10-QSB for the quarter ended
March 31, 1996)
10.7 -- Form of Series A Common Stock Warrant
dated May 17, 1996 between the
Company and Manuel Landa, Ricardo
Orea Gudino, Oscar Garcia Mora and
Christopher Efird (Incorporated
herein by reference to Exhibit 10.1
to the Company's Report on Form 8-K
dated June 3, 1996)
10.8 -- Employment Agreement for E. Scott
Crist (Incorporated herein by
reference to Exhibit 10.1 to the
Company's Report on Form 10-QSB for
the quarter ended September 30, 1996)
10.9 -- Employment agreement for Todd M.
Binet (Incorporated herein by
reference to Exhibit 10.29 to the
Company's Report on Form 10-KSB for
the year ended December 31, 1996)
10.10 -- Form of Promissory Note dated July 1,
1997, between Telereunion and Jose
Luis Apan Wong, Raul de la Parra
Zavala and Alejandro Apan Wong
(Incorporated herein by reference to
Exhibit 10.4 to the Company's Current
Report on Form 8-K dated August 5,
1997)
10.11 -- Form of Convertible Promissory Note
dated July 1, 1997, between the
Company and Telereunion and Jose Luis
Apan Wong, Raul de la Parra Zavala
and Alejandro Apan Wong (Incorporated
herein by reference to Exhibit 10.4
to the Company's Current Report on
Form 8-K dated August 5, 1997)
10.12 -- Form of Common Stock Warrant dated
July 1, 1997, between the Company and
Jose Luis Apan Wong, Raul de la Parra
Zavala and Alejandro Apan Wong
(Incorporated herein by reference to
Exhibit 10.4 to the Company's Current
Report on Form 8-K dated August 5,
1997)
10.13 -- Stock Purchase Agreement dated July
1, 1997, by and among the Company,
Telscape USA, Telereunion and Jose
Luis Apan Wong, Raul de la Parra
Zavala and Alejandro Apan Wong
(Incorporated herein by reference to
Exhibit 10.4 to the Company's Current
Report on Form 8-K dated August 5,
1997)
10.14 -- Stock Purchase Agreement dated
October 1, 1997, by and among
Telscape USA, Inc., Telereunion, Inc.
and Jose Martin Pena Nunez, Carlos
Joaquin De Lara Y Campos, Jorge Pena
Nunez, Martha Teresita Martin Del
Campo Gutierrez (Incorporated herein
by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K
dated October 15, 1997)
10.15 -- Stock Purchase Agreement dated
January 22, 1998, by and among the
Company; MSN Communications, Inc.;
Stuart Newman; and Michael Newman,
together with Form of Promissory Note
dated January 23, 1998 in the
principal amount of $375,000 payable
to Stuart Newman attached as Exhibit
B-1 and Form of Promissory Note dated
January 23, 1998 in the principal
amount of $375,000 payable to Michael
Newman attached as Exhibit B-2
(Incorporated herein by reference to
Exhibit 10.1 to the Company's Current
Report on Form 8-K dated February 6,
1998)
10.16 -- Stock Purchase Agreement dated May
18, 1998, by and among Telscape
International, Inc.; California Microwave,
Inc., and California Microwave
Services Divisions, Inc. together
with a Form of Supply Agreement
between California Microwave, Inc.
and California Microwave Services
Division, Inc. as Exhibit B
(Incorporated herein by reference to
Exhibit 10.1 to the Company's Current
Report on Form 8-K dated June 9,
1998)
10.17 -- Securities Purchase Agreement between
Deere Park Capital Management, LLC
and Telscape International, Inc.
dated as of May 1, 1998; Registration
Rights Agreement dated as of May 1,
1998 between Telscape International,
Inc. and Deere Park Capital
Management, LLC; Form of Convertible
Subordinated Debenture for $3,000,000
dated May 1, 1998; Form of Stock
Purchase Warrant to Purchase 8,952
shares of Common Stock of Telscape
International, Inc. dated May 12,
1998, (all filed as Exhibit 4.4 to
the Company's Report on Form 10-Q for
the quarter ended March 31, 1998 and
incorporated herein by reference)
10.18 -- Form of Convertible Subordinated
Debenture in the principal amount of
$1,000,000 between Deere Park Capital
Management, LLC and Telscape Interna-
tional, Inc. dated as of May 28,
1998; and a form of Stock Purchase
Warrant to Purchase 2,427 shares of
Common Stock of Telscape
International, Inc. dated May 28,
1998 (Incorporated herein by
reference to Exhibit 10.3 to the
Company's Current Report on Form 8-K
dated June 9, 1998)
10.19 -- Securities Purchase Agreement dated
May 29, 1998 by and between Telscape
International, Inc. and Gordon
Brothers Capital, LLC; together with
a Form of Convertible Debenture in
the principal amount of $5,000,000
payable to Gordon Brothers Capital,
LLC attached as Exhibit A; a Form of
Stock Purchase Warrant for Gordon
Brothers Capital, LLC, for 12,136
shares of Common Stock of Telscape
International, Inc. attached as
Exhibit B; and a Registration Rights
Agreement by and between Gordon
Brothers Capital, LLC and Telscape
International, Inc. attached as
Exhibit C (Incorporated herein by
reference to Exhibit 10.4 to the
Company's Current Report on Form 8-K
dated June 9, 1998)
10.20 -- Equity Purchase Agreement by and
between Interlink Communications
Holding Co., Inc. and each of
Telscape International, Inc., E.
Russell Hardy, Stephen Strohman,
Monty J. Moore, and Salvador Giblas
dated as of May 18, 1998
(Incorporated herein by reference to
Exhibit 10.5 to the Company's Current
Report on Form 8-K dated June 9,
1998)
10.21 -- Form of Employment Agreement by and
between California Microwave Services
Division, Inc. and E. Russell Hardy
dated as of May 18, 1998
(Incorporated herein by reference to
Exhibit 10.6 to the Company's Current
Report on Form 8-K dated June 9,
1998)
10.22 -- Form of Employment Agreement by and
between California Microwave Services
Division, Inc. and Stephen Strohman
dated as of May 18, 1998
(Incorporated herein by reference to
Exhibit 10.7 to the Company's Current
Report on Form 8-K dated June 9,
1998)
10.23 -- Form of Employment Agreement by and
between California Microwave Services
Division, Inc. and Monty J. Moore
dated as of May 18, 1998
(Incorporated herein by reference to
Exhibit 10.8 to the Company's Current
Report on Form 8-K dated June 9,
1998)
10.24 -- Form of Consulting Agreement by and
between California Microwave Services
Division, Inc. and Salvador Giblas
dated as of May 18, 1998
(Incorporated herein by reference to
Exhibit 10.9 to the Company's Current
Report on Form 8-K dated June 9,
1998)
16.1 -- Letter regarding change in certifying
accountant (Hoffman, McBryde & Co.,
P.C.) (Incorporated herein by
reference to Exhibit 1.1 to the
Company's Report on Form 8-KA dated
November 6, 1996)
*21.1 -- Subsidiaries of the registrant
23.1 -- Consent of BDO Seidman, LLP
23.2 -- Consent of Hoffman, McBryde & Co.,
P.C.
23.3 -- Consent of De Las Fuentes, De La Mora
y Valdivia, S.C.
24.1 -- Power of Attorney (on signature page)
*99.1 -- Form of Letter of Transmittal
*99.2 -- Form of Notice of Guaranteed Delivery
*99.3 -- Form of Letter to Brokers, Dealers,
Commercial Banks, Trust Companies and
Other Nominees
*99.4 -- Form of Letter to Clients
*99.5 -- Guides for Certification of Taxpayer
Identification Number on Form W-9
- ------------
* To be filed by Amendment
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBIC ACCOUNTANTS
Telscape International, Inc.
Houston, Texas
We hereby consent to the use in the Prospectus constituting a part of this
Registration Statement of our report dated March 9, 1998, relating to the
consolidated financial statements of Telscape International, Inc. and
subsidiaries (formerly Polish Telephones and Microwave Corporation), which is
contained in that Prospectus, and of our report dated March 6, 1998, relating to
the financial statements of MSN Communications, Inc., which is contained in that
Prospectus.
We also consent to the reference to us under the caption "Experts" in the
Prospectus.
/s/ BDO SEIDMAN, LLP
Houston, Texas
July 30, 1998
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
Telscape International, Inc.
Houston, Texas
We hereby consent to the use in the Prospectus constituting a part of this
Registration Statement of our report dated March 27, 1996, relating to the
consolidated financial statements of Telscape International, Inc. and
subsidiaries (formerly Polish Telephone and Microwave Corporation) for the year
ended December 31, 1995, which is contained in that Prospectus.
We also consent to the reference to us under the caption "Experts" in the
Prospectus.
/s/ HOFFMAN, MCBRYDE & CO., P.C.
Dallas, Texas
July 30, 1998
EXHIBIT 23.3
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Telscape International, Inc.
Houston, Texas
We hereby consent to the use in the Prospectus constituting a part of this
Registration Statement of our report dated September 6, 1997, relating to the
financial statements of Integracion de Redes, S.A. de C.V. as of December 31,
1996 and for the year then ended, which is contained in the Prospectus.
We also consent to the reference to us under the caption "Experts" in the
Prospectus.
/s/ DE LAS FUENTES, DE LA MORA Y VALDIVIA, S.C.
Mexico City
July 30, 1998
EXHIBIT 24.1
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints E. Scott Crist and Todd M. Binet, and
each of them severally, as his true and lawful attorneys-in-fact and agents,
with full power of substitution and resubstitution, for him and in his name,
place, and stead, in any and all capacities, to sign any and all amendments
(including post-effective amendments) to this Registration Statement, and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in connection
therewith, as fully to all intents and purposes as he or she might or could do
in person, hereby ratifying and confirming all that said attorneys-in-fact and
agents or any of them, or of his or her substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
<TABLE>
<CAPTION>
<S> <C> <C>
/s/E. SCOTT CRIST Chief Executive Officer (Principal July 28, 1998
E. SCOTT CRIST Executive Officer and Director)
Director July 28, 1998
MANUEL LANDA
/s/OSCAR GARCIA Director July 28, 1998
OSCAR GARCIA
/s/RICARDO OREA Director July 28, 1998
RICARDO OREA
/s/DARREL O. KIRKLAND Director July 28, 1998
DARREL O. KIRKLAND
Director July 28, 1998
ENRIQUE ORIHUELA
/s/TODD M. BINET Chief Financial Officer, Secretary, July 28, 1998
TODD M. BINET Treasurer and Director (Principal
Financial and Accounting Officer)
</TABLE>
