AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 27, 1998
REGISTRATION NO. 333-
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
(EXACT NAME OF ISSUER AS SPECIFIED IN ITS CHARTER)
COLORADO
(STATE OF INCORPORATION)
4813 84-1238018
(PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER IDENTIFICATION
CLASSIFICATION CODE NUMBER) NO.)
8 S. NEVADA AVENUE, SUITE 200 ROBERT A. SPADE, CHAIRMAN OF THE
COLORADO SPRINGS, COLORADO 80903 BOARD
(719) 471-3332 AND CHIEF EXECUTIVE OFFICER
(ADDRESS AND TELEPHONE NUMBER OF 8 S. NEVADA AVENUE, SUITE 200
PRINCIPAL EXECUTIVE OFFICE) COLORADO SPRINGS, COLORADO 80903
(719) 471-3332
(NAME, ADDRESS AND TELEPHONE
NUMBER OF AGENT FOR SERVICE)
Copies to:
DOUGLAS R. WRIGHT, ESQ. ROBERT W. WALTER, ESQ.
PARCEL, MAURO & SPAANSTRA, P.C. BERLINER ZISSER WALTER & GALLEGOS,
1801 CALIFORNIA STREET, SUITE 3600 P.C.
DENVER, COLORADO 80202 1700 LINCOLN, SUITE 4700
(303) 292-6400 DENVER, COLORADO 80203
(303) 830-1700
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: As soon as
practicable after the Registration Statement becomes effective.
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,
check the following box. [X]
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(c)
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 this form is a post-effective amendment filed pursuant to Rule 462(d)
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
===============================================================================
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED PER SECURITY OFFERING PRICE REGISTRATION FEE (1)
- ------------------------------------------------------------------------------------------------
Common Stock (2)....... 1,265,000 $11.00 $13,915,000 $4,104.92
- ------------------------------------------------------------------------------------------------
Common Stock (3)....... 263,600 $11.00 $ 2,899,600 $ 855.38
- ------------------------------------------------------------------------------------------------
Representative's
Warrants (4).......... 110,000 $ -- $ -- $ -- (5)
- ------------------------------------------------------------------------------------------------
Common Stock Underlying
Representative's
Warrants (6).......... 110,000 $13.75 $ 1,512,500 $ 446.18
- ------------------------------------------------------------------------------------------------
TOTAL.................. $18,327,100 $5,406.49
================================================================================================
(1) Calculated pursuant to Rule 457 of the rules and regulations promulgated
under the Securities Act of 1933, as amended.
(2) These shares will be offered to the public in the registrant's public
offering (including 165,000 shares that the representative of the
underwriters (the "Representative") has the option to purchase from the
registrant to cover over-allotments, if any).
(3) These shares consist of the Selling Securityholders' Shares which will be
offered to the public by the Selling Securityholders. The number of such
shares is estimated solely for the purpose of calculating the Registration
Fee.
(4) The registrant will issue to the Representative at the closing of this
offering warrants to purchase 110,000 shares of Common Stock (the
"Representative's Warrants").
(5) No fee pursuant to Rule 457(g).
(6) These shares of Common Stock are issuable upon exercise of the
Representative's Warrants. An indeterminate number of additional shares of
Common Stock are registered hereunder which may be issued as provided in
the Representative's Warrants in the event that the provisions against
dilution in the Representative's Warrants become operative.
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 THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
===============================================================================
EXPLANATORY NOTES
All historical share and per share information has been removed from this
registration statement (the "Registration Statement") pending a proposed
reverse stock split that the Company intends to effectuate in order to comply
with the listing requirements of The Nasdaq Stock Market, Inc. Upon the
determination of the reverse stock split ratio, this Registration Statement
will be amended to include all such share and per share information.
This Registration Statement contains two prospectuses: one related to the
offering of 1,100,000 shares of Common Stock (the "Common Stock") by
Communications Systems International Inc. (the "Company") (the "Prospectus");
and one relating to the offering of shares of Common Stock by certain selling
Securityholders (the "Selling Securityholders' Prospectus"). The exact number
of Selling Securityholders' Shares to be registered cannot be determined until
the Company effects its proposed reverse stock split. Following the Prospectus
are certain substitute pages of the Selling Securityholders' Prospectus,
including alternate front outside and back outside cover pages, an alternate
"The Offering" section of the "Prospectus Summary" and sections entitled
"Concurrent Offering" and "Plan of Distribution." Each of the alternate pages
for the Selling Shareholder Prospectus included herein is labeled "Alternate
Page for Selling Securityholders' Prospectus" or "Additional Page for Selling
Securityholders' Prospectus." All other sections of the Prospectus, other than
"Underwriting" and "Concurrent Offering," are to be used in the Selling
Securityholders' Prospectus. In addition, cross-references in the Prospectus
will be modified in the Selling Securityholders' Prospectus to refer to the
appropriate sections.
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+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 A 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 SALES OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE LAWS OF ANY SUCH +
+STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED FEBRUARY 27, 1998
PRELIMINARY PROSPECTUS
1,100,000 SHARES
[LOGO OF COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.]
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
COMMON STOCK
Communications Systems International, Inc. is offering 1,100,000 shares (the
"Shares") of common stock of the Company ("Common Stock") hereby. The Common
Stock is traded sporadically in limited amounts on the OTC Bulletin Board under
the symbol CSYG. On February 25, 1998, the closing high bid price of the Common
Stock was $ per share. It is currently estimated that the offering price of
the Common Stock will be between $9.00 and $11.00 per share after giving effect
to a proposed 1 for reverse stock split to be effective prior to the date
of this Prospectus. The Company has applied to have the Common Stock quoted on
The Nasdaq SmallCap Market under the symbol [CSIL]. See "Price Range of Common
Stock."
Concurrently with the Offering, shares of Common Stock are being
registered for offer and sale by certain Securityholders (collectively, the
"Selling Securityholders") of the Company. Such shares consist of a maximum of
113,600 shares of Common Stock that were issued in a private placement
completed in December 1997 and shares issuable upon the exercise of certain
warrants (collectively, the "Selling Securityholders' Shares"). The Selling
Securityholders' Shares are not part of the underwritten offering. Other than
receipt of the exercise price of those certain warrants, the Company will not
receive any proceeds from the sale of the Selling Securityholders' Shares. In
addition, the Selling Securityholders have agreed not to sell or transfer the
Selling Securityholders' Shares for a period of 180 days following the date of
this Prospectus. See "Selling Securityholders and Plan of Distribution."
-----------
THE SECURITIES OFFERED HEREBY ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK
AND IMMEDIATE SUBSTANTIAL DILUTION AND SHOULD NOT BE PURCHASED BY INVESTORS WHO
CANNOT AFFORD THE LOSS OF THEIR ENTIRE INVESTMENT. SEE "RISK FACTORS" BEGINNING
ON PAGE 6.
-----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE COMMISSION OR
ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
- -------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNTS (1) COMPANY (2)
- --------------------------------------------------------------------------------
Per Share................................... $ $ $
- --------------------------------------------------------------------------------
Total(3).................................... $ $ $
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1) The Company has agreed to pay the Representative of the Underwriters (the
"Representative") a non-accountable expense allowance equal to 3% of the
offering proceeds and to issue to it the Representative's Warrants (as
defined herein). The Company has also agreed to indemnify the Underwriters
against certain liabilities, including liabilities under the Securities Act
of 1933, as amended. See "Underwriting."
(2) Before deducting estimated offering expenses of $680,000, which includes
the non-accountable expense allowance, exclusive of the Selling
Securityholders' expenses.
(3) The Company has granted to the Representative an option, exercisable within
45 days after the date of this Prospectus, to purchase up to an additional
165,000 shares of Common Stock on the same terms as set forth above solely
to cover over-allotments, if any. If the option is exercised in full the
total Price to Public, Underwriting Discounts and Proceeds to Company will
be $ , $ , and $ , respectively. See "Underwriting."
The Shares are being offered severally by the Underwriters, subject to prior
sale, when, as and if delivered to and accepted by the Underwriters, and
subject to their right to reject orders in whole or in part and certain other
conditions. It is expected that delivery of certificates representing the
Shares will be made on or about , 1998.
COHIG & ASSOCIATES, INC.
THE DATE OF THIS PROSPECTUS IS , 1998
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMONSTOCK OF
THE COMPANY. SUCH TRANSACTIONS MAY INCLUDE STABILIZING BIDS, THE IMPOSITION OF
PENALTY BIDS, THE PURCHASE OF SECURITIES TO COVER SYNDICATE SHORT POSITIONS
AND OVER-ALLOTMENTS IN CONNECTION WITH THE OFFERING. FOR A DISCUSSION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
The Company intends to furnish its security holders with annual reports
containing audited financial statements and quarterly reports for the first
three quarters of each fiscal year containing unaudited interim financial
information.
On the effective date of the Registration Statement of which this Prospectus
forms a part, the Company will become a "reporting company" under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Company
intends to register the Common Stock under the Exchange Act as of the
effective date of the Registration Statement. The Company is a "small business
issuer" as defined under Regulation S-B adopted under the Securities Act of
1933, as amended (the "Securities Act"), and will file reports with the
Securities and Exchange Commission (the "Commission") pursuant to the Exchange
Act on forms applicable to small business issuers.
The Company claims proprietary rights in its logo and the terms "LINK-US"
and "DIAL." This Prospectus also includes trademarks of other companies.
SUMMARY
This Prospectus contains forward-looking statements that involve risks and
uncertainties. Actual results could differ materially from those discussed
herein. Factors that could cause or contribute to such differences include, but
are not limited to, those discussed in "Risk Factors" and elsewhere in this
Prospectus. Certain information contained herein is derived from industry
sources. Although the Company believes that this information is reliable, it
has not independently verified this information. The following summary is
qualified in its entirety by the more detailed information and Financial
Statements, including notes thereto, appearing elsewhere in this Prospectus.
Per share and other financial information assumes a proposed 1 for reverse
stock split that will be completed prior to the date of this Prospectus. CSI
has an agreement in principle to acquire all of the outstanding stock of
International Telephone Company. The consummation of this acquisition (the "ITC
Acquisition") is conditioned upon, and will occur simultaneously with, the
completion of this Offering. Unless the context otherwise requires, (i)
references to the "Combined Company" refer to Communications Systems
International, Inc. and International Telephone Company, assuming the ITC
Acquisition is consummated, (ii) references to the "Company" or "CSI" refer to
Communications Systems International, Inc. and (iii) references to "ITC" refer
to International Telephone Company. References to the present action of the
Combined Company refer to activities or matters that are common to each of CSI
and ITC as of the date of this Prospectus. Statements regarding prospective
activities or matters relating to the Combined Company refer to activities that
may be undertaken or matters that may result following the ITC Acquisition.
Unless otherwise indicated, information contained in this Prospectus does not
give effect to exercise of the Representative's over-allotment option.
THE COMPANY
Communications Systems International, Inc. is a growing provider of
international long distance telecommunications services principally to
customers in South America, Europe, the Pacific Rim, South Africa and Central
America. CSI emphasizes innovative software solutions and technical expertise
to provide higher quality, lower cost alternative routing of telecommunications
for its customer base. CSI is focusing its marketing efforts on high volume
customers such as hotels, large local businesses and foreign branches of
multinational businesses in addition to individuals and small businesses.
International Telephone Company is a provider of international long distance
telecommunications service principally to customers in Africa, Europe and the
Middle East. Existing customers of the Combined Company include the Inter-
Continental Hotel in Rio de Janiero, Brazil and foreign offices of Nike Inc.,
Microsoft Corporation, Mitsubishi Corporation, Chrysler International, Warner
Lambert Corporation, Diners Club International, DHL Aviation, Holiday Inn
Hotels, Best Western Hotel, Wal-Mart Stores, Inc., Citibank, N.A., Bank of
Tokyo, Royal Bank of Canada and the United States embassies in Chile, Korea,
Australia and the Ukraine, the United Nations consulate in South Africa and
other countries' embassies and international agencies.
As a switch-based reseller of international long distance services, the
Combined Company purchases access to multiple telecommunications networks from
companies such as AT&T Corporation ("AT&T"), Sprint Communications L.P.
("Sprint"), and Cable & Wireless plc ("Cable & Wireless"). Through its least
cost routing capabilities, the Combined Company routes calls via
telecommunications networks that offer the Combined Company the lowest cost
available among its carriers ("least cost routing"). The Combined Company
resells network time by providing customized telecommunications services to its
international business and residential customers that may not typically be
available from incumbent telecommunications operators ("ITOs"). Decisions as to
how such services are technically delivered to its international customers are
based on several factors, including the local regulatory environment, market
conditions, telecommunications traffic volume and strategic economic
considerations.
1
The current means by which the Combined Company provides long distance
service is reverse origination, or "call-reorigination," in which a customer
seeking to make an international call is connected to the United States
telephone system by a computer signal at its telecommunications center, located
in Florida at the U.S. telecommunications gateway to Latin America. The
computer triggers a call to be originated in the United States and routed back
to the caller. The caller is then connected to the international destination by
a second call also originating in the United States. The lines are joined and
the call is completed using two high quality, low cost outgoing calls from the
United States. The result is an effortless, high quality, rapid connection
typically at a cost savings for the customer compared to ITO-provided service.
Through utilization of proprietary software technologies, dedicated lines,
automated call triggering circuits and the Internet, CSI is increasingly making
its service seamless (or "transparent") to the customer. When customers use the
Combined Company's transparent call-reorigination service, callers may not even
be aware they are using call-reorigination because transparent call-
reorigination requires no additional actions by the caller other than the
normal dialing process. CSI has installed its proprietary call-reorigination
systems, DIAL and LINK-US, and other call-reorigination technologies in several
major hotel properties in Brazil and South Africa and has received indications
of interest regarding commencement of call-reorigination service from several
additional hotels in Brazil, Argentina, South Africa and Hong Kong. Management
of the Company believes call-reorigination will remain a viable technical,
economic telecommunications solution in many countries for years to come.
As regulatory and competitive environments evolve around the world, the
Combined Company intends to employ other telecommunications bypass solutions
including "call through" international long-distance services to serve its
customers and expand its customer base in specific target countries which have
deregulated telecommunications industries. Unlike call-reorigination,
"callthrough" service does not re-originate a call from another country.
Instead, the call bypasses the ITO, is sent through an alternate switch and is
then routed to the desired destination by means of least cost routing.
Of the Combined Company's telecommunications revenue for the ten months ended
October 31, 1997, approximately 42.5% was generated from customers located in
South America (primarily in Argentina), 20.5% from Europe, 18.7% from Africa,
11.2% from Asia, and 7.1% from Central America and other areas. Nearly all of
this revenue was generated from call-reorigination services which are
anticipated to continue to provide the majority of revenue in the near term.
Both CSI and ITC have achieved significant growth since their respective
inceptions in 1993. CSI's revenue increased from $1.8 million in the fiscal
year ended April 30, 1995 to $6.7 million in the fiscal year ended April 30,
1996 and $11.9 million in the fiscal year April 30, 1997. The number of CSI's
customers increased from approximately 8,400 at January 31, 1997 to
approximately 10,200 at January 31, 1998. The Combined Company defines
customers as those persons or businesses who have used the Combined Company's
services within the previous four months. ITC's revenue increased from $1.4
million in the fiscal year ended December 31, 1994 to $7.6 million in the
fiscal year ended December 31, 1996. The number of ITC's customers was
approximately 8,800 at January 31, 1998. As of December 31, 1997, the Combined
Company had a network of approximately 95 local sales agents who have engaged
over 400 sub-agents to market the Combined Company's services. Based in the
Combined Company's telecommunications center, the Combined Company's
multilingual sales and customer service departments assist the agents, sub-
agents and customers. A portion of the proceeds from this Offering will enable
the Combined Company to recruit additional sales agents and sub-agents to
support its growth strategy.
The global market for international telecommunications services is undergoing
significant deregulation and reform. The industry is being shaped by: (i)
deregulation and privatization of telecommunications markets worldwide; (ii)
diversification of services through technological innovation; and (iii)
globalization of major carriers through market expansion, consolidation and
strategic alliances. As a result of these factors, it is anticipated that the
industry will experience considerable growth in the foreseeable future, both in
terms of traffic volume and revenue. According to the International
Telecommunications Union ("ITU"), the international
2
telecommunications industry accounted for $53 billion in revenue and over 60
billion minutes of use in 1995, increasing from $21.7 billion in revenue and
16.7 billion minutes of use in 1986, which represents compound annual growth
rates of 10% and 15%, respectively. The ITU projects that international
telecommunications revenue will approach $76.0 billion by the year 2000 with
the volume of traffic expanding to 107.0 billion minutes of use, representing
compound annual growth rates of 7% and 12%, respectively, from 1995. Based on
information available to the Company from the ITU and telecommunications
industry publications, the call-reorigination, and call through segments of the
telecommunications industry accounted for approximately $1.4 billion in revenue
in 1997 and is growing at a rate of approximately 15% per year.
CSI believes that its emphasis on innovative software solutions to
telecommunications services strategically positions the Combined Company to
take advantage of the multiple changes occurring in the telecommunications
industry as a result of global deregulation and rapid technological change. Key
elements of CSI's business strategy include: (1) integrating the ITC business
and capitalizing on the resulting economies of scale; (2) increasing sales to
larger customers through deployment of its proprietary transparent technology;
(3) offering additional products, such as Internet, facsimile and hotel
operator services; (4) applying resources to increase its sales agent base and
sales and marketing activities; (5) utilizing technology to reduce costs; (6)
pursuing and implementing strategic acquisitions; and (7) broadening and
improving relationships with U.S. and international telecommunications
providers.
CSI is a Colorado corporation formed in April 1993. The Combined Company's
executive offices are located at 8 South Nevada, Colorado Springs, Colorado
80903, and its telephone number is (719) 471-3332. The Combined Company's
Internet address is http://www.csil.com.
RECENT DEVELOPMENTS
ITC ACQUISITION
CSI has a agreement in principle to acquire all of the outstanding capital
stock of ITC for $3.1 million in cash and 207,000 shares of Common Stock based
on an assumed initial offering price of $10.00 per Share, to be issued one year
from the closing of this Offering. A portion of the cash will be held in escrow
for one year and the Common Stock will be subject to set-off to secure certain
indemnification obligations of the stockholders of ITC. ITC is currently owned
by Lynch Family, LLC, Philip Thomas and Sean Thomas. Upon completion of the ITC
Acquisition, Philip Thomas and Sean Thomas will become employees of the
Combined Company. The ITC Acquisition is conditioned on, among other things,
the consummation of this Offering. See "ITC Acquisition" and ITC's Financial
Statements and the Notes related thereto included elsewhere is this Prospectus.
DECEMBER 1997 FINANCING
In December 1997, CSI completed a private placement (the "December 1997
Financing") of an aggregate of $2.84 million principal amount Mandatorily
Redeemable Convertible Promissory Notes (the "Bridge Notes"). Based on an
assumed offering price of $10.00 per Share, the holders of the Bridge Notes
will receive 4,000 shares of Common Stock (the "Bridge Shares") for each
$100,000 principal amount of Bridge Notes held by such noteholder. The
Representative acted as placement agent in connection with the December 1997
Financing. The Combined Company intends to use a portion of the net proceeds of
this Offering to repay the entire principal amount and accrued interest on the
Bridge Notes. The net proceeds from the December 1997 Financing were used to
repay notes payable of $850,000 and accounts payable of $1.1 million and for
payments representing a deposit to a carrier of $150,000 and a standstill
payment to ITC of $100,000. The repayment of the notes payable will result in a
gain on early extinguishment of debt totaling $747,000, net of related
expenses, in December 1997. See "Use of Proceeds."
3
THE OFFERING
Securities offered................ 1,100,000 shares
Common Stock outstanding before shares (1)
the Offering.....................
Common Stock outstanding after the shares (1)
Offering.........................
Use of proceeds................... To repay the Bridge Notes; to consummate
the ITC Acquisition; to further develop and
expand the Combined Company's sales and
marketing capabilities; to install
equipment to facilitate transparent call-
reorigination services for additional
hotels and large multinational businesses;
to locate regional switches or other
telecommunications equipment in Europe,
Africa and Asia to facilitate least cost
routing; for research and development and
system capacity expansion associated with
the Combined Company's enhanced services,
including facsimile and debit card services
and compression technology that is intended
to improve service and reduce operating
costs; and for working capital to fund
operating expenses. See "Use of Proceeds"
and "Business."
Proposed Nasdaq SmallCap Market
Symbol for the Common Stock...... [CSIL]
- --------
(1) Includes 113,600 Bridge Shares to be issued immediately prior to the
closing of this Offering based on an assumed offering price of $10.00 per
Share. Does not include (i) up to shares of Common Stock issuable upon
exercise of outstanding options, which have weighted average exercise
prices of $ per share, (ii) up to shares of Common Stock issuable
upon the exercise of outstanding warrants, which have weighted average
exercise prices of $ per share, (iii) an indeterminate number of shares
of Common Stock issuable upon conversion of outstanding promissory notes in
the aggregate principal amount of $30,000 which have a conversion price per
share equal to 90% of the average bid and ask price of the Common Stock on
the day before conversion, (iv) up to 110,000 shares of Common Stock
issuable upon exercise of the Representative's Warrants and (v) any shares
issuable in connection with the ITC Acquisition (collectively referred to
herein as "Additional Securities"). See "Management," "Description of
Securities" and "Underwriting."
4
SUMMARY FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
The summary financial information set forth below is derived from the audited
financial statements of CSI and ITC, the unaudited financial statements of CSI
and ITC, and the unaudited pro forma condensed combined financial statements of
CSI and ITC. Such information should be read in conjunction with such financial
statements and the notes thereto and the reports of the Independent Public
Accountants.
CSI ACTUAL ITC ACTUAL PRO FORMA COMBINED(1)
----------------------------- ------------------------------ ---------------------------
YEAR ENDED SIX MONTHS
APRIL 30, ENDED YEAR ENDED TEN MONTHS YEAR ENDED SIX MONTHS ENDED
---------------- OCTOBER 31, DECEMBER 31, ENDED OCTOBER 31, APRIL 30, OCTOBER 31,
1996 1997 1997 1996 1997 1997 1997
------- ------- ----------- ------------ ----------------- ---------- ----------------
STATEMENT OF OPERATIONS DATA:
Revenue........................ $ 6,741 $11,865 $6,372 $7,603 $8,054 $19,732 $11,426
Cost of revenue................ 5,963 7,755 3,807 5,070 6,790 13,253 8,357
------- ------- ------ ------ ------ ------- -------
Gross margin................... 778 4,110 2,565 2,533 1,264 6,479 3,069
Operating expenses:
Sales and marketing.......... 1,573 2,080 1,271 1,099 715 2,928 1,703
General and administrative... 1,258 1,302 1,326 1,446 1,388 2,929 2,183
Technical and developmental.. 394 722 389 -- -- 722 389
Depreciation................. 58 103 68 69 73 179 113
Amortization of intangibles.. -- -- -- -- -- 937 468
------- ------- ------ ------ ------ ------- -------
Total operating expenses....... 3,283 4,207 3,054 2,614 2,176 7,695 4,856
------- ------- ------ ------ ------ ------- -------
Income (loss) from operations.. (2,505) (97) (489) (81) (912) (1,216) (1,787)
Other income (expense)--net.... (19) (162) (88) 88 62 (62) (109)
------- ------- ------ ------ ------ ------- -------
Net income (loss).............. (2,524) (259) (577) 7 (850) (1,278) (1,896)
======= ======= ====== ====== ====== ======= =======
Net income (loss) per
share(2)......................
Weighted average number of
shares outstanding............
CSI ACTUAL ITC ACTUAL PRO FORMA
--------------------- ----------- COMBINED
APRIL 30, OCTOBER 31, OCTOBER 31, OCTOBER 31,
1997 1997 1997 1997(1)(3)
--------- ----------- ----------- -----------
BALANCE SHEET DATA:
Current assets.................. $ 1,284 $ 1,499 $ 1,950 $ 8,369
Long-term assets................ 662 779 770 1,452
Intangible assets............... -- -- -- 4,683
Total assets.................... 1,946 2,278 2,720 14,505
Current liabilities............. 3,615 3,532 3,209 5,543
Long-term liabilities........... -- 850 292 292
Total liabilities............... 3,615 4,382 3,501 5,835
Working capital (deficit)....... (2,331) (2,033) (1,259) 2,826
Shareholders' equity
(deficiency)................... (1,669) (2,104) (781) 8,670
- --------
(1) Refer to the Pro Forma Condensed Combined Financial Statements contained
herein.
(2) Based on the weighted average number of shares outstanding.
(3) Gives effect to the December 1997 Financing, the ITC Acquisition and the
sale of the Shares offered hereby at the assumed offering price of $10.00
per Share and the application of the estimated net proceeds therefrom. See
"Use of Proceeds."
5
RISK FACTORS
Investment in the Securities involves substantial risks, some of which are
summarized below. Prospective investors should carefully consider the
following risk factors, among others, relating to the Combined Company and
this Offering prior to making an investment. The discussions and information
in this Prospectus contain both historical and forward-looking statements.
Forward-looking statements are those identified with words such as "believes,"
"expects," "anticipates" and similar terms. To the extent that this Prospectus
contains forward-looking statements regarding the financial condition,
operating results, business prospects or any other operations of the Combined
Company, please be advised that the Combined Company's actual financial
condition, operating results and business prospects may differ materially from
that projected or estimated by the Combined Company in forward-looking
statements. Actual results will differ from the Combined Company's current
expectations. The differences may be caused by a variety of factors, including
but not limited to adverse economic conditions, intense competition, including
entry of new competitors, loss of agents and their customer bases, the
introduction of more competitive pricing structures by long distance carriers,
adverse government regulation, both foreign and domestic, inadequate capital,
unexpected costs, the imposition of new, or the increase of existing, tariffs,
lower revenue and net income than anticipated, failure to obtain new
customers, higher than anticipated costs, difficulties of consummating and
integrating the ITC Acquisition and the acquisitions of other businesses that
do not perform as anticipated, the potential fluctuation and volatility of the
Combined Company's operating results and financial condition, inability to
carry out marketing and sales plans, loss of key executives, changes in
interest rates or international exchange rates, inflationary factors, and
other specific risks that may be alluded to in this Prospectus or in other
reports issued by the Combined Company.
Risks Related to the Combined Company and the Telecommunications Industry
LIMITED RELEVANT OPERATING HISTORY; SIGNIFICANT AND CONTINUING LOSSES
Both CSI and ITC began operations in 1993. Accordingly, CSI and ITC have
limited operating histories upon which an evaluation of their combined
prospects and future performance can be made. Such prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered in the operation and expansion of a business in the highly
competitive telecommunications industry, which is characterized by an
increasing number of market entrants. The Combined Company has no combined
operating history. Therefore, there is no assurance the Combined Company will
operate profitably or be successful in capitalizing on perceived synergies.
CSI has incurred significant losses, including losses of approximately $2.5
million and $259,000 during the years ended April 30, 1996 and 1997,
respectively, and a loss of approximately $577,000, during the six months
ended October 31, 1997, resulting in an accumulated deficit of approximately
$4.6 million at October 31, 1997. In addition, ITC incurred a loss of
approximately $850,000 during the ten months ended October 31, 1997. Losses
may continue until such time, if ever, that the Combined Company is able to
generate a level of revenue sufficient to offset its cost structure. There can
be no assurance that the Combined Company will achieve significant increased
revenue or profitable operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Financial Statements.
SIGNIFICANT CAPITAL REQUIREMENTS; NEED FOR ADDITIONAL FINANCING
The capital requirements of CSI and ITC have been and will continue to be
significant and their cash requirements have been exceeding cash flow from
operations. At October 31, 1997, CSI and ITC had working capital deficits of
approximately $2.0 million and $1.3 million respectively. The Combined Company
has been substantially dependent upon sales of its equity and debt securities
and financing from trade creditors. Based on the Combined Company's current
proposed plans, the Combined Company anticipates that the net proceeds of this
Offering will be sufficient to satisfy its contemplated cash requirements for
at least 12 months following the consummation of this Offering. If the
Combined Company's plans change or its assumptions prove inaccurate (due to
unanticipated expenses, delays or difficulties or otherwise), or the proceeds
of this Offering otherwise prove insufficient to fund operations and implement
the Combined Company's proposed expansion strategy, the Combined Company could
be required to seek additional financing sooner than currently anticipated.
The
6
Combined Company has no current arrangements with respect to, or potential
sources of, additional financing and it is not anticipated that any current
shareholders will provide any additional guarantees for Combined Company
obligations. Consequently, there can be no assurance that any additional
financing will be available to the Combined Company when needed, on
commercially reasonable terms, or at all. The inability to obtain additional
financing when needed would have a material adverse effect on the Combined
Company, requiring it to curtail its expansion efforts. In addition, any
additional equity financing may involve substantial dilution to the interests
of the Combined Company's then existing shareholders. See "Use of Proceeds,"
"Dilution," "Capitalization" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
DEPENDENCE ON KEY SALES AGENTS
CSI currently depends on approximately 40 independent sales agents to sell
its services, including Edward Stoever, who operates in Argentina, and CS do
Brazil. These two sales agents accounted for approximately 54.3%, and 11.5%,
respectively, of CSI's revenue in the six months ended October 31, 1997, and
the ten largest sales agents accounted for approximately 91.3% of CSI's
revenue in the six months ended October 31, 1997. ITC currently depends on
approximately 55 independent sales agents to sell its services, including
Generic Telecom, Inc., Zohair Attoue and Janel Richards. These three sales
agents accounted for approximately 26.6%, 21.4% and 12.7%, respectively, of
ITC's revenue in the ten months ended October 31, 1997, and the ten largest
sales agents accounted for approximately 89.1% of ITC's revenue in the ten
months ended October 31, 1997.
If the Combined Company fails to retain the services of Mr. Stoever, CS do
Brazil, Generic Telecom, Inc., Mr. Attoue or Ms. Richards for any reason or
loses the services of other sales agents that contribute significantly to the
Combined Company's revenue, the Combined Company's cash flow and results of
operations would be adversely affected because of expected high customer
attrition due to the loss of sales agents. The Combined Company also depends
on these sales agents and persons engaged by them to install and service much
of the Combined Company's call-reorigination technology. The failure of such
persons to properly install or service the Combined Company's systems could
adversely affect the Combined Company. Although sales agents are subject to
distributor agreements, the agreements may be difficult to enforce because the
sales agents are domiciled in foreign countries. Under the terms of the sales
agent agreements, the sales agents are responsible for collecting customer
payments except for credit card payments, and sales agents generally are
responsible for customer bad debts less, in some cases, an allowance granted
by the Combined Company. Failure of sales agents to collect and remit customer
payments to the Combined Company presents a risk to the Combined Company.
CSI's former Singapore distributor recently failed to remit payments of
$215,000. CSI is aggressively pursuing collection of this debt. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--General" and "Business--Sales and Marketing."
NEED TO INTEGRATE AND MANAGE ITC; SELECTION AND INTEGRATION OF UNSPECIFIED
ACQUISITIONS
Management believes that the consummation of the ITC Acquisition will
substantially increase the Combined Company's sales agent base, technological
capabilities, management expertise and carrier relationships. The Combined
Company's ability to realize any long-term advantages from the ITC Acquisition
will depend in large part on successfully integrating, managing and improving
the operations of ITC. The Combined Company's management team has no
experience in integrating acquired companies. Risks relating to such
integration include the risk of loss of services of ITC's executive officers,
including Philip Thomas and Sean Thomas, the loss of key sales agents of CSI
or ITC or adverse changes in relationships with carriers or other strategic
relationships. There can be no assurance that the Combined Company will be
able to successfully integrate ITC. Failure to successfully integrate ITC
would have a material adverse effect on the business of the Combined Company.
A key element to the Combined Company's strategy is expansion through the
additional acquisition of products, technologies, businesses or customer
bases. Except for the agreement with respect to the ITC Acquisition, the
Combined Company has no commitment for any such acquisition as of the date of
this
7
Prospectus, and there can be no assurance that the Combined Company will be
successful in identifying appropriate acquisition opportunities or negotiating
favorable terms. In most cases, the Combined Company will not be required to
obtain shareholder approval in order to complete its acquisitions. Any future
acquisitions or related activity such as strategic alliances or licensing
arrangements will be accompanied by the risks commonly encountered in such
transactions. Such risks include, among others, the difficulty of identifying
appropriate acquisition candidates, the difficulty of assimilating the
operations and personnel of the respective entities, the potential disruption
of the Combined Company's ongoing business, the inability of management to
capitalize on the opportunities presented by the acquisitions or related
efforts, the failure to successfully incorporate licensed or acquired
technology and rights into the Combined Company's services, the inability to
maintain uniform standards, controls, procedures and policies, the impairment
of relationships with employees and customers as a result of changes in
management and an increase of amortization of intangibles, such as goodwill,
in the Combined Company's financial statements. In addition, to the extent the
Company uses cash to complete acquisitions, it may deplete its tangible
assets. If the Company's tangible assets falls below $2 million, the Common
Stock may be delisted from the Nasdaq. There can be no assurance that the
Combined Company will be able to finance any future acquisitions.
The successful integration of any such acquisition is critical to future
financial performance of the Combined Company. Complete integration of any
acquisitions could take several fiscal quarters to accomplish and would
require, among other things, coordination of the respective companies' sales
and marketing, and technical development efforts. There can be no assurance
that present and potential customers of the Combined Company and any acquired
entity would continue their historic usage patterns without regard to the
acquisition, and any significant delay or reduction in usage could have an
adverse effect on the Combined Company's business, financial condition and
results of operations. The process of integrating companies may cause
management's attention to be diverted from operating the Combined Company, and
any difficulties encountered in the transition process could have an adverse
impact on the business, financial condition and results of operations of the
Combined Company. In addition, the process of combining two organizations
could cause the interruption of, or loss of momentum in, the activities of
either or both companies' businesses, which could have an adverse impact on
their combined operations.
The difficulty of combining companies may be increased by the need to
integrate the personnel and the geographic distances between companies.
Changes brought about by any acquisition may cause key employees, sales
agents, or carriers to terminate their relationships with the Combined
Company. There can be no assurance that the Combined Company will retain the
employees, sales agents, and carrier relationships of an acquired entity or
that the Combined Company will realize any of the other anticipated benefits
of any acquisition. There can be no assurance that costs of combining
potential acquisitions will not have an adverse effect upon the Combined
Company's operating results, particularly in the fiscal quarters immediately
following the consummation of any acquisition, while the operations of the
acquired business are being integrated into the Combined Company's operations.
There can be no assurance that, following any acquisition, the Combined
Company will be able to operate any acquired business on a profitable basis.
RELATIONSHIP WITH LONG DISTANCE CARRIERS
The Combined Company's ability to achieve and maintain profitable operations
is heavily dependent upon the agreements the Combined Company has with certain
international long distance telephone carriers based in the United States. The
Combined Company uses the long distance telephone systems of these carriers to
provide its long distance telephone service to customers located outside the
United States. The Combined Company, among other things, must negotiate
favorable rates with these long distance carriers. Because of the frequent
fluctuations in rates of long distance carriers, the Combined Company believes
that it is in its best interest to have short-term agreements with long
distance carriers. Most of the Combined Company's agreements with its long
distance telephone carriers will expire, or may be terminated by either party,
within one year, and there can be no assurance that these agreements will be
renewed or that the Combined Company will be able to obtain favorable rates
from these long distance carriers. The Combined Company's dependence on
particular carriers will vary because the Combined Company shifts its use of
carriers depending on the rates that are offered. The
8
Combined Company is continually attempting to renegotiate rates with its
current carriers and to establish relationships with new long distance
carriers that provide the most favorable rates. The Combined Company's ability
to obtain favorable rates from the carriers depends, in large part, on the
Combined Company's total volume of long distance traffic. There is no
guarantee that the Combined Company will be able to maintain the volume of
international long distance traffic necessary to obtain favorable rates. Due
to its financial condition, CSI defaulted on payment obligations to certain
carriers in 1995, 1996 and 1997. Although CSI was able to negotiate deferred
payment arrangements with these carriers (and thereafter made such deferred
payments) and was able to continue purchasing minutes from certain of these
carriers, there is no assurance that it will be able to make such arrangements
with these or other carriers if required in the future. In addition, in
November 1997, WorldCom, Inc. ("WorldCom") commenced an action against ITC in
Connecticut state court seeking damages of approximately $1.1 million for
alleged past due carrier bills. ITC believes it has meritorious defenses to
the suit. ITC intends to vigorously defend its position and will attempt to
reach a settlement with this carrier.
Under certain carrier contracts, the Combined Company obtains rate
commitments (subject to adjustment, as provided in each carrier contract),
which are generally more favorable than otherwise would be available, by
committing to purchase a minimum number of minutes from such carriers. If the
Combined Company fails to meet its minimum requirements under a carrier
contract, it could still be required to pay some or all of its minimum monthly
commitment as a penalty. Historically, CSI failed to meet required minimum
purchases and incurred unused usage charges from AT&T and MCI. The Combined
Company's aggregate minimum monthly commitments currently are approximately
$400,000, which represent approximately 28.7% of the Combined Company's
average monthly cost of revenue for the six months ended October 31, 1997.
Failure to maintain favorable carrier contracts would increase the Combined
Company's direct cost and the ability to achieve and maintain profitability.
See "Business" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
CHANGING INDUSTRY ENVIRONMENT
The majority of the Combined Company's operations involve the telephone
call-reorigination industry. This industry operates under the guidelines of
multiple foreign and domestic government regulations. If the Combined Company
should lose the authorization to offer call-reorigination services in any of
its current markets, the results of operations of the Combined Company could
be materially adversely affected. The call-reorigination industry is based
upon the arbitrage opportunities created by higher international calling rates
charged by non-U.S. ITOs compared to rates charged by U.S.-based long distance
carriers. However, ITOs may lower their international calling rates, thereby
eliminating or severely affecting the market for call-reorigination services.
Representatives of 69 countries, including the United States, recently entered
into an agreement with the World Trade Organization ("WTO"), which became
effective on February 5, 1998, with the goal of increasing competition among
telecommunications providers in those markets. If some or all of the non-U.S.
ITOs operating in the Combined Company's current markets lower their rates,
the results of operations of the Combined Company in those markets would be
adversely affected if the Combined Company in turn is required to reduce its
rates. In addition, certain European countries have enacted or have proposed
enacting a value added tax (VAT) on international call-reorigination services.
In February 1997, the government of Argentina enacted legislation that
simultaneously lowered the international long distance calling rates from
Argentina and increased the domestic rates within Argentina. Historically, the
Combined Company has received a significant portion of its revenue from
customers in Argentina. To date this legislation has not had an adverse effect
on the Combined Company's results of operations, but there can be no assurance
such an adverse effect will not occur in the future as a result of this or
other pending legislation. See "Business."
COMPETITION
General. The Combined Company faces a high level of competition for
customers and sales agents in all of its markets, and expects competition to
intensify in the future. There are no substantial barriers to entry in the
call-reorigination industry. The Combined Company competes with other
organizations that have greater resources than the Combined Company. The
Combined Company believes that there are more than 150
9
companies engaged in the international call-reorigination industry. Many of
the Combined Company's competitors are significantly larger, have
substantially greater financial, technical and marketing resources, larger
networks and a broader portfolio of services than the Combined Company.
Additionally, many competitors have strong name recognition and "brand"
loyalty, long-standing relationships with the Combined Company's target
customers, and economies of scale that can result in a lower relative cost
structure for transmission and related costs.
Competition for customers and sales agents in the telecommunication markets
in which the Combined Company operates is on the basis of price and on the
basis of the type and quality of service offered. Increased competition could
force the Combined Company to reduce its prices and profit margins if the
Combined Company's competitors are able to procure rates or enter into service
agreements comparable to or better than those the Combined Company obtains or
if competitors are able to offer other incentives to existing and potential
customers and sales agents. Similarly, the Combined Company has no control
over the prices set by its competitors in the long distance resale market. The
Combined Company is aware that its ability to market its long distance resale
services depends upon the existence of spreads between the rates offered by
the Combined Company and those offered by the providers with whom it competes
as well as those from whom it obtains service for resale. A decrease in such
spreads or price competition in the Combined Company's markets could have a
material adverse effect on the Combined Company's business, financial
condition or results of operations.
Other potential competitors include cable television providers, wireless
telephone providers, Internet access providers, electric and other utilities
with rights of way, railways, microwave carriers and large end users that have
private networks. The intensity of such competition has recently increased and
the Combined Company believes that such competition will continue to intensify
as the number of new entrants increases. If the Combined Company's competitors
devote significant additional resources to the provision of international and
domestic interstate long distance telecommunications services to the Combined
Company's target customer base of high volume customers such as hotels, large
local businesses and foreign branches of multinational businesses, such action
could have a material adverse effect on the Combined Company's business,
financial condition and results of operations. There can be no assurance that
the Combined Company will be able to compete successfully against new or
existing competitors. See "Business--Competition."
U.S. Based Competition. The large U.S. long distance carriers have, in the
past, been reluctant to compete directly with ITOs by entering the
international call-reorigination business and attempting to capture
significant market share of the domestic customers of the ITOs. This is
changing, and AT&T, among others, is entering the call-reorigination business.
The Combined Company's principal U.S.-based competitors are providers of
international call-reorigination services such as Access Authority, AT&T, IDT
Corporation, Justice Technology Corp, Kallback, NetSource Communications,
Telegroup, USA Global Link, UTG Communications, Viatel, Inc. and Worldpass,
and as well as providers of traditional long distance services such as AT&T,
MCI, Sprint, WorldCom, Cable & Wireless, Frontier Corp., LCI International,
Inc., GTE Communications, Qwest Communications and Regional Bell Operating
Companies ("RBOCs") outside their exchange territories.
International Based Competition. The Combined Company's principal
international-based competitors include, among others, Telekom S.A. in South
Africa; Telefonica de Argentina and Telecom Argentina in Argentina; Telebras,
Telesp and Telerj in Brazil; France Telecom in France; PTT Telecom B.V. in the
Netherlands; Cable & Wireless plc, British Telecommunications plc, Mercury
Communications Ltd., AT&T, WorldCom, Sprint and ACC Corp., Swiftcall Ltd.,
Oystel Communications, Ltd. and First Telecom in the United Kingdom; Deutsche
Telecom AG in Germany; Optus in Australia and Kokusan Denshin Denwa
International Telecom Japan (KDD) and International Digital Communications in
Japan. The Combined Company also competes with non-U.S. based providers of
international call-reorigination or other alternative international long-
distance services. The Combined Company believes that local ITOs generally
have certain competitive advantages due to their control over local
connectivity and close ties with national regulatory authorities. The Combined
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 ITO. If an ITO were to successfully
pressure national regulators to outlaw the provision of call-reorigination
services and
10
prevent the Combined Company from providing its services, the Combined Company
could be denied regulatory approval in certain jurisdictions in which its
services would otherwise be permitted. Any delay in obtaining approval, or
failure to obtain approval, could have a material adverse effect on the
Combined Company's business, financial condition and results of operations. If
the Combined Company encounters anti-competitive behavior in countries in
which it operates (such as an ITO attempting to block access to call-
reorigination services) or if the ITO in any country in which the Combined
Company operates uses its competitive advantages to the fullest extent, the
Combined Company's business, financial condition and results of operations
could be materially adversely affected. Deregulation and increased competition
in international markets could cause prices for direct-dial international
calls to decrease so much that the Combined Company's international call-
reorigination services would no longer be attractive to customers. See
"Business--Competition" and "Business--Government Regulation."
GOVERNMENT REGULATION
The Combined Company's international telecommunications services are subject
to the jurisdiction of many regulators. The United States Federal
Communications Commission ("FCC") has imposed certain restrictions on
international call-reorigination providers, including the requirement that
authorized carriers provide service in a manner consistent with the laws of
the countries in which they operate. Recently, the ITU agreed that any country
could ban call-reorigination services, and the provision of some forms of
call-reorigination services is illegal in Uruguay, Venezuela, the Philippines
and certain other countries. In addition, approximately 30 countries primarily
in Central and South America, the Middle East and Asia (including China) have
informed the FCC that they have banned certain forms of call-reorigination.
Call-reorigination service providers or customers violating these countries'
laws may be subject to fines or penalties. Call-reorigination services in
these countries comprised approximately 7.8% of the Combined Company's revenue
in the ten months ended October 31, 1997. Currently, the Combined Company
believes that it is not in violation of any country's laws or regulations
related to the provision of international long distance services, but rules or
regulations could be adopted by one or more countries that could prevent the
Combined Company from operating in such countries, thereby having a material
adverse effect on the Combined Company's operations. Local laws and
regulations differ significantly among the jurisdictions in which the Combined
Company operates, and the interpretation and enforcement of such laws and
regulations vary and are often based on the informal views of the local
ministries which, in some cases, are subject to influence by government owned
or sanctioned local telephone companies. In addition, failure to interpret
accurately the applicable laws and regulations and the mode of their
enforcement in particular jurisdictions could result in monetary penalties
imposed against the Combined Company that could be significant. The Combined
Company generates a significant portion of its revenue from customers
originating calls in South America, Europe, the Pacific Rim, Africa, the
Middle East and Central America. There can be no assurance that foreign
regulation will not have a material adverse effect on the Combined Company's
business, results of operations and financial condition. See "Business--
Regulation."
As a switch-based reseller of international long distance telecommunications
services, the Combined Company is regulated by the FCC. The Combined Company
is currently authorized by the FCC as a reseller of international long
distance telephone services. The Combined Company has not been the subject of
any action by the FCC or any other regulatory entity that would affect its
ability to resell international long distance services. The FCC has determined
that call-reorigination service using uncompleted call signaling, such as that
used by the Combined Company, does not violate United States or international
law, but has held that United States companies providing such services must
comply with the laws of the countries in which they operate as a condition of
such companies' FCC authorizations. The FCC reserves the right to condition,
modify or revoke any authorizations and impose fines for violations of the
Communications Act of 1934, as amended (the "Communications Act") or the FCC's
regulations, rules or policies promulgated thereunder, or for violations of
the clear and explicit telecommunications laws of other countries that are
unable to enforce their laws against U.S. carriers. See "Business--
Regulation."
11
RISKS OF OPERATIONS IN FOREIGN COUNTRIES
At the present time, substantially all of the Combined Company's revenue is
from international customers. The Combined Company anticipates that revenue
from international customers will continue to account for substantially all of
its total revenue. Therefore, the Combined Company is particularly exposed to
risks associated with international operations, including unexpected changes
in legal and regulatory requirements, changes in tariffs, exchange rates and
other barriers, political and economic instability, difficulties in collecting
accounts receivable, longer payment cycles, difficulties in establishing,
maintaining and managing independent sales agents, difficulties in staffing
and managing international operations, difficulties in installing, maintaining
and repairing equipment abroad, difficulties in protecting the Combined
Company's intellectual property overseas, potential confiscation of property
and equipment, potentially adverse tax consequences and the regulation of
telecommunications companies by foreign jurisdictions. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business."
RELIANCE ON RAPIDLY CHANGING TECHNOLOGY; DEPENDENCE ON THIRD PARTY SUPPLIERS
The market for long distance services is characterized by rapidly changing
technology, evolving industry standards and customer demands, and frequent new
product, service and software introductions and enhancements. The Combined
Company has invested significantly in sophisticated and specialized
telecommunications and computer technologies such as the LINK-US and DIAL, and
has focused on the application of these and other technologies to provide
customized solutions to meet its customers' needs. Future technological
advances in the industry may result in the availability of new services or
products that could compete directly with the services currently provided by
the Combined Company or could lower the cost of competitive services and
products to a level where the Combined Company's services and products could
lose any competitive technological advantage. The Combined Company anticipates
that it will be necessary to continue to select, invest in, and develop new
and enhanced technology on a timely basis in order to maintain its
competitiveness. The Combined Company's future success will also depend, in
part, on its ability to continue to evolve and adapt telecommunications
technology solutions that keep pace with changing customer demands. There can
be no assurance that the Combined Company will be successful in anticipating
technological changes or in selecting and developing new and enhanced
information technology on a timely basis.
The Combined Company is dependent on certain third-party suppliers of
equipment and hardware components, including its integrated computer systems
and switching platform, and expects that it will become more dependent on such
suppliers as its business expands. A failure by a supplier to deliver quality
products on a timely basis, or the inability to develop other sources if
required, could result in delays that could adversely affect the Combined
Company. In addition, the Combined Company's business is highly dependent on
its computer systems, telephone equipment and software. See "Business."
DEPENDENCE ON EFFECTIVE MANAGEMENT INFORMATION SYSTEMS
The Combined Company believes that the integration of its management
information systems and switching platforms is important in order to best
provide least cost routing and efficient billing of customers. Although the
Combined Company's computer system and switching platform located at its
telecommunications center in Ft. Lauderdale are integrated, there can be no
assurance, if its current system becomes damaged or obsolete, that the
Combined Company will be able to upgrade or replace such system with another
integrated system at commercially reasonable prices, or at all. Failure to
maintain an integrated system could have a material adverse effect on the
Combined Company.
The computer system that runs ITC's switches and billing operation has not
yet been upgraded to be Year 2000 compliant. A new system called NTS 2000,
which is Year 2000 compliant, is expected to be released and implemented in
1998 at an estimated cost of $30,000 to the Combined Company. Failure to
achieve Year 2000 compliance could have a material adverse effect on the
Combined Company.
12
The Combined Company believes, based on its current business plan, that its
management information systems will be sufficient for the next 12 months, but
will require substantial additional investments to continue their
effectiveness after such time as the Combined Company continues to expand its
operations and process a higher volume of calls. The failure to successfully
implement enhancements, replacements and investments in a timely fashion could
result in a material adverse effect on the Combined Company's business,
financial condition and results of operations. Furthermore, even if the
Combined Company is successful in implementing such investments in a timely
fashion there can be no assurance that the Combined Company's management
information systems will not require further investments.
DEPENDENCE UPON EXECUTIVE OFFICERS AND MANAGEMENT PERSONNEL
The Combined Company's operations are dependent upon the continued services
of Robert Spade, its Chairman and Chief Executive Officer, and Patrick
Scanlon, its President and Chief Operating Officer. The loss of the services
of either of Messrs. Spade or Scanlon could have a material adverse effect on
the Combined Company. The Combined Company has an employment agreement with
Mr. Spade that expires April 30, 2000. The Combined Company maintains a key-
person life insurance policy on the life of Mr. Spade in the amount of $2
million. The Company has applied for key-person life insurance on the life of
Mr. Scanlon in the amount of $2 million. The Company has an employment
agreement with Mr. Scanlon which expires on August 25, 2000. The Combined
Company's success also is dependent on its ability to hire and retain other
qualified management, technical, marketing, sales and customer service
personnel. There can be no assurance that the Combined Company will be
successful in recruiting and retaining such personnel. See "Management."
MANAGEMENT OF GROWTH
The Combined Company has experienced significant growth in the past two
years and expects such growth to continue. The Combined Company's growth may
place significant strains on the Combined Company's management, staff, working
capital and operating and financial control systems. There can be no assurance
that the Combined Company's management, staff, working capital and systems
will be adequate to support its future anticipated growth. The failure to
continue to upgrade operating and financial control systems, to recruit
qualified staff or to respond effectively to difficulties encountered during
expansion could have a material adverse effect on the Combined Company's
business, financial condition and results of operation.
PROPRIETARY RIGHTS AND LICENSES
The Combined Company does not have a formal patent or other intellectual
property protection program. It relies on trade secret and contractual
restrictions to establish and protect its technology. The Combined Company's
success depends in part on its ability to enforce intellectual property rights
for its proprietary software technology, both in the United States and in
other countries. The Combined Company's proprietary software is protected by
the use of confidentiality agreements that restrict the unauthorized
distribution of the Combined Company's proprietary data. While the Combined
Company has attempted to limit unauthorized use of its software products or
the dissemination of its proprietary information, there can be no assurance
that the Combined Company will be able to retain its proprietary software
rights and prohibit the unauthorized use of proprietary information. The
hardware and other equipment used by the Combined Company for its call-
reorigination systems are purchased from third party suppliers and therefore
are not proprietary to the Combined Company. See "Business--Sales and
Marketing" and "--Technology and Intellectual Property."
INTERNATIONAL CURRENCY FLUCTUATIONS
The Combined Company's operations may be adversely affected by fluctuations
in the value of the U.S. dollar against certain non-U.S. currencies, and the
enactment of exchange controls or non-U.S. government restrictions on the
transfer of funds. The Combined Company currently prices all of its products
and services in U.S. dollars. However, swings in the relative value of the
U.S. dollar in relation to currencies in nations in which the Combined Company
conducts operations can affect the prices of the Combined Company's products
and
13
services. There is no assurance that the Combined Company will be able to
maintain a competitive position in foreign countries where the domestic
currency is experiencing devaluation. To the extent the Combined Company
expands its international operations or changes its pricing practices to
denominate prices in foreign currencies, the Combined Company will be exposed
to increased risks of currency fluctuation as the Combined Company does not,
and has no plans to, engage in hedging activities designed to protect against
currency fluctuations.
Risks Related to the Offering
DETERMINATION OF OFFERING PRICE
The offering price of the Shares was determined through negotiations between
CSI and the Representative. Among the factors considered were the limited
financial resources of the Combined Company, the Combined Company's potential
revenue and cash flow, the industry in which the Combined Company operates and
the general condition of the securities market. The offering price of the
Shares is not necessarily reflective of the Combined Company's assets, history
of revenue and cash flow, book value or any other objective criteria of value.
See "Underwriting."
MARKET FOR THE COMMON STOCK; PRICE FLUCTUATIONS
Prior to this Offering, there has been only a limited market for the Common
Stock. The Common Stock is traded sporadically in limited quantities on the
OTC Bulletin Board, and the Combined Company has applied to have the Common
Stock quoted on the Nasdaq SmallCap Market. There can be no assurance that a
regular, active trading market will develop or that the market price of the
Common Stock will not decline below the public offering price. The price at
which the Common Stock trades may be highly volatile. In addition, other
events, such as quarter-to-quarter variations in operating results, news
announcements, trading volume, general market trends and other factors, could
result in wide fluctuations in the market price of the Common Stock. The stock
market is subject to significant price and volume fluctuations. These
fluctuations, which are often unrelated to the operating performance of
specific companies, have had a substantial effect on the market price for many
small capitalization companies. Factors such as those cited above, as well as
other factors which may be unrelated to the operating performance of the
Combined Company, may adversely affect the price of the Combined Company's
securities. See "Price Range of Common Stock."
SHARES AVAILABLE FOR RESALE
As of 1998, there were shares of CSI's Common Stock issued and
outstanding. Of this amount, approximately shares are "restricted
securities" as defined by Rule 144 of the Securities Act. Of the shares of
restricted stock which are presently outstanding, approximately shares of
restricted stock have satisfied the one year holding period required by Rule
144. The remaining shares of restricted stock will become available for resale
pursuant to Rule 144 in various amounts each month, with all shares of
restricted stock being available for resale by January 1999. All of the
officers and directors and persons known by CSI to be the beneficial holders
of 2% or greater of the Common Stock have agreed not to sell such shares for a
period of 270 days following the date of this Prospectus. The Selling
Securityholders have agreed not to sell their shares for a period of 180 days
following the date of this Prospectus.
No prediction can be made as to the effect, if any, that the sale of Common
Stock (or the availability of such Common Stock for sale) by the holders of
the Company's restricted stock will have on the market price of the Common
Stock. Nevertheless, the possibility of a substantial number of shares of
Common Stock being offered for sale in the public market may adversely affect
prevailing market prices for the Common Stock and could impair investors'
ability to sell the Common Stock or the Combined Company's ability to raise
capital through the sale of its equity securities. See "Shares Eligible for
Future Sale."
14
DIVIDENDS
CSI has paid no dividends since inception. The payment of dividends on the
Common Stock rests with the discretion of the Board of Directors. Payment of
dividends is contingent upon, among other things, future earnings, if any, and
the financial condition of the Combined Company, capital requirements, general
business conditions, and other factors which cannot now be predicted. There
can be no assurance that the future operations of the Combined Company will be
profitable or that dividends will ever be paid by the Combined Company. See
"Dividend Policy."
IMMEDIATE SUBSTANTIAL DILUTION
A purchaser of Common Stock in this Offering will experience immediate
substantial dilution of $ per Share or %, which amount represents the
difference between the pro forma net tangible book value per share of Common
Stock after the Offering and the assumed public offering price of $10.00 per
share. See "Dilution."
POTENTIAL FUTURE DILUTION
Currently, the Combined Company has outstanding (i) options to purchase up
to shares of Common Stock, which have weighted average exercise prices of
$ per share, (ii) warrants to purchase up to shares of Common Stock,
which have weighted average exercise prices of $ per share, and
(iii) convertible promissory notes in the aggregate principal amount of
$30,000 convertible into an undeterminable number of shares of Common Stock,
which have a conversion price per share equal to 90% of the average bid and
ask price of the Common Stock on the day before conversion. The issuance of
any Common Stock pursuant to the exercise or conversion of any options,
warrants, or convertible promissory notes at a price less than the book value
per share of the Common Stock will dilute the book value of the Common Stock.
POSSIBLE ADVERSE EFFECT OF ISSUANCE OF PREFERRED STOCK; POTENTIAL ANTI-
TAKEOVER EFFECT OF COLORADO LAW
CSI is authorized to issue up to 5,000,000 shares of Preferred Stock, and
the Board of Directors may fix the preferences, limitations and relative
rights of those shares without any vote or action by the shareholders. The
potential issuance of Preferred Stock may delay, deter, or prevent a change in
control of the Combined Company, may discourage bids for the Common Stock at a
premium over the market price of the Common Stock, and may adversely affect
the market price of, and the voting and other rights of the holders of, the
Common Stock. The Combined Company presently has no plans to issue shares of
Preferred Stock. In addition, certain provisions of Colorado law could have
the effect of delaying, deterring or preventing a change in control of the
Combined Company. See "Description of Securities."
15
USE OF PROCEEDS
The net proceeds to the Combined Company from this Offering, after deduction
for estimated offering expenses and underwriting discounts of $1,780,000, are
estimated to be $9,220,000 ($10,655,500 if the Representative's over-allotment
option is exercised in full), assuming a public offering price of $10.00 per
share of Common Stock. The Combined Company expects to use the net proceeds
during the 12 months following the Offering as follows:
PERCENTAGE OF
APPLICATION OF PROCEEDS DOLLAR AMOUNT NET PROCEEDS
----------------------- ------------- -------------
Repayment of Bridge Notes(1)...................... $2,911,000 31.6%
Completion of ITC Acquisition(2).................. 2,975,000 32.3
Expansion of marketing capability(3).............. 750,000 8.1
Installation of automated switching equipment(4).. 500,000 5.4
Purchase or lease and installation of regional
switches(5)...................................... 500,000 5.4
Technical development(6).......................... 300,000 3.3
Working capital and general corporate
purposes(7)...................................... 1,284,000 13.9
---------- -----
$9,220,000 100.0%
========== =====
- --------
(1) Represents amounts to be used for the repayment of the entire $2,840,000
amount of Bridge Notes and estimated accrued interest thereon. The Bridge
Notes bear interest at a rate of 10% per annum and are repayable on the
earlier of five days after the consummation of this Offering or December
30, 1998. CSI used the proceeds of the December 1997 Financing principally
in connection with the repayment of trade payables and notes payable to
telecommunications carriers. See "Description of Securities--Description
of Indebtedness."
(2) Represents amounts to be paid to Lynch Family, LLC, Philip Thomas and Sean
Thomas as partial consideration for all of the capital stock of ITC and
estimated acquisition costs of $100,000. In addition, on the first
anniversary of the closing of this Offering, Lynch Family, LLC and Messrs.
Thomas and Thomas will receive 207,000 shares of Common Stock based on an
assumed initial offering price of $10.00 per Share. See "Business--The ITC
Acquisition."
(3) Represents amounts to be paid for recruiting and for salaries of
specialized sales personnel to promote hotel and large business, operator
services, cellular and other specialized services. This amount also
represents funds to be used to pay for additional technical, customer
service and overhead resulting from the expansion of the sales and
marketing effort. See "Business--Business Strategy."
(4) Represents amounts to be used to install DIAL, LINK-US and other automated
switching equipment which facilitate transparent call-reorigination
services for hotels and large businesses in select countries. See
"Business--Business Strategy."
(5) Represents amounts to be used to purchase or lease and locate regional
switches or other telecommunications equipment in South America, Europe,
Africa or Asia to facilitate least cost routing. See "Business--Business
Strategy."
(6) Represents amounts to be used to continue technical development associated
with the Combined Company's enhanced services, including facsimile and
debit card services and compression technology, which is intended to
improve service and reduce operating costs. See "Business--Business
Strategy."
(7) Working capital will be used, among other things, to pay security deposits
in connection with carrier agreements and to pay general and
administrative expenses. This amount includes approximately $80,000
payable to a former employee of CSI and $50,000 payable to a director of
CSI.
Pending use of the proceeds, the Combined Company intends to invest the net
proceeds in short term, interest bearing, investment grade securities,
including government obligations and other money market instruments.
16
The amounts set forth above represent the Combined Company's present
intentions for the use of the proceeds from this Offering. Actual expenditures
could vary considerably depending upon many factors, including, without
limitation, changes in economic conditions, unanticipated complications,
delays and expenses, or the availability of alternative financing. Any
reallocation of net proceeds of this Offering will be made at the discretion
of the Board of Directors but will be in furtherance of the Combined Company's
strategy as described in this Prospectus.
DIVIDEND POLICY
CSI has paid no dividends since inception. The payment of dividends on the
Common Stock rests with the discretion of the Board of Directors. There are no
restrictions on payment of dividends under any agreements to which the
Combined Company is a party. Payment of dividends is contingent upon, among
other things, future earnings, if any, and the financial condition of the
Combined Company, capital requirements, general business conditions, and other
factors which cannot now be predicted. There can be no assurance that the
future operations of the Combined Company will be profitable or that dividends
will ever be paid by the Combined Company. To the extent the Combined Company
issues preferred stock, it may have a preference over the Common Stock with
respect to dividends.
17
PRICE RANGE OF COMMON STOCK
The Common Stock currently is traded infrequently in limited quantities on
the OTC Bulletin Board under the symbol CSYG. The following table sets forth
the range of high and low sales prices per share for the Common Stock through
the fiscal quarter ending April 30, 1998, and the range of high and low
closing bid prices thereafter, as adjusted to give effect to the assumed 1 for
reverse stock split. Market quotations represent prices between dealers and
do not reflect retail mark-ups, mark-downs or commissions, and may not
represent actual transactions. There was no market for the Common Stock prior
to March 18, 1996.
PRICE RANGE OF
FISCAL QUARTER ENDED COMMON STOCK
-------------------- ---------------
HIGH LOW
------- -------
1996
April 30, 1996 (commencing March 18, 1996)......................
1997
July 31, 1996...................................................
October 31, 1996................................................
January 31, 1997................................................
April 30, 1997..................................................
1998
July 31, 1997...................................................
October 31, 1997................................................
January 31, 1998................................................
April 30, 1998 (through , 1998)............................
On , 1998, the closing bid price of the Common Stock as reported on the
OTC Bulletin Board was $ per share. As of , 1998, there were holders
of record of the Common Stock.
18
DILUTION
The difference between the public offering price per Share and the adjusted
net tangible book value (deficit) per share of Common Stock after this
Offering constitutes the dilution to investors in this Offering. Net tangible
book value per share of Common Stock on any given date is determined by
dividing the net tangible book value (total tangible assets less total
liabilities) on that date, by the number of shares of Common Stock outstanding
on that date.
CSI's net tangible book value (deficit) at October 31, 1997 was ($2.1
million) or ($ ) per share of Common Stock. After giving effect to the
December 1997 Financing (the "Pro Forma Adjustments"), the Pro Forma net
tangible book value (deficit) of CSI as of October 31, 1997 would have been
($562,000) or ($ ) per share. After also giving effect to the sale by the
Combined Company of 1,100,000 shares of Common Stock at an assumed offering
price of $10.00 per share and the receipt of the estimated net proceeds
thereof and the ITC Acquisition, the adjusted net tangible book value of the
Combined Company at October 31, 1997 would have been approximately $4.1
million or $ per share. This represents an immediate increase in net
tangible book value of $ per share to existing shareholders and an immediate
dilution of $ per share to new investors purchasing in this Offering.
The following table illustrates this per share dilution:
Assumed public offering price...................................... $10.00
Net tangible book value (deficit) before Pro Forma Adjustments...
Increase attributable to the Pro Forma Adjustments...............
Pro Forma net tangible book value (deficit) per share of Common
Stock before Offering...........................................
Increase per share of Common Stock attributable to this Offering
and the ITC Acquisition.........................................
Adjusted net tangible book value per share of Common Stock after
this Offering..................................................... $
------
Dilution per share of Common Stock to new investors in this
Offering.......................................................... $
======
Dilution as a percentage of assumed offering price................. %
======
The following table summarizes as of October 31, 1997, the difference
between existing shareholders and new investors with respect to the number of
shares of Common Stock purchased from the Combined Company, the total
consideration paid and the average price paid per share by the Combined
Company hereby (before deducting underwriting discounts and estimated offering
expenses):
SHARES PURCHASED TOTAL CONSIDERATION
------------------ ------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT (PER SHARE)
---------- ------- ----------- ------- -------------
Existing
shareholders(1)(2)...... % $ 2,750,285 20.0% $
New shareholders......... 1,100,000 11,000,000 80.0% $10.00
---------- ----- ----------- -----
Total.................... 100.0% $13,750,285 100.0%
========== ===== =========== =====
- --------
(1) Includes 113,600 Bridge Shares to be issued immediately prior to the
closing of this Offering based on an assumed offering price of $10.00 per
share. Excludes the Additional Securities. See "Management," "Description
of Securities" and "Underwriting."
(2) Includes shares issued in exchange for services rendered, rent and
equipment valued at $423,114. Statements of Shareholders' Equity
(Deficiency) in the Financial Statements.
19
CAPITALIZATION
The following table sets forth the capitalization of CSI at October 31,
1997, the Pro Forma capitalization of CSI to reflect the December 1997
Financing, and the Pro Forma Combined capitalization to reflect the December
1997 Financing, the ITC Acquisition and the sale of the Common Stock at an
assumed public offering price of $10.00 and the application of the estimated
net proceeds therefrom. The table should be read together with the Financial
Statements and the notes thereto.
OCTOBER 31, 1997
------------------------------------------
PRO FORMA
CSI ACTUAL CSI PRO FORMA(1) COMBINED(2)(3)
---------- ---------------- --------------
(IN THOUSANDS)
Long-term liabilities, net of
current portion.................... $ 850 $ 2,045 $ 292
Shareholders' equity (deficiency):
Preferred stock, no par value;
5,000,000 shares authorized, none
issued or outstanding............ 0 0 0
Common Stock, no par value;
25,000,000 shares authorized;
shares issued and outstanding
actual; shares issued and
outstanding pro forma; and
shares issued and outstanding, as
adjusted......................... 2,750 2,750 14,008
Common Stock subscribed............. -- 795 --
Notes receivable from shareholder... (35) (35) (35)
Accumulated deficit................. (4,577) (3,830) (5,061)
Treasury Stock, at cost............. (243) (243) (243)
------- ------- -------
Total shareholders' equity
(deficiency)....................... (2,104) (562) 8,670
------- ------- -------
Total capitalization (deficiency)... $(1,254) $ 1,483 $ 8,962
======= ======= =======
- --------
(1) Gives effect to the December 1997 Financing.
(2) Adjusted to reflect the December 1997 Financing, the ITC Acquisition and
net proceeds from the sale by the Combined Company in this Offering of
1,100,000 Shares at an assumed public offering price of $10.00 per Share.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
(3) Does not include the Additional Securities.
20
SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
The following selected financial data should be read in conjunction with the
financial statements of CSI and ITC and the related notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." The selected financial data below has been derived from CSI's
audited statement of operations data for the years ended April 30, 1996 and
1997, and the balance sheet data as of April 30, 1996 and 1997, from ITC's
audited statement of operations data for the ten months ended October 31, 1997
and the year ended December 31, 1996, and the balance sheet data as of October
31, 1997. The selected financial data for CSI with respect to the periods
ended October 31, 1996 and 1997 and the balance sheet data as of October 31,
1997 have been derived from CSI's unaudited financial statements. Management
believes that CSI's interim financial statements as of October 31, 1996 and
1997 and for the periods ended October 31, 1996 and 1997 include all
adjustments, consisting of normal recurring accruals, necessary for a fair
presentation of the financial position and the results of operations of the
CSI for such interim periods. Prior results are not a prediction of future
results of operations. The Pro Forma Combined information does not purport to
present the Combined Company's financial position or results of operations
that would have occurred had the transactions, to which pro forma effect is
given, been consummated as of the dates or for the periods indicated and do
not purport to project the Combined Company's financial position or results of
operations at any future date or for a future period, and should be read in
conjunction with the separate financial statements of CSI and ITC and the pro
forma condensed combined financial statements of CSI and ITC.
CSI ACTUAL ITC ACTUAL PRO FORMA COMBINED(1)
-------------------------------- ------------------------ ----------------------
SIX MONTHS
YEAR ENDED ENDED TEN MONTHS SIX MONTHS
APRIL 30, OCTOBER 31, YEAR ENDED ENDED YEAR ENDED ENDED
---------------- -------------- DECEMBER 31, OCTOBER 31, APRIL 30, OCTOBER 31,
1996 1997 1996 1997 1996 1997 1997 1997
------- ------- ------ ------ ------------ ----------- ---------- -----------
STATEMENT OF OPERATIONS
DATA:
Revenue................. $ 6,741 $11,865 $5,530 $6,372 $7,603 $8,054 $19,732 $11,426
Cost of revenue......... 5,963 7,755 3,608 3,807 5,070 6,790 13,253 8,357
------- ------- ------ ------ ------ ------ ------- -------
Gross margin............ 778 4,110 1,922 2,565 2,533 1,264 6,479 3,069
Operating expenses:
Sales and marketing... 1,573 2,080 877 1,271 1,099 715 2,928 1,703
General and
administrative......... 1,258 1,302 609 1,326 1,446 1,388 2,929 2,183
Technical and
developmental.......... 394 722 294 389 -- -- 722 389
Depreciation.......... 58 103 42 68 69 73 179 113
Amortization of
intangibles............ -- -- -- -- -- -- 937 468
------- ------- ------ ------ ------ ------ ------- -------
Total operating
expenses............... 3,283 4,207 1,822 3,054 2,614 2,176 7,695 4,856
------- ------- ------ ------ ------ ------ ------- -------
Income (loss) from
operations............. (2,505) (97) 100 (489) (81) (912) (1,216) (1,787)
Other income (expense)-
net.................... (19) (162) (76) (88) 88 62 (62) (109)
------- ------- ------ ------ ------ ------ ------- -------
Net income (loss)....... (2,524) (259) 24 (577) 7 (850) (1,278) (1,896)
======= ======= ====== ====== ====== ====== ======= =======
Net income (loss) per
share(2)...............
Weighted average number
of shares outstanding..
CSI ACTUAL ITC ACTUAL PRO FORMA
------------------------------- ----------- COMBINED
APRIL 30, APRIL 30, OCTOBER 31, OCTOBER 31, OCTOBER 31,
1996 1997 1997 1997 1997(1)(3)
--------- --------- ----------- ----------- -----------
BALANCE SHEET DATA:
Current assets.......... $ 1,223 $ 1,284 $ 1,499 $ 1,950 $ 8,369
Long-term assets........ 296 662 779 770 1,452
Intangible assets....... -- -- -- -- 4,683
Total assets............ 1,519 1,946 2,278 2,720 14,505
Current liabilities..... 3,375 3,615 3,532 3,209 5,543
Long-term liabilities... -- -- 850 292 292
Total liabilities....... 3,375 3,615 4,382 3,501 5,835
Working capital
(deficit).............. (2,152) (2,331) (2,033) (1,259) 2,826
Shareholders' equity
(deficiency)........... (1,856) (1,669) (2,104) (781) 8,670
- --------
(1) Refer to the Pro Forma Condensed Combined Financial Statements contained
herein.
(2) Based on the weighted average number of shares outstanding.
(3) Gives effect to the December 1997 Financing, the ITC Acquisition and the
sale of the Shares at an assumed offering price of $10.00 per Share
offered hereby and the application of the estimated net proceeds
therefrom. See "Use of Proceeds."
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
With the exception of historical matters, the matters discussed herein are
forward-looking statements that involve risks and uncertainties. Forward-
looking statements include, but are not limited to, statements concerning
anticipated trends in revenue and net income, the mix of the Combined
Company's revenue, projections concerning operations and available cash flow.
The Combined Company's actual results could differ materially from the results
discussed in such forward-looking statements. Factors that could cause or
contribute to such differences include those discussed below, as well as those
discussed in "Risk Factors" and elsewhere in this Prospectus.
THE COMBINED COMPANY
GENERAL
Communications Systems International, Inc. and International Telephone
Company are growing providers of international long distance
telecommunications services. CSI's customers are principally located in South
America, the Pacific Rim, South Africa and Central America, while ITC's
customers are principally located in Africa, Europe and the Middle East. CSI
emphasizes innovative software solutions and technical expertise to provide
higher quality, lower cost alternative routing of telecommunications for its
customer base. CSI focuses its marketing efforts on high volume customers such
as hotels, large local businesses and foreign branches of multinational
businesses in addition to individuals and small businesses. ITC emphasizes its
wholesale long distance services, least cost routing capabilities and superior
customer service for its individual and small business customers. The Combined
Company expects to benefit from the synergies of a complementary customer
base, geographic diversity, technical expertise and marketing and customer
support services; however, no assurance can be given that such synergies will
occur. The Combined Company contracts with several United States and other
long distance carriers to ensure a ready supply of long distance service at
competitive rates.
Prices in the international long distance telecommunications industry in
many of the countries in which the Combined Company provides its services have
declined in recent years due to increased competition and deregulation, and
the Combined Company believes that prices are likely to continue to decrease.
In addition, the Combined Company believes that the deregulation trends in
some international markets will result in greater competition that could
reduce telecommunications revenue per minute and the Combined Company's
operating margins. For example, representatives of 69 countries, including the
United States, recently entered into an agreement with the World Trade
Organization, which became effective on February 5, 1998 (the "WTO
Agreement"), with the goal of increasing competition among telecommunications
providers in those markets. The Combined Company believes, however, that any
decreases in prices as a result of deregulation and increased competition will
be at least partially offset by increased telecommunications usage and the
decreased cost structure discussed below. See "Business--Competition" and "--
Regulation."
CSI and ITC experienced rapid growth in revenue in fiscal years 1996 and
1997. Revenue is generated primarily from international call-reorigination
services and is based on the minutes of customer use billed by the Combined
Company on completed calls. An international call-reorigination call has two
segments: an origination segment and a destination segment. Revenue is
recorded and billed from the beginning of the origination segment to the
completion of the destination segment, if the destination segment is answered
or otherwise connected. If the destination segment is not answered or
connected, the origination segment is not completed and not billable, and the
Combined Company incurs a nonrecoverable cost. CSI and ITC estimate that less
than 6.0% of all minutes charged by its carriers resulted from non-billable
calls during the 12 months ended April 30, 1997. The Combined Company's gross
margin on each completed call or service placed through its facility is equal
to the difference between the amount charged its customer for a call or
service and the amount it is charged by the long distance carrier for the same
call or service.
22
Approximately 60.0% of all revenue is collected through weekly automatic
charges to pre-approved customer credit cards. Under the terms of the sales
agent agreements, the sales agents are responsible for collecting customer
payments except for credit card payments, and sales agents generally are
responsible for customer bad debts less, in some cases, an allowance granted
by the Combined Company. Failure of sales agents to collect and remit customer
payments to the Combined Company presents a risk to the Combined Company.
Although collection terms for other customers are net 30 days, the time
necessary to process billings and collect billings through the Combined
Company's sales agents may at times result in receivables reaching 60 to 90
days.
Cost of revenue consists primarily of costs paid to carriers for the
origination, transmission and termination of voice and data telecommunications
services and to a lesser extent, debit card costs and agent allowances and
discounts. Currently, a substantial portion of the Combined Company's
telecommunications revenue is derived from services that are accessed through
the facilities of long distance carriers. Accordingly, a significant portion
of the Combined Company's cost of telecommunications services is variable,
based on the number of minutes of use, with transmission and termination costs
being the Combined Company's most significant expense.
One of the Combined Company's business strategies is to minimize costs
through efficient call management. The Combined Company continually seeks to
negotiate more favorable rates with its existing long distance carriers. Under
certain carrier contracts, the Combined Company obtains guaranteed rates,
which are generally more favorable than otherwise would be available, by
committing to purchase a minimum number of minutes from such carriers. If the
Combined Company fails to meet its minimum requirements under a carrier
contract, it could still be required to pay its minimum monthly commitment as
a penalty. The Combined Company's aggregate minimum monthly commitments are
approximately $400,000, which represents approximately 28.7% of the Combined
Company's monthly variable transmission cost. The Combined Company is seeking
to enter into agreements with additional long distance carriers in order to
access the lowest transmission and termination costs for each call segment.
This "least cost routing" allows the Combined Company to route each call
segment on the carrier with the least cost for that segment. In addition, the
Combined Company intends to establish additional switching facilities outside
the U.S. in order to utilize a larger number of long distance carriers and
reduce its call per unit operating costs. See "Use of Proceeds" and
"Business--Business Strategy."
The Combined Company generally realizes higher gross margins from its call-
reorigination services than from its wholesale services. Wholesale services,
however, provide a source of additional revenue and add significant minutes
originating and terminating on the Combined Company's network, thus enhancing
the Combined Company's purchasing power for leased lines and switched minutes
from its carriers and enabling it to take advantage of volume discounts. The
Combined Company expects gross margin percentages may decline if wholesale
revenue increases as a percentage of total revenue. CSI intends to expand its
wholesale business following the ITC Acquisition. In addition, gross margin
percentages could be adversely affected by price reductions due to market
competition.
Due to ITC's more sophisticated switching platform, the Combined Company has
the capacity of offering wholesale telecommunications services to its
customers. Wholesale services enable ITC to improve its operating results
despite lower gross margins on its wholesale sales because all wholesale
minutes generally are "billable" minutes even if the destination segment of
the call is not answered or connected. Furthermore, ITC is not responsible for
billing end users. Therefore, operating expenses are generally lower for
wholesale services.
Sales and marketing expenses primarily represent commissions paid to
independent sales agents, compensation paid to internal salespersons and
advertising expense. The Combined Company's decision to use independent agents
to date has been primarily driven by the low initial fixed costs associated
with this distribution channel, and the agents' familiarity with local
business and marketing practices. CSI currently depends on approximately 40
independent sales agents to sell its services, including Edward Stoever, who
operates in Argentina, and CS do Brazil. These two sales agents accounted for
approximately 54.3%, and 11.5%, respectively, of revenue in the six months
ended October 31, 1997, and the ten largest sales agents accounted for
approximately 91.3% of CSI's revenue in the six months ended October 31, 1997.
ITC currently depends on approximately 55 independent sales agents to sell its
services, including Generic Telecom, Inc., Zohair Attoue
23
and Janel Richards. These three sales agents accounted for approximately
26.6%, 21.4% and 12.7%, respectively, of ITC's revenue in the ten months ended
October 31, 1997, and the ten largest sales agents accounted for approximately
89.1% of ITC's revenue in the ten months ended October 31, 1997. The Combined
Company expects that sales and marketing expenses will continue to increase as
the Combined Company obtains additional sales agents either directly or in
connection with acquisitions, and otherwise generally expands its sales and
marketing activities. The Combined Company anticipates, however, that as sales
networks become fully integrated and economies of scale are realized, sales
and marketing expenses ultimately will decline as a percent of revenue and
that its dependence on the five principal sales agents also will be reduced.
See "Use of Proceeds" and "Business--Business Strategy" and "--Sales and
Marketing--Sales Agents."
General and administrative expenses are primarily compensation paid for
agent and customer support, executives and accounting personnel, credit card
merchant charges, bad debt expense and other corporate overhead costs. The
Combined Company devotes considerable resources to collect receivables from
agents and customers who fail to remit payment in a timely manner. While the
Combined Company continually seeks to minimize bad debt, the Combined
Company's experience indicates that a certain portion of past due receivables
will never be collected, and that such bad debt is a necessary cost of
conducting business in the telecommunications industry. The Combined Company
expects that general and administrative expenses will increase in absolute
terms as the Company integrates personnel from the ITC Acquisition and
implements its growth strategy; however, The Combined Company expects general
and administrative expenses will decrease as a percent of revenue due to
anticipated cost reductions resulting from the efficiencies of combining CSI
and ITC.
In conjunction with the December 1997 Financing, CSI will incur additional
monthly non-cash expenses totaling $117,000, including: accrued interest
expense of $24,000 on the Bridge Notes; amortized interest expense of $66,000
from the accretion of a $795,000 discount on the Bridge Notes; and $27,000 of
amortized prepaid debt offering expenses totaling $323,000. Upon repayment of
the Bridge Notes and accrued interest, CSI will recognize an extraordinary
item from loss on early retirement of debt equal to the unamortized balances
of the $795,000 discount on the Bridge Notes and $323,000 prepaid offering
expenses.
EFFECTS OF INFLATION AND FOREIGN CURRENCY EXCHANGE
Although increases in salaries, carrier costs and operating overhead can
adversely affect the Combined Company's operations, The Combined Company does
not believe that inflation has had a material effect on its operating results.
However, because future increases in inflation may cause the Combined
Company's suppliers to increase prices of materials and services to the
Combined Company, an increase in inflation could increase the Combined
Company's cost of revenue and operating expenses. The Combined Company
generally believes the Combined Company will be able to adjust its rates to
offset such increases. Because the Combined Company prices its services in
United States dollars, foreign currency exchange rates have not had, and are
not expected to have, a material effect on the Combined Company.
SEASONALITY
The Combined Company's business exhibits a small degree of seasonality.
Historically, the Combined Company's revenue (as well as sales in the
telecommunications industry in general) has decreased slightly in August and
December, which CSI attributes to vacations and holidays in its European and
Latin American markets and in the United States. As a result of these factors,
reported quarterly revenue in future periods will vary and are not indicative
of revenue in subsequent comparable periods.
ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) has issued FAS No. 128,
"Earnings per Share," FAS No. 129, "Disclosure of Information about Capital
Structure," FAS No. 130, "Reporting Comprehensive Income" and FAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" and FAS
No. 132, "Employers' Disclosures about Pensions and Other Post Retirement
Benefits. FAS No. 128 modifies the standards for computing and presenting
earnings per share and applies to entities with publicly held common stock or
potential common stock and is effective for periods ending after December 15,
1997, including interim periods; the Combined Company expects that the
adoption of this statement will have a negative effect on
24
previously presented or future earnings per share amounts. FAS No. 129
provides for increased disclosure information about an entity's capital
structure and is effective for periods ending after December 15, 1997; the
Combined Company does not expect the adoption of this standard to
significantly affect its capital structure disclosures. FAS No. 130
establishes standards for reporting and display of comprehensive income and
its components and is effective for years beginning after December 15, 1997;
the Combined Company does not believe the adoption of this Statement will have
an effect on earlier periods. FAS No. 131 modifies the disclosure requirements
for reportable segments and is effective for the Combined Company's year
ending April 30, 1999; the Combined Company has not determined if the effect
of the adoption of this Statement would require the Combined Company to report
industry segments. FAS No. 132 modifies the disclosure requirements for
pensions and other postretirement benefits and is effective for the Combined
Company's fiscal year ending April 30, 1999. The Combined Company currently
does not have any benefit plan that would be affected by this Statement.
YEAR 2000 STATEMENT
The computer system that runs ITC's switches and billing operation has not
yet been upgraded to be Year 2000 compliant. A new system called NTS 2000,
which is Year 2000 compliant, is expected to be released and implemented in
1998 at an estimated cost of $30,000 to the Combined Company.
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
CSI OVERVIEW
CSI was incorporated in April 1993 as a provider of international
telecommunications services. CSI had an accumulated deficit of approximately
$4.6 million as of October 31, 1997. CSI incurred significant net operating
losses totaling $633,000 and $2.5 million during the fiscal years ended April
30, 1995 and 1996, respectively, primarily because of low gross margins
resulting from contractual commitments with its primary long distance
carriers. Gross margin was approximately $582,000 for fiscal year 1995 and
approximately $778,000 for fiscal year 1996. Gross margin as a percent of
revenue was 29.4% and 11.5% for fiscal years 1995 and 1996, respectively. In
fiscal year 1997, CSI improved its gross margin to approximately $4.1 million,
or 34.6% of revenues, due to increased revenue and improved per unit costs
that principally resulted from lower rates charged CSI by long distance
carriers. As a result, CSI's net loss was reduced to $259,000 for the fiscal
year ended April 30, 1997.
In March 1997 and November 1997, CSI completed negotiations with its two
largest carriers to further improve its rate structure which resulted in
agreements that are expected to improve CSI's per unit carrier costs.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship to revenue of certain items in CSI's statements of operations:
SIX MONTHS ENDED
YEAR ENDED APRIL 30, OCTOBER 31,
----------------------- ------------------
1996 1997 1996 1997
---------- ---------- -------- --------
Revenue................... 100.0% 100.0% 100.0% 100.0%
Cost of revenue........... 88.5 65.4 65.2 59.7
Gross margin.............. 11.5 34.6 34.8 40.3
Operating expenses:
Sales and marketing..... 23.3 17.5 15.9 19.9
General and
administrative......... 18.7 11.0 11.0 20.8
Technical and
developmental.......... 5.8 6.1 5.3 6.1
Depreciation and
amortization........... 0.9 0.9 0.8 1.1
Total operating expenses.. 48.7 35.5 32.9 47.9
Income (loss) from
operations............... (37.2) (0.8) 1.8 (7.7)
Interest income
(expense)................ (0.3) (1.4) (1.4) (1.4)
Net income (loss)......... (37.4)% (2.2)% 0.4% (9.1)%
25
COMPARISON OF SIX MONTHS ENDED OCTOBER 31, 1996 AND 1997
Revenue. Revenue increased 15.2% from approximately $5.5 million for the six
months ended October 31, 1996 to $6.4 million for the six months ended October
31, 1997. The increase was due primarily to a 27.9% increase in billable
minutes from approximately 5.2 million billable minutes for the six months
ended October 31, 1996 to approximately 6.7 million billable minutes for the
six months ended October 31, 1997. The number of customers increased from
approximately 8,400 customers at January 31, 1997 to approximately 10,200
customers at January 31, 1998. The increase in customers, billable minutes,
and revenue was due to the improved performance of CSI's sales agent base.
Customers are defined as those persons or businesses who have used the
Combined Company's services within the previous four months. These increases
were offset by a 9.4% decrease in the average revenue per billable minute.
Cost of revenue. CSI's cost of revenue increased by 5.5% from approximately
$3.6 million in the six months ended October 31, 1996 to approximately $3.8
million for the six months ended October 31, 1997. As a percentage of revenue,
these costs decreased from 65.2% to 59.7% for the six months ended October 31,
1996 and 1997, respectively. As of March 1997, CSI had in place new
contractual commitments with its primary carriers reflecting more favorable
rates that resulted in improved gross margins during the six months ended
October 31, 1997. Management continues to negotiate improved pricing and
expects to continue to reduce costs per minute as a result of improved
technology which reduces the percentage of non-completed calls and therefore
reduces origination minutes and costs. Origination and destination segment
minute usage increased 27.0% from approximately 9.7 million switched minutes
for the six months ended October 31, 1996 to approximately 12.3 million
switched minutes for the six months ended October 31, 1997.
Sales and marketing. Sales and marketing expenses increased 44.9% from
$877,000 for the six months ended October 31, 1996 to $1.3 million for the six
months ended October 31, 1997. As a percentage of revenue, these costs
increased from 15.9% to 19.9% for the six months ended October 31, 1996 and
1997, respectively. The increase in absolute dollars was due primarily to an
increase in agent commissions caused by the increase in revenue, while the
increase as a percentage of revenue was due primarily to an increase in
advertising expense and hiring of additional internal sales personnel.
General and administrative. General and administrative expenses increased
117.7% from $609,000 for the six months ended October 31, 1996 to $1.3 million
for the six months ended October 31, 1997. As a percentage of revenue, these
costs increased from 11.0% to 20.8% for the six months ended October 31, 1996
and 1997, respectively. The significant increase in expenses was due to
several non-recurring costs incurred by CSI, including: a $215,000 reserve for
bad debt associated with a former sales agent; a $188,000 compensation expense
associated with a severance agreement with a former employee; a $50,000
accrued consulting fee to a director of CSI for negotiating a settlement with
a carrier and a more favorable contractual commitment to one of its primary
long distance carriers; and a $35,000 expense associated with the relocation
of CSI employees to the Combined Company's operations center in Florida.
Excluding these non-recurring costs, general and administrative expenses
increased 37.6% to $838,000 and increased to 13.2% of revenue. The remaining
increase in costs was due to additional customer support and administrative
personnel hired to support the growth of CSI's operations. CSI has implemented
internal control procedures to mitigate the risk of significant loss in the
future from individual sales agents. CSI continues to vigorously pursue the
collections of all bad debt expenses from former customers and sales agents.
Technical and developmental. Technical and developmental expenses are
primarily compensation paid to internal technical personnel, fixed telephone
circuit and line costs and other costs associated with the development,
operation and maintenance of CSI's proprietary products and services.
Technical and development expenses increased 32.3% from $294,000 for the six
months ended October 31, 1996 to $389,000 for the six months ended October 31,
1997. As a percentage of revenue, these costs increased from 5.3% to 6.1% for
the six months ended October 31, 1996 and 1997, respectively. The increase in
absolute dollars was due primarily to an increase in fixed telephone circuit
and line costs due to the significant increase in revenue. The Company expects
the technical and developmental expenses will increase in absolute dollars in
the near future as the Combined Company incurs additional costs related to the
installation of automated switching equipment and technical and developmental
costs associated with the Combined Company's enhanced services. The Combined
26
Company expects technical and developmental expenses to decrease as a
percentage of revenue in the future because revenue is expected to increase at
a rate greater than that of technical and developmental expenses.
Depreciation and amortization. Depreciation and amortization expense
increased 61.9% from approximately $42,000 for the six months ended October
31, 1996 to approximately $68,000 for the six months ended October 31, 1997.
These costs increased primarily as a result of CSI's higher fixed asset base
during the six months ended October 31, 1997 as compared with the six months
ended October 31, 1996. The Combined Company expects depreciation and
amortization expense to increase significantly in the future as the Combined
Company continues it growth strategy which includes purchases and
installations of automated switching equipment for its hotel and larger
business customers, purchases and installation of regional switches and
amortization of intangible assets associated with the ITC acquisition.
Interest income/expense. Interest income/expense, which represents primarily
interest expense, increased 15.8% from approximately $76,000 for the six
months ended October 31, 1996 to approximately $88,000 for the six months
ended October 31, 1997. Interest expense for the six months ended October 31,
1997 includes accrued interest of approximately $117,000 to one of CSI's
carriers, which was forgiven in December 1997 as a part of a settlement
agreement reached in October 1997. Interest and other expense will increase
significantly until completion of this Offering due to accrued interest
expense on the Bridge Notes, amortization of other debt offering costs,
accretion of the discount on the Bridge Notes associated with the December
1997 Financing and issuance of 113,600 shares of Common Stock (based on an
assumed initial offering price of $10.00 per Share).
Income taxes. CSI did not record an income tax expense or benefit for the
six months ended October 31, 1996 or 1997 but recorded valuation allowances to
offset the deferred tax asset due to the uncertainty of the ultimate
realization of the net operating loss carryforwards.
Net income/loss. CSI had a net loss of $577,000 for the six months ended
October 31, 1997 compared to net income of $24,000 for the six months ended
October 31, 1996. The decrease in net income was primarily due to significant
non-recurring expenses including a $215,000 bad debt expense from a sales
agent, a $188,000 compensation expense related to a severance agreement with a
former employee, a $50,000 accrued consulting fee to a director of CSI for
negotiating a more favorable contractual commitment to one of its primary
carriers, and $35,000 associated with relocation expenses. Excluding the
effects of these non-recurring costs, CSI would have incurred a net loss of
$89,000 for the six months ended October 31, 1997.
Net income/loss per share. CSI had a net loss per share of $ for the six
months ended October 31, 1997 compared to net income per share of less than
$ for the six months ended October 31, 1997. The change in per share
results was due primarily to an increase in net loss and by an increase in
weighted average shares outstanding.
EBITDA. EBITDA represents net earnings (loss) plus interest expense
(income), income taxes, depreciation and amortization. CSI had a negative
EBITDA of $421,000 for the six months ended October 31, 1997 compared to a
positive EBITDA of $142,000 for the six months ended October 31, 1996. The
decrease in EBITDA was primarily due to the non-recurring costs discussed
herein. Excluding the effects of these non-recurring costs, CSI would have a
positive EBITDA of $67,000 for the six months ended October 31, 1997.
COMPARISON OF FISCAL YEARS ENDED APRIL 30, 1996 AND 1997
Revenue. Revenue increased 76.0% from $6.7 million for the year ended April
30, 1996 to $11.9 million for the year ended April 30, 1997. This increase was
primarily due to growth in the number of customers and the resultant rise in
billable minutes. Billable minutes increased accordingly, reaching
approximately 11.5 million minutes in fiscal year 1997. The significant
increase in customers, billable minutes and revenue was primarily due to CSI's
efforts to increase its sales agent base in its target markets.
Cost of revenue. Cost of revenue increased 30.1% from $6.0 million for
fiscal year 1996 to $7.8 million for fiscal year 1997 and as a percentage of
revenue decreased from 88.5% to 65.4%, respectively. During fiscal year 1996,
CSI increased minute volume, in advance of its ability to secure more
favorable volume discount rates with its carriers.
27
Sales and marketing. Sales and marketing expenses increased 32.2% from $1.6
million for the year ended April 30, 1996 to $2.1 million for the year ended
April 30, 1997. As a percentage of revenue, these costs decreased from 23.3%
to 17.5% for the years ended April 30, 1996 and 1997, respectively. The
increase in absolute dollars was due primarily to commissions from increased
revenue while the decrease as a percentage of revenue was due primarily to
revenues increasing at a greater rate than marketing expenses and costs
associated with internal salespersons.
General and administrative. General and administrative expenses increased
3.5% from less than $1.3 million for the year ended April 30, 1996 to slightly
more than $1.3 million for the year ended April 30, 1997. As a percentage of
revenue, these costs decreased from 18.7% to 11.0% for the years ended April
30, 1996 and 1997, respectively. The increase in costs were due to additional
customer support and administrative personnel hired to support the growth of
CSI's operations.
Technical and developmental. Technical and developmental expenses increased
83.2% from $394,000 for the year ended April 30, 1996 to $722,000 for the year
ended April 30, 1997. As a percentage of revenue, these costs increased from
5.8% to 6.1% for the years ended April 30, 1996 and 1997, respectively. The
increase in absolute dollars was due primarily to an increase in fixed
telephone circuit and line costs due to the significant increase in revenue
and to increased costs associated with the development of CSI's transparent
automated call processors.
Depreciation and amortization. Depreciation and amortization expenses
increased 77.6% from approximately $58,000 for fiscal year 1996 to
approximately $103,000 for fiscal year 1997. These expenses increased
primarily as a result of CSI's higher fixed asset base in fiscal year 1997
which was principally due to investments in telecommunications equipment and
infrastructure and facility expansion.
Interest income/expense. Interest income/expense, which represents primarily
interest expense, increased from approximately $19,000 for the year ended
April 30, 1996 to approximately $162,000 for the year ended April 30, 1997.
The increase in interest expense was due primarily to the issuance of notes
payable to satisfy carrier obligations.
Income taxes. CSI did not record an income tax benefit in either fiscal year
1996 or 1997 but recorded valuation allowances to offset the deferred tax
asset due to the uncertainty of the ultimate realization of the net operating
loss carryforwards. As of April 30, 1997, CSI had federal net operating loss
carryforwards of approximately $3.4 million. These carryforwards will begin
expiring in the year 2009. The amount of these carryforwards that can be used
in any given year may be limited in the event of certain changes in the
ownership of CSI. CSI is currently not able to determine the effect that a
change in ownership that will result from this Offering may have on CSI's
ability to use its net operating loss carryforwards.
Net loss. The net loss decreased from $2.5 million for the year ended April
30, 1996 to $259,000 for the year ended April 30, 1997. The decrease in net
loss was primarily due to CSI's obtaining more favorable carrier rates and
increases in customer volume.
Net income (loss) per share. CSI had net loss per share of $ for the year
ended April 30, 1997 compared to net loss per share of $ for the year ended
April 30, 1996. The decrease in net loss per share was due primarily to CSI's
obtaining more favorable carrier rates and increases in customer volumes as
well as an increase in the weighted average number of shares outstanding.
EBITDA. CSI had a negative EBITDA of $2.5 million for the year ended April
30, 1996 compared to a positive EBITDA of $6,000 for the year ended April 30,
1997. The increase in EBITDA was primarily due to CSI's obtaining more
favorable carrier rates resulting in improved gross margin percentages and
overall operating results.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, CSI has experienced net losses and negative cash flow
from operations. As of October 31, 1997, CSI had a working capital deficit of
approximately $2.0 million. CSI has satisfied its capital
28
requirements principally through a combination of sales of equity and debt
securities, borrowings from third parties (including its shareholders) and
trade credit extended by carriers. The proceeds from the issuance of stock and
notes were used for development and expansion, and other general corporate
purposes, including working capital. During fiscal year 1996 and 1997, CSI
issued shares of its Common Stock for aggregate proceeds of $537,000 and
$111,000, respectively, and generated additional working capital of $320,000
through the issuance of convertible notes. The notes bear interest at the rate
of 10% per annum and mature two years after issuance. In fiscal year 1998,
$95,000 of principal amount of such notes were also issued. The notes are
convertible into shares of Common Stock at a conversion price equal to 90% of
the average of the bid and ask price on the day preceding the date of
conversion. As of October 31, 1997, $375,000 of the convertible notes had been
converted. In fiscal year 1997, CSI also raised $85,000 through the issuance
of notes that bear interest at 15% per annum and mature in March 1998. In
December 1997, the Company issued Bridge Notes in the principal amount of
$2,840,000. The Bridge Notes bear interest at 10% per annum and are due five
days following the closing of this Offering. See "Description of Securities."
Net cash used in operating activities was approximately $25,000 for the six
months ended October 31, 1997, as compared to cash provided by operating
activities of approximately $406,000 for the six months ended October 31,
1996. The decrease in cash provided was primarily due to a $601,000 decrease
in net income offset by an increase in accounts payable and accrued expenses.
Net cash used in investing activities was approximately $163,000 for the six
months ended October 31, 1997, as compared to approximately $178,000 for the
six months ended October 31, 1996. The increase was primarily due to
acquisition to ITC. Net cash provided by financing activities was
approximately $185,000 for the six months ended October 31, 1997, compared to
cash used in financing activities of approximately $208,000 for the six months
ended October 31, 1996. The increase in cash provided was primarily due to
proceeds from the issuance of stock, net of cash payments to acquire treasury
stock from former CSI employees, and decreased debt service requirements.
Net cash provided by operating activities was approximately $730,000 for the
year ended April 30, 1997, as compared to cash used in operating activities of
approximately $362,000 for the year ended April 30, 1996. The increase in cash
provided was primarily due to a $2.3 million decrease in net loss and by an
increase in accounts payable of approximately $911,000. Net cash used in
investing activities was approximately $244,000 for the year ended April 30,
1997, as compared to approximately $223,000 for the year ended April 30, 1996.
The increase was primarily due to acquisition standstill payments to ITC. Net
cash used in financing activities as approximately $397,000 for the year ended
April 30, 1997, compared to cash provided by financing activities of
approximately $560,000 for the year ended April 30, 1996. The increase in cash
used was primarily due to repayment of notes payable, net of proceeds from the
sale of stock and issuances of notes.
During fiscal year 1996 and 1997, CSI incurred usage fees, which it was
unable to pay on a current basis, with two of its primary carriers totaling
approximately $2.0 million. In February 1997, CSI restructured these
obligations and converted all amounts into notes bearing interest ranging from
10% to 12% payable in monthly installments ranging from $40,000 to $123,000
through August 1997 and $40,000 thereafter through January 2001. In December
1997, all carrier obligations were paid in full from the proceeds of the
Bridge Financing. CSI anticipates that its minimum commitments to carriers
(exclusive of any carrier commitments of ITC) will be approximately $3.7
million and $1.45 million for fiscal year 1998 and fiscal year 1999,
respectively.
Although CSI realized a significant increase in revenue, a greater
percentage of CSI's customers paid amounts due by credit card, thus resulting
in lower receivable balances in relation to revenue billed. CSI is
experiencing improved cash flow from increased volume, a higher percentage of
credit card customers which enhances collections, improved pricing structure,
least cost routing, reduced carrier costs and the implementation of cost
containment policies.
CSI believes that, based upon its present business plan, the net proceeds
from the sale of the Shares offered hereby, together with its increased cash
flow from operations, will be sufficient to meet its currently anticipated
working capital and capital expenditure requirements for at least the next 12
months. Thereafter, if cash generated from operations is insufficient to
satisfy the Combined Company's requirements, the Combined Company would likely
seek to establish credit facilities or sell additional securities.
29
INTERNATIONAL TELEPHONE COMPANY
ITC OVERVIEW
ITC was incorporated in March 1993 as a provider of international
telecommunications services. ITC had an accumulated deficit of approximately
$782,000 as of October 31, 1997 primarily because ITC reported a net loss of
approximately $850,000 for the ten months ended October 31, 1997. The net loss
includes a $1.1 million claim against ITC by a carrier for usage charges, a
portion of which ITC is disputing. ITC was committed to purchase transmission
capacity from WorldCom, but was not able to meet these minimum usage
commitments due to the unavailability of sufficient capacity from the carrier.
ITC is currently negotiating with the carrier to resolve the dispute and has
requested credits from the carrier for the minimum usage charges and losses
incurred by ITC resulting from the carrier's inability to provide ITC with
sufficient capacity. ITC and the carrier have not reached a settlement. ITC
intends to vigorously defend its position and will continue to attempt to
reach a settlement with the carrier.
RESULTS OF OPERATIONS
Due to the pendency of the ITC Acquisition, ITC's financial statements are
being presented for the period ending October 31, 1997. The statement of
operations data for the ten months ended October 31, 1997 is therefore not
directly comparable to the statement of operations data for the year ended
December 31, 1996. The results of operations for the ten-month period ended
October 31, 1997 may also not be reflective of results achieved in the 12
months ended December 31, 1997. The following table sets forth, for the
periods indicated, the percentage relationship to revenue of certain items in
ITC's statements of operations:
YEAR ENDED TEN MONTHS ENDED
DECEMBER 31, 1996 OCTOBER 31, 1997
----------------- ----------------
Revenue...................................... 100.0% 100.0%
Cost of revenue.............................. 66.7 84.3
Gross margin................................. 33.3 15.7
Operating expenses:
Sales and marketing........................ 14.5 8.9
General and administrative................. 19.0 17.2
Technical and developmental................ 0.0 0.0
Depreciation............................... 0.9 0.9
Total operating expenses..................... 34.4 (27.0)
Income (loss) from operations................ (0.1) (11.3)
Interest and other income (expense).......... 0.1 0.7
Income (loss) before taxes................... 0.0 (10.6)
Income tax expense........................... 0.0 0.0
Net income (loss)............................ 0.1 (10.6)
COMPARISON OF TEN MONTHS ENDED OCTOBER 31, 1997 TO THE YEAR ENDED DECEMBER 31,
1996
Revenue. Revenue increased 5.9% from approximately $7.6 million for the year
ended December 31, 1996 to approximately $8.1 million for the ten months ended
October 31, 1997. The increase is due primarily to an increase in billable
minutes. During this period of time, the number of customers, billable
minutes, and revenue increased due to an increase in ITC's sale agent base as
well as the improved performance of ITC's existing sales agent base.
Cost of revenue. Cost of revenue increased 33.9% from approximately $5.1
million for the year ended December 31, 1996 to approximately $6.8 million for
the ten months ended October 31, 1997. As a percentage of revenue, these costs
increased from 66.7% to 84.3% for the periods ended December 31, 1996 and
October 31, 1997, respectively. The increase in cost of revenue is due to an
increase in origination and destination segment minute usage as well as the
carrier dispute previously discussed. The increased cost of revenue as a
30
percentage of total revenue was due to an increase in revenue from wholesale
services as a percentage of total revenue, which has lower gross margin
percentages, and an increase in costs associated with the carrier dispute.
Sales and marketing. Sales and marketing expenses decreased from
approximately $1.1 million for the year ended December 31, 1996 to
approximately $715,000 for the ten months ended October 31, 1997. As a
percentage of revenue, sales and marketing decreased from 14.5% to 8.9% for
the periods ended December 31, 1996 and October 31, 1997, respectively. The
decrease was due primarily to lower commissions to agents resulting from an
increase in the revenue from wholesale services, which the Company does not
pay.
General and administrative. General and administrative expenses decreased
4.0% from over $1.4 million for the year ended December 31, 1996 to slightly
under $1.4 million for the ten months ended October 31, 1997. The decrease in
these costs was due primarily to the different length of the time periods
presented.
Depreciation. Depreciation expense increased 5.8% from approximately $69,000
for the year ended December 31, 1996 to approximately $73,000 for the ten
months ended October 31, 1997. These costs increased primarily as a result of
ITC's higher fixed asset base during the ten months ended October 31, 1997 as
compared with the year ended December 31, 1996 related to the acquisition of
telecommunication equipment.
Interest and other income/expense. Interest and other income/expense
decreased 32.6% from approximately $88,000 for the year ended December 31,
1996 compared to approximately $62,000 for the ten months ended October 31,
1997. The decrease in interest and other income/expense was due primarily to
an increase in other expenses related to a loss on the sale of equipment and
an increase in interest expense related to a capital lease obligation incurred
to acquire telecommunications equipment. ITC also had consulting fees totaling
approximately $113,000, net of related consulting expenses, received from CSI
in conjunction with ITC assisting CSI in the settlement of a note with a
carrier.
Income taxes. ITC did not record an income tax benefit for the ten months
ended October 31, 1997 but recorded valuation allowances to offset the
deferred tax asset due to the uncertainty of the ultimate realization of the
net operating loss carryforwards. ITC recorded an income tax expense of $4,000
for the year ended December 31, 1996.
Net income/loss. ITC reported a net loss of approximately $850,000 for the
ten months ended October 31, 1997 compared to net income of approximately
$7,000 for the year ended December 31, 1996. The net loss includes a $1.1
million claim against ITC by a carrier for usage charges, a portion of which
ITC is disputing.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was approximately $626,000 for the
ten months ended October 31, 1997, as compared to cash provided by operating
activities of approximately $286,000 for the year ended December 31, 1996. The
increase in cash provided was primarily due to a net loss of $850,000 offset
by an increase in accounts payable of $1.2 million and a decrease in accounts
receivable of $180,000. Net cash provided by investing activities was
approximately $242,000 for the ten months ended October 31, 1997, as compared
to cash used in investing activities of approximately $29,000 for the year
ended December 31, 1996. The increase was primarily due to proceeds received
from the sale of telecommunications equipment. Net cash used in financing
activities was approximately $238,000 for the ten months ended October 31,
1997, compared to cash used in financing activities of approximately $186,000
for the year ended December 31, 1996. The change was due primarily to an
increase in capital lease payments related to the acquisition of
telecommunications equipment.
31
BUSINESS
GENERAL
Communications Systems International, Inc. is a growing provider of
international long distance telecommunications services principally to
customers in South America, Europe, the Pacific Rim, South Africa and Central
America. CSI emphasizes innovative software solutions and technical expertise
to provide higher quality, lower cost alternative routing of
telecommunications for its customer base. CSI is focusing its marketing
efforts on high volume customers such as hotels, large local businesses and
foreign branches of multinational businesses in addition to individuals and
small businesses. International Telephone Company is a provider of
international long distance telecommunications service principally to
customers in Africa, Europe and the Middle East. Existing customers of the
Combined Company include the Inter-Continental Hotel in Rio de Janeiro, Brazil
and foreign offices of Nike Inc., Microsoft Corporation, Mitsubishi
Corporation, Chrysler International, Warner Lambert Corporation, Diners Club
International, DHL Aviation, Holiday Inn Hotels, Best Western Hotel, Wal-Mart
Stores, Inc., Citibank, N.A., Bank of Tokyo, Royal Bank of Canada and the
United States embassies in Chile, Korea, Australia and the Ukraine, the United
Nations consulate in South Africa and other countries' embassies and
international agencies.
THE ITC ACQUISITION
The ITC Acquisition is CSI's first step in its acquisition strategy. ITC is
a provider of international long distance telecommunication services, with
approximately $7.6 million in revenue for the year ended December 31, 1996 and
$8.1 million for the ten months ended October 31, 1997 and approximately 8,800
customers. ITC currently focuses its marketing efforts on individuals and
small businesses.
Although ITC provides services to customers in many regions of the world,
ITC primarily targets customers in Europe, Africa and the Middle East. These
three regions comprised approximately 33.2%, 33.7% and 14.7%, respectively, of
ITC's revenue for the ten months ended October 31, 1997.
Sales of ITC's call-reorigination services are conducted through a network
of approximately 55 independent sales agents based in the countries in which
ITC conducts business. The sales agents have engaged approximately 100 sub-
agents to assist in sales and marketing on behalf of ITC. The agents earn
commissions on revenue collected from their customers. ITC generally recruits
agents through advertisements in international newspapers.
ITC services its customers through a switching platform located at its
telecommunications center in Ft. Lauderdale, Florida. The center is a fiber
optic facility that directs international telephone and facsimile traffic and
has a broad spectrum of Internet capabilities. ITC's facility includes an
integrated management information system and switching platform, which
enhances ITC's ability to provide least cost routing and efficient billing of
its customers.
CSI believes that the acquisition of ITC will provide a number of advantages
to the combined entity. These advantages include:
Combined Cost Structures. Although there can be no assurance, management
believes the integration of existing cost structures will result in
immediate savings. ITC has traditionally concentrated its marketing on
Africa and Europe, while CSI has focused on South America. As a result,
through relationships with their respective carriers, each company believes
it has achieved superior rate structures in its area of emphasis. CSI
anticipates that the combined entity will integrate the best of both rate
structures, realizing cost reductions on each of the pre-existing customer
bases.
Increased Buying Power with Carriers. CSI entered into a reciprocal
telecommunications agreement with ITC in July 1997 (the "Reciprocal
Telecommunications Agreement"), which entitles CSI to use ITC's volume of
minutes, in addition to its own, to negotiate with carriers for reduced
rates. As a result, the Combined Company is beginning to realize additional
savings via its increased bargaining power with its carriers. CSI believes
minimum volume commitments will be easier to fulfill, and will be increased
where there are cost benefits, while redundancy in carrier deposits may be
eliminated when the ITC Acquisition is consummated.
32
Customer and Agent Diversification. As the combined entity attains
greater geographic diversity, management believes capacity efficiencies can
be achieved by spreading traffic more evenly over the 24-hour day.
Equipment and personnel can be allocated and optimized over 24 hours,
rather than over the shorter "peak" periods associated with each continent.
This diversification also reduces the concentration of the Combined
Company's exposure to regulatory and business risk and reduces its
dependence upon individual sales agents.
Additional Products. In addition to the basic telecommunications products
and services presently offered by CSI, the ITC switch makes it possible for
CSI to significantly expand its wholesale business, and to introduce new
value-added services such as facsimile, debit card and hotel long-distance
operator services to its hotel and business customers. The Combined Company
also will have the opportunity to market CSI's proprietary DIAL and LINK-US
transparent, automated, call re-origination systems through ITC's
established agent network in Europe, the Middle East and Africa.
Elimination of Redundant Overhead. The Combined Company believes it will
be able to reduce employee headcount and its hiring of outside contractors
through the consolidation of functional areas such as accounting, customer
service and technical operations. The Combined Company intends that
marketing services, accounting and administration functions will be
centralized in Colorado Springs, Colorado, while technical and customer
service functions will reside in Fort Lauderdale, Florida.
Personnel Experience and Expertise. Both ITC and CSI possess broad
telecommunications industry experience. The Combined Company anticipates
that synergies will be achieved in the areas of marketing, collections,
customer provisioning, carrier relationships, development and enhancement
of switch technologies and Internet expertise.
CSI has entered into an agreement in principle to acquire all of the
outstanding capital stock of ITC for $3.1 million in cash and 207,000 shares
of Common Stock based on an assumed initial offering price of $10.00 per
Share, to be issued on the first anniversary of the closing of this Offering.
A portion of the cash will be held in escrow for one year to secure certain
indemnification obligations of the stockholders of ITC. ITC is currently owned
by Lynch Family, LLC, Philip Thomas and Sean Thomas. Upon completion of the
ITC Acquisition, Philip Thomas and Sean Thomas will become employees of the
Combined Company. The ITC Acquisition is conditioned upon, and will occur
immediately following, the consummation of this Offering. See the Financial
Statements and the Notes related thereto included elsewhere in this
Prospectus.
INDUSTRY OVERVIEW
International telecommunications services consist of wire and cable,
wireless and satellite transmissions that originate in one country and
terminate in a different country. The international long distance
telecommunications services market is divided into two major segments:
telecommunications that either originate or terminate in the United States;
and telecommunications between countries other than the United States. The ITU
estimates that in 1995, the international long distance telecommunications
services market was approximately $53 billion, with AT&T, Deutsche Telekom AG,
MCI, France Telcom and British Telecommunications plc generating the largest
share of global long distance carrier revenue, and numerous other
telecommunications carriers and resellers accounting for the balance of the
market. The ITU projects that by the year 2000 revenue will approach $76
billion with the volume of traffic expanding to 107 billion minutes of use.
Based on information available to the Company from the ITU and
telecommunications industry sources, the call-reorigination and call through
segments of the telecommunications industry accounted for approximately $1.4
billion in revenue in 1997 and is growing at a rate of approximately 15% per
year. Historically, ITOs provided all of the telephone services required by
their respective countries, leaving customers with no choice but to use those
services and pay the prices charged by ITOs. Additionally, ITOs have
historically controlled much of the inter-country traffic. Due to this lack of
competition, the historical cost of making international telephone calls from
points of origin outside of the United States has been significantly higher
than that of making international calls from inside the United States. In
connection with increasing deregulation in international markets,
telecommunications providers such as the Combined Company offered savings over
the rates charged by local telephone companies in countries with
33
regulated telecommunications markets through a process known as "call-
reorigination." Call-reorigination technology allows telecommunications
providers to purchase telecommunications capacity from service providers
outside the regulated countries at lower rates and resell the service to
customers at a favorable rate relative to that offered by the local telephone
companies. The reduced costs afforded by call-reorigination technology,
coupled with the introduction of value-added services such as debit cards,
facsimile and data transmission, have resulted in new competitors to ITOs in
providing international telecommunications services.
CSI believes that continuing deregulation of international
telecommunications markets coupled with technological advances will lead to
increased international competition similar to that within the United States.
Specifically, CSI believes that increased utilization of high-speed fiber
optic cable and technologically advanced switching software may increase
capacity, speed and quality and may offer value-added features while reducing
cost. CSI believes that these developments will result in decreased demand for
basic, traditional call-reorigination services in deregulated markets, but
that these factors should also lead to increased traffic volume for high
quality, state-of-the-art international facilities-based carriers with an
established customer base, carrier relationships and switches.
The international telecommunications industry provides voice and data
transmission from one national telephone network to another. The industry has
experienced dramatic changes during the past decade that have resulted in
significant growth in the use of services and in enhancements to technology.
The industry is expecting similar growth in revenue and traffic volume in the
foreseeable future. The market for telecommunications services is highly
concentrated, with Europe and the United States accounting for approximately
43% and 25%, respectively, of the industry's worldwide minutes of use in 1995.
AT&T, Deutsche Telecom, MCI, France Telecom and BT originated approximately
40% of the aggregate international long distance traffic minutes in 1995.
Growth and change in the international telecommunications industry have been
fueled by a number of factors, including greater consumer demand,
globalization of the industry, increases in international business travel,
privatization of ITOs, and growth of computerized transmission of voice and
data information, including the Internet. These trends have sharply increased
the use of, and reliance upon, telecommunications services throughout the
world. CSI believes that despite these trends, a high percentage of the
world's businesses and residential consumers continue to be subject to high
prices with poor quality of service which have been characteristic of many
ITOs. Demand for improved service and lower prices has created opportunities
for private industry to compete in the international telecommunications
market. Increased competition, in turn, has spurred a broadening of products
and services, and new technologies which have contributed to improved quality
and increased transmission capacity and speed.
Consumer demand and competitive initiatives have also acted as catalysts for
government deregulation, especially in developed countries. Deregulation in
the domestic interstate long distance market accelerated in the United States
in 1984 with the divestiture by AT&T of the RBOCs. Today, there are over 500
U.S. long distance companies, most of which are small- or medium-sized
companies. In order to be successful, these small- and medium-sized companies
have to offer their customers a full range of services, including
international long distance. However, most of these carriers do not have the
critical mass of customers to receive volume discounts on international
traffic from the larger facilities-based carriers such as AT&T, MCI and
Sprint. In addition, these small- and medium-sized companies have only a
limited ability to invest in international facilities. Alternative
international carriers such as the Combined Company have capitalized on this
demand for less expensive international transmission facilities. These
emerging international carriers are able to take advantage of larger traffic
volumes to obtain volume discounts on international routes (resale traffic)
and/or invest in facilities when volume on particular routes justify such
investments. As these emerging international carriers have become established,
they have also begun to carry overflow traffic from the larger long distance
providers that own overseas transmission facilities.
On February 15, 1997, pursuant to the WTO Agreement, which became effective
on February 5, 1998, 69 members, including the United States, of the WTO
agreed to open their respective telecommunications markets
34
to competition and foreign ownership committed to and adopted regulatory
measures to protect market entrants against anticompetitive behavior by
dominant telecommunications providers. Although CSI believes that the WTO
Agreement could provide the Combined Company with significant opportunities to
compete in markets that were not previously accessible, the WTO Agreement
could also provide similar opportunities to the Combined Company's
competitors. In some countries, for example, the Combined Company will be
allowed to own facilities or to interconnect to the public switched network on
reasonable and non-discriminatory terms. There can be no assurance, however,
that the pro-competitive effects of the WTO Agreement will not have a material
adverse effect on the Combined Company's business, financial condition and
results of operations or that members of the WTO will implement the terms of
the WTO Agreement.
By eroding the traditional monopolies held by ITOs, many of which are wholly
or partially government owned, implementation of the WTO Agreement will
provide U.S.-based providers the opportunity to negotiate more favorable
agreements with both the traditional ITOs and emerging foreign providers. In
addition, deregulation in certain foreign countries will enable 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.
BUSINESS STRATEGY
The Combined Company is a switch-based reseller of international, long
distance telecommunications products and services within South America,
Europe, the Middle East, Africa, Pacific Rim and Central America markets.
Management's strategy is to grow its business through aggressive marketing and
agent expansion programs, provision of higher margin products and provision of
enhanced services such as Internet fax and its proprietary DIAL and LINK-US
automated call processors, and strategic acquisitions of complementary
telecommunications companies and customer bases. CSI believes that its DIAL
and LINK-US high volume, automated call processors and high quality service
provide it with advantages over other similar telecommunications providers. As
regulatory and competitive environments around the world evolve and change,
CSI expects to respond in a prudent fashion to maintain and increase its
customer base and competitive position. Key elements of CSI's business
strategy include the following:
Integrate ITC. In July, 1997, CSI entered into a Reciprocal Operating
Agreement with ITC wherein the two companies agreed to combine their
respective technologies and operating strengths in order to take advantage
of resulting synergies and economies of scale. This relationship has
yielded improved rates from carriers; greater CSI and ITC flexibility in
marketing new, customized wholesale and retail products; and improved CSI
cost savings due to superior least-cost routing capabilities of the ITC
switch and its location at a major telecommunication's gateway for
terminating Latin American traffic. In addition to overall carrier rate
reductions, ITC has also benefited from CSI's automated, Internet
triggering technology allowing it to expand its customer base in Middle
Eastern markets where standard call-reorigination has not been an effective
product offering.
Management of CSI believes that the Combined Company will generate
additional synergies and efficiencies. In order to increase revenue, the
Combined Company will offer new and expanded products and services, such as
its proprietary DIAL and LINK-US high volume PBX installations and Internet
fax products, to ITC's existing agents in Europe, the Middle East and
Africa. To decrease costs, the Combined Company intends to optimize its
equipment utilization over a full 24-hour day at the Ft. Lauderdale
operations and customer service center. In addition, consolidation of
administrative, financial and customer service staffs should yield
additional efficiencies.
Increase Number of Larger Customers Through the Deployment of Transparent
Technology. The Combined Company's customers consist primarily of small
businesses and individuals who do not require transparent service and who
are rate sensitive. CSI has developed its proprietary DIAL and LINK-US
35
transparent technologies that, coupled with its offering of other
transparent technologies manufactured by other suppliers, are attractive to
high volume customers, such as hotels, embassies and the local offices of
large multinational businesses which are seeking improved international
telecommunications services. CSI has found that its target market of hotel
and other business customers are willing to pay a premium for high quality,
transparent access to call-reorigination services. CSI has installed
transparent switches in hotels and in offices of large multinational
companies located in Brazil, South Africa and Argentina. Following
completion of the ITC Acquisition, CSI expects ITC's sales force, which
does not currently market transparent technologies to its customers, to
begin marketing transparent services to large customers in ITC's target
markets as well as to ITC's current customer base.
Rapidly Expand Service Offerings. For existing and potential hotel and
multinational business customers, the Combined Company is developing a
complement of enhanced services, including operator services for hotel
customers, custom debit calling cards, Internet/private network fax and
data services with substantial savings over normal telephone rates, and
Internet-managed conference calling.
Increase Sales Agent Base and Sales and Marketing Activities. The
Combined Company has a network of approximately 95 local sales agents and
400 sub-agents employed by such sales agents. CSI believes that it can most
effectively increase its customer base and revenue through the attraction
of qualified additional local sales agents, and believes that it can
attract sales agents because of its advanced technology, its focus on
higher volume hotel and business customers and its emphasis on high quality
service. The Combined Company also will seek to expand its business by
increasing its sales and marketing activities and by hiring additional
personnel to support its increased sales and marketing efforts.
Utilize Technology to Reduce Costs. The Combined Company is seeking to
reduce its costs through the use of automated "least cost routing" of its
call segments. The Combined Company's least cost routing system coordinates
the worldwide process of selecting the lowest cost route for each call
based on the time of day and the requirements for optimal quality among
available routes. The Combined Company, under the Reciprocal
Telecommunications Agreement, runs its telecommunications traffic over
ITC's switch, taking advantage of its least cost routing capabilities and
its proximity to the South American switch gateway. In addition, this
switch platform enhances the Combined Company's ability to provide
customized wholesale services. In addition, where conditions warrant, the
Combined Company also plans to install switches capable of performing least
cost routing in Europe, South America, the Pacific Rim and elsewhere to
achieve cost savings by reducing the need to route a call through the
United States. Instead, calls would use the long distance services of non-
U.S. countries that have favorable rates. The Combined Company has acquired
full Internet capability to provide a wide range of enhancements to its
services. These include lower cost transmission of data and facsimile
traffic, assisting in least cost routing and providing real time billing
and accounting information.
Pursue and Implement Strategic Acquisitions. As a key part of its growth
strategy, the Combined Company intends to actively pursue and execute
strategic acquisitions of complementary international customer bases,
products and telecommunications companies. ITC is the first such
significant acquisition. Management believes the worldwide
telecommunications industry will continue to undergo a period of strong
consolidation activity due to the general cost advantages of economies of
scale associated with larger operations. The Combined Company intends on
being an active participant during this consolidation period acquiring
those products and companies that fit its strategy of providing business
and other customers with high quality, state-of-the-art telecommunications
service.
Broaden and Improve Strategic Relationships with U.S. Carriers and
International Telecommunications Providers. The Combined Company intends to
forge strategic alliances with major U.S. and international
telecommunications companies when and where such alliances can be an
advantage to the Combined Company. Such alliances may be attractive in the
case of large corporate accounts involving multiple locations of high
volume international long distance traffic. This business potential is
possible due to CSI's capabilities using its proprietary DIAL and LINK-US
PBX automated call-reorigination installations in Brazil and South Africa.
36
SERVICES
Call-reorigination. The largest segment of the Combined Company's business
involves call-reorigination services. When the Combined Company provides call-
reorigination service, it connects its international customers to the U.S.
telephone system via computer triggering, which makes each international
customer's call originate in the U.S. As a result, the customer's call cost
structure is based on the lower charges of the U.S. telecommunications
marketplace. The Combined Company provides two basic types of call-
reorigination: transparent and non-transparent. When customers use the
Combined Company's transparent call-reorigination service, callers may not
even be aware they are using call-reorigination because transparent call-
reorigination requires no additional actions by the caller other than the
normal dialing process. When customers use the Combined Company's non-
transparent call-reorigination service, they are required to make an initial
telephone call to the Combined Company's computer and then wait for a "call
back" from the Combined Company's computer to complete the call. As of the
date of this Prospectus, most of the Combined Company's customers utilize non-
transparent call-reorigination services. Customers who use non-transparent
call-reorigination typically are individuals or smaller businesses. The
Combined Company intends to focus its future sales and marketing efforts
toward recruitment of larger transparent call-reorigination customers.
Non-transparent Call-reorigination. Customers of the Combined Company that
do not make a large number of international calls, usually residential
customers and some small businesses, do not normally require or demand
transparent call-reorigination, which is more expensive and requires more
sophisticated equipment. These customers are each assigned a special telephone
number to dial when they want to make an international call. The caller dials
this special number that triggers the Combined Company's computer to make the
call-reorigination. Because the computer does not answer the call, the caller
is not charged for a completed call. When the caller answers the call-
reorigination, he or she can dial any location in the world via the Combined
Company's computer and typically at lower rates than those charged by the ITO.
The Combined Company believes that the quality of the calls made using the
Combined Company's system is normally as good as, or better than, the quality
obtained by using the ITO. Approximately 81% of the Combined Company's traffic
is currently non-transparent.
Transparent Call-reorigination. CSI has developed advanced call triggering
methods which, when used along with standard triggering methods and
commercially available, state-of-the-art call processing devices, provide
transparent access to the Combined Company's call-reorigination system. These
methods take advantage of global data networks such as X.25, Internet and
frame relay, and digital services such as Integrated Services Digital Networks
(ISDN), to provide extremely fast and reliable call-reorigination initiation.
The Combined Company currently utilizes the X.25 network in Brazil and
Argentina and the Internet in Brazil, Argentina, Venezuela, South Africa and
Lebanon to facilitate the call-reorigination process. The Combined Company
plans to have Internet triggering installed in Singapore and New Zealand in
the near future. The utilization of proprietary, software-based triggering
methods and commercially produced, full-featured call processing devices
provide the Combined Company with a transparent solution to a wide array of
telecommunications situations. The Combined Company is able to quickly adapt
its call processors to virtually any type of customer's requirements,
providing extremely fast and reliable service.
CSI's transparent call processors function by recognizing the customer's
dialed digits and routing the customer's call through a predetermined route
for call completion. When a call processor recognizes the initiation of an
international call, typically by detecting the leading "00" in a customer's
dialed string, the call processor triggers the Combined Company's switch in
the United States, indicating that a call-reorigination has been requested by
the call processor at the customer's site. The call-reorigination request is
processed and the call processor receives the call-reorigination, often by the
time the customer has finished dialing his or her international call. The call
processor answers the incoming call-reorigination and immediately sends the
international number dialed by the customer to the Combined Company's switch,
which places the call on another outgoing telephone line to the number dialed
by the customer. The call-reorigination call to the customer and the call to
the customer's dialed destination are then joined and the international call
is completed. This procedure, while complex in nature, actually only takes a
few seconds to occur.
37
CSI has developed proprietary call processors called "DIAL" and "LINK-US,"
which allow hotels and other large businesses that have PBX telephone systems
to use its transparent call-reorigination services. Prior to the development
of this proprietary technology, the PBX telephone systems used by these
organizations were incompatible with CSI's switching technology. The Company
installs its PBX processors in hotels and large businesses and offers similar
but less sophisticated and less expensive switches that are manufactured by
third parties to small businesses and other customers.
CSI estimates that approximately 19% of the Combined Company's traffic is
currently routed through transparent call processors. The Combined Company has
approximately 200 DIAL and five LINK-US as well as approximately 200 other
transparent call processors installed at various hotels and businesses. DIAL
or LINK-US processors or other transparent call-reorigination processors are
installed at the Inter-Continental, Caesar Park, Copacabana Palace, Marina
Palace and Atlantico Hotels in Rio de Janeiro, and the Austacem business park
in Sao Paulo, several Holiday Inns in South Africa and are proposed to be
installed in several additional hotels and businesses in Brazil, Argentina,
South Africa and Hong Kong.
RELATED SERVICES
In addition to call-reorigination service, the Combined Company intends to
offer facsimile and debit card services. The Combined Company plans to provide
value-added services such as hotel operator services and Internet services.
The Combined Company currently provides domestic long distance reselling as an
agent for several domestic carriers.
Hotel Operator Services and Other Hotel Services. The Combined Company plans
to introduce operator services for hotel customers. With operator services in
place, a hotel guest seeking to use his credit card to "dial around" the hotel
system is routed via the Combined Company's call-reorigination system to an
international operator. The call is billed on the guest's credit card once the
card is validated. The hotel normally would not receive the revenue from these
calls. The Combined Company may share a small percentage of its revenue from
operator services with the hotel by agreement in order to introduce operator
services into the hotel. The Combined Company intends to offer a variety of
other services to hotel customers and their guests, including direct dial
call-reorigination, facsimile and Internet services, voice-mail and debit card
services.
Wholesale Long Distance Reselling. The Combined Company intends to expand
its wholesale call-reorigination services. The provision of wholesale services
enables the Combined Company to resell its services to companies and sales
agents wanting to sell long distance services under their own names. Companies
and sales agents purchasing wholesale services will receive such services at
rates below the retail rates the Combined Company traditionally charges its
retail customer because the Combined Company will not incur the overhead costs
associated with servicing retail accounts. The Combined Company will be able
to provide customized billing formats and rate structures for its wholesale
clients. The Combined Company anticipates that the additional traffic from
wholesale customers will enable it to negotiate further rate reductions with
its carriers.
Facsimile Services. The Combined Company offers its customers the ability to
send quality, high-speed facsimiles internationally. The Combined Company
currently transmits facsimiles over its call-reorigination network. The
Combined Company intends to commence offering the transmission of facsimiles
via the Internet or private data networks. Both facsimile and Internet usage
are increasing significantly worldwide. The Combined Company's switching
facilities are equipped with redundant, dedicated T-1 access to the Internet.
The Combined Company believes that the integration of call-reorigination
technology, facsimile and Internet capabilities will provide it with important
competitive data telecommunication advantages over other call-reorigination
companies. The Company intends to use a portion of the proceeds of this
Offering to implement and expand these services.
Debit Card Services. The Combined Company offers rechargeable debit cards to
its customers. The use of debit calling cards is a common practice in Western
Europe and Asian countries. Debit cards operate the same as conventional
"charge-a-call" cards issued by AT&T, MCI and Sprint, but are purchased with a
set amount of
38
time available. For the cardholder, toll fraud is no longer a concern. If the
card is lost or stolen, the loss is limited to the amount of the time
remaining on the card, and then the card simply expires and is of no further
value to the holder. The Combined Company plans to offer debit cards through
its hotel and business customers that will combine call-reorigination with
local debit card platforms.
SALES AND MARKETING
General
Sales of the Combined Company's call-reorigination services are conducted
through a network of approximately 95 independent sales agents based in the
countries in which the Combined Company conducts business. The sales agents
have engaged approximately 400 sub-agents, many of whom may be employed by
such sales agents on a part-time basis, to assist in sales and marketing on
behalf of the Combined Company. The agents earn commissions on revenue
collected from their customers. These commissions generally range between ten
to fifteen percent of the revenue collected by the agents and sub-agents. The
Combined Company trains and supplies agents and sub-agents with necessary
promotional materials for use in attracting customers and product and service
updates through printed material and access to the Combined Company's
operations center in Ft. Lauderdale, Florida. The Combined Company provides
order entry and product fulfillment services through customer service
personnel located at its operations center. The Combined Company currently
advertises its services in international newspapers and on a limited basis via
a web site on the Internet to attract sales agents, sub-agents and customers.
Historically, the Combined Company has had a limited marketing budget. CSI
intends to use a portion of the net proceeds of this Offering to increase
significantly its marketing program in order to further develop its Latin
American and Pacific Rim markets, and recruit new agents around the world.
Agents
All of the Company's sales agents are required to enter into one of two
forms of agreement: a "CSI Distributor Agreement," or a "CSI Branch Office
Distributor Agreement." ITC has entered into an "ITC Independent Contractor
Agreement," a wholesale agreement or a consulting agreement with certain of
its sales agents. After the consummation of the ITC Acquisition, CSI intends
to review the forms of sales agent agreements currently used by both companies
and maintain only those forms which management believes will provide the best
relationship between the Combined Company and its sales agents. See "Risk
Factors--Dependence on Key Sales Agents."
CSI Distributor Agreement. The distributor agreements grant authority to
agents to solicit offers to subscribe for or purchase CSI's services and
products, but grants no authority to bind the Company. All customer orders are
subject to the approval of the Company. Although the distributor agreements do
not establish a specific territory, each agent must obtain the Company's
permission with respect to each area in which such sales agent intends to
solicit offers. The agent generally is responsible for soliciting and
servicing of customers, but the Company is responsible for all billing and
collections. The agent is responsible to the Company for all bad debts less,
in certain circumstances, an allowance granted by the Company.
Each agent earns commissions on collected revenue from its customers. Such
commissions are on a scale ranging from 10% for less than $50,000 of monthly
collected revenue to 15% for monthly collected revenue of $250,000 or more.
Certain distributor agreements relating to high volume large businesses such
as hotels limit commissions to a maximum of 10% of monthly collected revenue.
Generally, each sales agent must meet sales goals ranging from $3,000 in
billings per month after six months from the effective date of such
distributor's agreement to $33,000 in billings per month after 36 months.
Branch Office Distributor Agreement. Under CSI's branch office distributor
agreements, agents establish offices designed to serve specific territories.
In addition, such agents may solicit customers outside their territories with
the Company's prior consent. Except as set forth below, the terms of the
branch office distributor agreements are the same as the distributor
agreements. CSI's two largest agents are engaged under branch office
distribution agreements.
39
Unlike the distributor agreements, the branch offices are responsible for
billing and collection, except for bills paid by credit card, which are paid
directly to the Company. The branch offices are required to remit all revenue
collected, twice monthly. The branch offices are responsible to the Company
for all bad debts less, in certain cases, an allowance granted by the Company.
Each branch office is paid commissions on monthly collected revenue based on
a scale ranging from 13% for up to $50,000 of monthly collected revenue to 15%
for monthly collected revenue of $100,000 or more. Generally, each branch
office agent must meet the sales goals ranging from $20,000 per month in
billings after six months from the effective date of such branch office
distributor's agreement to $250,000 in billings per month after 36 months.
ITC Independent Contractor Agreement. Under ITC's Independent Contractor
Agreement, each sales agent can market and sell ITC's services within a
defined geographical region. Generally, within six months of the agreement,
each sales agent must meet certain sales and customer quotas and must maintain
a monthly billing of $100,000 per month to be authorized exclusive rights to
market the services of ITC in that region. ITC is responsible for billing and
maintaining all records for the sales agent's accounts.
Sales agents collect, in advance, payments from each of their customers
equal to the customer's average monthly telephone bill. Sales agents are
responsible for their customers' account balances. Each sales agent earns
commissions on collected revenue from customers such sales agent has solicited
on a scale ranging from 6% for less than $25,000 of collected monthly revenue
to 10% for collected monthly revenue of $100,000 or more. ITC has made certain
exceptions to this scale and pays certain agents commissions higher than 10%
of monthly collected revenue. The agreements are generally in effect for one
calendar year and are renewed yearly unless terminated by ITC or the agent.
Technicians
CSI currently has three technicians available to install and program its
DIAL and LINK-US transparent call-reorigination technologies at customer
sites. Before the Company sends one of its technicians to an international
customer's location to perform an installation, the Company verifies that the
customer's site is equipped to handle the type of equipment to be installed.
The Company's technicians typically perform the first few equipment
installations for each sales agent. The sales agents are responsible for
hiring technical consultants, who are trained by CSI's technicians, to perform
additional transparent equipment installations. CSI plans to hire additional
in-house technicians as needed to support the demand for the Company's
automated call-reorigination systems.
Customers
The Combined Company believes that its customers prefer the Combined
Company's service to their local telephone ITO's service for several reasons,
including: (1) lower international, and in some cases intra-country, telephone
rates; (2) increased system reliability and call completion rates; (3)
improved line quality, with less echo, static and snow; and (4) available and
responsive customer service support. The Combined Company's system is also
easy to use, particularly with transparent call-reorigination. Large corporate
users, especially hotels, benefit from CSI's transparent system, through which
employees and hotel guests are able to dial just as they would on the local
ITO's system.
The Combined Company's primary customers currently are residential and
individual customers, hotels and small and medium-sized businesses. The
Combined Company also serves large corporations and non-profit entities such
as missions, schools and churches. The Combined Company provides
telecommunications services to approximately 19,000 customers as of January
31, 1998. The Combined Company defines customers as those persons or
businesses who have used the Combined Company's services within the prior four
months; however, a high level of customer attrition is typical in the call-
reorigination industry. South America (particularly Argentina and Brazil),
Europe and Africa currently represent the greatest areas of market penetration
for the Combined Company.
40
The Combined Company is developing a variety of service and payment
structures to attract a broader base of customers and to retain existing price
sensitive accounts. New payment methods are necessary for customers in many
parts of the world where credit cards are not as prevalent or easily
accessible as in the United States. The two leading methods are pre-payment by
guaranteed funds or direct bank debit (automatic bank withdrawal), which is a
method of payment preferred by larger businesses in several countries.
CSI has recently entered into cellular markets in South Africa and Italy.
Cellular providers are natural competitors to ITOs and are open to alliances
with call-reorigination providers such as the Combined Company that have
similar competitive objectives. The Combined Company will seek to market its
services to the existing subscriber base of the cellular providers with which
it has contracts.
CARRIER CONTRACTS
Carrier costs constitute a significant portion of the Combined Company's
variable costs. The Combined Company has entered into contracts to purchase
switched minute capacity from various domestic and foreign carriers and
depends on such contracts for origination and termination of its
telecommunications. Pursuant to these contracts, the Combined Company obtains
rates, which are generally more favorable than otherwise would be available,
by committing to purchase switched minute minimums from such carriers. If the
Combined Company fails to meet its switched minute minimum requirements under
a carrier contract, it could still be required to pay its minimum monthly
commitment as a penalty or the contracts could be canceled. The Combined
Company's aggregate minimum monthly commitments are approximately $400,000
which represent approximately 31% of the Combined Company's monthly variable
transmission expense. Because of the frequent fluctuations in rates of long
distance carriers, the Combined Company believes that it is in its best
interest to have short-term agreements with these carriers. Most of the
Combined Company's agreements with its long distance telephone carriers will
expire, or may be terminated by either party, within one year. The Combined
Company's dependence on particular carriers will vary because the Combined
Company shifts its use of carriers depending on the rates that are offered.
The Combined Company is continually attempting to renegotiate rates with its
current carriers and to establish relationships with new long distance
carriers that provide the most favorable rates. Due to its financial
condition, the Combined Company defaulted on payment obligations to certain
carriers in 1995, 1996 and 1997. Although the Combined Company was able to
negotiate deferred payment arrangements with these carriers (and subsequently
payoff such arrangements), there is no assurance that it will be able to make
such arrangements with these or other carriers if required in the future. In
November 1997, WorldCom commenced an action against ITC in Connecticut state
court seeking damages of approximately $1.1 million for alleged past due
carrier bills. ITC believes it has meritorious defenses to the suit. ITC
intends to vigorously defend its position and will attempt to reach a
settlement with this carrier. The Combined Company's ability to obtain
favorable rates from the carriers depends, in large part, on the Combined
Company's total volume of long distance traffic. The Combined Company does not
believe that the loss of any one supplier or contract would have a material
adverse impact on the Combined Company's business, financial condition or
results of operations. See "Risk Factors--Relationship With Long Distance
Carriers" and "Management's Discussion of Financial Condition and Results of
Operations."
COMPETITION
General
The Combined Company faces a high level of competition for customers and
sales agents in all of its markets, and expects competition to intensify in
the future. There are no substantial barriers to entry in the call-
reorigination industry. The Combined Company believes that there are more than
150 companies engaged in the international call-reorigination industry. Many
of the Combined Company's competitors are significantly larger, have
substantially greater financial, technical and marketing resources, larger
networks and a broader portfolio of services than the Combined Company.
Additionally, many competitors have strong name recognition and "brand"
loyalty, long-standing relationships with their target customers, and
economies of scale which can result in a lower relative cost structure for
transmission and related costs.
41
Inasmuch as the Combined Company believes that competition for customers and
sales agents is based primarily on price, transmission quality, services
offered and the ability of the supplier to "bundle" various telecommunications
services to meet customer requirements, the U.S.-based providers of
international call-reorigination service typically set pricing, quality,
service, and standards that the Combined Company seeks to match or exceed in
order to compete. Increased competition could force the Combined Company to
reduce its prices and profit margins if the Combined Company's competitors are
able to procure rates or enter into service agreements comparable to or better
than those the Combined Company obtains or if competitors are able to offer
other incentives to existing and potential customers and sales agents.
Similarly, the Combined Company has no control over the prices set by its
competitors in the long distance resale market. The Combined Company is aware
that its ability to market its long distance resale services depends upon its
ability to continue to offer rates lower than the ITOs. A decrease in the
arbitrage spreads could have a material adverse effect on the Combined
Company's business, financial condition or results of operations.
Other potential competitors include cable television providers, wireless
telephone providers, Internet access providers, electric and other utilities
with rights of way, railways, microwave carriers and large end users that have
private networks. The intensity of such competition has recently increased and
the Combined Company believes that such competition will continue to intensify
as the number of new entrants increases. If the Combined Company's competitors
devote significant additional resources to the provision of international and
national long distance telecommunications services to the Combined Company's
target customer base of high-volume residential consumers and small- and
medium-sized businesses, such action could have a material adverse effect on
the Combined Company's business, financial condition and results of
operations. There can be no assurance that the Combined Company will be able
to compete successfully against new or existing competitors.
On February 15, 1997, representatives of 69 countries, including the United
States, finalized the WTO Agreement, which addresses market access, foreign
investment and procompetitive regulatory principles for countries generating
more than 90% of world-wide telecommunications revenue. The WTO Agreement
became effective February 5, 1998. Although certain countries took specific
exceptions to the agreement, the WTO Agreement generally provides (i) market
access for United States companies to local, long distance and international
service through means of network technology on either a resale or facilities
basis, (ii) the opportunity for United States companies to acquire, establish
or hold a significant stake in telecommunications companies in the countries
which are a party to the WTO Agreement, and (iii) the ability to take
advantage of these opportunities within a framework of procompetitive
regulatory principles. The Combined Company expects to benefit from the
anticipated effects of the WTO Agreement because of its procompetitive
aspects, but it expects that it may take several years before the principles
of the agreement are implemented in many countries and it cannot predict the
extent of the opportunities that may be presented.
U.S. Based Competition.
The large U.S. long distance carriers have, in the past, been reluctant to
compete directly with ITOs by entering the international call-reorigination
business and attempting to capture significant market share of the domestic
customers of the ITOs. This is changing, and AT&T, among others, is entering
the call-reorigination business. The Combined Company's principal U.S.-based
competitors are providers of international call-reorigination services such as
AT&T, Access Authority, IDT Corporation, Justice Technology Corp., Kallback,
NetSource Communications, Telegroup, USA Global Link, UTG Communications,
Viatel, Inc. and Worldpass as well as providers of traditional long distance
services such as AT&T, Cable & Wireless, Inc., Frontier Corp., GTE
Communications, LCI International, Inc., MCI, Qwest Communications
International, Inc., RBOCs, Sprint, WorldCom, outside their exchange
territories providing long distance services in the United States.
International Based Competition.
The Combined Company's principal international-based competitors include,
among others, Telekom S.A. in South Africa; Telefonica de Argentina and
Telecom Argentina in Argentina; Telebras, Telesp and Telerj in
42
Brazil; France Telecom in France; PTT Telecom B.V. in the Netherlands; ACC
Corp., First Telecom plc, Oystel Communications Ltd., Swiftcall Ltd., AT&T,
British Telecommunications plc, Cable & Wireless, Mercury Communications Ltd.,
Sprint and WorldCom in the United Kingdom; Deutsche Telecom AG in Germany;
Optus in Australia and Kokusan Denshin, Denwa, International Telecom Japan and
International Digital Communications in Japan. The Combined Company also
competes with non-U.S. based providers of international call-reorigination
services. The Combined Company believes that these international ITOs
generally have certain competitive advantages due to their control over local
connectivity and close ties with national regulatory authorities. The Combined
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 ITO. If an ITO were to successfully
pressure national regulators to outlaw the provision of call-reorigination
services, the Combined Company could be denied regulatory approval in certain
jurisdictions in which its services would otherwise be permitted, thereby
requiring the Combined Company to seek judicial or other legal enforcement of
its right to provide services. Any delay in obtaining approval, or failure to
obtain approval, could have a material adverse effect on the Combined
Company's business, financial condition and results of operations. ITOs may
influence regulatory authorities to outlaw the provision of certain call-
reorigination services or block access to the call-reorigination services the
Combined Company markets. The ITOs generally seek to prevent call-
reorigination companies from using uncompleted local telephone service to
trigger international calls. In such environments, the Combined Company uses
X.25 or Internet triggering to avoid violating local laws or regulations. The
Combined Company has benefited from the fact that regulation of
telecommunications services in foreign countries has created a high
differential between the rates charged by ITOs and the rates charged by the
Combined Company. As deregulation continues in foreign markets, this
differential in rates is expected to decrease, thus placing pricing pressure
on the Combined Company. Furthermore, deregulation may lead to additional
competitors entering the international telecommunications market. If the
Combined Company encounters anti-competitive behavior in countries in which it
operates (such as an ITO attempting to block access to call-reorigination
services) or if the ITO in any country in which the Combined Company operates
uses its competitive advantages to the fullest extent, the Combined Company's
business, financial condition and results of operations could be materially
adversely affected. Deregulation and increased competition in foreign markets
could cause prices for direct-dial international calls to decrease so much
that customers are no longer willing to use the Combined Company's
international call-reorigination services.
TECHNOLOGY AND INTELLECTUAL PROPERTY
The Combined Company does not have a formal patent or other intellectual
property program. It relies on trade secret and contractual restrictions to
establish and protect its technology. The Combined Company's success depends
in part on its ability to enforce intellectual property rights for its
proprietary software technology, both in the United States and in other
countries. The Combined Company's proprietary software is protected by the use
of confidentiality agreements that restrict the unauthorized distribution of
the Combined Company's proprietary data.
Although the Combined Company believes that its success is more dependent
upon its technical expertise than its proprietary rights, the Combined
Company's success and ability to compete is dependent in part upon its ability
to enhance its technology. The Combined Company continually strives to provide
faster, higher quality, enhanced service for its customers. Part of the
Combined Company's success in speed and reliability of its call-reoriginations
can be attributed to its use of transparent X.25 and Internet automated call-
reorigination-triggering technology.
Redundancy. The Combined Company's operations center in Ft. Lauderdale,
Florida has redundant computer systems and fiber optics that provide two
advantages. First, its telecommunications services are rarely off-line. The
Combined Company believes that this gives it an advantage compared to many of
the Combined Company's smaller competitors, and enhances the Combined
Company's reputation for quality, service and uninterrupted system
availability. Second, the Combined Company's redundant system architecture
permits the Combined Company the flexibility to take individual computers off
line intentionally for scheduled maintenance, upgrades and enhancements.
43
DIAL and LINK-US Technology. CSI utilizes proprietary DIAL and LINK-US
technologies in connection with transparent call-reorigination. These
technologies are incorporated into a switch that permits automatic call-
reorigination to occur when interconnected with PBX's of hotels, large
businesses and other high volume customers. As of October 31, 1997, CSI had
installed approximately 200 DIAL systems and five LINK-US systems.
The DIAL technology, which largely consists of proprietary programming
enhancements to third-party switching equipment is beneficially owned entirely
by CSI and is not subject to royalty payments or any restrictions or financial
penalties whatsoever regarding its deployment or lack of deployment.
CSI supports two versions of its DIAL technology. The first version is the
Enhanced DIAL system, which is installed to facilitate transparent call-
reorigination in large hotels and business parks. Enhanced DIAL is a system
that facilitates transparent call-reorigination through the utilization of
X.25 and Internet triggering technologies interconnected with commercial PBX
environments. The Company plans to emphasize the installation of its Enhanced
DIAL technology at the sites of its largest customers in the future. The
Enhanced DIAL system can support the same volume of traffic as 64 of the Basic
DIAL systems. The Company's Basic DIAL system is more of an entry-level system
that is installed to facilitate transparent call-reorigination for smaller
companies. The Basic DIAL system is able to utilize X.25 and Internet
triggering, but is also commonly used in locations that do not currently have
X.25 or Internet access.
CSI has entered into a consulting agreement with Gary Kamienski with respect
to the LINK-US technology. Mr. Kamienski has worked in the computer science
field for over 24 years, specializing in systems programming and data
communications and spent 17 years working with Bell Communications Research.
Pursuant to Mr. Kamienski's agreement, dated September 19, 1996, Mr. Kamienski
transferred the LINK-US switch technology to the Company. The Company agreed
to pay the costs of installation and associated costs for LINK-US, and to pay
Mr. Kamienski a monthly royalty equal to 4% of the Company's gross revenue
related to LINK-US. The Company has the option to buy out the royalty for an
amount equal to the greater of $2,500,000 or three times the aggregate royalty
payments for the first twelve months of the Agreement. In addition, for each
installation of LINK-US, the Company agrees to pay Mr. Kamienski a flat fee of
$1,500 if such installation produces gross revenue between $10,000 and $20,000
in its first full billing month of operation, and a flat fee of $3,000 if such
revenue exceeds $20,000 in its first full billing month of operation. In
addition, Mr. Kamienski agrees to provide ongoing maintenance, support and
consulting with respect to LINK-US for as long as the system is in operation
at a rate of $5,200 per month. The agreement stays in effect for as long as
the LINK-US is operational until September 1, 2006, unless earlier terminated.
The agreement may be terminated by either party upon 30 days notice to the
other of a material default or consummation of the buy out of the royalty. Mr.
Kamienski has agreed not to develop or market any technology similar to LINK-
US which in any way might compete with the Combined Company for the lesser of
10 years or the period of time the Company is utilizing the technology
associated with LINK-US.
X.25 Triggering Technology. An X.25 data network can transport data or voice
information to any network destination in the world. CSI has proprietary
software technology that makes X.25 triggering technology work with its call-
reorigination system. The Company uses X.25 technology in areas where it has
several business customers. The Company currently has X.25 triggering
available in Argentina and Brazil.
In countries with underdeveloped telecommunications systems, it can be
difficult and time consuming to make an international phone call. With X.25
triggering technology installed, up to 100% of the trigger calls to the
Combined Company's switch make it out of the country and nearly 100% of the
call-reorigination calls make it back into the country. The combination of
X.25 triggering technology with a DIAL or LINK-US switch is especially
appealing to hotels and business owners. See "--Call-reorigination--
Transparent Call-reorigination."
By utilizing these alternate call-triggering mechanisms, the ITO is removed
from the call-reorigination process. ITOs typically object to call-
reorigination because call-reorigination companies use the ITO's lines to
trigger the call-reorigination without paying the ITO for the use of its lines
on the long distance segment because that long distance call is not completed.
When the Combined Company uses X.25 or Internet triggering
44
technology to trigger its call-reoriginations, the ITO's long distance lines
are not used. Instead, a low cost, local call is completed as part of the
call-reorigination triggering process. See "Risk Factors--Risks of Operations
in Foreign Countries."
Internet Triggering Technology. Internet triggering is a newer technology
and is less expensive than X.25 triggering technology. CSI is currently
triggering call-reoriginations via the Internet in Argentina, Brazil,
Venezuela, South Africa and Lebanon and intends to have it installed in New
Zealand and Singapore. CSI has found that call-reoriginations using Internet
triggering usually take four to six seconds and are nearly 100% effective at
getting back to the customer.
REGULATION
The Combined Company's international call-reorigination services are subject
to the jurisdiction of many regulators. The terms and conditions under which
the Combined Company provides international communications services are
subject to government regulation. The FCC has imposed certain restrictions on
international call-reorigination providers, including the requirement that
authorized carriers provide service in a manner consistent with the laws of
the countries in which they operate. Local laws and regulations differ
significantly among the jurisdictions in which the Combined Company operates,
and the interpretation and enforcement of such laws and regulations vary and
are often based on the informal views of the local ministries which, in some
cases, are subject to influence by the local telephone companies. In addition,
since the Combined Company's call-reorigination services effectively bypass
the local telephone system, regulators in certain countries have objected to
call-reorigination services, and approximately 30 countries have notified the
FCC that they have declared certain call-reorigination services illegal. The
Combined Company's services in such countries comprised approximately 7.8% of
its revenue for the ten months ended October 31, 1997. The Combined Company
generates a significant portion of its revenue from customers originating
calls in Argentina, Brazil, Europe, the Middle East and South Africa. In the
event that any of these countries prohibited the Combined Company's services
or regulated the pricing or profit levels of such services, the Combined
Company's business, results of operations and financial condition could be
materially adversely affected. At this time, the Argentine government is
attempting to provide sufficient information to demonstrate to the FCC's
satisfaction that call-reorigination is unlawful in Argentina. Although the
Combined Company believes that the probability that the FCC would rescind the
Combined Company's grant of authority to provide call-reorigination services
for failure to comply with non-U.S. law is unlikely, such action by the FCC
would have a material adverse effect on the Combined Company's business. The
Combined Company intends to expand its international service offerings to
continue to be competitive in additional countries. To facilitate this
expansion, the Combined Company may deploy additional switching facilities to
be located in a number of countries. As a result, the Combined Company will be
directly subject to regulation in an increasing number of countries, and there
can be no assurance that such regulation will not have a material adverse
effect on the Combined Company's business, results of operations and financial
condition. In addition, there can be no assurance that the Combined Company
has accurately interpreted or will accurately predict the interpretation of
applicable laws and regulations or regulatory and enforcement trends in a
given jurisdiction or that the Combined Company will be found to be in
compliance with all such laws and regulations. Failure to interpret accurately
the applicable laws and regulations and the mode of their enforcement in
particular jurisdictions could cause the Combined Company to lose, or be
unable to obtain, regulatory approvals necessary for it to be able to provide
certain services in such jurisdictions or to use certain of its transmission
methods. Such failure could result in significant monetary penalties being
imposed against the Combined Company. See "Risk Factors--Government
Regulation."
Federal regulations, regulatory actions and court decisions have had, and
may have in the future, an impact on the Combined Company and its ability to
compete as well as on the number and types of competitors in the market. The
FCC typically imposes obligations to file tariffs containing the rate, terms
and conditions of service. The FCC does not currently regulate the Combined
Company's profit levels, although the FCC has the authority to do so. There
can be no assurance that regulators will not raise material issues with regard
to the Combined Company's compliance with regulations or that existing or
future regulations will not have a material adverse effect on the Combined
Company's business, financial condition and results of operations.
45
The Combined Company offers service by means of call-reorigination pursuant
to an FCC authorization ("Section 214 Switched Voice Authorization") pursuant
to Section 214 of the Communications Act and certain relevant FCC decisions.
The FCC has determined that call-reorigination service using uncompleted call
signaling does not violate United States or international law, but has held
that United States companies providing such services must comply with the laws
of the countries in which they operate as a condition of such companies'
Section 214 Switched Voice Authorizations. The FCC reserves the right to
condition, modify or revoke any Section 214 Authorizations and impose fines
for violations of the Communications Act or the FCC's regulations, rules or
policies promulgated thereunder, or for violations of the clear and explicit
telecommunications laws of other countries that are unable to enforce their
laws against U.S. carriers. FCC policy provides that foreign governments that
satisfy certain conditions may request FCC assistance in enforcing their laws
against U.S. carriers. Thirty countries have formally notified the FCC that
certain call-reorigination services violate their laws. Only eight of these
countries have submitted copies of actual laws to the FCC that declare certain
call-reorigination services unlawful. Two of the 30 countries have requested
assistance from the FCC in enforcing their prohibitions on call-reorigination
within their respective jurisdictions. The FCC has held that it would consider
enforcement action against companies based in the United States engaged in
call-reorigination by means of uncompleted call signaling in countries where
this activity is expressly prohibited. While the Combined Company believes
that the FCC has not initiated any action to date to limit the provisions of
call-reorigination services, there can be no assurance that it will not take
action in the future. Enforcement action could include an order to cease
providing call-reorigination services in such country, the imposition of one
or more restrictions on the Combined Company, monetary fines or, ultimately,
the revocation of the Combined Company's Section 214 Switched Voice
Authorization, and could have a material adverse effect on the Combined
Company's business, financial condition and results of operations.
EMPLOYEES AND CONSULTANTS
As of December 31, 1997, CSI had 21 full-time employees and two consultants.
As of December 31, 1997, ITC had 14 full-time employees and one consultant.
CSI plans to hire additional employees and consultants as may be required to
support expansion of the Combined Company's operations and the Combined
Company's sales agent network. None of the Combined Company's employees are
covered by a collective bargaining agreement. Management believes that the
Combined Company's relationship with its employees is good.
FACILITIES
CSI's executive offices are located at 8 South Nevada Avenue, Colorado
Springs, Colorado 80903. The Combined Company leases approximately 11,000
square feet of space under a lease that expires January 31, 1999 with respect
to 5,100 square feet, and December 31, 1999 with respect to the remainder. See
"Certain Transactions."
ITC's executive offices are located at 290 Pratt Road, Meriden, Connecticut
06450. The telecommunications and customer service center for the Combined
Company is leased by ITC and located at 110 East Broward Boulevard, Suite 610,
Ft. Lauderdale, Florida 33301.
LITIGATION
In November 1997, WorldCom commenced an action entitled "WorldCom, Inc. v.
International Telephone Company d/b/a Interglobal Telephone Company" against
ITC in Connecticut state court (Docket No. CV-970407418, Superior Court, J.D.
of New Haven) seeking damages of approximately $1.1 million for alleged past
due carrier bills. ITC believes it has meritorious defenses to the suit. ITC
intends to vigorously defend its position and will attempt to reach a
settlement with this carrier.
In the ordinary course of business, the Combined Company is a party to
several legal proceedings, the outcome of which, singly or in the aggregate,
is not expected to be material to the Combined Company's financial position,
results of operations or cash flows. The Combined Company intends to
aggressively pursue collection of debts, including those owed by a former
distributor in Singapore.
46
MANAGEMENT
OFFICERS AND DIRECTORS
The following table contains the name, age and position with CSI of each
executive officer and director of CSI as of the date of this Prospectus.
NAME AGE POSITION WITH CSI
- ---- --- -----------------
Robert A. Spade........................ 51 Chief Executive Officer and Chairman
of the Board
Patrick R. Scanlon..................... 51 President, Chief Operating Officer
and Director
Daniel R. Hudspeth..................... 35 Chief Financial Officer and
Treasurer
Philip A. Thomas....................... 52 Vice President and General Manager
(upon completion of the ITC
Acquisition)
Cassandra A. Zajac..................... 26 Vice President of Investor Relations
and Secretary
Dean H. Cary........................... 49 Director
Richard F. Nipert...................... 41 Director
Robert A. Spade has been the Chairman of the Board since March 1994 and
CSI's Chief Executive Officer since January 1995. Mr. Spade also served as
President of CSI from April 1995 to June 1997 and as the Treasurer CSI from
April 1995 to July 1996. He devotes substantially all of his time to the
business of CSI. Mr. Spade is a director of MedPlus Corporation, a company
that operates a workers' compensation medical clinic and arranges financing
for patients. He was a director of World Information Networks On The Net, Inc.
("WIN"), a company that provides Internet access, designs web pages and
broadcasts facsimiles via the Internet, from August 1995 to March 1997. From
1994 to 1995, Mr. Spade was an Adjunct Professor of International Corporate
Finance with, and was a director of, the International School of Management in
Colorado Springs. In 1991, Mr. Spade founded Diamante Properties, Inc.
("Diamante"), a company engaged in commercial real estate. He served as
President of Diamante from inception through 1995 and currently serves as its
Chairman and Secretary. Mr. Spade graduated from the Johns Hopkins School of
Advanced International Studies in 1971 with a Masters Degree, and from
University of California, Santa Barbara in 1968 with a B.A. Degree in
Economics and Hispanic Civilization. Mr. Spade is fluent in Spanish and
Portuguese.
Patrick R. Scanlon has been President and Chief Operating Officer of CSI
since June 1997 and a director of the Company since January 1996. He also
served as Treasurer from June 1997 to December 1997. From May 1991 to June
1996 Mr. Scanlon served as Executive Vice President of BRC Imagination Arts,
Inc., a designer and producer of custom exhibits and attractions for world
fairs, aquariums, theme parks and visitor centers. Prior to that time, Mr.
Scanlon was with Walt Disney Imagineering, the theme park design, engineering,
production, and construction division of the Walt Disney Company, for 18
years, most recently as Senior Vice President. Mr. Scanlon is also an owner
and partner in a number of real estate ventures, and has served on the Boards
of Directors of the Theme Entertainment Association, the Angeles Chorale, and
The Learning Company. Mr. Scanlon earned an M.S. Degree in Finance in 1971
from the UCLA Graduate School of Management and a B.A. Degree in Economics
from the University of California, Santa Barbara in 1968.
Daniel R. Hudspeth has been Chief Financial Officer and Treasurer of CSI
since December 1997. From October 1995 to December 1997, Mr. Hudspeth served
as Chief Financial Officer and Corporate Secretary of Wireless Telecom, Inc.,
a company that distributes wireless data products and services for the
telecommunications and computer industries. From January 1995 to October 1995,
he was Vice President and Corporate Controller of CWE, Inc., a publicly traded
computer retail company. From August 1992 to January 1995, Mr. Hudspeth was
Vice President of Finance and Administration and Treasurer of OfficeScapes
Business
47
Furniture, and from July 1985 to August 1992, he was an Audit Manager of
Emerging Business Services for Deloitte & Touche LLP. Mr. Hudspeth is a
Certified Public Accountant in Colorado and a member of the Colorado Society
of Certified Public Accountants and the American Institute of Certified Public
Accountants. He earned his B.S. Degree in Business Administration from
Colorado State University in 1985.
Philip Thomas will become Vice President-General Manager of CSI upon the
closing of this Offering. Mr. Thomas was a co-founder and served as Vice
President of Operations of ITC since March 1993. From 1990 until 1993, Mr.
Thomas was a partner of Thomas Powell and Associates, a software developer for
voice mail systems, automated attendants and international call-reorigination
systems. From 1977 until 1990, Mr. Thomas was principal of Thomas Business
Systems, Inc., a computer hardware dealer. Mr. Thomas received his H.N.D.
Degree in Applied Physics from the Farnborough College of Technology.
Cassandra A. Zajac has been CSI's Secretary since June 1996, Vice President
of Investor Relations since September 1995 and an employee of CSI since June
1995. From January 1994 to May 1995, Ms. Zajac was a Business Analyst for
Amoco Production Company. From June 1992 to December 1993, Ms. Zajac was a
licensed real estate agent in the State of Colorado and worked for Woodland
Real Estate Better Homes and Gardens. Ms. Zajac was a director of World
Information Network ("WIN") from August 1995 to July 1996. Ms. Zajac graduated
in 1993 from Colorado State University with a B.S. Degree in Finance and
Computer Information Systems. Ms. Zajac is the step-daughter of Mr. Spade.
Dean H. Cary has been a director of CSI since January 1997. Since November
1995 he has been an Executive Director of Forval International
Telecommunications, Inc., an international long distance carrier based in
Japan. From November 1993 to November 1995 he served as Executive Vice
President of Viatel, Inc., one of CSI's principal competitors. In 1992 he
formed Paragon Management Group, a business engaged in strategic and business
planning, and served as its President. From 1988 to 1992 he was the Vice
President/General Manager of Metromedia Communications Corp., a U.S. based
long distance carrier. He earned a B.A. Degree in Business, Education and
Psychology from the University of Minnesota in 1969.
Richard F. Nipert has been a director of CSI since November 1996. Since
January 1993, Mr. Nipert has been a partner in the law firm of Bright, Gibson
and Nipert, P.C. in Denver, Colorado. Mr. Nipert previously practiced law with
three other law firms located in Denver. Mr. Nipert practices law primarily in
the fields of business and commercial real estate. He earned his J.D. Degree
from the University of Southern California in 1980 and a B.A. Degree in Social
Ecology from the University of California at Irvine in 1977.
BOARD COMMITTEES
The Board of Directors maintains a Compensation Committee and an Audit
Committee. The Compensation Committee, consisting of Messrs. Nipert and Cary,
reviews compensation and option matters and makes recommendations to the Board
regarding changes in executive compensation. The Audit Committee, consisting
of Messrs. Nipert and Cary, reviews CSI's internal audit controls.
COMPENSATION OF DIRECTORS
Directors who are also employees of CSI receive no additional compensation
for serving as directors. Non-employee directors have received options to
purchase shares of Common Stock at the time they commenced service on the
Board of Directors. The options are exercisable at the bid price of the Common
Stock at the date of grant. The options vest 20% per year over five years from
the date of grant. CSI reimburses all of its directors for travel and out-of-
pocket expenses in connection with their attendance at meetings of the Board
of Directors and for carrying out various board-directed assignments for the
benefits of CSI.
LIMITATION OF LIABILITY AND INDEMNIFICATION
CSI's Articles of Incorporation eliminate the personal liability of its
directors to CSI and its shareholders for monetary damages for breach of the
directors' fiduciary duties in certain circumstances. CSI's Bylaws
48
provide that CSI will indemnify its officers and directors to the fullest
extent permitted by law. In addition, CSI carries officers' and directors'
liability insurance with an annual $1 million aggregate limit. Insofar as
indemnification for liabilities arising under the Securities Act may be
permitted to directors, officers and controlling persons of CSI pursuant to
the foregoing provisions, or otherwise, CSI has been advised that in the
opinion of the Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable.
KEY EMPLOYEES
Mark Lyons has been CSI's Director of Sales and Marketing since November
1996. From 1990 to 1996 he worked for Sprint as its Senior Business Services
Representative. He previously worked as a Branch Manager for Norwest Bank and
First Interstate Bank. He earned a B.S. Degree in Finance from Utah State
University in 1983 and has earned graduate credits in telecommunications from
the University of Denver.
Sean Thomas will become CSI's Director of Business Development in Europe
upon the closing of this Offering. Mr. Thomas was a co-founder of ITC in 1993
and served as Vice President of Sales of ITC since November 1996. From 1991 to
1993, Mr. Thomas served as Sales Manager with Connecticut Computer
Technologies. Mr. Thomas attended Loyola University in New Orleans. Mr. Thomas
is the son of Philip Thomas.
Stuart Agranoff has been CSI's Director of Technical Operations since
September 1997 and a senior engineer for CSI since January 1996. From 1992 to
1996, Mr. Agranoff worked as an Associate Engineer for Kaman Sciences
Corporation. From 1984 to 1992 he served in the United States Navy where he
worked as an Aircraft Intermediate Maintenance Department Supervisor and as a
Senior Communication/Navigation Technician. Mr. Agranoff earned his degree in
Electronics Technology from the University of Phoenix.
John Spade has been CSI's Director of Technology and Development since
September 1997 and Special Projects Manager since March 1997. He has been an
employee of CSI since August 1996. From August 1995 to July 1996, Mr. Spade
was Vice President and a director of WIN, an Internet services provider. In
1994, he earned his B.A. degree from Chico State University, where he also
taught courses on Economics and the Internet. John Spade is the son of Robert
A. Spade.
Keith Busch has been CSI's Director of Business Development in Asia since
December 1997. Mr. Busch previously served as President of two other call-
reorigination providers. From 1996 to 1997 he founded and served as President
of American Fone Network, and from 1995 to 1996 he served as President of
Rapid Link USA. Mr. Busch also previously worked as the International Sales
Manager for Premiere Communications, an international calling card company. He
earned his B.A. Degree from the University of Washington in 1991.
EXECUTIVE COMPENSATION
No executive officer of CSI received total compensation in excess of
$100,000 in any of the last three fiscal years. Robert A. Spade, Chief
Executive Officer of CSI since 1995, received total salary and bonus of $9,000
in fiscal year 1995 and $48,000 in fiscal year 1996. In fiscal year 1996, CSI
granted to Mr. Spade, pursuant to CSI's Non-Qualified Stock Option Plan,
options to purchase shares of Common Stock at an exercise price of $ per
share, that expire on August 31, 1998, options to purchase shares of
Common Stock at an exercise price of $ that expire on October 31, 1999,
options to purchase shares of Common Stock at $ per share that expire on
July 31, 1999, and options to purchase shares of Common Stock at $ per
share that expire on August 29, 2007. The options Mr. Spade received in 1997
represent approximately 5.7% of all options granted to employees in fiscal
year 1997. Mr. Spade did not exercise any of his options in fiscal year 1996.
Based on the closing high bid price of the Common Stock of $ per share as
quoted on the OTC Bulletin Board on , 1998, Mr. Spade's unexercised
vested options on that date had no value.
49
EMPLOYMENT AGREEMENTS
CSI has entered into an employment agreement with Mr. Spade. Mr. Spade's
employment agreement, dated May 1, 1997, provides for a base salary of a
minimum of $150,000 which will be increased by 4% annually during the three
year term of the agreement. CSI may terminate Mr. Spade's employment only for
cause (as defined in the agreement). Mr. Spade also is entitled to receive an
annual bonus of up to 65% of his salary pursuant to any cash bonus plan
adopted by the Board of Directors. He has the option to convert any cash bonus
to stock options having an exercise price equal to the price of CSI's Common
Stock on the first day of the fiscal year on which a bonus is calculated.
Pursuant to the agreement, Mr. Spade has agreed not to compete with CSI for a
period of three years following termination of the agreement.
CSI has entered into an employment agreement with Mr. Scanlon. Mr. Scanlon's
employment agreement, dated October 31, 1997, provides for a base salary of a
minimum of $140,000, which may be increased to reflect the market rate for
persons in comparable positions. CSI may terminate Mr. Scanlon's employment
only for cause (as defined in the agreement). Mr. Scanlon also is entitled to
receive an annual bonus pursuant to any cash bonus plan adopted by the Board
of Directors and stock options. He has the option to convert any cash bonus to
stock options having an exercise price of CSI's Common Stock on the first day
of the fiscal year on which a bonus is calculated. Pursuant to the agreement,
Mr. Scanlon has agreed not to compete with CSI for a period of three years
following termination of the agreement.
CSI has entered into an employment agreement with Mr. Hudspeth. Mr.
Hudspeth's employment agreement, dated December 1997, provides for a base
salary of a minimum of $110,000 which may be increased to reflect the market
rate for persons in comparable positions. CSI may terminate Mr. Hudspeth's
employment only for cause (as defined in the agreement). Mr. Hudspeth also is
entitled to receive an annual bonus pursuant to any cash bonus plan adopted by
the Board of Directors and stock options. He has the option to convert any
cash bonus to stock options having an exercise price of CSI's Common Stock on
the first day of the fiscal year on which a bonus is calculated. Pursuant to
the agreement, Mr. Hudspeth has agreed not to compete with CSI for a period of
three years following termination of the agreement.
Upon the completion of the ITC Acquisition, CSI will enter into one year
employment agreements with Philip Thomas and Sean Thomas which provide for
base salaries of $115,000 and $65,000, respectively. CSI may terminate Messrs.
Thomas and Thomas only for cause (as defined in the agreements). Messrs.
Thomas and Thomas have each agreed not to compete with the Company for a
period of six months following termination of the respective agreements.
STOCK OPTION PLAN
In 1995 the Board of Directors adopted, and the shareholders approved, an
Incentive Stock Option Plan and a Non-qualified Stock Option Plan, which in
January 1998 the shareholders approved combining into one stock option plan
(the "Stock Option Plan"). The Stock Option Plan allows for the issuance of
stock options to officers, employees, and directors, and to consultants and
advisors who render bona fide services to CSI not in connection with the
issuance of securities in a capital-raising transaction. CSI has authorized
3,000,000 shares of Common Stock for issuance upon the exercise of options
granted under this plan. The aggregate fair market value (measured at the time
the options are granted) of all Common Stock issued pursuant to exercise of
Incentive Stock Options under the Stock Option Plan may not exceed $100,000.
The Incentive Stock Options granted under the Stock Option Plan are intended
to qualify as "Incentive Stock Options" within the meaning of Section 422 of
the Internal Revenue Code. The Non-Qualified Stock Options granted under the
Stock Option Plan are not intended to meet the requirements of Section 422 of
the Internal Revenue Code. The plans are administered by the Compensation
Committee. As of January 31, 1998, Non-Qualified Stock Options to purchase up
to shares of Common Stock have been granted under the Stock Option Plan.
No Incentive Stock Options have been granted under the Stock Option Plan. In
January 1998, CSI terminated its Stock Bonus Plan.
The exercise price and period for the options granted under the plans are as
determined by the Board of Directors or committee thereof. For Incentive Stock
Options, the exercise price cannot be below the fair market
50
value of the underlying Common Stock at the time the options are granted, and
in the case of holders of over 10% of the combined voting power of all classes
of voting stock of CSI, the exercise price cannot be below 110% of the fair
market value of the underlying Common Stock at the time the options are
granted. The exercise period cannot exceed ten years under either plan.
Options may not be transferred other than by will and the laws of descent and
distribution without the express consent of the Board of Directors or a
committee thereof.
The exercise of such options is subject to the satisfaction of any
applicable withholding tax or other liabilities and any listing, registration,
or qualification with any regulatory authority of the Shares of Common Stock
to be issued upon exercise of such options. Unless the Common Stock issuable
upon exercise of the options has been registered with the Commission and any
applicable state regulatory authorities, each optionee represents, by
accepting such shares, that such optionee is acquiring such shares for
investment and not for resale or distribution.
The Board of Directors has reserved the right to alter, suspend, or
discontinue the plans, but may not, without the affirmative vote of a majority
of shares of capital stock then entitled to vote, do any of the following:
abolish the committee then administering the plans, if any, change the
qualification of its members, or withdraw the plans from its supervision; make
any material change to the class of persons eligible to receive options;
increase the total number of shares of Common Stock reserved for issuance
under the plans; increase the number of shares for which an option is
exercisable to any one employee; extend the term of the plan or the maximum
option periods; decrease the minimum exercise price; or materially increase
the benefits accruing to plan participants.
51
PRINCIPAL SHAREHOLDERS
The following table sets forth, as of January 31, 1998, the number of and
percentage of outstanding shares of Common Stock owned of record or
beneficially by (i) each director and executive officer of the Combined
Company; (ii) each person who owns beneficially more than five percent (5%) of
the Company's outstanding Common Stock; and (iii) all directors and executive
officers as a group. Unless otherwise indicated, the address of each person
listed is the Combined Company's address, 8 South Nevada Avenue, Colorado
Springs, Colorado 80903.
PERCENT OF COMMON STOCK(1)
---------------------------------------
SHARES AFTER OFFERING
BENEFICIALLY BEFORE AND ITC
NAME AND ADDRESS OWNED OFFERING(2) ACQUISITION
- ---------------- ------------ ----------- --------------
DIRECTORS AND EXECUTIVE OFFICERS:
Robert A. Spade(3)..................
Patrick R. Scanlon(4)...............
Cassandra A. Zajac(5)...............
Daniel R. Hudspeth..................
Dean H. Cary(6).....................
71 Burnwood Lane
Upper Saddle River, NJ 07458
Richard F. Nipert(7)................
1140 Grant Street, Suite 100
Denver, CO 80203
Philip A. Thomas(8).................
All directors and executive officers
as a group (6 persons)(9)..........
OTHER SHAREHOLDERS:
James L. Williams(10)...............
123 Vientos Road
Camarillo, CA 93010
- --------
*Less than 1%.
(1) Calculated pursuant to Rule 13d-3(d) of the Exchange Act. Under Rule 13d-
3(d), shares not outstanding which are subject to options, warrants,
rights or conversion privileges exercisable within 60 days are deemed
outstanding for the purpose of calculating the number and percentage
owned by such person, but are not deemed outstanding for the purpose of
calculating the percentage owned by each other person listed.
(2) Shares outstanding before offering include 113,600 Bridge Shares to be
issued immediately prior to this Offering.
(3) Of such shares, are held of record by Mr. Spade or his spouse and
shares are issuable upon exercise of options held by Mr. Spade.
(4) Of such shares, are held of record and shares are issuable upon
exercise of options held by Mr. Scanlon.
(5) Of such shares, are held of record and shares are issuable upon
exercise of options held by Ms. Zajac.
(6) Of such shares, none are held of record and are issuable upon exercise
of options held by Mr. Cary.
(7) Of such shares, are held of record and are issuable upon exercise
of options held by Mr. Nipert.
(8) Mr. Thomas will receive shares on the first anniversary of the closing
of this Offering in connection with the ITC Acquisition.
(9) Of such shares, are held of record and shares are issuable upon
exercise of options.
(10) Of such shares, are held of record and shares are issuable upon
exercise of warrants.
52
CERTAIN TRANSACTIONS
Effective September 14, 1995, Redden Dynamics, Inc. ("Redden") was merged
with and into CSI. Shareholders of Redden received a total of shares of
Common Stock of CSI in connection with the merger. At the time of the merger,
Redden had no operations, minimal assets and no liabilities. CSI undertook the
merger in order to enable it to have a sufficient number of shareholders to
permit CSI to commence trading of its Common Stock on the OTC Bulletin Board,
which occurred effective March 18, 1996. To acquire control of Redden in order
to facilitate the merger, Robert Spade purchased approximately 80% of Redden's
outstanding common stock in May 1995 from certain shareholders of Redden for
$34,500. Mr. Spade was then elected President and a director of Redden. In the
merger, Mr. Spade exchanged the Redden shares for shares of Common Stock.
Immediately after the merger, Mr. Spade transferred shares of such Common
Stock to 21 persons, including the following: Mr. Nipert ( shares); Mr.
Scanlon ( shares); and Ms. Zajac ( shares).
CSI has received periodic advances from Robert Spade. On April 30, 1996, CSI
issued an unsecured note payable to Mr. Spade in the principal amount of
$160,000, payable on May 31, 1999 and bearing interest at 10% to reflect
advances made through that date. As of January 31, 1998, the total amount of
outstanding advances from Mr. Spade was $149,000.
The building in which CSI has its principal executive office is owned by a
partnership, the managing general partner of which is owned by Robert Spade
and his wife. CSI paid the partnership $37,592 and $87,259 in lease expense
for the fiscal years ended April 30, 1996 and 1997, respectively. Minimum
lease payments for the fiscal years ended April 30, 1998, 1999 and 2000 are
approximately $137,000, $118,000 and $55,000 reflecting the increase in leased
space from 5,100 square feet in fiscal year 1996 to 11,000 square feet
commencing September 1996. See "Business--Facilities" and the Financial
Statements.
In August 1996, CSI issued shares of Common Stock and granted options to
purchase shares of Common Stock at $ per share to certain minority
shareholders of WIN in exchange for their shares of WIN Common Stock. As a
result of this exchange, CSI became a shareholder of WIN. CSI then transferred
the WIN shares to WIN for certain technology and equipment owned by WIN. Ms.
Zajac and certain other family members of Mr. Spade, who were shareholders of
WIN, received options to purchase and shares of Common Stock
respectively, in the WIN transaction. The Common Stock was valued at $ per
share in the WIN transaction. Following the WIN transaction, John Spade, who
was an officer, director and a principal shareholder of WIN, became an
employee of CSI. John Spade is the son of Robert Spade. Robert Spade was a
director of WIN at the time of the transaction and therefore this transaction
may have been at terms less favorable than one with a third party. See
"Management."
On January 10, 1997, CSI granted Dean H. Cary, a Director of CSI, options to
purchase shares of Common Stock at $ per share in connection with
consulting services provided by Mr. Cary to CSI. The options vest 20% per year
over five years from the date of grant; provided that vesting may be
accelerated if the trading price of the Common Stock exceeds certain levels
ranging from $ to $ per share.
In October 1997, CSI incurred an obligation to pay $50,000 and in January
1998 granted options to purchase shares of Common Stock at an exercise
price of $ per share to Mr. Cary in consideration of business consulting
services.
In November 1997, CSI entered into an agreement in principle with ITC and
its stockholders, Lynch Family, LLC, Sean Thomas and Philip Thomas. Upon
consummation of this Offering and the ITC Acquisition, Lynch Family, LLC and
Messrs. Thomas and Thomas will receive an aggregate of $3.1 million in cash
and 207,000 shares of Common Stock based on an assumed initial offering price
of $10.00 per Share to be issued on the first anniversary of the closing of
this Offering. Furthermore, John Lynch, a manager of Lynch Family, LLC, will
enter into a one year consulting agreement with the Combined Company under
which he will receive $125,000,
53
and Philip Thomas and Sean Thomas will enter into one year employment
agreements with the Combined Company under which they will receive annual
salaries of $115,000 and $65,000, respectively. See "Management."
In December 1997, CSI paid $178,000 to ITC in consideration of consulting
services provided by John Lynch, a manager of Lynch Family, LLC, in
negotiating a carrier agreement on behalf of CSI.
Richard F. Nipert, a Director of CSI, is a partner of the law firm of
Bright, Gibson and Nipert P.C., which from time to time has provided legal
services to CSI. Fees paid to the firm by CSI were less than 5% of the law
firm's gross revenue for each fiscal year in which they have represented CSI.
Other than as set forth above, the transactions described above were on
terms that CSI's Board of Directors believed to be fair to CSI and no less
favorable to CSI than terms that could have been obtained from an unrelated
party. The Combined Company has adopted a policy that future transactions
between the Company and its officers, directors and 5% or more shareholders
are subject to approval by a majority of the disinterested directors of the
Company. Any such transactions will be on terms believed to be no less
favorable than could be obtained from unaffiliated parties.
TRANSACTIONS WITH PROMOTERS
CSI believes that Messrs. Robert Spade and James L. Williams may be
considered "founders" or "promoters" of CSI. In addition to the transactions
referenced in "Certain Transactions," Mr. Spade purchased shares of Common
Stock from CSI at various times from April 1993 to December 1994 at prices
ranging from $ per share to $ per share.
Mr. Williams purchased shares of Common Stock from CSI at various times
from April 1993 to June 1995 at prices ranging from $ to $ per share.
Mr. Williams also acquired shares from Mr. Spade at various times from
August 1993 to December 1994. Mr. Williams has received approximately $38,400
from CSI as compensation for services in connection with equity and debt
financings by CSI. In addition, Mr. Williams loaned $40,000 to CSI and
received a 10% convertible note in October 1996 that he converted into shares
of Common Stock in January 1997. In connection with the note, Mr. Williams
received warrants to purchase shares of Common Stock at $ per share. In
June 1997, Mr. Williams purchased an additional 10% convertible note with a
$20,000 principal amount. In connection therewith, he received a warrant to
purchase shares of Common Stock at an exercise price of $ per share. In
October 1997, Mr. Williams purchased shares of Common Stock for $ per
share in a private placement.
CSI used the proceeds from the sales of Common Stock discussed above to fund
its operations. CSI believes that these transactions were conducted on terms
that were fair and reasonable to CSI and at prices that approximated the fair
market value of the Common Stock at the time of the transactions. See
"Principal Shareholders."
54
DESCRIPTION OF SECURITIES
The following description of CSI's securities is qualified in its entirety
by reference to CSI's Articles of Incorporation and Bylaws, copies of which
have been filed as exhibits to the Registration Statement of which this
Prospectus is a part. As of December 31, 1997, the Common Stock was held of
record by 621 shareholders. See "Additional Information."
COMMON STOCK
CSI is authorized to issue 25,000,000 shares of Common Stock, no par value.
As of the date of this Prospectus, the Company had shares of Common Stock
issued and outstanding. Holders of Common Stock are each entitled to cast one
vote for each share held of record on all matters presented to shareholders.
Cumulative voting is not allowed; hence, the holders of a majority of the
outstanding Common Stock can elect all directors.
Holders of Common Stock are entitled to receive such dividends as may be
declared by the Board of Directors out of funds legally available therefor
and, in the event of liquidation, to share pro rata in any distribution of the
Company's assets after payment of liabilities. The Board of Directors is not
obligated to declare a dividend and it is not anticipated that dividends will
be paid in the foreseeable future. See "Dividend Policy."
Holders of Common Stock do not have preemptive rights to subscribe to
additional shares if issued by the Company. Except for shares which were
purchased with a note, which is outstanding, all of the outstanding shares of
Common Stock are fully paid and non-assessable and all of the Shares of Common
Stock offered hereby will be, upon issuance, fully paid and non-assessable.
PREFERRED STOCK
CSI is authorized to issue up to 5,000,000 shares of Preferred Stock, no par
value. As of the date of this Prospectus, no shares of Preferred Stock were
outstanding. The Board of Directors has the authority to issue Preferred Stock
in one or more series and to fix the number of shares constituting any such
series and the preferences, limitations, and relative rights, including
dividend rights, and liquidation preferences of the Shares constituting any
series, without any further vote or action by the shareholders of the Company.
The issuance of Preferred Stock by the Board of Directors could adversely
affect the rights of holders of Common Stock.
The potential issuance of Preferred Stock may have the effect of delaying,
deterring, or preventing a change in control of the Company, may discourage
bids for the Common Stock at a premium over the market price of the Common
Stock and may adversely affect the market price of, and the voting and other
rights of the holders of, Common Stock. The Company has no current intention
to issue shares of Preferred Stock.
DESCRIPTION OF INDEBTEDNESS
Mandatorily Redeemable Convertible Promissory Notes. In December 1997, CSI
issued Bridge Notes in an aggregate principal amount of $2,840,000. Interest
on the Bridge Notes is payable at a rate of 10% per annum, semi-annually. The
aggregate outstanding principal amount of the Bridge Notes is due five days
following the closing of this Offering. Robert Spade, the Chairman and Chief
Executive Officer of CSI, and Patrick Scanlon, the President and Chief
Operating Officer of CSI, each guaranteed payment of the Bridge Notes for up
to $750,000. For each $100,000 of principal amount of the Bridge Notes, the
holder will receive 4,000 Bridge Shares upon the closing of this Offering,
based on a $10.00 per share initial offering price. Such Bridge Shares are
offered by this Registration Statement. See "Selling Securityholders and Plan
of Distribution."
10% Notes. From October 1996 through July 1997, CSI issued unsecured
convertible promissory notes (the "10% Notes") in an aggregate principal
amount of $415,000. Interest on the 10% Notes is payable at a rate of 10% per
annum, semi-annually, commencing on March 31, 1997 and continuing until the
maturity date, which
55
is two years from the respective dates of investment. The aggregate
outstanding principal amount of the 10% Notes is due on the maturity date. The
10% Notes may be converted into shares of Common Stock at a conversion price
of 90% of the average high bid and low asked price of the Common Stock on the
day before conversion. CSI may prepay any of the 10% Notes in full at any time
without penalty, and any note holders may cause CSI to repay such holder's
note at the end of each six-month period that any principal is outstanding
upon 30 days written notice. As of January 31, 1998, $385,000 principal amount
of 10% Notes have been converted. For each $10,000 of principal amount of the
10% Notes, the holder received warrants to purchase shares of Common Stock
of CSI at an exercise price equal to the closing bid price of the Common Stock
on the date of the 10% Notes.
15% Notes. From February 1997 through March 1997, CSI issued $85,000
aggregate principal amount of the 15% Notes. Interest on the 15% Notes, and
the aggregate outstanding principal amount of the 15% Notes, are payable on
the maturity date, which is six months after the date of each Note. For each
$10,000 of principal amount of 15% Notes, the holder received warrants to
purchase shares of Common Stock at an exercise price equal to the closing
bid price of the Common Stock on the date of the 15% Notes.
REGISTRATION RIGHTS
CSI has agreed to grant to two holders of shares of the Common Stock (the
"Rights Holders") certain "piggy-back" registration rights under the
Securities Act with respect to such shares. Under the terms of agreements
between the Company and these Rights Holders, if CSI proposes to register any
of its Common Stock under the Securities Act for its own account or for the
account of other security holders (other than pursuant to this Offering and
certain excluded registration forms), the Rights Holders are entitled to
notice of such registration and to include in such registration shares of
Common Stock that they hold, subject to cutback limitations that may be
imposed by the underwriter of any underwritten public offering of the Common
Stock. The Rights Holders are not required to bear any expenses incurred by
CSI in connection with registering the Rights Holders' shares, but
underwriting fees, discounts, or commissions relating to the sale of each
Rights Holder's shares are borne by the applicable Rights Holder. CSI is not
required to include any of the shares with registration rights in a
registration if the holders of such shares would be able to sell such shares
without registration pursuant to Rule 144 of the Securities Act or otherwise.
None of the Rights Holders will participate in this Offering.
CSI has agreed to grant to Lynch Family, LLC, Philip Thomas and Sean Thomas
(collectively, the "Former ITC Stockholders") certain "demand" registration
rights under the Securities Act with respect to the Common Stock (the "ITC
Acquisition Stock") they will receive in connection with the ITC Acquisition.
Under the terms of the Stock Purchase Agreement, CSI is obligated, after the
first anniversary of the completion of the ITC Acquisition, upon the demand of
the Former ITC Stockholders, to file within 30 days of such demand (subject to
an extension in the event CSI is then involved in certain transactions not in
the ordinary course of business) a registration statement on Form S-3 covering
the ITC Acquisition Stock. The Former ITC Stockholders are not required to
bear any expenses incurred by CSI in connection with registering the ITC
Acquisition Stock.
TRANSFER AGENT
American Securities Transfer & Trust, Inc. is the Transfer Agent and
registrar for the Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this Offering and after giving effect to the ITC
Acquisition, CSI will have shares of Common Stock outstanding ( shares
if the Representative's over-allotment option with respect to the Common Stock
is exercised in full). The 1,100,000 shares of Common Stock sold in this
Offering will be freely transferable and tradeable without restriction or
further registration under the Securities Act except for any shares purchased
or held by any "affiliate" of CSI, which will be subject to the resale
limitation of Rule 144 promulgated under the Securities Act.
56
Of CSI's approximately million shares of Common Stock outstanding
immediately prior to the date of this Prospectus, million are "restricted
securities" as that term is defined under Rule 144 of the Securities Act.
Restricted securities may be sold in open market transactions in compliance
with Rule 144 if the conditions of such rule are satisfied. Under Rule 144 any
person (or persons whose shares are aggregated) who has beneficially owned
restricted shares for at least one year is entitled to sell, within any three-
month period, a number of shares that does not exceed the greater of (i) 1% of
the then outstanding shares of CSI's Common Stock ( shares immediately
after this Offering) or (ii) the average weekly trading volume during the four
calendar weeks immediately preceding the date on which notice of the sale is
filed with the Commission. Sales pursuant to Rule 144 are also subject to
certain requirements relating to the manner of sale, notice and availability
of current public information about CSI. A person who is not deemed to have
been an affiliate of CSI at any time during the 90 days immediately preceding
the sale and whose restricted shares have been fully paid for two years since
the later of the date they were acquired from CSI or the date they were
acquired from an affiliate of CSI may sell such restricted shares under Rule
144(k) without regard to the limitations described above.
Up to 110,000 additional shares of Common Stock may be purchased by the
Representative after the first anniversary date of this Prospectus through the
exercise of the Representative's Warrants. Any and all shares of Common Stock
purchased upon exercise of the Representative's Warrant may be freely
tradeable, provided that CSI satisfies certain securities registration and
qualification requirements in accordance with the terms of the
Representative's Warrants. See "Underwriting."
CSI, its officers and directors and persons known by CSI to be greater than
2% shareholders, have agreed not, directly or indirectly, to sell, offer to
sell, contract to sell, grant any option for the sale of, otherwise dispose
of, or register or announce the sale or Offering of any shares of capital
stock of CSI beneficially owned by them or any securities beneficially owned
by them convertible into, or exercisable or exchangeable for capital stock of
CSI for a period of 270 days after the date of this Prospectus without the
prior written consent of the Representative. Furthermore, the holders of the
Selling Securityholders' Warrants have agreed not to sell or offer for sale
the share of Common Stock underlying the Selling Securityholders' Warrants for
a period of 180 days after this Prospectus.
Sales of substantial numbers of shares of Common Stock pursuant to Rule 144
or otherwise could adversely affect the market price of the Common Stock,
should any such market develop.
57
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, a copy of
which has been filed as an exhibit to the Registration Statement of which this
Prospectus is a part, the Underwriters named below (the "Underwriters"), have
severally agreed, through Cohig & Associates, Inc., the Representative of the
Underwriters, to purchase from CSI, and CSI has agreed to sell the
Underwriters, the aggregate number of shares of Common Stock set forth
opposite their respective names.
UNDERWRITERS NUMBER OF SHARES
------------ ----------------
Cohig & Associates, Inc...................................
Total................................................... 1,100,000
=========
The Common Stock are being offered by the several Underwriters, subject to
prior sale, when, as, and if delivered to and accepted by the Underwriters and
subject to their right to reject orders in whole or in part and subject to
approval of certain legal matters by counsel and to various other conditions.
The nature of the Underwriters' obligation is such that they must purchase all
of the Common Stock offered hereby if any are purchased.
CSI has granted to the Representative a separate option, exercisable within
45 days from the effective date of the Registration Statement, to purchase an
additional number of shares of Common Stock as will be equal to not more than
15% each of the total number of shares of Common Stock initially offered at
the public offering price less the underwriting discount of $ per share of
Common Stock. The Representative may exercise such option only for the purpose
of covering any over-allotments in the sale of the Common Stock offered
hereby.
The Underwriters have advised CSI that the Underwriters propose to offer the
Common Stock directly to the public at the public offering prices set forth on
the cover page of this Prospectus, and to selected dealers at that price, less
a concession of not more than $ per share of Common Stock. After the public
offering, the price to the public and the concession may be changed by the
Underwriters.
The Underwriters have informed CSI that they do not expect to sell any
Common Stock offered hereby to accounts over which they exercise discretionary
authority in excess of 5% of the Offering.
CSI will pay the Representative a non-accountable expense allowance of 3% of
the offering proceeds, which will include proceeds from the over-allotment
option to the extent exercised. CSI has paid to the Representative $40,000
against the non-accountable expense allowance. The Representative's expenses
in excess of the non-accountable expense allowance will be borne by the
Representative. To the extent that the expenses of the Representative are less
than the non-accountable expense allowance, the excess shall be deemed to be
compensation to the Representative.
CSI has granted the Representative a right of first refusal with respect to
additional public or private offerings proposed to be undertaken by CSI for a
period of 12 months after the date of this Prospectus.
CSI and the Underwriters have agreed to indemnify each other against certain
liabilities, including liabilities under the 1933 Act, and, if such
indemnifications are unavailable or insufficient, CSI and the Underwriters
have agreed to damage contribution agreements between them based upon relative
benefits received from this Offering and relative fault resulting in such
damages. CSI also has agreed with the Underwriters that CSI will use its best
efforts to cause a registration statement pursuant to Section 12(g) of the
Exchange Act to become effective no later than the date of this Prospectus.
Although there is no contractual agreement or other obligation, officers,
directors and affiliates of CSI might be sold a portion of the Common Stock,
but only on the same terms and conditions as will be offered to the public.
Such persons will be required to represent that purchases by such persons, if
any, will be for investment purposes only with no present intent to sell.
58
The Underwriters may engage in over-allotment, stabilizing transactions,
syndicate covering transactions and penalty bids in accordance with Regulation
M under the 1934 Act. Over-allotment involves syndicate sales in excess of the
offering size, which creates a syndicate short position. Stabilizing
transaction permit bids to purchase the underlying security so long as the
stabilizing bids do not exceed a specified maximum. Syndicate covering
transactions involve purchases of the securities in the open market after the
distribution has been completed in order to cover syndicate short positions.
Penalty bids permit the Underwriters to reclaim a selling concession from a
syndicate covering transaction to cover syndicate short positions. Such
stabilizing transactions, syndicate covering transactions and penalty bids may
cause the price of the Common Stock to be higher than it would otherwise be in
the absence of such transactions.
Neither the Company nor the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the
transactions described above may have on the price of the Common Stock. In
addition, neither the Company nor any of the Underwriters makes any
representation that the Underwriters will engage in such transactions or that
such transactions, once commenced, will not be discontinued without notice.
The foregoing does not purport to be a complete statement of the terms and
conditions of the Underwriting Agreement, copies of which are on file at the
offices of the Representative, CSI and the Commission. See "Additional
Information."
The Common Stock is traded infrequently in limited quantities on the OTC
Bulletin Board under the symbol CSYG. The public offering prices of the Common
Stock was determined by negotiations between the Representative and CSI. Among
the factors considered in determining the public offering prices were the
prospects for CSI, an assessment of the industry in which CSI operates, the
assessment of management, the number of shares of Common Stock offered, and
the price that purchasers of such securities might be expected to pay given
the nature of CSI and the general condition of the securities markets at the
time of the Offering. Accordingly, the offering price set forth on the cover
page of this Prospectus should not be considered an indication of the actual
value of CSI or the Common Stock.
REPRESENTATIVE'S WARRANTS
At the closing of the Offering, CSI will sell and deliver to the
Representative for an aggregate purchase price of $100, warrants (the
"Representative's Warrants"), consisting of 110,000 warrants to purchase
110,000 shares of Common Stock (the "Representative's Warrants") at a price
that is equal to 125% of the public offering price for the Common Stock.
The Representative's Warrants will be non-transferable for a period of one
year following the date of this Prospectus except to the Underwriters, other
selling group members, and their respective officers or partners. The
Representative's Warrants contain anti-dilution provisions for stock splits,
recombinations and reorganizations, a one-time demand registration provision
(at CSI's expense), piggyback registration rights (both of which expire five
years from the date of this Prospectus), a cashless exercise provision, and
will otherwise be in form and substance satisfactory to the Representative.
The Representative's Warrants will be exercisable during the four-year period
commencing one year after the date of this Prospectus.
LEGAL MATTERS
The validity of the Securities offered hereby will be passed upon for CSI by
Parcel, Mauro & Spaanstra, P.C., Denver, Colorado and for the Representative
by Berliner Zisser Walter & Gallegos, P.C., Denver, Colorado.
59
EXPERTS
The financial statements of CSI as of April 30, 1997 and for the years ended
April 30, 1996 and 1997 included in this prospectus, have been audited by
Stockman Kast Ryan & Scruggs, P.C., independent auditors, as stated in their
report appearing herein, and have been so included in reliance upon the report
of such firm given upon their authority as experts in accounting and auditing.
The financial statements of ITC as of October 31, 1997 and for the year ended
December 31, 1996 and the ten months ended October 31, 1997 included in this
prospectus, have been audited by Richard A. Eisner & Company, LLP.,
independent auditors, as stated in their report appearing herein, and have
been so included in reliance upon the report of such firm given upon their
authority as experts in accounting and auditing
ADDITIONAL INFORMATION
CSI has filed with the Securities and Exchange Commission (the
"Commission"), 450 Fifth Street, N.W., Washington, D.C. 20549, a Registration
Statement on Form SB-2 under the Securities Act with respect to the Securities
offered hereby. This Prospectus does not contain all of the information set
forth in the Registration Statement and exhibits and schedules thereto. For
further information with respect to CSI and the Securities, reference is made
to the Registration Statement, including exhibits and schedules thereto, which
may be inspected without charge at, and copies of which may be obtained at
prescribed rates from, the public reference facilities of the Commission's
principal office at 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
Commission's regional offices at 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661-2511 and 7 World Trade Center, Suite 1300, New York, New York
10048. Copies of all or any part of the Registration Statement may be obtained
from the Public Reference Section of the Commission in Washington, D.C. upon
the payment of the fees prescribed by the Commission. The Commission maintains
a Web site (http://www.sec.gov) that contains reports, proxy statements, and
other information that will be filed by the Company.
60
INDEX TO FINANCIAL STATEMENTS
PAGE
NUMBER
------
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
PRO FORMA COMBINED FINANCIAL STATEMENTS (UNAUDITED).................... F-2
Pro Forma Condensed Combined Balance Sheet at of October 31, 1997...... F-3
Pro Forma Condensed Combined Statement of Operations for the year ended
April 30, 1997........................................................ F-4
Pro Forma Condensed Combined Statement of Operations for six months
ended October 31, 1997................................................ F-5
Notes to Pro Forma Condensed Combined Financial Statements............. F-6
HISTORICAL FINANCIAL STATEMENTS
Independent Auditors' Report........................................... F-7
Balance Sheets as of April 30, 1997 and October 31, 1997 (unaudited)... F-8
Statements of Operations for the year ended April 30, 1997 and six
months ended October 31, 1996 and 1997 (unaudited).................... F-9
Statements of Shareholders' Equity (Deficiency) for the year ended
April 30, 1997 and six months ended October 31, 1997 (unaudited)...... F-10
Statements of Cash Flows for the year ended April 30, 1997 and six
months ended October 31, 1996 and 1997 (unaudited).................... F-11
Notes to Financial Statements.......................................... F-12
INTERNATIONAL TELEPHONE COMPANY
HISTORICAL FINANCIAL STATEMENTS
Report of Independent Auditors......................................... F-20
Balance Sheet as of October 31, 1997................................... F-21
Statements of Operations for the ten months ended October 31, 1997 and
year ended December 31, 1996.......................................... F-22
Statements of Stockholders' Equity for the ten months ended October 31,
1997 and year ended December 31, 1996................................. F-23
Statements of Cash Flows for the ten months ended October 31, 1997 and
year ended December 31, 1996.......................................... F-24
Notes to Financial Statements.......................................... F-25
F-1
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
The following unaudited pro forma condensed combined financial statements
have been prepared to give effect to the private placement of promissory
notes, completion of the public offering and the acquisition of International
Telephone Company (ITC) described below.
On December 30, 1997, Communications Systems International, Inc. (the
Company) completed a private placement of mandatorily redeemable convertible
promissory notes (the "Bridge Notes") totalling $2,840,000. The holders of the
Bridge Notes are also entitled to receive shares valued at $1,136,000, the
number of shares to be issued by the Company will be based on the public
offering per share price. The Company also has entered into a proposed
agreement to acquire all of the stock of ITC for $3,100,000 cash and the
issuance of shares of the Company's common stock valued at $2,070,000, the
number of shares to be issued by the Company will be based on the public
offering per share price. The pro forma condensed combined financial
statements for the year ended April 30, 1997 and the six months ended October
31, 1997 assume the Bridge Notes and related shares were issued and the
proposed acquisition was consummated on May 1, 1996 and May 1, 1997,
respectively.
In management's opinion, all material adjustments necessary to reflect the
transactions are presented in the pro forma adjustments for the year ended
April 30, 1997 and the six months ended October 31, 1997 which are based upon
available information and the currently agreed upon terms of the proposed
acquisition. The pro forma condensed combined financial statements do not
purport to present the Company's financial position or results of operations
that would have occurred had the transactions, to which pro forma effect is
given, been consummated as of the dates or for the periods indicated and do
not purport to project the Company's financial position or results of
operations at any future date or for any future period, and should be read in
conjunction with the separate financial statements of the Company and ITC.
F-2
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
PRO FORMA CONDENSED COMBINED BALANCE SHEETS (UNAUDITED)
OCTOBER 31, 1997
HISTORICAL PRO FORMA PRO FORMA HISTORICAL PRO FORMA PRO FORMA
CSI ADJUSTMENTS CSI ITC ADJUSTMENTS COMBINED
---------- ----------- ---------- ---------- ----------- -----------
ASSETS
Current assets:
Cash.................... $ 143,632 $ 2,516,550 (a) $ 468,182 $ 847,994 $ 7,895,000 (b) $ 4,943,457
(2,192,000)(a) (2,840,000)(c)
122,281 (b)
(1,550,000)(d)
Restricted cash......... -- -- -- -- 1,325,000 (b) 1,325,000
Accounts receivable--
net.................... 1,092,111 -- 1,092,111 1,045,061 (178,047)(e) 1,959,125
Other................... 263,081 (178,047)(a) 85,034 56,424 -- 141,458
---------- ----------- ---------- ---------- ----------- -----------
Total current assets.... 1,498,824 146,503 1,645,327 1,949,479 4,774,234 8,369,040
Property and equipment--
net.................... 453,090 -- 453,090 640,167 -- 1,093,257
Deferred offering
costs.................. 122,281 323,450 (a) 445,731 -- (122,281)(b) --
(323,450)(c)
Deposits................ 203,820 250,000 (a) 453,820 130,250 (225,000)(d) 359,070
Intangible assets....... -- -- -- -- 4,683,358 (d) 4,683,358
---------- ----------- ---------- ---------- ----------- -----------
Total assets........... $2,278,015 $ 719,953 $2,997,968 $2,719,896 $ 8,786,861 $14,504,725
========== =========== ========== ========== =========== ===========
LIABILITIES AND
SHAREHOLDERS' EQUITY
(DEFICIENCY)
Current liabilities:
Accounts payable........ $1,540,935 $(1,091,810)(a) $ 449,125 $2,455,784 $ (65,505)(e) $ 2,839,404
Accrued commissions..... 264,361 -- 264,361 145,000 -- 409,361
Accrued expenses and
customer deposits...... 401,912 (116,755)(a) 285,157 317,083 -- 602,240
Accrued income taxes
payable................ -- -- -- 7,227 -- 7,227
Payables to former
shareholders........... 242,619 -- 242,619 -- -- 242,619
Debt to related party... 148,761 -- 148,761 -- 884,284 (d) 1,033,045
Capitalized lease
obligations............ -- -- -- 281,385 -- 281,385
Notes payable........... 933,292 (808,292)(a) 125,000 2,686 -- 127,686
---------- ----------- ---------- ---------- ----------- -----------
Total current
liabilities............ 3,531,880 (2,016,857) 1,515,023 3,209,165 818,779 5,542,967
---------- ----------- ---------- ---------- ----------- -----------
Long-term liabilities... 850,190 2,840,000 (a) 2,044,800 291,804 (2,840,000)(c) 291,804
(795,200)(a) 795,200 (c)
(850,190)(a)
---------- ----------- ---------- ---------- ----------- -----------
Shareholders' equity
(deficiency):
Common stock............ 2,750,285 -- 2,750,285 12 9,220,000 (b) 14,008,486
795,200 (b)
1,243,001 (d)
(12)(d)
Additional paid-in
capital................ -- -- -- 988 (988)(d) --
Common stock
subscribed............. -- 795,200 (a) 795,200 -- (795,200)(b) --
Notes receivable from
shareholder............ (35,000) -- (35,000) -- -- (35,000)
Accumulated deficit..... (4,576,721) 747,000 (a) (3,829,721) (782,073) (1,118,650)(c) (5,060,913)
(112,542)(e)
782,073 (d)
Treasury stock, at
cost................... (242,619) -- (242,619) -- -- (242,619)
---------- ----------- ---------- ---------- ----------- -----------
Total shareholders'
equity (deficiency)... (2,104,055) 1,542,200 (561,855) (781,073) 10,012,882 8,669,954
---------- ----------- ---------- ---------- ----------- -----------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY
(DEFICIENCY)........... $2,278,015 $ 719,953 $2,997,968 $2,719,896 $ 8,786,861 $14,504,725
========== =========== ========== ========== =========== ===========
See notes to pro forma condensed combined financial statements.
F-3
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS (UNAUDITED)
FOR THE YEAR ENDED APRIL 30, 1997
HISTORICAL HISTORICAL
CSI ITC
YEAR ENDED TWELVE MONTHS
APRIL 30, ENDED PRO FORMA PRO FORMA
1997 APRIL 30, 1997 ADJUSTMENTS(G) COMBINED
----------- -------------- -------------- -----------
REVENUE................. $11,865,412 $7,867,078 $ -- $19,732,490
COST OF REVENUE......... 7,754,897 5,498,553 -- 13,253,450
----------- ---------- --------- -----------
GROSS MARGIN............ 4,110,515 2,368,525 -- 6,479,040
----------- ---------- --------- -----------
OPERATING EXPENSES
Sales and marketing..... 2,080,020 848,012 -- 2,928,032
General and
administrative......... 1,302,272 1,626,845 -- 2,929,117
Technical and
developmental.......... 722,111 -- -- 722,111
Depreciation............ 102,983 76,231 -- 179,214
Amortization............ -- -- 936,672 (f) 936,672
----------- ---------- --------- -----------
Total operating
expenses............. 4,207,386 2,551,088 936,672 7,695,146
----------- ---------- --------- -----------
LOSS FROM OPERATIONS.... (96,871) (182,563) (936,672) (1,216,106)
OTHER INCOME (EXPENSE)--
Net.................... (162,602) 100,238 -- (62,364)
----------- ---------- --------- -----------
NET LOSS................ $ (259,473) $ (82,325) $(936,672) $(1,278,470)
=========== ========== ========= ===========
NET LOSS PER SHARE...... $ $
=========== ===========
WEIGHTED AVERAGE SHARES
OUTSTANDING............
=========== ===========
See notes to pro forma condensed combined financial statements.
F-4
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS (UNAUDITED)
FOR THE SIX MONTHS ENDED OCTOBER 31, 1997
SIX MONTHS ENDED
OCTOBER 31, 1997
----------------------
HISTORICAL HISTORICAL PRO FORMA PRO FORMA
CSI ITC ADJUSTMENTS(G) COMBINED
---------- ---------- -------------- -----------
REVENUE................. $6,371,549 $5,054,014 $ -- $11,425,563
COST OF REVENUE......... 3,807,066 4,549,470 -- 8,356,536
---------- ---------- --------- -----------
GROSS MARGIN............ 2,564,483 504,544 -- 3,069,027
---------- ---------- --------- -----------
OPERATING EXPENSES
Sales and marketing..... 1,270,857 432,260 -- 1,703,117
General and
administrative......... 1,326,260 856,530 -- 2,182,790
Technical and
developmental.......... 388,663 -- -- 388,663
Depreciation............ 67,808 45,000 -- 112,808
Amortization............ -- -- 468,336 (f) 468,336
---------- ---------- --------- -----------
Total operating
expenses............. 3,053,588 1,333,790 468,336 4,855,714
---------- ---------- --------- -----------
LOSS FROM OPERATIONS.... (489,105) (829,246) (468,336) (1,786,687)
OTHER INCOME (EXPENSE)--
Net.................... (87,905) 91,307 (178,047)(e) (109,140)
65,505 (e)
---------- ---------- --------- -----------
NET LOSS................ $ (577,010) $ (737,939) $(580,878) $(1,895,827)
========== ========== ========= ===========
NET LOSS PER SHARE...... $ $
========== ===========
WEIGHTED AVERAGE SHARES
OUTSTANDING............
========== ===========
See notes to pro forma condensed combined financial statements.
F-5
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
The following pro forma adjustments give effect to (i) the private placement
of the Bridge Notes as of October 31, 1997, (ii) the completion of the
offering and the proposed acquisition of ITC as of October 31, 1997, and (iii)
the proposed acquisition of ITC as of the beginning of each period presented
for the statements of operations:
(a) Reflects the private placement of promissory notes of $2,840,000, net of a
discount of $795,200 for the value of common stock to be issued, debt
offering costs of $323,450, and the net proceeds of $2,516,550. Reflects
$2,192,000 of the net proceeds used for the repayment of notes payable of
$850,190 and accounts payable of $1,091,810 and for deposits of $250,000.
Reflects the forgiveness of $808,292 of notes payable and $116,755 of
accrued interest, offset by prepaid consulting fees of $178,047 incurred
to obtain such forgiveness, resulting in a gain of $747,000.
The common stock to be issued to the holders of the Bridge Notes, valued at
$1,136,000 based on the public offering per share price, which value has
been discounted by 30% to $795,200 as a result of the limitations on the
transferability of the shares subsequent to their issuance.
(b) Reflects the estimated net proceeds of the offering of $9,220,000, of
which $1,325,000 is to be placed in escrow to satisfy the terms of the
proposed ITC acquisition agreement. Reflects the reclassification of
deferred offering costs of $122,281, which have been included as a
reduction in determining the estimated net proceeds of the offering.
Reflects the issuance of the common stock valued at $795,200 to the
holders of the Bridge Notes.
(c) Reflects the repayment of the Bridge Notes of $2,840,000. Reflects the
loss totalling $1,118,650 from the early retirement of the Bridge Notes
resulting from the write-off of the debt placement offering costs of
$323,450 and the full and immediate amortization of the discount on the
Bridge Notes of $795,200.
(d) Reflects the proposed acquisition of ITC based on currently agreed upon
terms which includes: cash payments of $1,325,000, excluding deposits
previously made, to the ITC shareholders; the commitment to issue an
estimated number of shares of stock valued at $1,243,001 to the ITC
shareholders, which value is based on the public offering price and
discounted by 30% as a result of the timing of the issuance of such stock
and the limitations on its transferability; accrual of an estimated
payment to the ITC shareholders of $884,284; reclassification of deposits
given to ITC of $225,000; and, the elimination of ITC's historical equity
balances in connection with purchase accounting. The recorded values of
ITC's assets and liabilities are believed to be reasonable estimates of
their fair values. The number of shares to be issued to, and the amount of
cash to be paid from escrow to ITC shareholders, is ultimately dependent
upon the resolution of certain ITC liabilities; the acquisition price,
however, is not expected to be adjusted.
(e) Reflects the elimination of intercompany transactions and balances.
(f) Reflects the increase in amortization expense due to the amortization of
the intangible assets recorded in the acquisition of ITC. The intangible
assets are amortized over a five-year period using the straight-line
method.
(g) Does not reflect pro forma adjustments for the following material
nonrecurring charges and credit which result directly from the Bridge
Notes and which will be included in the Company's statements of operations
within the twelve months subsequent to such placement: an extraordinary
gain of $747,000 resulting from the forgiveness of debt and accrued
interest; interest expense, excluding amortization of the discount on the
Bridge Notes, of $284,000 for the twelve months subsequent to the
placement, respectively; and, amortization to interest expense of the
discount on the Bridge Notes and the deferred placement offering costs of
$1,118,650 for the twelve months subsequent to the placement,
respectively.
F-6
INDEPENDENT AUDITORS' REPORT
Communications Systems International, Inc.
Colorado Springs, Colorado
We have audited the accompanying balance sheet of Communications Systems
International, Inc. as of April 30, 1997, and the related statements of
operations, stockholders' equity (deficiency) and cash flows for each of the
years in the two-year period ended April 30, 1997. 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, such financial statements present fairly, in all material
respects, the financial position of Communications Systems International, Inc.
as of April 30, 1997, and the results of its operations and its cash flows for
each of the years in the two-year period ended April 30, 1997 in conformity
with generally accepted accounting principles.
Stockman Kast Ryan & Scruggs, P.C.
Colorado Springs, Colorado
June 2, 1997
(August 11, 1997 as to the matters discussed in the tenth paragraph of Note
4; September 17, 1997 as to the matters discussed in the fourth paragraph
of Note 10; October 9, 1997 as to the matters discussed in the second
paragraph of Note 3; October 31, 1997 as to the matters discussed in the
last paragraph of Note 4, the first paragraph of Note 10, and Note 13; and,
December 30, 1997 as to the matters discussed in the third paragraph of
Note 3 and Note 14)
F-7
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
BALANCE SHEETS
APRIL 30, OCTOBER 31,
1997 1997
----------- -----------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash................................................. $ 146,686 $ 143,632
Accounts receivable--net............................. 1,053,233 1,092,111
Prepaid expenses and other current assets............ 83,962 263,081
----------- -----------
Total current assets................................. 1,283,881 1,498,824
PROPERTY AND EQUIPMENT--Net (Note 2)................. 457,791 453,090
DEFERRED OFFERING COSTS (Notes 12 and 14)............ 83,939 122,281
DEPOSITS (Note 13)................................... 120,880 203,820
----------- -----------
TOTAL ASSETS....................................... $ 1,946,491 $ 2,278,015
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)
CURRENT LIABILITIES
Accounts payable (including bank overdraft of $85,035
at October 31)...................................... $ 1,287,187 $ 1,540,935
Accrued commissions.................................. 145,352 264,361
Accrued expenses and customer deposits (Note 10)..... 88,940 401,912
Payables to former shareholders (Note 4)............. -- 242,619
Debt to related party (Note 8)....................... 148,761 148,761
Current portion of notes payable (Note 3)............ 1,944,896 933,292
----------- -----------
Total current liabilities.......................... 3,615,136 3,531,880
----------- -----------
NOTES PAYABLE (Note 3)............................... -- 850,190
-----------
COMMITMENTS AND CONTINGENCIES
(Notes 4, 8 and 10)
SHAREHOLDERS' EQUITY (DEFICIENCY)
(Notes 4, 5 and 6)
Preferred stock, no par value--5,000,000 shares
authorized, none issued or outstanding Common stock,
no par value--25,000,000 shares authorized;
9,765,590 and 10,047,091 shares issued and
outstanding at April 30, 1997 and October 31, 1997.. 2,366,066 2,750,285
Notes receivable from shareholder.................... (35,000) (35,000)
Accumulated deficit.................................. (3,999,711) (4,576,721)
Treasury stock, at cost.............................. -- (242,619)
----------- -----------
Total shareholders' equity (deficiency)............ (1,668,645) (2,104,055)
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIENCY)...................................... $ 1,946,491 $ 2,278,015
=========== ===========
See notes to financial statements.
F-8
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF OPERATIONS
SIX MONTH
YEAR ENDED APRIL 30, PERIOD ENDED OCTOBER
------------------------ ------------------------
1996 1997 1996 1997
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
REVENUE.................... $ 6,741,022 $11,865,412 $5,530,847 $6,371,549
COST OF REVENUE............ 5,962,609 7,754,897 3,608,465 3,807,066
----------- ----------- ---------- ----------
GROSS MARGIN............... 778,413 4,110,515 1,922,382 2,564,483
----------- ----------- ---------- ----------
OPERATING EXPENSES
Sales and marketing........ 1,572,747 2,080,020 876,630 1,270,857
General and administrative
(Note 10)................. 1,257,964 1,302,272 608,689 1,326,260
Technical and
developmental............. 394,410 722,111 294,512 388,663
Depreciation and
amortization.............. 57,843 102,983 42,219 67,808
----------- ----------- ---------- ----------
Total operating
expenses................ 3,282,964 4,207,386 1,822,050 3,053,588
----------- ----------- ---------- ----------
INCOME (LOSS) FROM
OPERATIONS................ (2,504,551) (96,871) 100,332 (489,105)
INTEREST INCOME (EXPENSE)--
Net....................... (19,389) (162,602) (76,142) (87,905)
----------- ----------- ---------- ----------
NET INCOME (LOSS).......... $(2,523,940) $ (259,473) $ 24,190 $ (577,010)
=========== =========== ========== ==========
NET INCOME (LOSS) PER
SHARE..................... $ (.30) $ (.03) $ .00 $ (.06)
=========== =========== ========== ==========
WEIGHTED AVERAGE SHARES
OUTSTANDING............... 8,394,451 9,414,238 9,388,938 9,996,455
=========== =========== ========== ==========
See notes to financial statements.
F-9
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIENCY)
NOTES
COMMON STOCK COMMON RECEIVABLE TREASURY STOCK
---------------------- STOCK FROM ACCUMULATED -------------------
SHARES AMOUNT SUBSCRIBED SHAREHOLDER DEFICIT SHARES AMOUNT TOTAL
---------- ---------- ---------- ----------- ----------- -------- --------- -----------
BALANCES,
May 1, 1995............ 4,901,040 $ 530,929 $ 503,437 $ -- $(1,216,298) -- $ -- $ (181,932)
Issuance of subscribed
stock.................. 1,687,263 503,437 (503,437) -- -- -- --
Sale of stock for cash
and note............... 934,000 542,000 -- (5,000) -- -- -- 537,000
Stock issued for
services............... 657,910 312,775 -- -- -- -- -- 312,775
Stock issued in
acquisition............ 818,774 -- -- -- -- -- -- --
Net loss................ -- -- -- -- (2,523,940) -- -- (2,523,940)
---------- ---------- --------- -------- ----------- -------- --------- -----------
BALANCES,
April 30, 1996......... 8,998,987 1,889,141 -- (5,000) (3,740,238) -- -- (1,856,097)
Sale of stock for cash.. 61,500 111,200 -- -- -- -- -- 111,200
Stock issued in exchange
for note............... 60,000 30,000 -- (30,000) -- -- -- --
Stock issued for
services............... 140,000 34,224 -- -- -- -- -- 34,224
Stock issued in
acquisition of
affiliate.............. 179,076 49,993 -- -- -- -- -- 49,993
Conversion of notes and
accrued interest to
stock.................. 326,027 251,508 -- -- -- -- -- 251,508
Net loss................ -- -- -- -- (259,473) -- -- (259,473)
---------- ---------- --------- -------- ----------- -------- --------- -----------
BALANCES,
April 30, 1997......... 9,765,590 2,366,066 -- (35,000) (3,999,711) -- -- (1,668,645)
Unaudited:
Conversion of notes and
accrued interest to
stock.................. 213,986 104,467 -- -- -- -- -- 104,467
Sale of stock for cash.. 908,641 499,752 -- -- -- -- -- 499,752
Purchase of common
stock.................. -- -- -- -- -- (841,126) (462,619) (462,619)
Retirement of treasury
stock.................. (400,000) (220,000) -- -- -- 400,000 220,000 --
Net loss................ -- -- -- -- (577,010) -- -- (577,010)
---------- ---------- --------- -------- ----------- -------- --------- -----------
BALANCES,
October 31, 1997
(unaudited)........... 10,488,217 $2,750,285 $ -- $(35,000) $(4,576,721) (441,126) $(242,619) $(2,104,055)
========== ========== ========= ======== =========== ======== ========= ===========
See notes to financial statements.
F-10
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF CASH FLOWS
SIX MONTH
YEAR ENDED APRIL 30, PERIOD ENDED OCTOBER 31,
---------------------- ---------------------------
1996 1997 1996 1997
----------- --------- ------------ ------------
(UNAUDITED) (UNAUDITED)
OPERATING ACTIVITIES
Net income (loss)....... $(2,523,940) $(259,473) $ 24,190 $ (577,010)
Adjustments to reconcile
net income (loss) to
cash provided by (used
in) operating
activities:
Stock issued or
subscribed for services
and interest........... 312,775 38,566 -- --
Depreciation and
amortization.......... 57,843 102,983 42,219 67,808
Changes in operating
assets and
liabilities:
Accounts receivable.... (904,447) 52,565 138,973 (38,878)
Other assets........... (15,393) (115,783) (21,274) (162,767)
Accounts payable and
accrued expenses...... 2,711,390 911,463 222,116 685,904
----------- --------- ----------- ------------
Net cash provided by
(used in) operating
activities............. (361,772) 730,321 406,224 (24,943)
----------- --------- ----------- ------------
INVESTING ACTIVITIES
Purchases of property
and equipment.......... (222,813) (218,668) (177,581) (63,107)
Increase in deposits for
acquisition............ -- (25,000) -- (100,000)
----------- --------- ----------- ------------
Net cash used in
investing activities... (222,813) (243,668) (177,581) (163,107)
----------- --------- ----------- ------------
FINANCING ACTIVITIES
Proceeds from issuance
of notes............... 7,000 405,000 100,000 95,000
Proceeds from the
issuance of stock...... 537,000 111,200 225,417 499,752
Repayment of notes
payable................ (78,530) (818,418) (533,573) (151,414)
Increase in deferred
offering costs......... -- (83,989) -- (38,342)
Payment for treasury
stock.................. -- -- -- (220,000)
Net proceeds
(repayments) from
issuances of debt to
related party.......... 94,915 (11,154) -- -
----------- --------- ----------- ------------
Net cash provided by
(used in) financing
activities............. 560,385 (397,361) (208,156) 184,996
----------- --------- ----------- ------------
NET INCREASE (DECREASE)
IN CASH................ (24,200) 89,292 20,487 (3,054)
CASH, Beginning of
period................. 81,594 57,394 57,394 146,686
----------- --------- ----------- ------------
CASH, End of period..... $ 57,394 $ 146,686 $ 77,881 $ 143,632
=========== ========= =========== ============
SUPPLEMENTAL CASH FLOW
INFORMATION
Interest paid.......... $ 7,879 $ 126,066 $ 56,892 $ 28,610
SUPPLEMENTAL NONCASH
INVESTING AND FINANCING
ACTIVITIES
Stock issued or
subscribed for
services and
interest.............. $ 312,775 $ 38,566 -- --
Conversion of accounts
payable to notes
payable............... 1,938,227 761,617 -- --
Issuance of stock in
exchange for note..... 5,000 30,000 -- --
Stock issued in
acquisition of
affiliate (Note 4).... -- 49,993 -- --
Conversion of notes and
accrued interest to
stock (Note 4)........ -- 274,342 -- $ 104,467
Purchase of treasury
stock................. -- -- -- 242,619
See notes to financial statements.
F-11
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED OCTOBER 31, 1996 AND 1997 IS
UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Communications Systems International, Inc. (the Company) is a rapidly
growing provider of international long distance telecommunications services
principally in South America, Europe, the Pacific Rim, Central America and
South Africa. The Company emphasizes innovative software solutions and
technical expertise to provide higher quality, lower cost alternative routing
of telecommunications for its customer base. The Company's telecommunications
center is a fiber optic facility which directs international telephone and fax
traffic and has a broad spectrum of Internet capabilities. The Company
purchases long distance time increments from established international
telecommunication carriers and derives its revenue by providing competitively
priced international telecommunications services combined with enhanced
technical capabilities and services not typically available from local
telecommunications providers. The Company's principal service is reverse
origination, in which a customer seeking to make an international call is
connected to the United States telephone system by a computer signal that
triggers a call to be originated in the United States and routed back to the
caller who is then connected to the international destination by a second call
also originating in the United States.
In fiscal 1997, the Company's management took actions to increase its
revenue through increased calling volume and, as a result, the Company has
been able to negotiate more favorable rates with its long distance telephone
carriers enabling the Company to reduce its cost of revenues per unit of
service sold. These steps have enabled the Company to significantly improve
its gross margins and improve its results of operations during the year ended
April 30, 1997 and the six-month period ended October 31, 1997.
In fiscal 1998, in order to raise additional working capital and satisfy
certain obligations, the Company issued mandatorily redeemable convertible
promissory notes in a private offering (see Note 14). Also in fiscal 1998,
management believes it will be successful in raising a significant amount of
equity capital in a public offering (see Note 12) and intends to use the
proceeds for repayment of the mandatorily redeemable convertible promissory
notes and to complete a pending acquisition (see Note 13) as well as repay
existing obligations, working capital, development of new product and service
offerings and enhancement and expansion of existing products and services.
Accounts Receivable--Accounts receivable are presented net of an allowance
for doubtful accounts which is based on management's estimate of uncollectible
accounts. At April 30, 1997 and October 31, 1997, the allowance for doubtful
accounts was $186,489 and $318,693, respectively.
Property and Equipment--Property and equipment are recorded at cost.
Depreciation is provided on a straight-line method over the estimated useful
lives of the respective assets (generally five to seven years).
Use of Estimates--The preparation of the Company's financial statements in
conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates.
Stock-Based Compensation--Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation," encourages, but does not
require companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has elected to continue to
account for stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. Accordingly,
compensation cost for stock options is measured as the excess, if any, of the
quoted market price of the Company's stock at the date of the grant over the
amount an employee must pay to acquire the stock. See Note 5.
F-12
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Per Share Amounts--The net loss per share is based upon the weighted average
of common shares outstanding during the period; the effect of outstanding
stock options and warrants is antidilutive. The net income per share amount
for the six-month period ended October 31, 1996 is de minimis; the effect of
the outstanding stock options and warrants on the computation of fully diluted
net income per share is less than $.01.
Interim Financial Statements--The financial statements of the Company for
the six months ended October 31, 1996 and 1997 are unaudited. In management's
opinion, the financial statements reflect all adjustments necessary for a fair
presentation of the results for these periods, all adjustments being of a
normal and recurring nature. The Company's interim financial statements may
not be indicative of the results of operations for a full year.
2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
APRIL 30, OCTOBER 31,
1997 1997
--------- -----------
Equipment.............................................. $574,966 $636,337
Furniture and fixtures................................. 61,601 61,601
Leasehold improvements................................. 13,651 15,387
-------- --------
Total................................................ 650,218 713,325
Less accumulated depreciation and amortization......... 192,427 260,235
-------- --------
Property and equipment--net............................ $457,791 $453,090
======== ========
3. NOTES PAYABLE
Notes payable consist of the following:
APRIL 30, OCTOBER 31,
1997 1997
---------- -----------
Unsecured note payable to a long distance carrier,
bearing interest at 10%, payable in monthly
installments of $40,000 due January 2001, repaid
December 1997; see below and Note 14............... $1,485,909 $1,458,292
Unsecured note payable to a long distance carrier,
bearing interest at 12%, payable in varying monthly
installments ranging from $60,000 to $123,117,
repaid December 1997; see below and Note 14........ 323,987 200,190
Unsecured notes payable, bearing interest at 15%,
principal and interest due March 1998.............. 85,000 85,000
Unsecured convertible notes payable bearing interest
at 10% which is payable semi-annually on March 31
and September 30; the outstanding principal is due
in 1998, however, the notes are callable at the
option of the noteholders at any interest payment
date............................................... 50,000 40,000
---------- ----------
Total............................................. 1,944,896 1,783,482
Current portion..................................... 1,944,896 933,292
---------- ----------
Long-term portion of notes payable.................. $ -- $ 850,190
========== ==========
On October 9, 1997, the Company entered into an agreement with the long
distance carrier to which the Company had a note payable with an outstanding
balance of $1,458,292 as of October 31, 1997. The agreement provided that the
carrier would accept a payment of $650,000 in full satisfaction of the
remaining principal balance on the note and all accrued and unpaid interest
thereon ($116,755 at October 31, 1997). The Company was also obligated to pay
a fee of $178,047 to the company which the Company intends to acquire (see
Note 13) for assistance in obtaining this agreement.
F-13
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
On December 30, 1997 the Company issued promissory notes totalling
$2,840,000, due December 30, 1998 or five days after the closing of the
proposed public offering (see Notes 12 and 14). A portion of the proceeds from
the issuance of such notes was used to satisfy the reduced liability of
$650,000 to the carrier and to repay the note with the outstanding balance of
$200,190 at October 31, 1997 and, accordingly, such amounts have been
classified as long-term as of October 31, 1997. The Company will recognize a
gain of $747,000 in December 1997 upon the payment of the $650,000 liability.
As of April 30, 1997, all of the Company's obligations are classified as
current liabilities due to their repayment terms or the Company's failure to
make timely principal and interest payments.
4. SHAREHOLDERS' EQUITY
The Company offered up to 1,000,000 shares of its no par common stock at a
purchase price of $.50 per share under a private placement memorandum dated
January 31, 1995. At May 1, 1995, 185,000 shares had been subscribed. During
the year ended April 30, 1996, the offering was fully subscribed.
In September 1995, the Company's shareholders authorized a 10-for-1 stock
split of the Company's common stock. The split was effective for shares issued
and shares subscribed as of March 1, 1995. See also Note 11.
In September 1995, in an effort to increase the number of shareholders of
the Company's common stock, the Company's shareholders approved a plan of
merger to acquire all of the outstanding shares of Redden Dynamics Corporation
(Redden) for $34,500 cash and 818,774 shares of the Company's common stock.
Under the plan of merger, the shareholders of Redden received one share of the
Company's common stock in exchange for each 13.5 shares of Redden stock.
Effective as of the date of the merger, all shares of Redden were cancelled,
the assets of Redden became assets of the Company and Redden ceased to exist.
Redden's only recorded asset consisted of $11,050 of organizational costs.
Redden had no liabilities and had no revenues or expenses since inception.
Subsequent to the merger, the Company determined that Redden's assets were of
no value to the Company. Accordingly, no amounts have been recognized for the
issuance of the common stock in connection with the merger of Redden.
During the year ended April 30, 1996, the Company issued 657,910 shares of
its common stock in exchange for financial and technological consulting
services. The cost of the services provided of $312,775 has been charged to
operations.
During the year ended April 30, 1997, the Company sold 61,500 shares for
$2.00 per share and received $111,200 after offering costs of $11,800.
In August 1996, the Company acquired the net assets of an affiliated company
through the issuance of 179,076 shares of the Company's common stock to
certain shareholders of the affiliate and granted options to purchase 97,000
shares of the Company's common stock (see Note 5) to certain other
shareholders of the affiliate. The assets acquired totalling $72,749 and
liabilities assumed totalling $22,756 were recorded by the Company at the
affiliate's net book value. Pro forma information combining the results of
operations of the Company and the affiliate as if the acquisition had occurred
at the beginning of fiscal 1996 and 1997 has not been presented as such
information would not differ significantly from the reported amounts.
During the year ended April 30, 1997, the Company sold convertible notes
totalling $320,000. The notes, bearing interest at 10%, are convertible into
shares of the Company's common stock at a conversion price equal to 90% of the
average of the bid and ask price on the day prior to conversion. As of April
30, 1997, the holders of notes totalling $270,000 principal amount had
converted their notes and accrued interest of $4,342 into 326,027 shares of
stock; upon conversion, the Company charged the remaining unamortized deferred
financing costs of $22,834 relating to such notes against the recorded amount
of common stock. During the six months ended October 31, 1997, the Company
sold an additional $95,000 principal amount of the convertible notes, and
F-14
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
noteholders converted notes totalling $105,000 principal amount and accrued
interest of $175 into 213,986 shares of stock. Upon conversion, the Company
charged unamortized deferred financing costs of $708 relating to such notes
against the recorded amount of common stock.
During the year ended April 30, 1997, the Company issued 140,000 shares of
its common stock in exchange for financial and technological consulting
services. The cost of the services provided of $34,224 has been charged to
operations.
The Company has notes receivable from a shareholder totalling $35,000 which
resulted from the issuance of stock, bear interest at 10% and are payable on
demand.
In August 1997, the Company entered into settlement agreements with two
former employees who were also shareholders of the Company to repurchase
841,126 shares of its common stock from such individuals for $.55 per share,
or a total price of $462,619. The agreements require payments by the Company
of $220,000 no later than September 12, 1997, $110,000 no later than February
11, 1998, and $132,619 no later than August 11, 1998. As of October 31, 1997,
the Company has made payments totalling $220,000 to these individuals and
received 400,000 shares of its common stock which have been retired. As of
October 31, 1997, the Company has recorded a liability for the remaining
payments totalling $242,619 and treasury stock for the shares that it is
committed to purchase.
In a private placement in September and October 1997, the Company sold
908,641 shares of its common stock for $499,752, or $.55 per share, the
proceeds of which were partially used to repurchase the shares described in
the preceding paragraph.
5. STOCK OPTIONS
Under the terms of the Company's non-qualified stock option plan, options to
purchase shares of the Company's common stock are to be granted at prices to
be determined by the Board of Directors. The options' expiration date may not
be more than 10 years from the date of the grant. The aggregate number of
shares of the Company's common stock which may be issued upon the exercise of
options granted under the plan shall not exceed 3,000,000. The Company has
granted the following stock options:
EXERCISE
NUMBER OF PRICE PER EXPIRATION
OPTIONS SHARE DATE
--------- ----------- ----------
April 30, 1996.............................. 899,150 $.50--$2.00 1998--2006
April 30, 1997.............................. 884,200 $.50--$2.88 1998--2007
October 31, 1997............................ 954,800 $.20--$2.88 1998--2007
Information with respect to options granted under the plan is as follows:
Outstanding at May 1, 1995......................................... --
Granted.......................................................... 899,150
Exercised........................................................ --
Expired or cancelled............................................. --
--------
Outstanding at April 30, 1996...................................... 899,150
Granted.......................................................... 440,650
Exercised........................................................ (60,000)
Expired or cancelled............................................. (395,600)
--------
Outstanding at April 30, 1997...................................... 884,200
Granted.......................................................... 317,700
Exercised........................................................ --
Expired or cancelled............................................. (247,100)
--------
Outstanding at October 31, 1997.................................... 954,800
========
F-15
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been recognized for the
stock option plans. Had compensation cost for the Company's stock option plans
been determined based on the fair value at the grant date for awards in the
years ended April 30, 1996 and 1997 consistent with the provisions of SFAS No.
123, the Company's net loss and net loss per share would have been increased
to the pro forma amounts indicated below:
APRIL 30, APRIL 30,
1996 1997
----------- ---------
Net loss--as reported............................... $(2,524,000) $(259,000)
Net loss--pro forma................................. (2,724,000) (575,000)
Net loss per share--as reported..................... (.30) (.03)
Net loss per share--pro forma....................... (.32) (.06)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in the years ended April 30, 1996 and 1997;
expected volatility of 132%; risk-free interest rate of 6% and expected lives
of three to ten years.
6. WARRANTS
During the year ended April 30, 1996, the Company issued warrants in
connection with common stock in exchange for financial services. The warrants
provide for the purchase of 150,000 shares of the Company's common stock at
prices ranging from $1.50 to $3.50, and expire in 2000 and 2001.
In connection with the issuance of the convertible and 15% promissory notes
(see Note 3), the Company also is committed to deliver to the noteholders
58,500 warrants to purchase shares of the Company's common stock. The exercise
price of the warrants is equal to the bid price of such stock on the date the
note was executed and ranges from $0.27 to $1.38 per share; the warrants
expire in 1998 and 1999.
7. INCOME TAXES
The tax effects of temporary differences to significant portions of deferred
taxes are as follows:
APRIL 30,
1997
----------
Deferred tax asset--
Net operating loss carryforwards................................. $1,330,000
Less valuation allowance......................................... 1,330,000
----------
$ --
==========
As of April 30, 1997, the Company's net operating loss carryforwards of
approximately $3,400,000 will begin expiring in the year 2009. The
carryforwards will be available for the reduction of future income tax
liabilities. As of April 30, 1997, the Company has recorded a valuation
allowance to reduce the existing deferred tax asset to an amount that is more
likely than not to be realized. The valuation allowance increased by $860,000
and $60,000 during the years ended April 30, 1996 and 1997, respectively. The
utilization of approximately $540,000 of tax loss carryforwards is limited to
approximately $80,000 each year as a result of an ownership change in the
Company (as defined by Section 382 of the Internal Revenue Code of 1986, as
amended), which occurred in 1995. The amount of the remaining carryforwards
that can be used in any given year may be limited in the event of additional
future changes in the ownership of the Company.
F-16
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
8. RELATED PARTY TRANSACTIONS
The Company leases office space from a partnership in which the Company's
principal shareholder owns a general partnership interest. Rental expense
under such leases totalled $37,592 and $87,259 for the years ended April 30,
1996 and 1997, respectively. Future annual minimum lease payments required
under such leases are as follows as of April 30, 1997:
Fiscal year ending April 30:
1998............................................................ $136,633
1999............................................................ 118,101
2000............................................................ 54,822
--------
Total......................................................... $309,556
========
The Company receives periodic advances from its principal shareholder. At
April 30, 1997 and October 31, 1997, the Company had an unsecured note payable
of $148,761 to its principal shareholder, payable on May 31, 1999 and bearing
interest at 10%.
9. MAJOR CUSTOMERS, SUPPLIERS AND FOREIGN MARKETS
The Company's major markets are currently in Argentina, Brazil, Europe and
South Africa. As a result, the Company's operations may be adversely affected
by significant fluctuations in the value of the U.S. dollar against certain
foreign currencies, the enactment of exchange controls, or foreign
governmental or regulatory restrictions on the transfer of funds. The Company
currently prices all its products and services in terms of U.S. dollars.
Significant fluctuations in the value of the U.S. dollar in relation to
currencies in countries where the Company conducts operations can greatly
affect the competitive price position of the Company's products and services.
The Company's distributors in Argentina and Brazil generated revenues (as a
percentage of the Company's total revenues) as follows:
YEAR ENDED
APRIL 30,
-------------
1996 1997
----- -----
Argentina.................................................... 49% 56%
Brazil....................................................... 14 10
The Company's ability to provide its telephone services is heavily dependent
upon the agreements the Company has with its long distance telephone carriers.
The Company's long distance services were provided by various carriers as
follows:
YEAR ENDED
APRIL 30,
-------------
1996 1997
----- -----
Carrier A.................................................... 39% 59%
Carrier B.................................................... 49 23
Other carriers............................................... 12 18
10. COMMITMENTS AND CONTINGENCIES
In October 1997, the Company entered into a release and settlement agreement
with one of its carriers, pursuant to which the carrier has agreed to accept
payment of $391,800 for usage charges for the period February 1996 through
August 1997 and $150,000 as a security deposit to ensure payment of future
usage charges. The carrier also agreed, upon receipt of the Company's payment
on December 30, 1997, to release the Company from its minimum usage commitment
shortfall and early termination charges which totalled $3,651,300. The Company
also concurrently entered into an agreement for minimum annual usage, as
discussed in the last paragraph of this note.
F-17
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
In September 1996, the Company entered into a consulting and royalty
agreement to acquire the rights of to a switching system which is installed at
customer locations. Under the terms of the agreement, the Company is required
to pay the developer a monthly royalty equal to 4% of the Company's gross
collected revenues related to the system. In addition, the Company is also
required to provide monthly funding for the installation of two systems. In
the event that the Company fails to provide such funds and installation is
prevented or delayed by more than sixty days, the royalty payment to the
developer is increased to 6%. The Company has the option to buy out the
royalty obligation for $1,500,000 prior to September 1997; after September
1997, the buyout amount is the greater of $2,500,000 or an amount equal to
three times the aggregate royalty payments for the first twelve months of the
agreement. In addition, for each installation, the Company agrees to pay the
developer $1,500 if such installation produces gross revenues between $10,000
and $20,000 in the first full billing month, and $3,000 if such revenues
exceed $20,000. The developer has agreed to provide ongoing maintenance,
support and consulting while the system is in operation at a rate of $4,000
per month through September 1, 1997, and $5,200 thereafter. The agreement is
in effect for as long as the system is operational until September 1, 2006,
unless earlier terminated.
The Company has employment agreements with certain of its officers which
provide for annual salaries totalling $400,000 and expire in 1999 and 2000.
One of the agreements requires annual increases of 4%.
In fiscal year 1998, the Company entered into a settlement agreement with
one of its former officers which provides for payments totalling $188,000
through January 1998. Such amount has been reflected as a general and
administrative expense for the six months ended October 31,1997.
The Company is subject to a $100,000 claim by a manufacturer from which the
Company received telecommunications equipment. The Company believes that the
equipment is not suitable for its intended purpose and that the manufacturer
misrepresented certain matters pertaining to this equipment. The Company has
offered to return the equipment in exchange for a release of the
manufacturer's claim and the manufacturer has rejected the Company's offer.
The Company has not made a provision for any loss that might result from the
outcome of this matter; however, the Company believes that the ultimate
resolution of this claim will not have a material adverse effect on its
financial position or results of operations.
The Company has agreements with certain of its carriers which provide for
guaranteed rates and minimum annual usage. The agreements expire through 1999
and require minimum annual usage as follows:
Fiscal year ending April 30:
1998............................................................. $3,700,000
1999............................................................. 1,450,000
----------
Total.......................................................... $5,150,000
==========
11. PROPOSED STOCK SPLIT
In December 1997, the Company's Board of Directors authorized a reverse
split of the Company's common stock (not to exceed 1-for-30) whereby the
Company will issue one share of common stock in exchange for a number of
shares yet to be determined. The authorization for the reverse split is
subject to approval by the Company's shareholders. All references to numbers
of shares, options and warrants and per share amounts, including exercise
prices, in the accompanying financial statements and related notes have not
been restated to reflect any potential reverse stock split.
12. PROPOSED PUBLIC OFFERING
The Company is planning a public offering of its common stock in 1998, the
net proceeds from which are expected to be used to complete the acquisition
described in Note 13, to repay the debt described in Note 14, for working
capital, development of new product and service offerings, and enhancement and
expansion of existing products and services.
F-18
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
13. PENDING ACQUISITION
The Company has entered into an agreement to acquire all of the outstanding
stock of another telecommunications company which provides services similar to
that of the Company. The purchase price of $5,170,000 is to be satisfied by
the payment of $3,100,000 cash and the issuance of shares of the Company's
common stock valued at $2,070,000 (before any discount) based on the public
offering per share price in the Company's proposed public offering (see Note
12). The agreement provides that $1,325,000 of the cash payment will be placed
into an escrow account to satisfy any potential claims against the selling
shareholders, and for the shares of the Company's common stock to be issued to
the selling shareholders one year after the acquisition is completed to ensure
compliance with the specific performance provisions of the agreement.
Included in deposits in the accompanying balance sheets at April 30, 1997
and October 31, 1997 are deposits totalling $25,000 and $125,000,
respectively, which are nonrefundable and to be credited against the purchase
price. The Company made an additional deposit of $100,000 on December 30, 1997
with a portion of the proceeds received from the issuance of the mandatorily
redeemable convertible promissory notes (see Note 14).
The acquisition is expected to occur upon closing of the Company's proposed
public offering.
14. MANDATORILY REDEEMABLE CONVERTIBLE PROMISSORY NOTES
The Company issued mandatory redeemable convertible promissory notes
totalling $2,840,000 on December 30, 1997 in a private placement offering. The
notes, which bear interest at 10% and are payable semiannually, are due one
year from the date of issuance or five days after the closing of the proposed
public offering, whichever is earlier. The notes are collateralized by a first
security interest on all unpledged assets of the Company and a second security
interest on all assets subject to a prior lien. The notes are personally
guaranteed as to $1,500,000 of principal and interest by two of the Company's
officers and directors ($750,000 guaranteed by each, severally). The net
proceeds from the issuance of the notes were primarily used to satisfy the
Company's obligations to carriers (see Note 3), to pay the consulting fee
incurred in connection with obtaining the reduction in an obligation to a
carrier (see Note 3), and to make an additional deposit for the Company's
pending acquisition (see Note 13).
The Company is to file a registration statement for a public offering that
meets certain conditions by February 28, 1998; if the filing is not made by
the required date, the notes become freely convertible. The notes otherwise
are convertible into the Company's common stock after nine months at a 50%
discount to the average of the closing bid price for the immediately preceding
20 trading days. The holders of the converted shares have certain registration
rights. As additional consideration for purchasing the notes, if the public
offering is (a) not completed within nine months of the closing of the
offering, the noteholder is to receive 30,000 shares of the Company's common
stock for each $100,000 of principal or (b) completed, the noteholder will
receive a certain number of shares valued at $40,000 based on the proposed
public offering price per share.
The Company also issued to the placement agent 284,000 warrants to purchase
shares of the Company's common stock. The warrants are exercisable at 125% of
proposed public offering price per share; if no offering occurs within one
year from the closing of the offering of the notes, the exercise price is
reduced to 50% of the closing bid price, as defined above.
F-19
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
International Telephone Company
Meriden, Connecticut
We have audited the accompanying balance sheet of International Telephone
Company (the "Company") as of October 31, 1997 and the related statements of
operations, changes in stockholders' equity and cash flows for the ten months
ended October 31, 1997 and the year ended December 31, 1996. 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 financial statements enumerated above present fairly, in
all material respects, the financial position of International Telephone
Company, at October 31, 1997, and the results of its operations and its cash
flows for the ten months ended October 31, 1997 and the year ended December
31, 1996 in accordance with generally accepted accounting principles.
As discussed in Note G[2], one of the Company's carriers has initiated
litigation against the Company for collection of approximately $1.1 million.
Richard A. Eisner & Company, LLP
New York, New York
December 12, 1997
F-20
INTERNATIONAL TELEPHONE COMPANY
BALANCE SHEET
OCTOBER 31, 1997
ASSETS
Current assets:
Cash and cash equivalents (Notes B[1] and D)................... $ 848,000
Accounts receivable (net of allowance for doubtful accounts of
$25,000)...................................................... 1,045,000
Other current assets........................................... 57,000
-----------
Total current assets......................................... 1,950,000
Furniture and equipment (net of accumulated depreciation of
$87,000) (Notes B[4] and C)..................................... 640,000
Security deposits................................................ 130,000
-----------
$ 2,720,000
===========
LIABILITIES
Current liabilities:
Loan payable (Note D).......................................... $ 3,000
Accounts payable............................................... 2,463,000
Accrued expenses............................................... 167,000
Accrued commissions............................................ 145,000
Customer advances.............................................. 150,000
Equipment lease obligations--current portion (Note E).......... 281,000
-----------
Total current liabilities.................................... 3,209,000
Equipment leases obligations, less current portion (Note E)...... 292,000
-----------
3,501,000
-----------
Commitments and contingencies (Note G)
STOCKHOLDERS' EQUITY
Common stock--$.01 par value, 1,200 shares authorized, 1,200
shares issued and outstanding
Additional paid-in capital..................................... 1,000
Accumulated deficit............................................ (782,000)
-----------
Total stockholders' equity................................... (781,000)
-----------
$ 2,720,000
===========
See notes to financial statements
F-21
INTERNATIONAL TELEPHONE COMPANY
STATEMENT OF OPERATIONS
TEN MONTHS
ENDED YEAR ENDED
OCTOBER 31, DECEMBER 31,
1997 1996
----------- ------------
Operating revenue:
Telecommunication services (Notes B[2] and H)..... $ 8,054,000 $ 7,603,000
----------- -----------
Operating expenses:
Cost of telecommunication services (Note B[3]).... 6,790,000 5,070,000
Selling expenses (Note B[3])...................... 715,000 1,099,000
General and administrative expenses............... 1,205,000 1,022,000
Officers salaries................................. 256,000 493,000
----------- -----------
8,966,000 7,684,000
----------- -----------
Loss from operations before other income (expense).. (912,000) (81,000)
Other income (expense):
Miscellaneous..................................... 101,000
Consulting fee.................................... 113,000
Loss on sale of equipment......................... (22,000)
Interest income................................... 28,000 12,000
Interest expense.................................. (57,000) (21,000)
----------- -----------
INCOME (LOSS) BEFORE INCOME TAX PROVISION........... (850,000) 11,000
Income tax provision (Note F)....................... 0 4,000
----------- -----------
NET INCOME (LOSS)................................... $ (850,000) $ 7,000
=========== ===========
See notes to financial statements
F-22
INTERNATIONAL TELEPHONE COMPANY
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
COMMON STOCK
1,200 SHARES
AUTHORIZED
---------------- RETAINED STOCKHOLDERS'
NUMBER OF ADDITIONAL EARNINGS EQUITY
SHARES PAID-IN (ACCUMULATED (CAPITAL
ISSUED AMOUNT CAPITAL DEFICIT) DEFICIENCY)
--------- ------ ---------- ------------ -------------
Balance--January 1,
1996................... 1,200 $ 0 $1,000 $ 61,000 $ 62,000
Net income for the year
ended December 31,
1996................... 7,000 7,000
----- --- ------ --------- ---------
Balance--December 31,
1996................... 1,200 0 1,000 68,000 69,000
Net loss for the ten
months ended October
31, 1997............... (850,000) (850,000)
----- --- ------ --------- ---------
Balance--October 31,
1997................... 1,200 $ 0 $1,000 $(782,000) $(781,000)
===== === ====== ========= =========
See notes to financial statements
F-23
INTERNATIONAL TELEPHONE COMPANY
STATEMENTS OF CASH FLOWS
TEN MONTHS
ENDED YEAR ENDED
OCTOBER 31, DECEMBER 31,
1997 1996
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................... $ (850,000) $ 7,000
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation....................................... 73,000 69,000
Provision for doubtful accounts.................... 25,000 43,000
Loss on sale of equipment.......................... 22,000
Deferred taxes..................................... (6,000) 2,000
Changes in:
Accounts receivable............................... 180,000 (33,000)
Other assets...................................... (42,000) 1,000
Customer advance payments......................... (20,000) 38,000
Commissions payable............................... (20,000) (24,000)
Accrued expenses.................................. 26,000 91,000
Accounts payable.................................. 1,239,000 108,000
Income taxes payable.............................. (1,000) (16,000)
---------- ---------
Net cash provided by operating activities....... 626,000 286,000
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of furniture and equipment................ (17,000) (29,000)
Proceeds from sale of equipment..................... 259,000
---------- ---------
Net cash provided by (used in) investing
activities..................................... 242,000 (29,000)
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (repayments of) loan payable.......... (63,000) 66,000
Payments under capital leases....................... (175,000) (112,000)
Repayment of note payable........................... (140,000)
---------- ---------
Net cash used in financing activities........... (238,000) (186,000)
---------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS............. 630,000 71,000
Cash and cash equivalents--beginning of year.......... 218,000 147,000
---------- ---------
CASH AND CASH EQUIVALENTS--END OF YEAR................ $ 848,000 $ 218,000
========== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest.......................................... $ 57,000 $ 21,000
Income taxes...................................... $ 26,000
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING
ACTIVITIES:
Equipment acquired under capital lease obligations
(Note E).............................................
See notes to financial statements
F-24
INTERNATIONAL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS
OCTOBER 31, 1997
NOTE A--ORGANIZATION AND BUSINESS
International Telephone Company (the "Company") was organized in the state
of Delaware on March 3, 1993. The Company operates an international
telecommunications system offering long distance telephone service to
corporations and individuals located outside the United States.
The Company incurred a loss of $850,000 during the ten months ended October
31, 1997, resulting principally from the accrual of a $1.1 million claim
against the Company by a carrier for usage charges that the Company is
disputing (see Note G[2]). The Company intends to vigorously defend such claim
and is attempting to settle with the carrier. If the Company is not successful
in its defense or in reaching a settlement, the Company believes that by
reducing its administrative expenses, including officers' compensation, the
cash flow from operations will be sufficient for the Company to pay such claim
and to operate as a going concern. In addition, the Company believes that it
will be able to obtain financing, if necessary.
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(1) Cash equivalents:
The Company considers money-market funds to be cash equivalents.
(2) Revenue recognition:
Telecommunication revenues are recognized at the time services are provided.
(3) Cost of telecommunication revenues and selling expenses:
Cost of telecommunication services are recorded as incurred and consist
principally of charges from carriers for long distance services. Selling
expenses includes commissions to agents, which are recorded net of chargebacks
for amounts deemed uncollectible in the period the related services were
provided.
(4) Depreciable assets:
Depreciable assets, consisting principally of telecommunication related
equipment such as switches and computer equipment, are stated at cost.
Equipment acquired under capital leases is stated at the present value of the
future minimum lease payments.
Depreciation is provided for using the straight-line method over the
estimated useful lives of the assets which range from five to seven years.
Equipment under capital leases is depreciated over the estimated useful life
of the equipment, which is generally longer than the terms of the leases since
the leases generally contain bargain purchase options which the Company
intends to exercise.
(5) Use of estimates in the preparation of financial statements:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(6) Deferred income taxes:
The Company provides for income taxes using the asset and liability method
under which deferred income taxes are recognized for the estimated future tax
consequences attributable to net operating loss carryforwards
F-25
INTERNATIONAL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
OCTOBER 31, 1997
and temporary differences between the basis of assets and liabilities for
financial and tax reporting purposes. Such differences relate primarily to
depreciation and equipment acquired under capital leases.
NOTE C--FURNITURE AND EQUIPMENT
Furniture and equipment at October 31, 1997 consists of the following:
Telecommunications equipment....................................... $634,000
Furniture and fixtures............................................. 6,000
Office equipment................................................... 87,000
--------
727,000
Less accumulated depreciation and amortization..................... 87,000
--------
$640,000
========
NOTE D--LOAN PAYABLE
The Company has a $250,000 line of credit, which expires on September 30,
1998, with a financial institution. At October 31, 1997 the balance due under
this line of credit was $3,000, which is collateralized by the assets of the
Company, including cash on deposit with such institution. Amounts due under
the line of credit bear interest at prime plus 1.5%.
NOTE E--CAPITAL LEASE OBLIGATIONS
The Company leases equipment under agreements with terms of thirty-six
months, which are accounted for as capital leases. During the ten months ended
October 31, 1997 the Company acquired telecommunications equipment with a cost
of $634,000 under a capital lease. Simultaneously, the Company exchanged
telecommunications equipment with a book value of $281,000 and received
proceeds of $259,000, resulting in a loss on the exchange of $22,000. The net
book value of equipment held under capital lease was $609,000 at October 31,
1997.
Future annual lease payments at October 31, 1997 are as follows:
1998............................................................... $288,000
1999............................................................... 247,000
2000............................................................... 111,000
--------
646,000
Less amounts representing interest................................. 73,000
--------
Present value of future lease payments at October 31, 1997......... 573,000
Less amounts due within one year................................... 281,000
--------
Amounts due after one year......................................... $292,000
========
F-26
INTERNATIONAL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
OCTOBER 31, 1997
NOTE F--INCOME TAXES
The provision for federal and state income taxes for the year ended December
31, 1996 is comprised of the following:
Current:
Federal............................................................. $1,000
State............................................................... 0
------
1,000
------
Deferred:
Federal............................................................. 2,000
State............................................................... 1,000
------
3,000
------
$4,000
======
At October 31, 1997 the Company has a net operating loss carryforward of
$1,008,000 resulting from its loss for income tax purposes for the ten months
then ended. As a result the Company has a deferred tax asset of $393,000 at
October 31, 1997. The Company has provided a valuation allowance, which
increased by $323,000 during the ten months ended October 31, 1997, against
the entire deferred tax asset. Accordingly, there is no provision for federal
and state income taxes for the ten months ended October 31, 1997.
The deferred tax liability of $88,000 at October 31, 1997, represents the
anticipated future tax consequences attributable to temporary differences
between the basis of assets and liabilities for financial and tax reporting
purposes. Such differences relate to depreciation and the acquisition of
equipment under a capital lease.
The difference between the tax provision (benefit) and the amount that would
be computed by applying the statutory federal income tax rate to income before
taxes is attributable to the following:
TEN MONTHS
ENDED YEAR ENDED
OCTOBER 31, DECEMBER 31,
1997 1996
----------- ------------
Federal income tax provision (benefit) at
statutory rate................................... $(289,000) $3,000
Provision (benefit) for state income taxes--net of
U.S. federal taxes............................... (34,000) 1,000
Valuation allowance............................... 323,000
--------- ------
$ 0 $4,000
========= ======
NOTE G--COMMITMENTS, CONTINGENCIES AND OTHER MATTERS
[1] Operating leases:
The Company is subject to operating leases for its office space in Florida
and Connecticut, which include escalation clauses for increases in real estate
taxes and certain operating expenses. Rent expense for the period ended
October 31, 1997 totaled $73,000.
F-27
INTERNATIONAL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
OCTOBER 31, 1997
Future minimum lease payments at October 31, 1997 are as follows:
YEAR ENDING
OCTOBER 31,
-----------
1998................................................................. $50,000
1999................................................................. 26,000
2000................................................................. 21,000
-------
$97,000
=======
[2] Carrier payables:
Pursuant to an agreement, the Company was committed to purchase transmission
capacity from a certain carrier. The Company has requested credits from the
carrier for minimum usage charges and losses incurred in connection with the
unavailability of sufficient capacity. As a result a significant balance due
to the carrier became past due. The carrier has initiated litigation against
the Company for collection of approximately $1.1 million, which is included in
accounts payable at October 31, 1997. The Company intends to vigorously defend
its position and will continue to try to reach a settlement with the carrier.
In May 1997, a carrier agreed to issue a credit for $210,000 in connection
with the settlement of charges disputed by the Company and the Company agreed
to pay the outstanding balance by December 1, 1997. The carrier subsequently
presented an invoice to the Company which did not reflect such credit and the
Company believes that such statement does not acknowledge a $100,000 payment
made in January 1997. As a result, the Company has not made the scheduled
payments and accounts payable at October 31, 1997 includes $400,000 due to
this carrier.
[3] Concentration of carriers:
The Company purchases transmissions capacity from a limited number of
domestic telephone carriers 85% of such capacity was purchased from 3
telephone carriers and 75% of such capacity was purchased from 3 carriers
during the ten months ended October 31, 1997 and the year ended December 31,
1996, respectively.
[4] Concentration of agents:
During the ten months ended October 31, 1997 and the year ended December 31,
1996 3 agents were responsible for 53% and 3 agents were responsible for 66%
of the Company's telecommunications revenues, respectively.
NOTE H--TELECOMMUNICATION REVENUES:
The information below summarizes telecommunication revenues by geographic
area:
TEN MONTHS
ENDED YEAR ENDED
OCTOBER 31, DECEMBER 31,
1997 1996
----------- ------------
Europe................................................. $2,416,000 $ 2,742,000
Africa................................................. 2,511,000 2,508,000
Middle East............................................ 1,593,000 1,095,000
Latin America.......................................... 1,110,000 626,000
Asia................................................... 74,000 529,000
Other.................................................. 350,000 103,000
---------- -----------
$8,054,000 $ 7,603,000
========== ===========
F-28
INTERNATIONAL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
OCTOBER 31, 1997
NOTE I--OTHER INCOME
During the year ended December 31, 1996 the Company recognized $100,000 of
income from a nonrefundable deposit received in connection with a potential
transaction which did not close by the agreed upon date.
During the ten months ended October 31, 1997 the Company recognized $113,000
of consulting fees in connection with assisting another telecommunications
company in settling its charges with a carrier.
NOTE J--REGULATORY MATTERS
In June 1993, the Federal Communications Commission (the "FCC") granted the
Company's Application for Authority under Section 214 of the Communications
Act of 1934, as amended. Pursuant to such action the Company is authorized to
resell the public switched telecommunications services of other U.S. carriers.
The Company is subject to regulation in other countries in which it does
business. The Company believes that an adverse determination as to the
permissibility of the Company's services under the laws and regulations of any
such country would not have a material adverse long-term effect on its
business.
NOTE K--PROPOSED SALE OF THE COMPANY
The Company has received a letter of intent related to the purchase, by
another telecommunications company, of all of the outstanding shares of common
stock of the Company. A final agreement has not been
executed. The Company's stockholders have received $125,000 from this
telecommunications company in connection with such anticipated sale.
F-29
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO PERSON IS AUTHORIZED IN CONNECTION WITH ANY DISTRIBUTIONS MADE HEREBY TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THE PRO-
SPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY CSI OR THE UNDERWRITERS. THIS PRO-
SPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO
BUY ANY SECURITY OTHER THAN THE SECURITIES OFFERED HEREBY, NOR DOES IT CONSTI-
TUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURI-
TIES OFFERED HEREBY TO ANY PERSON IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL
TO MAKE SUCH AN OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS
NOR ANY SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICA-
TION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSE-
QUENT TO THE DATE HEREOF.
----------------
TABLE OF CONTENTS
PAGE
----
Summary.................................................................. 1
Risk Factors............................................................. 6
Use of Proceeds.......................................................... 16
Dividend Policy.......................................................... 17
Price Range of Common Stock.............................................. 18
Dilution................................................................. 19
Capitalization........................................................... 20
Selected Financial Data.................................................. 21
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 22
Business................................................................. 32
Management............................................................... 47
Principal Shareholders................................................... 52
Certain Transactions..................................................... 53
Description of Securities................................................ 55
Shares Eligible for Future Sale.......................................... 56
Underwriting............................................................. 58
Legal Matters............................................................ 59
Experts.................................................................. 60
Additional Information................................................... 60
Index to Financial Statements............................................ F-1
----------------
UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EF-
FECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICIPAT-
ING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN
ADDITION TO THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
1,100,000 SHARES OF COMMON STOCK
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
----------------
P R O S P E C T U S
----------------
COHIG & ASSOCIATES, INC.
, 1998
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+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 A 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 SALES OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE LAWS OF ANY SUCH +
+STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
[ALTERNATE PAGE FOR SELLING SECURITYHOLDERS' PROSPECTUS]
SUBJECT TO COMPLETION, DATED FEBRUARY 27, 1998
PRELIMINARY PROSPECTUS
SHARES
[LOGO OF COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.]
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
COMMON STOCK
This Prospectus relates to the offer and sale by certain Securityholders
(collectively, the "Selling Securityholders") of a maximum of 113,600 shares of
Common Stock of Communications Systems International, Inc. that were issued in
a private placement completed in December 1997 and shares issuable upon the
exercise of certain warrants (collectively, the "Selling Securityholders'
Shares"). The Selling Securityholders' Shares are not part of the concurrent
underwritten offering and may not be offered or sold prior to 180 days from the
date of this Prospectus. The Company will not receive any proceeds from the
sale of the Selling Securityholders' Shares. See "Selling Securityholders and
Plan of Distribution."
The Common Stock is traded sporadically in limited amounts on the OTC
Bulletin Board under the symbol CSYG. On February 25, 1998, the last reported
closing high bid price of the Common Stock was $ per share. It is currently
estimated that the offering price of the Common Stock will be between $9.00 and
$11.00 per share after giving effect to a proposed reverse stock split to be
effective prior to the date of this Prospectus. The Company has applied to have
the Common Stock quoted on The Nasdaq SmallCap Market under the symbol [CSIL].
See "Price Range of Common Stock."
The distribution of shares of Common Stock offered hereby by the Selling
Securityholders may be effected in one or more transactions that may take place
on the over-the-counter market, including ordinary broker's transactions,
privately negotiated transactions or through sales to one or more dealers for
sale of such securities as principals, at market prices prevailing at the time
of sale, at prices relating to such prevailing market prices or at negotiated
prices. Usual and customary or specifically negotiated brokerage fees or
commissions may be paid by the Selling Securityholders.
THE SECURITIES OFFERED HEREBY ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK
AND IMMEDIATE SUBSTANTIAL DILUTION AND SHOULD NOT BE PURCHASED BY INVESTORS WHO
CANNOT AFFORD THE LOSS OF THEIR ENTIRE INVESTMENT. SEE "RISK FACTORS" BEGINNING
ON PAGE 6.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE COMMISSION OR
ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The Selling Securityholders and intermediaries through whom such securities
are sold may be deemed "underwriters" within the meaning of the Securities Act
of 1933, as amended (the "Securities Act") with respect to the securities
offered, and any profits realized or commission received may be deemed
underwriting compensation.
On the date of this Prospectus, a registration statement including a
prospectus of even date filed under the Securities Act with respect to an
underwritten public offering by the Company of 1,100,000 shares of Common Stock
and up to an additional 165,000 shares of Common Stock to cover over-
allotments, if any, was declared effective by the Securities and Exchange
Commission (the "Commission"). The Company will receive net proceeds of
approximately $ from the sale of the shares of Common Stock included in the
underwritten public offering, and will receive approximately $ in additional
net proceeds if the over-allotment option is exercised in full after payment of
underwriting discounts and commission and estimated expenses of the
underwritten public offering. See "Concurrent Offering."
[ALTERNATE PAGE FOR SELLING SECURITYHOLDERS' PROSPECTUS]
THE OFFERING
Common Stock offered....................... shares
Common Stock outstanding before the Offer-
ing....................................... shares (1)
Common Stock outstanding after the Offer-
ing....................................... shares (1)
Use of proceeds............................ The Company will receive no pro-
ceeds from the sale of the Sell-
ing Securityholders' Shares. Upon
exercise of warrants underlying
certain selling Securityholders'
Shares, the Company will receive
the applicable exercise price.
Proposed Nasdaq SmallCap Market Symbol for
the Common Stock.......................... [CSIL]
- --------
(1) Includes 1,100,000 shares of Common Stock to be issued in connection with
an underwritten public offering by the Company and 113,600 Bridge Shares to
be issued immediately prior to the closing of this Offering based on an
assumed offering price of $10.00 per Share. Does not include (i) up to
shares of Common Stock issuable upon exercise of outstanding options, which
have weighted average exercise prices of $ per share, (ii) up
to shares of Common Stock issuable upon the exercise of outstanding
warrants, which have weighted average exercise prices of $ per share,
(iii) an indeterminate number of shares of Common Stock issuable upon
conversion of outstanding promissory notes in the aggregate principal
amount of $ , which have a conversion price per share equal to 90% of the
average bid and ask price of the Common Stock on the day before conversion,
(iv) up to 110,000 shares of Common Stock issuable upon exercise of the
Representative's Warrants and (v) any shares issuable in connection with
the ITC Acquisition (collectively referred to herein as "Additional
Securities"). See "Management," "Description of Securities" and
"Underwriting."
A-4
[ALTERNATE PAGE FOR SELLING SECURITYHOLDERS' PROSPECTUS]
CONCURRENT OFFERING
On the date of this Prospectus, a registration statement including a
prospectus of even date filed under the Securities Act with respect to an
underwritten public offering by the Company of 1,100,000 shares of Common Stock
and up to an additional 165,000 shares of Common Stock to cover over-
allotments, if any, was declared effective by the Commission. The Company will
receive net proceeds of approximately $ from the sale of the shares of Common
Stock included in the underwritten public offering, and will receive
approximately $ in additional net proceeds if the over-allotment option is
exercised in full after payment of underwriting discounts and commission and
estimated expenses of the underwritten public offering.
A-5
[ALTERNATE PAGE FOR SELLING SECURITYHOLDERS' PROSPECTUS]
SELLING SECURITYHOLDERS AND PLAN OF DISTRIBUTION
Up to Selling Securityholders' Shares, comprised of 113,600 Bridge
Shares and Selling Securityholders' Warrant Shares, may be offered and
sold pursuant to this Prospectus by the Selling Securityholders. The Combined
Company has agreed to register the public offering of the Selling
Securityholders' Shares under the Securities Act concurrently with this
Offering and to pay all expenses in connection therewith. The Selling
Securityholders' Shares have been included in the Registration Statement of
which this Prospectus forms a part. None of the Selling Securityholders'
Shares may be sold by the Selling Securityholders prior to 180 days after the
date of this Prospectus. Except as set forth below, none of the Selling
Securityholders nor their affiliates has ever held any position or office with
the Combined Company or had any other material relationship with the Combined
Company. The Combined Company will not receive any of the proceeds from the
sale of the Selling Securityholders' Shares by the Selling Securityholders.
The following table sets forth certain information with respect to the Selling
Securityholders:
AMOUNT OF BENEFICIAL
SELLING OWNERSHIP OF
SECURITYHOLDERS' COMMON
SHARES STOCK AFTER
SELLING SECURITYHOLDERS OFFERED SALE (1)
- ----------------------- ---------------- ------------
Lee E. Schlessman................................. 8,000 -0-
Swedbank Luxembourg S.A........................... 16,000 -0-
Lee Schlessman, POA Sandra Garnett................ 4,000 -0-
Susan M. Duncan................................... 4,000 -0-
Susan M. Duncan Irrevocable Gift Trust............ 4,000 -0-
The Schlessman Family Foundation.................. 4,000 -0-
Lee Schlessman, POA Gary Schlessman............... 4,000 -0-
Lee Schlessman, POA Cheryl Bennett................ 4,000 -0-
Cal J. Rickel & Amanda Mae Rickel................. 4,000 -0-
Arab Commerce Bank Ltd............................ 4,000 -0-
Dr. Thomas R. Phelps, M.D......................... 3,600 -0-
Todd & Tom Rafalovich............................. 2,000 -0-
First Mortgage Income Trust....................... 4,000 -0-
ProFutures Special Equities Fund, L.P............. 42,000 -0-
Adams 1977 Family Trust........................... 2,000 -0-
Ted Rafalovich Living Trust....................... 2,000 -0-
Germaine Robineau O'Hare Trust.................... 2,000 -0-
Network 1 Financial Securities, Inc............... (2) -0-
------
National Financial Services Group, Inc............ (2)
------ ---
Richard Sullivan.................................. (2)
====== ===
- --------
(1) Assumes all of the Bridge Shares and Selling Securityholders' Warrant
Shares are sold.
(2) Includes Selling Securityholders' Warrant Shares issuable upon exercise of
the Selling Securityholders' Warrants.
No Selling Securityholder other than Richard Sullivan ("Sullivan") and
National Financial Services Group, Inc. ("National") currently owns any shares
other than those being offered hereby. Accordingly, upon the sale of all the
Selling Securityholders' Shares registered concurrently herewith, no Selling
Securityholder other than Sullivan and National will own any of the Combined
Company's outstanding shares of Common Stock.
The Selling Securityholders' Shares may be offered and sold from time to
time as market conditions permit in the over-the-counter market, or otherwise,
at prices and terms then prevailing or at prices related to the then-current
market price, or in negotiated transactions. The Selling Securityholders'
Shares may be sold by one or
A-6
[ALTERNATE PAGE FOR SELLING SECURITYHOLDERS' PROSPECTUS]
more of the following methods, without limitations: (a) a block trade in which
a broker or dealer so engaged will attempt to sell the Shares as agent but may
position and resell a portion of the block as principal to facilitate the
transaction; (b) purchases by a broker or dealer as principal and resale by
such broker or dealer for its account pursuant to this Prospectus; (c)
ordinary brokerage transactions and transactions in which the broker solicits
purchases; and (d) face-to-face transactions between sellers and purchaser
without a broker or dealer. In effecting sales, brokers or dealers engaged by
the Selling Securityholders may arrange for other brokers or dealers may be
deemed to be "underwriters" within the meaning of the Securities Act, in
connection with such sales. From time to time, one or more of the Selling
Securityholders named herein may pledge, hypothecate or grant a security
interest in some or all of the Bridge Shares and Network/National Warrants,
owned by them, and the pledgees, secured parties or persons to whom such
securities have been hypothecated shall, upon foreclosure in the event of
default, be deemed to be Selling Securityholders for purposes hereof.
If any of the following occurs: (a) the securities are sold at a fixed price
or by option at a price other than the prevailing market price, (b) the
securities are sold in block transactions and the purchaser takes the
securities with an intent to resell, or (c) the compensation paid to broker-
dealers is other than usual and customary discounts, this Prospectus must be
amended to include additional disclosure relating to such price, arrangements
and compensation terms before offers and sales of the Selling Securityholders'
Shares may be made.
A-7
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 24. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
The Registrant's Bylaws require the Registrant to indemnify all of its
present and former officers and directors, or any person who may have served
at the Registrant's request as an officer or a director of another corporation
in which the Registrant owns shares of capital stock or of which the
Registrant is a creditor, and the personal representatives of all such
persons, against expenses actually and necessarily incurred in connection with
the defense of any legal proceeding in which any such person was made a party
by reason of having served in such capacity, unless such person is adjudged to
be liable for negligence or misconduct in the performance of any duty owed to
the Registrant.
The Registrant's Articles of Incorporation provide that no director of the
Registrant shall be liable to the Registrant or any of its shareholders for
damages caused by a breach of a fiduciary duty by such director except for the
breach of the duty of loyalty, acts or omissions not in good faith or which
involve intentional misconduct or knowing violation of the law, acts as
specified in the Colorado Business Corporation Act, or any transaction from
which such director received an improper personal benefit.
Section 7-109-102 of the Colorado Business Corporation Act authorizes the
indemnification against reasonable expenses of current and former directors
made party to a proceeding if the director conducted himself in good faith, in
the case of conduct in his official capacity with the corporation, the
director reasonably believed that his conduct was in the best interests of the
corporation, in the case of a criminal proceeding, the director had no
reasonable cause to believe that his conduct was unlawful, and in all other
cases, the director reasonably believed that his conduct was at least not
opposed to the corporation's best interest. A corporation may not indemnify a
director in connection with a proceeding (1) in which a director was adjudged
liable to the corporation or, (2) charging that the director derived an
improper personal benefit in which the director was adjudged liable. Section
7-109-107 provides that a corporation may indemnify an officer to the same
extent that it may indemnify a director.
The above discussion of the Registrant's Bylaws, Articles of Incorporation
and the Colorado Business Corporation Act is only a summary and is qualified
in its entirety by the full text of each of the foregoing.
Reference is made to the Underwriting Agreement, the proposed form of which
is filed as Exhibit 1.1, in which the Underwriters agree, under certain
circumstances, to indemnify the directors and officers of the Registrant and
certain other persons against certain civil liabilities.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the expenses expected to be incurred in
connection with the issuance and distribution of the Securities offered
hereby.
SEC registration fee............................................. $ 5,309
NASD filing fee.................................................. 2,054
Blue Sky filing fees............................................. 5,000*
Nasdaq SmallCap Market application fee........................... 10,000
Legal fees and expenses.......................................... 80,000*
Blue Sky legal fees.............................................. 20,000*
Accounting fees and expenses..................................... 129,000*
Registrar and transfer agent fees................................ 8,000
Printing and engraving........................................... 50,000*
Representative's nonaccountable/expense allowance................ 330,000
Miscellaneous.................................................... 40,637
--------
TOTAL.......................................................... $680,000
========
- --------
* Estimated.
II-1
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
Note: The information contained in this Item 26 is based on the actual
current share and per share amounts. These numbers are subject to change
pursuant to the Registrant's proposed reverse stock split.
The Registrant made the following sales of securities within the past three
years without registering such securities under the Securities Act:
Unless otherwise stated, no underwriters or placement agents were used in
connection with any of the issuances of securities described below.
During 1995, the Registrant issued 175,000 shares of Common Stock to certain
directors, officers and key employees of the Registrant and consultants and
advisors who have rendered bona fide services to the Registrant not in
connection with the issuance of securities in a capital-raising transaction,
pursuant to its Stock Bonus Plan. (Note 3)
From 1995 to the present, the Registrant has granted options to purchase
1,108,800 shares of Common Stock to certain directors, officers and key
employees of the Registrant and consultants and advisors who have rendered
bona fide services to the Registrant not in connection with the issuance of
securities in a capital-raising transaction, pursuant to its Non-Qualified
Stock Option Plan (the "Plan"). (Note 3)
From March 1995 through June 1995, the Registrant issued an aggregate of
1,091,500 shares of Common Stock to accredited investors as defined under
Regulation D of the Securities Act ("Accredited Investors") at a price of $.50
per share. (Note 2)
On July 1, 1995, the Registrant granted options for 600,000 shares to two
employees who rendered bona fide services to the Registrant not in connection
with the issuance of securities in a capital-raising transaction. (Note 3)
On September 14, 1995, the Registrant issued 818,774 shares of the Common
Stock to Redden Dynamics Corporation ("Redden") pursuant to a plan of merger
to acquire all of the outstanding shares of capital stock of Redden. (Note 1)
On September 26, 1995, the Registrant issued 30,000 shares of Common Stock
to one purchaser for $3.00 per share. (Note 1)
From December 1995 through March 1996, the Registrant issued 180,000 shares
of Common Stock and warrants to purchase 150,000 shares of the Registrant's
Common Stock to three persons in exchange for financial consulting services.
Warrants to purchase 50,000 shares of Common Stock are exercisable at $1.50
per share, warrants to purchase 50,000 shares of Common Stock are exercisable
at $2.50 per share, and warrants to purchase 50,000 shares of Common Stock are
exercisable at $3.50 per share. As of the date hereof, no warrants have been
exercised. (Note 2)
From June 1996 through September 1996, the Registrant issued 61,500 shares
of Common Stock to 11 Accredited Investors at a price of $2.00 per share.
Jason Harmon received a commission of $11,800 for acting as placement agent.
(Note 2)
In July 1996, the Registrant issued 179,076 shares of Common Stock to 37
shareholders of WIN in exchange for shares of common stock of WIN held by
them. (Note 1)
In October 1996, the Registrant issued 140,000 shares of Common Stock to
Gary Kamienski in consideration for technological consulting services rendered
between February 1994 and July 1995. (Note 2)
II-2
From October 1996 to July 1997, the Registrant issued 10% convertible
promissory notes in the original aggregate principal amount of $415,000 and
warrants to purchase up to 41,500 shares of Common Stock to 23 investors. The
notes are convertible into shares of Common Stock at the option of the holder,
at a conversion price equal to 90% of the average between the bid and asked
prices of the Registrant's Common Stock on the day prior to the conversion
date. Warrants to purchase 1,500 shares of Common Stock are exercisable at
$.27 per share, warrants to purchase 4,000 shares of Common Stock are
exercisable at $.52 per share, warrants to purchase 4,000 shares of Common
Stock are exercisable at $.53 per share, warrants to purchase 2,000 shares of
Common Stock are exercisable at $.63 per share, warrants to purchase 7,000
shares of Common Stock are exercisable at $.75 per share, warrants to purchase
9,000 shares of Common Stock are exercisable at $.81 per share, warrants to
purchase 7,000 shares of Common Stock are exercisable at $.88 per share and
warrants to purchase 7,000 shares of Common Stock are exercisable at $1.38 per
share. From January 1997 through January 1998, 557,453 shares of Common Stock
were issued upon conversion of approximately $389,817 principal amount of the
notes, and no warrants have been exercised. (Note 2)
In February and March 1997, the Registrant issued 15% promissory notes in
the aggregate principal amount of $85,000 and warrants to purchase up to
17,000 shares of Common Stock to three investors. Warrants to acquire 6,500
shares of Common Stock are exercisable at $.38 per share, warrants to purchase
7,000 shares of Common Stock are exercisable at $.63 per share and warrants to
purchase 3,500 shares of Common Stock are exercisable at $.75 per share. As of
the date hereof, no shares of Common Stock have been issued upon conversion of
the notes and no warrants have been exercised. (Note 2)
From September through December 1997, the Registrant issued 908,641 shares
of Common Stock to 30 investors (29 of whom were Accredited Investors) for
$.55 per share. (Note 1)
In December 1997, the Registrant issued Bridge Notes in the aggregate
principal amount of $2,840,000 to 17 Accredited Investors. Upon the closing of
this Offering, each investor will receive 4,000 shares of Common Stock for
every $100,000 invested in the Bridge Notes based on an initial offering price
of $10.00 per share. The Representative acted as placement agent in the
December 1997 private placement for which it received $312,400 and warrants to
purchase 284,000 shares of Common Stock at a price equal to 125% of the price
to public of the shares in this Offering. (Note 2)
- --------
(1) The Registrant believes that the issuance of such securities was exempt
from registration pursuant to Section 4(2) of the Securities Act.
(2) The Registrant believes that the issuance of such securities was exempt
from registration pursuant to Rules 504, 505 and/or 506 of Regulation D
and Sections 3(b), 4(2) and/or 4(6) of the Securities Act.
(3) The Registrant believes that the issuance of such securities was exempt
from registration pursuant to Rule 701 and Section 3(b) of the Securities
Act.
ITEM 27. EXHIBITS.
EXHIBIT NO. DESCRIPTION
----------- -----------
1.1 Form of Underwriting Agreement between CSI and the Underwriters
Form of Selected Dealer Agreement between the Representative and
1.2 certain selected dealers
Plan and Articles of Merger dated September 14, 1995 between CSI
2.1 and Redden Dynamics, Inc.
Stock Purchase Agreement, dated February , 1997, among the
2.2* Registrant, ITC and its Stockholders
3.1 Articles of Incorporation of CSI
3.2 Bylaws of CSI
4.1 Specimen Common Stock certificate
Form of Warrant Agreement, including Form of Representative's
4.2 Warrant
II-3
EXHIBIT NO. DESCRIPTION
----------- -----------
5* Opinion of Parcel, Mauro & Spaanstra, P.C.
Form of 10% Convertible Promissory Note from to Registrant to
10.1 various investors
Form of Warrant and Terms of Warrant between Registrant and
10.2 various investors
10.3 Agreement between Registrant and Cable and Wireless
10.4 Promissory Note from CSI to Robert A. Spade
10.5* Stock Option Plan of CSI
Lease Agreement dated January 1, 1994 between CSI and The Mining
10.6 Exchange Partners Limited
LINK-US/PC Agreement dated September 19, 1996 between CSI and Gary
10.7 Kamienski
Form of Distributor Agreement between CSI and certain of its
10.8 distributors
Form of Branch Office Agency Agreement between the Registrant and
10.9 certain of its distributors
10.10* Agreement and Tariff Order dated November 1997 between the
Registrant and AT&T Communications.
10.11 Employment Agreement with Robert A. Spade
10.12 Employment Agreement with Patrick R. Scanlon
10.13 Employment Agreement with Daniel R. Hudspeth
10.14 Agreement between ITC and AIT
10.15 Agreement between ITC and Trescom
10.16 Agreement between ITC and Cable & Wireless
10.17 Agreement between ITC and Teleglobe
10.18 Promissory Note from CSI to Robert A. Spade, dated April 30, 1996
21 List of Subsidiaries
23.1* Consent of Parcel, Mauro & Spaanstra, P.C. (contained in Exhibit 5)
23.2 Consent of Stockman Kast Ryan & Scruggs, P.C.
23.3 Consent of Richard A. Eisner & Company, LLP
24 Power of Attorney (included on page II-6 hereof)
27 Financial Data Schedule
- --------
* To be filed by amendment.
ITEM 28. UNDERTAKINGS.
(a) Rule 415 Offering. The Registrant hereby undertakes that it will:
(1) File, during any period in which it offers or sells securities, a
post-effective amendment to this Registration Statement to:
(i) Include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) Reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the
information in the Registration Statement; and
(iii) Include any additional or changed material information on the
plan of distribution.
(2) For determining liability under the Securities Act, treat each post-
effective amendment as a new registration statement of the securities
offered, and the offering of the securities at that time to be the initial
bona fide offering.
(3) File a post-effective amendment to remove from registration any of
the securities that remain unsold at the end of the offering.
II-4
(d) Prompt Delivery. The Registrant undertakes to provide to the
Underwriters at the closing specified in the Underwriting Agreement
certificates in such denominations and registered in such names as required by
the Underwriters to permit prompt delivery to each purchaser.
(e) Indemnification. Insofar as indemnification for liabilities arising
under the Securities Act 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 Securities Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by the small business issuer of expenses incurred or
paid by a director, officer or controlling person of the small business issuer
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 small business issuer 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 Securities Act and will be
governed by the final adjudication of such issue.
(f) Rule 430A.
The Registrant hereby undertakes that it will:
(i) For determining any liability under the Securities Act, treat 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 under Rule 424(b)(1) or (4) or 497(h)
under the Securities Act as part of this Registration Statement as of the
time the Commission declared it effective.
(ii) For determining any liability under the Securities Act, treat each
post-effective amendment that contains a form of Prospectus as a new
registration statement for the securities offered in the registration
statement, and that offering of the securities at that time as the initial
bona fide offering of those securities.
II-5
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form SB-2 and authorized this
registration statement to be signed on their behalf by the undersigned in
Colorado Springs, Colorado, on February 26, 1998.
Communications Systems
International, Inc.
/s/ Robert A. Spade
By: _________________________________
Name: Robert A. Spade
Title: Chief Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below on this Registration Statement
hereby constitutes and appoints Robert A. Spade and Patrick R. Scanlon, and
each of them, as his true and lawful attorney-in-fact and agent, with full
power of substitution and resubstitution for him and in his name, place and
stead, in any and all capacities (until revoked in writing) to sign any and
all amendments (including pre-effective amendment and post-effective
amendments and amendments thereto) to this Registration Statement on Form SB-2
of Communications Systems International, Inc. 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 full
power and authority to do and perform each and every act and thing requisite
and necessary to be done in and about the premises, as fully to all intents
and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and gents, each acting alone or his
substitute, may lawfully do or cause to be done by virtue hereof.
In accordance with the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates stated.
/s/ Robert A. Spade Chief Executive February 26,
- ------------------------------------- Officer and 1998
ROBERT A. SPADE Chairman of the
Board (Principal
Executive Officer)
/s/ Patrick R. Scanlon President, Chief February 26,
- ------------------------------------- Operating Officer 1998
PATRICK R. SCANLON and Director
/s/ Daniel R. Hudspeth Chief Financial February 26,
- ------------------------------------- Officer and 1998
DANIEL R. HUDSPETH Treasurer
(Principal
Financial and
Accounting Officer)
/s/ Dean H. Cary Director February 26,
- ------------------------------------- 1998
DEAN H. CARY
/s/ Richard F. Nipert Director February 26,
- ------------------------------------- 1998
RICHARD F. NIPERT
II-6