AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 27, 1998.
REGISTRATION NO. 333-47045.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
AMENDMENT NO. 1 TO
FORM SB-2 ON
FORM S-1 REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
---------------
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
COLORADO 4813 84-1238018
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER
JURISDICTION OF INDUSTRIAL IDENTIFICATION NO.)
INCORPORATION OR CLASSIFICATION CODE
ORGANIZATION) NUMBER)
8 SOUTH NEVADA AVENUE, SUITE 200 ROBERT A. SPADE, CHIEF EXECUTIVE OFFICER
COLORADO SPRINGS, COLORADO 80903 8 SOUTH NEVADA AVENUE, SUITE 200
(719) 471-3332 COLORADO SPRINGS, COLORADO 80903
(ADDRESS, INLUDING ZIP CODE, AND (719) 471-3332
TELEPHONE NUMBER, INCLUDING AREA (NAME, ADDRESS, INCLUDING ZIP CODE,
CODE, OF REGISTRANT'S PRINCIPAL AND TELEPHONE NUMBER, INCLUDING AREA
EXECUTIVE OFFICES) CODE, OF AGENT FOR SERVICE)
Copies to:
DOUGLAS R. WRIGHT, ESQ. ROBERT W. WALTER, ESQ.
JEFFREY A. SHERMAN, ESQ. BERLINER ZISSER WALTER & GALLEGOS, P.C.
PARCEL, MAURO & SPAANSTRA, P.C. 1700 LINCOLN
1801 CALIFORNIA STREET, SUITE 3600 SUITE 4700
DENVER, COLORADO 80202 DENVER, COLORADO 80203
(303) 292-6400 (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 PROPOSED
MAXIMUM MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED PER SECURITY OFFERING PRICE FEE (1)
- -----------------------------------------------------------------------------------------
Common Stock(2)......... 3,450,000 $11.00 $37,950,000 $11,195.25
- -----------------------------------------------------------------------------------------
Common Stock(3)......... 263,600 $11.00 $ 2,899,600 $ 855.38
- -----------------------------------------------------------------------------------------
Representatives'
Warrants(4)............ 300,000 $ -- $ -- $ -- (5)
- -----------------------------------------------------------------------------------------
Common Stock Underlying
Representatives'
Warrants(6)............ 300,000 $13.20 $ 3,960,000 $ 1,168.20
- -----------------------------------------------------------------------------------------
TOTAL................................................... $44,809,600 $13,218.83
- -----------------------------------------------------------------------------------------
AMOUNT PREVIOUSLY PAID................................................. $ 5,406.49
- -----------------------------------------------------------------------------------------
AMOUNT OWED............................................................ $ 7,812.34
- -----------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
(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 450,000 shares that the representatives of the
underwriters (the "Representatives") have 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 Representatives at the closing of this
offering warrants to purchase 300,000 shares of Common Stock (the
"Representatives' Warrants").
(5) No fee pursuant to Rule 457(g).
(6) These shares of Common Stock are issuable upon exercise of the
Representatives' Warrants. An indeterminate number of additional shares
of Common Stock are registered hereunder which may be issued as provided
in the Representatives' Warrants in the event that the provisions against
dilution in the Representatives' 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 Communications Systems International, Inc. ("CSI")
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 shares of Common Stock (the "Common Stock") by CSI (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 CSI 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 Securityholder 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 APRIL 24, 1998
PROSPECTUS
SHARES
[LOGO]
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
COMMON STOCK
---------
All of the shares of Common Stock offered hereby are being sold by
Communications Systems International, Inc. ("CSI"). The Common Stock is
currently traded on the OTC Bulletin Board under the symbol "CSYG." Prior to
the offering, there has been a limited public market for the Common Stock of
CSI. On , 1998, the closing bid price of the Common Stock was $ per
share. See "Price Range of Common Stock." It is currently estimated that the
public offering price will be between $ and $ per share. See
"Underwriting" for a discussion of factors to be considered in determining the
offering price. Application has been made to have the Common Stock approved for
quotation on the Nasdaq SmallCap Market under the symbol "CSGL." Following
quotation on the Nasdaq SmallCap Market, the Common Stock will no longer be
quoted on the OTC Bulletin Board.
Concurrent 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 Security- holders' Shares"). The Selling
Securityholders' Shares are not part of the underwritten offering. Other than
receipt of the exercise price of certain warrants, the Company will not receive
any proceeds from the sale of the Selling Securityholders' Shares. In addition,
the Selling Securityholders have agreed with the Representatives not to sell or
transfer the Selling Securityholders' Shares for a period of 180 days following
the date of this Prospectus.
-----------
SEE "RISK FACTORS" BEGINNING ON PAGE 5 FOR INFORMATION
PROSPECTIVE INVESTORS SHOULD CONSIDER.
-----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COM- MISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS(1) COMPANY(2)
- --------------------------------------------------------------------------------
Per Share................... $ $ $
- --------------------------------------------------------------------------------
Total(3).................... $ $ $
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1) CSI has agreed to indemnify the Underwriters against certain liabilities,
including liabilities under the Securities Act of 1933, as amended. CSI has
also agreed to sell to the Representatives of the Underwriters warrants to
purchase shares of Common Stock exercisable at $ per share (the
"Representatives' Warrants"). See "Underwriting."
(2) Before deducting expenses payable by CSI estimated at $ , including the
Representatives' nonaccountable expense allowance.
(3) CSI has granted to the Underwriters a 45-day option to purchase an
aggregate of up to additional shares of Common Stock solely to cover over-
allotments, if any. If this option is exercised in full, the total Price to
Public, Underwriting Discounts and Commissions, and Proceeds to Company
will be $ , $ and $ , respectively. See "Underwriting."
---------
The shares of Common Stock are offered by the Underwriters subject to prior
sale when, as and if delivered to and accepted by them, and subject to the
right of the Underwriters to withdraw, cancel or modify such offer without
notice and reject orders in whole or in part. It is expected that delivery of
the certificates for the Common Stock will be made at the offices of Cruttenden
Roth Incorporated, Irvine, California or in book entry form through the book
entry facilities of The Depository Trust Company on or about , 1998.
---------
CRUTTENDEN ROTH Cohig & Associates, Inc.
INCORPORATED
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 COMMON STOCK OF
THE COMBINED 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."
On the effective date of the Registration Statement of which this Prospectus
forms a part, the Combined Company will become a "reporting company" under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Combined
Company intends to register the Common Stock under the Exchange Act as of the
effective date of the Registration Statement.
The Combined Company intends to furnish its security holders with annual
reports containing audited financial statements and quarterly reports for the
first three quarters of each year containing unaudited interim financial
information.
The Combined Company claims proprietary rights in its logo and the terms
"LINK-US" and "DIAL." Primecall(R) is a service mark of GlobalTel. Trade
names, trademarks and service marks of other companies appearing in this
Prospectus are the property of their respective holders.
SUMMARY
The following summary is qualified in its entirety by the more detailed
information and Financial Statements and the notes thereto appearing elsewhere
in this Prospectus. Unless the context otherwise requires, (i) references to
the "Combined Company" refer to Communications Systems International, Inc.,
GlobalTel Resources, Inc. and International Telephone Company, assuming the
GlobalTel Merger and the ITC Acquisition are consummated, (ii) references to
"CSI" refer to Communications Systems International, Inc., (iii) references to
"GlobalTel" refer to GlobalTel Resources, Inc. and its two wholly owned
subsidiaries, and (iv) references to "ITC" refer to International Telephone
Company.
THE COMPANY
The Combined Company is a growing provider of international
telecommunications services offering long distance, calling cards and enhanced
voice and data services. With more than 25,500 customers in over 170 countries,
the Combined Company primarily serves markets that have been historically
underserved by large telecommunications providers and incumbent telephone
operators ("ITOs"). The Combined Company presently focuses on international
call-reorigination, capitalizing on the arbitrage opportunity created by
differences between U.S. and international long-distance rates. Going forward,
the Combined Company intends to leverage the expertise derived from its call-
reorigination business, and capitalize on the established customer base
generated by its call-reorigination business, to provide higher margin
telecommunications services such as call-through, enhanced fax and business
grade Internet services.
The world's larger telecommunications carriers, such as AT&T, MCI, British
Telecom, Deutsche Telecom AG and France Telecom, have focused on developed
telecommunications markets that are characterized by high teledensity (ratio of
telephone lines to inhabitants), an advanced stage of deregulation, a large
volume of international telecommunications traffic and a concentration of
multinational corporations. These markets include the United States, the United
Kingdom, Germany, France and Japan. The Combined Company focuses on what it
characterizes as emerging telecommunications markets, which are (i) smaller
developed countries such as Argentina, Austria, Brazil, Switzerland, Ireland,
Singapore and South Africa, and (ii) markets that typically have less developed
telecommunications infrastructures, are in an earlier stage of deregulation and
have more monopolistic distribution profiles. Based on data from the
International Telecommunications Union, the Combined Company has calculated
that the approximately 145 countries that the Combined Company targets as
emerging telecommunications markets generated approximately 23.0 billion
minutes in outgoing international telecommunications traffic in 1995.
The Combined Company's telecommunications services are marketed and sold
through a network of independent sales agents, strategic relationships and in-
house direct marketing. The Combined Company relies primarily on over 170
independent sales agents that cover over 170 countries. GlobalTel has an
exclusive agreement with the International Business Network for World Commerce
and Industry, Ltd. ("IBNET"), the managing member of the Consortium of Global
Commerce, under which IBNET will market the services of GlobalTel, and
ultimately the Combined Company, through several thousand individual chambers
of commerce located in over 200 countries. In addition, GlobalTel has a
strategic relationship with Novell that provides it with a distribution channel
for its services, and ultimately those of the Combined Company, through a
select number of Novell's network of over 25,000 value-added resellers.
The Combined Company has a broad customer base including foreign offices of
multinational corporations, including Nike Inc., Microsoft Corporation,
Mitsubishi Corporation and Chrysler Corporation; major international hotels,
including the Inter-Continental Hotel and the Copacabana Palace in Rio de
Janeiro, Brazil and Southern Sun Group's Holiday Inn Hotels in South Africa;
and embassies and international agencies, including the United States embassies
in Chile, Korea, Australia and the Ukraine and the United Nations consulate in
South Africa.
1
The Combined Company provides telecommunications services through its (i)
voice switching and global fax messaging infrastructure in Los Angeles,
California, (ii) voice switching and billing center in Ft. Lauderdale, Florida,
(iii) access to third party infrastructure through international
telecommunications carriers and through Equant, a global data network services
provider, and (iv) enhanced fax nodes in Hong Kong and Mexico City. The
Combined Company uses both off-the-shelf technologies, which provide
flexibility to adapt to the rapidly changing telecommunications environment,
and proprietary automated call processing technologies (DIAL and LINK-US),
which enhance the Combined Company's competitive position in serving high
volume customers.
The principal components of the Combined Company's strategy are to (i)
increase penetration of emerging telecommunications markets by capitalizing
upon its call-reorigination experience, strategic marketing relationships and
proprietary technologies, (ii) pursue and implement additional strategic
acquisitions of complementary international customer bases, products and
infrastructure, (iii) exploit strategic marketing relationships to expand its
customer base and establish new relationships with independent ISPs and other
network providers in its target markets, (iv) provide an increasingly broad
range of services, such as enhanced voice and data services and a suite of
business grade Internet services, (v) employ flexible open architecture
technology that is modular, scalable and allows for the integration of a
variety of technologies, (vi) utilize proprietary call processing technologies
to provide quality telecommunications services to high volume customers, (vii)
increase revenue through targeted growth in its carrier and reseller business,
and (viii) exploit operating and marketing synergies and efficiencies resulting
from the GlobalTel Merger and the ITC Acquisition.
CSI is a Colorado corporation formed in April 1993. The Combined Company
intends to change its name to "CS GlobalTel, Inc." upon completion of the
GlobalTel Merger. The Combined Company's executive offices are located at 8
South Nevada Avenue, Colorado Springs, Colorado 80903, and its telephone number
is (719) 471-3332. The Combined Company's Internet address is
http://www.csil.com.
Unless otherwise indicated, the information contained in this Prospectus (i)
assumes no exercise of the Underwriters' over-allotment option or outstanding
options, warrants or convertible securities, and (ii) gives effect to a
proposed 1 for reverse stock split that will be completed prior to the date
of this Prospectus. CSI has entered into an agreement in principle to merge
(the "GlobalTel Merger") with GlobalTel, CSI has entered into an agreement to
acquire all of the outstanding stock of ITC (the "ITC Acquisition"), which is
expected to occur simultaneously with the completion of this offering.
References to the present action of the Combined Company refer to activities or
matters that are common to each of CSI, GlobalTel 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 GlobalTel Merger and the ITC Acquisition.
See "Glossary of Terms" for definitions of certain technical and other terms
used in this Prospectus. Certain information contained herein is derived from
industry sources. Although the Combined Company believes that this information
is reliable, it has not independently verified this information.
2
THE OFFERING
Common Stock offered... shares
Common Stock outstanding
after the offering.... shares(1)
Use of Proceeds........ To repay certain indebtedness of the Combined
Company; to consummate the ITC Acquisition; to
install equipment to facilitate transparent call-
reorigination services for additional hotels and
businesses; for technical development associated
with the Combined Company's enhanced services; to
pay certain deferred payables; and for general
working capital to fund operating expenses. In
addition, a portion of the proceeds will be used
to fund the repurchase of any securities tendered
in connection with the rescission offer that the
Combined Company intends to commence immediately
after this offering. See "Use of Proceeds,"
"Business" and "Rescission Offer."
Risk Factors........... The Common Stock offered hereby is speculative
and involves 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" and
"Dilution."
Proposed Nasdaq SmallCap
Market symbol......... [CSGL]
- --------
(1) Includes shares of Common Stock (the "Bridge Shares") to be issued
immediately prior to the closing of this offering based on an assumed
offering price of $ per share in connection with the notes (the "Bridge
Notes") issued by CSI in December 1997 (the "December 1997 Financing").
Excludes (i) up to shares of Common Stock issuable upon exercise of
outstanding options, which have a weighted average exercise price of $
per share, (ii) up to shares of Common Stock issuable upon the exercise
of outstanding warrants, which have a weighted average exercise price 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 asked price of the Common Stock on the day
before conversion, (iv) up to shares of Common Stock issuable upon
exercise of the Representatives' Warrants, (v) shares issuable in
connection with the ITC Acquisition, (vi) the issuance of and
shares of Common Stock to certain holders of notes of GlobalTel (the
"GlobalTel Full Coverage Notes") and past noteholders of GlobalTel,
respectively, assuming an initial public offering price of $ per share,
(vii) the issuance of shares of Common Stock upon the cashless
conversion of certain warrants (the "Cashless Warrants") at the closing of
this offering, assuming an initial public offering price of $ per share,
(viii) the issuance of shares of Common Stock to an officer of
GlobalTel upon the closing of this offering in connection with the
acquisition of GFP Group, Inc., (ix) the issuance of shares of Common
Stock to an affiliate of GlobalTel in connection with services to be
rendered by such affiliate, assuming an initial public offering price of
$ per share, and (x) the conversion of certain long-term debt into
shares of Common Stock upon the closing of the offering at a price of $
per share (collectively referred to herein as "Additional Securities").
See "Management," "Description of Securities" and "Underwriting."
3
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, GlobalTel and ITC, the unaudited financial
statements of CSI and ITC, and the unaudited pro forma condensed combined
financial statements of CSI, GlobalTel 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.
HISTORICAL--
HISTORICAL--CSI GLOBALTEL HISTORICAL--ITC PRO FORMA
----------------------------- ---------------- ------------------------ AS ADJUSTED 12
THREE MONTHS MONTHS ENDED
ENDED DECEMBER 31,
12 MONTHS 12 MONTHS
ENDED NINE MONTHS ENDED 10 MONTHS
APRIL 30, ENDED DECEMBER 31, ENDED
---------------- JANUARY 31, ---------------- OCTOBER 31, JANUARY 31,
1996 1997 1998 1996 1997 1997 1998 1997
------- ------- ----------- ------- ------- ----------- ------------ --------------
STATEMENT OF
OPERATIONS
DATA:
Revenue......... $ 6,741 $11,865 $ 8,895 $ 9,136 $12,862 $8,054 $2,849 $ 35,261
Cost of
revenue........ 5,963 7,755 5,394 8,230 11,171 6,790 2,194 28,094
------- ------- ------- ------- ------- ------ ------ ---------
Gross margin.... 778 4,110 3,501 906 1,691 1,264 655 7,167
Operating
expenses:
Sales and
marketing...... 1,573 2,080 1,961 682 788 715 244 3,520
General and
administrative.. 1,652 2,024 2,604 5,773 7,119 1,388 476 11,789
Depreciation and
amortization
expense........ 58 103 105 98 253 73 29 9,610
Acquired in-
process
research and
development.... -- -- -- -- -- -- -- 3,475
------- ------- ------- ------- ------- ------ ------ ---------
Total operating
expenses....... 3,283 4,207 4,670 6,553 8,160 2,176 749 28,394
------- ------- ------- ------- ------- ------ ------ ---------
Loss from
operations..... (2,505) (97) (1,169) (5,647) (6,469) (912) (94) (21,227)
Interest
expense,
including
amortization of
debt discount.. (19) (162) (348) (225) (1,368) (57) (15) (702)
Other income.... -- -- -- -- -- 119 12 --
------- ------- ------- ------- ------- ------ ------ ---------
Loss before
income taxes
and
extraordinary
item........... (2,524) (259) (1,517) (5,872) (7,837) (850) (97) (21,929)
Income tax
(benefit)...... -- -- -- -- -- -- -- (2,437)
------- ------- ------- ------- ------- ------ ------ ---------
Loss before
extraordinary
item........... (2,524) (259) (1,517) (5,872) (7,837) (850) (97) (19,492)
Extraordinary
item--gain on
extinguishment
of debt........ -- -- 747 -- -- -- -- --
------- ------- ------- ------- ------- ------ ------ ---------
Net loss........ $(2,524) $ (259) $ (770) $(5,872) $(7,837) $ (850) $ (97) $ (19,492)
======= ======= ======= ======= ======= ====== ====== =========
Series A
convertible
preferred stock
dividends...... -- -- -- -- (39) -- -- --
------- ------- ------- ------- ------- ------ ------ ---------
Net loss
applicable to
common
shareholders... $(2,524) $ (259) $ (770) $(5,872) $(7,876) $ (850) $ (97) $ (19,492)
======= ======= ======= ======= ======= ====== ====== =========
EBITDA(1)....... $(2,447) $ 6 $(1,064) $(5,549) $(6,216) $ (720) $ (53) $ (8,142)
Basic loss per
share(excluding
extraordinary
item)..........
Weighted average
number of
shares
outstanding....
HISTORICAL--
HISTORICAL--CSI GLOBALTEL HISTORICAL--ITC PRO FORMA
--------------------- ------------ ----------------------- AS ADJUSTED
APRIL 30, JANUARY 31, DECEMBER 31, OCTOBER 31, JANUARY 31, DECEMBER 31,
1997 1998 1997 1997 1998 1997
--------- ----------- ------------ ----------- ----------- ------------
BALANCE SHEET DATA:
Cash.................... $ 147 $ 566 $ 849 $ 848 $ 978 $21,761
Working capital
(deficit).............. (2,331) (2,977) (4,934) (1,259) (1,402) 13,364
Total assets............ 1,946 2,943 4,354 2,720 3,338 57,223
Long-term debt, net of
current maturities and
debt discount.......... -- -- 3,832 292 227 4,291
Common stock subject to
rescission............. -- -- 2,455 -- -- 2,455
Total shareholders'
equity (deficit)....... (1,669) (1,455) (8,534) (781) (878) 35,414
(1) "EBITDA' is defined as net income or loss plus depreciation, amortization
and interest expense, income taxes and other non-cash charges, minus
extraordinary income and gains and non-cash income, if any, and plus
extraordinary losses, if any. EBITDA is not a measure of financial
performance under generally accepted accounting principles and should not
be considered a substitute for measures of performance prepared in
accordance with generally accepted accounting principles.
4
RISK FACTORS
In addition to the other information contained in this Prospectus, the
following risk factors should be considered carefully in evaluating the
Combined Company and its business before purchasing shares of Common Stock
offered hereby. This Prospectus contains certain forward-looking statements
that involve substantial risks and uncertainties. When used in this
Prospectus, the words "may," "will," "expect," "anticipate," "continue,"
"estimate," "project," "intend," "believe" and similar expressions are
intended to identify forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 (the "Securities Act") and Section 21E of
the Exchange Act regarding events, conditions and financial trends that may
affect the Combined Company's future plan of operations, business strategy,
operating results and financial position. Prospective investors are cautioned
that any forward-looking statements are not guarantees of future performance
and are subject to risks and uncertainties and that actual results could
differ materially from the results expressed in or implied by these forward-
looking statements as a result of various factors, many of which are beyond
the Combined Company's control. These factors are described under the headings
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and in the risk factors set forth below.
RISKS RELATED TO THE COMBINED COMPANY AND THE TELECOMMUNICATIONS INDUSTRY
LIMITED OPERATING HISTORY; SUBSTANTIAL AND CONTINUING LOSSES; SUBSTANTIAL
DOUBT ABOUT THE ABILITY TO CONTINUE AS GOING CONCERNS
Both CSI and ITC commenced operations in 1993 and GlobalTel commenced
operations in 1995. Accordingly, CSI, GlobalTel and ITC have limited operating
histories upon which an evaluation of their performance can be based. The
Combined Company has no combined operating history. The Combined Company's
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in their early stage of operations. There
is no assurance that 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 12 months ended April 30, 1996 and 1997, respectively, and
a loss of approximately $770,000, during the nine months ended January 31,
1998, resulting in an accumulated deficit of approximately $4.8 million as of
January 31, 1998. GlobalTel has incurred significant losses, including losses
of $5.9 million and $7.8 million for the 12 months ended December 31, 1996 and
1997, respectively, resulting in an accumulated deficit of $15.6 million as of
December 31, 1997. In addition, ITC incurred a loss of approximately $850,000
during the 10 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 significantly increased revenue or
profitable operations. The Combined Company's results of operations may be
below the expectations of public market analysts and investors in future
quarters, which would likely result in a decline in the trading price for the
Common Stock. CSI's and GlobalTel's independent auditors have each included an
explanatory paragraph in their respective reports on the financial statements
stating that they have been prepared assuming that each of CSI and GlobalTel,
respectively, will continue as separate going concerns. However, recurring
losses from operations and projected future cash requirements raise
substantial doubt about each company's ability to continue as a going concern.
The explanatory paragraphs in the reports on the financial statements do not
consider the proposed consummation of this offering. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Financial Statements.
GLOBALTEL BILLING SYSTEM AND INTERNAL CONTROLS
In November 1997, GlobalTel commenced using a new billing system to record
revenue from calls made by GlobalTel's customers and the application of cash
receipts to customer accounts. In connection with auditing GlobalTel's 1997
financial statements, GlobalTel's independent auditors identified a material
weakness in GlobalTel's internal accounting controls with respect to the
administration of the billing system that could, if not corrected, lead to
errors in revenue reporting which may not be detected by management of
GlobalTel on a timely
5
basis. GlobalTel intends to eliminate this material weakness by outsourcing
the administration of its billing system to its billing system vendor until
the completion of the GlobalTel Merger, at which time GlobalTel's billing
functions will be transferred to the Combined Company's billing system. There
can be no assurance that this or other control deficiences will not occur in
the future. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
NEED FOR ADDITIONAL CAPITAL AND CAPITAL REQUIREMENTS
The efforts of CSI, GlobalTel and ITC to develop and introduce an array of
enhanced telecommunications services have required, and will continue to
require, the Combined Company to invest in network infrastructure and systems
development. Also, the Combined Company has incurred substantial pro forma
losses and expects to continue to incur losses due, in part, to significant
depreciation and amortization expense, through the foreseeable future. At
January 31, 1998, CSI and ITC, and at December 31, 1997, GlobalTel,
respectively, had working capital deficits of approximately $3.0 million, $1.4
million and $4.9 million, respectively. The Combined Company believes that,
based upon its present business plan, the net proceeds of this offering,
together with revenue from operations, will be sufficient to finance operating
losses, the development and introduction of enhanced services and to meet its
other currently planned working capital and capital expenditure requirements
through the next 12 months. However, due to the need to continue to expand its
network operations and service offerings and other factors, the Combined
Company expects that it will need to raise additional capital in future
periods. The Combined Company also intends to seek lease financing for a
portion of the equipment and systems that it acquires in 1998 and beyond,
although there can be no assurance that this financing will be available to
the Combined Company when needed or on acceptable terms. If the Combined
Company experiences greater than anticipated capital requirements, if the
implementation of the Combined Company's operating strategy fails to produce
anticipated revenue growth and cash flows, if lease financing is not available
or if additional working capital is required for any other reason, the
Combined Company will be required to obtain additional capital earlier than
currently anticipated. The timing of the need for additional capital
subsequent to the next 12 months also will be affected by the extent to which
the Combined Company's rescission offer is accepted. See "Rescission Offer."
There can be no assurance that the Combined Company will be able to obtain
equity, debt or lease financing when needed or on terms that the Combined
Company finds acceptable. Any issuances of additional equity or convertible
debt may cause substantial dilution to the Combined Company's shareholders. If
the Combined Company is unable to obtain sufficient funds to satisfy its
capital requirements, it will be forced to reduce the scope of its expansion
plans, curtail operations, dispose of assets or seek extended payment terms
from its vendors, any of which could have a material adverse effect on the
Combined Company's business, financial condition and results of operations.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
DEPENDENCE ON KEY INDEPENDENT SALES AGENTS
CSI currently depends on approximately 42 independent sales agents to sell
its services, including Edward Stoever, who operates in Argentina, and CS do
Brazil. These two independent sales agents accounted for approximately 54.3%,
and 11.5%, respectively, of CSI's revenue in the 12 months ended December 31,
1997, and the ten largest independent sales agents accounted for approximately
91.3% of CSI's revenue in the nine months ended January 31, 1998. GlobalTel
currently depends on 81 independent sales agents to sell its services. The 10
largest independent sales agents accounted for approximately 30.9% of
GlobalTel's revenue in the 12 months ended December 31, 1997. ITC currently
depends on approximately 55 independent sales agents to sell its services,
including Generic Telecom, Inc., Zohair Attoue and Janel Richards
(collectively, with Mr. Stoever and CS do Brazil, the "Key Independent Sales
Agents"). These three independent sales agents accounted for approximately
26.6%, 21.4% and 12.7%, respectively, of ITC's revenue in the 10 months ended
October 31, 1997, and the ten largest independent sales agents accounted for
approximately 89.1% of ITC's revenue in the 10 months ended October 31, 1997.
If the Combined Company fails to retain the services of any of the Key
Independent Sales Agents for any reason or loses the services of other
independent 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. The
Combined Company also depends on its independent sales agents and persons
engaged by them to install and service much of the Combined Company's
technologies. The
6
failure of such persons to properly install or service the Combined Company's
systems could adversely affect the Combined Company. Although independent
sales agents are subject to agreements, such agreements may be difficult to
enforce because the independent sales agents are domiciled in foreign
countries. Under the terms of the agreements, independent sales agents are
responsible for collecting customer payments except for credit card payments,
and are generally responsible for customer bad debts less, in some cases, an
allowance granted by the Combined Company. Failure of independent sales agents
to collect and remit customer payments to the Combined Company presents risks
to the Combined Company. CSI's former independent sales agent in Singapore
recently failed to remit aggregate payments of $215,000. CSI is aggressively
pursuing collection of this receivable, although its ultimate recovery is not
assured. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business--Sales and Marketing."
NEED TO INTEGRATE AND MANAGE GLOBALTEL AND ITC; SELECTION AND INTEGRATION OF
UNSPECIFIED ACQUISITIONS
Management believes that the consummation of the GlobalTel Merger and the
ITC Acquisition will substantially increase the Combined Company's independent
sales agent base, technological capabilities, management expertise and carrier
relationships. The Combined Company's ability to realize any long-term
advantages from the GlobalTel Merger and the ITC Acquisition will depend in
large part on successfully integrating, managing and improving the operations
of GlobalTel and 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 executive officers, including Ronald P.
Erickson and Philip A. Thomas, the loss of independent sales agents of the
Combined Company or adverse changes in strategic or carrier relationships.
There can be no assurance that CSI will be able to successfully integrate
GlobalTel or ITC, the failure of which would have a material adverse effect on
the business of the Combined Company.
A key element of the Combined Company's strategy is expansion through the
additional acquisitions of complementary international customer bases,
products and infrastructure. Except for the GlobalTel Merger agreement in
principle and the ITC Acquisition agreement, the Combined Company has no
agreements, arrangements or understandings for any such acquisition as of the
date of this Prospectus. 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.
Under the Colorado Business Corporation Act, a corporation may effect a merger
with or an acquisition of another company without shareholder approval if the
corporation will be the surviving entity, the articles of incorporation of the
corporation are not substantively amended, each shareholder will hold the same
number and type of shares after the transaction as he did before, and the
outstanding shares of the corporation will not be increased by more than 20%
as a result of the transaction. Any future acquisitions or related activity
will involve additional risks including, 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 and the inability of
management to capitalize on the opportunities presented by the acquisitions.
In addition, the failure to successfully incorporate 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 in amortization of intangible assets in the Combined Company's
financial statements may adversely affect the Combined Company. If the
Combined Company completes acquisitions through the issuance of Common Stock,
the ownership interest of existing holders would be decreased. 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 the 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,
marketing and technical development efforts. The integration process 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. There can be no assurance that present and potential
customers of the Combined Company and any acquired entity would
7
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 difficulty of combining companies may be increased by geographic
distances between companies and the need to integrate personnel. Changes
brought about by any acquisition may cause key employees, independent 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, independent 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. There can be no assurance that, following any
acquisition, the Combined Company will be able to operate any acquired
business on a profitable basis.
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
recruit qualified staff, to continue to upgrade operating and financial
control systems 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 operations.
DEPENDENCE ON CARRIERS AND OTHER SUPPLIERS
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 carriers. 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 its carriers. Most of the Combined Company's agreements with
its 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 or
other carriers. There are a small number of carriers with whom the Combined
Company has carrier agreements. The Combined Company's dependence on
particular carriers will vary because the Combined Company shifts its use of
carriers depending on the rates offered. The Combined Company periodically
renegotiates rates with its current carriers and seeks 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. The loss of any carrier could have a material
adverse effect on the Combined Company.
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. As of
March 31, 1998, CSI was in arrears on payments due to one carrier of
approximately $780,000. In October 1997, GlobalTel failed to pay amounts due
to one of its principal long distance carriers within the time period that
this carrier customarily had required payment. As a result, this carrier
ceased providing services to GlobalTel and, under the terms of its agreement
with GlobalTel, could demand a termination payment of up to $1.2 million.
GlobalTel was able to re-route traffic that previously had been carried by
this carrier without any interruption in service to GlobalTel's customers. In
December 1997, after GlobalTel paid this carrier a substantial portion of the
amounts past due, services were restored. GlobalTel has negotiated payment
terms on the
8
remaining balance owed and does not believe that it will be required to pay an
amount in excess of that owed for carrier services provided. As of March 31,
1998, GlobalTel was in arrears on approximately $641,000 due to this carrier.
There can be no assurance that GlobalTel will not be required to pay a penalty
to this or any other supplier or that the Combined Company will not be in
default of its obligations to its suppliers 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 recorded a $1.1 million charge against
earnings in the ten month period ended October 31, 1997. 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
$550,000, which represent approximately 23.5% of the Combined Company's
average monthly cost of revenue for the 12 months ended December 31, 1997.
Failure to maintain favorable carrier contracts would increase the Combined
Company's cost of revenue and the ability to achieve and maintain
profitability. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business."
A failure by a carrier to deliver quality services or products on a timely
basis, or the inability of the Combined Company to develop alternative
suppliers if and as required, could result in delays in the provision of
service to the Combined Company's customers which could have a material
adverse effect on the Combined Company. The Combined Company's remedies
against carriers that fail to deliver services or products on a timely basis
are limited, in certain cases, by the Combined Company's desire to maintain
relationships with its key carriers. In addition, as the Combined Company's
carriers upgrade their technology, the Combined Company may encounter
difficulties in integrating new technology into the Combined Company's
network.
The Combined Company is dependent on certain third-party suppliers of
equipment and hardware components, including its integrated computer systems
and switching platforms, 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
of supply 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."
RECENT INTRODUCTION AND ONGOING DEVELOPMENT OF ENHANCED SERVICES
Substantially all of the Combined Company's revenue to date has been derived
from international call- reorigination services and reselling international
long distance minutes to other carriers and resellers. The Combined Company
believes that as deregulation occurs and competition increases in markets
around the world, the pricing advantage of traditional call-reorigination
relative to conventional international long-distance service will diminish. In
order to maintain its existing customer base, attract new customers and
increase its revenue, the Combined Company must offer a variety of enhanced
telecommunications services, as well as its own call-through service, at
competitive prices. Accordingly, the Combined Company is in the process of
developing a number of enhanced telecommunications services such as fax and
business grade Internet services. The first of these enhanced services was
offered to GlobalTel's customers in November 1997. To date GlobalTel has not
generated significant revenue from these services. Several other new services
described in this Prospectus are still under development and are not scheduled
for implementation until various times in 1998 or later. It is not uncommon
for the introduction of new telecommunications services to be delayed or
occasioned by technical problems. There can be no assurance that the Combined
Company will not encounter delays or technical problems in the introduction of
new services which will inhibit the Combined Company's ability to compete.
Also, there can be no assurance that the Combined Company will have sufficient
capital to complete development
9
and introduction of all of the enhanced services that it currently plans to
offer to its customers or that the introduction of such services will result
in increased revenue. The failure to introduce enhanced telecommunications and
Internet-related services, failures in the systems that would deliver those
services or the absence of demand for such services when introduced would have
a material adverse effect on the Combined Company's ability to achieve or
sustain profitability in the future. See "Business--Services."
DEPENDENCE ON NEW NETWORK SYSTEMS
The Combined Company's success is dependent upon its ability to deliver high
quality, uninterrupted telecommunications services. During 1997, GlobalTel
installed new switching software and hardware in its Los Angeles switching
center. These facilities did not commence carrying customer traffic until the
fourth quarter of 1997. Prior to implementing these new systems, virtually all
of GlobalTel's revenue was attributable to international call-reorigination
services and sales to carriers. Accordingly, successful implementation and
reliable operation of these new systems is essential to the Combined Company's
operations. Under terms of its Reciprocal Telecommunications Agreement with
ITC, CSI transferred its telecommunications traffic to ITC's switching center
in Ft. Lauderdale in early 1998. This transfer occurred after CSI technicians
upgraded ITC's switches to accept Internet triggering of its call-
reorigination services. There can be no assurance that these recently
installed systems and system upgrades will be adequate to perform their
intended functions or that the Combined Company will not suffer adverse
consequences in connection with their implementation. For example, there can
be no assurance that the Combined Company will not encounter material delays
in the introduction or provisioning of new services to new or existing
customers. There also can be no assurance that the Combined Company will not
encounter difficulties in enhancing, or integrating new technology into, its
systems. The inability of the Combined Company to implement any required
system enhancement, to acquire new systems or to integrate new technology in a
timely and cost effective manner could have a material adverse effect on the
Combined Company's business, financial condition and results of operations.
See "Business--Services" and "--Network and Operations."
CHANGING INDUSTRY ENVIRONMENT
The majority of the Combined Company's operations involve the international
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 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 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. 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
because the rates charged by Argentina's ITOs remain higher than the Combined
Company's rates. There can be no assurance such an adverse effect will not
occur in the future as a result of this or other legislation. See "Business."
COMPETITION
General. The Combined Company faces a high level of competition for
customers and independent 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
10
engaged in the international call-reorigination business. 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 compared to the
Combined Company.
Competition for customers and independent sales agents in the
telecommunication markets in which the Combined Company operates is on the
basis of price, type and quality of services 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 independent sales agents. Similarly, the Combined
Company has no control over the prices set by its competitors in the long
distance market. The Combined Company is aware that its ability to market its
long distance services depends upon the existence of spreads between the rates
offered by the Combined Company and those offered by the carriers with which
it competes as well as those from which it obtains service. 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 and 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 long
distance telecommunications services to the Combined Company's target customer
base, the Combined Company could suffer a reduction in revenue which could
have a material adverse effect on the Combined Company's business, financial
condition and results of operations.
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. 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 Corporation,
International Telecom, Ltd. (Kallback), Telegroup, Inc., USA Global Link,
Inc., UTG Communications International, Inc., Viatel, Inc. and Worldpass
Communications Corp., and as well as providers of traditional long distance
services such as AT&T, Cable & Wireless, Frontier Corp., GTE Communications,
LCI International, Inc., MCI, Qwest Communications International, Inc.,
Sprint, WorldCom, and Regional Bell Operating Companies ("RBOCs") outside
their exchange territories.
International Based Competition. The Combined Company's principal
international-based competitors include, among others, Telefonica de Argentina
and Telecom Argentina in Argentina; Optus Communications in Australia,
Telebras, Telesp and Telerj in Brazil; France Telecom in France; Deutsche
Telecom AG in Germany; Kokusan Denshin Denwa International Telecom Japan (KDD)
and International Digital Communications in Japan; PTT Telecom B.V. in the
Netherlands; and Telekom S.A. in South Africa; and 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. 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 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, regulators have shown a
reluctance to adopt policies and grant regulatory approvals that would result
in increased competition for the ITO. If an ITO were to successfully pressure
national regulators to outlaw the provision of call-reorigination services and
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
11
regulatory approval, or failure to obtain regulatory 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 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 "--Regulation."
REGULATION
United States domestic interstate long-distance telecommunications services
are subject to limited regulation by the FCC. Intrastate long distance
services are regulated by state commissions, which have varying requirements.
International call-reorigination services are subject to regulation by both
U.S. and foreign 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 International Telephone Union ("ITU") agreed that
any country could ban call-reorigination services. The provision of some forms
of call-reorigination is illegal in Uruguay, Venezuela, the Philippines and
certain other countries. In addition, 34 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 10.6% of the Combined Company's revenue in
the 12 months ended December 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 because it
has either ceased actively recruiting customers or employed alternate, non-
banned forms of call-reorigination in those countries. If the Combined Company
is found to have violated such foreign laws it could be subject to fines,
penalties or revocation of its FCC license. However, 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 are often based on
the informal views of the local ministries which, in some cases, are subject
to influence by ITOs. 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. There can be no assurance that
the Combined Company has accurately predicted or will accurately predict the
interpretation of foreign laws and regulations or regulatory and enforcement
trends or will be found to be in compliance with all such laws and
regulations. 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, financial condition and results of operations.
See "Business--Regulation."
The Combined Company is regulated by the FCC and 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
12
of the clear and explicit telecommunications laws of other countries that are
unable to enforce their laws against U.S. carriers. See "Business--
Regulation."
The Telecommunications Act of 1996 (the "1996 Act") and the WTO Agreement
substantially altered the regulatory framework for the telecommunications
industry for domestic and international telecommunications services. The 1996
Act and the WTO Agreement will require the FCC to conduct a variety of
rulemakings to implement various requirements. The Combined Company cannot
predict the ultimate effects of the WTO Agreement or the 1996 Act upon the
Combined Company's business other than to note that the Combined Company will
not be required to contribute to the FCC's Universal Service fund. Such
contributions could be as much as 4.5% or more of revenue for the calendar
year 1998, and would increase in subsequent years.
LEGAL PROCEEDINGS
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. Although ITC believes it has meritorious defenses to the
suit, there can be no assurance that it will be successful in such defense.
Failure to successfully defend such suit could have a material adverse effect
on the Combined Company.
RESCISSION OFFER
Immediately after the closing of this offering, the Combined Company intends
to commence a rescission offer (the "Rescission Offer") in accordance with the
federal securities laws and the securities laws of the State of Washington
(the "Washington Securities Act") with respect to an aggregate of shares
of Common Stock (the "Rescission Stock"), $350,000 in aggregate principal
amount of promissory notes (the "Rescission Notes") and warrants (the
"Rescission Warrants") to purchase an aggregate of approximately shares of
Common Stock issued in conjunction with the Rescission Stock and Rescission
Notes. The Rescission Notes, the Rescission Stock and the Rescission Warrants
are hereinafter collectively referred to as the "Rescission Securities." The
Rescission Securities were issued or sold by GlobalTel from 1995 through 1997
to approximately 40 individuals and entities who GlobalTel believes at the
time of purchase were residents of the State of Washington. Following this
offering the Combined Company intends to refile a registration statement
previously filed by GlobalTel relating to the Rescission Offer (the
"Rescission Offer Registration Statement") under the Securities Act.
GlobalTel believes that the Rescission Securities may have been issued or
sold in violation of the registration requirements of the Washington
Securities Act. As a precaution against potential claims by holders of
Rescission Securities, and without admitting non-compliance with the
Washington Securities Act, the Combined Company plans to offer to rescind such
prior issuances and sales by offering to repurchase the Rescission Securities
at the price paid therefor plus interest at the statutory rate of 8% per annum
from the date of purchase to the expiration of the Rescission Offer. The price
paid will be based upon the price paid for the original security purchased by
the purchaser from GlobalTel, regardless of the type of Rescission Security
currently held by the purchaser. The weighted average price paid for the
Rescission Stock is $ per share. The aggregate price paid for the
Rescission Notes, which are to be repaid from the proceeds of this offering,
is $350,000. See "Use of Proceeds." Each of the Rescission Warrants was issued
in conjunction with Rescission Stock or Rescission Notes and for no separate
consideration. Accordingly, the Rescission Warrants must be surrendered for no
separate consideration if the holder of the related Rescission Securities
elects to accept the Rescission Offer with respect to its Rescission
Securities. The aggregate accrued interest with respect to all of the
Rescission Securities as of June 30, 1998 will be approximately $397,000. If
all holders of Rescission Securities were to accept the Rescission Offer, the
Combined Company would be required to make payments aggregating approximately
$3.2 million, plus the aggregate amount of any additional interest thereon
that accrues after June 30, 1998. The Rescission Offer will expire 15 days
after the offer is transmitted. The Combined Company currently expects to use
a portion of the proceeds from this offering to make payments under the
Rescission Offer, if any are required. Offerees who do not accept the
Rescission Offer will thereafter hold
13
registered Rescission Securities under the Securities Act which, in the case
of the Rescission Stock, will be freely tradeable by non-affiliates in the
public market as of the effective date of the Rescission Offer Registration
Statement.
As of the date hereof, GlobalTel is not aware of any claims for rescission
against GlobalTel. Also, current and former officers and directors of
GlobalTel holding an aggregate of $1.4 million (including statutory interest
accrued thereon as of June 30, 1998) of the Rescission Securities have
indicated their intent not to accept the Rescission Offer, although no formal
Rescission Offer has been made to them and they have not and may not agree to
reject the Rescission Offer until the Rescission Offer Registration Statement
has been declared effective by the Securities and Exchange Commission and the
Rescission Offer has commenced. There can be no assurance that all or a
substantial portion of the Rescission Securities will not be tendered in
response to the Rescission Offer. Use of a portion of the proceeds of this
offering in connection with the Rescission Offer will reduce the amount of
working capital available to the Combined Company and require it to seek
additional capital sooner than otherwise might be required. The Rescission
Offer is being made in order to limit, so far as may be permitted under
applicable federal and state securities laws, the potential liability of the
Combined Company with respect to the offer and sale of the Rescission
Securities. Although the Combined Company believes that the offer and sale of
the Rescission Securities were made in compliance with the registration
requirements of federal securities laws, if a holder of the Rescission
Securities were to assert a claim that the Rescission Securities were sold in
violation thereof, the position of the Securities and Exchange Commission is
that liabilities under the federal securities laws are not terminated by
making a rescission offer. Furthermore, notwithstanding the Rescission Offer,
there can be no assurance that the Combined Company will not be subject to
penalties or fines relating to past securities issuances or that other holders
of the Combined Company's securities will not assert or prevail in claims
against the Combined Company for rescission or damages under state or federal
securities laws. See "Use of Proceeds," "Rescission Offer," "Shares Eligible
for Future Sale" and Note 6 of Notes to GlobalTel's Consolidated Financial
Statements.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
The Combined Company's strategy is to focus on international markets. In
many emerging telecommunications markets in which the Combined Company seeks
to market its services, ITOs control access to the local networks, enjoy
better brand recognition and customer loyalty and possess significant
operational economies, including operating agreements with other ITOs.
Moreover, an ITO may take many months before allowing competitors, such as the
Combined Company, to interconnect to its switches within the target market.
There can be no assurance that the Combined Company will be able to obtain the
permits and operating licenses required to operate, access transmission
facilities or market and sell competitive services in its markets. In
addition, pursuit of international growth opportunities may require
significant investments for extended periods before returns, if any, on such
investments are realized.
The Combined Company's operations also will be subject to a wide range of
general business 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;
restrictions on repatriation of funds or profits from foreign markets; long
accounts receivable payment cycles in certain countries; difficulty in
protecting the Combined Company's intellectual property; potentially adverse
tax consequences and the regulation of ISPs by foreign regulatory authorities.
Although the Combined Company's sales to date have been denominated in U.S.
dollars, the value of the U.S. dollar in relation to foreign currencies also
may adversely affect the Combined Company's results of operations. To the
extent the Combined Company changes its pricing practices to denominate prices
in foreign currencies, the Combined Company will be exposed to increased risks
of currency fluctuation. Any such fluctuation could have a material adverse
effect on the Combined Company's earnings or assets when translated into U.S.
dollars. Although the Combined Company has not entered into foreign exchange
contracts to hedge exchange transactions, it may do so in the future.
Additionally, the Combined Company generally will be subject to taxes in
foreign countries where the Combined Company operates. The Combined Company's
ability to claim a foreign tax credit against its U.S. federal income taxes is
subject to various limitations that could result in a
14
high effective tax rate on the Combined Company's earnings, if any. There can
be no assurance that laws or administrative practice relating to taxation,
foreign exchange or other matters in countries in which the Combined Company
operates or will operate will not change in a manner adverse to the Combined
Company. There can be no assurance that such factors will not have a material
adverse effect on the Combined Company's business, financial condition and
results of operations.
The Combined Company is subject to the Foreign Corrupt Practices Act
("FCPA"), which generally prohibits U.S. companies and their intermediaries
from bribing foreign officials for the purpose of obtaining or keeping
business. The Combined Company may be exposed to liability under the FCPA as a
result of past or future actions taken without the Combined Company's knowledge
by independent sales agents, strategic partners and other intermediaries. Any
liability incurred by the Combined Company under the FCPA could be material.
RAPID CHANGES IN TECHNOLOGY
The telecommunications industry is characterized by rapidly changing
technology, evolving industry standards, emerging competition and frequent new
service introductions. Examples of some newly developed telecommunications
technologies include satellite-based transmission systems such as those
proposed by Iridium World Communications Ltd., GlobalStar Telecommunications
Limited and Teledesic Corporation, utilization of the Internet for voice and
data transmission, and digital wireless communications systems. The Combined
Company has invested significantly in sophisticated and specialized
telecommunications and computer technologies such as LINK-US and DIAL. 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 can successfully
identify new service opportunities and develop and bring new services to market
in a timely and cost-effective manner, or that services or technologies
developed by others will not render the Combined Company's services or
technologies noncompetitive or obsolete. In addition, there can be no assurance
that service developments or enhancements introduced by the Combined Company
will achieve or sustain market acceptance or that the Combined Company's
technologies will be compatible with new technology or new industry standards.
See "Business--Competition."
DEPENDENCE ON EFFECTIVE MANAGEMENT INFORMATION SYSTEMS
As a telecommunications service provider, the Combined Company must record
and process millions of call detail records quickly and accurately to produce
customer bills and financial reports in a timely manner. The Combined Company
believes that the integration of its management information systems and
switching platforms is essential in order to provide least cost routing and
efficient billing. Although the Combined Company's billing systems and
switching platforms located at its network switching centers in Ft. Lauderdale
and Los Angeles, California are to be integrated following this offering, there
can be no assurance that such integration can be completed on a cost effective
and timely basis. If its current systems become obsolete or are damaged, the
Combined Company may be unable to upgrade or replace such systems with another
integrated system at commercially reasonable prices, or at all. Failure to
maintain integrated billing and management information systems could have a
material adverse effect on the Combined Company.
Demands on the Combined Company's information systems will increase
significantly if the Combined Company realizes anticipated growth and expands
its customer base. There can be no assurance that the Combined Company's
information systems will be adequate as the volume of customer traffic
increases or that the Combined Company will not suffer adverse consequences
should such systems fail to operate effectively. In addition, the Combined
Company has not previously reported financial results on a quarterly basis and
there can be no assurance that the Combined Company will not encounter material
delays or errors in billing of customers or in financial reporting. While the
Combined Company believes that its information systems are sufficient for its
current operations, it will be necessary to expand the capacities and
capabilities of its systems as the Combined Company grows. There can be no
assurance that the Combined Company will be able to do so, and
15
the failure to implement enhancements or to make the necessary investments in
the Combined Company's information systems in a timely fashion could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Business--Network and Operations."
The computer system that runs the Combined Company's switches and billing
operation has not yet been upgraded to be Year 2000 compliant. The Combined
Company is currently evaluating its computer systems to identify potential
problems relating to the Year 2000 date change. The Combined Company does not
expect the cost to modify its computer systems to address Year 2000 issues
will be material to the Combined Company's financial condition or results of
operations, and does not anticipate any material disruption in its operations
as a result of any Year 2000 issues. The Combined Company does not have any
information concerning the potential impact of Year 2000 issues on any of its
suppliers or customers. In the event that the Combined Company or any of the
Combined Company's significant suppliers or customers does not successfully
and timely address Year 2000 issues, the Combined Company's business or
operations could be adversely affected.
RISK OF NETWORK FAILURE
The success of the Combined Company is largely dependent upon the efficient
and uninterrupted operation of its network infrastructure. While the Combined
Company has fully redundant network switching centers, the Combined Company's
systems and operations remain vulnerable to damage or interruption from fire,
earthquake or other natural disaster and from power loss, telecommunications
failure, break-ins and similar events. The Combined Company's switching
centers are located in Los Angeles, California and Ft. Lauderdale, Florida,
and the Combined Company has additional equipment located in Hong Kong, Mexico
City, Colorado Springs, Colorado and Seattle, Washington. Although the
Combined Company carries business interruption insurance, there can be no
assurance that such insurance will be sufficient to cover any losses suffered
by the Combined Company. In addition, despite the implementation of network
security measures by the Combined Company, its servers are vulnerable to
computer viruses, electronic break-ins and similar disruptions, any of which
could lead to loss of customer data. The occurrence of any of the foregoing
could have a material adverse effect on the Combined Company's business,
financial condition and results of operations.
In the first two quarters of 1997, GlobalTel experienced temporary technical
and operational difficulties associated with the relocation of its primary
switching platform from Las Vegas to Los Angeles. As the Combined Company
attempts to expand its network to accommodate traffic growth, there will be
increased stress on its network equipment and traffic management systems.
There can be no assurance that the Combined Company will not experience
failure of all or part of its network. The Combined Company's operations also
are dependent on its ability to successfully expand its network and integrate
new and emerging technologies and equipment into its network, which are likely
to increase the risk of system failure and cause unforeseen strains upon the
network. Significant or prolonged system failures could damage the reputation
of the Combined Company and result in the loss of customers, could hinder the
Combined Company's ability to obtain new customers and could have a material
adverse effect on the Combined Company's business, financial condition and
results of operations. See "Business--Network and Operations."
DEPENDENCE UPON EXECUTIVE OFFICERS AND MANAGEMENT PERSONNEL
The Combined Company's operations are dependent upon the continued services
of Ronald P. Erickson, its Chairman of the Board, Robert A. Spade, its Vice-
Chairman of the Board and Chief Executive Officer, and Patrick R. Scanlon, its
President and Chief Operating Officer. The loss of the services of any of
Messrs. Erickson, Spade or Scanlon could have a material adverse effect on the
Combined Company. The Combined Company has employment agreements with Messrs.
Spade and Scanlon that expire in 2000 and intends to enter into an employment
agreement with Mr. Erickson. The Combined Company maintains a key-person life
insurance policy on the life of Mr. Spade in the amount of $2 million, and has
applied for key-person life insurance on the life of Mr. Scanlon in the amount
of $2 million. The Combined Company's success also is dependent on its ability
to hire and retain other qualified management, technical, sales and customer
service personnel. There can be no
16
assurance that the Combined Company will be successful in recruiting and
retaining such personnel. See "Management."
PROPRIETARY RIGHTS
The Combined Company does not have a formal intellectual property protection
program. It relies on trade secrets 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
technology, both in the United States and in other countries. The Combined
Company's proprietary technology 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 technology and the dissemination of its proprietary
information, there can be no assurance that the Combined Company will be able
to retain its proprietary technology 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--Technology" and "--Intellectual Property."
VALUE ADDED TAX AND SALES TAX COLLECTION
The Combined Company does not currently collect value-added tax ("VAT"),
sales tax or other similar taxes (other than federal excise tax) in respect of
any of its services. In addition, the rules for imposition of VAT vary from
country to country. For example, some EU member states deem telecommunications
services provided by U.S.-based companies to be performed outside the EU and,
therefore, exempt from VAT. Other EU member states, however, impose VAT on
telecommunications services provided by non-EU based companies. If the
Combined Company is required to collect VAT, sales or similar taxes on the
sale of its services, its business, financial condition and results of
operations could be materially adversely affected.
RISKS RELATED TO THE OFFERING
OFFERING PRICE DETERMINATION; LIMITED PUBLIC MARKET; PRICE FLUCTUATIONS
The public offering price of the Common Stock has been determined by the
Combined Company and the Representatives of the Underwriters (the
"Representatives") and does not necessarily bear any relationship to the
assets, book value, or earnings history of the Combined Company or any other
investment criteria. Prior to this offering, there has been only a limited
public market for the Common Stock of CSI on the OTC Bulletin Board. Although
the Common Stock is expected to be approved for quotation on the Nasdaq
SmallCap Market upon notice of issuance, there can be no assurance that an
active trading market will develop. Factors such as quarterly fluctuations in
results of operations, the Combined Company's ability to meet analysts'
expectations, changes in financial estimates by securities analysts or market
conditions in general may cause the market price of the Common Stock to
fluctuate, perhaps substantially. In addition, in recent years the stock
market has experienced 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 of the
stock of many small capitalization companies such as the Combined Company.
Factors such as those cited above, as well as other factors that may be
unrelated to the operating performance of the Combined Company and may be
beyond its control, could adversely affect the price of the Common Stock. See
"Underwriting."
SHARES ELIGIBLE FOR FUTURE SALE; RIGHTS TO ACQUIRE SHARES
Following this offering, shares of the Combined Company's outstanding
shares of Common Stock will be "restricted securities" and may in the future
be sold upon registration or in compliance with an exemption from registration
such as the exemption provided by Rule 144 adopted under the Securities Act.
Rule 144 as currently in effect generally provides that beneficial owners of
shares who have held such shares for one year may sell within a three-month
period a number of shares not exceeding the greater of 1% of the total
outstanding shares or the average trading volume of the shares during the four
calendar weeks preceding such sale. Of the
17
shares of restricted stock that are presently outstanding, approximately
shares of restricted stock will 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 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 outstanding prior to this
offering have agreed with the Representatives not to sell such shares for a
period of 12 months following the date of this Prospectus. The Selling
Securityholders have agreed with the Representatives not to sell their shares
for a period of 180 days following the date of this Prospectus. See "Shares
Eligible For Future Sale."
At the date of this Prospectus, the Combined Company has reserved shares for
issuance upon the exercise or conversion of: (i) options to purchase up to
shares of Common Stock, which have a weighted average exercise price of $
per share, (ii) warrants to purchase up to shares of Common Stock, which
have a weighted average exercise price of $ per share, (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 asked price of the Common
Stock on the day before conversion, (iv) shares of GlobalTel's Series A
Convertible Preferred Stock, which will be converted into approximately
shares of Common Stock and unpaid dividends on the Series A Convertible
Preferred Stock, which will be converted into Common Stock at a price of $
per share, (v) convertible promissory notes in the aggregate principal amount
of approximately $2.7 million that were issued by GlobalTel, which have a
conversion price per share equal to the price of the Common Stock in this
offering, and (vi) GlobalTel Full Coverage Notes in the aggregate principal
amount of approximately $3.0 million which have a conversion price of $ per
share. At the completion of this offering, the Representatives will receive
warrants (the "Representatives' Warrants") to purchase up to shares of
Common Stock at an exercise price of $ (120% of the offering price of the
Common Stock) during a period of four years commencing one year following the
date of this Prospectus. During the terms of the outstanding options and the
Representatives' Warrants, the holders thereof are given the opportunity to
profit from a rise in the market price of the Common Stock, and the exercise
thereof may dilute the ownership interests of existing shareholders, including
investors in this offering. The existence of warrants, options and the
Representatives' Warrants may adversely affect the terms on which the Combined
Company may obtain additional equity financing in the future. Moreover, the
holders are likely to exercise their rights to acquire Common Stock at a time
when the Combined Company would otherwise be able to obtain capital on terms
more favorable than through the exercise of such options and warrants. See
"Management--Stock Option Plan" and "Underwriting."
BENEFITS TO RELATED PARTIES; RELATED PARTY TRANSACTIONS
The Combined Company will use a portion of the net proceeds of the offering
to repay the Bridge Notes, as to which Robert A. Spade and Patrick R. Scanlon
have provided personal guaranties and pledged a portion of their Common Stock.
Such guaranties and pledges will be released upon completion of this offering.
A number of the officers and directors of GlobalTel who will become executive
officers and directors of the Combined Company hold notes and warrants to
purchase common stock of GlobalTel. Messrs. Ronald P. Erickson, Bruce L.
Crockett and Lyman C. Hamilton, members of the Board of Directors of the
Combined Company, are also directors of IBNET, and each holds options to
purchase shares of IBNET's common stock. In addition, Mr. Hamilton owns
100,000 shares of IBNET's common stock. IBNET previously entered into a ten-
year marketing agreement with GlobalTel. See "Management" and "Certain
Transactions."
ANTI-TAKEOVER EFFECTS OF CERTAIN CHARTER AND STATUTORY PROVISIONS
The Combined Company's Articles of Incorporation authorizes the issuance of
up to 5,000,000 shares of Preferred Stock. The Preferred Stock may be issued
in series with the material terms of any series determined solely by the Board
of Directors. Such terms would likely include dividend rights, conversion
features, voting rights, redemption rights and liquidation preferences. The
Combined Company does not currently anticipate that it will issue any
Preferred Stock. However, if the Combined Company does issue any series of
Preferred Stock in the future, it is likely that such shares will have
dividend privileges and liquidation preferences superior to those of the
Common Stock. Further, the Preferred Stock may be issued with voting,
conversion or other terms
18
determined by the Board of Directors including, among others, dividend payment
requirements, redemption provisions, preferences as to dividends and
distributions, and preferential voting rights. In addition, certain provisions
of Colorado law could have the effect of delaying, deterring or preventing a
change in control of the Combined Company.
ABSENCE OF DIVIDENDS
The Combined Company does not anticipate paying any cash dividends on its
Common Stock in the foreseeable future. The Combined Company intends to retain
profits, if any, to fund growth and expansion. See "Dividend Policy."
DILUTION
This offering will result in immediate substantial dilution of $ ( %) per
share, which amount represents the difference between the pro forma net
tangible book value per share after the offering and an assumed public
offering price of $ per share. See "Dilution."
LIMITATION OF LIABILITY
The Combined Company's Articles of Incorporation provides that directors of
the Combined Company shall not be personally liable for monetary damages to
the Combined Company or its shareholders for a breach of fiduciary duty in
their capacities as directors, subject to limited exceptions. Although such
limitation of liability does not affect the availability of equitable remedies
such as injunctive relief or rescission, the presence of these provisions in
the Articles of Incorporation could prevent the recovery of monetary damages
against directors of the Combined Company. See "Management--Limitation of
Liability and Indemnification."
LISTING AND MAINTENANCE CRITERIA FOR NASDAQ SECURITIES
The Combined Company has applied for listing on the Nasdaq SmallCap Market
and believes it will meet the recently adopted standards for such listing
which require: (i) net tangible assets of $4 million, (ii) a public float of
one million shares, (iii) a market value of the public float of $5 million,
(iv) three market makers, (v) a minimum $4.00 bid price per share of common
stock, and (vi) at least 300 shareholders.
Nasdaq has also adopted new criteria for continued Nasdaq SmallCap Market
eligibility. In order to continue to be included on the Nasdaq SmallCap Market
(thereby exempting a company from the "penny stock" regulations described
below), a company must maintain (i) at least two market makers, (ii) 300
holders of its common stock, (iii) a minimum bid price of $1.00 per share of
common stock, (iv) net tangible assets of $2 million (unless the company had
net income of $500,000 in two of the last three years or a market
capitalization of $35 million), (v) 500,000 shares in the public float, and
(vi) a market value of the public float of $1 million. The Combined Company's
failure to meet these maintenance criteria in the future may result in the
termination of listing of the Common Stock on the Nasdaq SmallCap Market. In
such event, trading, if any, in the Common Stock may continue to be conducted
in the non-Nasdaq over-the-counter market in what are commonly referred to as
OTC Bulletin Board and the "pink sheets." As a result, an investor may find it
more difficult to dispose of or to obtain accurate quotations as to the market
value of the Common Stock.
DISCLOSURE RELATED TO PENNY STOCKS
The Commission has adopted rules that define a "penny stock" as equity
securities priced at under $5.00 per share which are not listed for trading on
Nasdaq (unless (i) the issuer has a net worth of $2 million if in business for
more than three years or $5 million if in business for less than three years,
or (ii) the issuer has had average annual revenue of $6 million or more for
the prior three years). The Combined Company's Common Stock will not be
considered a "penny stock" initially if listed on the Nasdaq SmallCap Market.
In the event that the Common Stock is characterized in the future as penny
stock, broker-dealers dealing in the Common Stock will be subject to the
disclosure rules for transactions involving penny stocks which require the
broker-dealer, among other things, to (i) determine the suitability of
purchasers of the Common Stock, and obtain the
19
written consent of purchasers to purchase such Common Stock prior to the
transaction, (ii) provide customers with required risk disclosure documents,
disclose quotation and compensation information and provide monthly price
information and other required information, and (iii) disclose the best
(inside) bid and offer prices for such Common Stock and the price at which the
broker-dealer last purchased or sold the Common Stock. The additional burdens
imposed upon broker-dealers may discourage them from effecting transactions in
penny stocks, which usually reduces the liquidity of such securities.
RISKS RELATING TO FORWARD-LOOKING STATEMENTS
This Prospectus contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. Such forward-looking statements include, but are not limited to,
statements regarding the Combined Company's marketing plans, expectations
concerning growth in the market, and the planned use of proceeds. Actual
results could differ from those projected in any forward-looking statement.
The forward-looking statements are made as of the date of this Prospectus and
the Combined Company assumes no obligation to update such forward-looking
statements, or to update the reasons why actual results may differ from those
projected in the forward-looking statements. Numerous factors, including
without limitation those factors mentioned in this "Risk Factors" section,
could cause future results to differ substantially from those contemplated in
such forward-looking statements. A number of the factors that may influence
future results of operations are outside the Combined Company's control. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
20
THE ACQUISITIONS
Following completion of the offering, CSI will complete the GlobalTel Merger
and the ITC Acquisition.
GlobalTel provides international telecommunications services, principally to
small- and medium-sized business customers, in emerging telecommunications
markets. Currently, GlobalTel offers international long-distance, calling
cards and enhanced voice services to more than 8,500 customers in over 120
countries. GlobalTel began operations in 1995 with its entry into the
international call-reorigination business. GlobalTel primarily markets its
telecommunications services through a network of over 81 independent sales
agents that currently cover more than 80 countries. GlobalTel also has several
strategic relationships, including an exclusive marketing agreement with
IBNET, the managing member of the Consortium of Global Commerce, which will
enable the Combined Company to market its services through several thousand
individual chambers of commerce located in over 200 countries. In addition,
Novell will provide the Combined Company with a distribution channel for its
services through a select number of Novell's 25,000 value-added resellers
("VARs"). GlobalTel's telecommunications network includes an international
network switching center in Los Angeles, California consisting of two Summa
Four telecommunications switches and the use of a Northern Telecom DMS 250
tandem switch.
ITC provides call-reorigination services, primarily targeting individuals
and small business customers in Europe, Africa and the Middle East. Currently,
ITC offers international long-distance, calling cards and enhanced voice
services to more than 8,500 customers. ITC markets its call-reorigination
services through a network of approximately 55 independent sales agents. ITC
services its customers through a switching platform located at its
telecommunications center in Ft. Lauderdale, Florida. The center is a fiber
optic facility consisting of two NACT 1000 port class 3 switches that direct
international telephone and facsimile traffic and also have 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 services.
Benefit of Acquisitions
CSI believes that the GlobalTel Merger and the ITC Acquisition will provide
a number of advantages to the Combined Company. These advantages include:
Increased Buying Power with Carriers. The Combined Company will continue to
purchase minutes from substantial international telecommunications carriers
such as AT&T, Sprint, Cable & Wireless and Teleglobe. Upon completion of the
GlobalTel Merger and the ITC Acquisition, the Combined Company will use its
much larger combined call volume to seek lower rates from its carriers. In
addition, the carriers' minimum volume commitments will be easier for the
Combined Company to fulfill and redundant carrier deposits may be eliminated.
See "Business--Industry and Market Opportunity" and "--Network and
Operations."
Combined Cost Structures. Although there can be no assurance, management
believes the integration of existing cost structures will result in immediate
savings for the Combined Company. CSI has traditionally concentrated its
marketing efforts on South America, GlobalTel has focused on the Pacific Rim,
while ITC has focused on Africa and Europe. Through relationships with its
carriers, each company believes it has achieved superior rate structures in
its geographic region. The Combined Company anticipates integrating the best
of all three rate structures to realize cost reductions.
Operating Efficiencies and Geographic Diversification. As the Combined
Company attains greater geographic diversity, management believes it will
realize efficiencies by having traffic spread more evenly over the 24-hour
day. Equipment and personnel can be allocated and optimized more efficiently
over 24 hours, rather than over the shorter "peak" periods associated with
each continent. Geographic diversity also reduces the concentration of the
Combined Company's exposure to regulatory and business risk and reduces its
dependence upon individual independent sales agents.
21
Cross-Marketing Additional Services. In addition to the telecommunications
services each company presently provides, GlobalTel's and ITC's switches make
it possible for the Combined Company to significantly expand its carrier and
reseller business, and to introduce new enhanced services such as enhanced fax
and business grade Internet services to its existing customers. In addition,
the Combined Company's DIAL and LINK-US technologies facilitate transparent
call-reorigination, under which the mechanics of the call-reorigination
process are invisible to the customer.
Elimination of Redundant Overhead. The Combined Company believes it will be
able to reduce its number of employees and its outside contractors through the
consolidation of functional areas such as accounting, customer service and
technical operations. The Combined Company intends that marketing, accounting
and administration functions will be centralized in Colorado Springs,
Colorado, while technical and customer service functions will be concentrated
in Fort Lauderdale, Florida. Some additional technical and administrative
functions will continue to be performed in Los Angeles, California and
Seattle, Washington.
Capitalizing on Personnel Experience and Expertise. CSI, GlobalTel and ITC
each possess broad telecommunications industry experience. The Combined
Company anticipates that synergies will be achieved in the areas of marketing,
collections, customer provisioning, carrier relationships, Internet expertise,
and development and enhancement of switch technologies. Pursuant to the
Reciprocal Telecommunications Agreement between CSI and ITC, those companies
have already integrated certain of their key operations and personnel.
Terms of the Acquisitions
In April 1998, CSI entered into an agreement in principle to merge with
GlobalTel. Following the GlobalTel Merger, the Combined Company will be
renamed "CS GlobalTel, Inc." The agreement provides for the exchange of all of
the outstanding shares of common stock of GlobalTel for shares of Common Stock
of CSI. The holders of GlobalTel common stock will receive shares of Common
Stock of CSI for each share of GlobalTel common stock. Upon completion of the
GlobalTel Merger, Ronald P. Erickson, the current Chief Executive Officer of
GlobalTel, will become Chairman of the Board of the Combined Company. The
GlobalTel Merger is conditioned on, among other things, the approval of the
shareholders of both CSI and GlobalTel and there being no material adverse
change in the condition of either company. CSI expects the GlobalTel Merger
will be completed shortly after this offering.
CSI has entered into an agreement to acquire all of the outstanding capital
stock of ITC for $3.3 million in cash and shares of Common Stock based on
an assumed initial offering price of $ 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 shareholders of ITC. ITC is currently owned by Lynch Family, LLC, Philip
A. Thomas and Sean Thomas. Upon completion of the ITC Acquisition, Philip A.
Thomas will become Vice President--General Manager and Sean Thomas will become
Director of Business Development for Europe of the Combined Company. The ITC
Acquisition is conditioned upon, among other things, there being no material
adverse change in the condition of either company. The ITC Acquisition is
expected to occur concurrent with the consummation of this offering.
Prior Acquisition
In September 1995, in an effort to increase the number of shareholders of
CSI's Common Stock, and become a publicly traded entity, CSI's shareholders
approved a plan of merger to acquire all of the outstanding shares of Redden
Dynamics Corporation ("Redden") for $34,500 cash and shares of CSI's
Common Stock. Under the plan of merger, the shareholders of Redden received
one share of the CSI's Common Stock in exchange for each shares of Redden
stock. Effective as of the date of the merger, all shares of Redden were
canceled, the assets of Redden became assets of CSI and Redden ceased to
exist. Redden's only recorded asset consisted of $11,050 of organizational
costs. Redden had no liabilities and had no revenue or expenses from its
inception. Subsequent to the merger, CSI determined that Redden's assets were
of no value to CSI. Accordingly, no amounts have been recognized for the
issuance of the Common Stock in connection with the merger of Redden. See
"Certain Transactions."
22
USE OF PROCEEDS
Based on an assumed offering price of $ per share, the net proceeds
from the sale of the shares of Common Stock offered hereby are estimated to be
approximately $ million ($ million if the Underwriters' over-allotment
option is fully exercised).
The Combined Company plans to use (i) approximately $3.1 million to repay
the outstanding amount of Bridge Notes issued in December 1997 and estimated
accrued interest thereon; (ii) approximately $3.0 million to repay the
GlobalTel Full Coverage Notes issued by GlobalTel in December 1997; (iii)
approximately $3.0 million to pay deferred payables owed by the Combined
Company; (iv) approximately $2.9 million to complete the ITC Acquisition; (v)
approximately $1.6 million to pay the outstanding amount of the GlobalTel
Bridge Notes, issued at various times during 1996 and 1997; (vi) approximately
$1.1 million to repay the outstanding amount of the GlobalTel Note that
becomes payable in June 1998; (vii) approximately $600,000 to repay various
outstanding short term debt of CSI; (viii) approximately $400,000 to install
automated switching equipment that facilitates transparent call-reorigination
services in high volume customers; (ix) approximately $400,000 to purchase or
lease and install regional switches or other telecommunications equipment in
select countries to facilitate least cost routing; (x) approximately $200,000
for technical development associated with the Combined Company's enhanced
services; and (xi) the remaining net proceeds for working capital and general
corporate purposes, which includes an $80,000 severance payment to a former
employee of CSI and $50,000 to be paid a director of CSI for consulting
services provided. Additionally, a portion of the proceeds will be used to
fund the repurchase of any securities of the Combined Company tendered in
connection with the Rescission Offer in an approximate amount of up to $2.8
million, plus approximately $397,000 of statutory interest (as of June 30,
1998), of which up to approximately $1.4 million may be paid to officers and
directors of the Combined Company and their affiliates if they accept the
Rescission Offer. See "Rescission Offer."
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 to repay trade payables and notes to telecommunications carriers.
The notes issued by GlobalTel bear interest at a rate of either 10% or 12% and
are due upon the completion of this offering. The proceeds of such note
issuances were used for working capital or to repay debt.
The foregoing represents the Combined Company's best estimate of the use of
the net proceeds to be received in this offering, based on current planning
and business conditions. However, the Combined Company reserves the right to
change such uses when and if market conditions or unexpected changes in
operating conditions or results of operations occur. The amounts actually
expended for each use may vary significantly depending upon a number of
factors including, but not limited to, future growth and the amount of cash
generated by the Combined Company's operations. The Combined Company believes
that its existing capital resources, together with the net proceeds of this
offering, will be sufficient to maintain the current and planned operations of
the Combined Company for a period of at least 12 months from the date of this
Prospectus. Net proceeds not immediately required for the purposes described
above will be invested principally in U.S. government securities, short-term
certificates of deposit, money market funds or other short-term, interest-
bearing securities.
DIVIDEND POLICY
CSI has never declared or paid any cash dividends or distributions on its
capital stock. The Combined Company anticipates that for the foreseeable
future all earnings will be retained for use in the Combined Company's
business and no cash dividends will be paid to shareholders. Any payment of
cash dividends in the future on the Common Stock will be dependent upon the
Combined Company's financial condition, results of operations, current and
anticipated cash requirements, plans for expansion, restrictions, if any,
under debt obligations, as well as other factors that the Board of Directors
deems relevant.
23
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 April , 1998)....................
On , 1998, the closing bid price of the Common Stock as reported on
the OTC Bulletin Board was $ per share. CSI had approximately holders of
record of Common Stock as of March 31, 1998. While CSI is aware that a number
of beneficial owners of its Common Stock hold shares in street name, no
estimate has been made as to the number of shareholders owning stock of CSI in
street name.
24
DILUTION
As of December 31, 1997, CSI's net tangible book value was a $ million
deficit or $ per share of Common Stock. After giving effect to the sale by
the Combined Company of shares of Common Stock at an assumed offering
price of $ per share and the receipt of the estimated net proceeds thereof,
the GlobalTel Merger and the ITC Acquisition, the pro forma net tangible book
value of the Combined Company as of December 31, 1997 would have been
approximately $ million or $ per share. This represents an immediate
increase in pro forma net tangible book value of $ per share to existing
shareholders and an immediate dilution of $ per share to new investors.
"Dilution" is determined by subtracting pro forma net tangible book value per
share after the offering from the assumed offering price per share of Common
Stock, as illustrated by the following table:
Assumed public offering price......................................... $
Net tangible book value (deficit) per share as of December 31,
1997...............................................................
Increase per share of Common Stock attributable to new investors,
the GlobalTel Merger and the ITC Acquisition.......................
Pro forma net tangible book value per share after the offering........ $
----
Dilution per share of Common Stock to new investors................... $
====
Dilution as a percentage of assumed offering price.................... %
====
The following table summarizes as of December 31, 1997, the number of shares
of Common Stock purchased for cash, the total consideration paid and the
average cash price per share paid by the existing shareholders and by new
investors (assuming the sale of shares of Common Stock at the assumed
offering price of $ per share, before deduction of underwriting discounts
and commissions and other estimated offering expenses):
AVERAGE
SHARES PURCHASED TOTAL CONSIDERATION PRICE
------------------- --------------------- (PER
NUMBER PERCENT AMOUNT PERCENT SHARE)
------- --------- --------- ---------- -------
Existing sharehold-
ers(1)................. % $ % $
New shareholders........ %
------- --------- -------- ----------
Total................... 100.0% $ 100.0%
======= ========= ======== ==========
- --------
(1) Includes Bridge Shares to be issued immediately prior to the closing of
this offering based on an assumed offering price of $ per share and
shares issued in exchange for rent, services rendered and equipment valued
at $423,000. See "Management," "Description of Securities" and
"Underwriting."
The foregoing information excludes the Additional Securities and assumes no
exercise of the over-allotment option and no exercise of the Representatives'
Warrants. See "Description of Securities" and "Underwriting." To the extent
that the Additional Securities are issued, there will be further dilution to
new investors.
25
CAPITALIZATION
The following table sets forth (i) the actual capitalization of CSI at
December 31, 1997 and (ii) the Pro Forma As Adjusted capitalization to reflect
the GlobalTel Merger and ITC Acquisition and the sale of the shares of
Common Stock at an assumed public offering price of $ (after deducting
underwriting discounts and commissions and estimated offering expenses).
DECEMBER 31, 1997
----------------------------
PRO FORMA
CSI ACTUAL AS ADJUSTED(1)(2)
---------- -----------------
(IN THOUSANDS)
Current portion of notes payable, bridge
loans and capital leases.................... $2,687 $ 3,144
------ -------
Long-term debt, net of current portion....... -- 4,291
------ -------
Common stock subject to rescission........... -- 2,455
------ -------
Shareholders' equity (deficit):
Preferred stock, no par value; 5,000,000
shares authorized, none issued or
outstanding............................... -- --
Common Stock, no par value; 25,000,000
shares authorized; shares issued and
outstanding, actual; shares issued and
outstanding, pro forma as adjusted........ 2,750 40,311
Obligation to issue common stock............. 795 2,263
Common stock options......................... 37 37
Warrants..................................... -- 2,152
Notes receivable from shareholder............ (35) (35)
Accumulated deficit.......................... (4,351) (9,071)
Treasury stock, at cost...................... (243) (243)
------ -------
Total shareholders' equity (deficit)......... (1,047) 35,414
------ -------
Total capitalization......................... $1,640 $45,304
====== =======
- --------
(1) Adjusted to reflect the GlobalTel Merger, the ITC Acquisition and the
application of the net proceeds from the sale of Common Stock. See
"Management's Discussion and Analysis of Financial Condition and Results
of Operations."
(2) Does not include the Additional Securities.
26
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, GlobalTel 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 financial statements as of April 30 1996 and 1997 and for each of the
three years in the period ended April 30, 1997, from GlobalTel's audited
consolidated financial statements as of December 31, 1996 and 1997 and for
each of the three years in the period ended December 31, 1997, from ITC's
audited statement of operations data for the ten months ended October 31, 1997
and the years ended December 31, 1995 and 1996, and the balance sheet data as
of December 31, 1996, and October 31, 1997. The selected financial data for
CSI with respect to the periods ended January 31, 1997 and 1998 and the
balance sheet data as of January 31, 1998 have been derived from CSI's
unaudited financial statements. The selected financial data for ITC with
respect to the periods ended December 31, 1996 and January 31, 1998 and the
balance sheet data as of January 31, 1998 have been derived from ITC's
unaudited financial statements. Management believes that CSI's and ITC's
interim financial statements as of January 31, 1998 and for the periods ended
December 31, 1996, January 31, 1997 and 1998 include all adjustments,
consisting of normal recurring accruals, necessary for a fair presentation of
the financial position and the results of operations of CSI and ITC for such
interim periods. Prior results are not a prediction of future results of
operations. The Pro Forma As Adjusted 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, GlobalTel and ITC and the pro forma
condensed combined financial statements of CSI, GlobalTel and ITC.
HISTORICAL--CSI HISTORICAL--GLOBALTEL
------------------------------------------------ -------------------------
NINE MONTHS 12 MONTHS
12 MONTHS ENDED ENDED ENDED
APRIL 30, JANUARY 31, DECEMBER 31,
------------------------------- --------------- -------------------------
1994 1995 1996 1997 1997 1998 1995 1996 1997
----- ------ ------- ------- ------ ------- ------- ------- -------
Statement of
operations data:
Revenue......... $ 137 $1,838 $ 6,741 $11,865 $8,660 $ 8,895 $ 2,113 $ 9,136 $12,862
Cost of
revenue......... 191 1,298 5,963 7,755 5,695 5,394 1,928 8,230 11,171
----- ------ ------- ------- ------ ------- ------- ------- -------
Gross margin.... (54) 540 778 4,110 2,965 3,501 185 906 1,691
Operating
expenses:
Sales and
marketing....... 29 529 1,573 2,080 1,491 1,961 238 682 788
General and
administrative.. 461 625 1,652 2,024 1,326 2,604 1,536 5,773 7,119
Depreciation and
amortization.... 13 19 58 103 71 105 111 98 253
Acquired in-
process research
and
development..... -- -- -- -- -- -- -- -- --
----- ------ ------- ------- ------ ------- ------- ------- -------
Total operating
expenses........ 503 1,173 3,283 4,207 2,888 4,670 1,885 6,553 8,160
----- ------ ------- ------- ------ ------- ------- ------- -------
Income
(loss) from
operations...... (557) (633) (2,505) (97) 77 (1,169) (1,700) (5,647) (6,469)
Interest
expense,
including
amortization of
debt
discounted...... -- -- (19) (162) (114) (348) (34) (225) (1,368)
Other income.... -- -- -- -- -- -- -- -- --
----- ------ ------- ------- ------ ------- ------- ------- -------
Income (loss)
before income
taxes and
extraordinary
item............ (557) (633) (2,524) (259) (37) (1,517) (1,734) (5,872) (7,837)
Income tax
provision
(benefit)....... -- -- -- -- -- -- -- -- --
----- ------ ------- ------- ------ ------- ------- ------- -------
Income (loss)
before
extraordinary
item............ (557) (633) (2,524) (259) (37) (1,517) (1,734) (5,872) (7,837)
Extraordinary
item--gain
on extinguishment of
debt............ -- -- -- -- -- 747 -- -- --
----- ------ ------- ------- ------ ------- ------- ------- -------
Net income
(loss).......... $(557) $ (633) $(2,524) $ (259) $ (37) $ (770) $(1,734) $(5,872) $(7,837)
===== ====== ======= ======= ====== ======= ======= ======= =======
Series A
convertible
preferred stock
dividends....... -- -- -- -- -- -- -- -- (39)
----- ------ ------- ------- ------ ------- ------- ------- -------
Net income
(loss)
applicable to
common
shareholders.... $(557) $ (633) $(2,524) $ (259) $ (37) $ (770) $(1,734) $(5,872) $(7,876)
===== ====== ======= ======= ====== ======= ======= ======= =======
EBITDA.......... $(544) $ (614) $(2,447) $ 6 $ 148 $(1,064) $(1,589) $(5,549) $(6,216)
===== ====== ======= ======= ====== ======= ======= ======= =======
Basic loss per
share (excluding
extraordinary
item)...........
===== ====== ======= ======= ====== ======= ======= ======= =======
Weighted average
number of shares
outstanding.....
===== ====== ======= ======= ====== ======= ======= ======= =======
HISTORICAL--ITC
----------------------------------------------------
PRO FORMA
12 MONTHS 10 MONTHS THREE MONTHS ENDED AS ADJUSTED
ENDED ENDED ------------------------ 12 MONTHS ENDED
DECEMBER 31, OCTOBER 31, DECEMBER 31, JANUARY 31, DECEMBER 31,
--------------- ----------- ------------ ----------- ---------------
1995 1996 1997 1996 1998 1997
------- ------- ----------- ------------ ----------- ---------------
Statement of
operations data:
Revenue......... $8,197 $7,603 $8,054 $1,942 $2,849 $ 35,261
Cost of
revenue......... 5,407 5,070 6,790 1,274 2,194 28,094
------- ------- ----------- ------------ ----------- ---------------
Gross margin.... 2,790 2,533 1,264 668 655 7,167
Operating
expenses:
Sales and
marketing....... 1,220 1,099 715 210 244 3,520
General and
administrative.. 1,149 1,446 1,388 494 476 11,789
Depreciation and
amortization.... 53 69 73 22 29 9,610
Acquired in-
process research
and
development..... -- -- -- -- -- 3,475
------- ------- ----------- ------------ ----------- ---------------
Total operating
expenses........ 2,422 2,614 2,176 726 749 28,394
------- ------- ----------- ------------ ----------- ---------------
Income
(loss) from operations.. 368 (81) (912) (58) (94) (21,227)
Interest expense, including
amortization of
debt
discounted...... (11) (21) (57) (5) (15) (702)
Other income.... 8 113 119 7 12 --
------- ------- ----------- ------------ ----------- ---------------
Income (loss)
before income
taxes and
extraordinary
item............ 365 11 (850) (56) (97) (21,929)
Income tax
provision
(benefit)....... 21 4 -- -- -- (2,437)
------- ------- ----------- ------------ ----------- ---------------
Income (loss)
before
extraordinary
item............ 344 7 (850) (56) (97) (19,492)
Extraordinary
item--gain
on extinguishment of
debt............ -- -- -- -- -- --
------- ------- ----------- ------------ ----------- ---------------
Net income
(loss).......... $ 344 $ 7 $ (850) $ (56) $ (97) $(19,492)
======= ======= =========== ============ =========== ===============
Series A
convertible
preferred stock
dividends....... -- -- -- -- -- --
------- ------- ----------- ------------ ----------- ---------------
Net income
(loss)
applicable to
common
shareholders.... $ 344 $ 7 $ (850) $ (56) $ (97) $(19,492)
======= ======= =========== ============ =========== ===============
EBITDA.......... $ 429 $ 101 $ (720) $ (29) $ (53) $ (8,142)
======= ======= =========== ============ =========== ===============
Basic loss per
share (excluding
extraordinary
item)...........
======= ======= =========== ============ =========== ===============
Weighted average
number of shares
outstanding.....
======= ======= =========== ============ =========== ===============
HISTORICAL--
HISTORICAL--CSI GLOBALTEL HISTORICAL--ITC PRO FORMA
--------------------------------------- -------------- ------------------------------------ AS ADJUSTED
APRIL 30, JANUARY 31, DECEMBER 31, DECEMBER 31, OCTOBER 31, JANUARY 31, DECEMBER 31,
-------------------------- ----------- -------------- ------------ ----------- ----------- ------------
1994 1995 1996 1997 1998 1996 1997 1996 1997 1998 1997
---- ---- ------ ------ ----------- ------ ------ ------------ ----------- ----------- ------------
BALANCE SHEET
DATA:
Cash............ $ 7 $ 82 $ 57 $ 147 $ 566 $ 446 $ 849 $ 218 $ 848 $ 978 $21,761
Working capital
(deficit)....... (114) (288) (2,153) (2,331) (2,977) (5,248) (4,934) (383) (1,259) (1,402) 13,364
Total assets.... 161 459 1,519 1,946 2,943 3,701 4,354 1,956 2,720 3,338 57,223
Long-term debt,
net of current
maturities and
debt discount... -- -- -- -- -- 2,283 3,832 21 292 227 4,291
Common stock
subject to
rescission...... -- -- -- -- -- 1,519 2,455 -- -- -- 2,455
Total
shareholders'
equity
(deficit)....... (42) (182) (1,856) (1,669) (1,455) (7,565) (8,534) 69 (781) (878) 35,414
27
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
OVERVIEW
The Combined Company is a growing provider of international
telecommunications services offering long distance, calling cards and enhanced
voice and data services. With more than 25,500 customers in over 170
countries, the Combined Company primarily serves markets that historically
have been underserved by large telecommunications providers and ITOs. The
Combined Company provides its telecommunications services through its (i)
voice switching and global fax messaging infrastructure in Los Angeles,
California, (ii) voice switching and billing center in Ft. Lauderdale,
Florida, (iii) access to third party infrastructure through international
telecommunications carriers and through Equant, a global data network services
provider, and (iv) enhanced fax nodes in Hong Kong and Mexico City.
The Combined Company currently focuses on international call-reorigination,
capitalizing on the arbitrage opportunity created by differences between U.S.
and international long-distance rates. The Combined Company also resells its
international long-distance services to other telecommunications carriers and
resellers on a wholesale basis. In addition, the Combined Company provides
prepaid calling cards and enhanced voice services, consisting of voice-mail
and conference calling. For the 12 months ended December 31, 1997,
approximately 88.0% of the Combined Company's revenue was derived from call-
reorigination and 12.0% was provided by carrier resales. Going forward, the
Combined Company intends to leverage the expertise derived from, and
capitalize on the established customer base generated by, its call-
reorigination business to provide higher margin telecommunications services
such as call-through, enhanced fax and business grade Internet services.
The Combined Company generally realizes higher gross margins from its call-
reorigination services than from sales to carriers and resellers. Sales to
carriers and resellers, however, provide a source of additional revenue and
add significant minutes originating on the Combined Company's network, which
improves the Combined Company's purchasing power with its carriers and enables
it to take advantage of volume discounts. Unlike call-reorigination, minutes
generated from sales to carriers and resellers generally are "billable"
minutes even if the destination segment of the call is not answered or
connected. Furthermore, the Combined Company is not responsible for billing
end users or paying independent sales agent commissions. Therefore, operating
costs generally are lower for sales to carriers and resellers.
The Combined Company seeks to minimize costs through negotiation of
favorable rates with its existing long distance carriers. Under certain
carrier contracts, the Combined Company obtains guaranteed rates, which
generally are 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 is seeking to enter into agreements with additional long
distance carriers in order to apply "least cost routing" techniques, which
enable the Combined Company to access the lowest transmission costs charged by
its carriers for each call segment. The Combined Company also intends to
establish additional switching facilities outside the U.S. in order to utilize
a larger number of long distance carriers and reduce its per minute
transmission costs. See "Use of Proceeds" and "Business--Business Strategy."
28
As part of its acquisition strategy, CSI has entered into an agreement in
principle to merge with GlobalTel and an agreement to acquire ITC. The
GlobalTel Merger and the ITC Acquisition will enable the Combined Company to
rapidly obtain access to complementary infrastructure, personnel, customer
bases, sales and marketing resources and strategic relationships. The
integration of GlobalTel and ITC with CSI will afford the Combined Company an
opportunity to increase revenue through cross-marketing its services to each
company's customer base and the sale of excess international capacity to other
carriers and resellers. The Combined Company will seek to improve its margins
through the administrative efficiencies and operating synergies created by the
combination of the companies and through improved rate structures with
carriers.
The Combined Company's fiscal year end will be December 31.
ACCOUNTING POLICIES AND PROCEDURES
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. The Combined Company's call-reorigination revenue
represents the majority of the Combined Company's revenue and has increased as
the Combined Company has added independent sales agents and introduced its
services into new countries. The Combined Company also sells international
long distance minutes to other telecommunications carriers and resellers on a
wholesale basis. The Combined Company's call re-origination customer base is
diversified both geographically and by customer type.
Approximately 60.0% of all revenue is collected through automatic charges to
pre-approved customer credit cards. Under the terms of their agreements, the
independent sales agents are responsible for collecting customer payments
except for credit card payments, and independent sales agents generally are
responsible for customer bad debts less, in some cases, an allowance granted
by the Combined Company. Failure of independent sales agents to collect and
remit customer payments to the Combined Company presents a risk to the
Combined Company. Although collection terms for cash customers are net 30
days, the time necessary to process and collect billings through the Combined
Company's independent 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 and transmission of voice and data telecommunications services and
to a lesser extent, debit card costs and 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 costs being the Combined Company's most
significant expense. In December 1997, the Combined Company's aggregate
minimum monthly commitments were approximately $550,000, which represented
approximately 23.5% of the Combined Company's monthly variable transmission
cost.
Sales and marketing expense primarily represents commissions paid to
independent sales agents, compensation paid to in-house salespersons and
advertising expense. To date, the Combined Company's decision to use
independent sales agents has been primarily driven by the low initial fixed
costs associated with this distribution channel, and the benefits of
independent sales agents' familiarity with local business and marketing
practices. See "Risk Factors--Dependence on Key Sales Agents" and "Business--
Sales and Marketing."
General and administrative expense primarily represents compensation for
customer service, executive and accounting personnel, costs associated with
the operation and maintenance of the Combined Company's network switching
centers, costs related to the technical development of, and market planning
for, the Combined Company's planned enhanced services, professional fees, bad
debt expense and other operating and corporate overhead costs. The Combined
Company has a policy of aggressively attempting to collect receivables from
independent sales agents and customers who fail to remit payment in a timely
manner. While the Combined Company seeks to minimize bad debt, the Combined
Company's experience indicates that a certain portion of past due receivables
will never be collected.
29
Depreciation expense includes depreciation of switching and network
equipment, furniture and fixtures. The Combined Company provides for
depreciation using the straight line method of depreciation over the estimated
useful lives of the assets, which range from five to ten years. The Combined
Company will incur amortization expense which relates to the amortization of
the intangible assets recorded in the GlobalTel Merger and the ITC
Acquisition. The intangible assets will include identifiable intangible assets
which will be amortized over a two to seven year period and that relate to
distribution and customer arrangements, intellectual property and licenses.
Identifiable intangible assets also include in-process research and
development which will be charged to operating expense upon completion of the
GlobalTel Merger. In addition, intangible assets include goodwill, which will
be amortized over a five-year period.
Interest and debt discount expense includes interest expense on indebtedness
and non-cash financing expenses including amortized debt discount and
amortized deferred offering costs associated with debt financing.
As used herein, "EBITDA' is defined as net income or loss plus depreciation,
amortization and interest expense, income taxes and other non-cash charges,
minus extraordinary income and gains and non-cash income, if any, and plus
extraordinary losses, if any. EBITDA is not a measure of financial performance
under generally accepted accounting principles and should not be considered a
substitute for measures of performance prepared in accordance with generally
accepted accounting principles.
COMPARISON OF 12 MONTHS ENDED DECEMBER 31, 1995, 1996 AND 1997
The Combined Company's historical combined revenue was $15.1 million, $27.1
million and $35.3 million for the 12 months ended December 31, 1995, 1996 and
1997, respectively. The increase in revenue resulted from increased usage by
existing customers, the addition of new customers as the Combined Company
expanded its independent sales agent network and commenced providing services
in new countries, and the commencement of sales to carriers and resellers.
Call-reorigination revenue represented 100.0%, 95.8% and 88.0% for 1995, 1996
and 1997, respectively, while carrier and reseller revenue represented 4.2%
and 12.0% for 1996 and 1997, respectively. The Combined Company anticipates
that revenue will increase as it begins to cross-market its services to its
customers and continues to focus on carrier sales.
The Combined Company's historical combined cost of revenue was $11.2
million, $20.8 million and $28.1 million for the 12 months ended December 31,
1995, 1996 and 1997, respectively. As a percent of revenue, these costs were
74.3%, 76.8% and 79.7% for 1995, 1996 and 1997, respectively. The Combined
Company anticipates a significant increase in transmission costs associated
with greater calling volume. The growth in transmission volume should improve
the Combined Company's ability to negotiate preferential rates with its
carriers. In addition, integrating the cost structures of the Combined Company
may result in reduced costs per minute of use. The Combined Company expects
gross margin percentages may decline if carrier and reseller revenue increases
as a percentage of revenue or if price reductions occur due to competition.
The Combined Company's historical combined sales and marketing expense was
$2.6 million, $3.7 million and $3.5 million for the 12 months ended December
31, 1995, 1996 and 1997, respectively. As a percent of revenue, these costs
were 17.5%, 13.6% and 10.0% for 1995, 1996 and 1997, respectively. The
Combined Company anticipates a significant increase in sales and marketing
expense in absolute dollars due to an increase in independent sales agent
commissions caused by an expected increase in revenue. However, these costs as
a percentage of revenue are expected to decrease as the fixed portion of sales
and marketing expense, such as costs associated with in-house sales personnel
and advertising, are spread across a broader revenue base. In addition, the
Combined Company expects sales and marketing expense to decrease as a
percentage of revenue if carrier and reseller revenue increase as a percent of
total revenue because sales to carriers and resellers do not have advertising
and sales commission costs.
The Combined Company's historical combined general and administrative
expense was $3.6 million, $9.3 million and $11.8 million for the 12 months
ended December 31, 1995, 1996 and 1997, respectively. General and
administrative expense in 1997 included non-recurring costs totaling $670,000
associated with GlobalTel's
30
terminated public offering and $447,000 of non-cash compensation cost. As a
percent of revenue, general and administrative expense was 24.0%, 34.4% and
33.4% for 1995, 1996 and 1997, respectively. The Combined Company expects
general and administrative expense will decrease as a percent of revenue due
to cost savings resulting from operating efficiencies and the elimination of
redundant overhead.
The Combined Company's historical combined depreciation and amortization
expense was $203,000, $251,000 and $480,000 for the 12 months ended December
31, 1995, 1996 and 1997, respectively. As a percent of revenue, these costs
were 1.4%, .9% and 1.4% for 1995, 1996 and 1997, respectively. The Combined
Company anticipates amortization expense will increase by $11.5 million
annually due to amortization of the intangible assets related to the GlobalTel
Merger, the ITC Acquisition and future acquisitions not yet identified. In
addition, the Combined Company expects that depreciation expense may increase
due to planned capital expenditures related to the purchase and installation
of regional switches and automated switching equipment for its high volume
customers.
The Combined Company's historical combined interest and debt discount
expense was $50,000, $341,000 and $1.6 million for the 12 months ended
December 31, 1995, 1996 and 1997, respectively. As a percent of revenue, these
costs were .3%, 1.3% and 4.5% for 1995, 1996 and 1997, respectively. The
Combined Company anticipates non-cash financing expense of $1.4 million will
be incurred until completion of this offering due to the amortization of debt
discount expense, amortization of deferred offering costs and accrued interest
expense related to CSI's December 1997 Financing and the GlobalTel Full
Coverage Notes. The Combined Company expects interest expense may increase as
the Combined Company seeks other financing arrangements, such as a working
capital line of credit, lease financing, acquisition financing and term debt
to be used to fund the Combined Company's growth.
The Combined Company's historical combined negative EBITDA was $2.4 million,
$6.7 million and $8.0 million for the 12 months ended December 31, 1995, 1996
and 1997, respectively. As a percentage of revenue, negative EBITDA was 15.8%,
24.7% and 22.6% for 1995, 1996 and 1997, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Combined Company's capital resources have been used to fund operating
losses, debt service and capital expenditures associated with development of
its customer base and the establishment and upgrade of its network
infrastructure. The Combined Company had a working capital deficit of $8.8
million at December 31, 1997. The Combined Company has historically satisfied
its capital requirements principally through a combination of sales of equity
and debt securities, borrowings from third parties and trade credit extended
by carriers.
The Combined Company believes that cash on hand, together with cash flow
from its operating activities and cash available from this offering, will be
sufficient to fund the Combined Company's existing operations at least for the
next 12 months. However, the Combined Company intends to continue its strategy
of rapid growth, primarily through the expansion of its infrastructure and
pursuing other growth opportunities such as acquisitions of complementary
international customer bases, products and infrastructure. The Combined
Company is currently reviewing various alternatives for obtaining additional
financing to fund this strategy. The proceeds from such financing are
anticipated to be used to expand the Combined Company's operations, fund the
Combined Company's growth and enable the Combined Company to undertake
additional strategic initiatives. There can be no assurance that the Combined
Company will be able to raise additional capital on acceptable terms or at
all. If the Combined Company is unable to obtain such additional capital, the
Combined Company may have to curtail its expansion of operations, growth and
other strategic initiatives, which could adversely affect the Combined
Company's business, financial condition and results of operations and its
ability to compete.
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
31
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. Although the Combined Company's sales to date have
been denominated in U.S. dollars, the value of the U.S. dollar in relation to
foreign currencies also may adversely affect the Combined Company's revenue.
To the extent the Combined Company changes its pricing practices to denominate
prices in foreign currencies, the Combined Company will be exposed to
increased risks of currency fluctuation. Any such fluctuation could have a
material adverse effect on the Combined Company's earnings or assets when
translated into U.S. dollars. Although the Combined Company has not entered
into foreign exchange contracts to hedge exchange transactions, it may do so
in the future.
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
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosure about
Segments of an Enterprise and Related Information" ("Statement 131"), which is
effective for financial statements with fiscal years beginning after December
15, 1997. Statement 131 requires that public business enterprises report
certain information about operating segments in complete sets of financial
statements of the enterprise and in condensed financial statements of interim
periods issued to shareholders. Statement 131 also requires that public
business enterprises report certain information about their products and
services, the geographic areas in which they operate and their major
customers.
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits" ("Statements 132"), which revises employers'
disclosures about pension and other postretirement benefit plans. Statement
132 does not change the measurement or recognition of those plans, but
requires additional information on changes in benefit obligations and fair
values of plan assets, and eliminates certain disclosures previously required
by SFAS Nos. 87, 88 and 106. Statement 132 is effective for financial
statements with fiscal years beginning after December 15, 1997.
The Combined Company has not determined what additional disclosures, if any,
may be required by the provisions of Statements 131 and 132, but does not
expect adoption of either statement to have a material effect on its results
of operations.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities," which requires costs of start-up activities and organization
costs to be expensed as incurred. The SOP is effective for financial
statements with fiscal years beginning after December 15, 1998, although
earlier application is encouraged. The adoption of the SOP is not expected to
have a material adverse effect on the Combined Company.
YEAR 2000 STATEMENT
The Combined Company is currently evaluating its computer systems to
identify potential problems relating to the Year 2000 date change. The
Combined Company does not expect the cost to modify its computer systems to
address Year 2000 issues will be material to its financial condition or
results of operations, and does not anticipate any material disruption in its
operations as a result of any Year 2000 issues. The Combined Company does not
have any information concerning the potential impact of Year 2000 issues on
any of its suppliers or customers. In the event that the Combined Company or
any of the Combined Company's significant suppliers or customers does not
successfully and timely address Year 2000 issues, the Combined Company's
business or operations could be adversely affected.
32
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
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:
YEAR ENDED NINE MONTHS ENDED
APRIL 30, JANUARY 31,
--------------------- -------------------
1995 1996 1997 1997 1998
----- ----- ----- -------- --------
Revenue...................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenue.............. 70.6 88.5 65.4 65.8 60.6
----- ----- ----- -------- --------
Gross margin................. 29.4 11.5 34.6 34.2 39.4
Operating expenses:
Sales and marketing........ 28.8 23.3 17.5 17.2 22.1
General and administra-
tive...................... 34.0 24.5 17.0 15.3 29.2
Depreciation and amortiza-
tion...................... 1.0 0.9 0.9 0.8 1.2
----- ----- ----- -------- --------
Total operating expenses..... 63.8 48.7 35.4 33.3 52.5
----- ----- ----- -------- --------
Income (loss) from opera-
tions....................... (34.4) (37.2) (0.8) 0.9 (13.1)
Interest expense, including
amortization of debt dis-
count....................... 0.0 (0.3) (1.4) (1.3) (3.9)
----- ----- ----- -------- --------
Net income (loss) before ex-
traordinary item............ (34.4) (37.5) (2.2) (0.4) (17.0)
Extraordinary item........... -- -- -- -- 8.4
----- ----- ----- -------- --------
Net income (loss)............ (34.4)% (37.5)% (2.2)% (0.4)% (8.6)%
===== ===== ===== ======== ========
COMPARISON OF NINE MONTHS ENDED JANUARY 31, 1997 AND 1998
Revenue increased $235,000 or 2.7% from approximately $8.7 million for the
nine months ended January 31, 1997 to $8.9 million for the nine months ended
January 31, 1998. Revenue decreased $606,000 or 19.4% from approximately $3.1
million for the third quarter of fiscal 1997 to approximately $2.5 million
during the third quarter of fiscal 1998. This decrease in revenue was due to a
decline in customers and usage resulting from service disruptions caused by
the transfer of CSI's switching and billing functions into ITC's systems. CSI
experienced operational difficulties during this transfer process which
resulted in service disruptions for a number of customers. Although CSI's
revenue was adversely affected during this period, CSI believes that it has
resolved these difficulties.
CSI's cost of revenue decreased $301,000 or 5.3% from approximately $5.7
million in the nine months ended January 31, 1997 to approximately $5.4
million for the nine months ended January 31, 1998. As a percentage of
revenue, these costs decreased from 65.8% to 60.6% for the nine months ended
January 31, 1997 and 1998, respectively. As of March 1997, CSI had new
contractual commitments with Sprint reflecting more favorable rates that
resulted in improved gross margins during the nine months ended January 31,
1998.
Sales and marketing expense increased $471,000 or 31.6% from $1.5 million
for the nine months ended January 31, 1997 to $2.0 million for the nine months
ended January 31, 1998. As a percentage of revenue, these costs increased from
17.2% to 22.1% for the nine months ended January 31, 1997 and 1998,
respectively. The increase in absolute dollars was due in part to an increase
in independent sales agent commissions caused by the increase in revenue and
advertising expense and additional in-house sales personnel, while the
increase as a percentage of revenue was due primarily to an increase in
advertising expense and hiring of additional in-house sales personnel.
General and administrative expense increased $1.3 million or 96.3% from $1.3
million for the nine months ended January 31, 1997 to $2.6 million for the
nine months ended January 31, 1998. As a percentage of revenue, these costs
increased from 15.3% to 29.2% for the nine months ended January 31, 1997 and
1998, respectively. The significant increase in expenses is the result of CSI
building its administrative infrastructure during fiscal 1998 in anticipation
of significant growth. These expenses included costs associated with
relocating personnel and integrating operations with ITC's operations in Ft.
Lauderdale, Florida, costs associated with terminating former members of
senior management and hiring experienced executive management, and costs
associated with
33
adding additional customer support and administrative personnel to support the
growth of CSI's operations. CSI also increased its reserve for bad debt by
$350,000, which was primarily associated with a receivable owed by a former
independent sales agent. CSI has implemented internal control procedures to
mitigate the risk of significant loss in the future from individual
independent sales agents. CSI continues to vigorously pursue the collections
of all bad debt expenses from former customers and independent sales agents.
Depreciation and amortization expense increased $34,000 or 48.4% from
approximately $71,000 for the nine months ended January 31, 1997 to
approximately $105,000 for the nine months ended January 31, 1998. These costs
increased primarily as a result of CSI's higher fixed asset base during the
nine months ended January 31, 1998 as compared with the nine months ended
January 31, 1997.
Interest and debt discount expense increased $234,000, or 205% from
approximately $114,000 for the nine months ended January 31, 1997 to
approximately $348,000 for the nine months ended January 31, 1998. These
expenses primarily represent amortized costs associated with the December 1997
Financing. Interest and debt discount expense will increase significantly
until completion of this offering due to accrued interest and amortized costs
associated with the December 1997 Financing.
CSI did not record an income tax expense or benefit for the nine months
ended January 31, 1997 or 1998 but recorded valuation allowances to offset the
deferred tax asset due to the uncertainty of the ultimate realization of the
net operating loss carryforwards.
CSI had a net loss of approximately $37,000 for the nine months ended
January 31, 1997 compared to a net loss before extraordinary item of
approximately $1.5 million for the nine months ended January 31, 1998. The
increase in net loss before extraordinary items was due primarily to the
significant increase in general and administrative expense and debt financing
costs.
CSI recorded an extraordinary gain on extinguishment of debt totaling
$747,000, net of related expense, associated with the early repayment of notes
from proceeds of the December 1997 Financing.
CSI had a net loss of $37,000 for the nine months ended January 31, 1997
compared to a net loss of $770,000 for the nine months ended January 31, 1998.
The increase in net loss was due primarily to the significant increase in
general and administrative expense and debt financing costs partially offset
by the gain on extinguishment of debt.
CSI had basic loss per share of $ for the nine months ended January 31,
1997 compared to basic loss per share of $ for the nine months ended
January 31, 1998. The change in per share results was due primarily to an
increase in net loss and by an increase in weighted average shares
outstanding.
CSI had positive EBITDA of $148,000 for the nine months ended January 31,
1997 compared to negative EBITDA of $1.1 million for the nine months ended
January 31, 1998. The decrease in EBITDA was primarily due to the increase in
general and administrative expenses.
COMPARISON OF FISCAL YEARS ENDED APRIL 30, 1996 AND 1997
Revenue increased $5.1 million or 76.0% from $6.7 million for fiscal 1996 to
$11.9 million for fiscal 1997. This increase was primarily due to growth in
the number of customers. The significant increase in revenue was primarily due
to CSI's efforts to increase its independent sales agent base in its target
markets.
Cost of revenue increased $1.8 million or 30.1% from $6.0 million for fiscal
1996 to $7.8 million for fiscal 1997. As a percentage of revenue, cost of
revenue decreased from 88.5% to 65.4%, respectively. Cost of revenue increased
at a lower rate than revenue as CSI recognized the benefit of more favorable
carrier rates.
Sales and marketing expenses increased $507,000 or 32.3% from $1.6 million
for fiscal 1996 to $2.1 million for fiscal 1997. As a percentage of revenue,
these costs decreased from 23.3% to 17.5% for fiscal 1996 and fiscal 1997,
respectively. The increase in absolute dollars was due primarily to
commissions due on increased revenue
34
while the decrease as a percentage of revenue was due primarily to revenue
increasing at a greater rate than marketing expense and costs associated with
in-house salespersons.
General and administrative expense increased $372,000 or 22.5% from $1.7
million for fiscal 1996 to $2.0 million for fiscal 1997. As a percentage of
revenue, these costs decreased from 24.5% to 17.1% for fiscal 1996 and fiscal
1997, respectively. The increase in costs were due to additional customer
support and administrative personnel hired to support the growth of CSI's
operations.
Depreciation and amortization expense increased $45,000 or 78.0% from
approximately $58,000 for fiscal 1996 to approximately $103,000 for fiscal
1997. These expenses increased primarily as a result of CSI's higher fixed
asset base in fiscal 1997 which was principally due to investments in
telecommunications equipment, infrastructure and facility expansion.
Interest expense increased $143,000 from approximately $19,000 for fiscal
1996 to approximately $162,000 for fiscal 1997. The increase in interest
expense was due primarily to the issuance of notes to satisfy carrier
obligations.
CSI did not record an income tax benefit in either fiscal 1996 or fiscal
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.
The net loss decreased from $2.4 million for fiscal 1996 to $259,000 for
fiscal 1997. The decrease in net loss was primarily due to CSI's obtaining
more favorable carrier rates and increases in customer volume.
CSI had basic loss per share of $ for fiscal 1996 compared to basic loss
per share of $ for fiscal 1997. The decrease in basic 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.
CSI had negative EBITDA of $2.5 million for fiscal 1996 compared to positive
EBITDA of $6,000 for fiscal year 1997. The increase in EBITDA was primarily
due to CSI's obtaining more favorable carrier rates, which improved gross
margin percentages.
COMPARISON OF FISCAL YEARS ENDED APRIL 30, 1995 AND 1996
Revenue increased $4.9 million or 266.8% from $1.8 million for fiscal 1995
to $6.7 million for fiscal 1996. This increase was primarily due to growth in
the number of customers, which resulted from CSI's efforts to increase its
independent sales agent base in its target markets.
Cost of revenue increased $4.7 million or 359.4% from $1.3 million for
fiscal 1995 to $6.0 million for fiscal 1996 and as a percentage of revenue
increased from 70.6% to 88.5%, respectively. During fiscal 1996, CSI increased
minute volume in advance of its ability to secure more favorable volume
discount rates with its carriers.
Sales and marketing expense increased $1.0 million or 197.2% from $529,000
for fiscal 1995 to $1.6 million for fiscal 1996. As a percentage of revenue,
these costs decreased from 28.8% to 23.3% for fiscal 1995 and fiscal 1996,
respectively. The increase in absolute dollars was due primarily to
commissions on increased revenue while the decrease as a percentage of revenue
was due primarily to revenue increasing at a greater rate than marketing
expenses and costs associated with in-house salespersons.
General and administrative expense increased $1.0 million or 164.6% from
$624,000 for fiscal 1995 to $1.7 million for fiscal 1996. As a percentage of
revenue, these costs decreased from 34.0% to 24.5% for fiscal year 1995 and
fiscal 1996, respectively. The increase in absolute dollars was due to
additional customer support and administrative personnel hired to support the
growth of CSI's operations.
35
Depreciation and amortization expense increased $39,000 or 202.7% from
approximately $19,000 for fiscal 1995 to approximately $58,000 for fiscal
1996. These expenses increased primarily as a result of CSI's higher fixed
asset base in fiscal 1996 which was principally due to investments in
telecommunications equipment, infrastructure and facility expansion.
Interest expense was approximately $19,000 for fiscal 1996 and was a nominal
amount in fiscal 1995. Interest expense was due primarily to the issuance of
notes payable to satisfy carrier obligations.
CSI did not record an income tax benefit in either fiscal 1995 or fiscal
1996 but recorded valuation allowances to offset the deferred tax asset due to
the uncertainty of the ultimate realization of the net operating loss
carryforwards.
The net loss increased from $633,000 for fiscal 1995 to $2.5 million for
fiscal 1996. The increase in net loss was primarily due to CSI's unfavorable
carrier rates and significant increase in operating expenses.
CSI had basic loss per share of $ for fiscal 1996 compared to basic loss
per share of $ for fiscal 1995. The increase in basic loss per share was
due primarily to an increase in CSI's net loss as well as an increase in the
weighted average number of shares outstanding.
CSI had negative EBITDA of $614,000 for fiscal 1995 compared to negative
EBITDA of $2.4 million for fiscal 1996. The decrease in EBITDA was due
primarily to a significant increase in operating expenses during fiscal 1996.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain quarterly financial data for the
seven quarters ended January 31, 1998. This quarterly information has been
derived from CSI's unaudited financial statements which, in the opinion of
CSI's management, reflect all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the information for the
periods presented. Operating results for any one quarter are not necessarily
indicative of the results that may be expected in any future period.
CSI's quarterly operating results have fluctuated in the past and may
fluctuate significantly in the future as a result of a variety of factors,
some of which are outside CSI's control. These factors include demand for
international telecommunications services, capital expenditures and other
costs relating to the expansion of operations, the timing of new service
introductions by CSI or its competitors, market availability and acceptance of
new and enhanced versions of CSI's or its competitors' services, changes in
the mix of revenue, rates of customer acquisition and retention and general
economic conditions.
FISCAL 1997 QUARTER ENDED FISCAL 1998 QUARTER ENDED
--------------------------------------- ------------------------------
JULY 31 OCTOBER 31 JANUARY 31 APRIL 30 JULY 31 OCTOBER 31 JANUARY 31
------- ---------- ---------- -------- ------- ---------- ----------
(IN THOUSANDS)
Revenue................. $2,579 $2,952 $3,129 $3,205 $3,370 $3,002 $2,523
Cost of revenue......... 1,675 1,933 2,086 2,061 2,023 1,784 1,587
------ ------ ------ ------ ------ ------ ------
Gross margin............ 904 1,019 1,043 1,144 1,347 1,218 936
------ ------ ------ ------ ------ ------ ------
Operating expenses:
Sales and marketing.... 447 496 548 589 654 616 691
General and
administrative........ 388 455 484 697 798 918 888
Depreciation and
amortization.......... 19 23 28 33 33 35 37
------ ------ ------ ------ ------ ------ ------
Total operating
expenses............... 854 974 1,060 1,319 1,485 1,569 1,616
------ ------ ------ ------ ------ ------ ------
Income (loss) from
operations............. 50 45 (17) (175) (138) (351) (680)
Interest expense........ (40) (36) (38) (48) (47) (42) (259)
------ ------ ------ ------ ------ ------ ------
Net income (loss) before
extraordinary item..... 10 9 (55) (223) (185) (393) (939)
Extraordinary item...... -- -- -- -- -- -- 747
------ ------ ------ ------ ------ ------ ------
Net income (loss)....... $ 10 $ 9 $ (55) $ (223) $ (185) $ (393) $ (192)
====== ====== ====== ====== ====== ====== ======
36
CSI experienced declining revenue in the quarters ended October 31, 1997 and
January 1, 1998 in comparison to prior quarters. This decline was primarily a
result of a decline in customers and usage resulting from service disruptions
caused by the transfer of CSI's switching and billing functions into ITC's
systems. CSI experienced operational difficulties during this transfer process
which resulted in service disruptions for a number of customers. Although
CSI's revenue was adversely affected during this period, CSI believes that it
has resolved these difficulties.
Operating expenses have increased during each quarter, reflecting an
increase in general and administrative expense associated with the development
of CSI's administrative infrastructure. Installation, sales and marketing
expense has increased primarily due to commissions on increased revenue and
in-house sales personnel. CSI also increased its reserve for bad debt during
quarters ended October 31, 1997 and January 31, 1998, due to unpaid
receivables owed by a former independent sales agent. Interest expense
increased significantly during the quarter ended January 31, 1998, primarily
to non-cash financing activities in the quarter. CSI also recognized gain on
extinguishment of debt during the quarter ended January 31, 1998 related to
the repayment of notes using the proceeds of the December 1997 Financing.
LIQUIDITY AND CAPITAL RESOURCES
CSI's capital resources have been used to fund operating losses, debt
service and capital expenditures associated with development of its customer
base and the establishment and upgrade of its network infrastructure. Since
its inception, CSI has experienced net losses and negative cash flow from
operations. As of January 31, 1998, CSI had a working capital deficit of
approximately $3.0 million. CSI has satisfied its capital 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 expansion of operations and general corporate purposes. During fiscal
1996 and fiscal 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 in fiscal 1997 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 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 asked price
on the day preceding the date of conversion. As of January 31, 1998, $385,000
of the convertible notes had been converted. In fiscal 1997, CSI also raised
$85,000 through the issuance of notes that bear interest at 15% per annum and
mature in September 1998. In December 1997, CSI issued Bridge Notes in the
principal amount of $2.8 million. The Bridge Notes bear interest at 10% per
annum and are due five days following the closing of this offering. CSI has
entered into employment agreements that obligate the Combined Company to pay
annual salaries of approximately $400,000. CSI also has an agreement to pay
certain royalties to Gary Kamienski relating to CSI's LINK-US technology.
As a result of CSI's operating losses, working capital has not always been
sufficient to satisfy CSI's obligations, and CSI from time to time has been in
arrears on its payment obligations to its carriers. During fiscal 1996 and
fiscal 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 December 1997 Financing. CSI
anticipates that its minimum commitments to carriers (exclusive of any carrier
commitments of GlobalTel or ITC) will be approximately $4.2 million and $1.5
million for fiscal 1998 and fiscal 1999, respectively. As of March 31, 1998,
CSI was again in arrears on carrier payments due to one carrier of
approximately $780,000. The Combined Company intends to use a portion of the
proceeds of this offering to repay such amount. There can be no assurance CSI
will not be required to pay a penalty to this or any other carrier or that CSI
will not be in default of its obligations to its carriers in the future.
Net cash used in operating activities was approximately $882,000 for the
nine months ended January 31, 1998, as compared to cash provided by operating
activities of approximately $473,000 for the nine months ended January 31,
1997. Adjustments to the $770,000 net loss for the period to reconcile to net
cash used in operating
37
activities consisted primarily of a $747,000 extraordinary gain on
extinguishment of debt, $208,000 in amortized costs associated with the
December 1997 Financing and $105,000 in depreciation and amortization. The
decrease in cash provided from operating activities was primarily due to a
$733,000 increase in net loss for such period partially offset by an increase
in accounts payable and accrued expenses. Net cash used in investing
activities was approximately $362,000 for the nine months ended January 31,
1998, compared to approximately $167,000 for the nine months ended January 31,
1997. The increase was primarily due to acquisition deposits paid to ITC. Net
cash provided by financing activities was approximately $1.7 million for the
nine months ended January 31, 1998, compared to cash used in financing
activities of approximately $314,000 for the nine months ended January 31,
1997. The increase in cash provided by financing activities was primarily due
to receipt of proceeds from the Bridge Notes from the December 1997 Financing,
issuance of stock, net of cash payments to acquire treasury stock from two
former CSI employees, and repayment of a carrier note.
Net cash provided by operating activities was approximately $730,000 for
fiscal 1997, compared to cash used in operating activities of approximately
$362,000 for fiscal 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 fiscal 1997, compared to approximately $223,000 for
fiscal 1996. The increase was primarily due to acquisition deposits paid to
ITC. Net cash used in financing activities was approximately $397,000 for
fiscal 1997, compared to cash provided by financing activities of
approximately $560,000 for fiscal 1996. The increase in cash used was
primarily due to repayment of notes, net of proceeds from the sale of stock
and issuances of additional notes.
Net cash used in operating activities was approximately $362,000 for fiscal
1996, as compared to cash used in operating activities of approximately
$398,000 for fiscal 1995. The decrease in cash used was primarily due to an
increase in accounts payable of approximately $2.7 million partially offset by
a $1.9 million increase in net loss. Net cash used in investing activities was
approximately $223,000 for fiscal 1996, compared to approximately $54,000 for
fiscal 1995. The increase was primarily due to the acquisition of switching
equipment. Net cash provided by financing activities was approximately
$560,000 for fiscal 1996, compared to cash provided by financing activities of
approximately $526,000 for fiscal 1995. The increase in cash provided was
primarily due to proceeds from the sale of stock and issuances of notes.
38
GLOBALTEL RESOURCES, INC.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated, the percentage
relationship to revenue of certain items in GlobalTel's statements of
operations.
YEAR ENDED
DECEMBER 31,
---------------------
1995 1996 1997
----- ----- -----
Revenue............................................ 100.0% 100.0% 100.0%
Cost of revenue.................................... 91.3 90.1 86.9
----- ----- -----
Gross margin....................................... 8.7 9.9 13.1
Operating expenses:
Sales and marketing.............................. 11.3 7.5 6.1
General and administrative....................... 72.7 63.1 55.3
Depreciation and amortization.................... 5.2 1.1 2.0
----- ----- -----
Total operating expenses........................... 89.2 71.7 63.4
----- ----- -----
Loss from operations............................... (80.5) (61.8) (50.3)
Interest expense, including amortization of debt
discount.......................................... (1.6) (2.5) (10.6)
----- ----- -----
Net loss........................................... (82.1)% (64.3)% (60.9)%
===== ===== =====
COMPARISON OF YEARS ENDED DECEMBER 31, 1996 AND 1997
Revenue increased $3.8 million or 41.7% from $9.1 million in 1996 to $12.9
million in 1997. Revenue from call-reorigination increased $262,000 or 3.1%
from $8.3 million in 1996 to $8.6 million in 1997. This increase resulted from
higher usage by existing customers, the addition of new customers and the
expansion of GlobalTel's agent network. Following the relocation of
GlobalTel's primary switching platform to Los Angeles in late 1996, GlobalTel
also commenced selling international long-distance minutes on a wholesale
basis to several carriers. Revenue from carriers, which commenced in October
1996, increased to $4.3 million in 1997. Call-reorigination and carrier
revenue represented 66.9% and 33.1% of GlobalTel's revenue, respectively, in
1997.
Cost of revenue increased $2.9 million or 35.7% from $8.2 million in 1996 to
$11.2 million in 1997. This increase is primarily attributable to increased
transmission costs associated with greater calling volume. As a percentage of
revenue, cost of revenue decreased from 90.1% to 86.9% in 1996 and 1997,
respectively. This decrease in percentage of revenue is primarily attributable
to a decrease in the costs associated with implementation of least-cost call
routing in late 1996. This decrease was offset, in part, by higher cost of
revenue as a percentage of revenue attributable to GlobalTel's carrier
revenue.
Sales and marketing expense increased $106,000 or 15.5% to $788,000 in 1997
from $682,000 in 1996. This increase is primarily attributable to increased
sales commissions and a higher effective commission rate. Substantially all of
GlobalTel's sales commissions are related to call-reorigination sales
generated by independent sales agents. As a percentage of revenue, sales and
marketing expense declined from 7.5% to 6.1% in 1996 and 1997, respectively,
resulting in part from higher levels of carrier sales not requiring
advertising or sales commissions.
General and administrative expense increased $1.3 million or 22.4% from $5.8
million in 1996 to $7.1 million in 1997. This increase is primarily
attributable to $670,000 in expense that was charged to operations and
associated with GlobalTel's discontinued public offering and $447,000 of non-
cash compensation costs. General and administrative expense also increased due
to compensation costs resulting from increased staffing levels. As a
percentage of revenue, general and administrative expense declined from 63.1%
to 55.3% in 1996 and 1997, respectively. This decrease is primarily
attributable to economies of scale associated with GlobalTel's ability to
spread general and administrative expense across a broader revenue base.
39
Depreciation and amortization increased $155,000 or 158.2% from $98,000 in
1996 to $253,000 in 1997. This increase is primarily attributable to the
depreciation of capital assets acquired in late 1996 and in 1997, including a
new voice switching platform, facility improvements, fax gateway switching
platform and an electronic billing and customer interface system.
Interest expense and amortization of debt discount increased $1.1 million or
508.0% from $225,000 in 1996 to $1.4 million in 1997. This increase is
primarily attributable to an increase in GlobalTel's outstanding indebtedness,
together with financing costs associated with the incurrence of additional
debt. Also included in 1997 is $440,000 of additional amortized debt expense
as a result of the conversion of a portion of GlobalTel's indebtedness to
common stock, issuance of certain GlobalTel notes, and amendment of certain
stock warrant agreements.
GlobalTel did not record a provision for income taxes for either 1996 or
1997 as a full valuation allowance was recorded for both periods to offset net
deferred tax assets due to the uncertainty of the ultimate realization of the
net operating loss carryforwards.
GlobalTel had a net loss of $5.9 million for 1996 and $7.9 million for 1997.
The increase in net loss was due primarily to the significant increase in
general and administrative expense and debt financing costs.
GlobalTel had basic loss per share of $ for 1996 and basic loss per share
of for 1997. The increase in basic loss per share was due primarily to an
increase in net loss, offset by an increase in weighted average shares
outstanding.
GlobalTel had negative EBITDA of $5.5 million for 1996 compared to negative
EBITDA of $6.2 million for 1997. The increase in negative EBITDA was primarily
due to the increase in general and administrative expense.
COMPARISON OF YEARS ENDED DECEMBER 31, 1995 AND 1996
Revenue increased $7.0 million or 333.3% from $2.1 million in 1995 to $9.1
million in 1996 . Revenue from call-reorigination increased $6.2 million or
295.2% from $2.1 million in 1995 to $8.3 million in 1996. The increase in
call-reorigination revenue was primarily due to increased usage by existing
customers and the addition of new customers. Revenue in 1996 also included
$793,000 of sales to carriers commencing in October 1996. GlobalTel's revenue
from call-reorigination and carrier sales represented approximately 91.3% and
8.7%, respectively, of GlobalTel's revenue in 1996.
Cost of revenue increased $6.3 million or 331.6% from $1.9 million in 1995
to $8.2 million in 1996. This increase is primarily attributable to increased
transmission costs associated with greater calling volume. As a percentage of
revenue, these costs decreased from 91.3% to 90.1% in 1995 and 1996,
respectively, primarily as a result of better network utilization offset in
part by carrier revenue.
Sales and marketing expense increased $444,000 or 186% from $238,000 in 1995
to $682,000 in 1996. This increase was primarily attributable to higher sales
commissions and advertising costs. The increase in sales commissions is
attributable to increased levels of sales generated by agents as well as an
increase in the effective commission rate. As a percentage of revenue, sales
and marketing expense decreased from 11.3% to 7.5% in 1996, respectively. This
decrease is primarily attributable to economies of scale associated with
GlobalTel's ability to spread costs of operations across a broader revenue
base.
General and administrative expense increased $4.3 million or 286.7% from
$1.5 million in 1995 to $5.8 million in 1996. This increase is primarily
attributable to the costs, including wages, travel and facilities, associated
with the addition of administrative, technical and customer support personnel
as GlobalTel developed its management team and network. During this period
GlobalTel also incurred professional, consulting and facilities expense
associated with the establishment of its relationship with Equant and the
development of
40
GlobalTel's enhanced services. General and administrative expense declined as
a percentage of revenue from 72.7% to 63.1% in 1995 and 1996, respectively.
This decrease is primarily attributable to economies of scale associated with
GlobalTel's ability to spread general and administrative expense across a
broader revenue base.
Depreciation and amortization decreased $13,000 or 11.8% from $111,000 in
1995 to $98,000 in 1996. This decrease resulted from a one-time write-off in
1995 of certain organizational costs.
Interest expense increased $191,000 or 561.8% from $34,000 in 1995 to
$225,000 in 1996. This increase is primarily attributable to an increase in
GlobalTel's outstanding indebtedness, together with the amortization of debt
issuance costs.
GlobalTel did not record a provision for income taxes for either 1996 or
1995 as a full valuation allowance was recorded for both periods to offset net
deferred tax assets due to the uncertainty of the ultimate realization of net
operating loss carryforwards.
GlobalTel had a net loss of $1.7 million for 1995 and a net loss of $5.9
million for 1996. The increase in net loss was due primarily to the
significant increase in general and administrative expenses and increased debt
financing costs.
GlobalTel had basic loss per share of $ for 1995 compared to basic loss
per share of $ for 1996. The change in basic loss per share was due
primarily to an increase in net loss.
GlobalTel had negative EBITDA of $1.6 million for 1995 compared to negative
EBITDA of $5.5 million for 1996. The increase in negative EBITDA was primarily
due to the increase in general and administrative expense.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain quarterly financial data for the
eight quarters ended December 31, 1997. This quarterly information has been
derived from unaudited consolidated financial statements which, in the opinion
of GlobalTel's management, reflect all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the information
for the periods presented. Operating results for any one quarter are not
necessarily indicative of the results that may be expected in any future
period.
GlobalTel's quarterly operating results have fluctuated in the past and may
fluctuate significantly in the future as a result of a variety of factors,
some of which are outside GlobalTel's control. These factors include demand
for international telecommunications services, capital expenditures and other
costs relating to the expansion of operations, the timing of new product
introductions by GlobalTel or its competitors, market availability and
acceptance of new and enhanced versions of GlobalTel's or its competitors'
services, changes in the mix of revenue, customer acquisition and retention
and general economic conditions.
1996 QUARTER ENDED 1997 QUARTER ENDED
------------------------------------ ------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31 MARCH 31 JUNE 30 SEPT. 30 DEC. 31
-------- ------- -------- ------- -------- ------- -------- -------
(IN THOUSANDS)
Revenue................. $ 1,507 $ 2,048 $ 2,275 $ 3,306 $ 4,385 $ 3,589 $ 2,665 $ 2,223
Cost of revenue......... 1,520 1,753 1,882 3,075 3,811 2,992 2,204 2,164
------- ------- ------- ------- ------- ------- ------- -------
Gross margin............ (13) 295 393 231 574 597 461 59
Operating expenses:
Sales and marketing.... 122 199 173 188 226 229 209 124
General and
administrative........ 1,087 1,538 1,470 1,678 1,411 1,497 1,750 2,461
Depreciation and
amortization.......... 22 24 40 12 18 59 65 111
------- ------- ------- ------- ------- ------- ------- -------
Total operating
expenses............... 1,231 1,761 1,683 1,878 1,655 1,785 2,024 2,696
------- ------- ------- ------- ------- ------- ------- -------
Loss from operations.... (1,244) (1,466) (1,290) (1,647) (1,081) (1,188) (1,563) (2,637)
Interest expense,
including amortization
of debt discount....... (20) (21) (62) (122) (169) (240) (178) (781)
------- ------- ------- ------- ------- ------- ------- -------
Net loss................ $(1,264) $(1,487) $(1,352) $(1,769) $(1,250) $(1,428) $(1,741) $(3,418)
======= ======= ======= ======= ======= ======= ======= =======
41
Following the relocation of GlobalTel's switch to Los Angeles in the fourth
quarter of 1996, GlobalTel commenced reselling long-distance minutes to
certain carriers. Sales to carriers accounted for a major portion of the 45.3%
and 32.6% increase in total revenue for the fourth quarter of 1996 and the
first quarter of 1997, respectively. Revenue from carrier sales increased $1.2
million or 152.2% to $2.0 million in the first quarter of 1997 from $793,000
in the fourth quarter of 1996. As a percentage of revenue, GlobalTel's cost of
revenue increased as a percentage of revenue in the third and fourth quarters
of 1996 due to lower margins associated with carrier sales. In the first
quarter of 1997, GlobalTel raised prices on sales to carrier customers, while
cost of revenue as a percentage of revenue declined to 86.9% despite the
increasing proportion of carrier sales.
GlobalTel experienced declining revenue in the quarters ended June 30, 1997,
September 30, 1997, and December 31, 1997. This decline was primarily a result
of GlobalTel's decision in May 1997 to temporarily de-emphasize its carrier
business. Due to the lengthy payment cycles GlobalTel had experienced with
certain of its carrier customers and GlobalTel's relatively low cash reserves,
GlobalTel reduced its carrier sales in order to limit its credit risk and to
reduce its effective carrying costs associated with carrier accounts
receivable. Specifically, GlobalTel ceased doing business with two carriers
and reduced its level of business with several others, resulting in a decline
in carrier revenue from $2.0 million in the quarter ended March 31, 1997 to
$473,000 in the quarter ended December 31, 1997. In order to continue to
capitalize on the benefits of greater network utilization and increased buying
power, GlobalTel anticipates increasing the level of carrier sales in the next
12 months as GlobalTel seeks to develop business relationships with additional
carriers.
Additionally, call-reorigination revenue declined moderately during the
second, third, and fourth quarters of 1997. Due to anticipated capacity
constraints and limited access to multiple carriers, GlobalTel relocated its
primary switching platform from Las Vegas to Los Angeles in late 1996.
GlobalTel experienced technical and operational difficulties in connection
with this relocation process which resulted in service disruptions for a
number of customers. Although GlobalTel's sales were adversely affected during
this period, GlobalTel believes that it resolved these difficulties by June
1997. Increased competitive pressures encountered by some of GlobalTel's
independent sales agents also contributed to the decline in revenue during
these quarters. During the second half of 1997 GlobalTel installed a new
switching platform which became fully operational on November 1, 1997,
enabling GlobalTel to offer a wider variety and more competitive package of
services to its independent sales agents and customers.
GlobalTel also experienced an increase in cost of revenue as a percentage of
revenue in the quarter ending December 31, 1997. This increase was primarily
due to an increase in transmission costs resulting from the temporary re-
routing of traffic previously carried by one of its principal long-distance
carriers after this carrier ceased providing services to GlobalTel. General
and administrative expense increased in the quarter ending December 31, 1997
primarily due to professional fees charged to operations and relating to
GlobalTel's discontinued public offering. In addition, interest expense
increased significantly in the quarter ending December 31, 1997, resulting
primarily from non-cash financing activities in the quarter.
LIQUIDITY AND CAPITAL RESOURCES
GlobalTel's capital resources have been used to fund operating losses, debt
service and capital expenditures associated with development of its customer
base and the establishment and upgrade of its network infrastructure. Since
its inception, GlobalTel has experienced net losses and negative cash flow
from operations. As of December 31, 1997, GlobalTel had a working capital
deficit of approximately $4.9 million. Through December 31, 1997, GlobalTel
had met these capital requirements largely through financing activities that
included $2.7 million in net proceeds from the sale of Common Stock, $1.0
million in net proceeds from the sale of Preferred Stock, $5.2 million in net
borrowings from shareholders and others represented by promissory notes (the
"Notes"), as well as revenue from operations. See "Certain Transactions." At
December 31, 1997, Notes aggregating approximately $7.0 million remained
outstanding, of which $1.8 million will mature prior to December 31, 1998.
Substantially all of the Notes accrue interest at the rate of 10% per annum,
increasing to 12% when the Notes become past due. Notes outstanding at
December 31, 1997, with an aggregate principal amount of $2.7 million are
convertible at the option of the holders into an aggregate of shares
of
42
Common Stock, assuming an initial public offering price of $ per share.
Warrants to purchase an aggregate of shares of Common Stock were
issued in connection with the issuance of the Notes, all of which remained
outstanding at December 31, 1997. Also, in September 1997, deferred salaries
aggregating $1.2 million were converted into warrants to purchase shares of
Common Stock. In October 1997, GlobalTel obtained an additional $550,000 in
connection with the issuance of notes to four individuals. These notes bear
interest at a rate of 10% per annum, are due in full on March 1, 1999, and are
convertible at any time prior to maturity at the fair market value per share
of Common Stock in effect as of the date of conversion. Warrants exercisable
for an aggregate of shares of Common Stock at an exercise price of $ per
share were granted in this round of financing.
In November 1997 GlobalTel obtained an additional $325,000 in connection
with the issuance of notes to three individuals. These notes bore interest at
10% per annum and were repaid in full from the proceeds of certain notes
issued in November and December 1997. In addition, each holder of these notes
will receive, following the closing of this offering, shares of Common Stock
equal to one-half of the principal amount of such holder's note divided by the
initial public offering price of the Common Stock.
In November and December 1997 GlobalTel obtained approximately $3.0 million
in connection with the issuance of additional notes. These GlobalTel Full
Coverage Notes bear interest at the rate of 10% per annum and will be repaid
from proceeds of this offering.
As a result of GlobalTel's operating losses, available working capital has
not always been sufficient to satisfy GlobalTel's obligations and GlobalTel
from time to time has been in arrears on payment obligations to its carriers.
In October 1997, GlobalTel failed to pay amounts due to one of its principal
long-distance carriers within the time period that this carrier customarily
had required payment. As a result, this carrier ceased providing services to
GlobalTel and, under the terms of its agreement with GlobalTel, could demand a
termination payment of up to $1.2 million. GlobalTel was able to re-route
traffic that previously had been carried by this carrier without any
interruption in service to GlobalTel's customers. In December 1997, after
GlobalTel paid this carrier a substantial portion of the amounts past due,
services were restored. GlobalTel has negotiated the payment terms of the
remaining balance owed and does not believe that it will be required to pay an
amount in excess of that owed for carrier services provided. As of March 31,
1998, GlobalTel was in arrears on approximately $641,000 due to this carrier.
There can be no assurance that GlobalTel will not be required to pay a penalty
to this or any other carrier or that GlobalTel will not be in default of its
obligations to its carriers in the future.
Net cash used in operating activities was $5.1 million for 1997, as compared
to net cash used in operating activities of $2.6 million for 1996. The
increase in net cash used in operating activities was due primarily to a $2.0
million increase in net loss as well as a $3.3 million decrease in trade
accounts payable, accrued liabilities and notes payable. Net cash used in
investing activities was $667,000 for 1997, as compared to net cash used in
investing activities of $688,000 for 1996. Investing activities for 1997 and
1996 primarily represent capital expenditures for hardware and software. Net
cash provided by financing activities was $6.2 million for 1997, as compared
to net cash provided by financing activities of $3.0 million for 1996.
Financing activities in 1997 and 1996 primarily represent proceeds from the
issuance of bridge loans and Series A Convertible Preferred Stock in 1997.
Net cash used in operating activities was $2.6 million for 1996, as compared
to net cash used in operating activities of $1.0 million for 1995. The
increase in net cash used in operating activities was due primarily to a $4.1
million increase in net loss which was partially offset by a $3.1 million
increase in trade accounts payable, accrued liabilities and notes payable. Net
cash used in investing activities was $688,000 for 1996, as compared to net
cash used in investing activities of $522,000 for 1995. Investing activities
for 1996 primarily represent capital expenditures for hardware and software
while investing activities for 1995 includes $260,000 in capital equipment and
$262,000 in capitalized organization costs. Net cash provided by financing
activities was $3.0 million for 1996, as compared to net cash provided by
financing activities of $2.0 million for 1995. Financing activities in 1996
primarily represent proceeds from the issuance of bridge loans while investing
activities in 1995 primarily represent proceeds from the issuance of common
stock.
43
INTERNATIONAL TELEPHONE COMPANY
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 and the three months ended December 31, 1996 is
not directly comparable to the three months ended January 31, 1998. 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 DECEMBER 31, THREE MONTHS ENDED
------------------------- TEN MONTHS ENDED ----------------------------------
1995 1996 OCTOBER 31, 1997 DECEMBER 31, 1996 JANUARY 31, 1998
------------ ----------- ---------------- ----------------- ----------------
Revenue....................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenue............... 65.9 66.7 84.3 65.6 77.0
----------- ----------- ------ ----- -----
Gross margin.................. 34.1 33.3 15.7 34.4 23.0
Operating expenses:
Sales and marketing......... 14.9 14.5 8.9 10.8 8.6
General and administrative.. 14.7 19.0 17.2 25.4 16.7
Depreciation................ 0.6 0.9 0.9 1.2 1.0
----------- ----------- ------ ----- -----
Total operating expenses...... 30.2 34.4 27.0 37.4 26.3
----------- ----------- ------ ----- -----
Income (loss) from opera-
tions........................ 3.9 (1.1) (11.3) (3.0) (3.3)
Interest and other income
(expense).................... 0.0 1.2 0.7 0.1 (0.1)
----------- ----------- ------ ----- -----
Income (loss) before taxes.... 3.9 0.1 (10.6) (2.9) (3.4)
Income tax expense............ 0.3 0.0 0.0 0.0 0.0
----------- ----------- ------ ----- -----
Net income (loss)............. 3.6% 0.1% (10.6)% (2.9)% (3.4)%
=========== =========== ====== ===== =====
COMPARISON OF THREE MONTHS ENDED DECEMBER 31, 1996 TO THE THREE MONTHS ENDED
JANUARY 31, 1998
Revenue increased $907,000 or 46.7% from approximately $1.9 million for the
three months ended December 31, 1996 to approximately $2.8 million for the
three months ended January 31, 1998. The increase is due primarily to an
increase in customers and customer usage. During this period of time, the
number of customers increased due to additions in ITC's independent sale agent
base as well as the improved performance of the existing independent sales
agent base.
Cost of revenue increased $920,000 or 72.2% from approximately $1.3 million
for the three months ended December 31, 1996 to approximately $2.2 million for
the three months ended January 31, 1998. As a percentage of revenue, these
costs increased from 65.6% to 77.0% for the periods ended December 31, 1996
and January 31, 1998, respectively. The increase in cost of revenue is due to
an increase in transmission costs directly related to usage. The increased
cost of revenue as a percentage of total revenue was due to an increase in
revenue from sales to carriers and resellers, which has lower gross margins.
Sales and marketing expense increased $34,000 or 16.2% from approximately
$210,000 for the three months ended December 31, 1996 to approximately
$244,000 for the three months ended January 31, 1998. As a percentage of
revenue, sales and marketing expense decreased from 10.8% to 8.6% for the
periods ended December 31, 1996 and January 31, 1998, respectively. The
decrease was due primarily to higher levels of carrier and reseller sales not
requiring advertising and sales commissions.
44
General and administrative expense decreased $18,000 or 3.6% from $494,000
for the three months ended December 31, 1996 to $476,000 for the three months
ended January 31, 1998. The decrease in these costs was due primarily to lower
officers' compensation.
Depreciation expense increased $7,000 or 31.8% from approximately $22,000
for the three months ended December 31, 1996 to approximately $29,000 for the
three months ended January 31, 1998. These costs increased primarily as a
result of ITC's higher fixed asset base during the three months ended January
31, 1998.
Interest expense increased $10,000 or 200.0% from approximately $5,000 for
the three months ended December 31, 1996 to approximately $15,000 for the
three months ended January 31, 1998. The increase in interest expense was due
primarily to a capital lease obligation incurred to acquire telecommunications
equipment.
ITC did not record an income tax benefit for the three months ended January
31, 1998 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.
ITC reported a net loss of approximately $97,000 for the three months ended
January 31, 1998 compared to net loss of approximately $56,000 for the three
months ended December 31, 1996.
COMPARISON OF YEAR ENDED DECEMBER 31, 1996 TO THE TEN MONTHS ENDED OCTOBER 31,
1997
Revenue increased $451,000 or 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
customers and customer usage. During this period of time, the number of
customers increased due to additions in ITC's independent sale agent base as
well as the improved performance of the existing independent sales agent base.
Cost of revenue increased $1.7 million or 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 transmission costs directly related to usage as well as a dispute
with a carrier. The increased cost of revenue as a percentage of total revenue
was due to an increase in revenue from sales to carriers and resellers, which
has lower gross margin percentages, and an increase in costs associated with
the carrier dispute. See "Business--Legal Proceedings."
Sales and marketing expense decreased $384,000 or 34.9% 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 expense 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 higher levels of carrier and reseller sales not requiring
advertising and sales commissions.
General and administrative expense remained relatively constant at $1.4
million for the year ended December 31, 1996 and $1.4 million for the ten
months ended October 31, 1997. The similarity in these costs was due primarily
to the different length of the time periods presented.
Depreciation expense increased $4,000 or 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.
Interest and other income decreased $26,000 or 29.5% from approximately
$88,000 for the year ended December 31, 1996 to approximately $62,000 for the
ten months ended October 31, 1997. The decrease in
45
interest and other income 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. ITC had consulting fees totaling
approximately $113,000, net of related consulting expenses, which it received
from CSI for assistance in the settlement of a dispute with a carrier.
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.
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.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1995 AND 1996
Revenue decreased $594,000 or 7.3% from approximately $8.2 million for 1995
to approximately $7.6 million for 1996. The decrease is due primarily to a
decrease in customers resulting from the loss of a significant independent
sales agent.
Cost of revenue decreased $337,000 or 6.2% from approximately $5.4 million
for 1995 to approximately $5.1 million for 1996. As a percentage of revenue,
these costs increased from 65.9% to 66.7% for 1995 and 1996, respectively. The
decrease in cost of revenue is due to a decrease in transmission costs
directly related to usage resulting from a decrease in customer base. The
increased cost of revenue as a percentage of total revenue was due to an
increase in revenue from sales to carriers and resellers.
Sales and marketing expense decreased $121,000 or 9.9% from approximately
$1.2 million for 1995 to approximately $1.1 million for 1996. As a percentage
of revenue, sales and marketing expense decreased from 14.9% to 14.5% for 1995
and 1996, respectively. This decrease was due primarily to higher levels of
carrier and reseller sales not requiring advertising and sales commissions.
General and administrative expense increased $297,000 or 25.8% from $1.1
million for 1995 to $1.4 million for 1996. The increase in this expense was
due primarily to an increase in officers' compensation.
Depreciation expense increased $16,000 or 30.2% from approximately $53,000
for 1995 to approximately $69,000 for 1996. This expense increased primarily
as a result of ITC's higher fixed asset base during 1996 as compared with
1995.
Interest and other income/expense increased $112,000 from a net expense of
approximately $24,000 for 1995 to net other income of approximately $88,000
for 1996. The increase in interest and other income was due primarily to the
receipt of consulting fees totaling approximately $113,000, net of related
consulting expenses.
ITC 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 $21,000 and $4,000 for
1995 and 1996, respectively.
ITC reported net income of approximately $344,000 for 1995 compared to net
income of approximately $7,000 for 1996. The decrease in net income is due
primarily to a decrease in gross margin, the loss of a significant independent
sales agent and an increase in general and administrative expense related to
officers' compensation.
46
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was approximately $205,000 for the
three months ended January 31, 1998, compared to cash used in operating
activities of approximately $143,000 for the three months ended December 31,
1996. The increase in cash provided by operating activities was due primarily
to the increase in accounts payable and a payable due to CSI under the
Reciprocal Telecommunications Agreement, net of an increase in trade
receivables related primarily to an increase in revenue from the comparable
period in 1996. Net cash used in investing activities totaling $10,000 during
the three months ended January 31, 1998 was due primarily to additional
equipment purchases. Net cash used in financing activities totaling $65,000
during the three months ended January 31, 1998 was due to payments on capital
lease obligations.
Net cash provided by operating activities was approximately $626,000 for the
ten months ended October 31, 1997, compared to cash provided by operating
activities of approximately $286,000 for the year ended December 31, 1996. The
increase in cash provided by operating activities 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, 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.
Net cash provided by operating activities was approximately $286,000 for
1996, compared to cash provided by operating activities of approximately
$533,000 for 1995. The decrease in cash provided by operating activities was
primarily due to a decrease in net income. Net cash used in investing
activities was approximately $29,000 for 1996, compared to cash used in
investing activities of approximately $152,000 for 1995. The decrease was
primarily due to fewer equipment purchases in 1996. Net cash used in financing
activities was approximately $186,000 for 1996, compared to cash used in
financing activities of approximately $291,000 for 1995. The decrease was due
primarily to proceeds from loan payable.
47
BUSINESS
OVERVIEW
The Combined Company is a growing provider of international
telecommunications services offering long distance, calling cards and enhanced
voice and data services. With more than 25,500 customers in over 170
countries, the Combined Company primarily serves markets that have been
historically underserved by large telecommunications providers and ITOs. The
Combined Company presently focuses on international call-reorigination,
capitalizing on the arbitrage opportunity created by differences between U.S.
and international long-distance rates. Going forward, the Combined Company
intends to leverage the expertise derived from, and capitalize on the
established customer base generated by, its call-reorigination business to
provide higher margin telecommunications services such as call-through,
enhanced fax and business grade Internet services.
The Combined Company's telecommunications services are marketed and sold
through a network of independent sales agents, strategic relationships and in-
house direct marketing. The Combined Company relies primarily on over 170
independent sales agents that cover over 170 countries. GlobalTel has an
exclusive agreement with the International Business Network for World Commerce
and Industry, Ltd. ("IBNET"), the managing member of the Consortium of Global
Commerce, under which IBNET will market the services of GlobalTel, and
ultimately the Combined Company, through several thousand individual chambers
of commerce located in over 200 countries. In addition, GlobalTel has a
strategic relationship with Novell that provides it with a distribution
channel for its services, and ultimately those of the Combined Company,
through a select number of Novell's network of over 25,000 value-added
resellers. The Combined Company intends to pursue additional strategic
relationships and to expand its sales channels. The Combined Company's also
markets and sells through its small in-house sales staff, which is responsible
for call-reorigination sales and carrier resales.
The Combined Company has a broad customer base including foreign offices of
multinational corporations, including Nike Inc., Microsoft Corporation,
Mitsubishi Corporation and Chrysler Corporation; major international hotels,
including the Inter-Continental Hotel and the Copacabana Palace in Rio de
Janeiro, Brazil and Southern Sun Group's Holiday Inn Hotels in South Africa;
and embassies and international agencies, including the United States
embassies in Chile, Korea, Australia and the Ukraine and the United Nations
consulate in South Africa.
The GlobalTel Merger and the ITC Acquisition will enable the Combined
Company to rapidly obtain access to complementary infrastructure, personnel,
customer bases, sales and marketing resources and strategic relationships. The
integration of GlobalTel and ITC with CSI will afford the Combined Company a
greater opportunity to enter new markets, acquire new infrastructure, improve
its rate structure with carriers, and resell excess international capacity to
other carriers and resellers. The Combined Company intends to actively pursue
additional acquisitions of complementary international customer bases,
products and infrastructure.
The Combined Company provides its telecommunications services through its
(i) voice switching and global fax messaging infrastructure in Los Angeles,
California; (ii) voice switching and billing center in Ft. Lauderdale,
Florida; (iii) access to third party infrastructure through international
telecommunications carriers and through Equant, a global data network services
provider; and (iv) enhanced fax nodes in Hong Kong and Mexico City. The
Combined Company uses both off-the-shelf technologies, which provide
flexibility to adapt to the rapidly changing telecommunications environment,
and proprietary automated call processing technologies (DIAL and LINK-US),
which enhance the Combined Company's competitive position in serving larger,
high-volume customers.
INDUSTRY AND MARKET OPPORTUNITY
Historically, telephone service within individual countries has been
monopolized by large, typically government-owned or protected entities, often
referred to as incumbent telephone operators ("ITOs"). As a result,
international callers have had little choice but to use the services provided
by and pay the prices charged by local ITOs. Deregulation, together with
decreases in the cost of providing services, and the introduction of
48
more sophisticated enhanced services has made it possible for new entrants to
compete with the ITOs in providing international telecommunications services.
The resulting decrease in non-regulated rates has produced a resale market for
long-distance telecommunications services permitting companies to obtain
favorable volume-based rates from third party providers and to resell services
at competitive rates to other providers and users. These and other factors
have contributed to an increase in telecommunications usage and a
proliferation of enhanced telecommunications services in these markets. The
combination of a continually expanding global telecommunications market,
demand for lower prices and improved quality, and ongoing deregulation has
created competitive opportunities for new telecommunications companies in many
countries. According to the ITU, the international telecommunications industry
accounted for $52.8 billion in revenue and 61.9 billion minutes of long
distance international telephone calls worldwide in 1995. Based upon trends in
revenue growth from 1991 through 1995 measured by the ITU, the Combined
Company believes that international long distance telecommunications revenue
will surpass $76 billion by the year 2000. The projected revenue and growth
rates, as reported by the ITU, should not be relied upon as an indication of
the Combined Company's financial future.
Emerging Telecommunications Markets. The world's larger telecommunications
carriers (AT&T, Sprint, MCI, WorldCom, Deutsche Telecom AG, France Telecom)
have focused on developed telecommunications markets that are characterized by
high teledensity (ratio of telephone lines to inhabitants), an advanced stage
of deregulation, a large volume of international telecommunications traffic
and a concentration of large multinational corporations. These markets include
the United States, the United Kingdom, Germany, France and Japan. The Combined
Company focuses on what it characterizes as emerging telecommunications
markets, which are (i) smaller developed countries such as Argentina, Austria,
Brazil, Switzerland, Ireland, Singapore and South Africa, and (ii) markets
that typically have less developed telecommunications infrastructures, are in
an earlier stage of deregulation and have more monopolistic distribution
profiles. Based on data from the ITU, the Combined Company has calculated that
the approximately 145 countries that the Combined Company targets as emerging
telecommunications markets generated approximately 23.0 billion minutes in
outgoing international telecommunications traffic in 1995.
Convergence of Technology. Deregulation and evolving price competition have
coincided with technological innovation in the telecommunications industry.
New technologies such as fiber optic cable and improvements in digital
compression, computer software and call processing technology have contributed
to improvements in telecommunications quality and speed, increased
transmission capacities, and decreased transmission costs. For example, fiber
optic cable has dramatically increased the capacity and speed of telephone
lines and has eliminated capacity constraints as a technical barrier to entry
for new international telecommunications providers. The improved quality of
these new telephone lines also has facilitated the development of global
voice-mail and fax services and has enhanced data communication. Improvements
in computer software and processing technology have laid a foundation for
services such as itemized and multi-currency billing. In addition,
international debit and credit networks now permit customers to pay for long-
distance calls made from any telephone using a single home account. The
convergence of conventional telephony and computing technologies also has
created the opportunity for data networks, and computers in general, to become
primary telecommunications tools.
Private Networks and Emergence of the Internet. Until recently, the data
communications services offered by public carriers had limited security
features, were expensive and did not adequately ensure accurate and reliable
transmission. As a result, many corporations established private networks to
provide network-based services, such as transaction processing, to their
customers and to coordinate operations between employees, suppliers and
business partners. These private networks were frequently customized and thus
had the capability of providing organizations and users with tailored
performance, security, reliability and private-label branding. As the demand
for private networks has grown, there has been an increase in intranet
services and virtual private networks ("VPNs"), which combine the security of
a private network and the cost efficiencies of a public network.
Despite the benefits of private networks, they still have limitations that
reduce their effectiveness. These networks require leased telephone lines,
dedicated bandwidth and vendor-specific networking equipment. As a
49
result, such networks are inherently expensive. The Combined Company believes
that the costs of maintaining a private network infrastructure and the risks
of investing in new technologies have precluded many small- and medium-sized
businesses from utilizing private networks, VPNs and intranet infrastructures.
The emergence of the Internet and the widespread adoption of internet
protocol ("IP") as a data transmission standard, combined with deregulation of
the telecommunications industry and advances in telecommunications technology,
have significantly increased the attractiveness of providing data
communications over a public network. At the same time, the growth in
client/server computing, multimedia personal computers, on-line computing
services and network technologies has resulted in a large and growing group of
people who are accustomed to using networked computers for a variety of
purposes, including e-mail, electronic file transfers, on-line computing and
electronic financial transactions. These trends increasingly have led
businesses to explore opportunities to provide IP-based applications and
services within their organizations and to customers and business partners
outside the enterprise. The ubiquitous nature and relatively low cost of the
Internet have resulted in its widespread usage for certain applications, most
notably Internet access and electronic mail. However, use of the Internet for
mission-critical business applications has been impeded by the limited
security and unreliable performance inherent in the structure and management
of the Internet. Therefore, there is a market opportunity to offer a service
combining the best features of the Internet with the security of private
networks. The Combined Company intends to address this need with its business
grade Internet services.
Industry analysts expect the market size for both enhanced IP data services
and Internet access to continue to grow rapidly as businesses and consumers
increase their use of the Internet, intranets, and privately managed IP
networks. Industry sources project total Internet service provider ("ISP")
enhanced services revenue alone to grow from $197.8 million in 1996 to
approximately $11.4 billion in the year 2000, reaching average annual growth
of approximately 175.6% during that period.
Regulatory Environment. In a deregulated telecommunications market such as
the United States, carriers have multiple options for providing
telecommunications access to their customers. Carriers can establish switching
facilities, own or lease fiber optic cable or enter into operating agreements
with foreign carriers. In markets that have not deregulated or are slowly
deregulating, international long-distance carriers have used advances in
technology to develop innovative alternative access methods, such as call-
reorigination and other less regulated enhanced voice and data services. In
other countries, such as Japan and most European Union ("EU") member states,
where the deregulation process is more advanced but not complete, carriers
often are permitted to offer facilities-based data and facsimile services, as
well as limited voice services. As countries deregulate telecommunications
services, the market for alternative access methods typically becomes more
competitive as ITO's and other providers are permitted to offer a wider range
of facilities-based services on a more cost-competitive basis.
Call-reorigination, which is the most common form of alternative
international access, avoids the high international rates charged by the ITO
in a particular regulated country by providing a dial tone from a deregulated
country, typically the United States. To place a call using traditional call-
reorigination, a user dials a unique phone number to an international
carrier's switching center and then hangs up. The user then receives an
automated call back providing a dial tone from the United States, which
enables the user to complete the call using U.S. telecommunications
infrastructure. Technical innovations such as inexpensive dialers have enabled
telecommunications carriers to offer a newer, more advanced form of call-
reorigination (referred to as "transparent call-reorigination") that makes the
call-reorigination mechanics transparent to the customer. In addition, in-
country switching platforms have enabled carriers to offer "call-through"
services, allowing the customer direct access to a provider's network without
the need to reoriginate the call in the U.S.
The Combined Company believes that as deregulation occurs and competition
increases in markets around the world, the pricing advantage of call-
reorigination to most destinations will diminish relative to call-through
international long-distance service. The Combined Company also believes that
deregulation will continue to create opportunities for new entrants in
telecommunications services, particularly companies capable of meeting the
challenges presented by emerging telecommunications markets.
50
World Trade Organization Agreement. On February 15, 1997, pursuant to the
WTO Agreement, which became effective on February 5, 1998, 69 members of the
WTO, including the United States, agreed to open their respective
telecommunications markets to competition and foreign ownership, and to
protect market entrants against anticompetitive behavior by dominant
telecommunications providers. By eroding the traditional monopolies held by
ITOs, many of which are wholly or partially government owned, implementation
of the WTO Agreement will allow U.S.-based providers the opportunity to
negotiate more favorable agreements with both ITOs and other providers in
emerging telecommunications markets. 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 carry international long distance traffic originating in those countries.
BUSINESS STRATEGY
The Combined Company's objective is to become a leading provider of enhanced
telecommunications services in markets that historically have been underserved
by large telecommunications providers and ITOs. The Combined Company's
strategy to accomplish this objective includes the following key elements:
Increase Penetration of Emerging Telecommunications Markets. The Combined
Company markets its services in emerging telecommunications markets that
typically have less developed telecommunications infrastructures, are in an
earlier stage of deregulation and have historically faced less competition
from larger telecommunications providers. The Combined Company believes that,
due to the more monopolistic distribution profile of these markets, customers
traditionally have been underserved and consequently are more receptive to
higher quality, competitively priced services. The Combined Company believes
that its experience in offering call-reorigination, combined with its
strategic marketing relationships and proprietary technologies, will enable
the Combined Company to more effectively penetrate these markets and provide
more sophisticated and higher margin telecommunications services.
Pursue and Implement Strategic Acquisitions. The Combined Company intends to
actively pursue and execute strategic acquisitions of complementary
international customer bases, products and infrastructure. GlobalTel and ITC
are its first significant acquisitions. Management believes the worldwide
telecommunications industry will continue to undergo a period of strong
consolidation activity due to the savings associated with larger operations.
The Combined Company intends to actively pursue those customer bases, products
and infrastructure that fit its strategy of providing high quality, state-of-
the-art telecommunications services. Except for the GlobalTel Merger and the
ITC Acquisition agreements in principle, the Combined Company has no
agreements, arrangements or understandings for any acquisitions as of the date
of this Prospectus.
Exploit Strategic Marketing Relationships and Sales Channels. In addition to
its over 170 independent sales agents, the Combined Company has access to
channels of distribution through its strategic marketing relationships.
Management expects that its relationships with IBNET and Novell will enhance
the Combined Company's ability to expand its customer base as well as
establish new relationships with independent ISPs and other network providers
in its target markets. The Combined Company believes that it can most
effectively increase its customer base and revenue by recruiting independent
sales agents. The Combined Company will be able to recruit independent sales
agents because of its advanced technology, its focus on high volume customers
and its emphasis on quality service.
Leverage Customer Base Through Enhanced Service Offerings. The Combined
Company has developed and is introducing additional telecommunications
services. To retain existing customers and attract new customers, the Combined
Company plans to increase its range of services to include enhanced voice and
data services and a suite of business grade Internet services. Most of these
services can be provided under the existing regulatory frameworks in the
Combined Company's markets. In addition, as regulatory and competitive
environments evolve and the availability of capital permits, the Combined
Company intends to migrate its call-reorigination customers, including its
enhanced service customer base, to a more cost effective call-through service.
51
Employ Flexible, Open Architecture and Proprietary Technology. By using off-
the-shelf technology that is modular, scalable and allows for the integration
of a variety of technologies, the Combined Company expects to provide its
customers with enhanced services in a timely and cost-efficient manner. The
Combined Company is committed to continue to invest in improvements in its
electronic billing, customer interface and network management systems, all of
which are critical to its delivery of services. The Combined Company also uses
proprietary call processing technologies that enable it to provide quality
telecommunications services to high volume customers. The Combined Company
intends to expand its offering of CSI's proprietary DIAL and LINK-US
transparent call processing systems and to market such systems to customers of
GlobalTel and ITC.
Increase Sales to Carriers and Resellers; Reduce Transmission Costs.
Utilizing its enhanced telecommunications infrastructure and combined carrier
transmission rates, the Combined Company intends to substantially increase its
carrier and reseller business. In expanding this business, the Combined
Company intends to leverage its extensive relationships and contacts among
telecommunications carriers and resellers. In addition to expected increases
in revenue, the related growth in transmission volume should also improve the
Combined Company's ability to negotiate preferential rates with its carriers.
The Combined Company also intends to utilize additional point-to-point private
lines, access IP and other data networks to process compressed voice and data
telecommunications traffic, and employ alternate telecommunications solutions
such as "call-through" to further reduce its overall transmission costs.
Capitalize on GlobalTel and ITC Synergies. The Combined Company anticipates
that the GlobalTel Merger and the ITC Acquisition will provide operating
synergies and efficiencies. In addition to integrating networks of independent
sales agents and infrastructure and increasing sales to carriers and
resellers, the Combined Company will seek to introduce new enhanced services
such as call-through, enhanced fax and business-grade Internet services. The
Combined Company also will have the opportunity to cross-market CSI's
proprietary DIAL and LINK-US systems to the 17,000 existing customers of
GlobalTel and ITC and to take advantage of the new business opportunities
provided by GlobalTel's strategic relationships and business grade Internet
services.
SERVICES
The Combined Company seeks to address the evolving telecommunications needs
of customers located in emerging telecommunications markets. Currently, the
Combined Company offers international long-distance services, calling cards,
and enhanced voice and data services such as voice-mail, conference calling
and enhanced fax services. As changes in regulatory environments and the
availability of capital permits, the Combined Company intends to migrate its
call-reorigination customers and its enhanced service customer base to a more
cost effective call-through service.
The Combined Company believes that the growing globalization of business has
increased the mobility of business people and led to the proliferation of
multi-office enterprises, creating greater demand for convenient access to
electronic information from remote locations worldwide. As a result, the
Combined Company is designing and implementing a range of business grade
Internet services. The Combined Company expects these services to include
business quality messaging, global enhanced VPNs and other enhanced services.
GlobalTel also is designing a comprehensive "Turnkey Business ISP" solution
that incorporates all of the Combined Company's business grade Internet
services. "Turnkey Business ISP" is designed for independent ISPs and other
network providers in the Combined Company's target markets. These service
offerings are being designed to emphasize authentication, security and
notification. The following tabulates the Combined Company's current services
and services under development:
CURRENT SERVICES SERVICES UNDER DEVELOPMENT
---------------- --------------------------
International Call-Reorigination Call-Through
(Transparent and Non-transparent) Enhanced Fax
Carrier Reselling Global Enhanced VPN
Prepaid Calling Cards Business Quality Messaging
Enhanced Voice Services Global Desktop
Hotel Operator Services and Other Hotel Serv-
ices "Turnkey Business ISP"
Facsimile Services
52
Current Services
International Call-Reorigination. The largest segment of the Combined
Company's business is call-reorigination services. Call-reorigination service
involves connecting 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 rather than the
charges of the ITO. The Combined Company believes that the quality of the
calls made using the Combined Company's call-reorigination system is as good
as, if not better than, the quality obtained by using the ITO. The Combined
Company provides two basic types of call-reorigination: non-transparent and
transparent. To place a call using non-transparent call-reorigination, a
customer dials a unique phone number to an international carrier's switching
center and then hangs up. The customer then receives an automated call back
providing a dial tone from the United States, which enables the customer to
complete the call using U.S. telecommunications infrastructure. As of the date
of this Prospectus, approximately 89.1% of the Combined Company's customers
use non-transparent call-reorigination services. Customers who use non-
transparent call-reorigination typically are individuals or smaller businesses
that do not require the convenience and speed of transparent call-
reorigination.
Transparent call-reorigination involves the transmission of an international
call via a processor at the customer's site and one of the Combined Company's
switches in Ft. Lauderdale, Florida or Los Angeles, California. The switch
automatically connects the call to the caller's dialed destination. When
customers use the Combined Company's transparent call-reorigination service,
the call-reorigination mechanics are transparent to the customer. CSI has
developed advanced proprietary call processors called "DIAL" and "LINK-US."
When used with standard triggering methods and commercially available call
processing devices, DIAL and LINK-US provide transparent access to the
Combined Company's call-reorigination system. These systems are more expensive
than non-transparent call-reorigination systems and are typically installed in
hotels and businesses that have PBX telephone systems and require fast,
reliable, high-volume service. Less expensive systems are available for small
businesses and other customers desiring transparent call-reorigination. These
systems initiate all reorigination through global data networks, such as X.25,
Internet and frame relay, and local network digital services such as
Integrated Services Digital Networks (ISDN). 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, Hong Kong and New Zealand in the near future. The
Combined Company is able to quickly adapt its call processors to virtually any
type of customer requirement, providing extremely fast and reliable service.
CSI estimates that approximately 10.9% of the Combined Company's traffic is
currently routed through transparent call processors. The Combined Company has
installed approximately 200 DIAL and five LINK-US as well as approximately 200
other transparent call processors at various hotels and businesses.
Transparent call processors are proposed to be installed in several additional
hotels and businesses in Brazil, Argentina, South Africa and Hong Kong. The
Combined Company intends to focus its future sales and marketing efforts
toward recruitment of hotels and businesses that will use the Combined
Company's transparent call-reorigination service.
Carrier Reselling. The Combined Company resells its international long-
distance services to other telecommunications carriers on a wholesale basis.
The Combined Company intends to expand such services and anticipates that the
additional traffic from carrier resale customers will enable it to negotiate
more favorable rates with its carriers.
Prepaid Calling Cards. The Combined Company recently launched prepaid card
services to its customers worldwide. The Combined Company's prepaid domestic
and international calling cards may be used by customers for international
telephone calls from more than 70 countries. Calling card customers also have
access to 24-hour multi-lingual customer service and certain customization
options.
Enhanced Voice Services. The Combined Company offers enhanced voice
services, consisting of voice-mail and conference calling. Conference calling
enables customers to set up "meet me" dial-in conference calls
53
as well as add-on conference calls, with or without operator intervention.
Conference calling has a higher margin than the Combined Company's basic voice
services. The Combined Company's services also enable customers to originate
international voice calls over the Internet by allowing call-reorigination
service to be activated from their PCs.
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 a 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 any international
long-distance revenue from such "dial around" calls. In order to market and
expand its hotel operator services, the Combined Company intends to share a
percentage of its revenue from operator services with the hotel. The Combined
Company also intends to offer a variety of other services to hotel customers,
including transparent call-reorigination, facsimile, Internet access, voice-
mail and debit card services.
Facsimile Services. The Combined Company offers its customers the ability to
send high-speed international facsimiles over its network. The Combined
Company also intends to offer transmission of facsimiles via the Internet or
private data networks. The Combined Company has redundant, dedicated T-1
access to the Internet to enhance this service. The Combined Company intends
to use a portion of the proceeds of this offering to implement and expand
these services.
Services Under Development
The Combined Company is developing the following new services:
Call-Through. The Combined Company will offer call-through or "direct
access" service to customers in selected markets where current regulations and
local market access charges make call-reorigination less competitive than
call-through. Call-through service involves the installation of an access
point in the local market that is connected to one of the Combined Company's
switches by a dedicated long-distance line that is leased from a carrier or
other network operator. The international customer accesses this connection to
the Combined Company's switch either by dialing a local telephone number or,
in markets where the regulatory environment permits, through an
interconnection with the ITO.
Enhanced Fax. The Combined Company's enhanced fax service, currently being
tested in Hong Kong and Mexico City, uses advanced technology to provide
customers with a higher quality and less expensive method to send facsimile
messages than conventional analog fax. Unlike conventional analog fax service,
enhanced fax service: (i) results in significantly fewer transmission errors,
particularly with international transmissions, because it is transmitted over
a digital data network; (ii) is easier to use than conventional fax, with a
feature that will retransmit the fax until it is successfully received at its
destination; and (iii) is much less expensive because it can be sent as a
digital packet in a shorter period of time. A recent study conducted by Pitney
Bowes/Gallup found that international faxes transmitted over analog phone
lines are transmitted twice on average due to interruptions and quality
problems, creating a hidden cost for users. Other features of the enhanced fax
offering include commercial-grade broadcast fax, fax on demand (or "fax
catalog") and timed delivery.
In the first half of 1998, the Combined Company plans to install an
Internet-based fax service to its fax gateway in Los Angeles, California. This
service will allow customers with Internet access to send faxes to any fax
machine worldwide and to any Internet-based e-mail address.
Business Grade Internet Services. The Combined Company is developing a suite
of enhanced services that will permit business-grade communications utilizing
Internet technologies. The Combined Company expects these business grade
Internet services to include: (i) Global Enhanced VPN, (ii) Business Quality
Messaging, (iii) Global Desktop and (iv) "Turnkey Business ISP." These
services will combine the best features of the Internet, such as openness,
easy access and low cost, with the advantages of a private network, such
54
as high security and customized features. The Combined Company believes its
services will overcome many of the perceived inefficiencies of today's
Internet and will allow its customers to conduct business quality transactions
via the Combined Company's network infrastructure.
The Combined Company, in conjunction with Novell and other technology
providers, is developing business grade Internet services. In addition,
GlobalTel has become a Novell Business Internet Services ("BIS") partner, an
affiliation that the Combined Company believes will further enhance its
service delivery strategy and provide it access to certain key networking
technologies. Other BIS partners include AT&T, Bell Atlantic Corporation,
Nippon Telegraph and Telephone Corporation, Deutsche Telecom AG, Singapore
Telecommunications Limited Corporation and Korea Telecom. See "--Network and
Operations" and "--Sales and Marketing."
Global Enhanced VPN. The Combined Company's Global Enhanced VPN service
enables customers to establish a wide area network among several locations
by using the Combined Company's network infrastructure, thereby eliminating
the cost associated with establishing and maintaining a dedicated private
network. For example, a U.S.-based user in Hong Kong would dial a local
number to access his or her wide area network in the United States and
could then work on the network in the United States in accordance with the
user's normal access privileges. The Combined Company's VPN service will be
enhanced through the use of a commercial-grade directory infrastructure and
certain certification and security mechanisms. Global Enhanced VPN enables
electronic commerce by providing the user with controlled, managed and
secure access to its VPN for customers, vendors and business partners.
Business Quality Messaging. The Combined Company's Business Quality
Messaging ("BQM") service will enable customers to exchange messages, faxes,
e-mail or voice-mail in a secure and reliable manner via the Combined
Company's network infrastructure. BQM also will allow companies to connect
dissimilar mail systems. These features can be customized to enable the
Combined Company to provide different levels of service based on customer
requirements and to price such service levels accordingly.
Global Desktop. The Global Desktop product will combine the Global
Enhanced VPN, BQM and additional features targeting the global business
traveler. Specifically, it will permit the user to access and exchange
electronic information from public switched or wireless telephone networks
worldwide.
"Turnkey Business ISP." The Combined Company believes that the great
majority of regional ISPs need to offer additional enhanced services to
remain competitive, but have insufficient resources to develop these
services internally. According to an August 1997 report by Business
Research Group, 77% of all ISPs in the United States were regional ISPs,
83% of which lacked out-of-region access and therefore were required to
develop their own billing and tracking systems. The Combined Company is
designing a comprehensive turnkey service solution for regional ISPs that
will include its business grade Internet services. This "Turnkey Business
ISP" solution will enable regional ISPs to access the Combined Company's
suite of enhanced services and, when available, voice-over-IP.
Completion of Services Under Development. The Combined Company has not
generated significant revenue from its enhanced services to date. The new
services described above are still under development and are not scheduled for
implementation until various times in 1998 or later. Also, the completion of
development and introduction of new services will require the investment of
significant operating capital. Of the net proceeds from this offering,
$300,000 have been allocated to the development and introduction of these new
services. It is not uncommon that the introduction of new telecommunications
services is delayed or is occasioned by technical problems.
SALES AND MARKETING
The Combined Company's telecommunications services are marketed and sold
through a network of independent sales agents, strategic relationships and
direct marketing efforts.
Independent Sales Agents
In selling its retail services, the Combined Company employs a network of
over 170 independent sales agents that sell to customers located in over 170
countries, supplemented by direct marketing efforts. Independent
55
sales agents are recruited through advertising in the Combined Company's
target markets and by referrals from customers and industry contacts. The
Combined Company's agreements with its independent sales agents typically are
non-exclusive and require the independent sales agents to offer the Combined
Company's services at rates prescribed by the Combined Company in accordance
with the Combined Company's policies. The Combined Company's ten largest
independent sales agents accounted for 68.6% of the Combined Company's pro
forma revenue for the 12 months ended December 31, 1997. See "Risk Factors--
Dependence on Independent Sales Agents."
Strategic Relationships
The Combined Company intends to leverage its strategic marketing
relationships to expand its customer base. In particular, the Combined Company
expects that its relationship with IBNET and its access to a select number of
Novell's network of over 25,000 VARs will facilitate additional contact with
many small- and medium-sized domestic business customers, foreign branch
offices of large multinational corporations and local ISPs.
IBNET
IBNET is the managing member of the Consortium for Global Commerce, which
represents thousands of individual chambers of commerce (the "Chambers") in
over 200 countries. The Consortium for Global Commerce was established to (i)
create a global intranet enabling the Chambers and their members to exchange
information and conduct business transactions electronically, and (ii) obtain
more favorable pricing and terms for certain products and services for such
members.
The Consortium's four member organizations are the International Chambers of
Commerce, the Paris Chamber of Commerce and Industry, the G77 (a non-
governmental organization comprised of 137 developing countries and China) and
IBNET, the managing partner of the Consortium. The Combined Company believes
that its relationship with the Consortium, through GlobalTel's agreement with
IBNET, will enhance its ability to establish relationships with regional ISPs
and expand its customer base in its target markets.
In April 1997, GlobalTel entered into a ten-year marketing agreement with
IBNET to provide the Chambers and their members with telecommunications
services including international voice, international fax, calling card
services, Internet services, intranet, VPN and messaging. The individual
Chambers may act as sales and marketing agents for GlobalTel's, and
ultimately, the Combined Company's services. IBNET has agreed to market
GlobalTel's services to the Chambers by promoting GlobalTel services in
Consortium literature, at Consortium trade shows and speaking engagements, and
by listing the Combined Company's services in the Consortium's databases. In
November 1997, the Consortium launched its marketing campaign to inform the
Chambers about available products and services, including GlobalTel's
services. Under its agreement with IBNET, the Combined Company also will have
the right to co-brand its services with the Chambers' trademarks, a feature
that the Combined Company believes will enhance its marketing and sales
efforts because the local chamber brand is typically well recognized and held
in high regard by local business communities. Following execution of the
agreement, Ronald P. Erickson, who will serve as Chairman of the Board of the
Combined Company, and Bruce L. Crockett and Lyman C. Hamilton, who will serve
as Directors of the Combined Company, were invited and accepted offers to
serve as Directors of IBNET.
Novell
In October 1997, GlobalTel entered into a three-year technology licensing
agreement with Novell that provides the Combined Company with access, and
support in marketing, to Novell's over 25,000 VARs. Novell VARs range from
small computer networking companies to large system integration firms. The
Combined Company, in conjunction with Novell, intends to create a
certification program for channel partners with respect to the Combined
Company's product offerings. In addition, GlobalTel has become a Novell BIS
partner. Other BIS partners include Deutsche Telecom AG, Bell Atlantic
Corporation, Nippon Telegraph and Telephone Corporation and Singapore
Telecommunications Limited. BIS partners have agreed upon standards for
interconnecting their respective Internet networks. The Combined Company
believes that its status as a BIS partner will allow it to benefit from any
future network connections among the BIS partners.
56
Direct Sales
The Combined Company has a direct sales force of ten individuals. The direct
sales force is responsible for agent recruitment and development, retail and
wholesale sales and development of high volume corporate accounts. The
Combined Company plans to expand the existing direct sales force, which will
enable it to take advantage of its strategic marketing relationships, expand
its carrier resale business, and develop additional relationships with
regional ISPs and other network providers.
Customer Service
The Combined Company provides its customers, independent sales agents and
resellers with high-quality customer service. As of January 31, 1998, the
Combined Company employed ten customer service representatives in Seattle,
Washington and ten customer service representatives at the Combined Company's
switching facility in Ft. Lauderdale, Florida. The Combined Company intends
ultimately to concentrate its customer service functions in Ft. Lauderdale.
The customer service center operates 24 hours a day, seven days a week and
offers support in over five languages.
CUSTOMERS
As of March 31, 1998, the Combined Company's customer base consisted of more
than 25,500 customers in over 170 countries. The Combined Company believes
that its customers prefer its service compared to the ITO's service for the
following reasons: (i) lower international, and in some cases intra-country,
telephone rates; (ii) increased system reliability and call completion rates;
(iii) improved line quality, with less echo, static and snow; and (iv)
available and responsive customer service support.
In addition to selling directly to customers, the Combined Company also
sells its reorigination service on a wholesale basis to resellers and long-
distance carriers. The Combined Company believes that long-distance services,
when sold to resellers and other carriers, are generally a commodity product
with the purchase decision based primarily on price. Although the margins on
sales to other carriers and resellers are lower than the margins on sales to
business and government customers, these sales involve lower operating
expenses and help the Combined Company optimize the use of its network and
reduce its overall carrier transmission costs. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Overview."
Business and Government Customers
The Combined Company's geographically diversified business and government
customers include: foreign offices of multinational corporations, major
international hotels and embassies and international agencies. Among these
customers are:
FOREIGN OFFICES OF
MULTINATIONAL CORPORATIONS INTERNATIONAL HOTELS EMBASSIES AND INTERNATIONAL AGENCIES
- -------------------------- ---------------------- ------------------------------------
Nike, Inc. Holiday Inn Hotels(11) U.S. Embassy in Chile
Microsoft Corporation InterContinental Hotel U.S. Embassy in Korea
Mitsubishi Corporation Copacabana Palace U.S. Embassy in Australia
Chrysler International Marina Hotel U.S. Embassy in Ukraine
Warner-Lambert Corporation Caesar Park Hotel UN Consulate in South Africa
Diners Club International
DHL Aviation
Wal-Mart Stores, Inc.
Citibank, N.A.
Bank of Tokyo
Royal Bank of Canada
57
Resellers
The Combined Company sells its reorgination service to resellers on a
wholesale basis. These resellers purchase service in bulk at a discounted rate
for resale to their customers. Resellers are responsible for billing their
users and for providing customer service. Resellers may sell the Combined
Company's services to their customers under their own company's name. The
Combined Company can prepare bills for resellers or resellers can prepare
their own bills based on information provided by the Combined Company.
Resellers, rather than the Combined Company, are responsible for collecting
amounts due from the customers. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Carriers
The Combined Company's carrier customers are long-distance companies that
purchase the Combined Company's excess international long distance capacity on
a wholesale basis for their own use. These carriers purchase service in bulk
at a discounted rate for resale to their customers. The carriers are
responsible for billing their customers and for providing customer service.
The Combined Company currently provides these services to four carrier
customers that are based in the United States.
NETWORK AND OPERATIONS
The Combined Company provides its telecommunication services through its (i)
voice switching and global fax messaging infrastructure in Los Angeles,
California, and Ft. Lauderdale, Florida, (ii) access to third party
infrastructure through international telecommunications carriers and through
Equant, and (iii) enhanced fax nodes in Hong Kong and Mexico City. By using
off-the-shelf technology, which is modular and scalable and allows for the
integration of a variety of technologies, the Combined Company expects to be
able to provide its customers with enhanced services in a timely and cost-
efficient manner. The Combined Company is committed to investing in
improvements in its electronic billing, customer interface and network
management systems, which the Combined Company believes are critical to its
delivery of services. The Combined Company expects these systems to provide it
with the ability to quickly upgrade its customers from a single service to
multiple services.
International Network Switching Center--Los Angeles, California. GlobalTel's
switching center is located at One Wilshire Boulevard, Los Angeles,
California, the West Coast's principal telecommunications gateway. Most major
carriers have a switching facility at this location. In 1997, GlobalTel
upgraded its switching center to provide fiber optic access for GlobalTel to
all major carriers in the facility. As a protective measure, GlobalTel has
diversified its access to long-distance providers through contracts with
various local access providers supplying redundancy in the event of single
point failures.
At this facility GlobalTel uses two Summa Four voice switches that are
controlled by a real-time rating, billing and switching platform. This
switching platform provides enhanced voice telecommunications services and has
sufficient capacity to accommodate customer growth. GlobalTel also leases a
portion of a Northern Telecom DMS 250 tandem switch, which is connected to the
Summa Four switching platform to support GlobalTel's carrier traffic.
GlobalTel's switching center also houses a fax gateway switching platform with
e-mail to fax conversion capability and software for enhanced service
features, including fax broadcasting, fax on demand and fax mail.
International Network Switching Center--Ft. Lauderdale, Florida. ITC's
switching center is located in Ft. Lauderdale, Florida, which is
interconnected to the Miami gateway to the Latin American, African and
European telecommunications markets. The switching center consists of a
billing and provisioning system and two 1000 port class 4 tandem switches. The
switches are designed to handle international call-reorigination,
international and domestic long-distance and debit card traffic. The inbound
and outbound traffic is cross-connected to eight telecommunications carriers
via a DS3 fiber optic line. ITC uses NACT switches, billing platform and
interactive voice response ("IVR").
The Combined Company has recently added voice recognition, fax functions and
Internet and X.25 triggering to the switching center. These features enable
the Combined Company to offer transparent call-
58
reorigination and call-through services, daily agent reports via the Internet
and automated credit card debiting. An additional feature under development is
customer provisioning via the World Wide Web. The Combined Company's customers
are able to access its switches in any one of 12 languages.
Redundancy. The Combined Company's operations center will be in Ft.
Lauderdale, Florida, which has redundant computer systems and fiber optics.
The Combined Company believes that redundancy gives it enhanced service
reliability, which gives it an advantage compared to many of the Combined
Company's smaller competitors that do not have redundant systems. In addition,
the Combined Company's redundant system architecture allows the flexibility to
take individual computers off line intentionally for scheduled maintenance,
upgrades and enhancements.
Fax Nodes--Hong Kong and Mexico City. GlobalTel leases and operates two fax
nodes in Hong Kong and Mexico City that are co-located in Equant's network
facilities. The nodes are serviced and maintained by Equant on a 24-hour basis
and are interconnected to local access providers. The Combined Company intends
to deploy fax nodes in additional locations during 1998.
Carriers and Network Access. The Combined Company has resale agreements with
a number of long-distance carriers in order to obtain the best available
pricing and service on certain routes. The Combined Company's enhanced fax and
business-grade Internet services will be carried through Equant's global data
network. GlobalTel's Los Angeles switching center is connected to the Equant
network center through high-speed fiber optic circuits. The Combined Company's
switching nodes have the ability to select quality and least cost routes,
depending on the quality of service desired by the customer.
The Combined Company relies on major telecommunications carriers including
AT&T, Sprint, WorldCom Cable & Wireless and Teleglobe to provide service to
its customers. Carrier costs constitute the largest portion of the Combined
Company's variable costs. The Combined Company has entered into contracts to
purchase capacity from various domestic and foreign carriers. Pursuant to
these contracts, the Combined Company obtains rates, which are generally more
favorable than otherwise would be available. To obtain these rates, the
Combined Company commits to purchase minute minimums from such carriers. If
the Combined Company fails to meet its minute minimums 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 $550,000, which represent
approximately 23.5% of the Combined Company's average monthly cost of revenue
for the 12 months ended December 31, 1997. Because of the frequent
fluctuations of long distance carriers' rates, the Combined Company believes
that it is in its best interest to have short-term carrier agreements. Most of
the Combined Company's carrier agreements 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 periodically
attempts 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. 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--Dependence on Carriers and Other Suppliers" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
COMPETITION
General
The Combined Company faces a high level of competition for customers and
independent 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
59
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 resulting in
a lower relative cost structure. There can be no assurance that the Combined
Company will be able to compete successfully against new or existing
competitors.
Inasmuch as the Combined Company believes that competition for customers and
independent sales agents is based primarily on price, transmission quality,
services offered and the ability of the supplier to "bundle" various
telecommunications services, the U.S.-based providers of international long
distance service typically set pricing, quality, service, and standards that
the Combined Company seeks to match or exceed. 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 of the Combined Company, or if
competitors are able to offer other incentives to existing and potential
customers and independent 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 offer rates lower than
those of ITOs. A decrease in arbitrage spreads between U.S.-based
international calling rates and ITO rates could have a material adverse effect
on the Combined Company's business, financial condition and 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, the Combined Company could suffer a
reduction of revenue and profits that could have a material adverse effect on
the Combined Company's business, financial condition and results of
operations.
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 worldwide 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 hold a significant
stake in telecommunications companies in the countries that are parties to the
WTO Agreement, and (iii) the ability to take advantage of these opportunities
within a framework of pro competitive 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
Historically, the large U.S. long distance carriers have been reluctant to
compete directly with ITOs by entering the international call-reorigination
business. AT&T and others, are beginning to enter 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, International Telecom, Ltd.(Kallback), Justice
Technology Corporation, Telegroup, Inc., USA Global Link, Inc., UTG
Communications International, Inc., Viatel, Inc. and Worldpass Communications
Corp. as well as providers of traditional long distance services such as AT&T,
Cable & Wireless, Frontier Corp., GTE Communications, LCI International, Inc.,
MCI, Qwest Communications International, Inc., Sprint, WorldCom and RBOCs that
provide long distance services outside their exchange territories.
60
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; 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 Communications 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 ITOs generally have certain competitive
advantages due to their control over local connectivity and their 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 calls 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 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 to such a degree that customers are no longer
willing to use the Combined Company's international call-reorigination
services.
TECHNOLOGY
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 transparent call-
reorigination to occur when interconnected with PBX's of hotels, large
businesses and other high volume customers. As of December 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, restrictions or
financial penalties whatsoever regarding its 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 utilizes a
unique combination of X.25 and Internet triggering technologies interconnected
with commercial PBX environments. The Combined Company plans to emphasize the
installation of its Enhanced DIAL system, which can support the same volume of
traffic as 64 of the Basic DIAL systems. The Combined Company's Basic DIAL
61
system is an entry-level system that is installed to facilitate transparent
call-reorigination for smaller companies. The Basic DIAL system is also
capable of utilizing X.25 and Internet triggering, but is commonly used in
locations that do not currently have X.25 or Internet access.
The LINK-US system is a PC-based automated call processing system designed
to link an internationally located PBX to the CSI switching center. Its design
includes multiple call processing redundancies to insure rapid call
completion, real time billing, and other enhanced features including voice
prompts and remote programming capability. For a description of the license
agreement relating to the LINK-US technology see "Management--Consulting
Agreement."
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 uses X.25 triggering technology in its call-
reorigination system. The Combined Company provides X.25 triggering in
Argentina and Brazil and plans to provide it in any locality where it has
several high volume customers.
In countries with underdeveloped telecommunications systems, it can be
difficult and time consuming to make an international phone call. With X.25
triggering technology up to 100% of the trigger calls to the Combined
Company's switch are transmitted out of the country and nearly 100% of the
call-reorigination calls are transmitted into the country. The combination of
X.25 triggering technology with a DIAL or LINK-US switch provides a highly
reliable telecommunications service that is especially appealing to hotels and
business owners. See "--Services."
By utilizing 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 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 Associated with International Operations."
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 Brazil, Argentina,
Venezuela, South Africa and Lebanon. It intends to install Internet triggering
in Singapore, Hong Kong and New Zealand. CSI has found that call-
reoriginations using Internet triggering usually take four to six seconds and
are nearly 100% effective.
INTELLECTUAL PROPERTY
GlobalTel owns U.S. Registration No. 1,944,078 for the mark PRIMECALL for
reselling long-distance telecommunications services. GlobalTel has filed
applications in the national trademark offices of Australia, Hong Kong and
Japan and in the regional European Community trademark office to register the
service mark PRIMECALL. GlobalTel filed an Intent to Use with the Patent and
Trademark Office for the mark "GLOBALTEL." There can be no assurance that the
Combined Company's trademark applications will result in any registration
being issued, or that such registration will be held valid and enforceable if
challenged. The Combined Company currently does not hold any trademark
registrations for the marks CS GLOBALTEL, GLOBALTEL, DIAL or LINK-US.
The Combined Company is aware of a pending U.S. application by Cellnet
Corporation ("Cellnet") to register the mark GLOBALTEL for providing
international wireless telephone communication services on a temporary basis.
The Combined Company believes that GlobalTel may have commenced using the mark
GLOBALTEL before Cellnet and is assessing whether to oppose Cellnet's
application. The Combined Company is also aware that Interactive Media
Technologies, Inc. is doing business in the area of international callback
services under the trade name GlobalTel. There can be no assurance that the
Combined Company's use of the
62
mark GLOBALTEL will continue unimpeded or the Combined Company's measures to
protect its intellectual property will deter or prevent the unauthorized use
of the Combined Company's intellectual property. The Combined Company could
incur substantial costs and diversion of management resources relating to the
enforcement of its intellectual property rights. In addition, if the Combined
Company is unable to adequately protect its intellectual property, including
existing service marks and trademarks, there could be a material adverse
effect on the Combined Company's business, financial condition and results of
operations.
The Combined Company does not have an intellectual property protection
program and does not hold any patents or copyrights. 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
information.
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.
These regulations are often based on the informal views of the local
ministries which, in some cases, are subject to influence by ITOs. 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 34 countries have notified the
FCC that they have declared certain call-reorigination services illegal. The
Combined Company's services in such countries comprised approximately 10.6% of
its revenue for the 12 months ended December 31, 1997. The Combined Company
generates a significant portion of its revenue from customers originating
calls in Europe, the Middle East, South Africa and South America. In the event
that countries in these regions that now permit call-reorigination prohibited
the Combined Company's services or regulated the pricing or profit levels of
such services, the Combined Company's business, financial condition and
results of operations 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 it is unlikely that the
FCC would rescind the Combined Company's authority to provide call-
reorigination, such action by the FCC would have a material adverse effect on
the Combined Company's business.
To facilitate the Combined Company's expansion plans, it may deploy
additional switching facilities to be located in a number of countries. As a
result, the Combined Company may be directly subject to regulation in an
increasing number of countries. 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--
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. 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
63
will not raise material issues with regard to the Combined Company's
compliance with existing or future regulations.
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-four 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 34 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, any of which could have a material adverse effect on the
Combined Company's business, financial condition and results of operations.
EMPLOYEES AND CONSULTANTS
As of March 31, 1998, CSI had 18 full-time employees and two consultants;
GlobalTel had 28 full-time employees; and ITC had 18 full-time employees and
two consultants. The Combined Company plans to hire additional employees and
consultants as may be required to support expansion of the Combined Company's
operations and independent 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.
PROPERTIES
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. CSI
pays approximately $10,720 per month for such space. See "Certain
Transactions."
GlobalTel leases approximately 4,800 square feet of office space for its
headquarters and operations center at 1520 Eastlake Avenue East, Seattle,
Washington 98102 under a lease that expires on December 31, 1998 and requires
monthly payments of $5,850. In addition, GlobalTel leases approximately 1,500
square feet of space in Los Angeles, California, for switch equipment under a
lease that expires on June 30, 2006 and requires monthly payments of $5,040.
ITC leases approximately 2,310 square feet for its executive offices at 290
Pratt Road, Meriden, Connecticut 06450 at a rate of approximately $2,380 per
month. ITC leases approximately 1,027 square feet for its switching center at
110 East Broward Boulevard, Suite 610, Ft. Lauderdale, Florida 33301 at a rate
of approximately $4,225 per month.
64
In the opinion of management, each of the properties is adequately covered
by insurance and is suitable for each of such properties' current and intended
future uses. Following completion of the offering, the Combined Company
intends to evaluate and may sub-lease certain properties in order to optimize
operating efficiencies.
LEGAL PROCEEDINGS
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 addition, in the ordinary course of business, the Combined Company may
become a party to legal proceedings, the outcome of which, singly or in the
aggregate, is not expected to be material to the Combined Company's business,
financial condition and results of operations. The Combined Company intends to
aggressively pursue collection of debts, including those owed by a former
independent sales agent in Singapore.
65
MANAGEMENT
OFFICERS AND DIRECTORS
The following table contains the name, age and position with the Combined
Company of each executive officer and director of the Combined Company as of
the date of this Prospectus.
NAME AGE POSITION WITH THE COMBINED COMPANY
---- --- ----------------------------------
Ronald P. Erickson...... 54 Chairman of the Board (upon completion of the
GlobalTel Merger)
Robert A. Spade......... 51 Chief Executive Officer and Vice
Chairman of the Board (upon completion of the
GlobalTel Merger)
Patrick R. Scanlon...... 52 President, Chief Operating Officer and
Director
Daniel R. Hudspeth...... 35 Chief Financial Officer and Treasurer
German F. H. Burtscher.. 39 Vice President
Philip A. Thomas........ 55 Vice President and General Manager (upon completion
of the ITC Acquisition)
Dean H. Cary............ 49 Director
Richard F. Nipert....... 41 Director
Charles A. Shields...... 53 Director
Bruce L. Crockett....... 53 Director (upon completion of the GlobalTel Merger)
Lyman C. Hamilton....... 71 Director (upon completion of the GlobalTel Merger)
Michael S. Brownfield... 57 Director (upon completion of the GlobalTel Merger)
Officers are appointed by and serve at the discretion of the Board of
Directors. Each director holds office until the next annual meeting of
shareholders or until a successor has been duly elected and qualified. All of
the Combined Company's officers devote full-time to the Combined Company's
business and affairs.
Ronald P. Erickson has served as Chairman of the Board, President, Chief
Executive Officer and a Director of GlobalTel since January 1996 and will
serve as Chairman of the Board of the Combined Company following the GlobalTel
Merger. From August 1994 to January 1996, he was Managing Director of
Globalvision L.L.C., an international strategic consulting firm. From
September 1992 to August 1994, he served variously as Chairman and Vice
Chairman of the Board, President and Chief Executive Officer of Egghead
Software, Inc., a retailer of software and computer peripheral products. He
was also the co-founder and a director of Microrim, Inc., a database software
developer from November 1981 to May 1992. Currently, he is a director of ITEX
Corporation, a trading and financial services company, Westower Corporation, a
wireless communications company, Intrinsyc Software, Inc., a developer of
software tools and components and IBNET. Mr. Erickson received a B.A. degree
from Central Washington University, an M.A. degree from the University of
Wyoming and a J.D. from the University of California, Davis, School of Law.
Robert A. Spade has been the Chairman of the Board since March 1994 and
CSI's Chief Executive Officer since January 1995. Upon completion of the
GlobalTel Merger, Mr. Spade will become Vice Chairman of the Board. 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. 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 is a director of MedPlus Corporation, a company that operates a workers'
compensation medical clinic
66
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. Mr. Spade received a Masters degree from the Johns Hopkins
School of Advanced International Studies and B.A. degree from University of
California, Santa Barbara 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 CSI 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 received an M.S. degree in Finance from the
UCLA Graduate School of Management and a B.A. degree in Economics from the
University of California, Santa Barbara.
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 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 received his B.S. degree in Business Administration from
Colorado State University.
German F. H. Burtscher has served as GlobalTel's Senior Vice President,
Marketing and Sales since February 1997 and served as its Vice President,
Strategic Marketing and Product Development from October 1995 to February 1997
and will serve as a Vice President of the Combined Company following the
GlobalTel Merger. In January 1995, he co-founded Ratsten International
Telecommunications, Inc., a telecommunications services provider, and served
as its President until October 1995. He also served as Regional Sales Manager
and Senior Account Executive of World Call Telecommunications, a long distance
telephone carrier, from June 1992 to January 1995. Mr. Burtscher received a
B.A. degree in Business and Sociology from the University of Austria,
Innsbruck and an M.B.A. degree in Finance and International Marketing from the
University of Austria, Graz.
Philip A. Thomas will become Vice President and General Manager of CSI upon
the closing of this offering. Mr. Thomas was a co-founder and has 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 (England) College of
Technology.
Dean H. Cary has been a director of CSI since January 1997. Since November
1995 he has served as Executive Director and President 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 received a B.A. degree in Business, Education and
Psychology from the University of Minnesota.
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
67
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 received a J.D. degree from the University of Southern California and a
B.A. degree in Social Ecology from the University of California at Irvine.
Charles A. Shields has been a director of CSI since April 1998. Since March
1996, Mr. Shields has served as President of Charles A. Shields and
Associates, Inc., a human resources consulting firm. From October 1989 until
March 1996, he served as Senior Vice President of Human Resources and
Administration for Manor Care, Inc., a holding company for Choice Hotels,
International and Manor Care Health Services. From 1965 until 1987, Mr.
Shields held various positions for the Walt Disney Company including Vice
President of Administration and Human Resources for Walt Disney Imagineering,
Inc. He received a B.S. degree in Business and Marketing from California State
University at Long Beach.
Bruce L. Crockett has served as a Director of GlobalTel since September 1997
and will serve as a Director of the Combined Company following the GlobalTel
Merger. From February 1992 to July 1996, he served as President, Chief
Executive Officer and a Director of COMSAT Corporation, a global
telecommunications company. He is also a director, chairman of the
compensation committee and member of the audit committee of ACE Limited, a
multi-link insurance company, a director and trustee of mutual funds managed
by AIM Management Group Inc., a mutual fund company and a director of IBNET.
Mr. Crockett received an A.B. degree in Geography from the University of
Rochester, a B.S. degree in Accounting from the University of Maryland and an
M.B.A. degree in Finance from Columbia University.
Lyman C. Hamilton has served as a Director of GlobalTel since November 1997
and will serve as a Director of the Combined Company following the GlobalTel
Merger. He also served as President and Chief Executive Officer of
Interdigital Communications Corporation from 1994 to 1995. Prior to that, Mr.
Hamilton served as Chairman of the Board from 1993 to 1994, and as President
and Chief Executive Officer from 1991 to 1993, of Alpine Polyvision, Inc., a
developer of flat panel displays. Mr. Hamilton was employed by ITT Corporation
from 1962 to 1979 where he served as President from 1977 to 1979 and as Chief
Executive Officer in 1978 and 1979. Currently, he is a director of Marine
Management Systems, Inc., a provider of shipboard hardware and software
management systems, Scan-Optics, Inc., a provider of optical character
recognition equipment, Polyvision Inc., a provider of visual display equipment
and developer of flat panel displays and IBNET. Mr. Hamilton received a B.A.
degree from Principia College and an M.P.A. degree from Harvard University.
Michael S. Brownfield has served as a Director of the GlobalTel since
January 1996 and will serve as a Director of the Combined Company following
the GlobalTel Merger. Mr. Brownfield, a private investor, is also a director
of NW Cascade Inc., a construction service and supply company, Cutter & Buck,
Inc. a men's apparel company, and Accurate Molded Plastics Inc., a plastics
manufacturer. Mr. Brownfield received a B.S. degree from the University of
Oregon.
BOARD COMMITTEES
The Board of Directors maintains a Compensation Committee and an Audit
Committee. The Compensation Committee, consisting of Messrs. Shields, Nipert
and Hamilton, reviews compensation and option matters and makes
recommendations to the Board regarding changes in executive compensation. The
Audit Committee, consists of Messrs. Crockett, Nipert and Cary. The function
of the Audit Committee is to review and approve financial policies and
practices and the scope of audit procedures employed by the Combined Company's
independent auditors, review and approve the audit reports rendered by the
Combined Company's independent auditors and approve the audit fee charged by
the independent auditors. The Audit Committee reports to the Board of
Directors with respect to such matters and recommends the selection of the
independent auditors.
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.
68
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 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
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.
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.
Ronald Fox has served as GlobalTel's Senior Vice President since October
1997, as President of GlobalTel's subsidiary, Primecall, Inc., since September
1997, and as a Director of GlobalTel since December 1997. From January 1994 to
February 1997, he served as Vice President of Hi Rim Communications, Inc., an
international facilities-based telecommunications carrier. In April 1997,
subsequent to Mr. Fox's resignation as an officer, Hi Rim Communications, Inc.
filed a petition under the federal bankruptcy laws in the United States
Bankruptcy Court for the District of Nevada. From June 1988 to March 1994, he
served as President of Ronald B. Fox & Associates, a telecommunications
consulting firm. From 1983 to 1988, Mr. Fox served as National Sales Director
of CMI Corporation. From 1981 to 1983, he served as President of National Tel
Data Corporation. Mr. Fox received an A.S. degree in Business Marketing from
Lansing Community College.
Brian Louviere has served as GlobalTel's Chief Technology Officer since
February 1998. Until 1998, Mr. Louviere previously served as Director, Service
Delivery and Customer Care for Pacific Bell Network Integration. From 1991 to
1996, Mr. Louviere served in various positions with Pacific Bell including
Senior Product Manager. From 1979 to 1990, he served in various marketing and
product development positions at BT Tymnet. He received a B.S. degree in
computer science and mathematics from McNeese State University.
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 received a B.S. degree in Finance from Utah State
University in 1983 and has earned graduate credits in telecommunications from
the University of Denver.
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 received 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.
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 A. Thomas.
69
CONSULTING AGREEMENT
CSI has entered into a consulting agreement with Gary Kamienski, who
developed the LINK-US technology for CSI. Pursuant to Mr. Kamienski's
agreement, dated September 19, 1996, Mr. Kamienski transferred the LINK-US
switch technology to the Combined Company. The Combined 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 Combined Company's gross
revenue related to LINK-US. The Combined Company has the option to buy out the
royalty for an amount equal to the greater of $2.5 million or three times the
aggregate royalty payments for the first 12 months of the agreement. In
addition, for each installation of LINK-US, the Combined Company has agreed 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 will remain in effect for as long as the LINK-US technology is
operational or 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 Mr. Kamienski's
royalties. 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 ten years or the period of time the Combined Company is
utilizing the LINK-US technology.
EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth certain
compensation awarded to, earned by or paid to CSI's Chief Executive Officer
(the "Named Executive Officer"). No other executive officer of CSI received
annual salary and bonus exceeded $100,000 in the year ended December 31, 1997.
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
AWARDS
ANNUAL ------------
COMPENSATION SECURITIES
------------- UNDERLYING ALL OTHER
NAME AND POSITION YEAR SALARY BONUS OPTIONS COMPENSATION
----------------- ---- ------- ----- ------------ ------------
Robert A. Spade
Vice-Chairman and Chief Executive
Officer.......................... 1997 $90,374
1996 67,500
1995 41,000
70
Option Grants Table
The following table contains information concerning stock option grants made
to the Named Executive Officer during the year ended December 31, 1997. See
"--Stock Option Plan" for information relating to vesting and exercise terms.
OPTION GRANTS IN YEAR ENDED DECEMBER 31, 1997
INDIVIDUAL GRANTS
-----------------------------------------
NUMBER OF % OF TOTAL POTENTIAL REALIZABLE
SECURITIES OPTIONS EXERCISE VALUE AT ASSUMED
UNDERLYING GRANTED TO PRICE ANNUAL RATES OF STOCK
OPTIONS EMPLOYEES PER EXPIRATION PRICE APPRECIATION FOR
NAME GRANTED IN 1997 SHARE DATE OPTION TERMS(1)
---- ---------- ---------- -------- ---------- -----------------------
5% 10%
----------- -----------
Robert A. Spade......... 20.1 8/29/07
- --------
(1) Potential gains are net of the exercise price but before taxes associated
with the exercise. The 5% and 10% assumed annual rates of compounded stock
appreciation are mandated by the rules of the Securities and Exchange
Commission and do not represent the Combined Company's estimate or
projection of the future Common Stock price. Actual gains, if any, on
stock option exercises are dependent on the future financial performance
of the Combined Company, overall market conditions and the option holders'
continued employment through the vesting period.
Option Values. The following table contains information concerning options
to purchase Common Stock held by the Named Executive Officer as of December
31, 1997. The Named Executive Officer did not exercise any stock options
during 1997.
1997 YEAR-END OPTION VALUES
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
DECEMBER 31, 1997 (#) DECEMBER 31, 1997 ($) (1)
------------------------------------ -------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- --------------- ---------------- ----------- -------------
Robert A. Spade......... -- -- --
- --------
(1) Options are "in the money" if the fair market value of the underlying
securities exceeds the exercise price of the options. The exercise prices
for all options granted to the Named Executive Officer was equivalent to
the fair market value of the Common Stock of the Combined Company, as
determined by the Board of Directors, as of December 31, 1997.
71
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No member of the Compensation Committee was an officer, former officer or
employee of CSI, GlobalTel, ITC or their subsidiaries or had any relationship
with such companies of the type requiring disclosure in "Certain
Transactions." No executive officer of the Combined Company serves as a member
of the board of directors or compensation committee of any entity which has
one or more executive officers serving as a member of the Combined Company's
Board of Directors or Compensation Committee.
EMPLOYMENT AGREEMENTS
The Combined Company has entered into employment agreements with each of
Messrs. Spade, Scanlon and Hudspeth (collectively, the "Executives") for a
term of one year. The employment agreements will provide for an annual salary
of $150,000, $140,000 and $110,000 for Messrs. Spade, Scanlon and Hudspeth,
respectively. The Combined Company may terminate the Executives employment
only for cause (as defined in the related agreement). The Executives may also
be entitled to receive bonuses pursuant to any cash bonus plan adopted by the
Board of Directors. Pursuant to the employment agreements, each Executive will
agree not to compete with the Combined Company for a period of three years
following termination of his employment. The Combined Company anticipates
entering into employment agreements with Messrs. Erickson, Burtscher and Fox
effective upon completion of the GlobalTel Merger. Upon the completion of the
ITC Acquisition, CSI will enter into one year employment agreements with
Philip A. 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 Combined Company for a period of six months
following termination of the respective agreements. The Combined Company
intends to establish a cash bonus plan with an aggregate of less than $100,000
prior to completion of the offering.
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 the Stock Option 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 to any one
individual to be exercisable for the first time in any one calendar year 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 Stock Option
Plan is 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.
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 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 the Stock Option Plan. Options
may not be transferred other than by will and the laws of descent and
distribution.
72
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 modify or terminate the
Stock Option Plan, 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 Stock Option Plan, if any, change
the qualification of its members, or withdraw the Stock Option Plan 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 Stock Option Plan; increase the number of shares for
which an option is exercisable to any one employee; extend the term of the
Stock Option Plan or the maximum option periods; decrease the minimum exercise
price; or materially increase the benefits accruing to participants in the
Stock Option Plan.
73
PRINCIPAL SHAREHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Combined Company's Common Stock as of March 31, 1998 assuming
completion of the GlobalTel Merger and as adjusted to reflect the sale of the
Common Stock offered by this Prospectus, by (i) each person who is known by
the Combined Company to own beneficially more than 5% of the Combined
Company's outstanding Common Stock, (ii) each of the Combined Company's
executive officers and directors, and (iii) all executive officers and
directors as a group. Common Stock not outstanding but deemed beneficially
owned by virtue of the right of an individual to acquire shares within 60 days
are treated as outstanding only when determining the amount and percentage of
Common Stock owned by such individual. Except as noted, each person has sole
voting and investment power with respect to the shares shown. Unless otherwise
indicated, the address of each person listed is the Combined Company's
address, 8 South Nevada Avenue, Colorado Springs, Colorado 80903.
SHARES BENEFICIALLY
OWNED PRIOR TO OFFERING PERCENTAGE
-------------------------- OWNED AFTER
NAME AND ADDRESS NUMBER(1) PERCENT OFFERING
---------------- ------------ ----------- -----------
DIRECTORS AND EXECUTIVE OFFICERS:
Ronald P. Erickson(2)................
Robert A. Spade(3)...................
Patrick R. Scanlon(4)................
Daniel R. Hudspeth...................
Philip A. Thomas(5)..................
Dean H. Cary(6)......................
71 Burnwood Lane
Upper Saddle River, NJ 07458
Richard F. Nipert(7).................
1140 Grant Street, Suite 100
Denver, CO 80203
Charles A. Shields...................
Bruce L. Crockett(8).................
Lyman C. Hamilton....................
Michael S. Brownfield(9).............
All directors and executive officers
as a group (11 persons)(10).........
OTHER SHAREHOLDERS:
James L. Williams(11)................
123 Vientos Road
Camarillo, CA 93010
Steven S.V. Wong(12).................
20 Queen Astrid Park
Singapore 266824
DuPont Ltd.(13)......................
20 Queen Astrid Park
Singapore 266824
PBIG-GTR Partners L.P.(14)...........
- --------
* Less than 1%.
(1) Shares outstanding before offering include Bridge Shares to be issued
immediately prior to this offering and shares of Common Stock issued
in connection with the GlobalTel Merger.
(2) Includes shares of Common Stock issuable upon conversion of
outstanding warrants, shares of Common Stock issuable upon the
cashless conversion of outstanding warrants, shares of Common Stock
issuable upon exercise of options, and shares of Common Stock held by
North
74
Willow Family L.P., a limited partnership in which Mr. Erickson and his two
daughters are partners. See "Certain Transactions."
(3) Includes shares held of record by Mr. Spade or his spouse and
shares are issuable upon exercise of options held by Mr. Spade.
(4) Includes shares issuable upon exercise of options.
(5) Excludes shares Mr. Thomas will receive on the first anniversary of
the closing of this offering in connection with the ITC Acquisition.
(6) Includes shares issuable upon exercise of options.
(7) Includes shares issuable upon exercise of options.
(8) Includes shares of Common Stock issuable upon exercise of options and
shares of Common Stock issuable upon closing of the offering in
connection with a GlobalTel Full Coverage Note in the principal amount of
$25,000. See "Description of Securities."
(9) Includes shares of Common Stock issuable upon exercise of outstanding
warrants, shares of Common Stock issuable upon exercise of options,
shares of Common Stock issuable upon the closing of the offering in
connection with a GlobalTel Full Coverage Note in the principal amount of
$25,000 and shares of Common Stock issuable upon conversion of a
promissory note in the principal amount of $150,000, plus accrued
interest as of January 31, 1998. See "Certain Transactions."
(10) Includes shares issuable upon exercise of options.
(11) Includes shares issuable upon exercise of warrants.
(12) Includes shares of Common Stock issuable upon exercise of options,
shares of Common Stock issuable upon the closing of the offering in
connection with a bridge loan promissory note in the original principal
amount of $20,000 that has been repaid, shares of Common Stock
issuable upon the cashless conversion of outstanding warrants held by
Dupont Ltd., shares of Common Stock issuable upon the cashless
conversion of outstanding warrants held by Trans-Pacific Consultants Pte
Ltd., shares of Common Stock issuable upon the cashless conversion of
outstanding warrants held by Gereg Capital Corporation and shares of
Common Stock held by Gereg Capital Corporation. Also includes shares
of Common Stock issuable upon conversion of $1,000,000 in principal, plus
accrued interest as of January 31, 1998, pursuant to a promissory note
held by Dupont Ltd. See "Certain Transactions." Mr. Wong is Chairman and
a 50 percent owner of Dupont Ltd. and is Chairman and a controlling
shareholder of Gereg Capital Corporation and Trans-Pacific Consultants
Pte, Ltd.
(13) Includes shares of Common Stock issuable upon the cashless conversion
of outstanding warrants and shares of Common Stock issuable upon
conversion of a $1,000,000 in principal, plus accrued interest as of
January 31, 1998, pursuant to a promissory note held by Dupont Ltd. See
"Certain Transactions."
(14) Includes shares of Common Stock issuable upon exercise of outstanding
warrants, shares of Common Stock issuable upon the cashless conversion
of outstanding warrants and shares of Common Stock issuable upon
conversion of two outstanding promissory notes in the aggregate principal
amount of $1,070,000, plus accrued interest as of January 31, 1998. See
"Certain Transactions." PBIG-GTR Partners is controlled by Kenneth Huang.
Mr. Huang's address is 20987 Fairwoods Drive, Cupertino, CA 90541.
75
CERTAIN TRANSACTIONS
CSI
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 A. Spade purchased approximately 80% of
Redden's outstanding common stock in May 1995 from certain shareholders of
Redden for $34,500. Mr. Spade was a principal shareholder, director and
President of Redden and was a principal shareholder, Chief Executive Officer,
President and Chairman of CSI prior to the merger. 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 Mr. Nipert ( shares) and Mr. Scanlon ( shares).
CSI has received periodic advances from Robert A. Spade. In April 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 under the note 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 A. 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.
Certain 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 A. Spade. Robert A. 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."
In January 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 each case in consideration of business
consulting services.
In March and April 1998, CSI issued $320,000 aggregate principal amount of
10% Notes. For each $10,000 principal amount of 10% Notes, the holder received
warrants to purchase shares of Common Stock at an exercise price equal to
the closing bid price on the date of the 10% Notes. Three CSI directors
invested in the notes, including: Richard F. Nipert, who was issued a $40,000
10% Note and granted warrants; Charles A. Shields (and his wife Mary Jo
Shields), who was issued a $50,000 10% Note and granted warrants; Dean H.
Cary, who was issued a $100,000 10% Note and granted warrants. James L.
Williams, was also issued a $40,000 10% Note and granted warrants.
76
In December 1997, Robert A. Spade and Patrick R. Scanlon each guaranteed up
to $750,000 of the amounts due on the Bridge Notes in connection with the
December 1997 Financing.
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.
GLOBALTEL
In December 1995, GlobalTel acquired GFP Group. Inc. ("GFP") through the
issuance of shares of GlobalTel common stock in a one-for-one
exchange for all of the outstanding capital stock of GFP. Pursuant to this
transaction, North Willow Family L.P., a limited partnership in which Ronald
P. Erickson, GlobalTel's Chairman, President and Chief Executive Officer, and
his two daughters are limited partners, was issued shares of GlobalTel
common stock; and Sirius International Communications, a general partnership
in which German F. H. Burtscher, GlobalTel's Senior Vice President, Marketing
and Sales, and Frank Krentzman, a director and former Senior Vice President of
GlobalTel, were the sole partners, was issued shares of GlobalTel
common stock. In connection with the acquisition, GlobalTel also agreed to
issue to each of Messrs. Burtscher and Krentzman shares of GlobalTel
common stock, and to grant Mr. Erickson an option to purchase shares
of GlobalTel common stock, all conditioned upon GlobalTel obtaining certain
financing as determined by GlobalTel's Board of Directors. Additionally,
GlobalTel assumed GFP's obligations under employment agreements with Messrs.
Erickson and Burtscher. By mutual consent of the parties, the terms of these
employment agreements were never performed.
In December 1995, as part of GlobalTel's acquisition of GFP, GlobalTel
assumed GFP's obligations under two demand promissory notes totaling $70,000
that are payable to Michael S. Brownfield, who will become a director of the
Combined Company upon completion of the GlobalTel Merger, both bearing
interest at a rate of 10% per annum, increasing to 12% per annum when the
notes are past due. Both of these notes are secured by a pledge of certain
shares of GFP stock held by GlobalTel. In connection with the assumption of
these notes, GlobalTel also issued to Mr. Brownfield a warrant to purchase for
nominal consideration shares of GlobalTel common stock. Concurrently
therewith, GlobalTel sold to Mr. Brownfield shares of GlobalTel common
stock for a purchase price of $ per share and granted Mr. Brownfield a
warrant to purchase shares of GlobalTel common stock at an exercise
price of $ per share.
In November 1995, Gereg Capital Corporation ("Gereg") purchased
shares of GlobalTel common stock from GlobalTel for a purchase price of $
per share. In consideration of this purchase of GlobalTel common stock,
GlobalTel granted Gereg a warrant to purchase shares of GlobalTel
common stock. The warrant has an exercise price of $ per share and expires
on December 29, 1998. Stephen S.V. Wong, a director of GlobalTel, is Chairman
and a controlling shareholder of Gereg.
In April 1997, GlobalTel entered into an Exclusive Services and Marketing
Agreement with IBNET. See "Business--Sales and Marketing." Pursuant to this
agreement, GlobalTel granted to IBNET a warrant to purchase shares of
GlobalTel common stock, and will grant additional warrants if GlobalTel
reaches certain revenue targets. The warrants all have an exercise price of
$ per GlobalTel share and expire three years from the date of grant.
GlobalTel also agreed to pay IBNET certain fees based upon a percentage of
GlobalTel's gross margin for services purchased by customers referred to
GlobalTel by IBNET. In return, IBNET agreed to issue to GlobalTel 100,000
shares of common stock of IBNET. Bruce L. Crockett, Ronald P. Erickson and
Lyman C. Hamilton are directors of IBNET, and each holds options to purchase
50,000 shares of IBNET's common stock. In addition, Mr. Hamilton owns 100,000
shares of IBNET's common stock (or approximately 2% of IBNET's total
outstanding common stock).
77
GlobalTel has issued convertible promissory notes and GlobalTel Full
Coverage Notes in connection with loans by several directors and executive
officers of GlobalTel, including Messrs. Erickson and Brownfield. For a
description of the terms of these notes, see "Description of Securities--
Description of Indebtedness." The following table describes promissory notes
issued by GlobalTel to persons who will become directors or executive officers
of the Combined Company and to Stephen S. V. Wong and his affiliates and PBIG-
GTR Partners L.P., each of which will hold more than 5% of the Combined
Company's outstanding Common Stock after completion of the offering and the
GlobalTel Merger. See "Principal Shareholders."
NAME DATE OF LOAN PRINCIPAL AMOUNT MATURITY
---- ------------ ---------------- --------
Michael S. Brownfield............... 10/95 $ 50,000(2)(11) 1/96
11/95 20,000(2)(11) 2/96
2/96 100,000(1)(2) 2/97
4/96 300,000(1)(2) 4/97
10/97 150,000(1) 3/99
11/97 25,000(3) (4)
Ronald P. Erickson.................. 6/96 150,000(1)(5) 6/97
ITEX Corporation (/6/).............. 12/97 200,000(3) (4)
Gereg Capital Corporation........... 10/96 150,000(1)(7) 10/97
Dupont Ltd.(/8/).................... 11/96 500,000(1)(9) 5/98
4/97 2,000,000(1) 12/99
PBIG-GTR Partners, L.P.............. 12/96 900,000(1)(10) 6/98
3/97 400,000(10) 6/98
- --------
(1) Convertible note. See "Description of Securities--Description of
Indebtedness--GlobalTel Convertible Notes."
(2) In November 1997, Mr. Brownfield agreed to convert $235,000 in principal
plus interest accrued thereon owed under past due promissory notes into
shares of common stock of GlobalTel. Mr. Brownfield also agreed to
reschedule an additional $235,000 in principal plus accrued interest owed
under past due promissory notes into this new note.
(3) GlobalTel Full Coverage Note. See "Description of Securities--Description
of Indebtedness--GlobalTel Full Coverage Notes."
(4) See "Description of Securities--Description of Indebtedness--GlobalTel
Full Coverage Notes." In consideration of the above loans, GlobalTel
granted warrants to purchase GlobalTel common stock or, in the case of the
GlobalTel Full Coverage Notes, the right to receive shares of GlobalTel
common stock maturing upon closing of the offering.
(5) In November 1997, Mr. Erickson converted 171,805 in principal and accrued
interest under this note into shares of GlobalTel common stock.
(6) A company of which Ronald P. Erickson is a director.
(7) This note was repaid in full in May 1997.
(8) Stephen S.V. Wong is chairman and a 50% owner of this company.
(9) In September 1997, Dupont Ltd. converted the full amount of principal and
accrued interest under the note into shares of GlobalTel common stock.
(10) In September 1997, PBIG-GTR Partners, L.P. converted a $30,000 principal
amount of the $900,000 note and $200,000 principal amount of the $400,000
note into shares of GlobalTel common stock.
(11) Demand note.
The following table describes the warrants issued or GlobalTel shares
issuable by GlobalTel to persons who will become directors or executive
officers of the Combined Company and to Stephen S.V. Wong and his affiliates
and PBIG-GTR Partners L.P., each of which will hold more than 5% of the
Combined Company's outstanding Common Stock after completion of the offering
and the GlobalTel Merger.
WARRANTS/GLOBALTEL ISSUE
NAME SHARES DATE EXERCISE PRICE EXPIRATION DATE
---- ------------------ ----- -------------- ---------------
Michael S. Brownfield.......................
Ronald P. Erickson..........................
ITEX Capital Corporation....................
Gereg Capital Corporation...................
Dupont Ltd..................................
Trans-Pacific Consultants Pte. Ltd..........
PBIG-GTR Partners, L.P......................
78
The following table shows the amounts outstanding under GlobalTel notes to
the foregoing persons as of March 31, 1998 and the amounts that will be
outstanding after giving effect to the application of the net proceeds of this
offering. See "Use of Proceeds."
OUTSTANDING
PRINCIPAL AMOUNT
-------------------
BEFORE AFTER
NAME OFFERING OFFERING
---- ---------- --------
Michael S. Brownfield....................................... $ 410,000 $150,000
Ronald P. Erickson.......................................... 0 0
ITEX Corporation............................................ 200,000 0
Gereg Capital Corporation................................... 0 0
Dupont Ltd.................................................. 2,000,000 0
Trans-Pacific Consultants Pte. Ltd.......................... 0 0
PBIG-GTR Partners, L.P...................................... 1,070,000 0
In November 1997, Stephen S.V. Wong loaned GlobalTel $25,000 pursuant to a
promissory note bearing interest at a rate of 10% per annum, increasing to 15%
after default. This note was repaid in full in December 1997.
Other than as set forth above, the transactions described above were on
terms that GlobalTel's Board of Directors believed to be fair to GlobalTel and
no less favorable to GlobalTel than terms that could have been obtained from
an unrelated party.
ITC
In August 1997, CSI entered into a Reciprocal Telecommunications Agreement
with ITC. In April 1998, CSI entered into an agreement with ITC and its
shareholders, Lynch Family, LLC, Sean Thomas and Philip Thomas by which CSI
will purchase all of the outstanding common stock of ITC from its
shareholders. Upon consummation of this offering and the ITC Acquisition,
Lynch Family, LLC and Messrs. Thomas and Thomas will receive an aggregate of
$3.3 million in cash and shares of Common Stock based on an assumed
initial offering price of $ per share to be issued on the first anniversary
of the closing of this offering. Furthermore, John Lynch, the manager of Lynch
Family, LLC, will enter into a one year consulting agreement with the Combined
Company under which he will receive $125,000, 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 ITC in negotiating an agreement with a carrier on behalf
of CSI.
The Combined Company has adopted a policy that future transactions between
the Combined Company and its officers, directors and 5% or more shareholders
are subject to approval by a majority of the disinterested directors of the
Combined 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 A. 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.
79
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. In March 1998, Mr. Williams loaned $40,000 to
CSI and received a note bearing interest at 10% per annum.
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."
80
DESCRIPTION OF SECURITIES
The authorized capital stock of CSI consists of 25,000,000 shares of Common
Stock, no par value per share, and 5,000,000 shares of Preferred Stock, no par
value per share.
COMMON STOCK
Upon consummation of the offering, shares of Common Stock will be issued
and outstanding (assuming no options are exercised after March 31, 1998, and
assuming the Underwriters' over-allotment option is not exercised). If the
over-allotment option is exercised in full, shares of Common Stock will be
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 CSI'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 CSI. 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
The Board of Directors has the authority, without further shareholder
approval, to issue up to 5,000,000 shares of Preferred Stock from time to time
in one or more series, to establish the number of shares to be included in
each such series, and to fix the designation, powers, preferences and rights
of the shares of each such series and the qualifications, limitations or
restrictions thereof. The issuance of Preferred Stock may have the effect of
delaying or preventing a change in control of CSI. The issuance of Preferred
Stock could decrease the amount of earnings and assets available for
distribution to the holders of Common Stock or could adversely affect the
rights and powers, including voting rights, of the holders of the Common
Stock. In certain circumstances, such issuances could have the effect of
decreasing the market price of the Common Stock. As of the closing of this
offering, no shares of Preferred Stock will be outstanding and CSI currently
has no plans to issue any 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 $2.8 million. 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 A. Spade, the Chairman and
Chief Executive Officer of CSI, and Patrick R. 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 Bridge Shares upon the closing of this offering,
based on a $ per share initial offering price. Such Bridge Shares are
offered by this Registration Statement.
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 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
81
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. In March 1998, the
note holders agreed to extend their notes until various times between June
1998 and September 1998.
GlobalTel Convertible Notes. As of January 31, 1998, promissory notes issued
by GlobalTel in the aggregate principal amount of $2.7 million convertible
into an aggregate of approximately shares of GlobalTel common stock were
outstanding. The notes generally bear interest at a rate of 10% per annum, are
for a term of 12 or 18 months and are convertible into GlobalTel common stock
under certain circumstances.
GlobalTel Full Coverage Notes. Promissory notes issued by GlobalTel in
November and December 1997 (the "GlobalTel Full Coverage Notes") in the
aggregate principal amount of $3.0 million are outstanding. These notes bear
interest at a rate of 10% per annum, increasing to 15% after default, and are
due upon the closing of this offering. In addition to repayment of principal
and interest, note holders will receive a total of shares of Common Stock
upon the closing of the GlobalTel Merger. If the offering is not completed by
July 1, 1998, noteholders have the right to receive warrants to purchase
shares of common stock equal to the principal amount of the note divided by
$ , in lieu of the shares of common stock to be issuable upon closing of the
GlobalTel Merger, warrants equal to the principal amount of the note divided
by $ . These warrants will have an exercise price of $ per share and will
expire three years from the date of grant.
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 CSI 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 Shareholders") 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 Shareholders, to file within 30 days of such demand (subject to
82
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 Shareholders are not required to
bear any expenses incurred by CSI in connection with registering the ITC
Acquisition Stock.
Following the closing of the GlobalTel Merger, the holders of approximately
shares of outstanding Common Stock and Common Stock issued upon conversion
or exercise of certain of GlobalTel's outstanding securities will be entitled
to certain rights with respect to the registration of such shares under the
Securities Act.
TRANSFER AGENT
The transfer agent and registrar for CSI's Common Stock is American
Securities Transfer & Trust, Inc.
RESCISSION OFFER
Immediately after the closing of this offering, the Combined Company intends
to commence the Rescission Offer in accordance with the federal securities
laws and the Washington Securities Act with respect to the following
securities which were issued or sold by GlobalTel from 1995 through 1997 to
approximately 40 individuals and entities who GlobalTel believes at the time
of purchase were residents of the State of Washington:
(i) an aggregate of shares of Common Stock, of which and shares were
issued at $ and $ per share, respectively (the "Cash Rescission
Stock");
(ii) an aggregate of shares of Common Stock (the "1995 Rescission Stock")
which were issued to one individual at $ per share, together with a
warrant to purchase approximately shares of Common Stock;
(iii) an aggregate of shares of Common Stock (the "Converted Note
Rescission Stock") issued upon conversion of promissory notes, together
with warrants to purchase an aggregate of approximately shares of
Common Stock delivered in conjunction with the issuance of such
promissory notes;
(iv) $350,000 in aggregate principal amount of promissory notes (the
"Rescission Notes"), together with warrants to purchase an aggregate of
approximately shares of Common Stock; and
(v) an aggregate of shares of Common Stock (the "Converted Warrants
Rescission Stock") to be issued upon the closing of this offering upon
conversion of certain warrants (the "Converted Warrants").
The Converted Warrants were originally issued to certain individuals in
conjunction with promissory notes that were subsequently converted (together
with accrued interest thereon) into shares of Converted Note Rescission Stock.
The Cash Rescission Stock, 1995 Rescission Stock, Converted Note Rescission
Stock and Converted Warrants Rescission Stock are hereinafter collectively
referred to as the "Rescission Stock." The Converted Warrants, together with
the warrants delivered in connection with the 1995 Rescission Stock, Converted
Note Rescission Stock and Rescission Notes are hereinafter collectively
referred to as the "Rescission Warrants." The Rescission Notes, the Rescission
Stock and the Rescission Warrants are hereinafter collectively referred to as
the "Rescission Securities." Following this offering the Combined Company
intends to refile a registration statement previously filed by GlobalTel
relating to the Rescission Offer.
The Combined Company believes that the Rescission Securities may have been
issued or sold in violation of the registration requirements of the Washington
Securities Act. As a precaution against potential claims by holders of
Rescission Securities, and without admitting non-compliance with the
Washington Securities Act, the Combined Company plans to offer to rescind such
prior issuances and sales by offering to repurchase the Rescission Securities
at the price paid therefor plus interest at the statutory rate of 8% per annum
from the date of purchase to the expiration of the Rescission Offer. The price
paid will be based upon the price paid for the original security purchased by
the purchaser from GlobalTel, regardless of the type of Rescission Security
currently held by the purchaser. The price paid for the Cash Rescission Stock
is $ per share with respect to shares and $ per share with respect to
shares, for an aggregate price of $1.0 million. The price
83
paid for the 1995 Rescission Stock is $ per share for an aggregate price of
approximately $500,000. The price paid for the Converted Note Rescission Stock
is equal to the principal amount of the original promissory notes related
thereto for an aggregate price of $791,000. The aggregate price paid for the
Rescission Notes is $350,000. There is no separate price for the Converted
Warrants Rescission Stock because by the terms and conditions of the
Rescission Offer, the Converted Warrants Rescission Stock must be surrendered
if the holder of the related Converted Note Rescission Stock elects to accept
the Rescission Offer with respect to its Converted Note Rescission Stock. The
aggregate accrued interest with respect to all of the Rescission Securities as
of June 30, 1998 will be approximately $397,000. If all holders of Rescission
Securities were to accept the Rescission Offer, the Combined Company would be
required to make payments aggregating approximately $3.2 million, plus the
aggregate amount of any additional interest thereon that accrues after June
30, 1998. The Rescission Offer will expire 15 days after the offer is
transmitted. The Combined Company currently expects to use a portion of the
proceeds from this offering to make payments under the Rescission Offer, if
any are required. Offerees who do not accept the Rescission Offer will
thereafter hold registered Rescission Securities under the Securities Act
which, in the case of the Rescission Stock, will be freely tradeable by non-
affiliates in the public market as of the effective date of the Rescission
Offer Registration Statement.
As of the date hereof, management is not aware of any claims for rescission
against GlobalTel or the Combined Company. Also, current and former officers
and directors of GlobalTel holding an aggregate of $1.4 million (including
statutory interest accrued thereon as of February 28, 1998) of the Rescission
Securities have indicated their intent not to accept the Rescission Offer,
although no formal Rescission Offer has been made to them and they have not
and may not agree to reject the Rescission Offer until the Rescission Offer
Registration Statement has been declared effective by the Securities and
Exchange Commission and the Rescission Offer has commenced. There can be no
assurance that all or a substantial portion of the Rescission Securities will
not be tendered in response to the Rescission Offer. Use of a portion of the
proceeds of this offering in connection with the Rescission Offer will reduce
the amount of working capital available to the Combined Company and may
require it to seek additional capital sooner than otherwise might be required.
The Rescission Offer is being made in order to limit, so far as may be
permitted under applicable federal and state securities laws, the potential
liability of the Combined Company with respect to the offer and sale of the
Rescission Securities. Although the Combined Company believes that the offer
and sale of the Rescission Securities were made in compliance with the
registration requirements of federal securities laws, if a holder of the
Rescission Securities were to assert a claim that the Rescission Securities
were sold in violation thereof, the position of the Securities and Exchange
Commission is that liabilities under the federal securities laws are not
terminated by making a rescission offer. Furthermore, notwithstanding the
Rescission Offer, there can be no assurance that the Combined Company will not
be subject to penalties or fines relating to past securities issuances or that
other holders of the Combined Company's securities will not assert or prevail
in claims against the Combined Company for rescission or damages under state
or federal securities laws.
84
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, CSI will have shares of Common Stock
outstanding, assuming no options are exercised after March 31, 1998 and
assuming the Underwriters' over-allotment option is not exercised. If the
Underwriters' over-allotment option is exercised in full, shares of Common
Stock will be outstanding. Of these shares, the shares sold in this
offering (and any shares sold by CSI upon exercise of the Underwriters' over-
allotment option) will be freely transferable by persons other than
"affiliates" of CSI (as that term is defined under the Securities Act) without
restriction or further registration under the Securities Act.
The remaining outstanding shares of Common Stock are "restricted
securities" within the meaning of Rule 144 under the Securities Act and may
not be sold in the absence of registration under the Securities Act unless an
exemption from registration is available, including the exemption contained in
Rule 144. All of such shares are eligible for sale under Rule 144 commencing
on or after 90 days from the date of this Prospectus. Pursuant to the terms of
the Underwriting Agreement, the Representative has required that the Common
Stock owned by officers, directors and holders of 2% or greater of the Common
Stock may not be sold until 12 months (180 days with respect to the Selling
Securityholders' Shares) from the date of this Prospectus without the prior
written consent of the Representative.
In general, under Rule 144 as currently in effect, a shareholder who has
beneficially owned shares for at least one year is entitled to sell, within
any three-month period, a number of "restricted" shares that does not exceed
the greater of 1% of the then outstanding shares of Common Stock or the
average weekly trading volume during the four calendar weeks preceding such
sale. Sales under Rule 144 are also subject to certain manner of sale
limitations, notice requirements and the availability of current public
information about CSI. Rule 144(k) provides that a shareholder who is not
deemed to be an "affiliate" and who has beneficially owned shares for at least
two years is entitled to sell such shares at any time under Rule 144(k)
without regard to the limitations described above.
In addition to the shares of Common Stock that are currently outstanding, a
total of shares of Common Stock have been reserved for issuance upon
exercise of options granted under the Option Plan, under which options to
acquire shares of Common Stock have been granted. Shares purchased
pursuant to options will be freely tradeable without restriction under the
Securities Act, except for shares held by an "affiliate" of the Combined
Company, which shares will remain subject to certain restrictions. See
"Management--Stock Option Plan."
The Combined Company is unable to estimate the number of shares that may be
sold in the future by the existing shareholders or holders of options or the
effect, if any, that sales of shares by the existing shareholders or option
holders will have on the market price of the Common Stock prevailing from time
to time. Sales of substantial amounts of Common Stock by the existing
shareholders or holders of options could adversely affect then prevailing
market prices.
85
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below, for which Cruttenden Roth Incorporated and Cohig &
Associates, Inc. are acting as the representatives (the "Representatives"),
have severally agreed to purchase from CSI the shares of Common Stock offered
hereby. Each Underwriter will purchase the number of shares set forth opposite
its name below, and will purchase the shares at the price to public less
underwriting discounts and commissions set forth on the cover page of this
Prospectus.
NUMBER
UNDERWRITER OF SHARES
----------- ---------
Cruttenden Roth Incorporated......................................
Cohig & Associates, Inc...........................................
----
Total.............................................................
====
The Underwriting Agreement provides that the Underwriters' obligations are
subject to certain conditions precedent and that the Underwriters are
committed to purchase all shares of Common Stock offered hereby (other than
those covered by the over-allotment option described below) if the
Underwriters purchase any shares.
The Representatives have advised CSI that the several Underwriters propose
to offer the shares of Common Stock in part directly to the public at the
price to public set forth on the cover page of this Prospectus, and in part to
certain dealers at the price to public less a concession not exceeding $
per share. The Underwriters may allow, and such dealers may reallow, a
concession not exceeding $ per share to other dealers. After the shares of
Common Stock are released for sale to the public, the Representatives may
change the initial price to public and other selling terms. No change in such
terms shall change the amount of proceeds to be received by CSI as set forth
on the cover page of this Prospectus. The Representatives will also receive a
nonaccountable expense allowance equal to 2.5% of the gross proceeds of the
offering including the over-allotment option, if exercised, of which $75,000
has been paid.
CSI has granted the Underwriters an option, exercisable for 45 days after
the date of this Prospectus, to purchase up to additional shares of Common
Stock at the initial price to public. The Underwriters may purchase these
shares solely to cover over-allotments, if any, in connection with the sale of
the shares of Common Stock offered hereby. If the Underwriters exercise the
over-allotment option, the Underwriters will purchase additional shares in
approximately the same proportions as those in the above table.
The Representatives have informed CSI that it does not expect any sales of
the shares of Common Stock offered hereby to be made to discretionary accounts
by the Underwriters.
The Underwriting Agreement provides that CSI and the Underwriters will
indemnify each other against certain liabilities under the Securities Act.
The Underwriters may engage in over-allotment, stabilizing transactions,
syndicate covering transactions and penalty bids in accordance with Regulation
M under the Exchange Act. Over-allotment involves syndicate sales in excess of
the offering size, which creates a syndicate short position. Stabilizing
transactions permit bids to purchase the underlying security so long as the
stabilizing bids do not exceed a specified maximum. Syndicate
86
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 member when the securities originally sold by such
syndicate member are purchased in 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 CSI 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.
CSI's officers and directors, holding in the aggregate shares of Common
Stock, have agreed not to offer, sell or otherwise dispose of any shares of
Common Stock for a period of 12 months after the date of this Prospectus
without the prior written consent of the Representatives.
CSI has also agreed to sell to the Representatives, for nominal
consideration, warrants (the "Representatives' Warrants") to purchase
shares of Common Stock. The Representatives' Warrants will be exercisable, at
a price per share equal to 120% of the initial price to public, commencing one
year from the date hereof and for a period of four years thereafter. During
the exercise period, holders of the Representatives' Warrants are entitled to
certain demand and incidental registration rights with respect to the
securities issuable upon exercise of the Representatives' Warrants. The Common
Stock issuable upon exercise of the Representatives' Warrants is subject to
adjustment in certain events to prevent dilution. The Representatives'
Warrants cannot be transferred, assigned or hypothecated for a period of one
year from the date of issuance except to Underwriters, selling group members
and their officers or partners.
Cruttenden Roth Incorporated ("Cruttenden Roth"), one of the
Representatives, provided GlobalTel with consulting, advisory and valuation
services throughout 1997 and agreed to continue to provide such services
throughout 1998 for a fee of $125,000. The fee is represented by a promissory
note due on the earlier of completion of this offering or July 1, 1999. The
note bears interest at the rate of 7% per annum. Following the completion of
the GlobalTel Merger, Cruttenden Roth will provide consulting, advisory and
valuation services to the Combined Company pursuant to the prior understanding
with GlobalTel.
In January 1998, GlobalTel entered into a letter agreement with Cruttenden
Roth (as amended, the "Letter Agreement") pursuant to which Cruttenden Roth
agreed to perform various investment banking services. The Letter Agreement
provides that, upon a change in control of GlobalTel, Cruttenden Roth will
receive a transaction fee equal to 5% of the consideration received by
GlobalTel or its shareholders (the "Transaction Fee"). Consideration is
defined by the Letter Agreement to include the cash or securities received,
the face amount of debt assumed by a purchaser, change of control compensation
and any distributions in contemplation of the change of control. Cruttenden
Roth will receive a Transaction Fee equal to $ on consummation of the
GlobalTel Merger. Other than $10,000 received as an advance, Cruttenden Roth
has not received any payments under the Letter Agreement.
The Common Stock is traded infrequently in limited quantities on the OTC
Bulletin Board under the symbol CSYG. The public offering price of the Common
Stock has been determined by arms-length negotiation between CSI and the
Representatives. There is no direct relation between the offering price of the
Common Stock and the assets, book value or net worth of CSI. Among the factors
considered by CSI and the Representatives in pricing the Common Stock were the
results of operations, the current financial condition and future prospects of
the Combined Company, the experience of management, the amount of ownership to
be retained by the existing shareholders, the general condition of the economy
and the securities markets, and the demand for securities of companies
considered comparable to CSI.
87
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon by
Parcel, Mauro & Spaanstra, P.C., Denver, Colorado. Parcel, Mauro & Spaanstra,
P.C. has represented Cruttenden Roth Incorporated from time to time in other
matters. Certain legal matters will be passed upon for the Underwriters by
Berliner Zisser Walter & Gallegos, P.C., Denver, Colorado.
EXPERTS
The financial statements of CSI as of April 30, 1996 and 1997 and for each
of the three years in the period ended April 30, 1997 included in this
prospectus, have been audited by Stockman Kast Ryan & Scruggs, P.C.,
independent auditors, as stated in their report appearing herein (which report
expresses an unqualified opinion and includes an explanatory paragraph
referring to matters that raise substantial doubt about CSI's ability to
continue as a going concern), and have been so included in reliance upon the
report of such firm given upon their authority as experts in accounting and
auditing.
The consolidated financial statements of GlobalTel as of December 31, 1996
and 1997 and for each of the three years in the period ended December 31, 1997
included in this prospectus have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their report with respect
thereto, (which report includes an explanatory paragraph concerning matters
that raise substantial doubt about GlobalTel's ability to continue as a going
concern) and are included herein in reliance upon the authority of said firm
as experts in accounting and auditing in giving said report.
The financial statements of ITC as of December 31, 1996 and October 31, 1997
and for the years ended December 31, 1995 and 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.
88
ADDITIONAL INFORMATION
CSI has filed with the Commission, a registration statement (together with
all amendments thereto, the "Registration Statement") under the Securities Act
with respect to the Common Stock of CSI offered hereby. This Prospectus, filed
as part of the Registration Statement, omits certain information contained in
the Registration Statement in accordance with the rules and regulations of the
Commission. For further information, reference is hereby made to the
Registration Statement and to the exhibits filed therewith, which may be
inspected without charge at the principal office of the Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549, and copies of the material contained
therein may be obtained from the Commission upon payment of applicable copying
charges. Statements contained in this Prospectus as to the contents of any
contract or other document referred to herein are not necessarily complete,
and in each instance reference is made to the copy of such contract or other
document filed as an exhibit to the Registration Statement.
Upon completion of this offering, CSI will be subject to the reporting and
other informational requirements of the Exchange Act and, in accordance
therewith, will file reports and other information with the Commission. Such
reports, proxy statements and other information, once filed by CSI, can be
inspected and copied at the public reference facilities maintained by the
Commission at the offices of the Commission at Room 1024, Judiciary Plaza, 450
Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's regional
offices at Northwest Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661-2511 and 7 World Trade Center, New York, New York
10048. The Commission also maintains a Web site on the Internet that contains
reports, proxy and information statements and other information regarding
issuers that file electronically with the Commission. The address of such site
is http://www.sec.gov. Copies of such materials can also be obtained by
written request to the Public Reference Section of the Commission at Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates.
89
GLOSSARY OF TERMS
access point--A location where a long-distance carrier has installed
transmission equipment in a service area that serves as, or relays calls to, a
network switching center of that long-distance carrier.
business grade Internet--An Internet network offering private network-like
security and reliability.
call-reorigination (or "call-back")--A form of dial-up access that allows a
user to access a telecommunications company's network by placing a telephone
call, hanging up, and waiting for an automated callback. The callback then
provides the user with dial tone which enables the user to initiate and
complete a call.
call-through--The provision of international long distance service through
the conventional long distance network or via an in-country switch allowing
the customer direct access to a long distance carrier's network without the
need to reoriginate the call in the United States.
co-location--The Combined Company's ability to locate the Combined Company's
network equipment at the facility of another telecommunications provider.
dedicated or direct access--A means of accessing a network through the use
of a permanent point-to-point circuit typically leased from a facilities-based
carrier. The advantage of dedicated access is simplified premises-to-anywhere
calling, faster call set-up times and potentially lower access and
transmission costs (provided there is sufficient traffic over the circuit to
generate economies of scale).
dial-up access--A form of service whereby access to a network is obtained by
dialing an international toll-free number or a paid local access number.
Equant--Equant Network Services International Corporation (formerly known as
Scitor International Telecommunications Services, Inc.), a global data network
service provider.
facilities-based carrier--A carrier which transmits a significant portion of
its traffic over its own transmission facilities.
fiber optic--A transmission medium consisting of high-grade glass fibers
through which light beams are transmitted carrying a high volume of
telecommunications traffic.
Global Enhanced VPN (Virtual Private Network)--The Combined Company's
enhanced VPN service.
IBNET--International Business Network for World Commerce and Industry, Ltd.,
the managing member of the Consortium of Global Commerce.
IDC--International Data Corporation.
intranet--A company's internal wide area network utilizing Internet
technologies.
IP--Internet Protocol.
ISP--Internet services provider.
ITO (Incumbent Telephone Operator)--The dominant carrier or carriers in each
country, often, but not always, government-owned or protected.
90
ITU--International Telecommunications Union.
LAN--Local area network. A data communications network designed to
interconnect PCS, workstations, minicomputer, file servers and other
communications and computing devices within a localized environment.
least cost routing--A method of routing long distance telephone call via the
carrier networks that offer the lowest rates.
node--A specially configured piece of telecommunications equipment which
provides the interface between the local ITO where the node is located and the
Combined Company's gateway switch. A node collects and concentrates call
traffic from its local area and transfers it to Combined Company's switch via
private line for call processing. Nodes permit the Combined Company to extend
its network into a new geographic location by accessing the local ITO without
requiring the deployment of a switch.
private line--A dedicated telecommunications connection between end user
locations.
resale--Resale by a provider of telecommunications services of services sold
to it by other providers or carriers on a wholesale basis.
switching facility--A device that opens or closes circuits or selects the
paths or circuits to be used for transmission of information. Switching is a
process of interconnecting circuits to form a transmission path between users.
VAR--Value-Added Reseller.
Value-Added Tax (VAT)--A consumption tax levied on end-consumers of goods
and services in applicable jurisdictions.
VPN--Virtual Private Network. A network capable of providing the tailored
services of private network (i.e., low latency, high throughput security and
customization) while maintaining the benefits of a public network (i.e.,
ubiquity and economies of scale).
WTO--World Trade Organization.
91
INDEX TO FINANCIAL STATEMENTS
PAGE
NUMBER
------
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
PRO FORMA COMBINED FINANCIAL STATEMENTS (UNAUDITED).................... F-2
Pro Forma Condensed Combined Balance Sheet as of December 31, 1997..... F-3
Pro Forma Condensed Combined Statement of Operations for the year ended
December 31, 1997..................................................... F-5
Notes to Pro Forma Condensed Combined Financial Statements............. F-6
HISTORICAL FINANCIAL STATEMENTS
Independent Auditors' Report........................................... F-8
Balance Sheets as of April 30, 1996 and 1997 and January 31, 1998 (un-
audited).............................................................. F-9
Statements of Operations for the years ended April 30, 1995, 1996 and
1997 and nine months ended January 31, 1997 and 1998 (unaudited)...... F-10
Statements of Shareholders' Deficit for the years ended April 30, 1995,
1996 and 1997 and nine months ended January 31, 1998 (unaudited)...... F-11
Statements of Cash Flows for the years ended April 30, 1995, 1996 and
1997 and nine months ended January 31, 1997 and 1998 (unaudited)...... F-12
Notes to Financial Statements.......................................... F-14
GLOBALTEL RESOURCES, INC.
HISTORICAL FINANCIAL STATEMENTS
Report of Independent Public Accountants............................... F-23
Consolidated Balance Sheets as of December 31, 1996 and 1997........... F-24
Consolidated Statements of Operations for the years ended December 31,
1995, 1996 and 1997................................................... F-25
Consolidated Statements of Common Stock Subject to Rescission and
Shareholders' Deficit for the years ended December 31, 1995, 1996 and
1997.................................................................. F-26
Consolidated Statements of Cash Flows for the years ended December 31,
1995, 1996 and 1997................................................... F-27
Notes to Consolidated Financial Statements............................. F-28
INTERNATIONAL TELEPHONE COMPANY
HISTORICAL FINANCIAL STATEMENTS
Report of Independent Auditors......................................... F-39
Balance Sheets as of December 31, 1996, October 31, 1997 and January
31, 1998 (unaudited).................................................. F-40
Statements of Operations for the years ended December 31, 1995 and
1996, ten months ended October 31, 1997 and three months ended Decem-
ber 31, 1996 and January 31, 1998 (unaudited)......................... F-41
Statements of Changes in Shareholders' Equity for the years ended De-
cember 31, 1995 and 1996, ten months ended October 31, 1997 and three
months ended January 31, 1998 (unaudited)............................. F-42
Statements of Cash Flows for the years ended December 31, 1995 and
1996, ten months ended October 31, 1997 and three months ended Decem-
ber 31, 1996 and January 31, 1998 (unaudited)......................... F-43
Notes to Financial Statements.......................................... F-44
F-1
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
The following unaudited pro forma condensed combined financial statements of
Communications Systems International, Inc. (CSI) have been prepared to give
effect to the completion of the proposed public offering (the Offering) and
the proposed acquisitions of GlobalTel Resources, Inc. (GlobalTel) (the
Merger) and International Telephone Company (ITC) (the Acquisition), described
below.
CSI has entered into a letter of intent with GlobalTel pursuant to which
GlobalTel will merge with CSI and CSI will issue shares of its Common Stock
for all outstanding shares of GlobalTel's preferred and common stock. The pro
forma condensed combined balance sheet as of December 31, 1997 assumes the
Merger was consummated on December 31, 1997. The pro forma condensed combined
statement of operations for the year ended December 31, 1997 assumes the
Merger was consummated on January 1, 1997.
CSI has entered into an agreement to acquire all of the stock of ITC for
$3,300,000 cash and the issuance of shares of CSI's Common Stock valued at
$2,070,000. The number of shares to be issued by CSI will be based on the
public offering per share price. The pro forma condensed balance sheet as of
December 31, 1997 assumes the Acquisition was consummated on December 31,
1997. The pro forma condensed combined statement of operations for the year
ended December 31, 1997 assumes the Acquisition was consummated on January 1,
1997.
In management's opinion, all material adjustments necessary to reflect the
transactions are presented in the pro forma adjustments as of and for the year
ended December 31, 1997 which are based upon available information and the
currently agreed upon terms of the Merger and Acquisition. The financial
statements of ITC as of and for the twelve months ended December 31, 1997 are
unaudited and are not derived from the audited financial statements of ITC as
of and for the ten months ended October 31, 1997. The pro forma condensed
combined financial statements do not purport to present CSI'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 CSI'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 CSI, GlobalTel, and ITC.
F-2
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
PRO FORMA CONDENSED COMBINED BALANCE SHEET (UNAUDITED)
DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
GLOBALTEL ITC
HISTORICAL HISTORICAL HISTORICAL PURCHASE PURCHASE RECAPITALIZATION PRO FORMA OFFERING
CSI GLOBALTEL ITC ADJUSTMENTS(A) ADJUSTMENTS(C) ADJUSTMENTS COMBINED ADJUSTMENTS
---------- ---------- ---------- -------------- -------------- ---------------- --------- -----------
ASSETS
Current assets:
Cash............ $ 429 $ 849 $ 905 $ -- $ -- $ -- $ 2,183 $24,293 (g)
(2,840)(h)
(125)(j)
(1,750)(i)
Restricted
cash............ -- -- -- -- -- -- -- 1,325 (g)
Receivables--
net............. 1,027 712 934 -- -- -- 2,673 --
Prepaid expenses
and other....... 19 106 106 -- -- -- 231 --
------- ------- ------- ------- ------ ----- ------- -------
Total current
assets 1,475 1,667 1,945 -- -- -- 5,087 20,903
Property and
equipment--net.. 484 1,372 629 -- -- -- 2,485 --
Deferred financ-
ing costs....... 450 568 -- (568) -- -- 450 (450)(h)
Deposits........ 448 -- 130 -- (225) -- 353 --
Other assets.... 118 747 -- (227) -- -- 638 (118)(g)
Distribution
channels and
customer lists.. -- -- -- 15,000 4,946 -- 19,946 --
Intellectual
property and li-
cense agree-
ment............ -- -- -- 5,000 -- -- 5,000 --
Goodwill........ -- -- -- 2,929 - -- 2,929 --
------- ------- ------- ------- ------ ----- ------- -------
TOTAL ASSETS.... $ 2,975 $ 4,354 $ 2,704 $22,134 $4,721 $ -- $36,888 $20,335
======= ======= ======= ======= ====== ===== ======= =======
PRO FORMA
AS ADJUSTED
-----------
ASSETS
Current assets:
Cash............ $21,761
Restricted
cash............ 1,325
Receivables--
net............. 2,673
Prepaid expenses
and other....... 231
-----------
Total current
assets 25,990
Property and
equipment--net.. 2,485
Deferred financ-
ing costs....... --
Deposits........ 353
Other assets.... 520
Distribution
channels and
customer lists.. 19,946
Intellectual
property and li-
cense agree-
ment............ 5,000
Goodwill........ 2,929
-----------
TOTAL ASSETS.... $57,223
===========
See notes to pro forma condensed combined financial statements.
F-3
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
PRO FORMA CONDENSED COMBINED BALANCE SHEET (UNAUDITED)
DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
GLOBALTEL ITC
HISTORICAL HISTORICAL HISTORICAL PURCHASE PURCHASE RECAPITALIZATION PRO FORMA OFFERING
CSI GLOBALTEL ITC ADJUSTMENTS(A) ADJUSTMENTS(C) ADJUSTMENTS(F) COMBINED ADJUSTMENTS
---------- ---------- ---------- -------------- -------------- ---------------- --------- -----------
LIABILITIES AND
SHAREHOLDERS' EQ-
UITY (DEFICIT)
Current liabili-
ties:
Accounts payable.. $ 930 $ 2,279 $ 2,927 $ -- $ -- $ -- $ 6,136 $ --
Accrued expenses.. 405 1,213 10 -- -- -- 1,628 --
Customer deposits
and prepayments... -- 845 -- -- -- -- 845 --
ITC acquisition
consideration..... -- -- -- -- 1,750 -- 2,623 (1,750)(i)
873
Payable to related
parties........... 243 247 -- -- -- -- 490 --
Debt to sharehold-
ers............... 274 -- 82 -- -- -- 356 (125)(j)
Capitalized lease
obligations....... -- -- 281 -- -- -- 281 --
Note payable...... 125 22 -- -- -- -- 147 --
Bridge notes pay-
able--net......... 2,045 1,995 -- -- -- -- 4,040 (2,840)(h)
795 (h)
------ -------- ------- ------- ------ ----- ------- -------
Total current
liabilities..... 4,022 6,601 3,300 -- 2,623 -- 16,546 (3,920)
------ -------- ------- ------- ------ ----- ------- -------
Long-term debt--
net............... -- 3,832 251 208 -- -- 4,291 --
------ -------- ------- ------- ------ ----- ------- -------
Deferred income
taxes............. -- -- -- 2,437 -- -- 2,437 --
------ -------- ------- ------- ------ ----- ------- -------
Common stock sub-
ject to rescis-
sion.............. -- 2,455 -- -- -- -- 2,455 --
------ -------- ------- ------- ------ ----- ------- -------
Shareholders' eq-
uity (deficit):
Series A convert-
ible preferred
stock............. -- 1,055 -- (1,055) -- -- -- --
Common stock:
CSI.............. 2,750 -- -- 11,266 -- 795 14,811 25,500 (g)
GlobalTel........ -- 2,805 -- (2,805) -- -- -- --
ITC.............. -- -- -- -- -- -- -- --
Additional paid in
capital........... -- -- 1 -- (1) -- -- --
Common stock op-
tions............. 37 -- -- -- -- -- 37 --
Obligation to is-
sue common stock.. 795 1,012 -- -- 1,251 (795) 2,263 --
Warrants.......... -- 2,152 -- -- -- -- 2,152 --
Note receivable
from shareholder.. (35) -- -- -- -- -- (35) --
Accumulated defi-
cit............... (4,351) (15,558) (848) 15,558 848 -- (7,826) (450)(h)
(3,475) (795)(h)
Treasury stock, at
cost.............. (243) -- -- -- -- -- (243) --
------ -------- ------- ------- ------ ----- ------- -------
Total sharehold-
ers' equity
(deficit)....... (1,047) (8,534) (847) 19,489 2,098 -- 11,159 24,255
------ -------- ------- ------- ------ ----- ------- -------
TOTAL LIABILITIES
AND SHAREHOLDERS'
EQUITY (DEFICIT).. $2,975 $ 4,354 $ 2,704 $22,134 $4,721 $ -- $36,888 $20,335
====== ======== ======= ======= ====== ===== ======= =======
PRO FORMA
AS ADJUSTED
-----------
LIABILITIES AND
SHAREHOLDERS' EQ-
UITY (DEFICIT)
Current liabili-
ties:
Accounts payable.. $ 6,136
Accrued expenses.. 1,628
Customer deposits
and prepayments... 845
ITC acquisition
consideration..... 873
Payable to related
parties........... 490
Debt to sharehold-
ers............... 231
Capitalized lease
obligations....... 281
Note payable...... 147
Bridge notes pay-
able--net......... 1,995
-----------
Total current
liabilities..... 12,626
-----------
Long-term debt--
net............... 4,291
-----------
Deferred income
taxes............. 2,437
-----------
Common stock sub-
ject to rescis-
sion.............. 2,455
-----------
Shareholders' eq-
uity (deficit):
Series A convert-
ible preferred
stock............. --
Common stock:
CSI.............. 40,311
GlobalTel........ --
ITC.............. --
Additional paid in
capital........... --
Common stock op-
tions............. 37
Obligation to is-
sue common stock.. 2,263
Warrants.......... 2,152
Note receivable
from shareholder.. (35)
Accumulated defi-
cit............... (9,071)
Treasury stock, at
cost.............. (243)
-----------
Total sharehold-
ers' equity
(deficit)....... 35,414
-----------
TOTAL LIABILITIES
AND SHAREHOLDERS'
EQUITY (DEFICIT).. $57,223
===========
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 YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
GLOBALTEL ITC
HISTORICAL HISTORICAL HISTORICAL PURCHASE PURCHASE RECAPITALIZATION PRO FORMA OFFERING
CSI GLOBALTEL ITC ADJUSTMENTS(B) ADJUSTMENTS ADJUSTMENTS COMBINED ADJUSTMENTS
---------- ---------- ---------- -------------- ----------- ---------------- --------- -----------
REVENUE.......... $ 12,437 $12,862 $9,962 $ -- $ -- $ -- $ 35,261 $--
COST OF REVENUE.. 7,639 11,171 8,240 -- -- -- 27,050 --
--------- ------- ------ -------- ------- -------- -------- ----
GROSS MARGIN..... 4,798 1,691 1,722 -- -- -- 8,211 --
--------- ------- ------ -------- ------- -------- -------- ----
OPERATING EX-
PENSES:
Sales and market-
ing.............. 2,557 788 878 -- -- -- 4,223 --
General and ad-
ministrative..... 3,218 7,119 1,664 -- -- -- 12,001 --
Depreciation and
amortization..... 134 253 93 -- -- -- 480 --
Amortization of
acquisition
intangibles...... -- -- -- 7,480 1,650 (d) -- 9,130 --
Acquired in-proc-
ess research and
development...... -- -- -- 3,475 -- -- 3,475 --
--------- ------- ------ -------- ------- -------- -------- ----
Total operating
expenses........ 5,909 8,160 2,635 10,955 1,650 -- 29,309 --
--------- ------- ------ -------- ------- -------- -------- ----
LOSS FROM OPERA-
TIONS............ (1,111) (6,469) (913) (10,955) (1,650) -- (21,098) --
OTHER INCOME (EX-
PENSE)--Net...... (174) (1,368) (3) 827 (178)(e) -- (831) --
65 (e)
--------- ------- ------ -------- ------- -------- -------- ----
LOSS BEFORE
INCOME TAXES AND
EXTRAORDINARY
ITEM............. (1,285) (7,837) (916) (10,128) (1,763) -- (21,929) --
INCOME TAX
BENEFIT.......... -- -- -- 2,437 -- -- 2,437 --
--------- ------- ------ -------- ------- -------- -------- ----
LOSS BEFORE
EXTRAORDINARY
ITEM............. $ (1,285) $(7,837) $ (916) $ (7,691) $(1,763) $ -- $(19,492) $--
========= ======= ====== ======== ======= ======== ======== ====
BASIC LOSS PER
SHARE BEFORE
EXTRAORDINARY
ITEM ............ $ (.13)
=========
WEIGHTED AVERAGE
SHARES OUTSTAND-
ING.............. 9,782,610
=========
PRO FORMA
AS ADJUSTED
-----------
REVENUE.......... $ 35,261
COST OF REVENUE.. 27,050
-----------
GROSS MARGIN..... 8,211
-----------
OPERATING EX-
PENSES:
Sales and market-
ing.............. 4,223
General and ad-
ministrative..... 12,001
Depreciation and
amortization..... 480
Amortization of
acquisition
intangibles...... 9,130
Acquired in-proc-
ess research and
development...... 3,475
-----------
Total operating
expenses........ 29,309
-----------
LOSS FROM OPERA-
TIONS............ (21,098)
OTHER INCOME (EX-
PENSE)--Net...... (831)
-----------
LOSS BEFORE
INCOME TAXES AND
EXTRAORDINARY
ITEM............. (21,929)
INCOME TAX
BENEFIT.......... 2,437
-----------
LOSS BEFORE
EXTRAORDINARY
ITEM............. $(19,492)
===========
BASIC LOSS PER
SHARE BEFORE
EXTRAORDINARY
ITEM ............ $
===========
WEIGHTED AVERAGE
SHARES OUTSTAND-
ING..............
===========
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 completion of the
GlobalTel Merger, the ITC Acquisition and the Offering as of December 31, 1997
for the balance sheet and (ii) the Merger, the Acquisition and the Offering as
of January 1, 1997 for the statement of operations:
PURCHASE ADJUSTMENTS
(a) Reflects the proposed acquisition of GlobalTel through the issuance of
shares of CSI's Common Stock for all the outstanding preferred and
common stock of GlobalTel, including GlobalTel's common stock subject
to rescission. The CSI Common Stock to be issued to GlobalTel's common
shareholders has been valued at an assumed public offering price of
$ per share, discounted by 30% due to trading restrictions and other
limitations on their transferability. The number of CSI's common shares
to be issued to GlobalTel's preferred shareholders has been determined
based on the liquidation value of such preferred shares. Adjustments
made to GlobalTel's assets and liabilities are based on estimates of
their fair values.
(b) Reflects the increase in amortization expense due to the amortization
of the intangible assets and the write-off of in-process research and
development recorded in the acquisition of GlobalTel. Such intangible
asset amortization assumes the following useful lives: distribution
channels and customer lists--2 to 3 years; intellectual property and
license agreement--5 to 7 years; goodwill--5 years. A deferred income
tax benefit, resulting from the generation of net operating losses
subsequent to the GlobalTel Merger and from the decreasing differences
between the book and tax bases of intangible assets, is recognized to
eliminate the deferred income tax liability. Interest expense, which
includes the amortization of debt issuance costs and debt discounts,
has been reduced as a result of the adjustment of GlobalTel's debt to
its fair value at the date of the Merger.
(c) Reflects the proposed acquisition of ITC for $5,370,000 based on
currently agreed upon terms which include: cash payments of $1,750,000
(excluding deposits of $225,000 made prior to December 31, 1997) due to
the ITC shareholders at the completion of the Offering; the commitment
to issue an estimated number of CSI Common Stock valued at $1,250,900
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 $873,000; 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 cost, however, is not expected to be
affected.
(d) Reflects the increase in amortization expense due to the amortization
of the distribution channels and customer lists recorded in the
acquisition of ITC which are amortized over a three-year period.
(e) Reflects the elimination of intercompany transactions and balances
between CSI and ITC.
RECAPITALIZATION ADJUSTMENT
(f) Reflects the issuance of the CSI Common Stock valued at $795,200 to the
holders of the bridge debt issued by CSI in December 1997. Such amount
is the estimated value of the equity features of the debt.
F-6
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
OFFERING ADJUSTMENTS
(g) Reflects the estimated net proceeds of the Offering of $25,617,719, of
which $1,325,000 is to be placed in escrow to satisfy the terms of the
ITC acquisition agreement. Reflects deferred offering costs of $117,719
incurred as of December 31,1997, which have been added back in
determining the estimated net proceeds of the Offering.
(h) Reflects the repayment of CSI's bridge debt of $2,840,000 which is
payable upon successful completion of the Offering. Reflects the write-
offs to accumulated deficit totalling $1,245,127 of the unamortized
debt issuance costs of $449,927 and the unamortized discount on such
debt of $795,200.
(i) Reflects the cash payment of $1,750,000 due to the shareholders of ITC
upon the successful completion of the Offering in accordance with the
terms of the acquisition (this pro forma adjustment does not take into
consideration any additional deposits which would have been made in
1998)
(j) Reflects payment amount due to a former officer of CSI pursuant to a
settlement agreement.
F-7
INDEPENDENT AUDITORS' REPORT
Communications Systems International, Inc.
Colorado Springs, Colorado
We have audited the accompanying balance sheets of Communications Systems
International, Inc. (CSI) as of April 30, 1996 and 1997, and the related
statements of operations, shareholders' deficit and cash flows for each of the
three years in the period ended April 30, 1997. These financial statements are
the responsibility of CSI'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, 1996 and 1997, and the results of its operations and its cash
flows for each of the three years in the period ended April 30, 1997 in
conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that CSI
will continue as a going concern. As discussed in Note 1 to the financial
statements, CSI's substantial losses since inception and working capital
deficit at April 30, 1997 raise substantial doubt about CSI's ability to
continue as a going concern. Management's plans in regard to these matters are
described in Note 1. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Stockman Kast Ryan & Scruggs, P.C.
Colorado Springs, Colorado
June 2, 1997
(August 11, 1997 as to the tenth paragraph of Note 4; September 17, 1997 as
to the last paragraph of Note 8; October 9, 1997 as to the second paragraph
of Note 3; October 31, 1997 as to the last paragraph of Note 4 and the
first paragraph of Note 13; December 30, 1997 as to the third paragraph of
Note 3; and, April 22, 1998 as to the second paragraph of Note 13)
F-8
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
BALANCE SHEETS
APRIL 30,
---------------------- JANUARY 31,
1996 1997 1998
---------- ---------- -----------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash...................................... $ 57,394 $ 146,686 $ 566,124
Accounts receivable--net.................. 1,104,606 1,053,233 835,024
Prepaid expenses and other current as-
sets..................................... 60,893 83,962 19,686
---------- ---------- ----------
Total current assets.................... 1,222,893 1,283,881 1,420,834
PROPERTY AND EQUIPMENT--Net (Notes 2 and
3)....................................... 271,499 457,791 515,143
DEFERRED OFFERING COSTS (Note 12)......... -- 83,939 183,769
DEPOSITS (Notes 10 and 13)................ 25,000 120,880 448,065
DEBT ISSUANCE COSTS (Note 3).............. -- -- 374,856
---------- ---------- ----------
TOTAL ASSETS............................ $1,519,392 $1,946,491 $2,942,667
========== ========== ==========
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable.......................... $ 965,646 $1,287,187 $1,191,190
Accrued commissions....................... 254,224 145,352 307,328
Accrued expenses and customer deposits.... 129,007 88,940 100,587
Payables to former shareholders (Note 4).. -- -- 242,619
Debt to related parties (Note 8).......... 159,915 148,761 263,343
Notes payable (Note 3).................... 1,866,697 1,944,896 2,292,333
---------- ---------- ----------
Total current liabilities............... 3,375,489 3,615,136 4,397,400
---------- ---------- ----------
COMMITMENTS AND CONTINGENCIES
(Notes 8 and 10)
SHAREHOLDERS' DEFICIT
(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; 8,998,987, 9,765,590
and 10,064,531 shares issued and
outstanding.............................. 1,889,141 2,366,066 2,760,127
Obligation to issue common stock.......... -- -- 795,200
Common stock options...................... -- -- 37,000
Notes receivable from shareholder......... (5,000) (35,000) (35,000)
Accumulated deficit....................... (3,740,238) (3,999,711) (4,769,441)
Treasury stock, at cost................... -- -- (242,619)
---------- ---------- ----------
Total shareholders' deficit............. (1,856,097) (1,668,645) (1,454,733)
---------- ---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' DEF-
ICIT................................... $1,519,392 $1,946,491 $2,942,667
========== ========== ==========
See notes to financial statements.
F-9
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF OPERATIONS
NINE MONTH
YEAR ENDED APRIL 30, PERIOD ENDED JANUARY 31,
------------------------------------ --------------------------
1995 1996 1997 1997 1998
---------- ----------- ----------- ------------ ------------
(UNAUDITED) (UNAUDITED)
REVENUE................. $1,837,580 $ 6,741,022 $11,865,412 $ 8,659,523 $ 8,894,803
COST OF REVENUE......... 1,297,861 5,962,609 7,754,897 5,694,895 5,393,796
---------- ----------- ----------- ----------- ------------
GROSS MARGIN............ 539,719 778,413 4,110,515 2,964,628 3,501,007
---------- ----------- ----------- ----------- ------------
OPERATING EXPENSES
Sales and marketing..... 529,161 1,572,747 2,080,020 1,490,805 1,961,350
General and administra-
tive (Note 8).......... 624,585 1,652,374 2,024,383 1,326,300 2,603,660
Depreciation and amorti-
zation................. 19,107 57,843 102,983 70,508 104,605
---------- ----------- ----------- ----------- ------------
Total operating ex-
penses............... 1,172,853 3,282,964 4,207,386 2,887,613 4,669,615
---------- ----------- ----------- ----------- ------------
INCOME (LOSS) FROM
OPERATIONS............. (633,134) (2,504,551) (96,871) 77,015 (1,168,608)
INTEREST EXPENSE........ 139 (19,389) (162,602) (114,155) (348,122)
---------- ----------- ----------- ----------- ------------
LOSS BEFORE
EXTRAORDINARY ITEM..... (632,995) (2,523,940) (259,473) (37,140) (1,516,730)
EXTRAORDINARY ITEM--
Gain on extinguishment
of debt
(Note 3)............... -- -- -- -- 747,000
---------- ----------- ----------- ----------- ------------
NET LOSS................ $ (632,995) $(2,523,940) $ (259,473) $ (37,140) $ (769,730)
========== =========== =========== =========== ============
BASIC PER SHARE AMOUNTS:
Loss before extraordi-
nary item............ $ (.10) $ (.30) $ (.03) $ (.00) $ (.15)
Extraordinary item.... -- -- -- -- .07
---------- ----------- ----------- ----------- ------------
Net loss.............. $ (.10) $ (.30) $ (.03) $ (.00) $ (.08)
========== =========== =========== =========== ============
WEIGHTED AVERAGE SHARES
OUTSTANDING............ 6,213,380 8,394,451 9,414,238 9,321,197 10,021,832
========== =========== =========== =========== ============
See notes to financial statements.
F-10
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF SHAREHOLDERS' DEFICIT
OBLIGATION NOTES
COMMON STOCK TO ISSUE COMMON RECEIVABLE TREASURY STOCK
---------------------- COMMON STOCK FROM ACCUMULATED -------------------
SHARES AMOUNT STOCK OPTIONS SHAREHOLDER DEFICIT SHARES AMOUNT TOTAL
---------- ---------- ---------- ------- ----------- ----------- -------- --------- -----------
BALANCES,
May 1, 1994....... 4,901,040 $ 530,929 $ 10,412 $ -- $ -- $ (583,303) -- $ -- $ (41,962)
Common stock sub-
scribed........... -- -- 493,025 -- -- -- -- -- 493,025
Net loss........... -- -- -- -- -- (632,995) -- -- (632,995)
---------- ---------- -------- ------- -------- ----------- -------- --------- -----------
BALANCES,
April 30, 1995.... 4,901,040 530,929 503,437 -- -- (1,216,298) -- -- (181,932)
Issuance of sub-
scribed 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 ac-
quisition......... 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 ex-
change for note... 60,000 30,000 -- -- (30,000) -- -- -- --
Stock issued for
services.......... 140,000 34,224 -- -- -- -- -- -- 34,224
Stock issued in ac-
quisition 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.......... 231,426 114,309 -- -- -- -- -- -- 114,309
Sale of stock for
cash.............. 908,641 499,752 -- -- -- -- -- -- 499,752
Issuance of debt
with stock
conversion
rights............ -- -- 795,200 -- -- -- -- -- 795,200
Stock options
granted........... -- -- -- 37,000 -- -- -- -- 37,000
Purchase of common
stock............. -- -- -- -- -- -- (841,126) (462,619) (462,619)
Retirement of trea-
sury stock........ (400,000) (220,000) -- -- -- -- 400,000 220,000 --
Net loss........... -- -- -- -- -- (769,730) -- -- (769,730)
---------- ---------- -------- ------- -------- ----------- -------- --------- -----------
BALANCES,
January 31, 1998
(unaudited)...... 10,505,657 $2,760,127 $795,200 $37,000 $(35,000) $(4,769,441) (441,126) $(242,619) $(1,454,733)
========== ========== ======== ======= ======== =========== ======== ========= ===========
See notes to financial statements.
F-11
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF CASH FLOWS
NINE MONTH
YEAR ENDED APRIL 30, PERIOD ENDED JANUARY 31,
--------------------------------- ----------------------------
1995 1996 1997 1997 1998
--------- ----------- --------- ------------ -------------
(UNAUDITED) (UNAUDITED)
OPERATING ACTIVITIES
Net loss................ $(632,995) $(2,523,940) $(259,473) $ (37,140) $ (769,730)
Adjustments to reconcile
net loss to cash
provided by (used in)
operating activities:
Gain on extinguishment
of debt.............. -- -- -- -- (747,000)
Amortization of debt
issuance costs and
debt discount........ -- -- -- -- 207,604
Stock and options is-
sued or subscribed
for services and in-
terest............... 32,000 312,775 38,566 35,671 37,000
Depreciation and amor-
tization............. 19,107 57,843 102,983 70,508 104,605
Changes in operating
assets and
liabilities:
Accounts receiv-
able............... (123,644) (904,447) 52,565 12,675 218,209
Other assets........ (65,000) (15,393) (115,783) (111,824) (64,075)
Accounts payable and
accrued
expenses........... 372,697 2,711,390 911,463 503,117 131,391
--------- ----------- --------- ----------- -------------
Net cash provided by
(used in) operating
activities............. (397,835) (361,772) 730,321 473,007 (881,996)
--------- ----------- --------- ----------- -------------
INVESTING ACTIVITIES
Purchases of property
and equipment.......... (53,987) (222,813) (218,668) (167,423) (161,957)
Increase in deposits for
acquisition............ -- -- (25,000) -- (200,000)
--------- ----------- --------- ----------- -------------
Net cash used in
investing activities... (53,987) (222,813) (243,668) (167,423) (361,957)
--------- ----------- --------- ----------- -------------
FINANCING ACTIVITIES
Proceeds from issuance
of notes............... -- 7,000 405,000 200,000 2,485,073
Proceeds from the
issuance of stock or
stock subscriptions.... 461,025 537,000 111,200 111,200 499,752
Repayment of notes
payable................ -- (78,530) (818,418) (625,582) (1,001,604)
Increase in deferred
offering costs......... -- -- (83,989) -- (99,830)
Payment for treasury
stock.................. -- -- -- -- (220,000)
Net proceeds
(repayments) from
issuances of debt to
related party.......... 65,000 94,915 (11,154) 812 --
--------- ----------- --------- ----------- -------------
Net cash provided by
(used in) financing
activities............. 526,025 560,385 (397,361) (313,570) 1,663,391
--------- ----------- --------- ----------- -------------
NET INCREASE (DECREASE)
IN CASH................ 74,203 (24,200) 89,292 (7,986) 419,438
CASH, Beginning of
period................. 7,391 81,594 57,394 57,394 146,686
--------- ----------- --------- ----------- -------------
CASH, End of period..... $ 81,594 $ 57,394 $ 146,686 $ 49,408 $ 566,124
========= =========== ========= =========== =============
(continued)
See notes to financial statements.
F-12
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF CASH FLOWS
NINE MONTH
YEAR ENDED APRIL 30, PERIOD ENDED JANUARY 31,
--------------------------- --------------------------
1995 1996 1997 1997 1998
------- ---------- -------- ------------ ------------
(UNAUDITED) (UNAUDITED)
SUPPLEMENTAL CASH FLOW
INFORMATION
Interest paid......... $ -- $ 7,879 $126,066 $ 75,301 $ 29,161
SUPPLEMENTAL NONCASH
INVESTING AND FINANCING
ACTIVITIES
Stock and options
issued or subscribed
for services and
interest............. $32,000 $ 312,775 $ 38,566 $ 35,671 $ 37,000
Conversion of accounts
payable to notes
payable.............. -- 1,938,227 761,617 -- --
Issuance of stock in
exchange for note.... -- 5,000 30,000 30,000 --
Stock issued in acqui-
sition of affiliate.. -- -- 49,993 49,993 --
Conversion of notes
and accrued interest
to stock............. -- -- 274,342 -- 115,475
Purchase of treasury
stock................ -- -- -- -- 242,619
(concluded)
See notes to financial statements.
F-13
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JANUARY 31, 1997 AND 1998 IS
UNAUDITED)
1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Communications Systems International, Inc. (CSI) is a rapidly growing
provider of international telecommunications services principally in South
America, Europe, the Pacific Rim, Central America and South Africa. CSI
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 in markets that are underserved by large
telecommunications providers and incumbent telephone operators (ITOs).
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles, which contemplates continuation of
CSI as a going concern. CSI has sustained substantial operating losses since
inception through April 30, 1997. In addition, CSI has used substantial
amounts of working capital in its operations. At April 30, 1997, current
liabilities exceeded current assets by $2,331,255 and total liabilities
exceeded total assets by $1,668,645.
In fiscal 1997, CSI's management took actions to increase its revenue
through increased calling volume and, as a result, CSI has been able to
negotiate more favorable rates with its telecommunications carriers enabling
CSI to reduce its cost of revenue per unit of service sold. These steps have
enabled CSI to significantly improve its gross margins during the year ended
April 30, 1997 and the nine-month period ended January 31, 1998.
In fiscal 1998, in order to raise additional working capital and satisfy
certain obligations, CSI issued mandatorily redeemable convertible promissory
notes (see Note 3) in a private offering. 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 the pending acquisitions (see Note 13) as well as repay existing
obligations, working capital, development of new service offerings and
enhancement and expansion of existing services.
Management believes that these actions and others presently being taken will
allow CSI to successfully meet its obligations and achieve and sustain
profitable levels of operations.
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, 1996 and 1997 and January 31, 1998, the allowance for
doubtful accounts was $164,245, $186,489 and $403,991, 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 CSI'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. CSI 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
CSI's stock at the date of the grant over the amount an employee must pay to
acquire the stock. See Note 5.
F-14
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.
Interim Financial Statements--The financial statements of CSI for the nine
months ended January 31, 1997 and 1998 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. CSI'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, APRIL 30, JANUARY 31,
1996 1997 1998
--------- --------- -----------
Equipment.................................... $311,446 $574,966 $734,656
Furniture and fixtures....................... 44,259 61,601 62,131
Leasehold improvements....................... 5,238 13,651 15,387
-------- -------- --------
Total...................................... 360,943 650,218 812,174
Less accumulated depreciation and amortiza-
tion........................................ 89,444 192,427 297,031
-------- -------- --------
Property and equipment--net.................. $271,499 $457,791 $515,143
======== ======== ========
F-15
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
3.NOTES PAYABLE
Notes payable consist of the following:
APRIL 30, APRIL 30, JANUARY 31,
1996 1997 1998
---------- ---------- -----------
Mandatorily redeemable convertible
promissory notes bearing interest at 10%
which is payable semiannually, due
December 29, 1998 or 5 days after the
closing of the proposed public offering
(see Note 12), whichever is earlier....... $ -- $ -- $2,840,000
Unsecured note payable to long distance
carriers, bearing interest at 10% and 12%,
repaid December 1997; see below .......... 1,859,697 1,809,896 --
Unsecured notes payable, bearing interest
at 15%, principal and interest due Septem-
ber 1998.................................. -- 85,000 85,000
Unsecured convertible notes payable bearing
interest at 10% which is payable semi-an-
nually on March 31 and September 30; the
outstanding principal is due in 1998, how-
ever, the notes are callable at the option
of the noteholders at any interest payment
date...................................... -- 50,000 30,000
Other...................................... 7,000 -- --
---------- ---------- ----------
1,866,697 1,944,896 2,955,000
Less discount on mandatorily redeemable
convertible promissory notes.............. -- -- 662,667
---------- ---------- ----------
Total..................................... $1,866,697 $1,944,896 $2,292,333
========== ========== ==========
On October 9, 1997, CSI entered into an agreement with a long distance
carrier to which CSI had a note payable with an outstanding balance of
$1,485,909 as of April 30, 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 ($1,458,292 at October 9, 1997) and all accrued and unpaid
interest thereon ($116,755 at October 9, 1997). CSI was also obligated to pay
a fee of $178,047 to one of the companies which CSI intends to acquire (see
Note 13) for assistance in obtaining this agreement. CSI recognized a gain of
$747,000 in December 1997 upon the payment of the $650,000 liability.
CSI issued mandatorily redeemable convertible promissory notes totalling
$2,840,000 on December 30, 1997 in a private placement offering,
collateralized by a first security interest on all unpledged assets of CSI 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
CSI's officers and directors ($750,000 guaranteed by each, severally). The
notes are convertible into CSI'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 CSI'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. As a result of the stock conversion rights, CSI has
recorded a discount on the notes and recognized an obligation to issue Common
Stock of $795,200. The discount is being amortized over a six-month period
since management believes CSI will complete its offering by June 30, 1998. At
January 31, 1998, the unamortized portion of the discount was $662,667. In
connection with the placement of the notes, CSI incurred debt issuance costs
of $449,927 which are also being amortized over a six-month period. At January
31, 1998, the unamortized portion of the debt issuance costs was $374,856.
F-16
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
As of April 30, 1997, all of CSI's obligations are classified as current
liabilities due to their repayment terms or CSI's failure to make timely
principal and interest payments.
4.SHAREHOLDERS' EQUITY
During the year ended April 30, 1995, CSI accepted deposits for purchase of
1,687,263 shares of its common stock in excess of the number of shares
authorized. In September 1995, CSI's shareholders voted to increase the number
of authorized shares of common stock to 25,000,000 shares and the subscribed
shares were issued.
CSI 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 April 30, 1995, 185,000 shares had been subscribed. During the year
ended April 30, 1996, the offering was fully subscribed.
In September 1995, in an effort to increase the number of shareholders of
CSI's Common Stock, CSI'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 CSI's Common Stock. Under the plan of
merger, the shareholders of Redden received one share of CSI'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 CSI and Redden ceased to exist. Redden's only recorded asset
consisted of $11,050 of organizational costs. Redden had no liabilities and
had no revenue or expenses since inception. Subsequent to the merger, CSI
determined that Redden's assets were of no value to CSI. Accordingly, no
amounts have been recognized for the issuance of the CSI Common Stock in
connection with the merger of Redden.
During the year ended April 30, 1996, CSI 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, CSI sold 61,500 shares of Common Stock
for $2.00 per share and received $111,200 after offering costs of $11,800.
In August 1996, CSI acquired the net assets of an affiliated company through
the issuance of 179,076 shares of CSI's Common Stock to certain shareholders
of the affiliate and granted options to purchase 97,000 shares of CSI'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 CSI at the affiliate's net book value. Pro forma information
combining the results of operations of CSI 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, CSI sold convertible notes totalling
$320,000, of which $190,000 of such notes were issued to three current
directors of CSI. The notes, bearing interest at 10%, are convertible into
shares of CSI'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, CSI charged the remaining unamortized deferred financing costs of
$22,834 relating to such notes against the recorded amount of Common Stock.
During the nine months ended January 31, 1998, CSI sold an additional $95,000
principal amount of the convertible notes, and noteholders converted notes
totalling $115,000 principal amount and accrued interest of $475 into 231,426
shares of Common Stock. Upon conversion, CSI charged unamortized deferred
financing costs of $1,166 relating to such notes against the recorded amount
of Common Stock.
During the year ended April 30, 1997, CSI 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.
F-17
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
CSI has notes receivable from a shareholder totalling $35,000 which resulted
from the issuance of Common Stock, bear interest at 10% and are payable on
demand.
In August 1997, CSI entered into settlement agreements with two former
employees who were also shareholders of CSI 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 CSI 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 January 31, 1998, CSI has made payments
totalling $220,000 to these individuals and received 400,000 shares of its
Common Stock which have been retired. As of January 31, 1998, CSI 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, CSI 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 CSI's non-qualified stock option plan, options to
purchase shares of CSI'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 CSI's Common Stock which may be issued upon the exercise of options granted
under the plan shall not exceed 3,000,000. CSI 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
January 31, 1998............................ 1,108,800 $.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......................................................... 471,700
Exercised....................................................... --
Expired or cancelled............................................ (247,100)
---------
Outstanding at January 31, 1998................................... 1,108,800
=========
CSI 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 CSI's stock option plans been determined
based on the fair value
F-18
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
at the grant date for awards in the years ended April 30, 1996 and 1997
consistent with the provisions of SFAS No.123, CSI'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, CSI issued warrants in connection with
Common Stock in exchange for financial services. The warrants provide for the
purchase of 150,000 shares of CSI'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), CSI also is committed to deliver to the noteholders 58,500
warrants to purchase shares of CSI'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 $.27 to $1.38 per share; the warrants expire in 1998
and 1999.
In connection with the placement of the mandatorily redeemable convertible
promissory notes, CSI issued to the placement agent 284,000 warrants to
purchase shares of CSI'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. (See note 3)
7.INCOME TAXES
The tax effects of temporary differences to significant portions of deferred
taxes are as follows:
APRIL 30, APRIL 30,
1996 1997
---------- ----------
Deferred tax asset--
Net operating loss carryforwards.................... $1,270,000 $1,330,000
Less valuation allowance.............................. 1,270,000 1,330,000
---------- ----------
$ -- $ --
========== ==========
As of April 30, 1997, CSI'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, CSI 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 $210,000, $860,000
and $60,000 during the years ended April 30, 1995, 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 CSI (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 CSI.
F-19
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
8.RELATED PARTY TRANSACTIONS
CSI leases office space from a partnership in which CSI's principal
shareholder owns a general partnership interest. Rental expense under such
leases totalled $17,346, $37,592 and $87,259 for the years ended April 30,
1995, 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
========
CSI receives periodic advances from its principal shareholder. At April 30,
1996 and 1997 and January 31, 1998, CSI had an unsecured note payable of
$159,915, $148,761 and $148,761, respectively, to its principal shareholder,
payable May 31, 1999 and bearing interest at 10%.
In fiscal year 1998, CSI entered into a settlement agreement with one of its
former officers which provided for payments totalling $63,000 through December
1997 and, a promissory note for $125,000 requiring twelve monthly payments of
$10,417 beginning January 1998. If the proposed public offering (see Note 12)
is completed prior to full payment of the note, the remaining balance is due.
Such amounts have been reflected as general and administrative expense for the
nine months ended January 31, 1998.
9.MAJOR CUSTOMERS, SUPPLIERS AND FOREIGN MARKETS
CSI's major markets are currently in Argentina, Brazil, Europe and South
Africa. As a result, CSI'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. CSI 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 CSI
conducts operations can greatly affect the competitive price position of CSI's
products and services. CSI's distributors in Argentina and Brazil generated
revenue (as a percentage of CSI's total revenue) as follows:
YEAR ENDED
APRIL 30,
----------------
1995 1996 1997
---- ---- ----
Argentina..................................................... -- 49% 56%
Brazil........................................................ 34% 14 10
CSI's ability to provide its telephone services is heavily dependent upon
the agreements CSI has with its telecommunications carriers. CSI's long
distance services were provided by various carriers as follows:
YEAR ENDED
APRIL 30,
----------------
1995 1996 1997
---- ---- ----
Carrier A..................................................... 59% 39% 59%
Carrier B..................................................... 22 49 23
Other carriers................................................ 19 12 18
F-20
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
10.COMMITMENTS AND CONTINGENCIES
In September 1996, CSI 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, CSI is required to pay the
developer a monthly royalty equal to 4% of CSI's gross collected revenue
related to the system. In addition, CSI is also required to provide monthly
funding for the installation of two systems. In the event that CSI 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%. CSI 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, CSI agrees
to pay the developer $1,500 if such installation produces gross revenue
between $10,000 and $20,000 in the first full billing month, and $3,000 if
such revenue 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.
CSI 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%.
CSI is subject to a $100,000 claim by a manufacturer from which CSI received
telecommunications equipment. CSI believes that the equipment is not suitable
for its intended purpose and that the manufacturer misrepresented certain
matters pertaining to this equipment. CSI has offered to return the equipment
in exchange for a release of the manufacturer's claim and the manufacturer has
rejected CSI's offer. CSI has not made a provision for any loss that might
result from the outcome of this matter; however, CSI believes that the
ultimate resolution of this claim will not have a material adverse effect on
its financial position or results of operations.
CSI has agreements with certain of its carriers that provide for guaranteed
rates and minimum annual usage. Certain agreements require CSI to make
deposits with the carriers; such deposits totalled $25,000, $95,000 and
$220,000 at April 30, 1996, and 1997 and January 31, 1998, respectively. 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, CSI's Board of Directors authorized a reverse split of
CSI's common stock (not to exceed 1-for-30) whereby CSI will issue one share
of common stock in exchange for a number of shares yet to be determined. The
authorization for the reverse split was approved by CSI's shareholders in
January 1998. 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
CSI is planning a public offering of its Common Stock in 1998, the net
proceeds from which are expected to be used to complete the acquisitions
described in Note 13, to repay the mandatorily redeemable promissory notes
described in Note 3, for working capital, development of new service
offerings, and enhancement and expansion of existing services.
F-21
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
13.PENDING ACQUISITIONS
CSI has entered into an agreement to acquire all of the outstanding stock of
International Telephone Company (ITC), another telecommunications company that
provides services similar to that of CSI. The purchase price of $5,370,000 is
to be satisfied by the payment of $3,300,000 in cash and the issuance of
shares of CSI's Common Stock valued at $2,070,000 (before any discount) based
on the public offering per share price in CSI'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 CSI's Common Stock to be issued to
the selling shareholders one year after the acquisition is completed to ensure
compliance with certain provisions of the agreement. Included in deposits in
the accompanying balance sheets at April 30, 1997 and January 31, 1998 are
standstill deposits totalling $25,000 and $225,000, respectively, which are
nonrefundable and are to be credited against the purchase price. The agreement
also requires additional standstill deposits to be made prior to the expected
acquisition date. The acquisition is expected to occur upon closing of CSI's
proposed public offering.
On April 22, 1998, CSI entered into a letter of intent to acquire all of the
outstanding common stock of GlobalTel Resources, Inc. (GlobalTel), another
telecommunications company which also provides services similar to that of
CSI, through the issuance of a number of shares of CSI's Common Stock to be
determined.
CSI's acquisitions of GlobalTel and ITC will be accounted for by the
purchase method.
F-22
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To GlobalTel Resources, Inc.:
We have audited the accompanying consolidated balance sheets of GlobalTel
Resources, Inc. (a Washington corporation) and subsidiaries as of December 31,
1996 and 1997, and the related consolidated statements of operations, common
stock subject to rescission and shareholders' deficit and cash flows for each
of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of GlobalTel'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 referred to above present fairly,
in all material respects, the financial position of GlobalTel Resources, Inc.
and subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
The accompanying consolidated financial statements have been prepared
assuming that GlobalTel will continue as a going concern. As discussed in
Notes 1 and 5, a significant portion of GlobalTel's bridge loans call for
principal repayment during 1998. In addition, as discussed in Note 6,
GlobalTel plans to commence an offer to rescind a significant portion of
GlobalTel's common stock and bridge loans. Management's current projections
indicate that there will not be sufficient cash flows from operations to fund
these obligations. These matters raise substantial doubt about GlobalTel's
ability to continue as a going concern. Management's plans in regard to these
matters are discussed in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
ARTHUR ANDERSEN LLP
Seattle, Washington,
April 10, 1998 (except
with respect to the
matters discussed in
Note 9, as to which the
date is April 24, 1998)
F-23
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-------------------------
1996 1997
----------- ------------
ASSETS
------
Current assets:
Cash.............................................. $ 446,257 $ 848,668
Receivables:
Trade accounts, net of allowance for doubtful
accounts of $207,000 and $180,000.............. 1,288,047 622,154
Related party................................... -- 35,500
Other .......................................... 333,181 54,859
Deposits and other................................ 149,178 105,814
----------- ------------
Total current assets............................ 2,216,663 1,666,995
Property and equipment, net......................... 670,712 1,372,154
Other assets:
License agreement, net............................ 163,573 151,749
Organizational costs, net......................... 110,114 75,381
Bridge loan issue costs, net...................... 107,356 567,804
Equipment to be placed in service................. 374,075 519,688
Other............................................. 58,994 --
----------- ------------
Total assets.................................... $ 3,701,487 $ 4,353,771
=========== ============
LIABILITIES AND SHAREHOLDERS' DEFICIT
-------------------------------------
Current liabilities:
Accounts payable.................................. $ 2,570,745 $ 2,278,611
Accounts payable to related parties............... -- 247,270
Accrued liabilities............................... 1,937,154 1,212,881
Bridge loans...................................... 1,840,000 1,995,000
Notes payable..................................... 92,310 21,542
Customer deposits and prepayments................. 1,024,743 845,474
----------- ------------
Total current liabilities....................... 7,464,952 6,600,778
Bridge loans, net of unamortized discount of $0 and
$1,208,511......................................... 2,282,500 3,832,289
----------- ------------
Total liabilities............................... 9,747,452 10,433,067
----------- ------------
Commitments and contingencies (see Notes 6 and 8)
Common stock subject to rescission; par value $0.05;
326,385 and 496,466 shares issued and outstanding.. 1,519,387 2,454,829
----------- ------------
Shareholders' deficit:
Series A convertible preferred stock; par value
$0.01; 5,000,000 shares authorized; 0, and
275,000 shares issued and outstanding;
liquidation preference of $0 and $1,138,666...... -- 1,054,689
Common stock; par value $0.05; 50,000,000 shares
authorized; 675,447 and 1,233,432 shares issued
and outstanding.................................. 56,383 2,804,709
Obligation to issue common stock.................. 8,400 1,012,309
Common stock warrants............................. 52,306 2,152,460
Accumulated deficit............................... (7,682,441) (15,558,292)
----------- ------------
Total shareholders' deficit..................... (7,565,352) (8,534,125)
----------- ------------
Total liabilities and shareholders' deficit..... $ 3,701,487 $ 4,353,771
=========== ============
The accompanying notes are an integral part of these consolidated balance
sheets.
F-24
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
-------------------------------------
1995 1996 1997
----------- ----------- -----------
Revenue................................. $ 2,113,047 $ 9,135,935 $12,862,629
Operating expenses:
Cost of revenue....................... 1,928,396 8,229,546 11,171,220
Sales and marketing................... 238,168 682,332 788,191
General and administrative............ 1,536,215 5,773,133 7,119,335
Depreciation and amortization......... 111,062 98,288 253,320
----------- ----------- -----------
Total operating expenses................ 3,813,841 14,783,299 19,332,066
----------- ----------- -----------
Operating loss.......................... (1,700,794) (5,647,364) (6,469,437)
Interest expense ($1,291, $61,350 and
$288,962 to related parties) including
amortization of debt discount.......... (33,681) (224,964) (1,367,748)
----------- ----------- -----------
Net loss before income taxes............ (1,734,475) (5,872,328) (7,837,185)
Provision for income taxes.............. -- -- --
----------- ----------- -----------
Net loss................................ $(1,734,475) $(5,872,328) $(7,837,185)
=========== =========== ===========
Series A convertible preferred stock
dividends.............................. -- -- (38,666)
----------- ----------- -----------
Net loss applicable to common sharehold-
ers.................................... $(1,734,475) $(5,872,328) $(7,875,851)
=========== =========== ===========
Basic loss per share.................... $ (2.75) $ (5.88) $ (6.48)
=========== =========== ===========
Weighted average number of common shares
outstanding (includes common shares
subject to rescission)................. 629,776 998,735 1,214,797
=========== =========== ===========
The accompanying notes are an integral part of these consolidated statements.
F-25
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON STOCK SUBJECT TO RESCISSION AND
SHAREHOLDERS' DEFICIT
SERIES A
COMMON STOCK SUBJECT CONVERTIBLE
TO RESCISSION PREFERRED STOCK COMMON STOCK OBLIGATION
-------------------- -------------------- ---------------------- TO ISSUE
NUMBER DOLLAR NUMBER DOLLAR NUMBER OF DOLLAR COMMON
OF SHARES AMOUNT OF SHARES AMOUNT SHARES AMOUNT STOCK
--------- ---------- --------- ---------- --------- ----------- ----------
BALANCE,
December 31, 1994................................. -- $ -- -- $ -- 421,760 $ 330,000 $ --
Issuance of common stock to founders.............. -- -- -- -- 23,499 -- --
Issuance of common stock ($0.42 per share) and
obligation to issue 60,000 shares ($0.14 per
share) to acquire GFP (see Notes 1 and 7)......... -- -- -- -- 216,791 91,600 8,400
Sale of common stock ($2.665 per share)........... 96,748 256,382 -- -- 110,910 297,344 --
Sale of common stock ($5.50 per share)............ 214,137 1,177,755 -- -- 180,560 993,078 --
Cost of common stock issuances.................... -- -- -- -- -- (126,236) --
Issuance of common stock warrants................. -- -- -- -- -- -- --
Repurchase of common stock ($5.50 per share)...... -- -- -- -- (262,573) (1,444,153) --
Net loss.......................................... -- -- -- -- -- -- --
------- ---------- ------- ---------- --------- ----------- ----------
BALANCE,
December 31, 1995................................. 310,885 1,434,137 -- -- 690,947 141,633 8,400
Repurchase of common stock ($5.50 per share)...... -- -- -- -- (18,000) (99,000) --
Sale of common stock to employees ($5.50
per share)........................................ 15,500 85,250 -- -- -- -- --
Sale of common stock to third party ($5.50 per
share)............................................ -- -- -- -- 2,500 13,750 --
Issuance of common stock warrants................. -- -- -- -- -- -- --
Net loss ......................................... -- -- -- -- -- -- --
------- ---------- ------- ---------- --------- ----------- ----------
BALANCE,
December 31, 1996................................. 326,385 1,519,387 -- -- 675,447 56,383 8,400
Issuance of Series A convertible preferred
stock............................................. -- -- 275,000 1,100,000 -- -- --
Cost of Series A preferred stock issuances........ -- -- -- (83,977) -- -- --
Preferred stock dividends......................... -- -- -- 38,666 -- -- --
Partial settlement of 1995 obligation............. -- -- -- -- 30,000 4,200 (4,200)
Severance contract paid in common stock
($5.50 per share)................................. -- -- -- -- 24,242 133,333 --
Deferred salary converted to common stock
warrants.......................................... -- -- -- -- -- -- --
Issuance of common stock warrants ................ -- -- -- -- -- -- --
Bridge loans converted to common stock ($5.50 per
share)............................................ 166,447 915,442 -- -- 408,540 2,218,681 --
Trade payables converted to common stock
($5.50 per share)................................. 3,634 20,000 -- -- 34,131 187,705 --
Issuance of common stock ($5.50 per share) to
certain related parties........................... -- -- -- -- 14,000 77,000 --
Issuance of common stock ($5.50 per share) in
consideration of bridge loan issue costs
incurred.......................................... -- -- -- -- 23,165 127,407 --
Obligation to issue common stock in connection
with certain bridge loan issuances................ -- -- -- -- -- -- 1,008,109
Exercise of common stock warrants................. -- -- -- -- 23,907 -- --
Net loss.......................................... -- -- -- -- -- -- --
------- ---------- ------- ---------- --------- ----------- ----------
BALANCE,
December 31, 1997................................. 496,466 $2,454,829 275,000 $1,054,689 1,233,432 $ 2,804,709 $1,012,309
======= ========== ======= ========== ========= =========== ==========
COMMON TOTAL
STOCK ACCUMULATED SHAREHOLDERS'
WARRANTS DEFICIT DEFICIT
---------- ------------- -------------
BALANCE,
December 31, 1994................................. $ -- $ (75,638) $ 254,362
Issuance of common stock to founders.............. -- -- --
Issuance of common stock ($0.42 per share) and
obligation to issue 60,000 shares ($0.14
per share) to acquire GFP (see Notes 1 and 7)..... -- -- 100,000
Sale of common stock ($2.665 per share)........... -- -- 297,344
Sale of common stock ($5.50 per share)............ -- -- 993,078
Cost of common stock issuances.................... -- -- (126,236)
Issuance of common stock warrants................. 10,751 -- 10,751
Repurchase of common stock ($5.50 per share)...... -- -- (1,444,153)
Net loss.......................................... -- (1,734,475) (1,734,475)
---------- ------------- -------------
BALANCE,
December 31, 1995................................. 10,751 (1,810,113) (1,649,329)
Repurchase of common stock ($5.50 per share)...... -- -- (99,000)
Sale of common stock to employees ($5.50 per
share)............................................ -- -- --
Sale of common stock to third party ($5.50 per
share)............................................ -- -- 13,750
Issuance of common stock warrants................. 41,555 -- 41,555
Net loss ......................................... -- (5,872,328) (5,872,328)
---------- ------------- -------------
BALANCE,
December 31, 1996................................. 52,306 (7,682,441) (7,565,352)
Issuance of Series A convertible preferred
stock............................................. -- -- 1,100,000
Cost of Series A preferred stock issuances........ -- -- (83,977)
Preferred stock dividends......................... -- (38,666) --
Partial settlement of 1995 obligation............. -- -- --
Severance contract paid in common stock ($5.50 per
share)............................................ -- -- 133,333
Deferred salary converted to stock warrants....... 1,184,856 -- 1,184,856
Issuance of common stock warrants ................ 915,298 -- 915,298
Bridge loans converted to common stock ($5.50
per share)........................................ -- -- 2,218,681
Trade payables converted to common stock ($5.50
per share)........................................ -- -- 187,705
Issuance of common stock ($5.50 per share) to
certain related parties........................... -- -- 77,000
Issuance of common stock ($5.50 per share) in
consideration of bridge loan issue costs
incurred.......................................... -- -- 127,407
Obligation to issue common stock in connection
with certain bridge loan issuances................ -- -- 1,008,109
Exercise of common stock warrants................. -- -- --
Net loss.......................................... -- (7,837,185) (7,837,185)
---------- ------------- -------------
BALANCE,
December 31, 1997................................. $2,152,460 $(15,558,292) $(8,534,125)
========== ============= =============
The accompanying notes are an integral part of these consolidated statements.
F-26
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-------------------------------------
1995 1996 1997
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................... $(1,734,475) $(5,872,328) $(7,837,185)
Adjustments to reconcile net loss to
net cash used in operating
activities--
Depreciation and amortization........ 111,062 98,288 253,320
Amortization of bridge loan issue
costs and debt discount............. 7,904 28,999 741,669
Loss on disposal of assets........... -- 12,538 49,800
Compensation and consulting expenses
paid in common stock and warrants... -- -- 398,326
Changes in certain assets and
liabilities:
Trade and related party accounts
receivable......................... (376,118) (911,929) 630,393
Other receivables and other current
assets............................. (160,061) (315,045) 322,592
Trade and related party accounts
payable, accrued liabilities and
notes payable...................... 658,421 3,807,276 514,199
Customer deposits and prepayments... 493,908 530,835 (179,269)
----------- ----------- -----------
Net cash used in operating activities.. (999,359) (2,621,366) (5,106,155)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment.... (260,449) (329,390) (649,963)
Proceeds from disposition of assets.... -- 15,000 --
Organizational costs incurred.......... (162,929) -- --
Acquisition of business, net of cash
acquired.............................. (99,003) -- --
Deposits made to purchase property and
equipment............................. -- (374,075) (16,773)
----------- ----------- -----------
Net cash used in investing activities.. (522,381) (688,465) (666,736)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of bridge
loans................................. 265,000 3,857,500 6,397,508
Payments made on bridge loans.......... -- -- (649,000)
Payments made on due to shareholders... (707,956) (649,015) --
Payments on notes payable.............. -- (33,342) (70,768)
Cash paid for bridge loan issue costs
incurred.............................. -- (76,954) (518,461)
Proceeds from issuance of common stock,
net................................... 2,598,323 99,000 --
Repurchase of common stock............. (200,000) (99,000) --
Proceeds from issuance of Series A
convertible preferred stock, net...... -- (58,088) 1,016,023
----------- ----------- -----------
Net cash provided by financing
activities............................ 1,955,367 3,040,101 6,175,302
----------- ----------- -----------
Net increase (decrease) in cash........ 433,627 (269,730) 402,411
Cash, beginning of year................ 282,360 715,987 446,257
----------- ----------- -----------
Cash, end of year...................... $ 715,987 $ 446,257 $ 848,668
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for--
Interest............................. $ 26,585 $ 17,446 $ 33,099
Income taxes ........................ -- -- --
SUPPLEMENTAL DISCLOSURE OF SIGNIFICANT
NONCASH INVESTING AND FINANCING
ACTIVITIES:
Issuance of common stock warrants...... $ 10,751 $ 41,555 $ 915,298
Bridge loans and accrued interest
converted to common stock, net........ -- -- 3,134,123
Deferred salaries converted to common
stock warrants........................ -- -- 1,184,856
Issuance of notes payable to finance
common stock repurchase............... 1,244,153 -- --
Issuance of notes payable to finance
equipment purchases................... -- 125,652 --
Trade payables converted to common
stock................................. -- -- 207,705
Issuance of common stock in
consideration of bridge loan issue
costs incurred........................ -- -- 127,407
Obligation to issue common stock....... 8,400 -- 1,008,109
The accompanying notes are an integral part of these consolidated statements.
F-27
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. DESCRIPTION OF THE BUSINESS
GlobalTel Resources, Inc. ("GlobalTel"), a Washington corporation, was
formed on November 17, 1994, to provide international telecommunications
services. GlobalTel began operations in 1995 with its entry into the
international call-reorigination business. GlobalTel also markets long-
distance calling cards and enhanced voice services including voice mail and
conference calling.
On December 29, 1995, GlobalTel acquired GFP Group, Inc. ("GFP"), a
Washington corporation formed on September 15, 1995. GFP was formed primarily
for the purpose of acquiring Ratsten International Telecommunications, Inc.
d/b/a Netstar Telecommunications, Inc. ("Ratsten") and was thereafter acquired
by GlobalTel. Ratsten held certain license rights critical to GlobalTel's
mission of providing global telecommunications services.
GlobalTel provides global long-distance call-reorigination services through
Primecall, Inc., ("Primecall") a wholly owned subsidiary. GlobalTel began
generating revenue in March 1995. Prior to January 1, 1995, GlobalTel's sole
operations consisted of general and administrative activities, which amounted
to $75,638 for the period ended December 31, 1994.
GlobalTel has generated substantial operating losses and has a limited
operating history. GlobalTel must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of operations. Losses may continue until such time, if ever, that
GlobalTel is able to generate a level of revenue sufficient to offset its cost
structure. There can be no assurance that GlobalTel will achieve increased
revenue or profitable operations. To date GlobalTel's losses have been
principally funded by a combination of common and preferred stock sales and
bridge loans, which mature in 1998 and early 1999 (see Notes 3 and 5). In
addition, GlobalTel will require additional capital to effect the Recission
Offer (see Note 6), to bring current approximately $2 million of certain past
due trade accounts payable as of April 10, 1998, and to finance its short- and
long-term growth strategies. To meet these obligations, management's plans
include merging (the "Merger") with Communications Systems International, Inc.
("CSI"), a communications company located in Colorado Springs, Colorado, which
has filed a registration statement for a public offering ("the CSI Offering")
of its common stock. However, there is no assurance that the Merger or the CSI
Offering will be completed or that GlobalTel will operate profitably or will
be successful in capitalizing on perceived synergies of the Merger. These
matters raise substantial doubt about GlobalTel's ability to continue as a
going concern. The consolidated financial statements do not include any
adjustments that might results from the outcome of this uncertainty.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidated Financial Statements
The accompanying consolidated financial statements include the financial
accounts of GlobalTel and its wholly owned subsidiaries, Primecall and GFP.
All intercompany transactions have been eliminated.
Use of Estimates
The preparation of consolidated 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,
the disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses during
the reporting periods. Actual results could differ from those estimates.
F-28
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
Cash
For purposes of the consolidated statements of cash flows, cash includes all
amounts on deposit with financial institutions. GlobalTel has no short-term
investments.
Property and Equipment
Property and equipment consist primarily of office furniture, computer and
telecommunications equipment. Property and equipment are recorded at cost and
are depreciated using the straight-line method over the estimated useful lives
of the related assets, which range from 5 to 10 years. Repairs, maintenance
and minor renewals are charged to expense as incurred. Major renewals and
betterments which substantially extend the useful life of the assets are
capitalized. Upon sale or other disposition of assets, the cost and the
related accumulated depreciation are removed from the accounts and a gain or
loss, if any, is reflected in the consolidated statements of operations.
Property and equipment is composed of the following:
DECEMBER 31,
---------------------
1996 1997
--------- ----------
Telecommunications equipment........................ $ 336,466 $1,018,292
Furniture, computers, fixtures and other............ 457,716 672,598
--------- ----------
794,182 1,690,890
Less--Accumulated depreciation...................... (123,470) (318,736)
--------- ----------
Property and equipment, net......................... $ 670,712 $1,372,154
========= ==========
GlobalTel recorded depreciation expense of $55,272, $76,884, and $206,763
for the years ended December 31, 1995, 1996 and 1997, respectively.
Other Assets
Other assets consist primarily of a license agreement, organizational costs,
bridge loan issue costs and telecommunications equipment to be placed in
service. The license agreement purchased by GlobalTel (see Note 7) is being
amortized on a straight-line basis over 15 years. GlobalTel recorded
amortization expense related to the license agreement of $1,970, $11,825 and
$11,825 for the years ended December 31, 1995, 1996 and 1997, respectively.
Certain organizational costs (primarily legal expenses) incurred in
connection with establishing and organizing GlobalTel and its subsidiaries are
being amortized on a straight-line basis over a period of five years.
GlobalTel recorded amortization expense related to these organizational costs
of $53,820, $9,579 and $34,732 for the years ended December 31, 1995, 1996 and
1997, respectively.
Bridge loan issue costs incurred in connection with obtaining bridge loans
have been deferred and are being amortized into interest expense on a
straight-line basis (which approximates the effective interest method) over
the terms of the loans. For the years ended 1995, 1996 and 1997, GlobalTel
recognized $7,904, $28,999 and $214,666, respectively, in additional interest
expense from amortization of the bridge loan issue costs.
For the years ended December 31, 1996 and 1997, GlobalTel held
telecommunications equipment to be placed in service of $374,075 and $519,688,
respectively. GlobalTel has not yet placed this equipment into service as
certain components necessary to complete the installation have not yet been
acquired.
F-29
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
Accrued Liabilities
DECEMBER 31,
---------------------
1996 1997
---------- ----------
Telecommunications costs............................ $ 511,550 $ 215,649
Deferred salaries................................... 667,000 --
Accrued interest.................................... 203,456 386,077
Other............................................... 555,148 611,155
---------- ----------
$1,937,154 $1,212,881
========== ==========
As of December 31, 1996, GlobalTel had deferred salaries payable to certain
members of GlobalTel's management. Interest accrued on the deferred balances
at an annual rate of 10%. During 1997, an additional $517,856 of deferred
salaries was accrued. During the year ended December 31, 1997, these deferred
salaries were converted to common stock warrants (see Note 3).
Equity-Based Compensation
GlobalTel accounts for employee equity-based compensation following the
provisions of Accounting Principles Board Opinion No. 25 ("APB 25"),
"Accounting for Stock Issued to Employees." In accordance with the provisions
of APB 25, GlobalTel has not recognized deferred compensation or compensation
expense in connection with its equity-based plans as the exercise price of the
options granted was equal to the fair value of the underlying equity
instrument at the date of grant.
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation," requires expanded disclosures of equity-based
compensation arrangements with employees and does not require, but encourages,
compensation cost to be measured based on the fair value of equity instruments
when awarded. GlobalTel, as allowed, intends to continue to measure employee
equity-based compensation under APB 25, which recognizes compensation cost
based on the intrinsic value of the equity instrument awarded.
Revenue Recognition and Cost of Revenue
Revenue and related cost of revenue are recognized in the period services
are provided. The related accruals for revenue, cost of revenue and customer
prepayments are included in the accompanying consolidated balance sheets.
Research and Development
Research and development costs are expensed as incurred, and are included in
general and administrative expense in the accompanying consolidated statements
of operations.
Income Taxes
GlobalTel accounts for income taxes using the asset and liability method. To
date, GlobalTel has fully reserved all net deferred tax assets.
Concentrations of Risk
During October 1996, GlobalTel began reselling international long-distance
service to other telecommunications carriers on a wholesale basis. As of
December 31, 1996, $793,000 of GlobalTel's accounts receivable was due from a
single telecommunications carrier. This receivable was fully collected during
the first quarter of 1997.
F-30
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
The geographic origin of revenue including domestic carrier resale revenue
of approximately $0, $793,000, and $4,298,000 for the years ended 1995, 1996
and 1997, respectively, approximates the following:
YEAR ENDED DECEMBER 31,
---------------------------------
1995 1996 1997
---------- ---------- -----------
Africa................................... $ 731,000 $3,180,000 $ 2,477,000
Asia..................................... 361,000 1,550,000 1,345,000
Australia................................ 130,000 557,000 1,352,000
Europe................................... 230,000 987,000 593,000
North America--United States (includes
domestic wholesale carrier revenue)..... 366,000 1,612,000 5,043,000
North America--other..................... 5,000 17,000 285,000
South America............................ 290,000 1,233,000 1,768,000
---------- ---------- -----------
$2,113,000 $9,136,000 $12,863,000
========== ========== ===========
Cost of revenue as a percentage of revenue does not vary significantly from
region to region. There are no other direct costs incurred outside the United
States, nor does GlobalTel own material assets located outside of the United
States. The continued legality and competitive advantage of call-reorigination
businesses in certain foreign countries is uncertain due to changing
regulatory environments.
GlobalTel's call-reorigination business is facilitated by a single switch
located in Los Angeles, California.
Basic Loss Per Share
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings Per Share," ("SFAS 128") which revises the calculation and
presentation of earnings per share. SFAS 128 is effective for GlobalTel's
fiscal year ending December 31, 1997, and retroactive application is required.
Basic loss per share for all periods presented in the accompanying
consolidated statements of operations has been computed under the provisions
of SFAS 128. As such, the anti-dilutive effects of convertible securities have
been excluded.
Reclassifications
Certain prior year amounts have been reclassified to conform with the
current year presentation.
Recently Issued Accounting Pronouncements
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities,"
(the "SOP") which requires costs of start-up activities and organization costs
to be expensed as incurred. The SOP is effective for financial statements with
fiscal years beginning after December 15, 1998, although earlier application
is encouraged. In the period that the SOP is adopted, GlobalTel will be
required to write-off any previously deferred start-up or organizational costs
as a cumulative effect of a change in accounting principle. Management intends
to adopt the SOP in the first quarter of 1998, which will result in a charge
of approximately $75,000 to GlobalTel's consolidated statement of operations.
Effects of retroactive application are not required by the SOP upon adoption.
F-31
3. SHAREHOLDERS' DEFICIT
Series A Convertible Preferred Stock
Each share of Series A convertible preferred stock is entitled to a dividend
at an annual rate of 6% of the issuance price, deferrable at the election of
GlobalTel but payable in preference to dividends on any other securities
issued by GlobalTel. All accrued and unpaid dividends on a share must be paid
before dividends on other securities. Each share is also entitled, in
liquidation, to a preferred distribution of the initial issuance price plus
all accrued but unpaid dividends. Each share is subject to automatic
conversion to common stock upon the sale of all or substantially all of the
assets of GlobalTel, an election to convert by two-thirds of the holders of
such shares, or upon the closing of an initial public offering ("IPO") of
GlobalTel, the net proceeds of which exceed $15 million if certain other
conditions are satisfied. Any unpaid cumulative dividends at the time of
conversion may be paid at the option of GlobalTel in cash, common stock, or as
notes payable to the preferred shareholders. Each share of Series A preferred
stock has a voting right based upon the number of shares of common stock into
which the Series A preferred stock would then be convertible, in addition to
certain demand and piggyback registration rights.
During 1996, GlobalTel incurred $58,088 in connection with its issuance of
Series A convertible preferred stock. These costs were capitalized as other
long-term assets in the accompanying December 31, 1996 consolidated balance
sheet and were subsequently reclassified as a charge to equity in connection
with GlobalTel's private placement of Series A convertible preferred stock.
Common Stock
During 1995, GlobalTel executed a stock purchase agreement with certain
common shareholders to buy back 262,573 shares of GlobalTel's common stock at
a price of $5.50 per share. GlobalTel paid $200,000 in cash and issued
$1,244,153 in promissory notes bearing interest at 8% to finance the
repurchase. These promissory notes were paid in full as of December 31, 1996.
During 1997, several bridge loan holders accepted an offer from GlobalTel to
convert their bridge loans in the amount of $2,835,208, and related unpaid
interest of $327,218 into 574,987 shares of common stock at a value equal to
$5.50 per share. The net amount of bridge loans converted to common stock
included a charge of approximately $28,000 relating to the unamortized bridge
loan issue costs that were simultaneously written off.
During September 1997, GlobalTel issued 24,242 shares of common stock with a
value of $133,333 to a former employee in satisfaction of GlobalTel's
obligations under the employee's severance agreement. The value of the common
stock issued was charged to compensation expense in the accompanying
consolidated statement of operations for the year ended December 31, 1997.
In November 1997, the Board of Directors ("the Board") approved a reverse
common stock split and increased the authorized number of common shares from
20 million to 50 million. The ratio of the reverse common stock split is 1:5.
All share and per share amounts have been retroactively adjusted in these
consolidated financial statements to reflect the reverse common stock split.
During 1997, an aggregate of $207,705 in trade payables due to certain
vendors were converted into 37,765 shares of common stock. Also during 1997,
GlobalTel issued 14,000 shares of common stock to certain Board members and
others in recognition of past services rendered to GlobalTel. GlobalTel
recognized consulting expense of $77,000 in connection with these stock
issuances.
Equity-Based Compensation
During 1996, GlobalTel approved the 1996 Stock Option Plan ("the Plan")
which provides for the granting of qualified and nonqualified stock options.
GlobalTel has reserved 520,000 shares of common stock for granting of stock
options under the Plan. During February 1998, GlobalTel's shareholders
approved an amendment to the Plan to increase the shares available for grants
to 700,000 shares of common stock. GlobalTel's Board has the authority to
determine all matters relating to options to be granted under the Plan,
including the selection of
F-32
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
individuals to be granted options, the number of shares to be subject to each
option, the exercise price and the term and vesting period, if any.
The following table summarizes activity related to stock options granted to
certain executives and employees of GlobalTel:
EXERCISE
NUMBER OF PRICE PER
SHARES SHARE
--------- ---------
Balance at January 1, 1995............................. -- $--
Grants............................................... 73,100 5.50
Exercised............................................ -- --
Canceled............................................. -- --
-------
Balance at December 31, 1995........................... 73,100 5.50
Grants............................................... 128,926 5.50
Exercised............................................ -- --
Canceled............................................. (30,000) 5.50
-------
Balance at December 31, 1996........................... 172,026 5.50
Grants............................................... 143,600 5.50
Exercised............................................ -- --
Canceled............................................. (97,200) 5.50
-------
Balance at December 31, 1997........................... 218,426 5.50
=======
There were 13,100, 63,609 and 162,546 options exercisable as of December 31,
1995, 1996 and 1997, respectively. The outstanding options at December 31,
1997 have a weighted average remaining contractual life of 8.9 years. As of
December 31, 1997, there were 301,574 shares available for future option
grants.
Pro forma information regarding results of operations and loss per share is
required by SFAS 123 for awards granted after December 31, 1994 as if
GlobalTel had accounted for its stock-based awards to employees under a
valuation method permitted by SFAS 123. The value of GlobalTel's stock-based
awards to employees in 1996 and 1997 was estimated using the minimum value
method, which does not consider stock price volatility. Had compensation cost
for the Plan been determined consistent with SFAS 123, GlobalTel's net loss
for the years ended December 31, 1995, 1996 and 1997 would have been increased
to $1,748,144, $5,918,197 and $7,930,158, respectively. Also under SFAS 123,
GlobalTel's basic loss per share would have been increased to $2.78, $5.93 and
$6.53, respectively.
The weighted average fair value per option of GlobalTel's stock-based awards
granted to employees was $1.05, $0.91 and $0.90 as of December 31, 1995, 1996
and 1997, respectively, and was estimated assuming no expected dividends and
the following weighted average assumptions:
DECEMBER 31,
-----------------------
1995 1996 1997
------- ------- -------
Risk-free interest rate............................ 5.4% 6.2% 6.1%
Expected life...................................... 4 years 3 years 3 years
F-33
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
Common Stock Warrants
The following table summarizes activity related to warrants granted to
purchase GlobalTel's common stock (1995 activity was not significant):
1996 1997
---------------------- -----------------------
NUMBER NUMBER
OF EXERCISE PRICE OF EXERCISE PRICE
SHARES PER SHARE SHARES PER SHARE
------- -------------- ------- --------------
Beginning balance.............. 23,896 $0.00 158,606 $0.00-$5.50
Grants in connection with
certain bridge loan
issuances..................... 78,910 $5.50 209,489 $3.50-$5.50
Grants to consultants.......... 55,800 $5.50 80,715 $0.05-$5.50
Deferred salaries converted to
warrants...................... -- -- 215,428 $0.05
Exercise of warrants........... -- -- (23,896) $0.00
------- -------
Ending balance................. 158,606 $0.00-$5.50 640,342 $0.05-$5.50
======= =======
In connection with the bridge loans issued by GlobalTel, warrants to
purchase 78,910 and 209,489 shares of GlobalTel's common stock were issued in
1996 and 1997, respectively. These warrants generally provide for increases in
the number of shares of common stock issuable if GlobalTel has not closed a
major financing transaction within specified periods. All of these warrants
were exercisable immediately upon issuance. GlobalTel estimated the value of
these warrants to be $41,555 and $197,584 in 1996 and 1997, respectively.
GlobalTel also issued warrants to various individuals in consideration for
consulting and other services received. With respect to the 1996 warrants,
30,000 vest upon the earlier of two years or the filing of a registration
statement in connection with a public offering. The remaining 25,800 warrants
were exercisable immediately upon issuance. The 1997 warrants were also
immediately exercisable upon issuance. The fair market value of the 1996
warrants when issued were not considered to be material. GlobalTel recognized
consulting expense of $187,993 with respect to the 1997 grants.
During 1997, certain former and current employees accepted common stock
warrants in lieu of salaries owed to them. Accordingly, deferred salaries of
$1,184,856 were converted into warrants to purchase 215,428 shares of common
stock with an exercise price of $0.05 per share. These warrants were
immediately exercisable upon issuance and have a three-year term.
During 1997, the Board amended certain common stock warrant agreements
whereby certain warrant holders could exercise their warrants at a price of
$3.50 per share in a cashless conversion to common stock rather than at the
original exercise price of $5.50 per share upon GlobalTel successfully
completing an IPO by April 30, 1998, at which time the amendments will expire.
Warrant holders representing 264,760 shares of common stock had indicated
their intention to exercise their warrants under these amended terms. As a
result of the amendment to these warrant agreements, GlobalTel recognized
$529,521 of additional debt discount, of which $296,985 resulted in additional
interest expense in 1997. The remaining debt discount will be amortized to
April 30, 1998.
4. INCOME TAXES
Significant components of GlobalTel's deferred tax assets and liabilities
are as follows:
F-34
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
DECEMBER 31,
------------------------
1996 1997
----------- -----------
Deferred tax assets:
Net operating loss carryforward................ $ 1,422,000 $ 3,330,000
Start-up costs................................. 813,000 1,618,000
Deferred compensation.......................... 227,000 152,000
Other deferred tax assets...................... 146,000 137,000
Valuation allowance............................ (2,528,000) (5,175,000)
----------- -----------
Total deferred tax assets.................... 80,000 62,000
Deferred tax liabilities:
Depreciation of furniture and equipment........ (24,000) (9,000)
Amortization of other long-term assets......... (56,000) (53,000)
----------- -----------
Net deferred taxes........................... $ -- $ --
=========== ===========
GlobalTel's net operating loss carryforward of approximately $9,794,000 as
of December 31, 1997 is subject to limitations and expires in 2012. GlobalTel
has determined that its deferred tax assets do not satisfy the recognition
criteria set forth under the provisions of SFAS No. 109, "Accounting for
Income Taxes." Accordingly, a valuation allowance has been recorded against
the applicable deferred tax assets. Therefore, no tax benefits have been
recorded in the accompanying consolidated statements of operations. The
valuation allowance increased by $538,000, $1,990,000 and $2,647,000 during
1995, 1996 and 1997, respectively.
The difference between the statutory tax rate of approximately 34% and the
tax benefit of zero recorded by GlobalTel is primarily due to GlobalTel's full
valuation allowance against its net deferred tax assets.
5. BRIDGE LOANS
To fund operations and capital expenditures, GlobalTel obtained bridge loans
from certain investors, some of whom are shareholders or management of
GlobalTel. All bridge loans bear interest at 10% annually and in certain cases
increase to 12% if the loans are past due. In addition, stock warrants were
granted to certain of these investors as discussed in Note 3. Bridge loans
outstanding were:
F-35
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
DECEMBER 31,
---------------------
1996 1997
---------- ----------
Payable to shareholders and management:
Maturing through March 1996, due upon demand after ma-
turity date........................................... $ 210,000 $ 0
Maturing through January 1999, or upon closing of an
IPO, whichever is earlier............................. 1,105,000 530,000
Maturing March 1999, payable in full or convertible at
the option of the holder to common stock upon closing
of additional equity financing at the price per share
paid by investors in the equity financing............. -- 150,000
Maturing December 1999 or, upon closing of an IPO, $1
million plus accrued interest will be payable out of
the proceeds of an IPO and $1 million plus accrued in-
terest will be converted to common stock at a price of
$3.85 per share....................................... -- 2,000,000
Principal and accrued interest converted to common
stock in 1997......................................... 500,000 --
Payable to third parties:
Maturing through March 1996, due upon demand after ma-
turity date........................................... 55,000 --
Due upon demand........................................ 150,000 --
Maturing through January 1999, or upon closing of an
IPO, whichever is earlier............................. 1,202,500 45,000
Maturing June 1998, convertible in whole or in part at
the option of the holder to: (i) common stock upon
closing of additional equity financing over $15 mil-
lion, at the price per share paid by investors in the
equity financing or, (ii) at a conversion price to
common stock of the ratio of 1.5 times annualized rev-
enue over the number of common shares outstanding..... 900,000 1,070,000
Maturing March 1999, payable in full or convertible at
the option of the holder to common stock upon closing
of additional equity financing at the price per share
paid by investors in the equity financing............. -- 400,000
Maturing January 1999, or upon closing of an IPO,
whichever is earlier.................................. -- 2,840,800
---------- ----------
Total bridge loans....................................... 4,122,500 7,035,800
Less:
Current portion (see Note 6)........................... 1,840,000 1,995,000
Debt discount.......................................... -- 1,208,511
---------- ----------
Long-term bridge loans................................... $2,282,500 $3,832,289
========== ==========
During November and December 1997, GlobalTel obtained additional bridge note
financing of $2,865,800, $25,000 of which was from a related party. These
notes bear interest at an annual rate of 10% and are due in full at the
earlier of the closing of an IPO or January 1999. In addition, following the
closing of an IPO, each holder of these notes will receive shares of common
stock equal to the initial principal amount of the note divided by the IPO
price per share. This obligation to issue stock was valued at $1,008,109 and
is included as a component of shareholders' deficit in the accompanying
December 31, 1997 consolidated balance sheet. The offsetting charge was
recorded as debt discount and will be amortized to June 30, 1998. As of
December 31, 1997, GlobalTel had recognized $146,838 of interest expense from
amortization of the debt discount. If an IPO has not closed by July 1, 1998,
these bridge note holders will have the right to receive warrants to purchase
shares of common stock in lieu of the GlobalTel common stock issuable on
closing of an IPO equal to the initial principal amount of the note divided by
$5.50. The warrants associated with these bridge loans will have an exercise
price of $5.50 per share. Closing costs incurred associated with these notes
included approximately $280,000 in cash and 23,165 shares of common stock at
$5.50 per share. The total amount of this consideration was recorded as bridge
loan issue costs to be amortized over the life of the loan.
F-36
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
6. SECURITIES SUBJECT TO RESCISSION
GlobalTel believes that certain of its outstanding shares of common stock
("Rescission Stock") and bridge loans and warrants to purchase shares of
common stock (collectively, the "Rescission Securities") may have been issued
in violation of certain state securities laws. As a result, conditioned on
completion of the proposed Merger and the CSI Offering, GlobalTel plans to
offer to rescind such prior sales by offering to repurchase the Rescission
Securities (the "Rescission Offer") at the price originally paid plus interest
at the annual statutory rate of eight percent from the date of purchase to the
expiration of the Rescission Offer. As such, the shares of common stock and
bridge loans making up the Rescission Securities have been classified as
common stock subject to rescission and current liabilities, respectively, in
the accompanying consolidated financial statements. As of December 31, 1997,
there were 496,466 shares of common stock, $350,000 in aggregate principal
amounts of bridge loans and warrants to purchase an aggregate of approximately
35,000 shares of common stock identified for possible rescission. In addition,
GlobalTel expects to repay $455,000 in bridge loans from proceeds of the CSI
Offering that would otherwise be identified for possible rescission. If all
holders of Rescission Securities as of December 31, 1997 were to accept the
Rescission Offer, GlobalTel would be required to pay approximately $3.1
million including statutory accrued interest.
GlobalTel estimates that the total amount of its obligation for the
statutory accrued interest with respect to Rescission Stock could aggregate
approximately $278,000 as of December 31, 1997, if all offerees holding
Rescission Stock were to accept the Rescission Offer. Because of the
contingent nature of this liability and because the ultimate amount to be
paid, if any, is not presently known, the potential interest liability with
respect to Rescission Stock has not been accrued in the accompanying
consolidated financial statements, but will be recorded as an expense and a
liability of GlobalTel if and when the shares of common stock subject to
rescission are tendered pursuant to the Rescission Offer. The statutory rate
of interest with respect to the bridge loans covered by the Rescission Offer
is less than the interest that has already been accrued by GlobalTel under the
original terms of the bridge loans.
GlobalTel plans to make the Rescission Offer if the CSI Offering and the
Merger are completed. A portion of the net proceeds of the CSI Offering will
be used to fund payments pursuant to the repurchase of the Rescission
Securities, if any are required. However, there can be no assurance that the
proposed Merger and CSI Offering will be successfully completed. The
consolidated financial statements do not include any adjustments that might
result from the outcome of the Rescission Offer. Furthermore, notwithstanding
the Rescission Offer, there can be no assurance that GlobalTel will not be
subject to penalties or fines relating to past issuances or that other holders
of securities from GlobalTel will not assert or prevail in claims against
GlobalTel for rescission or damages under state or federal securities laws.
7. ACQUISITIONS
Ratsten International Telecommunications, Inc.
On October 18, 1995, GFP purchased 50% of the outstanding common stock of
Ratsten for $100,000 and the other 50% for 108,791 shares of GFP's common
stock in a business acquisition accounted for using the purchase method of
accounting, the purpose of which was to acquire certain licensing rights held
by Ratsten. Prior to the Ratsten acquisition, GFP had issued 108,000 shares of
common stock to its founders. In total, GFP's common stock issued was valued
at approximately $91,600. Of the total purchase price, including the
obligation to issue shares described below, $177,368 was assigned to the
license agreement, with the remainder assigned to certain assets acquired and
liabilities assumed. No goodwill was recognized from the purchase. The sellers
of
F-37
GLOBALTEL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
Ratsten made certain warranties to GlobalTel, primarily that the license
agreement was valid and fully transferable to GFP after the purchase.
The acquisition agreement included an obligation for the issuance of an
additional 60,000 shares of GlobalTel's common stock to the sellers of one-
half of Ratsten, contingent upon GlobalTel obtaining additional financing
(other than bridge funding) in excess of a certain amount. This contingent
obligation was valued at approximately $8,400 as of the date of the agreement.
During the year ended December 31, 1997, 30,000 of these shares had been
issued.
GFP
On December 29, 1995, pursuant to a share exchange agreement and statutory
share exchange, GlobalTel issued 216,791 of voting common stock on a one-for-
one basis for all of GFP's issued and outstanding common stock. GFP's only
significant asset was the license agreement which had been acquired from
Ratsten in anticipation of the share exchange agreement. GFP did not have any
material operations during the period from its inception through December 29,
1995.
8. COMMITMENTS AND CONTINGENCIES
GlobalTel has entered into noncancelable operating lease agreements
involving office space and equipment, certain telecommunications equipment and
licensing agreements with lease terms extending through 2006. Minimum lease
payments are subject to change as provided for in the lease agreements.
GlobalTel's future minimum noncancelable lease payments as of December 31,
1997, are as follows:
YEARS ENDING
DECEMBER 31,
------------
1998........................................................ $ 577,958
1999........................................................ 329,259
2000........................................................ 276,931
2001........................................................ 61,181
2002........................................................ 60,482
Thereafter.................................................. 216,726
----------
$1,522,537
Lease expense for the years ended December 31, 1995, 1996 and 1997 was
$125,413, $442,292, and $883,421, respectively.
9. SUBSEQUENT EVENTS
On April 22, 1998, GlobalTel entered into a letter of intent with CSI
whereby CSI will acquire all of the outstanding common stock of GlobalTel
through the issuance of CSI's common stock in the Merger based on a conversion
formula to be determined. On April 24, 1998, CSI filed a registration
statement with the Securities and Exchange Commission related to the CSI
Offering.
F-38
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
International Telephone Company
Meriden, Connecticut
We have audited the accompanying balance sheets of International Telephone
Company (ITC) as of December 31, 1996 and October 31, 1997 and the related
statements of operations, changes in shareholders' equity (capital deficiency)
and cash flows for the years ended December 31, 1995 and December 31, 1996 and
the ten months ended October 31, 1997. These financial statements are the
responsibility of ITC'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 December 31, 1996 and October 31, 1997 and the results of its
operations and its cash flows for the years ended December 31, 1995 and
December 31, 1996 and the ten months ended October 31, 1997, in accordance
with generally accepted accounting principles.
As discussed in Note G[2], one of ITC's carriers has initiated litigation
against ITC for collection of approximately $1.1 million.
Richard A. Eisner & Company, llp
New York, New York
December 12, 1997
F-39
INTERNATIONAL TELEPHONE COMPANY
BALANCE SHEETS
DECEMBER
31, OCTOBER 31, JANUARY 31,
1996 1997 1998
----------- ----------- -----------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents (Notes B[1]
and D)............................... $ 218,000 $ 848,000 $ 978,000
Accounts receivable (net of allowance
for doubtful accounts of $25,000,
$57,000 and $25,000)................. 1,250,000 1,045,000 1,342,000
Other current assets.................. 15,000 57,000 267,000
----------- ----------- -----------
Total current assets................ 1,483,000 1,950,000 2,587,000
Furniture and equipment (net of accumu-
lated depreciation of $130,000,
$87,000, and $115,000) (Notes B[4] and
C)..................................... 343,000 640,000 621,000
Security deposits....................... 130,000 130,000 130,000
----------- ----------- -----------
$ 1,956,000 $ 2,720,000 $ 3,338,000
=========== =========== ===========
LIABILITIES
Current liabilities:
Loan payable (Note D)................. $ 66,000 $ 3,000 $ 3,000
Accounts payable (Note G)............. 1,224,000 2,463,000 3,058,000
Accrued expenses...................... 142,000 67,000 14,000
Accrued commissions................... 165,000 145,000 200,000
Customer advances..................... 170,000 150,000 175,000
Due to shareholders................... 100,000 22,000
Due to CSI (Note K)................... 236,000
Deferred taxes........................ 6,000
Equipment lease obligations--current
portion (Note E)..................... 93,000 281,000 281,000
----------- ----------- -----------
Total current liabilities........... 1,866,000 309,000 3,989,000
Equipment leases obligations, less cur-
rent portion (Note E).................. 21,000 292,000 227,000
----------- ----------- -----------
1,887,000 301,000 4,216,000
----------- ----------- -----------
Commitments and contingencies (Note G)
SHAREHOLDERS' EQUITY (CAPITAL
DEFICIENCY)
Common stock--$.01 par value, 1,200
shares authorized, 1,200 shares issued
and outstanding
Additional paid-in capital.............. 1,000 1,000 1,000
Accumulated deficit..................... 68,000 (782,000) (879,000)
----------- ----------- -----------
Total shareholders' equity (capital
deficiency)........................ 69,000 (781,000) (878,000)
----------- ----------- -----------
$ 1,956,000 $ 2,820,000 $ 3,338,000
=========== =========== ===========
See notes to financial statements
F-40
INTERNATIONAL TELEPHONE COMPANY
STATEMENTS OF OPERATIONS
THREE MONTHS ENDED
------------------------
TEN MONTHS
YEAR ENDED YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, OCTOBER 31, DECEMBER 31, JANUARY 31,
1995 1996 1997 1996 1998
------------ ------------ ----------- ------------ -----------
(UNAUDITED)
Operating revenue:
Telecommunication
services (Notes B[2]
and H)............... $8,197,000 $ 7,603,000 $ 8,054,000 $1,942,000 $2,849,000
---------- ----------- ----------- ---------- ----------
Operating expenses:
Cost of telecommunica-
tion services (Note
B[3])................ 5,407,000 5,070,000 6,790,000 1,274,000 2,194,000
Selling expenses (Note
B[3])................ 1,220,000 1,099,000 715,000 210,000 244,000
General and adminis-
trative
expenses............. 870,000 1,022,000 1,205,000 393,000 505,000
Officers salaries..... 332,000 493,000 256,000 123,000
---------- ----------- ----------- ---------- ----------
7,829,000 7,684,000 8,966,000 2,000,000 2,943,000
---------- ----------- ----------- ---------- ----------
Loss from operations be-
fore other income (ex-
pense)................. 368,000 (81,000) (912,000) (58,000) (94,000)
Other income (expense):
Miscellaneous......... 101,000
Consulting fee........ 113,000
Loss on sale of equip-
ment................. (22,000)
Interest income....... 8,000 12,000 28,000 7,000 12,000
Interest expense...... (11,000) (21,000) (57,000) (5,000) (15,000)
---------- ----------- ----------- ---------- ----------
INCOME (LOSS) BEFORE
INCOME TAX PROVISION... 365,000 11,000 (850,000) (56,000) (97,000)
Income tax provision
(Note F)............... 21,000 4,000 0 0 0
---------- ----------- ----------- ---------- ----------
NET INCOME (LOSS)....... $ 344,000 $ 7,000 $ (850,000) $ (56,000) $ (97,000)
========== =========== =========== ========== ==========
See notes to financial statements
F-41
INTERNATIONAL TELEPHONE COMPANY
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (CAPITAL DEFICIENCY)
COMMON STOCK
1,200 SHARES
AUTHORIZED
---------------- RETAINED SHAREHOLDERS'
NUMBER OF ADDITIONAL EARNINGS EQUITY
SHARES PAID-IN (ACCUMULATED (CAPITAL
ISSUED AMOUNT CAPITAL DEFICIT) DEFICIENCY)
--------- ------ ---------- ------------ -------------
Balance--January 1,
1995................... 1,200 $ 0 $1,000 $(283,000) $(282,000)
Net income for the year
ended December 31,
1995................... 344,000 344,000
----- --- ------ --------- ---------
Balance--December 31,
1995................... 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)
Net loss for the three
months ended January
31, 1998 (unaudited)... (97,000) (97,000)
----- --- ------ --------- ---------
Balance--January 31,
1998 (unaudited)....... 1,200 $ 0 $1,000 $(879,000) $(878,000)
===== === ====== ========= =========
See notes to financial statements
F-42
INTERNATIONAL TELEPHONE COMPANY
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, THREE MONTHS ENDED
----------------------- ------------------------
TEN MONTHS
ENDED
OCTOBER 31, DECEMBER 31, JANUARY 31,
1995 1996 1997 1996 1998
------------ ----------- ----------- ------------ -----------
(UNAUDITED)
CASH FLOWS FROM
OPERATING ACTIVITIES:
Net income (loss)..... $ 344,000 $ 7,000 $ (850,000) $(56,000) $(97,000)
Adjustments to recon-
cile net income
(loss) to net cash
provided by (used in)
operating activities:
Depreciation......... 53,000 69,000 73,000 22,000 29,000
Provision for doubt-
ful accounts........ 195,000 43,000 25,000 11,000
Loss on sale of
equipment........... 22,000
Deferred taxes....... 4,000 2,000 (6,000)
Changes in:
Accounts receiv-
able............... (1,206,000) (33,000) 180,000 (239,000) (297,000)
Other assets........ 13,000 1,000 (42,000) 156,000 (210,000)
Security deposits... (107,000)
Customer advance
payments........... 129,000 38,000 (20,000) 25,000
Commissions pay-
able............... 140,000 (24,000) (20,000) 40,000 55,000
Accrued expenses.... 50,000 91,000 (74,000) (179,000) (60,000)
Accounts payable.... 901,000 108,000 1,239,000 121,000 602,000
Income taxes pay-
able............... 17,000 (16,000) (1,000)
Due to CSI.......... 236,000
Due to Sharehold-
ers................ 100,000 (19,000) (78,000)
------------ ----------- ---------- -------- --------
Net cash provided
by (used in) op-
erating activi-
ties............. 533,000 286,000 626,000 (143,000) 205,000
------------ ----------- ---------- -------- --------
CASH FLOWS FROM
INVESTING ACTIVITIES:
Purchases of furniture
and equipment........ (152,000) (29,000) (17,000) (10,000)
Proceeds from sale of
equipment............ 259,000
------------ ----------- ---------- -------- --------
Net cash provided
by (used in) in-
vesting activi-
ties............. (152,000) (29,000) 242,000 0 (10,000)
------------ ----------- ---------- -------- --------
CASH FLOWS FROM
FINANCING ACTIVITIES:
Proceeds from (repay-
ments of) loan pay-
able................. 66,000 (63,000) (34,000)
Payments under capital
leases............... (41,000) (112,000) (175,000) (51,000) (65,000)
Repayment of loan from
shareholder.......... (180,000)
Repayment of note pay-
able................. (70,000) (140,000)
------------ ----------- ---------- -------- --------
Net cash used in
financing activi-
ties............. (291,000) (186,000) (238,000) (85,000) (65,000)
------------ ----------- ---------- -------- --------
NET INCREASE IN CASH AND
CASH EQUIVALENTS....... 90,000 71,000 630,000 (228,000) 130,000
Cash and cash equiva-
lents--beginning of pe-
riod................... 57,000 147,000 218,000 446,000 848,000
------------ ----------- ---------- -------- --------
CASH AND CASH
EQUIVALENTS--END OF
PERIOD................. $ 147,000 $ 218,000 $ 848,000 $218,000 $978,000
============ =========== ========== ======== ========
SUPPLEMENTAL DISCLOSURE
OF CASH FLOW
INFORMATION:
Cash paid during the
period for:
Interest............ $ 11,000 $ 21,000 $ 57,000 $ 5,000 $ 15,000
Income taxes........ 26,000
SUPPLEMENTAL DISCLOSURE
OF NONCASH FINANCING
ACTIVITIES:
Equipment acquired under
capital lease obliga-
tions (Note E)......... 267,000 634,000
Note payable issued as
full settlement of
telecommunication costs
previously incurred.... 246,000
See notes to financial statements
F-43
INTERNATIONAL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED WITH RESPECT TO DATA AS OF JANUARY 31, 1998 AND FOR THE THREE-MONTH
PERIODS ENDED DECEMBER 31, 1996 AND JANUARY 31, 1998)
NOTE A--ORGANIZATION AND BUSINESS
International Telephone Company ( "ITC") was organized in the State of
Delaware on March 3, 1993. ITC operates an international telecommunications
system offering long distance telephone service to corporations and
individuals located outside the United States.
ITC incurred a loss of $850,000 during the ten months ended October 31,
1997, including a $1.1 million claim against ITC by a carrier for usage
charges that ITC is disputing (see Note G[2]). ITC intends to vigorously
defend such claim and is attempting to settle with the carrier. If ITC is not
successful in its defense or in reaching a settlement, ITC believes that by
reducing its administrative expenses, including officers' compensation, the
cash flow from operations will be sufficient for ITC to pay such claim and to
operate as a going concern. In addition, ITC believes that it will be able to
obtain financing, if necessary.
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(1) Cash equivalents:
ITC considers money-market funds to be cash equivalents.
(2) Revenue recognition:
Telecommunication revenue is recognized at the time services are provided.
(3) Cost of telecommunication revenue 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 ITC 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 revenue and expenses during the
reporting period. Actual results could differ from those estimates.
F-44
INTERNATIONAL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JANUARY 31, 1998 AND FOR THE THREE-MONTH
PERIODS ENDED DECEMBER 31, 1996 AND JANUARY 31, 1998)
(6) Deferred income taxes:
ITC 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 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.
(7) Interim Financial Statements:
In the opinion of management, the unaudited balance sheet as of January 31,
1998, and the unaudited statements of operations and cash flows for the three
month periods ended December 31, 1996 and January 31, 1998, reflect all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the information set forth therein. The results of operations
for interim periods are not necessarily indicative of results for the full
year.
NOTE C--FURNITURE AND EQUIPMENT
Furniture and equipment consists of the following:
DECEMBER 31, OCTOBER 31, JANUARY 31,
1996 1997 1998
------------ ----------- -----------
Telecommunications equipment............. $398,000 $634,000 $634,000
Furniture and fixtures................... 6,000 6,000 6,000
Office equipment......................... 69,000 87,000 96,000
-------- -------- --------
473,000 727,000 736,000
Less accumulated depreciation and amorti-
zation.................................. 130,000 87,000 115,000
-------- -------- --------
$343,000 $640,000 $621,000
======== ======== ========
NOTE D--LOAN PAYABLE
ITC has a $250,000 line of credit, which expires on September 30, 1998, with
a financial institution. At October 31, 1997 and January 31, 1998 the balance
due under this line of credit was $3,000, which is collateralized by the
assets of ITC, 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
ITC leases equipment under agreements with original terms of thirty-six
months, which are accounted for as capital leases. During the ten months ended
October 31, 1997, ITC acquired telecommunications equipment with a cost of
$634,000 under a capital lease. Simultaneously, ITC 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 $196,000, $609,000 and
$580,000, respectively, at December 31, 1996, October 31, 1997 and January 31,
1998.
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-45
INTERNATIONAL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JANUARY 31, 1998 AND FOR THE THREE-MONTH
PERIODS ENDED DECEMBER 31, 1996 AND JANUARY 31, 1998)
NOTE F--INCOME TAXES
The provision for federal and state income taxes is comprised of the
following:
YEAR ENDED
DECEMBER 31,
--------------
1995 1996
------- ------
Current:
Federal........................................................ $11,000 $1,000
State.......................................................... 6,000 0
------- ------
17,000 1,000
------- ------
Deferred:
Federal........................................................ 3,000 2,000
State.......................................................... 1,000 1,000
------- ------
4,000 3,000
------- ------
$21,000 $4,000
======= ======
At October 31, 1997 and January 31, 1998, ITC has a net operating loss
carryforward of approximately $1,000,000 and $1,100,000, respectively,
resulting principally from its loss for income tax purposes for the ten months
ended October 31, 1997 and January 31, 1998. As a result, ITC has a deferred
tax asset of approximately $400,000 at October 31, 1997 and January 31, 1998.
ITC has provided a valuation allowance, which increased by approximately
$300,000 and 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 and the three months
ended January 31, 1998.
The deferred tax liability of approximately $100,000 at October 31, 1997 and
January 31, 1998, respectively, 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:
THREE MONTHS ENDED
------------------------
TEN MONTHS
YEAR ENDED YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, OCTOBER 31, DECEMBER 31, JANUARY 31,
1995 1996 1997 1997 1998
------------ ------------ ----------- ------------ -----------
Federal income tax pro-
vision (benefit) at
statutory rate......... $124,000 $3,000 $(289,000) $(19,000) $(33,000)
Provision (benefit) for
state income taxes--net
of U.S. federal taxes.. 4,000 1,000 (34,000) (2,000) (4,000)
Valuation allowance..... (107,000) 323,000 21,000 37,000
-------- ------ --------- -------- --------
$ 21,000 $4,000 $ 0 $ 0 $ 0
======== ====== ========= ======== ========
F-46
INTERNATIONAL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JANUARY 31, 1998 AND FOR THE THREE-MONTH
PERIODS ENDED DECEMBER 31, 1996 AND JANUARY 31, 1998)
NOTE G--COMMITMENTS, CONTINGENCIES AND OTHER MATTERS
[1] Operating leases:
ITC 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 years ended
December 31, 1995 and 1996, for the ten months ended October 31, 1997, and the
three months ended January 31, 1998 totaled $51,000, $69,000, $73,000 and
$16,000, respectively.
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, ITC was committed to purchase transmission
capacity from a certain carrier. ITC 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
ITC for collection of approximately $1.1 million, which is included in
accounts payable at October 31, 1997. ITC 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 ITC and ITC agreed to pay the
outstanding balance by December 1, 1997. The carrier subsequently presented an
invoice to ITC which did not reflect such credit and ITC believes that such
statement does not acknowledge a $100,000 payment made in January 1997. As a
result, ITC has not made the scheduled payments and accounts payable at
October 31, 1997 includes $400,000 due to this carrier.
[3] Concentration of carriers:
ITC purchases transmissions capacity from a limited number of domestic
telephone carriers. ITC purchased 75% of such capacity from three telephone
carriers, 85% of such capacity from 3 carriers and 94% of such capacity from 5
carriers during the year ended December 31, 1996, the ten months ended October
31, 1997 and the three months ended January 31, 1998, respectively.
[4] Concentration of agents:
During the years ended December 31, 1995 and 1996, the ten months ended
October 31, 1997 and the three months ended January 31, 1998, 3 agents were
responsible for 65%, 3 agents were responsible for 66%, 3 agents were
responsible for 53% and 4 agents were responsible for 65%, of ITC's
telecommunications revenue, respectively.
F-47
INTERNATIONAL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JANUARY 31, 1998 AND FOR THE THREE-MONTH
PERIODS ENDED DECEMBER 31, 1996 AND JANUARY 31, 1998)
NOTE H--TELECOMMUNICATION REVENUE:
The information below summarizes telecommunication revenue by geographic
area:
TEN MONTHS THREE MONTHS
YEAR ENDED YEAR ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, OCTOBER 31, JANUARY 31,
1995 1996 1997 1998
------------ ------------ ----------- ------------
Europe....................... $ 3,429,000 $ 2,742,000 $2,416,000 $ 826,000
Africa....................... 2,525,000 2,508,000 2,511,000 855,000
Middle East.................. 1,403,000 1,095,000 1,593,000 741,000
Latin America................ 614,000 626,000 1,110,000 342,000
Asia......................... 88,000 529,000 74,000 1,000
Other........................ 138,000 103,000 350,000 84,000
----------- ----------- ---------- ----------
$ 8,197,000 $ 7,603,000 $8,054,000 $2,849,000
=========== =========== ========== ==========
NOTE I--OTHER INCOME
During the year ended December 31, 1996, ITC 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, ITC 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
ITC's Application for Authority under Section 214 of the Communications Act of
1934, as amended. Pursuant to such action, ITC is authorized to resell the
public switched telecommunications services of other U.S. carriers.
ITC is subject to regulation in other countries in which it does business.
ITC believes that an adverse determination as to the permissibility of the
ITC'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 ITC
ITC and its stockholders have signed an agreement relating to the purchase
by Communications Systems International, Inc. ("CSI"), another
telecommunications company, of all of the outstanding shares of common stock
of ITC. ITC's stockholders have received $125,000 from CSI in connection with
such anticipated sale. ITC and CSI utilize each others' transmission capacity.
During the three months ended January 31, 1998, ITC incurred
telecommunications charges aggregating approximately $190,000 and recognized
telecommunications revenue of approximately $72,000 from CSI. There were no
significant telecommunications charges incurred or telecommunications revenue
earned from CSI during the year ended December 31, 1996 or the ten months
ended October 31, 1997.
F-48
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
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............................................................. 5
The Acquistions.......................................................... 21
Use of Proceeds.......................................................... 23
Dividend Policy.......................................................... 23
Price Range of Common Stock.............................................. 24
Dilution................................................................. 25
Capitalization........................................................... 26
Selected Financial Data.................................................. 27
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 28
Business................................................................. 48
Management............................................................... 66
Principal Shareholders................................................... 74
Certain Transactions..................................................... 76
Description of Securities................................................ 81
Rescission Offer......................................................... 83
Shares Eligible for Future Sale.......................................... 85
Underwriting............................................................. 86
Legal Matters............................................................ 88
Experts.................................................................. 88
Additional Information................................................... 89
Glossary of Terms........................................................ 90
Index to Financial Statements............................................ F-1
--------------
UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICI-
PATING 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.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SHARES
COMMUNICATIONS SYSTEMS INTERNATIONAL, INC.
COMMON STOCK
----------------------
P R O S P E C T U S
----------------------
Cruttenden Roth
INCORPORATED
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 APRIL 27, 1998
PRELIMINARY PROSPECTUS
SHARES
[LOGO]
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 without the consent of Cohig & Associates, Inc. The
Company will not receive any proceeds from the sale of the Selling
Securityholders' Shares. See "Selling Securityholders and Plan of
Distribution."
Prior to this Offering, the Common Stock was traded sporadically in limited
amounts on the OTC Bulletin Board under the symbol CSYG. On April , 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 $ and $ 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 "CSGL". Upon listing on the Nasdaq SmallCap Market, the Company's Common
Stock will no longer be listed on the OTC Bulletin Board. 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 Security holders 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 shares of Common Stock and
up to an additional 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 after
the offering................ shares (1)
Use of Proceeds.............. The Combined Company will receive no
proceeds from the sale of the Selling
Securityholders' Shares. Upon exercise
of warrants underlying certain selling
Security-holders' Shares, the Company
will receive the applicable exercise
price.
Risk Factors................. The Common Stock offered hereby is
speculative and involves a high degree
of risk and immediate and substantial
dilution and should not be purchased
by investors, who cannot afford the
loss of their entire investment. See
"Risk Factors" and "Dilution."
Proposed Nasdaq SmallCap
symbol...................... [CSGL]
- --------
(1) Includes shares of Common Stock to be issued in connection with an
underwritten public offering by the Combined Company and shares of
Common Stock (the "Bridge Shares") to be issued in connection with the
notes (the "Bridge Notes") issued by CSI in December 1997 (the "December
1997 Financing") immediately prior to the closing of this Offering based
on an assumed offering price of $ per share of Common Stock in the
Combined Company's underwritten public offering. 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 shares of Common Stock issuable upon exercise
of the Representatives' Warrants, (v) any shares issuable in connection
with the ITC Acquisition (vi) the issuance of and shares of Common
Stock to certain holders of notes of GlobalTel (the "GlobalTel Full
Coverage Notes") to be repaid at the closing of the Combined Company's
underwritten public offering and past noteholders of GlobalTel,
respectively, assuming an initial public offering price of $ per share,
(vii) the issuance of 161,783 shares of Common Stock upon the cashless
conversion of certain warrants (the "Cashless Warrants") at the closing of
the Combined Company's public offering, assuming an initial public
offering price of $ per share, (viii) the issuance of shares of
Common Stock to an officer of GlobalTel in connection with the acquisition
of GFP Group, Inc. upon the closing of the Combined Company's underwritten
public offering, (ix) the issuance of shares of Common Stock to an
affiliate of GlobalTel in connection with services to be rendered by such
affiliate, assuming an initial public offering price of $ per share, and
(x) the conversion of certain long-term debt into shares of Common
Stock upon the closing of the Combined Company's underwritten public
offering at a price of $ per share (collectively referred to herein as
"Additional Securities"). See "Management," "Description of Securities"
and "Selling Securityholders' and Plan of Distribution."
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 Combined Company of shares of Common
Stock and up to an additional shares of Common Stock to cover over-
allotments, if any, was declared effective by the Commission. The Combined
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
commissions 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. Pursuant to an agreement with Cohig &
Associates, Inc. ("Cohig") none of the Selling Securityholders' Shares may be
sold by the Selling Securityholders prior to 180 days after the date of this
Prospectus without the consent of Cohig. 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
SECURITY HOLDERS' COMMON STOCK
SELLING SECURITY HOLDERS SHARES OFFERED AFTER 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-
A-6
[ALTERNATE PAGE FOR SELLING SECURITYHOLDERS' PROSPECTUS]
current market price, or in negotiated transactions. The Selling
Securityholders' Shares may be sold by one or 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
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 Selling Securityholders'
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 13. 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............................................. $ 13,219
NASD filing fee.................................................. 4,981
Blue Sky filing fees............................................. 20,000*
Nasdaq Stock Market application fee.............................. 10,000
Legal fees and expenses.......................................... 200,000*
Blue Sky legal fees.............................................. 20,000*
Accounting fees and expenses..................................... 200,000*
Registrar and transfer agent fees................................ 8,000
Printing and engraving........................................... 80,000*
Representatives' nonaccountable expense allowance................ 750,000
Miscellaneous.................................................... 193,800*
----------
TOTAL.......................................................... $1,500,000
==========
- --------
* Estimated.
ITEM 14. 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.
II-1
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 15. RECENT SALES OF UNREGISTERED SECURITIES.
Note: The information contained in this Item 15 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. Except as
otherwise stated, the Registrant believes that the issuance of such securities
was exempt from registration pursuant to Section 4(2) of the Securities Act as
transactions not involving a public offering. The purchasers in such private
offerings represented their intention to acquire the securities for investment
only and not with a view to the distribution thereof and appropriate legends
were affixed to the stock certificates issued in such transactions. All
purchasers had adequate access, through their employment or other
relationships, to sufficient information about the Registrant to make an
informed investment decision. No underwriter was employed with respect to any
such sales.
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. The Combined Company believes that such
issuances were exempt from Registration pursuant to Rule 701 and Section 3(b)
of the Securities Act.
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"). The Combined Company believes that such
issuances were exempt from Registration pursuant to Rule 701 and Section 3(b)
of the Securities Act.
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.
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. The Combined
Company believes that such issuances were exempt from Registration pursuant to
Rule 701 and Section 3(b) of the Securities Act.
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.
On September 26, 1995, the Registrant issued 30,000 shares of Common Stock
to Elmo D. Murphy for $3.00 per share.
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.
II-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.
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.
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.
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 financially
sophisticated 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.
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 financially sophisticated 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.
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.
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.
In March and April 1998, the Registrant issued $320,000 aggregate principal
amount of notes bearing interest at 10% per annum to seven financially
sophisticated investors, including three directors and a principal shareholder
of the Registrant. The investors also received warrants to purchase shares of
Common Stock.
ITEM 16. EXHIBITS.
EXHIBIT
NO. DESCRIPTION
------- -----------
1.1 Form of Underwriting Agreement between CSI and the Underwriters
2.1* Plan and Articles of Merger dated September 14, 1995 between CSI and
Redden Dynamics, Inc.
2.2 Stock Purchase Agreement, dated April 23, 1998, among the Registrant,
ITC and its Shareholders
3.1* Articles of Incorporation of CSI
3.2 Bylaws of CSI
II-3
EXHIBIT
NO. DESCRIPTION
------- -----------
4.1* Specimen Common Stock certificate
4.2 Form of Warrant Agreement, including Form of Representatives' Warrant
5** Opinion of Parcel, Mauro & Spaanstra, P.C.
10.1* Form of 10% Convertible Promissory Note from to Registrant to various
investors
10.2* Form of Warrant and Terms of Warrant between Registrant and 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
10.6* Lease Agreement dated January 1, 1994 between CSI and The Mining
Exchange Partners Limited
10.7* LINK-US/PC Agreement dated September 19, 1996 between CSI and Gary
Kamienski
10.8* Form of Distributor Agreement between CSI and certain of its
distributors
10.9* Form of Branch Office Agency Agreement between the Registrant and
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
10.19 Office lease dated as of June 10, 1996 by and between GlobalTel, as
Lessee, and One Wilshire Arcade Imperial, Ltd., as Lessor, together
with First Amendment thereto dated June 24, 1997.
10.20+ Carrier Agreement dated as of August 20, 1996 by and between
Primecall, Inc. and Cable & Wireless, Inc.
10.21+ Reciprocal Telecommunications Agreement dated as of December 3, 1996
by and between STAR Vending, Inc. and Primecall, Inc.
10.22+ Switch Port Lease and Service Agreement dated as of August 7, 1996 by
and between Primecall, Inc. and World Touch, Inc.
10.23+ Trilogy Telemanagement Service Agreement dated as of April 2, 1997 by
and between Trilogy Telemanagement, L.L.C. and Primecall, Inc.
10.24+ Agreement for Managed Data Network Services dated April 28, 1995 (the
"Equant Agreement") by and between NetStar International
Telecommunications, Inc. ("NetStar") and Equant Network Services
International Corporation (f/k/a Scitor International
Telecommunications Services, Inc.) ("Equant"), together with Amendment
No. 1 to the Scitor ITS Agreement dated February 21, 1996 between
NetStar, Equant and GFP Group, Inc.
10.25+ Exclusive Services and Marketing Agreement dated as of April 15, 1997
between GlobalTel and International Business Network for World
Commerce & Industry, Ltd.
10.26+ Master Task Agreement dated as of September 19, 1997 by and between
GFP Group, Inc. and Novell, Inc.
II-4
EXHIBIT
NO. DESCRIPTION
------- -----------
10.27+ Novell Business Internet Services Affiliate Service Platform Statement
of Work to Agreement No. 97-GlobalTel-001 dated October 21, 1997
between Novell, Inc. and GFP Group, Inc.
10.28 Share Exchange Agreement dated as of December 29, 1995 by and among
GlobalTel and certain holders of shares of capital stock of GFP Group,
Inc.
10.29 Letter of Intent dated June 16, 1997 by and among Primecall, Inc.,
Netlink International Inc. and Kunmung Dayu Biological Engineering Co.
Ltd.
10.30 Letter Agreement dated November 6, 1997 by and among GlobalTel, Alan
H. Chin and Curtis E. Lew
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
23.4 Consent of Arthur Andersen LLP
24 Power of Attorney (included on page II-6 hereof)
27 Financial Data Schedule
- --------
* Previously filed.
** To be filed by amendment.
+ Portions of this exhibit have been omitted pursuant to an application for
an order granting confidential treatment. The omitted portions have been
separately filed with the Commission.
ITEM 17. 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.
(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.
II-5
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-6
SIGNATURES
PURSUANT WITH THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS DULY CAUSED THIS AMENDMENT NO. 1 TO THE REGISTRATION STATEMENT TO BE
SIGNED ON THEIR BEHALF BY THE UNDERSIGNED IN COLORADO SPRINGS, COLORADO, ON
APRIL , 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 S-1
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
Amendment No. 1 to the registration statement has been signed by the following
persons in the capacities and on the dates stated.
/s/ Ronald P. Erickson Chairman of the April , 1998
- ------------------------------------- Board designee
RONALD P. ERICKSON
/s/ Robert A. Spade
- ------------------------------------- Chief Executive April , 1998
ROBERT A. SPADE Officer and Vice
Chairman of the
Board (Principal
Executive Officer)
/s/ Patrick R. Scanlon President, Chief
- ------------------------------------- Operating Officer April , 1998
PATRICK R. SCANLON and Director
/s/ Daniel R. Hudspeth Chief Financial
- ------------------------------------- Officer and April , 1998
DANIEL R. HUDSPETH Treasurer
(Principal
Financial and
Accounting Officer)
II-7
/s/ Dean H. Cary Director
- ------------------------------------- April , 1998
DEAN H. CARY
/s/ Richard F. Nipert Director
- ------------------------------------- April , 1998
RICHARD F. NIPERT
/s/ Charles A. Shields Director April , 1998
- -------------------------------------
CHARLES A. SHIELDS
/s/ Bruce L. Crockett Director designee April , 1998
- -------------------------------------
BRUCE L. CROCKETT
/s/ Lyman C. Hamilton Director designee April , 1998
- -------------------------------------
LYMAN C. HAMILTON
/s/ Michael S. Brownfield Director designee April , 1998
- -------------------------------------
MICHAEL S. BROWNFIELD
II-8