<PAGE>
As filed with the Securities and Exchange Commission on June 12, 1996.
REGISTRATION STATEMENT NO. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________________
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
______________
TELCO COMMUNICATIONS GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)
<TABLE>
<S> <C> <C>
Virginia 4813 54-1674283
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
DONALD A. BURNS
4219 LAFAYETTE CENTER DRIVE PRESIDENT AND CHIEF EXECUTIVE OFFICER
CHANTILLY, VIRGINIA 22021 TELCO COMMUNICATIONS GROUP, INC.
(703) 631-5600 4219 LAFAYETTE CENTER DRIVE
(Address, including zip code, and telephone CHANTILLY, VIRGINIA 22021
number, including area code, (703) 631-5600
of registrant's principal executive offices) (Name, address, including zip code,
and telephone number, including area
code, of agent for service)
________________
Copies to:
MORRIS F. DEFEO, JR. DENNIS J. BLOCK
SWIDLER & BERLIN, CHARTERED AKIKO MIKUMO
3000 K STREET, N.W., SUITE 300 WEIL, GOTSHAL & MANGES, LLP
WASHINGTON, D.C. 20007 767 FIFTH AVE.,
(202) 424-7500 NEW YORK, N.Y. 10153
(212) 310-8000
________________
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(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 delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: [_]
________________
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
================================================================================
TITLE OF EACH CLASS OF PROPOSED MAXIMUM AMOUNT OF
SECURITIES TO BE REGISTERED AGGREGATE OFFERING PRICE (1) REGISTRATION FEE
- --------------------------------------------------------------------------------
<S> <C> <C>
Common Stock, no par value $180,837,500 $62,358
================================================================================
</TABLE>
(1) Estimated solely for purposes of calculating the registration fee.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
================================================================================
<PAGE>
TELCO COMMUNICATIONS GROUP, INC.
CROSS REFERENCE SHEET
PURSUANT TO ITEM 501(B) OF REGULATION S-K
<TABLE>
<CAPTION>
Item
Number Form S-1 Caption Prospectus Location or Caption
- ------ ---------------- ------------------------------
<S> <C> <C>
1. Forepart of the Registration Statement and
Outside Front Cover Page of
Prospectus................................ Outside Front Cover Page; Inside Front Cover
Page
2. Inside Front and Outside Back Cover
Pages of Prospectus....................... Inside Front Cover Page; Table of Contents
3. Summary Information, Risk Factors and
Ratio of Earnings to Fixed Charges........ Prospectus Summary; Risk Factors; Business
4. Use of Proceeds........................... Use of Proceeds
5. Determination of Offering Price........... Outside Front Cover Page; Underwriting
6. Dilution.................................. Dilution
7. Selling Security Holders.................. Principal and Selling Shareholders
8. Plan of Distribution...................... Outside Front Cover Page; Underwriting
9. Description of Securities to be
Registered................................ Outside Front Cover Page; Dividend Policy;
Description of Capital Stock
10. Interests of Named Experts and
Counsel................................... Not Applicable
11. Information with Respect to the
Registrant................................ Inside Front Cover Page; Prospectus Summary;
Risk Factors; Use of Proceeds; Dividend Policy; Dilution; Capitalization;
Selected Consolidated Historical and Pro Forma Financial Data; Pro Forma
Consolidated Financial Statements; Management's Discussion and Analysis of
Financial Condition and Results of Operations; Business; Management;
Certain Transactions; Principal and Selling Shareholders; Description of
Capital Stock; Shares Eligible for Future Sale; Consolidated Financial
Statements
12. Disclosure of Commission Position on
Indemnification for Securities Act
Liabilities............................... Not Applicable
</TABLE>
<PAGE>
EXPLANATORY NOTE
This Registration Statement contains two forms of Prospectus: (i) one to be
used in connection with an offering of the registrant's Common Stock in the
United States and Canada (the "U.S. Prospectus") and (ii) the other to be used
in a concurrent offering of the registrant's Common Stock outside the United
States and Canada (the "International Prospectus" and, together with the U.S.
Prospectus, the "Prospectuses"). The International Prospectus will be identical
to the U.S. Prospectus except that it will have a different front cover page and
back cover page. The U.S. Prospectus is included herein and is followed by the
alternate pages to be used in the International Prospectus. Such alternate pages
for the International Prospectus included herein are labeled "Alternate Page for
International Prospectus." If required pursuant to Rule 424(b) of the General
Rules and Regulations under the Securities Act of 1933, ten copies of the final
form of each Prospectus will be filed with the Securities and Exchange
Commission.
<PAGE>
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAW OF ANY SUCH STATE.
SUBJECT TO COMPLETION, DATED JUNE 12, 1996
PROSPECTUS
_________ SHARES
[INSERT LOGO]
TELCO COMMUNICATIONS GROUP, INC.
COMMON STOCK
______________________
Of the _________ shares of Common Stock offered hereby, _________ shares
will be sold by the Company and _________ shares will be sold by the Selling
Shareholders. The Company will not receive any of the proceeds from the sale of
the shares being sold by the Selling Shareholders. See "Principal and Selling
Shareholders."
A total of _________ shares (the "U.S. Shares") are being offered in the
United States and Canada (the "U.S. Offering") by the U.S. Underwriters and
_________ shares (the "International Shares") are being offered outside the
United States and Canada (the "International Offering") by the Managers. The
initial public offering price and the underwriting discounts and commissions are
identical for both the U.S. Offering and the International Offering
(collectively, the "Offerings").
Prior to the Offerings, there has been no public market for the Common
Stock. It is currently anticipated that the initial public offering price will
be between $___ and $___ per share. See "Underwriting" for a discussion of the
factors considered in determining the initial public offering price.
The Company intends to apply for the listing of the Common Stock on the New
York Stock Exchange under the symbol "_________."
SEE "RISK FACTORS" BEGINNING ON PAGE 8 FOR INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR
HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
==============================================================================================================================
Price to Underwriting Discounts Proceeds to Proceeds to
Public and Commissions (1) Company (2) Selling Shareholders (2)(3)
<S> <C> <C> <C> <C>
Per Share............... $_______ $_______ $_________ $_________
- ------------------------------------------------------------------------------------------------------------------------------
Total (4)............... $_______ $_______ $_________ $_________
==============================================================================================================================
</TABLE>
(1) See "Underwriting" for indemnification arrangements with the U.S.
Underwriters and the Managers.
(2) Before deducting expenses payable by the Company, estimated at $__________.
(3) Before deduction of $________ ($____ per share) to be paid to the Company
upon the exercise of a warrant relating to shares to be sold by one of the
Selling Shareholders.
(4) The Company has granted the U.S. Underwriters and the Managers 30-day
options to purchase in the aggregate up to _________ additional shares of
Common Stock solely to cover over-allotments, if any. If the options are
exercised in full, the total Price to Public, Underwriting Discounts and
Commissions, and Proceeds to Company will be $_________, $__________, and
$_________, respectively. See "Underwriting."
__________________
The U.S. Shares are offered by the several U.S. Underwriters subject to
prior sale, when, as and if delivered to and accepted by them and subject to
certain conditions, including the approval of certain legal matters by counsel.
The U.S. Underwriters reserve the right to withdraw, cancel or modify the U.S.
Offering and to reject orders in whole or in part. It is expected that the
delivery of the U.S. Shares will be made against payment therefor on or about
________, 1996, at the offices of Bear, Stearns & Co. Inc., 245 Park Avenue, New
York, New York 10167.
BEAR, STEARNS & CO. INC. SALOMON BROTHERS INC
___________, 1996
<PAGE>
[GRAPHICS TO BE INSERTED]
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE OR
OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
<PAGE>
- --------------------------------------------------------------------------------
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by; and should be
read in conjunction with the more detailed information, including risk factors
and consolidated financial statements and notes thereto, appearing elsewhere in
this Prospectus. Unless otherwise indicated, the information in this Prospectus
(i) assumes an estimated initial public offering price equal to $ (the midpoint
of the range shown on the cover page of this Prospectus) and that the U.S.
Underwriters' and the Managers' over-allotment options are not exercised, (ii)
has been adjusted to give effect to a 425- for-1 stock split (the "Stock Split")
and (iii) reflects the consummation of the "Reorganization" as defined below and
described in "Management's Discussion and Analysis of Financial Condition and
Results of Operations--The Reorganization." References in this Prospectus to the
"Company" and "Telco" refer to Telco Communications Group, Inc. and its
subsidiaries, except where the context otherwise requires.
THE COMPANY
Telco is a rapidly growing switch-based provider of domestic and
international long distance telecommunication services primarily to residential
customers in the United States. The majority of the Company's customers access
its network by dialing a unique carrier identification code ("CIC Code") before
dialing the number they are calling. Using a CIC Code to access the Company's
network is known as "casual calling" because customers can use the Company's
services at any time without changing their existing long distance carrier. The
Company markets its long distance services under two brands, each with a unique
CIC Code: Dial & Save (CIC Code 10457) and the Long Distance Wholesale Club (CIC
Code 10297), and prices its services at a discount to the basic "1 plus" rates
offered by the three major long distance carriers: AT&T Corp. ("AT&T"), MCI
Communications Corporation ("MCI") and Sprint Corporation ("Sprint"). During
April 1996, the Company provided long distance services to approximately 2.6
million customers (switched access lines) in 37 states and the District of
Columbia. The Company plans to expand its marketing efforts in these states and
to offer service in one additional New England and 10 additional western states
during 1996. Since the Company began operations in November 1993, its revenues
and net income have grown to approximately $215.4 million and $10.8 million,
respectively, for the year ended December 31, 1995, and to $91.9 million and
$3.3 million, respectively, for the three months ended March 31, 1996.
Although casual calling has been in existence since the mid-1980s,
only recently have companies such as Telco begun to aggressively pursue this
market opportunity. The Company markets its services primarily through direct
mail and an inbound telesales and marketing system, and believes that this
marketing strategy enables the Company to attract residential customers in a
cost effective manner. Because casual calling customers are not required to
cancel or change their presubscribed long distance carrier, the Company believes
that there is a substantial reduction in the potential impact of aggressive
"win-back" and other customer acquisition programs prevalent in the residential
long distance market.
The Company bills its casual calling customers through local exchange
carrier ("LEC") billing and collection agreements which enable the Company to
place its charges on the monthly local phone bills of its residential casual
calling customers. The Company has agreements with LECs, including all of the
Regional Bell Operating Companies ("RBOCs"), that cover approximately 96% of the
switched access lines in the United States. The Company believes that these
billing arrangements are the most effective mechanism for billing its
residential customers, because of the convenience to its customers of receiving
one
3
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
bill for both local and long distance service and the benefits derived from the
LECs' extensive collections infrastructure. The Company's billing information
systems and services are provided by Tel Labs, Inc. ("Tel Labs"), a
telecommunications billing company organized in 1991 by Telco's Chairman of the
Board. During April 1996, Tel Labs processed approximately 98 million call
records for 16 telecommunications companies, including Telco. Concurrently with
the completion of the Offerings, Telco will acquire all of the outstanding
capital stock of Tel Labs. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--The Reorganization."
To increase its volume of call traffic, Telco has begun to sell its
excess daytime capacity on a wholesale basis to other long distance carriers and
has created a Commercial Division to target business customers. Because the
Company's existing customer base is primarily residential, the majority of calls
are handled during off-peak evening and weekend periods.
The Company's switch-based network currently consists of five Digital
Switch Corporation ("DSC") DEX 600S, 600 and 600E switches located in
Washington, D.C.; Fort Lauderdale, Florida; Davenport, Iowa; Chattanooga,
Tennessee; and Austin, Texas, with another DEX 600E switch scheduled to be
operational in Las Vegas, Nevada, during the third quarter of 1996. The
Company's state-of-the-art digital switching and cross-connect systems are
designed to optimize traffic routing and provide for automatic traffic re-
routing in the event of a network failure. The Company leases transmission
lines from a variety of facilities-based long distance service providers. The
Company's sophisticated switch-based network (i) enables it to control
proprietary information such as customer call records and (ii) positions it to
take advantage of competitive rates for local access from Competitive Local
Exchange Carriers ("CLECs"), such as MFS Communications Company, Inc. ("MFS")
and Teleport Communications Group, Inc. ("Teleport").
The Company's strategy is to achieve continued growth by providing a
broad array of competitively priced long distance services. The Company's
primary objectives in pursuing this strategy are to (i) continue to grow its
casual calling distribution channels and further establish brand loyalty through
remarketing activities in its existing markets and expansion into new markets;
(ii) target business customers to more fully utilize its network's daytime
capacity by developing a direct sales force as part of its Commercial Division;
(iii) expand the Company's network while continuing to focus on providing low
cost nationwide origination and termination capabilities; and (iv) offer
innovative products and services to new and existing customers by leveraging the
Company's network and operating infrastructure and billing and information
systems.
The address of the Company's principal place of business is 4219
Lafayette Center Drive, Chantilly, Virginia 22021, and its phone number is (703)
631-5600.
4
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
THE OFFERINGS
Common Stock to be sold by the Company:
<TABLE>
<S> <C>
U.S. Offering ............................ __________ shares
International Offering.................... __________ shares
Total .............................. __________ shares
Common Stock to be sold by
Selling Shareholders (1):
U.S. Offering........................... __________ shares
International Offering.................. __________ shares
Total............................... __________ shares
Common Stock to be Outstanding
after the Offerings _________ shares (2)
Use of Proceeds.............................. To repay outstanding
indebtedness and for
working capital and other
general corporate purposes,
including expansion of the
Company's Commercial
Division. The Company will
not receive any proceeds
from the sale of Common
Stock by the Selling
Shareholders.
Proposed New York Stock Exchange
Symbol......................................
</TABLE>
__________
Footnotes:
(1) ________ shares to be sold by one of the Selling Shareholders will be
purchased by it immediately prior to sale through the exercise of an
outstanding warrant. The Company will receive an aggregate of $______
($_______ per share) upon such exercise. See "Description of Capital
Stock--The Signet Warrant."
(2) Gives effect to the Stock Split and the Offerings. Includes _____ shares of
Common Stock to be issued concurrently with the consummation of the
Offerings in exchange for all of the outstanding common stock of Tel Labs
and 5,102,125 shares of Common Stock issued during the second quarter of
1996 in exchange for the remaining minority interest in Long Distance
Wholesale Club ("LDWC") (such exchanges are collectively referred to as the
"Reorganization"). "See Management's Discussion and Analysis of Financial
Condition and Results of Operations--The Reorganization." Excludes
_________ shares of Common Stock issuable upon the exercise of currently
exercisable options. See "Management--Amended and Restated 1994 Stock
Option Plan."
5
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
SUMMARY CONSOLIDATED HISTORICAL AND PRO FORMA FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND PER MINUTE AMOUNTS)
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION (1)
THROUGH
DECEMBER YEAR ENDED DECEMBER 31, THREE MONTHS ENDED MARCH 31,
31, HISTORICAL PRO FORMA HISTORICAL PRO FORMA
1993 1994 1995 1995(2) 1995 1996 1996 (2)
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues, net.......................... $ 1,135 $44,707 $215,376 $45,277 $91,928
Cost of services....................... 993 27,736 133,728 28,079 54,730
Gross margin .......................... 142 16,971 81,648 17,198 37,198
Selling, general and administrative.... 1,310 12,018 55,936 10,186 27,863
Depreciation and amortization.......... 54 496 3,326 452 1,433
Operating income (loss)................ (1,222) 4,457 22,386 6,560 7,902
Interest expense....................... 25 897 2,952 -- 591 1,066 --
Other income (expense)................. -- 15 (92) 4 13
Provision for income taxes............. -- 1,432 7,531 2,326 3,135
Minority interest...................... -- 137 1,046 -- 109 433 --
Net income (loss)...................... $(1,247) $ 2,006 $ 10,765 3,538 3,281
Net income (loss) per share(3).........
Weighted average number
of shares outstanding
(in thousands).......................
Supplemental net income
per share(4).........................
BALANCE SHEET DATA (AT PERIOD END):
Cash and cash
equivalents.......................... $ 140 $ 475 $ 937 $ 1,300
Total assets........................... 2,051 33,533 87,124 108,928
Total debt (including
capital lease obligations)........... 1,559 18,884 44,410 54,437
Minority interest...................... -- 137 1,183 1,617
Shareholders' equity (deficit)......... (376) 1,655 12,420 15,701
OTHER OPERATING DATA:
EBITDA (5)............................. $(1,168) $ 4,953 $ 25,712 $ 7,012 $ 9,335
Minutes of use(6)......................
Revenue per minute of use(7)...........
Cost of services per minute of use(8)..
_________
</TABLE>
(Footnotes appear on the following page.)
6
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
Footnotes:
(1) The Company was incorporated in Virginia on July 21, 1993, and commenced
operations in November 1993.
(2) Adjusted to give pro forma effect to (a) the Offerings and the application
of the proceeds therefrom; and (b) the Reorganization. See "Use of
Proceeds," "Pro Forma Consolidated Financial Statements" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
The Reorganization."
(3) See Note 1 of the Notes to Consolidated Financial Statements of the Company
for the fiscal years ended December 31, 1995 and 1994.
(4) The net proceeds from the sale of approximately _________ of the shares of
Common Stock offered by the Company hereby will be used to repay certain
indebtedness. Supplemental net income is calculated assuming only these
shares had been issued and the indebtedness repaid as of the beginning of
the period.
(5) EBITDA represents net income (loss) plus depreciation expense, amortization
expense, interest expense, income taxes, other income (expense,) and other
non-cash charges. While EBITDA is not a measurement of financial
performance (income) under generally accepted accounting principles and
should not be construed as a substitute for net income as a measure of
performance, or cash flow as a measure of liquidity, it is included herein
because it is a measure commonly used in the telecommunications industry.
(6) Represents billed minutes during the period indicated.
(7) Represents revenues, net, during the period divided by minutes of use
during the period.
(8) Represents cost of services during the period divided by minutes of use
during the period.
7
- --------------------------------------------------------------------------------
<PAGE>
RISK FACTORS
Prospective investors should carefully review the information set forth
below prior to making an investment in the Common Stock.
RECENT RAPID GROWTH; ABILITY TO MANAGE GROWTH
Although the Company has experienced significant growth in a relatively
short period of time and intends to continue to grow rapidly, there can be no
assurance that the growth experienced by the Company will continue or that the
Company will be able to achieve the growth contemplated by its business
strategy. Implementation of the Company's growth strategy will place additional
demands upon the Company's management, operational and other resources and will
require additional long distance transmission capacity, additional working
capital, and billing and information systems. The Company's ability to continue
to grow may be affected by various factors, many of which are not within the
Company's control, including federal and state regulation of the
telecommunications industry, competition, the transmission capacity of the
Company's long distance carriers and adverse changes in customer attrition,
minute-usage patterns or response rates to direct mailings. While the Company
believes that its capital resources, network and infrastructure, including the
billing support provided by Tel Labs, provide a platform for future growth, the
Company's ability to continue to manage its growth successfully will require it
to further enhance its operational, management, financial and information
systems and controls and to expand, train and manage its employee base. In
addition, as the Company increases its service offerings and expands its
targeted markets, there will be additional demands on its customer service
support and sales, marketing and administrative resources. There can be no
assurance that the Company will successfully manage its expanding operations
and, if the Company's management is unable to manage growth effectively, the
Company's business, operating results, and financial condition could be
materially and adversely affected.
EXPANSION OF COMMERCIAL DIVISION
As part of its growth strategy, the Company will seek to further develop
and expand its Commercial Division which will offer presubscribed long distance
telephone service to business customers primarily using a direct sales effort.
Since the Company began operations in November 1993, it has focused primarily on
providing casual calling long distance telephone services to residential
customers and its marketing efforts have primarily relied upon direct mail
marketing and an inbound telesales and marketing system. The success of the
Company's Commercial Division will depend upon, among other things, the
Company's ability to build an effective direct sales force, including its
ability to attract, retain and train effective direct sales marketing personnel,
and to offer competitively-priced services attractive to business customers.
The Company expects to incur significant expenses and negative cash flows for
its Commercial Division as it expands its direct sales force and builds its
customer base. The start-up costs relating to its Commercial Division are
expected to reduce the Company's consolidated net income at least through 1997.
The success of the Company's Commercial Division will also depend on various
factors which are not within the Company's control, including changes in general
and local economic conditions, federal and state regulation of the
telecommunications industry and competition. Although certain members of
management have experience in direct sales marketing and the commercial
presubscribed long distance market, the Company itself does not have experience
in this distribution channel or market segment. There can be no assurance that
expansion costs will not exceed the Company's budgeted amounts, that the Company
will be able to successfully expand its Commercial Division or that its
Commercial Division will become profitable. In
8
<PAGE>
addition, while the Company through Tel Labs, has extensive experience in
producing direct bills, and certain members of management have experience with
respect to collections from direct billed customers, the Company itself does not
have experience in collections from direct billed customers; and there can be no
assurance that the Company will be able to successfully develop such collections
infrastructure.
LIMITED OPERATING HISTORY
The Company was incorporated on July 21, 1993 and commenced its operations
in November 1993, and therefore has a limited operating history. There can be
no assurance that the Company's future operations will continue to generate
operating or net income or that its business strategy will be successful. See
"Selected Consolidated Historical and Pro Forma Financial Data," "Pro Forma
Consolidated Financial Statements" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
INCREASING COMPETITION
The U.S. long distance telecommunications industry is highly competitive
and is significantly influenced by the marketing and pricing decisions of the
larger industry participants. The industry has relatively insignificant
barriers to entry, numerous entities competing for the same customers and high
attrition rates (customer turnover), as customers frequently change long
distance providers in response to the offering of lower rates or promotional
incentives by competitors.
Many of the Company's competitors are significantly larger, have
substantially greater financial, technical and marketing resources and larger
networks than the Company, control transmission lines and have long-standing
relationships with the Company's target customers. The Company's competitors
include AT&T, MCI and Sprint and numerous other long distance providers,
including long distance providers that have specifically targeted the casual
calling market by means of direct mail strategies.
In October 1995, the U.S. Federal Communications Commission (the "FCC")
reclassified AT&T as a "non-dominant" carrier for domestic interstate services,
substantially reducing the regulatory constraints on AT&T, which may make it
easier for AT&T to compete directly with the Company for long distance
subscribers. AT&T was reclassified as a "nondominant" carrier for
international services on May 14, 1996. The Company also currently competes with
the RBOCs and other LECs in the provision of "short haul" toll calls completed
within a local access and transport area ("LATA") (or intraLATA calls). In
addition, as a result of the Telecommunications Act of 1996, which was enacted
on February 8, 1996 (the "1996 Telecommunications Act"), the RBOCs and the GTE
Operating Companies ("GTOCs") will be allowed to compete for the provision of
interLATA ("long haul") toll calls, upon receipt of all necessary regulatory
approvals and the satisfaction of applicable conditions. For the RBOCs to
provide interLATA toll service within the same states in which local exchange
service also is provided ("in-region service"), FCC approval must be obtained.
FCC approval to provide "in-region" service is conditioned upon, among other
things, a showing by an RBOC that, in certain circumstances, facilities-based
competition is present in its market, and that it has entered into
interconnection agreements which satisfy a 14-point "checklist" of regulatory
requirements. In addition, the 1996 Telecommunications Act is designed to
facilitate the entry of any entity (including cable television companies and
utilities) into both the long distance and local telecommunications market. As
a result of the 1996 Telecommunications Act, long distance companies such as
AT&T and MCI should be able to facilitate their entry into the local telephone
market. It is unknown at this time what impact the 1996 Telecommunications Act
will have on the Company. Depending on the exact nature and timing of GTOC and
RBOC entry into the long distance market, such entry could have a material
adverse
9
<PAGE>
effect on the Company's business, results of operations and financial condition.
Certain of the RBOCs have already taken steps to provide interLATA long distance
services and the Company expects that most or all of the other RBOCs will file
applications for interLATA long distance service authority. See "Business--
Regulation."
The ability of the Company to compete effectively will depend upon, among
other factors, its continued ability to provide high quality services at
competitive prices, and there can be no assurance that the Company will be able
to compete successfully in the future in its markets. The Company's competitors
may reduce rates or offer incentives to existing and potential customers of the
Company, whether caused by general competitive pressures or the entry of the
RBOCs, GTOCs and other LECs into the long distance market. The Company's casual
calling services compete primarily on the basis of price as the Company prices
its services at a discount to the basic "1 plus" rates offered by AT&T, MCI and
Sprint. Because the Company believes that to maintain its competitive position
it must be able to reduce its prices in order to meet reductions in rates by
others, a decrease in the rates charged by others for long distance services
could have a material adverse effect on the Company's business, results of
operations and financial condition. In addition, the Company must generally
price its toll services at levels equal to or below the retail rates established
by the LECs for their own short-haul and long-haul rates. To the extent the
LECs are able to reduce the margin between the access costs charged to the
Company and the retail toll prices charged by the LECs, either by increasing
access costs or lowering retail toll rates (or both), the Company will encounter
adverse pricing and cost pressures in competing against LECs in both short-haul
and long-haul toll markets. See "--Regulatory and Legislative Risks." The
Company expects price competition to continue to increase and has observed a
recent increase in competition in the casual calling market. A further increase
in such competition could have a material adverse effect on the Company's
business, financial condition and results of operations, including a reduction
in the Company's response rates and higher customer attrition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business--Competition."
DEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS AND BILLING AND COLLECTION
AGREEMENTS
The Company must process millions of call detail records quickly and
accurately in order to produce customer bills. The Company's billing
information systems are provided by Tel Labs. While the Company believes that
its billing and information systems are competitive strengths and will be
capable of processing the increased amounts of data that will result from the
Company's growth, there can be no assurance that such systems will not require
enhancement or substantial investments in the future or that the Company will
not encounter difficulties in integrating new technology into the Company's
systems or in expanding its systems to meet the needs of its Commercial
Division. See "--Ability to Manage Growth," "--Expansion of Commercial
Division," "Business--Billing and Data Processing" and "--Network and
Operations." In addition, the Company bills its residential casual calling
customers through LEC billing and collection agreements, pursuant to which the
Company's charges are placed on its customers' monthly local telephone bills.
The Company believes that LEC billing and collection is the most effective
mechanism for billing and collecting charges from the Company's residential
customers, and the loss of agreements covering a significant number of
customers could have a material adverse effect on the Company's business,
results of operations and financial condition.
AVAILABILITY OF LEASED CAPACITY
All telephone calls made by the Company's customers are connected via
transmission lines leased
10
<PAGE>
by the Company from transmission facilities-based long distance carriers that
compete with the Company, including AT&T and WorldCom, Inc. ("WorldCom"). The
Company's profitability will continue to depend, in part, on its ability to
obtain and utilize leased capacity on a cost-effective basis. The Company
leases its capacity pursuant to agreements with terms ranging from 18 to 36
months. Accordingly, the Company is vulnerable to changes in its lease
arrangements, such as price increases and service cancellations. Although the
Company believes that it has and will continue to enjoy favorable relationships
with the transmission facilities-based long distance carriers from which the
Company leases transmission lines, there can be no assurance that leased
capacity will continue to be available at cost-effective rates.
RESPONSE RATES; CUSTOMER ATTRITION
The Company's business and results of operations are significantly affected
by the customer response rates to its direct mailing campaigns, customer minute-
usage patterns and by customer attrition rates with respect to its mailing
campaigns. The number of new customers who utilize the Company's service in the
near term period after a mailing determines the campaign's overall response
rate. Customer attrition generally represents the number of customers who
utilize the Company's service immediately after a mailing campaign in one month
but who fail to use the Company's service in subsequent months. The Company
believes that a high level of customer attrition is inherent in the long
distance industry. Attrition in the long distance telecommunications industry
is generally attributable to a number of factors, including (i) initiatives of
existing and new competitors as they engage in, among other things, national
advertising campaigns, telemarketing programs, and the issuance of cash and
other forms of customer "win back" incentives and other customer acquisition
programs prevalent in the residential long distance market and (ii) the
termination of service for non-payment. The Company typically experiences higher
customer attrition in the first few months following a specific mailing as a
significant number of customers sample the Company's casual calling service.
While remailings and additional marketing efforts in its existing markets are
important components of the Company's growth strategy, the Company recognizes
that it may eventually reach a point in its existing markets, at which the
Company determines that it is no longer cost-effective to market customers in
such markets with its direct mail marketing strategy. There can be no assurance
that the Company's customer attrition rate will not increase or that its
response rate or customer minute-usage pattern will not decrease. An increase in
the Company's attrition rate or a decrease in the Company's response rate or
customer minute-usage pattern could have a material adverse effect upon the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
REGULATORY AND LEGISLATIVE RISKS
Regulations, regulatory actions and court decisions have had, and in the
future may have, both positive and negative effects on the Company and its
ability to compete. The recent trend in both federal and state regulation of
telecommunication service providers has been in the direction of lessened
regulation. However, the general recent trend toward lessened regulation has
also given AT&T, the largest long distance carrier in the U.S., increased
pricing flexibility that has permitted it to compete more effectively with
smaller long distance carriers, such as the Company. In addition, the 1996
Telecommunications Act has opened the Company's markets to increased
competition. See "--Increasing Competition." There can be no assurance that
future regulatory, judicial and legislative changes will not have a material
adverse effect on the Company. See "Business--Regulation."
The Company is currently subject to federal and state government regulation
of its long distance
11
<PAGE>
telephone services. The FCC and relevant state public service commissions
("PSCs") have the authority to regulate interstate and intrastate rates,
respectively, ownership of transmission facilities, and the terms and
conditions under which the Company's services are provided. In general, neither
the FCC nor the relevant state PSCs exercise direct oversight over cost
justification for the Company's services or the Company's profit levels, but
either or both may do so in the future. However, the Company is required by
federal and state law and regulations to file tariffs listing the rates, terms
and conditions of services provided. The Company generally is also required to
obtain certification from the relevant state PSC prior to the initiation of
intrastate service, and is required to maintain a certificate issued by the FCC
in connection with the provision of international services. Any failure to
maintain proper federal and state tariffing or certification or any difficulties
or delays in obtaining required authorization could have a material adverse
effect on the Company.
To originate and terminate calls in connection with providing their
services, long distance carriers such as the Company must purchase "access" from
the LECs or CLECs. Access charges represent a significant portion of the
Company's cost of services and, generally, such access charges are regulated by
the FCC. The FCC has informally announced that it intends, in the near future,
to undertake a comprehensive review of its regulation of LEC access charges to
better account for increasing levels of local competition. Under alternative
access charge rate structures being considered by the FCC, LECs would be
permitted to allow volume discounts in the pricing of access charges. While the
outcome of these proceedings is uncertain, if these rate structures are adopted
many long distance carriers, including the Company, could be placed at a
significant cost disadvantage to larger competitors.
The FCC and certain state agencies also impose prior approval requirements
on transfers of control, including pro forma transfers of control and corporate
reorganizations, and assignments of regulatory authorizations. Such
requirements may delay, prevent or deter a change in control of the Company.
In addition, the Company's usage of its CIC Codes is regulated by the FCC.
Because all of the available three digit CIC Codes, such as those used by the
Company, have already been allocated, applicants for new CIC Codes are now
issued four digit codes. The FCC currently is conducting a rule making
proceeding in which it has proposed to require all carriers currently using
three digit CIC Codes, including the Company, to switch to four digit CIC Codes.
The FCC has not taken final action in this proceeding and has not determined the
date on which the carriers currently using three digit CIC Codes will be
required to switch to four digit CIC Codes. The Company is unable to determine
what effect a switch to new four digit CIC Codes would have on its business and
results of operations. See "Business - Industry Overview."
POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company's quarterly operating results have fluctuated in the past and
may fluctuate significantly in the future as a result of a variety of factors,
including the timing of direct mail marketing campaigns, general economic
conditions, specific economic conditions in the telecommunications industry, the
effects of governmental regulation and regulatory changes, user demand, capital
expenditures and other costs relating to the expansion of operations, the
introduction of new services by the Company or its competitors, the mix of
services sold and the mix of channels through which those services are sold, the
provision for bad debt expense, charges associated with the commissioning of new
switches, pricing changes and new service introductions by the Company and its
competitors and prices charged by the Company's facilities-based transmission
line suppliers. Certain of these factors are outside of the Company's control.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
DEPENDENCE ON KEY PERSONNEL
The Company's success depends to a significant degree upon the continued
contributions of its management team, as well as its technical, marketing and
sales personnel. While certain of the Company's employees have entered into
employment agreements with the Company, the Company's employees may voluntarily
terminate their employment with the Company at any time. The Company's success
also will depend on its ability to continue to attract and retain qualified
management, marketing, technical and sales
12
<PAGE>
personnel. The process of locating such personnel with the combination of
skills and attributes required to carry out the Company's strategies is often
lengthy. Competition for qualified employees and personnel in the
telecommunications industry is intense and, from time to time, there are a
limited number of persons with knowledge of and experience in particular sectors
of the telecommunications industry. There can be no assurance that the Company
will be successful in attracting and retaining such executives and personnel.
The loss of the services of key personnel, or the inability to attract
additional qualified personnel, could have a material adverse effect on the
Company's results of operations, development efforts and ability to expand. See
"Management."
CONTROL OF COMPANY BY PRINCIPAL SHAREHOLDERS
After completion of the Offerings and the Reorganization, the directors and
executive officers of the Company will own in the aggregate approximately % of
the then outstanding Common Stock (approximately ___ % if the U.S. Underwriters'
and the Managers' over-allotment options are exercised). Accordingly, if they
choose to do so, management acting as a group will have the power to amend the
Company's Articles of Incorporation, elect all of the directors, effect
fundamental corporate transactions such as mergers, asset sales and the sale of
the Company and otherwise direct the Company's business and affairs, without
the approval of any other shareholder. See "Management" and "Principal and
Selling Shareholders."
RELATED PARTY TRANSACTIONS
The Company has entered and, in connection with the Offerings, will enter,
into business transactions with certain of its principal shareholders, including
the acquisition of LDWC and the proposed acquisition of Tel Labs. Although the
Company may continue to enter into such transactions in the future, its policy
is not to enter into transactions with related persons unless the terms thereof
are at least as favorable to the Company as those that could be obtained from
unaffiliated third parties and are approved by a majority of disinterested
directors. See "Certain Transactions."
IMPACT OF INCREASED POSTAGE AND PAPER COSTS
Direct mail is the primary marketing vehicle for the Company's residential
services. Postage and paper costs are significant expenses in the operation of
the Company's business. There can be no assurance that the Company will be able
to pass on any significant postage and paper cost increases to its customers.
Additionally, strikes or other service interruptions associated with the
production or delivery of the Company's direct mail could adversely affect the
Company's ability to market services on a timely basis. Any increases in postage
or paper costs or substantial service interruptions in the production or
delivery of the Company's direct mail could have an adverse effect on the
Company's operating results.
RISKS ASSOCIATED WITH ACQUISITIONS, INVESTMENTS AND STRATEGIC ALLIANCES
In furtherance of its business strategy, the Company may enter into
strategic alliances with, acquire assets or businesses from, or make investments
in, companies that are complementary to its current operations. The Company has
no present commitments or agreements with respect to any such strategic
alliance, investment or acquisition. Any such future strategic alliances,
investments or acquisitions would be accompanied by the risks commonly
encountered in such transactions. Such risks include, among other things, the
difficulty of assimilating the operations and personnel of the companies, the
potential disruption
13
<PAGE>
of the Company's ongoing business, costs associated with the development and
integration of such operations, the inability of management to maximize the
financial and strategic position of the Company by the successful incorporation
of licensed or acquired technology into the Company's service offerings, the
maintenance of uniform standards, controls, procedures and policies and the
impairment of relationships with employees and customers as a result of changes
in management. In addition, the Company may experience higher customer
attrition with respect to customers obtained through acquisitions.
ANTITAKEOVER CONSIDERATIONS
The Company's Articles of Incorporation and Bylaws include certain
provisions which may have the effect of delaying, deterring or preventing a
future takeover or change in control of the Company without the approval of the
Company's Board of Directors. Such provisions may also render the removal of
directors and management more difficult. Among other things, the Company's
Articles of Incorporation and/or Bylaws: (i) provide for a classified Board of
Directors serving staggered three-year terms, (ii) impose restrictions on who
may call a special meeting of shareholders, (iii) include a requirement that
shareholder action be taken only by unanimous written consent or at shareholder
meetings and (iv) specify certain advance notice requirements for shareholder
nominations of candidates for election to the Board of Directors and certain
other shareholder proposals. In addition, the Board of Directors, without
further action by the shareholders, may cause the Company to issue up to
15,000,000 shares of Preferred Stock on such terms and with such rights,
preferences and designations as the Board of Directors may determine. Issuance
of such Preferred Stock, depending upon the rights, preferences and designations
thereof, may have the effect of delaying, deterring or preventing a change in
control of the Company. Further, certain "antitakeover" provisions of the
Virginia Stock Corporation Act impose restrictions on the ability of a third
party to effect a change in control of the Company and may be considered
disadvantageous by a shareholder. See "Description of Capital Stock --
Preferred Stock," "Description of Capital Stock--Certain Provisions of the
Company's Articles of Incorporation and Bylaws," and "Description of Capital
Stock--Virginia Stock Corporation Act; Antitakeover Effects." Certain federal
and state regulations requiring prior approval of transfers of control may also
have the effect of delaying, deterring or preventing a change in control of the
Company. See "--Regulatory and Legislative Risks" and "Business--Regulation."
ABSENCE OF PRIOR TRADING MARKET; POTENTIAL VOLATILITY OF STOCK PRICE
Prior to the Offerings, there has been no public market for the Common
Stock. Although the Company intends to apply to have the Common Stock approved
for listing on the New York Stock Exchange, there can be no assurance that an
active trading market will develop or be maintained after the Offerings. The
initial public offering price of the Common Stock offered hereby will be
determined by negotiations among the Company and the representatives of the U.S.
Underwriters and the Managers and may not be indicative of the market price of
the Common Stock after the Offerings. For a description of the factors
considered in determining the initial public offering price, see "Underwriting."
The market price of the Common Stock may be highly volatile. Factors such as
fluctuation in the Company's operating results, announcements of technological
innovations or new products or services by the Company or its competitors,
changes in the regulatory framework or in the cost of long distance service or
other operating costs and changes in general market conditions may have a
significant effect on the market price of the Common Stock.
DILUTION TO PURCHASERS OF COMMON STOCK
Investors purchasing shares of Common Stock in the Offerings will
experience an immediate
14
<PAGE>
dilution in net tangible book value of their shares of Common Stock. See
"Dilution."
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial numbers of shares of Common Stock in the public
market, or the perception that such sales could occur, could adversely affect
the market price of the Common Stock and make it more difficult for the Company
to raise funds through equity offerings in the future. Several of the Company's
principal shareholders hold a significant portion of the Company's outstanding
Common Stock and a decision by one or more of these shareholders to sell their
shares pursuant to the exercise of registration rights, under Rule 144 under the
Securities Act of 1933 (the "Securities Act") or otherwise, could materially
adversely affect the market price of the Common Stock. See "Principal and
Selling Shareholders" and "Description of Capital Stock--Registration Rights of
Certain Holders."
Upon completion of the Offerings, the Company will have __________ shares
of Common Stock outstanding, assuming (i) no exercise of the U.S. Underwriters'
and Managers' over-allotment options and (ii) the exercise of options to acquire
_______ shares and a warrant to acquire _______ shares outstanding as of April
30, 1996. Of the Common Stock outstanding upon completion of the Offerings, the
___________ shares of Common Stock sold in the Offerings will be freely
tradeable without restriction or further registration under the Securities Act,
except for any shares held by "affiliates" of the Company or persons who have
been affiliates within the preceding three months and approximately __________
outstanding shares of Common Stock are currently eligible for sale under Rule
144 or Rule 144(k). The Securities and Exchange Commission (the "Commission")
has recently proposed amendments to Rule 144 and Rule 144(k) that would shorten
by one year the applicable holding periods and could result in resales of
restricted securities sooner than would be the case under Rule 144 and Rule
144(k) as currently in effect. The remaining shares of Common Stock, including
shares issued in the Reorganization, representing ___ % of the outstanding
Common Stock upon completion of the Offerings, will be deemed "restricted
securities" under the Securities Act and as such will be subject to restrictions
on the timing, manner and volume of sales of such shares.
The Company, its executive officers and directors and the Selling
Shareholders have agreed that, subject to certain limited exceptions, for a
period of 180 days after the date of this Prospectus, they will not, directly or
indirectly, offer to sell, sell, hypothecate, pledge or otherwise dispose of any
shares of Common Stock (or securities convertible into, exercisable for or
evidencing the right to purchase any shares of Common Stock),without the prior
written consent of Bear, Stearns & Co. Inc. See "Underwriting."
Promptly following the Offerings, the Company intends to register on Form
S-8 under the Securities Act approximately 7,500,000 shares of Common Stock
issuable under options granted or to be granted under the Company's Stock Option
Plan. See "Shares Eligible for Future Sale."
15
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the Offerings are estimated to be
approximately $_____ million ($_____ million if the U.S. Underwriters' and
Managers' over-allotment options are exercised in full). The Company expects to
use the net proceeds from the Offerings to repay all outstanding indebtedness
under its revolving credit facility (the "Credit Facility") with Signet Bank as
Administrative Agent. The Credit Facility, which expires on January 24, 1998,
bears interest at a floating rate, based on LIBOR, which was approximately 7.5%
at April 30, 1996. As of April 30, 1996, $38.9 million of indebtedness was
outstanding under the Credit Facility. Of the remaining proceeds, approximately
$15.5 million will be used to repay outstanding amounts under the Company's
existing capital leases and the balance for working capital and general
corporate purposes, including the expansion of the Company's Commercial
Division. The Company may use a portion of the net proceeds from the Offerings
to further its business strategy through strategic alliances with, investments
in, or acquisitions of companies that are complementary to the Company's
operations. See "Business--Business Strategy." Pending application, such net
proceeds will be invested in short-term, marketable securities. The Company will
also receive de minimis proceeds upon the exercise of a warrant by one of the
Selling Shareholders. See "Description of Capital Stock--The Signet Warrant."
The Company will not receive any of the proceeds from the sale of shares by the
Selling Shareholders.
DIVIDEND POLICY
The Company currently intends to retain all future earnings for use in
the operation of its business and, therefore, does not anticipate paying any
cash dividends in the foreseeable future. The declaration and payment in the
future of any cash dividends will be at the discretion of the Company's Board of
Directors and will depend upon, among other things, the earnings, capital
requirements and financial position of the Company, existing and/or future loan
covenants and general economic conditions. Under the terms of the Credit
Facility, the Company and its subsidiaries are restricted from declaring, making
or paying any distributions except in certain limited circumstances. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
16
<PAGE>
DILUTION
The Company's pro forma net tangible book value as of March 31, 1996
would have been $18.6 million, or $___ per share. Pro forma net tangible book
value per share represents the total amount of tangible assets of the Company,
less the total amount of liabilities of the Company, divided by the number of
shares of Common Stock outstanding on a fully diluted basis, in each case after
giving pro forma effect to the Reorganization as if it had occurred on March 31,
1996 and the exercise of an outstanding warrant to purchase 533,375 shares of
Common Stock. After giving effect to the sale by the Company of the _________
shares of Common Stock offered hereby (at an assumed public offering price of
$__ per share), less estimated underwriting discounts and commissions and the
other estimated expenses of the Offerings payable by the Company, and the
application of the estimated net proceeds therefrom and the exercise of _______
options, the Company's pro forma net tangible book value as of March 31, 1996
would have been $_____ million, or $____ per share of Common Stock. This
represents an immediate increase in net tangible book value of $____ per share
to existing shareholders and an immediate dilution in net tangible book value of
$_____ per share to new investors purchasing shares of Common Stock in the
Offerings. The following table illustrates this dilution on a per share basis to
the new investors:
<TABLE>
<S> <C> <C>
Assumed public offering price per share............ $_____
Pro forma net tangible book value per share
at March 31, 1996............................ $
Increase in net tangible book value attributable
to new investors................................ $ ____
Pro forma net tangible book value per share after
giving effect to the Offerings ................ $
Dilution per share to new investors............... $
=====
</TABLE>
The following table sets forth, on a pro forma basis as of March 31,
1996, the number of shares of Common Stock purchased from the Company, the total
consideration paid to the Company and the weighted average price per share paid
by existing shareholders and by new investors before deducting the underwriting
discounts and commissions and estimated expenses of the Offerings payable by the
Company:
<TABLE>
<CAPTION>
Weighted
Average
Shares Price
Purchased Total Consideration Per
------------------- -------------------
Number Percent Amount Percent Share
------- ------- ------ ------- -----
<S> <C> <C> <C> <C> <C>
Existing shareholders.. % $ % $
New investors.......... % %
Total 100 % $ 100 %
</TABLE>
17
<PAGE>
The information in the table above excludes the effect of options to
purchase __________ shares of Common Stock outstanding at May 31, 1996, at
exercise prices ranging from $0.31 to $7.53 per share with a weighted average
exercise price of $________ per share. The exercise of any of________
outstanding options with exercise prices of less than $_______ would result in
additional dilution to new investors. See "Management--Executive Compensation"
and "--Amended and Restated 1994 Stock Option Plan; "Description of Capital
Stock--Signet Warrant" and "Principal and Selling Shareholders."
18
<PAGE>
CAPITALIZATION
The following table sets forth the cash and capitalization of the
Company (i) as of March 31, 1996, and (ii) on a pro forma basis giving effect to
the Reorganization and the issuance and sale by the Company of _________ shares
of Common Stock in the Offerings (at an assumed public offering price of $__ per
share) and the application of the estimated net proceeds therefrom. See "Use of
Proceeds," "Selected Consolidated Historical and Pro Forma Financial Data," "Pro
Forma Consolidated Financial Statements," "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the Company's consolidated
financial statements and notes thereto included elsewhere in this Prospectus.
AS OF MARCH 31, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
---------- ---------
<S> <C> <C>
Cash and cash equivalents........... $ 1,300 $
======= =======
Current portion of capital lease
obligations........................ $ 3,163 $ -
Long-term debt, net of current
portion:
Credit Facility (1)............. 38,634 $ -
Capital lease obligations(1).... 12,640 $ -
------- -------
Total long-term debt................ 51,274 -
Shareholders' equity:
Preferred Stock, no par value;
15,000,000 shares authorized;
no shares issued or outstanding.. $ - $ -
Common Stock, no par value;
150,000,000 shares authorized;
20,864,100 shares issued and
outstanding, historical; _________
issued and outstanding, pro forma as
adjusted (2)...................... 25
Retained earnings................... 15,676
------- -------
Total shareholders' equity.......... $15,701 $
Total capitalization $70,138 $
======= =======
</TABLE>
__________
(1) At April 30, 1996, approximately $38.9 million was outstanding under the
Credit Facility and $15.5 million was outstanding under capital leases.
After giving effect to the Offerings and the application of the net
proceeds therefrom, the Company would have had $65.0 million of
availability under the Credit Facility which can be borrowed (subject to
borrowing base limitations) to finance working
19
<PAGE>
capital requirements and for general corporate purposes.
(2) Excludes 3,625,542 shares of Common Stock issuable upon the exercise of
options outstanding on the date hereof at a weighted average exercise price of
$4.00 per share. Includes 533,375 shares of Common Stock issuable upon the
exercise of the Signet Warrant at a nominal exercise price. See "Description of
Capital Stock -Signet Warrant."
20
<PAGE>
SELECTED CONSOLIDATED HISTORICAL AND PRO FORMA FINANCIAL DATA
The following table sets forth certain consolidated financial information
for the Company for the periods ended December 31, 1993, 1994 and 1995, which
have been derived from the Company's audited consolidated financial statements
and notes thereto included elsewhere in this Prospectus and pro forma
information reflecting the Offerings and the Reorganization. The financial
information set forth below for the three-month periods ended March 31, 1995 and
1996 has been derived from unaudited consolidated financial statements of the
Company. In the opinion of management, the unaudited financial statements have
been prepared on the same basis as the audited financial statements and include
all adjustments, which consist only of normal recurring adjustments, necessary
for a fair presentation of the financial position and the results of operations
for these periods. Operating results for the three months ended March 31, 1996
are not necessarily indicative of the results that may be expected for the full
year. The following financial information should be read in conjunction with
"Pro Forma Consolidated Financial Statements" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
21
<PAGE>
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND PER MINUTE AMOUNTS)
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION (1)
THROUGH
DECEMBER YEAR ENDED DECEMBER 31, THREE MONTHS ENDED MARCH 31,
31, HISTORICAL PRO FORMA HISTORICAL PRO FORMA
1993 1994 1995 1995(2) 1995 1996 1996(2)
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues, net.......................... $ 1,135 $44,707 $215,376 $45,277 $91,928
Cost of services....................... 993 27,736 133,728 28,079 54,730
Gross margin .......................... 142 16,971 81,648 17,198 37,198
Selling, general and administrative.... 1,310 12,018 55,936 10,186 27,863
Depreciation and amortization.......... 54 496 3,326 452 1,433
Operating income (loss)................ (1,222) 4,457 22,386 6,560 7,902
Interest expense....................... 25 897 2,952 -- 591 1,066 -
Other income (expense)................. -- 15 (92) 4 13
Provision for income taxes............. -- 1,432 7,531 2,326 3,135
Minority interest...................... -- 137 1,046 -- 109 433 -
Net income (loss)...................... $(1,247) $ 2,006 $ 10,765 3,538 3,281
Net income (loss) per share(3).........
Weighted average number
of shares outstanding (in thousands).
Supplemental net income per share
(4)..................................
BALANCE SHEET DATA (AT PERIOD END):
Cash and cash
equivalents.......................... $ 140 $ 475 $ 937 $ 1,300
Total assets........................... 2,051 33,533 87,124 108,928
Total debt (including
capital lease obligations)........... 1,559 18,884 44,410 54,437
Minority interest .................. -- 137 1,183 1,617
Shareholders' equity (deficit)......... (376) 1,655 12,420 15,701
OTHER OPERATING DATA:
EBITDA (5)............................ $(1,168) $ 4,953 $ 25,712 $ 7,012 $ 9,335
Minutes of use(6).....................
Revenue per minute of use(7)..........
Cost of services per minute of use(8)..
</TABLE>
_________
(Footnotes appear on the following page.)
22
<PAGE>
Footnotes:
(1) The Company was incorporated in Virginia on July 21, 1993, and commenced
operations in November 1993.
(2) Adjusted to give pro forma effect to (a) the Offerings and the application
of the proceeds therefrom; and (b) the Reorganization. See "Use of
Proceeds," "Pro Forma Consolidated Financial Statements" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
The Reorganization."
(3) See Note 1 of the Notes to Consolidated Financial Statements of the Company
for the fiscal years ended December 31, 1995 and 1994.
(4) The net proceeds from the sale of approximately _________ of the shares of
Common Stock offered by the Company hereby will be used to repay certain
indebtedness. Supplemental net income is calculated assuming only these
shares had been issued and the indebtedness repaid as of the beginning of
the period.
(5) EBITDA represents net income (loss) plus depreciation expense, amortization
expense, interest expense, income taxes, other income (expense), and other
non-cash charges. While EBITDA is not a measurement of financial
performance (income) under generally accepted accounting principles and
should not be construed as a substitute for net income as a measure of
performance, or cash flow as a measure of liquidity, it is included herein
because it is a measure commonly used in the telecommunications industry.
(6) Represents billed minutes during the period indicated.
(7) Represents revenues, net, per minute of use for the period divided by
minutes of use for the period.
(8) Cost of services for the period divided by minutes of use for the period.
23
<PAGE>
PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
The following unaudited pro forma consolidated financial statements have
been prepared to give effect to the Reorganization and the Offerings. The
unaudited pro forma consolidated statements of income of the Company for the
year ended December 31, 1995 and the three months ended March 31, 1996, give
effect to the Reorganization and the Offerings as if they occurred on January 1,
1995 and January 1, 1996, respectively. The accompanying unaudited pro forma
consolidated balance sheet as of March 31, 1996 has been prepared as if the
Reorganization and the sale by the Company of the Common Stock offered hereby
were consummated as of that date. The pro forma statements are based upon
available information and certain assumptions that the Company believes are
reasonable under the circumstances.
As part of the Reorganization, Telco has purchased all of the outstanding
minority interest (44.4%) in LDWC, a 55.6% owned subsidiary of the Company,
effective on April 1, 1996 through the exchange of 5,102,125 shares of Telco for
100 shares of LDWC and the conversion of outstanding LDWC options into options
to purchase 291,842 shares of the Company's Common Stock, for a total purchase
price of approximately $39,984,000. Concurrently with the completion of the
Offerings, the Company will purchase all of the outstanding shares of Tel Labs
in exchange for _______ shares of the Company for a total purchase price of
$7,120,000. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--The Reorganization" and "Certain Transactions--Long
Distance Wholesale Club" and "--Tel Labs."
Under purchase accounting, the purchase price is allocated to the fair
value of the assets and liabilities of acquired entities at the date of
acquisition. For purposes of determining the pro forma effect of the LDWC
acquisition, the Company's unaudited pro forma consolidated financial statements
reflect management's estimate of such allocations based on knowledge gained
through its operating control and ownership of 55.6% of LDWC's capital stock.
Such allocations with respect to Tel Labs will be finalized based upon continued
analysis. As a result, the final allocation of the purchase price for Tel Labs
may differ from that set forth in the unaudited pro forma consolidated financial
statements. The Company does not expect that the final allocation of the
purchase price for Tel Labs will differ materially from the preliminary
allocation.
The unaudited pro forma consolidated financial statements and notes thereto
should be read in conjunction with "Use of Proceeds," "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the Company's
consolidated financial statements and notes thereto included elsewhere in this
Prospectus. These unaudited pro forma consolidated financial statements and
notes thereto are provided for informational purposes only and do not purport to
be indicative of the results that would have actually been obtained had the
Reorganization and the Offerings been completed on the dates indicated or that
may be expected to occur in the future.
24
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1995
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Telco Tel Labs Reorganization Offerings
Historical Historical Adjustments Adjustments Pro Forma
----------- ---------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Revenues, net $215,376 $2,895 $ (1,260)(1) $ $
Cost of services 133,728 656 -
-------- ------ ----------- ----------- ---------
Gross margin 81,648 2,239 (1,260)
Operating expenses:
Selling, general and 55,936 1,484 (1,260)(1)
administrative
Depreciation and
amortization 3,326 - 1,591 (2)
-------- ------ ----------- ----------- ---------
Total operating expenses 59,262 1,484 331
-------- ------ ----------- ----------- ---------
Operating income 22,386 755 (1,591)
Interest expense 2,952 - -
Other income (expense) (92) 24 -
Income taxes 7,531 327 -
Minority interest 1,046 (1,046)(3)
-------- ------ ----------- ----------- ---------
Net income $ 10,765 $ 452 $ (545) $ $
======== ====== =========== =========== =========
Net income per share
Weighted average number
of shares outstanding
(in thousands)
</TABLE>
The accompanying notes to Unaudited Pro Forma Consolidated Financial Statements
are an integral part of these statements.
25
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1996
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Telco Tel Labs Reorganization Offerings
Historical Historical Adjustments Adjustments Pro Forma
---------- ---------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Revenues, net $91,928 $1,091 $ (627)(1) $ $
Cost of services 54,730 275 -
---------- ---------- ----------- ----------- ----------
Gross margin 37,198 816 (627)
Operating expenses:
Selling, general and 27,863 369 (627)(1)
administrative
Depreciation and
amortization 1,433 13 398 (2)
---------- ---------- ----------- ----------- ----------
Total operating expenses 29,296 382 229
---------- ---------- ----------- ----------- ----------
Operating income (loss) 7,902 434 (398)
Interest expense 1,066 - - (4)
Other income (expense) 13 44 -
Income taxes 3,135 179 - (4)
Minority interest 433 (433)(3)
---------- ---------- ----------- =========== =========
Net income $ 3,281 $ 299 $ 35 $ $
========== ========== =========== =========== =========
Net income (loss) per share
Weighted average number
of shares outstanding
(in thousands)
</TABLE>
The accompanying notes to Unaudited Pro Forma Consolidated Financial
Statements are an integral part of these statements.
26
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
AS OF MARCH 31, 1996
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Telco Tel Labs Reorganization Offerings
Historical Historical Adjustments Adjustments Pro Forma
---------- ---------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C>
ASSETS
Current Assets:
Cash $ 1,300 $ 461 $ - $ $
Accounts receivable, trade, net 75,999 402 -
Prepaid expenses 1,378 2 -
Deferred income tax asset 697 - -
Other 66 345 (211)(5)
---------- ---------- ----------- ----------- ---------
Total current assets 79,440 1,210 (211)
---------- ---------- ----------- ----------- ---------
Property, Plant and
Equipment:
Leasehold improvements 1,168 - -
Network equipment 5,430 - -
Office furniture 2,194 268 -
Network equipment under
capital lease 19,291 - -
Network facilities under
development 5,595 - -
Accumulated depreciation (4,886) (78) -
---------- ------ ----------- ----------- ---------
Total property, plant and
equipment 28,792 190 -
---------- ------ ----------- ----------- ---------
39,041 (7)
Other Assets 696 583 5,129 (6)
---------- ------ ----------- ----------- ---------
Total Assets $108,928 $1,983 $43,959 $ $
========== ========== =========== =========== =========
</TABLE>
27
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
AS OF MARCH 31, 1996
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Telco Tel Labs Reorganization Offerings
Historical Historical Adjustments Adjustments Pro Forma
---------- ---------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C>
LIABILITIES AND
SHAREHOLDERS' EQUITY
Current Liabilities:
Capital lease obligation,
current portion $ 3,163 $ - $ - $ $
Excise taxes payable 1,338 - -
Accounts payable 12,812 37 -
Accrued network access
and transmission expense 12,605 - -
Other accrued expenses 6,333 315 -
Income taxes payable 2,394 187 -
Payable to related parties 280 - (211)(5)
--------- ----------- ------------ ----------- ---------
Total current liabilities 38,925 539 (211)
--------- ----------- ------------ ----------- ---------
Long-Term Liabilities:
Long-term debt 38,634 - -
Capital lease obligations 12,640 - -
Deferred income taxes 1,411 127 -
--------- ----------- ------------ ----------- ---------
Total long-term liabilities 52,685 127 -
--------- ----------- ------------ ----------- ---------
Minority Interest 1,617 - (1,617)(8)
Commitments and Contingencies
Shareholders' Equity:
Common stock 25 1 39,984(7)
7,120(6)
(1)(6)
Retained earnings 15,676 1,316 (1,316)(6)
--------- ----------- ------------ ----------- ---------
Total shareholders' equity 15,701 1,317 45,787
--------- ----------- ------------ ----------- ---------
Total Liabilities and
Shareholders' Equity $108,928 $1,983 $43,959 $ $
========= =========== ============ =========== =========
</TABLE>
The accompanying notes to Unaudited Pro Forma Consolidated Financial Statements
are an integral part of these statements.
28
<PAGE>
(1) Reflects the elimination of intercompany revenues and expenses between
Telco and Tel Labs.
(2) Reflects the amortization of identified intangibles and goodwill with
estimated lives ranging from 5 to 35 years.
(3) Reflects the elimination of minority interest in income of LDWC and Telco
Development Group of Delaware, Inc.
(4) Reflects reduction of interest expense resulting from the repayment of all
debt and capital lease obligations with proceeds of the Offerings and an
increase in income taxes associated therewith which were calculated at
statutory rates.
(5) Reflects the elimination of intercompany receivables and payables between
the Company and Tel Labs.
(6) Reflects the following pro forma adjustments associated with the purchase
of Tel Labs:
<TABLE>
<S> <C>
Purchase price, _______ shares of Telco Common Stock $7,120
Fair value of net assets at March 31, 1996 (1,991)
------
Excess purchase price $5,129
======
Estimated allocation:
Identified intangibles $1,000
Goodwill and trained workforce 4,129
------
$5,129
======
</TABLE>
(7) Reflects the following pro forma adjustments associated
with the purchase of LDWC:
<TABLE>
<S> <C>
Purchase Price: 5,102,125 shares of Common Stock $38,416
Conversion of LDWC options into options to purchase
a total of 291,842 shares of Common Stock 1,568
-------
39,984
Fair value of 44.4% of net assets of LDWC at March
31, 1996 (943)
-----
Excess purchase price $39,041
=======
Estimated allocation:
Goodwill and trained workforce $39,041
=======
</TABLE>
(8) Reflects the elimination of cumulative minority interest in the net assets
of LDWC and Telco Development Group of Delaware, Inc.
(9) Reflects the following application of net proceeds from the Offerings:
<TABLE>
<S> <C>
Offering proceeds $
Retirement of long-term debt (38,634)
Retirement of capital lease obligations
Current portion (3,163)
Long-term portion (12,640)
--------
$
========
</TABLE>
(10) Reflects net proceeds of $__________ from the Offerings.
29
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is presented to assist in assessing the changes
in financial condition and performance of the Company over the three fiscal
years since inception. The following information should be read in conjunction
with the financial statements and related notes and other detailed information
regarding the Company included elsewhere in this Prospectus and should not be
construed to imply management's belief that the results, causes or trends
presented will necessarily continue in the future. Certain information contained
below and elsewhere in this Prospectus, including information with respect to
the Company's plans and strategy for its business, are forward-looking
statements. See "Risk Factors" for a discussion of important factors which could
cause actual results to differ materially from the forward-looking statements
contained herein.
OVERVIEW
The Company is a rapidly growing switch-based provider of domestic and
international long distance telecommunications services primarily to residential
customers in the United States. The Company, which was formed in July 1993 and
commenced operations in November 1993, has expanded its originating service area
from Florida to 37 states and the District of Columbia, with switches located in
Washington, D.C., Ft. Lauderdale, Florida, Davenport, Iowa, Chattanooga,
Tennessee and Austin, Texas. The Company expects its Las Vegas, Nevada, switch
to be deployed in the third quarter of 1996 which will expand the Company's
originating service area to an additional 10 contiguous states. The Company is
considering deployment of a switch in the New York City metropolitan area by
early 1997, in order to increase network efficiency. The Company intends to
direct mail market to most of the households located in the 48 contiguous United
States in 1996.
Critical issues related to the casual calling distribution channel are the
customer response rates to individual mailing campaigns and customer attrition
following the campaign. The number of new customers who utilize the service in
the near term period after a mailing defines the campaign's overall response
rate. Customer attrition represents the number of customers who utilize the
Company's service after a mailing campaign in one month but who fail to continue
as a customer in subsequent months. Customer attrition is typically highest in
the first few months following a specific mailing campaign as a significant
number of customers initially sample the Company's casual calling service in
response to the mailing. Although the Company experiences monthly attrition in
its customer base, the Company's monthly average minute usage per customer
typically increases following the attrition of the initial users.
The Company has experienced significant growth since its inception. The
Company's revenues have increased to approximately $215.4 million in 1995 from
approximately $44.7 million in 1994, while for the three months ended March 31,
1996, revenues increased to $91.9 million versus $45.3 million for the three
months ended March 31, 1995. Although the Company intends to continue to grow
rapidly, there can be no assurance that the growth experienced by the Company
will continue. The Company believes that its further growth is dependent in part
on its diversification into other distribution channels and product categories.
A key element of the Company's strategy is the development of a direct sales
force for its Commercial Division which will target business customers to more
fully utilize its network's daytime capacity. See "Risk Factors--Recent Rapid
Growth; Ability to Manage Growth," "--Expansion of Commercial Division," "--
Availability of Leased Capacity," "--Increasing Competition," "--Response Rates;
Customer Attrition "
30
<PAGE>
and "--Regulatory and Legislative Risks."
The Company's revenues consist of sales revenues for long distance usage
less related bad debt expenses. The Company accrues for bad debt at varying
percentages of revenue, based on the higher of actual bad debt experience or the
contracted amount withheld pursuant to the Company's LEC billing and collection
agreements. For the three months ended March 31, 1996, the Company reduced its
revenue by approximately $7.8 million for amounts related to bad debt accruals
and charges.
The Company's cost of services consists of transmission and installation
expenses. The majority of transmission expenses consist of payments to LECs for
local access charges. The remainder of the transmission expenses are fixed cost
facilities lease payments to facilities-based carriers for leased transmission
lines and payments to other long distance providers for the Company's off-
network and international traffic. For the month ended April 30, 1996, 100% of
the Company's "1 plus" traffic minutes were originated on the Company's switch-
based network and approximately 82% of its domestic traffic minutes were
terminated on the network. After the installation of its Las Vegas switch, and
the incurrence of installation charges relating to the markets served by that
switch, the Company believes that its ongoing installation charges will be
reduced. Efficiencies attributable to the expansion of the Company's network
have enabled the Company to grow its revenues at a declining cost per minute of
use.
The Company's operating expenses consist primarily of mail marketing
expenses, depreciation, customer service, billing service, data processing and
other general corporate overhead items. Mail and other marketing expenses,
billing service and data processing are almost exclusively variable expenses
while customer service has both a variable and fixed component. The Company
expenses all mail and other marketing and telemarketing/customer service costs
in the period in which they are incurred, although certain long distance
providers capitalize some or all of such costs.
Billing service expense consists of payments made to LECs under billing
and collection agreements which enable the Company to include its charges on its
customers' monthly local telephone bills and take advantage of the LECs'
extensive collections infrastructure. The Company's back office and billing
support are provided by Tel Labs. The majority of the Company's depreciation
expense is related to network equipment and facilities, all of which is
depreciated for financial accounting purposes over a five-year period. The
Company anticipates increased amortization expense due to the goodwill created
in connection with the Company's acquisition of Tel Labs and the remaining
minority interest in LDWC. In addition, the Company expects to incur significant
operating expenses in its Commercial Division which are expected to reduce the
Company's consolidated net income through at least 1997. See "Risk Factors--
Recent Rapid Growth; Ability to Manage Growth" and "--Expansion of Commercial
Division. "
The Company's quarterly operating results have fluctuated in the past and
may fluctuate significantly in the future as a result of a variety of factors,
including, the timing of direct mail marketing campaigns, the installation of
new switches, the provision for bad debt expense, pricing changes and the
expansion of operations. See "Risk Factors--Potential Fluctuations in Quarterly
Operating Results" and "--Quarterly Results of Operations" below.
THE REORGANIZATION
Prior to April 1, 1996, LDWC was a 55.6%-owned subsidiary of the Company;
the remaining 44.4% was held by Thomas J. Cirrito, a director and executive
officer of the Company, and two of his children. On
31
<PAGE>
April 1, 1996, the Company agreed to acquire the remaining 44.4% interest in
LDWC in exchange for the issuance of 5,102,125 shares of the Company's Common
Stock. In connection with the transaction, options issued pursuant to the LDWC
stock option plan were converted into options to purchase 291,842 shares of the
Company's Common Stock under the Company's Stock Option Plan. See "Certain
Transactions --Long Distance Wholesale Club," "Management," and "Principal and
Selling Shareholders."
Prior to the consummation of the Offerings, all of the issued and
outstanding capital stock of Tel Labs was owned by Mr. Luken, the Company's
Chairman of the Board, Mr. Rachlin, the Company's Chief Operating Officer, and
two employees of Tel Labs. Concurrently with the consummation of the Offerings,
the shareholders of Tel Labs will exchange their shares in Tel Labs for a total
of shares of the Company's Common Stock, subject to adjustment based
upon Tel Labs' net worth upon closing of the acquisition of Tel Labs. See
"Certain Transactions --Tel Labs," "Management" and "Principal and Selling
Shareholders."
The Reorganization is being accounted for using the purchase method of
accounting which results in the revaluation of acquired assets and liabilities
to their estimated fair market values. These adjustments are expected to
increase depreciation and amortization expense by approximately $1.6 million
annually.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial
data as a percentage of revenues.
<TABLE>
<CAPTION>
PERCENTAGE OF REVENUES
----------------------
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
----------------------------------- ----------------
1993 1994 1995 1995 1996
---- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Revenues, net 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of services 87.5 62.0 62.1 62.0 59.5
----- ----- ----- ----- -----
Gross margin 12.5 38.0 37.9 38.0 40.5
Operating expenses:
Selling, general and administrative 115.3 26.9 26.0 22.5 30.3
Depreciation and amortization 4.8 1.1 1.5 1.0 1.6
----- ----- ----- ----- -----
Operating income (107.6) 10.0 10.4 14.5 8.6
Interest and other 2.2 2.0 1.4 1.3 1.2
Income taxes - 3.2 3.5 5.1 3.4
----- ----- ----- ----- -----
Net income (109.8%) 4.5% 5.0% 7.8% 3.6%
===== ===== ===== ===== =====
</TABLE>
THREE MONTHS ENDED MARCH 31, 1996 COMPARED TO THREE MONTHS ENDED MARCH 31, 1995
Revenues. Revenues increased 103%, or $46.6 million, from $45.3 million for
the three months ended March 31, 1995 to $91.9 million for the three months
ended March 31, 1996. The increase in revenues was due primarily to an increase
in billed customer minutes both from the casual calling and wholesale
distribution channels. The casual calling revenue growth is largely the result
of a significant increase in the amount of mail marketing sent by the Company
during both the three months ended December 31, 1995 and the three months ended
March 31, 1996 as compared to the prior period.
32
<PAGE>
Following the expansion of its switch facilities, the Company expanded its
mail marketing during the three months ended March 31, 1996 into areas served by
the Company's three switches deployed during 1995. In addition, the Company sent
significant mail into Florida in anticipation of the winter season, as well as
into New York and Massachusetts. During the three months ended March 31, 1996,
the Company began to experiment with radio advertising to augment mail campaigns
in specific geographical markets. Additionally, during this period the Company
entered 12 new states with the Dial & Save brand and 6 new states with the Long
Distance Wholesale Club brand. The Company's offsets to revenues increased
during the three months ended March 31, 1996 compared to the three months ended
March 31, 1995 both as a percentage of revenue and in the aggregate due to
increased billed customer minutes and increases in accruals for bad debts
principally in new geographic areas where LECs require a higher holdback
percentage.
Cost of Services. Cost of services increased 95%, or $26.6 million, from
$28.1 million for the three months ended March 31, 1995, to $54.7 million for
the three months ended March 31, 1996. $26.0 million of this increase was
attributable to direct costs relating to LEC access charges and from the
Company's transmission of on-net and off-net traffic, all of which increased
primarily as a result of the increase in the Company's billed minutes of use but
was partially offset by a decrease in per minute cost. The cost per minute
decrease was largely the result of a higher percentage of on-net traffic coupled
with greater network efficiencies and improved off-net pricing.
Gross Margin. Gross margin increased 116%, or $20 million, from $17.2
million for the three months ended March 31, 1995 to $37.2 million for the three
months ended March 31, 1996. As a percentage of revenues, gross margin increased
from 38.0% for the three months ended March 31, 1995 to 40.5% for the three
months ended March 31, 1996.
Selling, General and Administrative Expense. Selling, general and
administrative expense increased 174%, or $17.7 million, from $10.2 million for
the three months ended March 31, 1995 to $27.9 million for the three months
ended March 31, 1996. Approximately $9.5 million of this increase was
attributable to increases in marketing expenses as the Company increased by
approximately 195% the number of mail pieces sent, introduced radio advertising
and expanded its telesales marketing department. Additionally, $4.4 million of
this increase was due to LEC billing expense primarily related to the increase
in the minutes of use, differences in LEC fees and to increased accruals
associated with the LDWC subsidiary. As a percentage of revenues, selling,
general and administrative expense increased from 22.5% for the three months
ended March 31, 1995 to 30.3% for the three months ended March 31, 1996.
Percentage increases in marketing and general and administrative expense
accounted for the majority of the percentage increase.
Depreciation and Amortization Expense. Depreciation and amortization
expense increased by $1.0 million, from $0.5 million for the three months ended
March 31, 1995 to $1.4 million for the three months ended March 31, 1996. As a
percentage of revenues, depreciation and amortization expense increased from 1%
for the three months ended March 31, 1995 to 1.6% for the three months ended
March 31, 1996. These expenses were primarily attributable to depreciation
related to the expansion of the Company's switch network.
Interest Expense. Interest expense increased $0.5 million from $0.6 million
for the three months ended March 31, 1995 to $1.1 million for the three months
ended March 31, 1996. This increase was due primarily to interest expense
associated with borrowings under the Credit Facility primarily to fund working
capital and increases in capital leases outstanding as a result of the expansion
of the Company's switch
33
<PAGE>
network.
Net Income. Net income decreased $0.2 from $3.5 million for the three
months ended March 31, 1995 to $3.3 million for the three months ended March 31,
1996.
1995 COMPARED TO 1994
Revenues. Revenues increased 382%, or $170.7 million, from $44.7 million in
1994 to $215.4 million in 1995. This increase was due primarily to an increase
in billed customer minutes of use from casual calling customers. During 1994,
the Company marketed its casual calling services in Florida, five mid-Atlantic
states and the District of Columbia. During 1995, the Company expanded its mail
campaigns into 21 additional states in addition to remailings in certain states
targeted during 1994. The Dial & Save and Long Distance Wholesale Club brands
were jointly marketed in two states and nine states during 1994 and 1995,
respectively, and in the District of Columbia. The Company's offsets to revenues
increased as a percentage of revenues primarily as a result of the increased
accruals for bad debt principally related to the Company's expansion into
certain geographic areas where LECs require a higher holdback percentage and as
a result of an increase in the provision for bad debt expense. See "--Quarterly
Results of Operations."
Cost of Services. Cost of services increased 382%, or $106.0 million, from
approximately $27.7 million in 1994 to approximately $133.7 million in 1995.
$102.3 million of this increase was attributable to direct costs relating to LEC
access charges and from the Company's transmission of on-net and off-net
traffic, all of which increased primarily as a result of the increase in the
Company's billed minutes of use. Installation expenses increased from $0.5
million in 1994 to $4.2 million in 1995 primarily as a result of one-time
expenses associated with provisioning local network circuits at Company switch
facilities brought on-line during 1995. During 1995, the Company deployed three
switches, in Austin, Texas, Chattanooga, Tennessee and Davenport, Iowa, while in
1994 the Company deployed one switch in Washington, D.C.
Gross Margin. Gross margin increased 381%, or $64.6 million, from $17.0
million in 1994 to $81.6 million in 1995, due to the reasons discussed above. As
a percentage of revenues, gross margin decreased from 38.0% in 1994 to 37.9% in
1995.
Selling, General and Administrative Expense. Selling, general and
administrative expense increased 365%, or $43.9 million, from $12.0 million in
1994 to $55.9 million in 1995. $28.3 million of this increase was due to
increased mail marketing expenses as the Company expanded geographically and
remailed to certain existing markets and to increased LEC billing costs which
are directly related to the increase in the minutes of use. In addition,
customer service expense increased $6.8 million primarily as a result of an
increase in customer service personnel required to service the Company's
expanding customer base. As a percentage of revenues, selling general and
administrative expense decreased from 26.9% in 1994 to 26.0% in 1995 primarily
as a result of operating efficiencies associated with the Company's growth in
revenues.
Depreciation and Amortization Expense. Depreciation and amortization
expense increased by $2.8 million, from $0.5 million in 1994 to $3.3 million in
1995. As a percentage of revenues, depreciation and amortization increased from
1.1% in 1994 to 1.5% in 1995. These expenses were primarily attributable to
depreciation related to the expansion of the Company's switch network.
Interest Expense. Interest expense increased $2.1 million from $0.9 million
in 1994 to $3.0 million
34
<PAGE>
in 1995. The increase was due primarily to interest expense associated with
borrowings under the Credit Facility used primarily to fund working capital
requirements and increases in capital leases outstanding as a result of the
expansion of the Company's switch network.
Net Income. Net income increased $8.8 million from $2.0 million in 1994 to
$10.8 million in 1995.
1994 COMPARED TO 1993
Revenues. Revenues increased $43.6 million, from $1.1 million in 1993 to
$44.7 million in 1994. The Company commenced operations in November 1993, and
the Company marketed in southern and central Florida. During 1994, the Company
expanded its mail campaigns to additional areas of Florida, and began marketing
in Maryland, Virginia, Delaware, New Jersey, Pennsylvania and the District of
Columbia. In addition, 1994 revenues include revenues of LDWC, in which the
Company acquired a 55.6% ownership interest in 1994.
Cost of Services. Cost of services increased $26.7 million, from $1.0
million in 1993 to $27.7 million in 1994. This increase is consistent with the
growth in billable minutes.
Gross Margin. Gross margin increased $16.8 million, from $0.1 million in
1993 to $17.0 million in 1994. As a percentage of revenues, gross margin
increased from 12.5% in 1993 to 38.0% in 1994.
Selling, General and Administrative Expense. Selling, general and
administrative expense increased $10.7 million, from $1.3 million in 1993 to
$12.0 million in 1994. As a percentage of revenues, selling general and
administrative expense decreased from 115.3% in 1993 to 26.9% in 1994.
Depreciation and Amortization Expense. Depreciation and amortization
expense increased by $0.4 million, from a de minimis amount in 1993 to
approximately $0.5 million in 1994.
Interest Expense. Interest expense increased $0.9 million from a de minimis
amount in 1993 to $0.9 million in 1994. The increase was primarily due to
interest expense associated with borrowings under the Credit Facility and to
increases in capital leases outstanding.
Net Income. Net income increased $3.2 million from a net loss of
approximately $1.2 million in 1993 to approximately $2.0 million in 1994.
35
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain unaudited quarterly financial data
for each of the quarters within the twelve months ended December 31, 1994, the
twelve months ended December 31, 1995 and the three months ended March 31, 1996.
This quarterly information has been derived from and should be read in
conjunction with the Company's consolidated financial statements and the notes
thereto included elsewhere in this Prospectus, and, in management's opinion,
reflects all adjustments (consisting only of normal recurring adjustments,
except as described below) necessary for a fair presentation of the information
for the quarters presented. Operating results for any quarter are not
necessarily indicative of results for any future period.
(IN THOUSANDS, EXCEPT REVENUE AND COST PER MINUTE OF USE AND SELECTED DATA)
YEAR ENDED DECEMBER 31
<TABLE>
<CAPTION>
1994 1995 1996
------------------------------------------ -------------------------------------------- ----
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH FIRST
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
------- ------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues, net ............. $3,385 $4,925 $7,611 $28,786 $45,277 $47,318 $58,341 $64,440 $91,928
Cost of services .......... 2,130 3,043 5,031 17,532 28,079 28,416 36,338 40,895 54,730
----- ----- ----- ------ ------ ------ ------ ------ ------
Gross margin .............. 1,255 1,882 2,580 11,254 17,198 18,902 22,003 23,545 37,198
Selling, general and
administrative ............ 679 1,271 2,288 7,780 10,186 11,692 13,117 20,941 27,863
Depreciation and
amortization .............. 63 67 146 220 452 540 997 1,337 1,433
Operating income (loss).... 513 544 146 3,254 6,560 6,670 7,889 1,267 7,902
----- ----- ----- ------ ------ ------ ------ ------ ------
Interest expense 44 55 278 520 591 542 783 1,036 1,066
Other income (expense)..... - 13 2 - 4 4 (19) (80) 13
Net income (loss)
before taxes............... 469 502 (130) 2,734 5,973 6,132 7,087 151 6,849
----- ----- ----- ------ ------ ------ ------ ------ ------
Provision for income
taxes...................... 188 201 (52) 1,095 2,326 2,388 2,760 58 3,135
Minority interest.......... - - - 137 109 9 561 368 433
----- ----- ----- ------ ------ ------ ------ ------ ------
Net income (loss).......... $ 281 $ 301 $ (78) $ 1,502 $ 3,538 $ 3,735 $ 3,766 $ (275) $ 3,281
===== ===== ===== ====== ====== ====== ====== ====== ======
SELECTED DATA AS A
PERCENTAGE OF REVENUES:
Cost of services........... 62.9% 61.8% 66.1% 60.9% 62.0% 60.1% 62.3% 63.5% 59.5%
Gross margin 37.1% 38.2% 33.9% 39.1% 38.0% 39.9% 37.7% 36.5% 40.5%
Selling, general and
administrative............. 20.1% 25.8% 30.1% 27.0% 22.5% 24.7% 22.5% 32.5% 30.3%
OTHER OPERATING DATA:
EBITDA (1)................. $576 $611 $292 $3,474 $7,012 $7,210 $8,886 $2,604 $9,335
Minutes of use (2)
Revenue per minute of use (3)
...........................
Cost of services
per minute of use (4)......
</TABLE>
________________________________________________________________________________
(Footnotes appear on following page.)
36
<PAGE>
Footnotes:
(1) As used herein, EBITDA is defined as net income (loss) plus depreciation
expense, amortization expense, interest expense, income taxes, other
income (expense) and other non-cash charges. While EBITDA is not a
measurement of financial performance under generally accepted accounting
principles and should not be construed as a substitute for net income as a
measure of performance, or cash flow as a measure of liquidity, it is
included herein because it is a measure commonly used in the industry.
(2) Represents minutes billed during the period.
(3) Represents revenues, net, during the period divided by minutes of use
during the period.
(4) Represents cost of services during the period divided by minutes of use
during the period.
Quarterly revenues increased from approximately $3.4 million in the first
quarter of 1994 to approximately $91.9 million in the first quarter of 1996. The
growth in revenues from the first to the third quarter of 1994 was primarily due
to the Company's expansion of its Dial & Save marketing efforts in Florida and
the acquisition of an initial 55.0% interest in LDWC. From the third quarter to
the fourth quarter of 1994, revenues increased from $7.6 million to $28.8
million, mainly as the result of mail marketing in Florida, as well as from mail
marketing efforts in the mid-Atlantic region following the deployment of the
Company's Washington, D.C. switch.
In the first quarter of 1995, revenues increased to $45.3 million primarily
as a result of the expansion of the Long Distance Wholesale Club brand into
Massachusetts, remailings for both the Dial & Save and Long Distance Wholesale
Club brands in existing territories, and the expansion of the Dial & Save brand
into the southwestern United States following the deployment of the Company's
Austin, Texas switch. In the second quarter of 1995, revenues increased to $47.3
million from $45.3 million in the first quarter of 1995.
While the Company achieved substantially increased revenue from mailings
in other southwestern states, during the first quarter of 1995 the Company
directed a significant portion of its mailing efforts into Texas which
experienced below average response rates. The Company attributes its limited
success in Texas to the strong market presence in that state of other casual
calling companies. The increase in revenues during the second through the fourth
quarters of 1995 resulted from the further penetration into the southeast and
expansion into the midwest of the Dial & Save brand, and from the expansion of
the Company's Long Distance Wholesale Club brand into the mid-Atlantic,
southwestern, and, to a limited extent, the midwestern states already served by
Dial & Save. The increase in revenues during the fourth quarter of 1995 was
partially offset by an increase in the monthly provision for bad debt expense
caused by the Company's entry into geographic areas where the LECs require a
higher holdback percentage and $1.9 million in bad debt write-offs primarily
related to international traffic to Cuba and refunds (which the Company elected
to make) from improperly rated New York intrastate long distance calls by
LDWC.
In addition, management believes that the Company's revenues in the fourth
quarter of 1995 were limited as a result of constraints on the Company's
borrowing capabilities during September 1995, which precluded the Company from
conducting any significant mailings during that month, and because the bulk of
the Company's mail marketing during the fourth quarter of 1995 was conducted
late in the quarter. Since December 31, 1995, the Company has increased its
availability under its Credit Facility from $25 million to $65 million. See "--
Liquidity and Capital Resources."
In the first quarter of 1996, revenues increased to $91.9 million from
$64.4 million during the fourth quarter of 1995 due to increased network
capacity from the areas served by the two switches in Chattanooga, Tennessee and
Davenport, Iowa, combined with mail marketing in areas served by these switches
and in other markets both in the first quarter of 1996 and late in the fourth
quarter of 1995. During the first quarter of 1996, the Company introduced the
Dial & Save brand into 12 additional states, primarily in the southeast
37
<PAGE>
and midwest, while LDWC also entered 6 new states, primarily existing Dial &
Save states. The Company also targeted several existing markets such as Florida,
Pennsylvania and New Jersey with remailing campaigns.
Gross margin as a percentage of revenues for the nine quarters of 1994,
1995 and 1996 ranged from a low of 36.5% during the fourth quarter of 1995 to a
high of 40.5% for the first quarter of 1996, except for the third quarter of
1994 when the gross margin was 33.9%. During the third quarter of 1994, the
first period which included the consolidated operations of LDWC, a significant
portion of LDWC's traffic was transmitted over a third party network at a
materially lower gross margin. During 1994, cost of services included
approximately $0.5 million of expenses relating to the installation of switches,
of which $0.3 million was expensed during the third quarter. During 1995, such
expenses totaled approximately $4.2 million, of which approximately $1.1 million
and $1.8 million were expensed during the third and fourth quarters,
respectively. During the first quarter of 1996, installation expenses totaled
approximately $1.1 million.
Fixed cost facilities lease expense is another major component of cost of
services. During certain time periods, particularly when new switches were
being commissioned, facilities lease cost increased well in excess of either
revenue growth or the percentage changeover from off-net to on-net traffic.
This was particularly apparent during the fourth quarter of 1995, when the
facilities lease expense component of cost of services increased over the third
quarter by 87% even though revenues increased by 10% and the percentage of
domestic on-net traffic increased by 15%.
The Company's selling, general and administrative expense as a percentage
of revenues varied significantly over the nine quarter period due primarily to
quarterly fluctuations in mail marketing expenses, the largest component of
total marketing expenses. During two particularly heavy mail expense quarters,
the fourth quarter of both 1994 and 1995, marketing expense represented 76%
and 43%, respectively, of total marketing expenses for the corresponding year.
Over the eight quarters ended December 31, 1995 and the quarter ended March 31,
1996, marketing expense has represented 42% and 50%, respectively, of total
selling, general and administrative expenses. The Company's billing expenses,
the next largest selling, general and administrative expense item, have
generally decreased as a percentage of revenues due to efficiencies attributable
to direct billing and collection agreements with the LECs, along with the
benefits of increasing volume discounts. The Company's other selling, general
and administrative expenses, mainly customer service and corporate overhead
expenses, have continued to decrease as a percentage of revenues due to
operating leverage associated with increased sales. The one exception was the
fourth quarter of 1995, when bonuses aggregating $1.0 million were paid to the
Company's employees. Selling, general and administrative expenses as a
percentage of revenues will likely increase for the remainder of 1996 and into
1997 primarily as a result of the start-up expenses associated with the
Commercial Division.
LIQUIDITY AND CAPITAL RESOURCES
Since commencing operations in 1993, the Company has experienced rapid
growth, which has required substantial investments in working capital, capital
expenditures and mail marketing expenses. The Company initially funded these
investments from the sale of Common Stock for aggregate proceeds of $0.9 million
and shareholder loans totaling $0.8 million which were repaid in 1994. Net
cash used in operating activities was a de minimis amount, $11.9 million and
$1.0 million in 1995, 1994 and 1993, respectively, and $6.8 million for the
three months ended March 31, 1996. Net cash used in investing activities was
$9.8 million, $1.3 million and $0.3 million in 1995, 1994 and 1993,
respectively, and $2.4 million for the three months ended March 31, 1996. Net
cash from financing activities was $10.3 million, $13.5 million and $1.5 million
in 1995, 1994 and 1993, respectively, and $9.6 million for the three months
ended March 31, 1996.
38
<PAGE>
During 1995, the Company's growth in revenue necessitated a significant
investment in working capital, particularly in accounts receivable. The need to
fund daily operations is caused by the timing difference between the time the
Company pays its suppliers and the time it receives payments from the LECs, the
payors on the vast majority of the Company's accounts receivable. Additionally,
during 1995, the Company funded the commissioning of two switching facilities
located in Chattanooga, Tennessee and Davenport, Iowa, provided partial funding
for the Las Vegas, Nevada switching facility to be commissioned in the third
quarter of 1996, expanded switching capacity in existing switching locations and
expanded the Company's corporate office. During 1994, the Company funded a
significant working capital increase, funded the commissioning of two switching
facilities in Washington, D.C. and Austin, Texas and expanded the Company's
corporate office.
In June 1994, the Company obtained a credit facility, which provided for
borrowings of up to $8.0 million. In connection with the establishment of this
facility the Company issued to an affiliate of the lender a nominal warrant to
acquire 2% of the Common Stock of the Company. See "Description of Capital
Stock--Signet Warrant." During 1994, the facility was amended to increase
amounts available for borrowing to $15 million in November and to $25 million in
December. During the first quarter of 1996, the Company entered into its
current Credit Facility which provides for borrowings from a syndicate of
lenders of up to $65 million.
Borrowings under the Credit Facility are subject to a limitation of 85% of
eligible accounts receivable. As of April 30, 1996, approximately $38.9 million
was outstanding under the Credit Facility. The Credit Facility terminates in
January 1998. Borrowings under the Credit Facility bear interest at LIBOR plus
2% or, at the option of the Company, at the federal funds rate plus 1/2%,
provided that borrowings over $60 million bear interest at the higher of the
prime rate or the federal funds rate plus 1/2%. The interest rate on the Credit
Facility at April 30, 1996 was approximately 7.5%. The Credit Facility is
secured by (i) substantially all of the present and future assets of the Company
and its subsidiaries; (ii) a pledge of the stock of the Company's subsidiaries;
and (iii) a pledge, which will be released upon consummation of the Offerings,
of the Company's Common Stock owned by Messrs. Burns and Luken.
The Credit Facility contains a number of covenants, including, among
others, covenants restricting the Company and its subsidiaries with respect to
the conduct of business and maintenance of corporate existence, the incurrence
of indebtedness, the creation of liens, transactions with affiliates, the
consummation of certain merger or consolidation transactions or the sale of
substantial assets, the sale of the capital stock of any subsidiary, the making
of any investments or acquiring any assets and the making of restricted payments
including dividends. In addition, the Credit Facility contains a number of
financial covenants, including covenants requiring the Company to maintain (i) a
maximum leverage ratio (consolidated debt to consolidated adjusted cash flow
which excludes mail marketing expenses until December 31, 1996) equal to or
greater than 2 to 1 for 1996 and 3.5 to 1 for 1997 and thereafter, and (ii) a
minimum interest coverage ratio (consolidated adjusted cash flows to
consolidated interest expense which excludes mail marketing expenses until
December 31, 1996) of 2.5 to 1. The failure of the Company to satisfy any of
the covenants will constitute an event of default under the Credit Facility,
notwithstanding the Company's ability to meet its debt service obligations. The
Credit Facility includes other customary events of default, including cross
defaults to other indebtedness, change of control provisions and certain events
including bankruptcy, reorganization and insolvency and judgments in excess of
$250,000. An event of default would allow the lenders thereunder to accelerate
the maturity of the indebtedness under the Credit Facility and to enforce their
security interests.
39
<PAGE>
The Company leases certain equipment under capital leases, the majority of
which are with the Company's primary provider of switching equipment. Capital
lease obligations totaled $16.1 million, $3.3 million and $0.8 million at
December 31, 1995, 1994 and 1993, respectively, and $15.8 million for the three
months ended March 31, 1996. The effective interest expense associated with
these leases was approximately 10%. Capital leases have terms ranging from 28
to 60 months. The Company has made capital lease payments of $2.4 million, $1.3
million and a de minimis amount for 1995, 1994 and 1993, respectively, and $0.8
million for the three months ended March 31, 1996. Capital lease principal
payments of approximately $3.0 million are expected to be made during 1996 in
connection with outstanding capital lease obligations as of March 31, 1996.
Messrs. Burns and Luken have guaranteed certain of the Company's obligations
under its switching equipment leases.
In July 1994, the Company acquired a 55.0% interest in LDWC for cash
consideration of approximately $135,000. Concurrently, the Company purchased a
convertible note in the aggregate principal amount of $250,000 payable by LDWC.
The Company subsequently converted the note into shares of LDWC common stock
equal to 0.6% of LDWC's outstanding capital stock. As part of the
Reorganization, the Company acquired the remaining minority interest in LDWC for
consideration consisting of 5,102,125 shares of Common Stock and will acquire
all of the stock of Tel Labs in exchange for _______ shares of Common Stock,
subject to adjustment based upon Tel Lab's net worth upon closing of the
acquisition of Tel Labs. See "--The Reorganization."
The Company intends to use a portion of the net proceeds from the Offerings
to repay all outstanding borrowings under the Credit Facility and to repay
outstanding indebtedness under capital leases. The Company believes that the
estimated net proceeds to be received from the Offerings, together with cash
flow generated from operations and borrowings under the Credit Facility, will be
sufficient to fund the Company's working capital needs, planned capital
expenditures and interest expense for the foreseeable future. The Company has
identified approximately $20 million in capital expenditures (including assets
acquired under capital leases) which it intends to undertake in 1996. These
expenditures consist primarily of amounts for improvements and capacity upgrades
to the Company's switching facilities and expenses relating to the deployment of
a new switch in the New York City metropolitan area. The actual amount of
capital expenditures made in 1996 will depend on numerous factors, including the
timing of the Company's future expansion, economic conditions, competition,
regulatory developments and the availability of capital. The Company may also
require additional financing, which may include public or private debt and
equity financings, in the event the Company enters into strategic alliances,
acquires assets or businesses or makes investments in furtherance of its
business strategy.
SEASONALITY
The Company's long distance revenue is subject to some seasonal variations
due to the fact that residential customer usage is typically higher during the
fourth quarter due to holidays, and on weekends and other holidays throughout
the year.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which the
Company adopted as of January 1, 1996. This statement requires the Company to
review long-lived assets for impairment whenever events or changes in
circumstances indicate
40
<PAGE>
that the carrying amount of an asset may not be recoverable. Based on the
Company's current operating environment, adoption of SFAS 121 is not expected to
have a material impact.
In 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock Based Compensation." The Company has decided to continue
to apply Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees," for recognition and measurement purposes.
41
<PAGE>
BUSINESS
GENERAL
Telco is a rapidly growing switch-based provider of domestic and
international long distance telecommunication services primarily to residential
customers in the United States. The majority of the Company's customers access
its network by dialing a unique CIC Code before dialing the number they are
calling. Using a CIC Code to access the Company's network is known as "casual
calling" because customers can use the Company's services at any time without
changing their existing long distance carrier. The Company markets its long
distance services under two brands, each with a unique CIC Code: Dial & Save
(CIC Code 10457) and the Long Distance Wholesale Club (CIC Code 10297), and
prices its services at a discount to the basic "1 plus" rates offered by the
three major long distance carriers: AT&T, MCI and Sprint. During April 1996,
the Company provided long distance services to approximately 2.6 million
customers (switched access lines) in 37 states and the District of Columbia. The
Company plans to expand its marketing efforts in these states and to offer
service in one additional New England and 10 additional western states during
1996. Since the Company began operations in November 1993, its revenues
and net income have grown to approximately $215.4 million and $10.8 million,
respectively, for the year ended December 31, 1995, and to $91.9 million and
$3.3 million, respectively, for the three months ended March 31, 1996.
Although casual calling has been in existence since the mid-1980s, only
recently have companies such as Telco begun to aggressively pursue this market
opportunity. The Company markets its services primarily through direct mail and
an inbound telesales and marketing system, and believes that this marketing
strategy enables the Company to attract residential customers in a cost
effective manner. Because casual calling customers are not required to cancel or
change their presubscribed long distance carrier, the Company believes that
there is a substantial reduction in the potential impact of aggressive "win-
back" and other customer acquisition programs prevalent in the residential long
distance market.
The Company bills its casual calling customers through LEC billing and
collection agreements which enable the Company to place its charges on the
monthly local phone bills of its casual calling customers. The Company has
agreements with LECs, including all of the RBOCs, that cover approximately 96%
of the switched access lines in the United States. The Company believes that
these billing arrangements are the most effective mechanism for billing the
Company's residential customers, because of the convenience to its customers of
receiving one bill for both local and long distance service and the benefits
derived from the LECs' extensive collections infrastructure. The Company's
billing information systems and services are provided by Tel Labs, a
telecommunications billing company started in 1991 by Telco's Chairman of the
Board. During April 1996, Tel Labs processed approximately 98 million call
records for 16 telecommunications companies, including Telco. Concurrently with
the completion of the Offerings, Telco will acquire all of the outstanding
capital stock of Tel Labs. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--The Reorganization."
To increase its volume of call traffic, Telco has begun to sell its excess
daytime capacity on a wholesale basis to other long distance carriers and has
created a Commercial Division to target business customers. Because the
Company's existing customer base is primarily residential, the majority of
calls are handled during off-peak evening and weekend periods.
The Company's switch-based network currently consists of five Digital
Switch Corporation ("DSC") DEX 600S, 600 and 600E switches located in
Washington, D.C.; Fort Lauderdale, Florida; Davenport, Iowa;
42
<PAGE>
Chattanooga, Tennessee; and Austin, Texas with another DEX 600E switch scheduled
to be operational in Las Vegas, Nevada during the third quarter of 1996. The
Company is also considering deploying a DEX 600E switch in the metropolitan New
York City area by the first quarter of 1997. The Company's state-of-the-art
digital switching and cross-connect systems are designed to optimize traffic
routing and provide for automatic traffic re-routing in the event of a network
failure. The Company leases transmission lines from a variety of facilities-
based long distance service providers. The Company's sophisticated switch-based
network (i) enables it to control proprietary information such as customer call
records, and (ii) positions it to take advantage of competitive rates for local
access from CLECs, such as MFS and Teleport.
INDUSTRY OVERVIEW
The U.S. long distance market is dominated by the nation's three largest
long distance carriers, AT&T, MCI and Sprint, which, according to a report
issued by the FCC in December 1995, together accounted for 83% of the $67
billion in aggregate revenues generated by all U.S. long distance carriers in
1994. Other long distance carriers, some with national transmission and
marketing capabilities, accounted for the remainder of the market. The U.S.
local telecommunications services industry is dominated by the RBOCs, which,
according to the 1995 FCC report, together accounted for 83% of the $43 billion
in aggregate local service revenues generated by all reporting LECs in the U.S.
market in 1994. The remaining 17% was accounted for by the GTOCs and other
independent LECs. The three largest long distance providers, the RBOCs and
certain other carriers own transmission and switching facilities, and are
therefore sometimes referred to as facilities-based carriers. Non-facilities-
based carriers lease transmission lines from facilities-based carriers and are
either switch-based carriers, like the Company, or switchless resellers which
rely on third-party carriers for all aspects of call transmission.
The structure of the telecommunications industry since 1984 has been shaped
largely by the AT&T divestiture decree, which required the divestiture by AT&T
of its Bell operating companies and divided the country into 201 LATAs (the
"AT&T Divestiture Decree"). The 22 Bell operating companies were combined into
seven RBOCs and were permitted to provide local telephone service, local access
service to long distance carriers and long distance ("intraLATA") service within
the LATAs. However, the Bell operating companies were prohibited from providing
inter LATA long distance service, or service between LATAs. To encourage
competition in the long distance market, the AT&T Divestiture Decree and certain
regulations of the FCC require most LECs to provide carriers with access to
local exchange service that is "equal in type, quality and price" to that
provided to AT&T and with the opportunity to be selected by customers as a
preferred long distance service provider ("equal access"). According to a 1995
FCC report, as of December 31, 1994, there were 465 long distance carriers
purchasing equal access services from LECs in the United States.
For each long distance call, the originating and terminating LECs charge an
access fee to the long distance carrier. The long distance carrier charges its
customers a fee for its transmission of the call, a portion of which covers the
cost of the access fees charged by the LECs. Access charges represent a
significant portion of the Company's cost of services and, generally, such
access charges are regulated by the FCC. The FCC has informally announced that
it intends, in the near future, to undertake a comprehensive review of its
regulation of LEC access charges to better account for increasing levels of
local competition. See "Risk Factors--Regulatory and Legislative Risks" and
"Business--Regulation."
Thus, judicial and legislative factors have helped to create a foundation
for smaller companies, such as the Company, to emerge as competitive
alternatives to the larger facilities-based carriers for long distance
43
<PAGE>
services. Equal access, combined with the FCC's policy mandating that carriers
not unreasonably restrict resale of their services, allows resellers such as the
Company to lease transmission facilities from facilities-based long distance
carriers and to offer consumers long distance telecommunications services having
the same quality and convenience as those of the facilities-based carriers.
For policy reasons, equal access was fully implemented for interLATA long
distance service only. For intraLATA long distance service, a modified form of
equal access was adopted, which enables customers to reach a preferred carrier
(other than the customer's LEC) on a call-by-call basis by dialing a CIC Code.
Where equal access is available, a customer can reach the preferred carrier by
dialing an access code, such as 10XXX, or 950-OXXX (or on a toll-free basis),
where XXX is the CIC. The use of access codes to reach a preferred long distance
carrier has recently gained significant exposure and customer acceptance, as
evidenced by marketing campaigns of the larger facilities-based carriers, such
as AT&T's "1-800 CALLATT" and MCI's "1-800-COLLECT."
In view of anticipated exhaustion of CIC Codes, in April 1994 the FCC
initiated a proceeding on the issue and concluded that the expansion of the CIC
Codes is important because it increases access to the public switched telephone
network by both end users and carriers. The FCC tentatively proposed to expand
codes from 10XXX to a 101XXXX format, with a transition period of six years,
during which both formats could be utilized. After expiration of the transition
period, three digit (10XXX) CIC Codes, such as the 10XXX CIC Codes currently
used by the Company and other carriers, will no longer be able to be used.
Instead, the Company and all other carriers currently using three digit CIC
Codes will be assigned new four digit codes to be used after the transition
period has expired. The FCC has not yet acted upon this proposal and has not yet
finally determined the length of the transition period. On April 30, 1996, the
FCC released a Public Notice in which it requested additional public comment on
the issue of the appropriate length of the transition period. Comments and reply
comments were filed with the FCC on May 21, 1996 and May 28, 1996 respectively.
It is not known when the FCC will take final action in this proceeding or what
the length of the transition period will be when finally established by the FCC.
However, all of the three digit CIC Codes have already been allocated, and
commencing in March 1995, Bell Communications Research, Inc., the administrator
of the North American Numbering Plan, has only been issuing 101XXXX codes to
applicants for new CIC Codes.
The 1996 Telecommunications Act removed the restrictions concerning the
provision of long distance service by the RBOCs and GTOCs, although the RBOCs
will need to obtain specific FCC approval and satisfy other conditions,
including a checklist of interconnection and other requirements on LECs, prior
to providing long distance service in the regions in which they provide local
exchange service. See "Risk Factors--Increasing Competition" and "--Regulatory
and Legislative Risks."
In addition to promoting competition in the U.S. long distance
telecommunications market, the 1996 Telecommunications Act also opened U.S.
local service telecommunication markets to competition by preempting state and
local laws to the extent they prevent competitive entry into the provision of
any telecommunications service, and by imposing a variety of new duties on LECs
to promote competition in local exchange services. Among other requirements, all
LECs are required to permit resale of their telecommunications services without
unreasonable restrictions or conditions, and on a non-discriminatory basis. The
law and its accompanying regulations will enable the Company, upon receipt of
all necessary regulatory approvals, to resell local telecommunication services
in addition to its long distance services. The bases upon which such local
services will be available to carriers such as the Company for resale are to be
determined in proceedings of the various state PSCs. Significantly, the 1996
Telecommunications Act mandates that LECs make their services available to
resellers at "wholesale rates," defined as retail rates less any marketing, bill
collection and other costs that will be avoided by the LEC by providing the
wholesale service. The Company believes that the opening of the local
telecommunication services market to resellers provides the Company with
significant growth opportunities.
44
<PAGE>
BUSINESS STRATEGY
The Company's strategy is to achieve continued growth by providing a broad
array of competitively priced long distance services. The Company's primary
objectives in pursuing this strategy are to:
Continue to Expand the Company's Casual Calling Distribution Channel and
Brand Awareness by increasing its direct mail and telesales marketing efforts
for both the Dial & Save and Long Distance Wholesale Club brand names. The
Company continues to explore innovations within this product line including the
use of advertising media that are alternative or complementary to direct mail,
the development of casual calling advertising targeting specific affinity groups
and the creation of new casual calling products and services. The Company's goal
in all of these efforts is to increase advertising response rates and customer
usage and to lower customer attrition, thereby decreasing customer acquisition
costs. During 1996 the Company intends to expand into the 11 remaining
contiguous states where it has not yet marketed and to conduct additional
marketing and remailing in existing territories. Where possible, the Company may
also consider introducing its casual calling services to consumers in foreign
markets.
Expand the Commercial Division to increase its commercial customer base.
The Commercial Division's sales strategy is to build its sales force, including
direct and independent sales representatives and telesales marketing agents
targeting commercial accounts. The Company intends to supplement this sales
force with its existing strong customer support functions and field service
operations and Tel Labs' direct billing capabilities. Currently, usage of the
Company's network occurs mostly during the evenings and on weekends. By
increasing the number of commercial customers, the Company intends to more
effectively use the significant available daytime capacity of its network.
Decrease Network Cost per minute of use through the continued expansion and
development of the Company's network. The Company expects to complete its
national network in the third quarter of 1996 with the deployment of its Las
Vegas, NV switch. The Company further intends to continue to add low cost fixed
capacity to its network in order to keep pace with the Company's growth and to
reduce off-network transmission expenses. To enhance the efficiency of the
fixed-cost elements of its network, the Company seeks to increase traffic volume
and balance business-driven daytime traffic with night and weekend off-peak
traffic from residential customers. Low cost transmission expenses coupled with
an expansive network, are expected to provide the Company with the continued
ability to grow its existing casual calling distribution segment and to expand
into new distribution channels. Such growth may also be facilitated by select
strategic alliances, investments or acquisitions as the Company deems
appropriate.
Offer Innovative Products and Services While Leveraging its Network and
Operating Infrastructure and Business Information Systems, to meet the needs of
the Company's residential and commercial customer base. Tel Labs, a
telecommunications billing company, was organized in 1991 by Telco's Chairman.
During April 1996, Tel Labs processed approximately 98 million call records. The
Company believes that accurate and sophisticated information systems are
critical to growth in the telecommunications industry. Tel Labs provides the
Company with the support that will enable the Company to grow its existing
customer base and to provide new products and services to its residential and
commercial customer base, including the provision of direct bills to commercial
customers. Such products and services may also include the resale of local
exchange services, voice mail, FAX broadcast, video conferencing and conference
calling. The Company believes that its network intelligence, billing and
reporting systems enhance the Company's competitive ability and
45
<PAGE>
provide a platform for future growth and product expansion.
MARKETING AND SERVICES
Since it commenced operations in 1993, the Company's primary focus has been
residential sales through the marketing of casual calling service. The Company
further intends to expand its customer base by adding business customers through
its newly formed Commercial Division. A discussion of the Company's service
offerings and residential and commercial marketing follows.
Residential Services. The Company markets its residential casual calling
services under the Dial & Save and Long Distance Wholesale Club brand names. The
two brands are differentiated by rate structure and marketing approach, and the
Company believes that its dual brand strategy heightens market penetration by
broadening customer exposure to casual calling and appealing to different
segments of the population. Customers access the Company's network by dialing a
five digit code before the number they are calling (10457 for Dial & Save; 10297
for the Long Distance Wholesale Club), and therefore are not required to
permanently change or cancel their existing long distance carrier in order to
use the Company's service. Since inception, the Company has targeted the
domestic residential market, with an estimated 110 million households, and
typically offers its customers savings off of the basic direct dialed "1 plus"
rates charged by AT&T, MCI and Sprint. Approximately 99% of the Company's total
customers were residential customers at March 31, 1996. Customers who prefer to
access the Company's network by dialing "1 plus" rather than dialing the
Company's CIC Codes may select Dial & Save or Long Distance Wholesale Club as
their presubscribed long distance carrier. Whether a residential customer dials
the Company's access codes or is presubscribed, their calls will appear on the
customer's regular monthly local telephone bill.
The Company markets its residential services primarily through direct mail
pieces that seek to educate potential customers regarding casual calling and its
benefits. Direct mail is targeted towards residential customers within a
specified geographic region and includes a service explanation and dialing
instructions, a general pricing comparison, and a set of reminder stickers
highlighting the Company's CIC Codes for customers to keep near their telephone.
Prospective customers do not need to sign-up or call the Company to take
advantage of its discounted service offerings upon receiving a Company mail
solicitation. The Company works with various outside advertising agencies to
design the copy and creative components of the direct mail marketing pieces and
contracts with various vendors of mail shop and printing services in an effort
to ensure that mail is sent out in a timely and cost-effective manner. The
Company's data processing resources allow for prompt monitoring of customer long
distance usage and permit the Company to carefully measure response rates to its
direct mail campaigns. The Company constantly strives to improve response rates
by varying the design and components of its direct mail marketing packages, and
seeks to engineer the timing of its initial and follow-on direct mail campaigns
to maximize response rate and grow overall market penetration. In addition, the
Company has begun to experiment with other media to supplement direct mail.
The Company has typically targeted new and existing geographical areas for
a mailing campaign when its switch network, marketing and back office
infrastructure have allowed it to effectively manage incremental growth. Initial
mailings to new states are usually sequenced over a time period of several weeks
in an effort to ensure proper customer support and efficient call transmission.
The Company has periodically conducted subsequent mailings into its existing
territory to stimulate incremental usage by new and existing customers, and to
build brand awareness. The Company's experience indicates that subsequent
mailings into
46
<PAGE>
its geographic markets have generated incremental new customer usage, in some
cases with response rates equal to initial mailings into such markets.
The Company's in-bound telesales customer service department is designed to
complement the Company's direct mail marketing strategy. Customer Service
Representatives ("CSRs") are available 24 hours a day, 7 days a week in order to
answer marketing inquiries generated by the Company's marketing campaigns, as
well as to support existing customers. CSRs are trained to answer a broad range
of inquiries from prospective customers relating to service, pricing, and
optional features. See "--Customer Services."
Commercial Services. In order to provide an additional distribution channel
for the Company's telecommunications products and services, the Company has
developed and begun to implement a plan to build a direct commercial sales
force. In April 1996, the Company hired Stephen G. Canton as the President of
its newly formed Commercial Division as part of the Company's plan to sell
voice, data, and enhanced telecommunications services to business customers. The
Company intends to open regional sales offices throughout the country in order
to market these services. The Company's commercial sales agents will market the
Company's services through personal contacts which will emphasize customer
service, network quality, value-added services, reporting, rating and
promotional discounts. As of June 10, 1996,the Commercial Division had opened
nine sales offices.
In addition to competitive rates and a wide variety of products, the
Company is able to offer business customers a highly specialized direct bill
summary package that includes call summaries by account code, department,
employee, project, client, area code, country code, and time-of-day. Customer
call management reports are available in the form of hard-copy, magnetic media,
or via Internet or bulletin board services.
In addition to the Company's plan to establish a direct commercial sales
force, the Company currently markets basic long distance services on a
presubscribed basis to small business customers through direct mail and
telemarketing campaigns. The Company markets its "Prime Business" product by
including a description of this service in its Dial & Save residential mailings.
The Company also markets its Long Distance Wholesale Club brand's business
products via a direct mail insert in its LDWC mail campaigns and telesales
campaigns which are conducted both by in-house employees and through a
contractual arrangement with a third party telesales firm.
The Company is positioning itself to resell local exchange services and,
accordingly, has filed with approximately 22 states seeking authorization to
resell local exchange telecommunications products and services. As of March 31,
1996, local exchange resale authorization has been obtained from the State of
California. The Company anticipates that it will have filed applications for
authorization to resell local exchange telecommunications services and products
in an additional 26 states by the end of June 1996.
Wholesale Services. The Company sells transmission capacity and services to
other long distance carriers. Most of the Company's marketing activity in this
segment is through limited participation in industry trade shows. The Company
believes that the combination of the Company's nationwide network and Tel Labs'
data processing resources provides an avenue of continuing growth through the
wholesaling of one-stop telecommunications services to long distance resellers.
The Company offers a complete package of networking, billing and customer
service, eliminating the need for resellers to coordinate with multiple vendors
and giving them the ability to obtain all of their long distance services from a
single source. Additionally, the Company provides reseller clients with a
customized version of the Tel Labs' customer account database software,
TelePhone Maintenance system ("PM"). While revenue per minute from
47
<PAGE>
wholesale service sales is generally lower than the Company's average sales to
end users, the cost of sales and overhead involved in servicing carrier
customers is also lower. Moreover, the Company has used this market segment to
more effectively utilize its network during the daytime hours, the busiest time
of day for many carrier and reseller customers.
Other Value-Added Services. The Company has introduced and is developing
additional value-added services to extend features available to its existing
customer base and to attract additional customers. Within the past twelve
months, the Company has introduced 800 service and calling card services. In
addition, the Company expects to introduce enhanced calling card services,
including voice mail and information services, to casual and presubscribed
business and residential customers during 1996, and may decide to provide
additional services, including the resale of local telecommunications services,
paging, cellular and other wireless products and services, Internet access, and
other enhanced long distance products such as packet switching, video-
conferencing and conference calling.
CUSTOMER SERVICES
To ensure that in-bound telesales marketing and customer service are always
available, the Company's customer service department operates 24-hours a day, 7
days a week to provide full-service support for its residential and commercial
customer base and to handle marketing inquiries from potential and existing
customers. During the first quarter of 1996, the Company's customer telesales
and service department personally responded to approximately 900,000 customer
inquiries and service calls.
As of April 30, 1996 the Company employed approximately 119 CSRs and
related customer service personnel. In connection with its mailing campaigns,
the Company also employs additional personnel through a temporary employment
agency on an ongoing basis, particularly in connection with mass mailings. An
intensive one-week training program (including hands-on training in the
Company's PM system and computer software, participation in role playing
exercises, and monitoring of actual customer calls), as well as regular follow-
on training and repeated quality assurance assessments ensure that CSRs are
properly prepared to handle customer calls. The Company maintains a relationship
with an inbound telemarketing service provider capable of handling incoming
customer service calls should the Company's customer telesales and service
department become disabled.
The Company's call centers are equipped with state-of-the-art computer and
telecommunications technology. Incoming calls are managed efficiently with the
help of a Mitel Phone System, which includes an automatic call distributor and
an automated attendant. This high-powered, multi-task system allows for swift
management of call queue time, the formation of distinct work groups for
different projects, and on-line monitoring of customer service calls for quality
assurance purposes. Bilingual CSRs are available during day and evening shifts.
CSRs use the Company's proprietary PM software which delivers prompt access
to accurate, up-to-date customer account information. This customized software
is a powerful database which provides CSRs the capability to respond swiftly to
customer needs. CSRs are able to issue credits while speaking with a customer,
log service trouble tickets for treatment by the Company's Network Control
Center, record pertinent customer information into an account memo field to
maintain customer history, enter new customers into the database and assign
appropriate billing codes. The software also generates actual credit vouchers,
as well as letters responding to customer requests for additional stickers and
other marketing materials. While Tel Labs has customized the software to
accommodate the Company's specific needs, Tel
48
<PAGE>
Labs also has made this software available to its other long distance clients.
BILLING AND DATA PROCESSING
The Company believes that accurate and sophisticated information systems
are critical to growth in the telecommunications industry. The Company
has dedicated substantial resources to its information systems and believes that
the strong growth of its casual calling business is largely attributable to the
existence of the Tel Labs back office and billing platform. The Company's
information systems enable the Company to (i) monitor and respond to the
evolving needs of its customers by developing new and customized services; (ii)
provide sophisticated billing information that can be tailored to meet the
requirements of its customer base; (iii) provide high quality customer service;
(iv) detect and minimize fraud; (v) verify payables to suppliers; and (vi)
integrate additions to its customer base. The Company believes that its network
intelligence, billing and financial reporting systems enhance the Company's
competitive ability and provide a platform for future growth and the expansion
of its product line.
Tel Labs processes raw switch data into a format that can be used to
produce end-user invoices. During April 1996, Tel Labs processed approximately
98 million call records for 16 telecommunications companies, including Telco.
This data processing is executed on specially designed personal computers
operating a proprietary software program. Tel Labs receives the Company's raw
call records directly from the Company's switches, and prepares them for rating
by determining the answer status, originating location, terminating location and
mileage. The calls are then rated according to standard rates or according to
customer specific rates, if applicable. Rated calls are then sorted depending on
which LEC will actually bill the end-user and placed in an industry standard
format ("EMI"). Tel Labs then prepares management reports which provide the
Company with the total number of calls, minutes and dollars billed during that
bill cycle.
Since its inception, the Company has billed all of its residential traffic
through LECs. The Company has entered into billing and collection agreements
with LECs, including all of the RBOCs that cover approximately 96% of the
switched access lines in the U.S. These agreements permit the Company to place
its customers' call detail records on the customers' regular monthly local phone
bill. In addition, by billing through the LECs, the Company benefits from the
LECs' extensive collections infrastructure. The Company believes that LEC
billing agreements are the most effective mechanism for billing the Company's
residential customers because consumers can receive one bill for both local and
long distance service. The Company also provides billing clearinghouse services
through Tel Labs to other unaffiliated long distance carriers.
Since April 1995, the Company has contracted with a third party to manage
its billing and collection agreements ("Contract Manager"). After receiving
rated call records from Tel Labs, the Contract Manager transmits them to the LEC
and ensures that incoming and outgoing call records and revenues are properly
tracked. The Company is considering managing its own contracts to enable it to
realize greater operating efficiencies and more effectively manage its cash
flow.
NETWORK AND OPERATIONS
The Company operates an advanced telecommunications network consisting of
five switches, with a sixth switch (Las Vegas) scheduled to become operational
in the third quarter of 1996, leased transmission lines and sophisticated
network management systems designed to optimize traffic routing. The Company's
network currently originates traffic in all or some part of 37 states and the
District of Columbia and once the sixth switch becomes operational, the Company
will be able to extend its originating service area to all of
49
<PAGE>
the contiguous United States. The Company operates an "open network", meaning
that any individual within the Company's originating service area whose LEC
provides equal access can access the Company's long distance network by dialing
either of the Company's access codes, 10457 or 10297, or by presubscribing to
the Company as their long distance service provider. Because customers do not
need to register with the Company before accessing its network, the Company must
determine capacity needs and install and test circuits before entering a new
geographic market.
The Company's network provides high quality, reliable transmission and
switching. The Company's network surveillance capabilities, including self-
diagnostic software, generally enable the Company to anticipate and correct
problems before they result in service interruption. The Company's technicians
remotely monitor the Company's entire network 24 hours a day, 7 days a week,
from its Network Control Center in Chantilly, Virginia. To reduce the potential
impact of any equipment or transmission failure, the Company can reroute or
restore transmissions through the Company's standby transmission facilities or
reroute traffic over the networks of other carriers. The Company's technicians
also monitor the network for fraud on a real-time basis, using computer systems
that detect unusual or high volume calling patterns. The Company has established
a second Network Control Center in Austin, Texas to further enhance its
monitoring capabilities.
Switching Facilities. The Company currently operates five DSC DEX 600S, 600
and 600E digital telecommunications switches in Ft. Lauderdale, Florida;
Davenport, Iowa; Chattanooga, Tennessee; Austin, Texas; and Washington, D.C.,
with another DEX 600E switch expected to be operational in Las Vegas, Nevada in
the third quarter of 1996 and is considering deploying an additional switch in
metropolitan New York City by the first quarter of 1997. Switches are digital
computerized routing facilities that receive calls, route calls through
transmission lines to their destination and record information about the source,
destination and duration of the calls. In order for a call to be completed
through a switch, there must be two ports available -- an incoming port and an
outgoing port. For example, if a switch is equipped with 30,000 ports, the
switch can accommodate up to 15,000 simultaneous telephone calls. The Company's
switches are currently configured with between 13,824 and 36,480 equipped ports.
The Company's DEX 600 switch can be expanded to a configuration of 30,720
equipped ports while the Company's four DEX 600E switches can be expanded to a
configuration of 107,520 equipped ports. The Company continually evaluates the
capacity of its switches and in the future may expand its switches' capacity or
add new switches in selected markets where the volume of its customer traffic
makes such an investment economically viable.
Leased Transmission Lines. The Company leases transmission lines from a
variety of facilities-based and resale long distance carriers. The Company's
contracts with these entities typically have terms ranging from 18 to 36 months.
The Company supplements its leased "on-network" capacity with "off-net" services
from a variety of resale and facilities-based long distance carriers. In
addition, the Company does not have any on-network international network
arrangements and exclusively resells the network capacity of other resale and
facilities-based long distance carriers to international destinations.
Network Management Systems. Once calls are originated over the Company's
circuits, the calls are routed over leased digital, fiber optic transmission
facilities to the Company's nearest switch location and then routed on a least-
cost basis to either the Company's leased network or to an off-net supplier for
termination. The Company utilizes state-of-the-art Digital Access Cross Connect
Systems ("DACS") to electronically cross-connect circuits thereby increasing
call routing and circuit provisioning efficiency and providing better network
monitoring capabilities. The Company has installed Tellabs ABS Titan 5500 3/1
and 530 1/0 DACS equipment on three of the Company's switches. Additional DACS
systems are expected
50
<PAGE>
to be installed on the remaining switches by the third quarter of 1996. In
addition, the Company has configured a large portion of its network with
Signaling System 7 Common Channel Signaling ("SS7"). This network protocol
reduces connect time delays and provides additional technical capabilities and
efficiencies for call routing. The Company is currently in the process of
deploying SS7 in additional portions of its network.
COMPETITION
The telecommunications industry is highly competitive and affected by rapid
regulatory and technological change. The Company believes that the principal
competitive factors in its business include pricing, customer service, network
quality, service offerings and the flexibility to adapt to changing market
conditions. The Company's future success will depend upon its ability to compete
with AT&T, MCI, Sprint and other carriers (including the RBOCs when approved to
enter the long distance market) and other casual calling companies, many of
which have considerably greater financial and other resources than the Company.
The Company believes it competes favorably in its targeted markets, due to
its casual calling service and billing services, competitive pricing, high
network quality and customer service infrastructure. The Company also believes
that its success will depend increasingly on its ability to offer on a timely
basis new services based on evolving technologies and industry standards. There
can be no assurance that new technologies or services will be available to the
Company on favorable terms.
Regulatory trends have had, and may have in the future, significant effects
on competition in the industry. See "--Regulation," "Risk Factors--Legislative
and Regulatory Risks" and "Risk Factors--Increasing Competition."
REGULATION
The services which the Company provides are subject to varying degrees of
federal, state and local regulation. The FCC exercises jurisdiction over all
facilities of, and services offered by, telecommunications common carriers to
the extent that they involve the provision, origination or termination of
jurisdictionally interstate or international communications. The state PSCs
retain jurisdiction over jurisdictionally intrastate communications.
1996 Telecommunications Act. The 1996 Telecommunications Act was enacted in
February, 1996. The legislation is intended to introduce increased competition
in U.S. telecommunication markets. The legislation opens the local services
markets by requiring local exchange carriers to permit interconnection to their
networks and by establishing local exchange carrier obligations with respect to
unbundled access, resale, number portability, dialing parity, access to rights-
of-way, mutual compensation and other matters. In addition, the legislation
codifies the local exchange carriers' equal access and nondiscrimination
obligations and preempts inconsistent state regulation. The legislation also
contains special provisions that eliminate the restrictions on the RBOCs and the
GTOCs from providing long distance services. These new provisions permit an RBOC
to enter the "out-of-region" long distance market immediately, upon the receipt
of any state and/or federal regulatory approvals otherwise applicable to the
provision of long distance service, and the "in-region" long distance market if
it satisfies several procedural and substantive requirements, including
obtaining FCC approval upon a showing that in certain situations facilities-
based competition is present in its market, and that it has entered into
interconnection agreements which satisfy a 14-point "checklist" of competitive
requirements.
51
<PAGE>
The legislation defines in-region service to include every state, in its
entirety, in which the RBOC provides local exchange service, even if the RBOC is
not the incumbent local exchange service provider in all portions of that state.
The GTOCs are permitted to enter the long distance market as of the date of
enactment of the 1996 Telecommunications Act, without regard to limitations by
region, although necessary regulatory approvals to provide long distance
services must be obtained, and the GTOCs are subject to the provisions of the
1996 Telecommunications Act that impose interconnection and other requirements
on LECs. The Company will be facing new competition from the RBOCs and the GTOCs
that are able to obtain the necessary state and/or FCC approvals to provide out-
of-region and/or in-region long distance service. The new legislation provides
for certain safeguards to protect against anticompetitive abuse by the RBOCs.
Among other things, the legislation limits the ability of the RBOCs to market
jointly for a certain time period interLATA long distance service, equipment,
and certain information services together with local services. The RBOCs must
pursue such activities only through separate subsidiaries with separate books
and records, financing, management, and employees. All affiliate transactions
must be conducted on an arm's length and nondiscriminatory basis. The RBOCs are
also prohibited from jointly marketing local and long distance services,
equipment, and certain information services unless they permit competitors to
offer similar packages of local and long distance services. Further, the RBOCs
must obtain in-region long distance authority before jointly marketing local and
long distance service in a particular state. It is unknown whether these
safeguards will provide adequate protection against anti-competitive conduct by
the RBOCs, and the impact of anticompetitive conduct on the Company, if such
conduct occurs, is uncertain. In addition, long distance service providers such
as the Company will be significantly affected by the implementation and
enforcement of statutory and regulatory provisions designed to prevent the RBOCs
and the GTOCs from capitalizing on their monopolistic provision of local
services to existing subscribers to win interLATA business.
The 1996 Telecommunications Act also addresses a wide range of other
telecommunications issues that will potentially impact the Company's operations,
including a sunset provision pertaining to when safeguards designed to prevent
RBOCs from capitalizing on their local exchange monopolies will cease to apply;
provisions pertaining to regulatory forbearance by the FCC; the creation of new
opportunities for competitive local service providers; and requirements
pertaining to the treatment and confidentiality of subscriber network
information. The legislation also restricts for some period AT&T and other long
distance carriers serving more than five percent of the nation's presubscribed
access lines from packaging their long distance services with local services
provided over RBOC facilities. It is unknown at this time precisely the nature
and extent of the impact that the legislation will have on the Company. As
required by the legislation, the FCC is conducting a large number of proceedings
over the next year to adopt rules and regulations to implement the new statutory
provisions and requirements.
Depending on the exact nature and timing of GTOC and RBOC out-of-region and
in-region entry into the long distance market, such entry and the ability of the
Company's competitors to market jointly local and long distance services could
have a material adverse effect upon the Company's results of operations. It is
expected by the Company that most or all of the RBOCs will file applications for
out-of-region (and also eventually in-region) long distance service authority.
Certain of the RBOCs have already obtained the necessary authority to provide
out-of-region long distance services in multiple states. It is not known when,
and under what specific conditions, other applications for long distance
authority will be filed by the RBOCs and/or granted by state utility
commissions.
Federal. The FCC has classified the Company as a non-dominant interexchange
carrier. As a non-dominant carrier, the Company may provide domestic interstate
communications without prior FCC
52
<PAGE>
authorization, although FCC authorization is required for the provision of
international telecommunications by non-dominant carriers. Non-dominant
carriers currently are required to file tariffs listing the rates, terms and
conditions of interstate and international services provided by the carrier.
However, generally the FCC has chosen not to exercise its statutory power to
closely regulate the charges or practices of non-dominant carriers.
Nevertheless, non-dominant carriers are required by statute to offer interstate
and international services under rates, terms and conditions that are just,
reasonable, and not unduly discriminatory, and the FCC acts upon complaints
against such carriers for failure to comply with statutory obligations or with
the FCC's rules, regulations and policies. The FCC also has the power to impose
more stringent regulatory requirements on the Company and to change its
regulatory classification. The Company believes that, in the current regulatory
environment, the FCC is unlikely to do so.
Until October 1995, AT&T was classified as a dominant carrier, but AT&T
successfully petitioned the FCC for non-dominant status in the domestic
interstate market. Therefore, certain pricing restrictions that once applied to
AT&T have been eliminated, which could result in increased prices for services
the Company purchases from AT&T and more competitive retail prices offered by
AT&T to customers. AT&T is, however, still classified as a dominant carrier for
international services. AT&T also has been reclassified as non-dominant in the
international market.
Both domestic and international non-dominant carriers must maintain tariffs
on file with the FCC. Pursuant to this requirement, the Company has filed and
maintains with the FCC a tariff for its interstate and international services.
The Company also has obtained FCC authority to provide international services
through the resale of switched services of various carriers.
On March 21, 1996, the FCC initiated a rulemaking proceeding in which it
proposed to eliminate the requirement that non-dominant interstate carriers such
as the Company maintain tariffs on file with the FCC for domestic interstate
services. The FCC's proposed rules are pursuant to authority granted to the FCC
in the 1996 Telecommunications Act to "forebear" from regulating any
telecommunications service provider if the FCC determines that the public
interest will be served. The FCC also requested public comment on whether any
other regulations currently imposed on non-dominant carriers also should be
eliminated pursuant to the FCC's "forbearance" authority. It is not known when
the FCC will take final action on this proposal.
The FCC also imposes prior approval requirements on transfers of control
and assignments of operating authorizations. The FCC has the authority to
generally condition, modify, cancel, terminate or revoke operating authority for
failure to comply with federal laws and/or the rules, regulations and policies
of the FCC. Fines or other penalties also may be imposed for such violations.
There can be no assurance that the FCC or third parties will not raise issues
with regard to the Company's compliance with applicable laws and regulations.
Among domestic local carriers, only the incumbent local exchange carriers
are currently classified as dominant carriers. Thus, the FCC regulates many of
the local exchange carriers' rates, charges and services to a greater degree
than the Company's, although FCC regulation of the local exchange carriers is
expected to decrease over time, particularly in light of the 1996
Telecommunications Act.
Like other long distance carriers, the Company has been the subject of
informal complaints before the FCC regarding certain marketing and billing
issues. The Company has filed timely responses to these informal complaints. The
Company believes that such matters will be satisfactorily resolved without a
53
<PAGE>
material adverse impact upon the Company's results of operations.
State. The Company's intrastate long distance operations are subject to
various state laws and regulations including, in most jurisdictions,
certification and tariff filing requirements. The vast majority of the states
require the Company to apply for certification to provide intrastate
telecommunications services, or at least to register or to be found exempt from
regulation, before commencing intrastate service. The vast majority of states
also require the Company to file and maintain detailed tariffs listing their
rates for intrastate service. Many states also impose various reporting
requirements and/or require prior approval for transfers of control of certified
carriers, and/or for corporate reorganizations; acquisitions of
telecommunications operations; assignments of carrier assets, including
subscriber bases; carrier stock offerings; and incurrence by carriers of
significant debt obligations. Certificates of authority can generally be
conditioned, modified, canceled, terminated, or revoked by state regulatory
authorities for failure to comply with state law and/or the rules, regulations,
and policies of the state regulatory authorities. Fines and other penalties also
may be imposed for such violations.
The Company provides long distance service in all or some portion of 37
states and the District of Columbia and has received the necessary certificate
and tariff approvals to provide intrastate long distance service in 47 states.
Applications are pending in other states for certification. Although the Company
intends and expects to obtain operating authority in each jurisdiction in which
operating authority is required, there can be no assurance that one or more of
these jurisdictions will not deny the Company's request for operating authority.
The Company monitors regulatory developments in all 50 states to ensure
regulatory compliance.
Informal complaints concerning certain marketing and billing issues have
been lodged against the Company before certain state PSCs. The Company believes
that such matters will be satisfactorily resolved without a material adverse
impact upon the Company's results of operations.
PSCs also regulate access charges and other pricing for telecommunications
services within each state. The RBOCs and other local exchange carriers have
been seeking reduction of state regulatory requirements, including greater
pricing flexibility. This could adversely affect the Company in several ways. If
regulations are changed to allow variable pricing of access charges based on
volume, the Company could be placed at a competitive disadvantage over larger
long distance carriers. The Company also could face increased price competition
from the RBOCs and other local exchange carriers for intra-LATA and inter-LATA
long distance services, which may be increased by the removal of former
restrictions on long distance service offerings by the RBOCs as a result of the
1996 Telecommunications Act.
INTELLECTUAL PROPERTY
The Company has registered several trademarks for use in its marketing
materials. The original logo used by the Company to market its Dial & Save
residential long distance service is a registered trademark of the Company. The
logo is used in a limited fashion today, as it has been replaced by a more
updated logo design. The new logo utilized by the Company to market its Dial &
Save residential long distance service is actively used on all Dial & Save
marketing materials. The Company filed a registration application to obtain a
trademark for its new logo design and to trademark the words "Dial & Save" in
late 1994. The registration application has been suspended pending the
disposition of one other application before the Patent and Trademark Office
("PTO"). While each of the Company and the other applicant have filed an
opposition to the other's application, they have commenced discussions to
resolve the matter. The Company's CIC Code for its Long
54
<PAGE>
Distance Wholesale Club brand is a registered trademark of the Company.
"Prime Business" is the name of the Company's small business product line.
The Company filed its registration application to obtain a trademark for the
phrase "Prime Business" and its logo in 1995. The registration application is
currently pending.
EMPLOYEES
As of April 30, 1996, the Company has approximately 318 full-time
employees, 8 part-time employees, and approximately 200 workers who are employed
through various employment agencies. The employment agency workers are Customer
Service Representatives who handle inbound marketing inquiries from customers.
None of these employees are represented by a union. The Company believes that it
has good relations with its employees.
PROPERTIES
The Company currently leases approximately 23,189 square feet of space for
its corporate headquarters at 4219 Lafayette Center Drive and 4215 Lafayette
Center Drive in Chantilly, Virginia, pursuant to a lease agreement expiring on
July 31, 1999. See "Certain Transactions--Leases of Real Property from Affiliate
of Shareholder." The average monthly rent (not including electricity) as of
March 1996 is approximately $19,867. The Company is also negotiating for an
additional 6,000 square feet of space at 4200 Lafayette Center Drive. In
addition, the Company occupies approximately 14,508 square feet of leased office
space on the 11th floor of 1401 Wilson Boulevard in Arlington, Virginia, which
is occupied primerily of the Company's Washington, D.C. Commercial Division. The
monthly rental for this space as of April 1996 is approximately $24,785. The
lease expires on May 31, 2000 with an option to renew for one additional term of
five years. The Company also leases an aggregate of 27,162 square feet of space
in seven locations in Florida, Iowa, Nevada, Tennessee, Texas, and Washington,
D.C., to house its telecommunications switching equipment sites and one of its
network control centers. Due to the rapid expansion and growth of the Company,
there may be a need to lease additional office space. If this need arises, the
Company believes additional space can be readily obtained as needed. The
Company's Commercial Division is currently utilizing temporary office space in
eight of its nine existing locations. The Company expects to secure longer term
office space later in 1996.
LITIGATION
The Company is a party from time to time to litigation or proceedings
incident to its business, including, but not limited to, informal complaints
before the FCC and state agencies regarding certain marketing and billing
issues. There is no pending legal proceeding to which the Company is party that
in the opinion of management is likely to have a material adverse effect on the
Company's business, financial condition or results of operations.
55
<PAGE>
MANAGEMENT
The following table sets forth, as of March 31, 1996, certain information
regarding the Company's directors, executive officers and certain other
significant employees.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Henry G. Luken, III 37 Chairman of the Board
Donald A. Burns 33 Vice Chairman of the Board, Chief Executive
Officer and President
Thomas J. Cirrito 48 President--Consumer Division and Director
Robert W. Ross 55 Director
Natalie J. Marine-Street 27 Executive Vice President
Stephen G. Canton 40 President--Commercial Division
Bryan K. Rachlin 40 Chief Operating Officer, Secretary and General Counsel
Nicholas A. Merrick 33 Chief Financial Officer and Treasurer
Janet D. Anastasi 49 Vice President and Corporate Controller
Mark J. Stodter 37 Vice President - Electronic Data Processing
</TABLE>
Following completion of the Offerings, the Company intends to elect one
additional person to the Company's Board of Directors, who will be an
independent director.
HENRY G. LUKEN, III, a co-founder of the Company, has served as the
Chairman of the Company's Board of Directors since its formation in July 1993.
Mr. Luken served as the Company's Chief Executive Officer and Treasurer from
July 1993 to April 1996. Mr. Luken has also served as Chairman of Tel Labs since
1991 and Chairman of Telco Development Group, Inc., a computer systems company
owned by Mr. Luken, since 1987, both of which entities he founded.
DONALD A. BURNS, a co-founder of the Company, has served as Chief Executive
Officer and Vice Chairman of the Company's Board of Directors since April 1996,
and has served as the President and as a director of the Company since its
formation in July 1993. Mr. Burns served as the Company's Secretary from July
1993 to April 1996. Prior to joining the Company, Mr. Burns held several
positions with Mid Atlantic Telecom, Inc. ("Mid Atlantic"), a regional long
distance carrier based in Washington, D.C., including executive vice president
and chief operating officer from October 1992 to July 1993 and director of
operations from 1988 to October 1992.
THOMAS J. CIRRITO has served as the President of the Company's Consumer
Division since April 1996 and as a director of the Company since June 1996. Mr.
Cirrito is a co-founder of LDWC and has served as its president and chief
executive officer since its formation in September 1993. From November 1991
through September 1993, Mr. Cirrito served as president and chief executive
officer of Telecommunications Associates, an operator assisted services company.
Mr. Cirrito was vice president of marketing/sales with Mid Atlantic from
November 1988 to November 1991.
ROBERT W. ROSS has been a director of the Company since June 1996. Mr. Ross
has been Vice President, International Business Development, of Turner
Broadcasting System, Inc. ("TBS") since August 1990, and President of Turner
International, Inc., a subsidiary of TBS, since September 1994.
56
<PAGE>
NATALIE J. MARINE-STREET has served as an Executive Vice President of the
Company since February 1996. Ms. Marine-Street served in several other positions
with the Company since its formation in July 1993, including vice president of
administration from February 1995 to February 1996 and marketing manager/special
projects from July 1993 to February 1995. Prior to joining the Company, Ms.
Marine-Street served as marketing coordinator and in other capacities at Mid
Atlantic from April 1991 to July 1993.
STEPHEN G. CANTON has served as the President of the Company's Commercial
Division since April 1996. Prior to joining the Company, Mr. Canton held several
positions with Allnet Communications Services, Inc., a long distance
telecommunications company, including vice president of the sales division and
regional sales director from 1988 to 1995.
BRYAN K. RACHLIN has served as the Chief Operating Officer and Secretary of
the Company since April 1996. Mr. Rachlin has served as vice president and
general counsel of the Company since its inception, and as the chief executive
officer of Tel Labs since May 1994. Prior to joining the Company, Mr. Rachlin
was a partner in the law firm of Rachlin & Fitzgerald.
NICHOLAS A. MERRICK has served as Chief Financial Officer of the Company
since March 1996. Prior to joining the Company, from July 1990 to March 1996,
Mr. Merrick held several positions as an investment banker in the corporate
finance department of The Robinson-Humphrey Company, Inc. In this capacity, Mr.
Merrick was involved in numerous public and private financings and merger and
acquisition transactions involving companies in the telecommunications industry.
JANET D. ANASTASI has served as Vice President and Corporate Controller of
the Company since October 1994. Prior to joining the Company, Ms. Anastasi
served as a manager at Chase and Associates CPAs, P.C., certified public
accountants, from 1988 to 1994.
MARK J. STODTER has served as Vice President-Electronic Data Processing of
the Company since its formation in July 1993. Additionally, Mr. Stodter served
as Chief Operating Officer of the Company from July 1993 to March 1996. Prior to
joining the Company, Mr. Stodter served as director of management information
systems with Long Distance Service, Inc., a regional long distance carrier based
in Washington, D.C. from 1986 to July 1993.
All directors of the Company currently hold office until the next annual
meeting of the Company's shareholders or until their successors are elected and
qualified. The Company's Board of Directors is divided into three classes
serving staggered three-year terms. At each annual meeting of the Company's
shareholders, successors to the class of directors whose term expires at such
meeting will be elected to serve for three-year terms and until their successors
are elected and qualified. Officers are elected by, and serve at the discretion
of, the Board of Directors. There are no family relationships among any of the
Directors or officers of the Company.
COMMITTEES OF THE BOARD
Subsequent to the Offerings, the Board of Directors will establish an Audit
Committee. The Audit Committee will be comprised solely of independent directors
and will be charged with recommending the firm to be appointed as independent
accountants to audit the Company's financial statements, discussing the scope
and results of the audit with the independent accounts, reviewing the functions
of the Company's
57
<PAGE>
management and independent auditors pertaining to the Company's financial
statements and performing such other related duties and functions as are deemed
appropriate by the Audit Committee and the Board of Directors.
Also, subsequent to the Offerings, the Board of Directors will establish a
Compensation Committee. The Compensation Committee will be comprised solely of
"disinterested persons"or "Non-Employee Directors" as such term is used in Rule
16b-3 promulgated under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and "outside directors" as such term is used in Treasury
Regulation Section 1.162-27(c)(3) promulgated under the Internal Revenue Code of
1986, as amended (the "Code"). The Compensation Committee will be responsible
for reviewing general policy matters relating to compensation and benefits of
employees and officers, determining the total compensation of the officers and
Directors of the Company and administering the Company's Stock Option Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Board of Directors did not have a Compensation Committee during fiscal
year 1995. As a result, the entire Board of Directors participated in
deliberations concerning executive officer compensation. Subsequent to the
Offerings, the Board of Directors will establish a Compensation Committee
comprised of directors who are not executive officers or employees of the
Company.
DIRECTOR REMUNERATION
Following the completion of the Offerings, directors who are not employees
of the Company will receive an annual fee, a meeting fee for every board meeting
attended and each committee meeting held separately and a fee for each
telephonic board meeting or telephonic committee meeting held separately. The
Company is in the process of determining such fees. All directors will be
reimbursed for out-of-pocket expenses. The Company may, from time to time and in
the sole discretion of the Company's Board of Directors, grant options to
directors under the Company's Stock Option Plan.
58
<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth certain summary information concerning
compensation for services in all capacities awarded to, earned by or paid to,
the Company's Chief Executive Officer and each of the other most highly
compensated executive officers of the Company, whose aggregate cash and cash
equivalent compensation exceeded $100,000 (collectively, the "Named Officers"),
with respect to the year ended December 31, 1995.
SUMMARY COMPENSATION TABLE(1)
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
-------------------------------------------- ---------------
NAME OF INDIVIDUAL OTHER ANNUAL SECURITIES UNDER- ALL OTHER
AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) COMPENSATION LYING OPTIONS (#) COMPENSATION
- ---------------------- ---- --------- -------- ------------------ ------------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Henry G. Luken, III
Chairman of the Board 1995 $835,327(2) $300,000 $ 22,500 (5) $ 0 $ 0
Donald A. Burns, President
and Chief Executive Officer 1995 397,533(3) 300,000 0 0 0
Bryan K. Rachlin, Chief
Operating Officer,
Secretary
and General Counsel 1995 450,355(4) 0 $ 22,500 (5) 102,043 0
Thomas J. Cirrito,
President-
Consumer Division 1995 274,508 0 41,784 (6) 0 0
</TABLE>
___________
(1) Includes compensation paid by Telco and its subsidiaries, including LDWC.
The figures also include compensation paid by Tel Labs which, upon the
completion of the Offerings, will become a wholly owned subsidiary of
Telco.
(2) Mr. Luken's annual salary was adjusted to $400,000 in 1996.
(3) Mr. Burns's annual salary was adjusted to $400,000 in 1996.
(4) Mr. Rachlin's annual salary was adjusted to $375,000 in 1996. In October
1995, Mr. Rachlin was granted options to purchase two shares of LDWC at an
exercise price of $181,060.77 per share, exercisable for a period of ten
years. In connection with the Company's acquisition of the minority
interest in LDWC, such LDWC options were automatically converted into
options to purchase a total of 102,043 shares of Telco Common Stock at an
exercise price of $3.55 per share, with an exercise period expiring on
October 1, 2005. Options to purchase 76,532 shares vested in January 1996,
and the remaining options will vest in January 1997.
(5) Represents deferred compensation payable by Tel Labs under the Tel Labs
Simplified Employee Pension Plan.
(6) Represents accrued deferred compensation payable by LDWC under the LDWC
deferred compensation plan.
59
<PAGE>
STOCK OPTION GRANTS
The following table sets forth certain information regarding grants of
options to purchase Common Stock made by the Company during the fiscal year
ended December 31, 1995, to each of the Named Officers. No stock appreciation
rights were granted during 1995.
OPTION GRANTS IN 1995
INDIVIDUAL GRANTS
<TABLE>
<CAPTION>
PERCENT OF
NUMBER OF TOTAL POTENTIAL REALIZABLE
SECURITIES OPTIONS VALUE AT ASSUMED
UNDERLYING GRANTED TO EXERCISE ANNUAL RATES OF STOCK
OPTIONS EMPLOYEES PRICE EXPIRATION PRICE APPRECIATION FOR
GRANTED IN 1995 (1) ($/SHARE) DATE OPTION TERM (2)
------- ----------- --------- ---------- -------------
(5%) (10%)
NAME
----
<S> <C> <C> <C> <C> <C> <C>
Henry G. Luken, III 0 - - - - -
Donald A. Burns 0 - - - - -
Bryan K. Rachlin (3) 102,043 20.2% $3.55 10/01/05 $227,821 $577,339
Thomas J. Cirrito 0 - - - - -
Natalie Marine-Street 0 - - - - -
</TABLE>
_______________
(1) The Company granted options to purchase a total of 504,342 shares of Common
Stock in 1995, which includes options to purchase shares of common stock of
LDWC that were converted into options to purchase Common Stock of Telco in
connection with the Company's acquisition of the minority interest in LDWC
as part of the Reorganization.
(2) Represents amounts that may be realized upon exercise of options
immediately prior to the expiration of their term assuming the specified
compounded rates of appreciation (5% and 10%) on the Common Stock over the
terms of the options. These assumptions do not reflect the Company's
estimate of future stock price appreciation. Actual gains, if any, on the
stock option exercises and Common Stock holdings are dependent on the
timing of such exercise and the future performance of the Common Stock.
There can be no assurance that the rates of appreciation assumed in this
table can be achieved or that the amounts reflected will be received by the
option holder.
(3) In October 1995, Mr. Rachlin was granted options to purchase two shares of
LDWC at an exercise price of $181,060.77 per share, exercisable for a
period of ten years. In connection with the Company's acquisition of the
minority interest in LDWC, such LDWC options were automatically converted
into options to purchase a total of 102,043 shares of Telco Common Stock at
an exercise price of $3.55 per share, with an exercise period expiring on
October 1, 2005. Options to purchase 76,532 shares vested in January
1996, and the remaining options will vest in January 1997.
60
<PAGE>
OPTION EXERCISES AND HOLDINGS
The following table sets forth certain information regarding options to
purchase Common Stock held as of December 31, 1995, by each of the Named
Officers. None of the Named Officers exercised any stock options or stock
appreciation rights during fiscal year 1995.
FISCAL 1995 YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised "In-the-Money" Options at
Options at Fiscal Year-End (#) Fiscal Year-End ($) (1)
------------------------------ -----------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Henry G. Luken, III - 0 - - 0 - - 0 - - 0 -
Donald A. Burns - 0 - - 0 - - 0 - - 0 -
Bryan K. Rachlin (2) 700,432 25,511 2,672,838 23,725
Thomas J. Cirrito - 0 - - 0 - - 0 - - 0 -
Natalie Marine-Street 740,775 56,525 2,014,908 153,748
</TABLE>
______________
(1) Options are "in the money" if the fair market value of the underlying
securities exceeds the exercise price of the options. The amounts set forth
represent the difference between $4.48 per share, the market value of the
Common Stock issuable upon exercise of options at December 31, 1995 (as
determined by the Board of Directors), and the exercise price of the
option, multiplied by the applicable number of shares underlying the
options. Such fair market value has been adjusted to reflect the pro forma
effect of the Stock Split and the Reorganization.
(2) Includes options to purchase 102,043 shares of Telco Common Stock granted
to Mr. Rachlin in exchange for Mr. Rachlin's options to acquire shares of
LDWC common stock, pursuant to Telco's acquisition of the minority
interests in LDWC. See "Certain Transactions --Long Distance Wholesale
Club."
EMPLOYMENT AGREEMENTS
On June __, 1996, the Company entered into employment agreements with each
of Messrs. Burns and Rachlin and Ms. Marine-Street pursuant to which Mr. Burns
has agreed to serve as Vice Chairman of the Board of Directors, President and
Chief Executive Officer of the Company, Mr. Rachlin has agreed to serve as Chief
Operating Officer, General Counsel and Secretary, and Ms. Marine-Street has
agreed to serve as Executive Vice President. The agreement with Mr. Burns
expires on June __, 2001 and the agreements with Mr. Rachlin and Ms. Marine-
Street expire on June __, _____, in each case unless earlier terminated in
accordance with the terms of the respective agreement. The annual base salary
under such agreements is reviewed annually but cannot be less than $400,000 for
Mr. Burns, $375,000 for Mr. Rachlin, and $130,000 for Ms. Marine-Street.
Also on June ____, 1996, the Company entered into an employment agreement
with Mr. Luken, pursuant to which Mr. Luken has agreed to serve as Chairman of
the Company until June ___, 2001, unless earlier terminated in accordance
with the terms of the agreement. Mr. Luken's annual base compensation under
such agreement is reviewed annually but cannot be less than $400,000.
On March 19, 1996, the Company entered into an employment agreement with
Mr. Merrick, pursuant to which he has agreed to serve as the Chief Financial
Officer of the Company until March 19, 1999, unless
61
<PAGE>
earlier terminated in accordance with the terms of the agreement. Mr. Merrick's
annual base salary under the agreement is reviewed annually, but cannot be less
than $130,000. In addition, the agreement provides for an annual bonus for Mr.
Merrick in a minimum amount of $78,000 for each year of the agreement. Mr.
Merrick was also granted options to acquire 425,000 shares of the Company's
Common Stock at an exercise price of $7.53 per share, exercisable over a ten
year period from the date of grant and vesting in one-third increments over the
three-year period commencing with the date of the agreement. The agreement
provides that all unvested options shall vest immediately upon the occurrence of
a "change in control" of the Company (as defined in the agreement).
On April 4, 1996, the Company entered into an employment agreement with Mr.
Canton, pursuant to which he has agreed to serve as the President of the
Company's Commercial Division until April 3, 2001, unless earlier terminated in
accordance with the agreement. Mr. Canton's annual base salary under the
agreement is reviewed annually, but cannot be less than $300,000. Pursuant to
the agreement, Mr. Canton also received options to acquire 1,062,500 shares of
the Company's Common Stock, exercisable at an option price of $7.53 per share,
exercisable over a ten year period from the date of grant and vesting in one-
third increments over the three-year period commencing with the date of the
agreement. The agreement provides that all unvested options shall vest
immediately upon the occurrence of a "change in control" of the Company (as
defined in the agreement).
On June ___, 1996, the Company entered into an employment agreement with
Mr. Cirrito, pursuant to which he has agreed to serve as the President of the
Company's Consumer Division until June ____, 1999, unless earlier terminated in
accordance with the agreement. Mr. Cirrito's annual base salary under the
agreement is reviewed annually, but cannot be less than $375,000.
Under each of the agreements described above with Messrs. Burns, Luken and
Cirrito and Canton, in the event of termination "without cause", the named
individual will be entitled to receive termination payments equal to 100% of his
base salary for the remainder of the term of the agreement (with a minimum of
one year's salary). In addition, Messrs. Burns', Luken's and Cirrito's
agreements contain non-competition covenants which prohibit such individuals for
a period of one year following termination of their employment agreements in
most circumstances from working for any company that competes with the Company
in the United States. The Company will pay each of such individuals $1,000,000
in exchange for these non-competition covenants upon termination of the
individual's agreement.
AMENDED AND RESTATED 1994 STOCK OPTION PLAN
In April 1996, the Board of Directors of the Company adopted and the
shareholders of the Company approved the Stock Option Plan, which provides for
the grant to officers, key employees and directors of the Company and its
subsidiaries of both "incentive stock options" within the meaning of Section 422
of the Code, and stock options that are non-qualified for federal income tax
purposes. The total number of shares for which options may be granted pursuant
to the Stock Option Plan is 7,500,000 shares, subject to certain adjustments
reflecting changes in the Company's capitalization. The Stock Option Plan is
currently administered by the Company's Board of Directors. Upon creation of the
Compensation Committee, the Stock Option Plan will be administered by the
Compensation Committee. The Compensation Committee will determine, among other
things, which officers, employees and directors will receive options under the
plan, the time when options will be granted, the type of option (incentive stock
options, non-qualified stock options, or both) to be granted, the number of
shares subject to each option, the time or times when the options will become
exercisable, and, subject to certain conditions discussed below, the option
price and
62
<PAGE>
duration of the options. Members of the Compensation Committee will not be
eligible to receive discretionary options under the plan, but are entitled to
receive options as directors.
The exercise price of incentive stock options will be determined by the
Compensation Committee, but may not be less than the fair market value of the
Common Stock on the date of grant and the term of any such option may not exceed
ten years from the date of grant. With respect to any participant in the Stock
Option Plan who owns stock representing more than 10% of the voting power of all
classes of the outstanding capital stock of the Company or of its subsidiaries,
the exercise price of any incentive stock option may not be less than 110% of
the fair market value of such shares on the date of grant and the term of such
option may not exceed five years from the date of grant.
The exercise price of non-qualified stock options will be determined by the
Compensation Committee on the date of grant, and the term of such options may
not exceed ten years from the date of grant.
Payment of the option price may be made in cash or, with the approval of
the Compensation Committee, in shares of Common Stock having a fair market value
in the aggregate equal to the option price. Options granted pursuant to the
Stock Option Plan are not transferable, except by will or the laws of descent
and distribution. During an optionee's lifetime, the option is exercisable only
by the optionee.
The Board of Directors has the right at any time and from time to time to
amend or modify the Stock Option Plan, without the consent of the Company's
shareholders or optionees; provided, that no such action may adversely affect
options previously granted without the optionee's consent, and provided further
that no such action, without the approval of a majority of the shareholders of
the Company, may increase the total number of shares of Common Stock which may
be purchased pursuant to options under the plan, expand the class of persons
eligible to receive grants of options under the plan, decrease the minimum
option price, extend the maximum term of options granted under the plan or
extend the term of the plan. The expiration date of the Stock Option Plan, after
which no option may be granted thereunder, is April ___, 2006.
Promptly after the completion of the Offerings, the Company expects to file
with the Commission a Registration Statement on Form S-8 covering the shares of
Common Stock underlying options granted under the Stock Option Plan.
On April 30, 1996, options to purchase an aggregate of 3,625,542 shares of
Common Stock have been granted under the Stock Option Plan and a total of
3,874,458 shares of Common Stock remained available for grant. The outstanding
options were held by nine individuals and were exercisable at prices ranging
from $.31 to $7.53 per share. Shares subject to options granted under the plan
that have lapsed or terminated may again be subject to options granted under the
plan.
Of the total stock options available for grant, pursuant to Mr. Canton's
employment agreement, the Board of Directors has allocated 1,000,000 shares for
new employees of the Commercial Division to be designated by Mr. Canton.
Certain Federal Income Tax Consequences. The following discussion is
generally a summary of the principal United States federal income tax
consequences under current federal income tax laws relating to option grants to
employees under the Stock Option Plan. This summary is not intended to be
exhaustive and, among other things, does not describe state, local or foreign
income and other tax consequences.
63
<PAGE>
An optionee will not recognize any taxable income upon the grant of a non-
qualified option and the Company will not be entitled to a tax deduction with
respect to such grant. Generally, upon exercise of a non-qualified option, the
excess of the fair market value of the Common Stock on the exercise date over
the exercise price will be taxable as compensation income to the optionee.
Subject to the discussion below with respect to Section 162(m) of the Code and
the optionee including such compensation in income or the Company satisfying
applicable reporting requirements, the Company will be entitled to a tax
deduction in the amount of such compensation income. The optionee's tax basis
for the Common Stock received pursuant to such exercise will equal the sum of
the compensation income recognized and the exercise price.
Special rules may apply in the case of an optionee who is subject to
Section 16 of the Exchange Act.
In the event of a sale of Common Stock received upon the exercise of a
nonqualified option, any appreciation or depreciation after the exercise date
generally will be taxed to the optionee as capital gain or loss and will be
long-term capital gain or loss if the holding period for such Common Stock was
more than one year.
Subject to the discussion below, an optionee will not recognize taxable
income at the time of grant or exercise of an "incentive stock option" and the
Company will not be entitled to a tax deduction with respect to such grant or
exercise. The exercise of an "incentive stock option" generally will give rise
to an item of tax preference that may result in alternative minimum tax
liability for the optionee.
Generally, a sale or other disposition by an optionee of shares acquired
upon the exercise of an "incentive stock option" more than one year after the
transfer of the shares to such optionee and more than two years after the date
of grant of the "incentive stock option" will result in any difference between
the amount realized and the exercise price being treated as long-term capital
gain or loss to the optionee, with no deduction being allowed to the Company.
Generally, upon a sale or other disposition of shares acquired upon the exercise
of an "incentive stock option" within one year after the transfer of the shares
to the optionee or within two years after the date of grant of the "incentive
stock option," any excess of (i) the lesser of (a) the fair market value of the
shares at the time of exercise of the option and (b) the amount realized on such
sale or other disposition over (ii) the exercise price of such option will
constitute compensation income to the optionee. Subject to the discussion below
with respect to Section 162(m) of the Code and the optionee including such
compensation in income or the Company satisfying applicable reporting
requirements, the Company will be entitled to a deduction in the amount of such
compensation income. The difference between the amount realized on such sale or
disposition and the fair market value of the shares at the time of the exercise
of the option generally will constitute short-term or long-term capital gain or
loss, as the case may be, and will not be deductible by the Company.
Section 162(m) of the Code disallows a federal income tax deduction to any
publicly held corporation for compensation paid in excess of $1,000,000 in any
taxable year to the chief executive officer or any of the four other most highly
compensated executive officers who are employed by the corporation on the last
day of the taxable year. Under regulations promulgated under Section 162(m),
the deduction limitation of Section 162(m) does not apply to any compensation
paid pursuant to a plan that existed during the period in which the corporation
was not publicly held, to the extent the prospectus accompanying the initial
public offering disclosed information concerning such plan that satisfied all
applicable securities laws. However, the foregoing exception may be relied upon
only for awards made before the earliest of (i) the expiration of the plan; (ii)
the material modification of the plan; (iii) the issuance of all stock allocated
under the plan; or (iv) the first meeting of shareholders at which directors are
elected occurring after the close of
64
<PAGE>
the third calendar year following the calendar year in which the initial public
offering occurs (the "Reliance Period"). The Company has structured and intends
to implement the Stock Option Plan so that compensation attributable to awards
granted thereunder during the Reliance Period is not subject to the deduction
limitation of Section 162(m). The Company intends to consider whether to
structure and implement the Stock Option Plan in a manner so that compensation
attributable to awards made after the Reliance Period will not be subject to the
deduction limitation.
EMPLOYEE BENEFITS
Tel Labs has adopted a Simplified Employee Pension Plan ("SEP"). The SEP
allows employees to defer a portion of their salaries. Employer contributions
are optional, and the Board of Directors of Tel Labs will determine annually
whether Tel Labs will contribute amounts to the SEP and at what level. The
maximum amount that may be contributed annually per SEP participant from a
combination of salary deferrals plus Tel Labs optional contributions is $22,500.
The Company does not have a similar plan for any of its other employees.
65
<PAGE>
CERTAIN TRANSACTIONS
The Company, its shareholders and affiliates have been parties to the
following transactions:
LONG DISTANCE WHOLESALE CLUB
In connection with the organization of LDWC in 1994, 100 shares of LDWC's
common stock were issued to Henry Luken and 100 shares were issued to Thomas
Cirrito on January 1, 1994. On July 28, 1994, the Company purchased Mr. Luken's
LDWC shares for cash consideration of approximately $85,000. On July 28, 1994,
the Company purchased an additional 22.22 newly issued shares of LDWC common
stock for $50,000 and acquired a convertible note payable by LDWC in the
aggregate principal amount of $250,000. On August 16, 1995, the Company
converted the note into an additional 3.04 newly issued shares of LDWC common
stock. As a result of the foregoing transactions, approximately 55.6% of the
outstanding shares of LDWC common stock were held by the Company and
approximately 44.4% of such shares were held by Mr. Cirrito and two of his
children.
Pursuant to an Agreement dated April 1, 1996, on June __, 1996, Telco
acquired the remaining minority interest in LDWC in a transaction in which all
of the LDWC shares held by Mr. Cirrito and his two children were exchanged for
5,102,125 shares of the Company's Common Stock and LDWC became a wholly owned
subsidiary of Telco. In connection with such transaction, all outstanding
options under the LDWC stock option plan were converted into options to purchase
a total of 291,842 shares of the Company's Common Stock under the Company's
Stock Option Plan and the LDWC stock option plan was terminated. Such options
have exercise prices ranging from $0.67 to $3.55 per share.
TEL LABS
Pursuant to a Share Exchange Agreement dated June _____, 1996, concurrently
with the completion of the Offerings, Tel Labs will become a wholly owned
subsidiary of the Company, and the Tel Labs shareholders will receive an
aggregate of _______ shares of the Company's Common Stock in exchange for all
of their shares in Tel Labs, subject to certain adjustments. Tel Labs has been
owned by Henry Luken, Bryan Rachlin, Michael Cheng, and Kevin Yang. Prior to
the commencement of the Offerings, Telco Development Group of Delaware, Inc.
("Telco Delaware") has been an eighty percent (80%) owned subsidiary of the
Company; the remaining twenty percent (20%) has been held by Tel Labs. As a
result of the Tel Labs share exchange described above, Telco Delaware will
become a wholly owned subsidiary of the Company.
The Company purchases call translation and rating data processing on a
month-to-month basis from Tel Labs. The Company paid a total of $1.3 million
and $155,000 for these services for the years ended December 31, 1995 and 1994,
respectively, and $627,000 for the three months ended March 31, 1996.
LEASES OF REAL PROPERTY FROM AFFILIATE OF SHAREHOLDER
The Company leases its corporate headquarters office space and its
Chattanooga, Tennessee switch site from Bricks in the Sticks, Ltd., a company
50% owned by Mr. Luken. The lease for the Company's corporate headquarters space
expires on July 31, 1999 and the lease for the Chattanoga, Tennessee switch site
expires
66
<PAGE>
February 1999. The Company paid total rents of $179,420 and $63,500 for these
facilities for the years ended December 31, 1995 and 1994, respectively, and
$45,253 for the three months ended March 31, 1996. No rents were paid during
1993. The headquarters lease provides for a 4% rent increase and the switch
lease provides for a $1 per square foot rent increase for each year of the lease
term.
PURCHASE OF COMPUTER EQUIPMENT AND SUPPORT FROM COMPANY AFFILIATED WITH
SHAREHOLDER
The Company purchases computer equipment and support on a month-to-month
basis from Telco Development Group, Inc., a company owned by Mr. Luken. The
Company paid $779,918 and $229,100 for these services for the years ended
December 31, 1995 and December 31, 1994, respectively, and $130,687 for the
three months ended March 31, 1996. The Company expects that it will continue to
purchase computer maintenance services for Telco Development Group on a
month-to-month basis at a cost of approximately $3,000 per month. The Company is
currently negotiating with other third party vendors for the purchase of
computer equipment directly, rather than from Telco Development Group, and
expects to reduce its dependence on Telco Development Group during 1996.
SHARE EXCHANGE
On July 20, 1994, the Company purchased 5,793,812 shares of Common Stock
from a founding shareholder and a former director of the Company, representing
all of such shareholder's Common Stock, for a purchase price of $25,000 and, on
July 25, 1994, issued, at such shareholder's direction, 6,470,413 shares of
Common Stock for a sales price of $50,000, to Iceberg Transport, S.A.
("Iceberg"). On April 30, 1996, Iceberg notified the Company that it had
transferred its 6,470,413 shares of Common Stock to Gold & Appel Transfer, S.A.
("Gold & Appel"), a wholly owned subsidiary of Iceberg.
TRANSACTIONS WITH ESPRIT TELECOM, LTD.
Esprit Telecom, Ltd. ("Esprit"), a corporation in which Gold & Appel is a
minority shareholder, is a provider of international long distance service.
Esprit and the Company purchase long distance service from one another, and
Esprit purchases billing services from Tel Labs. See "Principal and Selling
Shareholders." The Company paid Esprit $1,882,638 and $1,451,684 and Esprit paid
the Company $2,205,912 and $782,854 for transmission services during the years
ended December 31, 1995 and 1994, respectively, and Esprit paid Tel Labs
$108,436 and $58,026 for billing services during the years ended December 31,
1995 and 1994 respectively and $75,076 for the three months ended March 31,
1996.
67
<PAGE>
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of May 31, 1996 and as adjusted to
reflect the sale of Common Stock being offered hereby by the Reorganization and
the Offerings (i) each person known by the Company to beneficially own more than
five percent of the Common Stock, (ii) each director of the Company, (iii) each
executive officer of the Company (including the Named Officers) and (iv) all
directors and executive officers of the Company, as a group. All information
with respect to beneficial ownership has been furnished to the Company by the
respective shareholders of the Company.
<TABLE>
<CAPTION>
Shares Beneficially Number Shares Beneficially
Owned Prior of Shares Owned After
to Offerings (1) Being Offered Offerings (1)(2)
---------------- ------------- ----------------
Beneficial Owner Number Percent Number Percent
---------------- ----- ------- ------ -------
<S> <C> <C> <C> <C> <C>
Donald A. Burns (3) 7,671,250
Henry G. Luken, III (3)
Gold & Appel Transfer, S.A. (4) 6,470,413
Thomas J. Cirrito (5) 4,898,041
Bryan K. Rachlin (6)
Natalie J. Marine-Street (7) 797,300
Signet Media Capital Group (8) 533,375
Mark Stodter - * - *
Janet Anastasi - * - *
Stephen G. Canton (9) - * - - *
Nicholas A. Merrick (10) - * - - *
All Directors and Executive
Officers as a Group (9)
persons, including those
named above)
James Sznajder - * - *
Dennis Jarman - * - *
</TABLE>
___________
* Represents beneficial ownership of less than 1% of the outstanding shares
of Common Stock.
(1) Beneficial ownership is determined in accordance with the rules of the
Commission. In computing the number of shares beneficially owned by a
person and the percentage of ownership of that person, shares of Common
Stock subject to options and warrants held by that person that are
currently exercisable or exercisable within 60 days of May 31, 1996 are
deemed outstanding. Such shares, however, are not deemed outstanding for
the purposes of computing the percentage of ownership of any other person.
Except as otherwise indicated, and subject to community property laws where
applicable, the persons named in the table above have sole voting and
investment power with respect to all shares of Common Stock shown as owned
by them.
(2) Assumes no exercise of the U.S. Underwriters' and Managers' over-allotment
options.
(3) All such shares have been pledged to secure the Company's indebtedness
under the Credit Facility. In the event of a default, the bank could
foreclose and acquire record and beneficial ownership of such shares. The
Agent has agreed to release such shares from the pledge upon consummation
of the Offerings.
(4) Gold & Appel is a wholly owned subsidiary of Iceberg Transport, S.A. Walter
Anderson, a former director and founding shareholder of the Company, is an
executive officer of Gold & Appel, Mr. Anderson disclaims
68
<PAGE>
beneficial ownership of such shares.
(5) Does not include 102,042 shares held by Mr. Cirrito's son Michael Cirrito
and 102,042 shares held by Mr. Cirrito's daughter, Nicole Cirrito, as to
which Mr. Cirrito disclaims beneficial ownership. Includes 489,804 shares
held by the Cirrito Family Trust.
(6) Assumes the exercise of options to acquire 700,432 shares of Common Stock
at a weighted average exercise price of $0.66 per share.
(7) Assumes the exercise of options to acquire 797,300 shares of Common Stock
at a weighted average exercise price of $1.76 per share.
(8) Signet Media Capital Group has informed the Company that it intends to
exercise the Signet Warrant and sell all of the 533,375 shares of Common
Stock issuable upon exercise of such warrant in the Offerings.
(9) Does not include options to acquire 1,062,500 shares of Common Stock
exercisable at $7.53 per share, which vest and become exercisable in one-
third increments on April 4, 1997, 1998 and 1999, subject to certain terms
and conditions covering his employment agreement.
(10) Does not include options to acquire 425,000 shares of Common Stock
exercisable at $7.53 per share, which vest and become exercisable in one-
third increments on March 19, 1997, 1998 and 1999 subject to certain terms
and conditions covering his employment agreement.
69
<PAGE>
DESCRIPTION OF CAPITAL STOCK
GENERAL
Effective upon completion of the Offerings, the Company's authorized
capital stock will consist of (i) 150 million shares of Common Stock, no par
value per share, and (ii) 15 million shares of Preferred Stock, no par value per
share (the "Preferred Stock"), of which __________ shares of Common Stock and no
shares of Preferred Stock will be issued and outstanding.
The statements under this caption are brief summaries of all material
provisions of the Company's Articles and Bylaws, as amended (the "Bylaws"),
relating to the Company's capital stock which are filed as exhibits to the
Registration Statement of which this Prospectus is a part. Such summaries do not
purport to be complete and are subject to, and are qualified in their entirety
by reference to, such documents.
COMMON STOCK
Holders of shares of Common Stock are entitled to one vote per share on all
matters on which the holders of Common Stock are entitled to vote and do not
have any cumulative voting rights. This means that the holders of more than 50%
of the shares voting for the election of directors can elect all of the
directors if they choose to do so; and, in such event, the holders of the
remaining shares of Common Stock will not be able to elect any person to the
Board of Directors. Subject to the rights of the holders of shares of any series
of Preferred Stock, holders of Common Stock are entitled to receive such
dividends as may from time to time be declared by the Board of Directors of the
Company out of funds legally available therefor. Holders of shares of Common
Stock have no preemptive, conversion, redemption, subscription or similar
rights. In the event of a liquidation, dissolution or winding up of the Company,
whether voluntary or involuntary, holders of shares of Common Stock are entitled
to share ratably in the assets of the Company which are legally available for
distribution, if any, remaining after the payment or provision for the payment
of all debts and other liabilities of the Company and the payment and setting
aside for payment of any preferential amount due to the holders of shares of any
series of Preferred Stock. All outstanding shares of Common Stock are, and all
shares of Common Stock offered hereby when issued will be, upon payment
therefor, validly issued, fully paid and nonassessable.
At present there is no established trading market for the Common Stock.
Application will be made to have the Common Stock approved for listing on the
New York Stock Exchange under the symbol "____________."
PREFERRED STOCK
The Company's Board of Directors is authorized to issue from time to time
up to 15 million shares of Preferred Stock in one or more series and to fix the
rights, designations, preferences, qualifications, limitations and restrictions
thereof, including dividend rights, dividend rates, conversion rights, voting
rights, terms of redemption, redemption prices, the terms of any sinking fund,
liquidation preferences and the number of shares constituting any series,
without any further action by the shareholders of the Company. Holders of the
Preferred Stock, if and when issued, will be entitled to vote as required under
applicable Virginia law and as otherwise provided in the resolutions
establishing such Preferred Stock. Virginia law includes provisions for the
voting of Preferred Stock in the case of any amendment to the Articles affecting
the rights of holders of the Preferred Stock, the payment of certain stock
dividends, merger or consolidation,
70
<PAGE>
sale of all or substantially all of the Company's assets and dissolution. The
issuance of Preferred Stock with voting rights could have an adverse effect on
the voting power of holders of Common Stock by increasing the number of
outstanding shares having voting rights. In addition, if the Board of Directors
authorizes Preferred Stock with conversion rights, the number of shares of
Common Stock outstanding could potentially be increased up to the amount
authorized under the Articles. The issuance of Preferred Stock could decrease
the amount of earnings and assets available for distribution to holders of
Common Stock. Any such issuance could also have the effect of delaying,
deterring or preventing a change in control of the Company and may adversely
affect the rights of holders of Common Stock. The Board of Directors does not
currently intend to issue any shares of Preferred Stock.
CERTAIN PROVISIONS OF THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The Company's Articles provide that directors are not personally liable to
the Corporation or its shareholders for breach of the director's duty as a
director, except for liability of a director for willful misconduct or a knowing
violation of law.
The Company's Bylaws require the Company to indemnify any director or
officer of the Company, or any person who is or was serving at the request of
the Company as a director, trustee, partner, officer, employee or agent of any
other corporation, partnership, joint venture, trust, employee benefit plan or
other enterprise, to the fullest extent permitted by law. The Company has
obtained officers' and directors' liability insurance of $5.0 million for
members of its Board of Directors and executive officers. In addition to the
indemnification provided in the Company's Bylaws, the Company intends to enter
into agreements to indemnify its directors and officers.
The Articles and Bylaws include certain provisions which are intended to
enhance the likelihood of continuity and stability in the composition of the
Company's Board of Directors and which may have the effect of delaying,
deterring or preventing a future takeover or change in control of the Company
unless such takeover or change in control is approved by the Company's Board of
Directors. Such provisions may also render the removal of the directors and
management more difficult.
The Articles will provide that the Board of Directors of the Company be
divided into three classes serving staggered three-year terms. The Articles and
Bylaws will also be amended to include restrictions on who may call a special
meeting of shareholders, to provide that shareholders may only act at an annual
or special meeting or by unanimous written consent. The Company's Bylaws
establish an advance notice procedure with regard to the nomination, other than
by or at the direction of the Board of Directors, of candidates for election as
directors and with regard to certain matters to be brought before an annual
meeting of shareholders of the Company. In general, notice must be received by
the Company not less than 60 days prior to the meeting and must contain certain
specified information concerning the person to be nominated or the matter to be
brought before the meeting and concerning the shareholder submitting the
proposal.
Shareholders may adopt, alter, amend or repeal provisions of the Bylaws
only by vote of the holders of 66 2/3% or more of the outstanding Common Stock
and any other voting securities. In addition, the affirmative vote of at least a
majority of the entire Board of Directors and the vote of the holders of the
outstanding Common Stock and any other voting securities is required to amend
certain provisions of the Articles, including the provisions relating to the
classification of the Company's Board of Directors, filling vacancies on the
Board of Directors and removal of directors only for cause. In both instances,
the affirmative vote required of the holders of the outstanding Common Stock and
any other voting securities
71
<PAGE>
is increased to 80% if there exists an "Interested Person" as defined in the
Articles. Under certain circumstances, the affirmative vote required of the
holders of the outstanding Common Stock and any other voting securities is
increased to 66 2/3%.
VIRGINIA STOCK CORPORATION ACT; ANTITAKEOVER EFFECTS
The Virginia Stock Corporation Act contains provisions governing
"Affiliated Transactions." These provisions, with several exceptions discussed
below, apply to Virginia corporations having more than 300 shareholders of
record and require approval of certain material transactions between a Virginia
corporation and any beneficial owner of more than 10% of any class of its
outstanding voting shares (an "Interested Shareholder") or an affiliate or
associate of the corporation that at any time within the past three years has
been an Interested Shareholder by a majority of disinterested directors and by
the holders of at least two-thirds of the remaining voting shares. Affiliated
Transactions subject to this approval requirement include mergers, share
exchanges, material dispositions of corporate assets not in the ordinary course
of business, any guarantee by the corporation of a material amount of
indebtedness of any Interested Shareholder, certain dispositions to an
Interested Shareholder of voting shares of the corporation, any dissolution of
the corporation proposed by or on behalf of an Interested Shareholder, or any
reclassification, including reverse stock splits, recapitalization or merger of
the corporation with its subsidiaries, which increases the percentage of voting
shares owned beneficially by an Interested Shareholder by more than 5%.
For three years following the time that an Interested Shareholder becomes
an owner of 10% of the outstanding voting shares, a Virginia corporation cannot
engage in any Affiliated Transaction with such Interested Shareholder without
the approval of two-thirds of the voting shares other than those shares
beneficially owned by the Interested Shareholder, and the approval of a majority
of the Disinterested Directors. "Disinterested Director" means, with respect to
a particular Interested Shareholder, a member of the Company's Board of
Directors who was (1) a member on the date on which an Interested Shareholder
became an Interested Shareholder or (2) recommended for election by, or was
elected to fill a vacancy and received the affirmative vote of, a majority of
the Disinterested Directors then on the Board. After the expiration of the
three-year period, the statute requires approval of Affiliated Transactions by
two-thirds of the voting shares other than those beneficially owned by the
Interested Shareholder.
The principal exceptions to the special voting requirements apply to
transactions proposed after the three-year period has expired and require either
that the transaction be approved by a majority of the Company's Disinterested
Directors or that the transaction satisfy the fair-price requirements of the
statute. In general, the fair-price requirement provides that in a two-step
acquisition transaction, the Interested Shareholder must pay the shareholders in
the second step either the same amount of cash or the same amount and type of
consideration paid to acquire the Company's shares in the first step.
None of the foregoing limitations and special voting requirements applies
to a transaction with a person who was an Interested Shareholder prior to the
consummation of the Offerings or to an Interested Shareholder whose acquisition
of shares making such person an Interested Shareholder was approved by a
majority of the Company's Disinterested Directors. See "Principal and Selling
Shareholders."
These provisions are designed to deter certain types of takeovers of
Virginia corporations. The statute provides that, by affirmative vote of a
majority of the voting shares other than shares owned by any Interested
Shareholder, a corporation can adopt an amendment to its articles of
incorporation or bylaws providing that the Affiliated Transactions provisions
shall not apply to the corporation. The Company has
72
<PAGE>
not "opted out" of the Affiliated Transactions provisions.
Virginia law also provides that, with respect to Virginia corporations
having 300 or more shareholders of record, shares acquired in a transaction that
would cause the acquiring person's voting strength to meet or exceed any of
three thresholds (20%, 33 1/3% or 50%) have no voting rights with respect to
such shares unless granted by a majority vote of shares not owned by the
acquiring person or any officer or employee-director of the corporation. This
provision empowers an acquiring person to require the Virginia corporation to
hold a special meeting of shareholders to consider the matter within 50 days of
its request. The Board of Directors of a Virginia corporation can opt out of
this provision at any time before four days after receipt of a control share
acquisition notice. The Company's Articles contain a provision "opting out" of
this provision.
TRANSFER AGENT AND REGISTRAR
Registrar and Transfer Company will serve as transfer agent and registrar
for the Common Stock.
73
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offerings, the Company will have approximately
__________ outstanding shares of Common Stock, assuming (i) no exercise of the
U.S. Underwriters' over-allotment option, (ii) the exercise of options to
purchase _______ shares of Common Stock and no exercise of other outstanding
options and (iii) the exercise of the Signet Warrant. Upon the consummation of
the Offerings, assuming the exercise of options to purchase ______ shares of
Common Stock and no exercise of other options outstanding as of March 31, 1996
and the exercise of the Signet Warrant, the Company will have outstanding
options exercisable for an aggregate of approximately _________ shares of Common
Stock, of which options with respect to _________ shares will then be
exercisable at a weighted average price of _____ per share.
Of the Common Stock outstanding upon completion of the Offerings, the
_________ shares of Common Stock sold in the Offerings will be freely tradeable
without restriction or further registration under the Securities Act, except for
any shares held by "affiliates" of the Company, as that term is defined in Rule
144 under the Securities Act, and the regulations promulgated thereunder (an
"Affiliate"), or persons who have been Affiliates within the preceding three
months. The remaining approximately __________ outstanding shares of Common
Stock will be "restricted securities" as that term is defined in Rule 144 and
may only be sold in the public market only if registered or if they qualify for
an exemption from registration under Rule 144 as described below.
Pursuant to a certain Registration Rights Agreement among the Company and
certain shareholders of the Company (the "Holders") holding approximately _____
shares of Common Stock ("Registrable Securities"), the Holders or their
permitted transferees are entitled to certain piggyback registration rights, and
in the event the Company becomes eligible to use a Form S-3 registration
statement, two demand registration rights, with respect to the Registrable
Securities. These rights are generally subject to certain conditions and
limitations, among them the right of the underwriters of an offering to limit
the number of shares included in such registration in certain circumstances.
The Registration Rights Agreement obligates the Company to pay all expenses of
any such registration, other than underwriting discounts and commissions
relating to the shares being sold on behalf of any Holders.
The Signet Warrant contains a provision which entitles Signet Media Capital
Group to include all or any portion of the shares of the Company's Common Stock
issuable upon the exercise of the Signet Warrant in a registration statement
filed by the Company in connection with its initial public offering. Signet
Media Capital Group has informed the Company that it intends to exercise the
Signet Warrant and sell all of the 533,375 shares of the Company's Common Stock
issuable upon such exercise in the Offerings. See "Principal and Selling
Shareholders."
Sales of restricted securities in the public market or the perception that
such sales could occur could adversely affect the market price of the Common
Stock.
In general, under Rule 144 as currently in effect, a person (or person
whose shares are aggregated), including an Affiliate, who has beneficially owned
restricted securities for a period of at least two years from the later of the
date such restricted securities were acquired from the Company and the date they
were acquired from an Affiliate, is entitled to sell, within any three-month
period, a number of shares that does not exceed the greater of 1% of the then
outstanding shares of Common Stock (approximately __________ shares immediately
after the Offerings) and the average weekly trading volume in the Common Stock
during the four calendar weeks preceding such sale. Sales under Rule 144 are
also subject to certain provisions
74
<PAGE>
relating to the manner and notice of sale and the availability of current public
information about the Company. Further, under Rule 144(k), if a period of at
least three years has elapsed between the later of the date restricted
securities were acquired from the Company and the date they were acquired from
an Affiliate of the Company, a holder of such restricted securities who is not
an Affiliate at the time of the sale and has not been an Affiliate for at least
three months prior to the sale would be entitled to sell the shares immediately
without regard to the volume and manner of sale limitations described above. The
Commission has recently proposed amendments to Rule 144 and Rule 144(k) that
would permit resales of restricted securities under Rule 144 after a one-year,
rather than a two-year holding period, subject to compliance with the other
provisions of Rule 144, and would permit resale of restricted securities by non-
Affiliates under Rule 144(k) after a two-year, rather than a three-year holding
period. Adoption of such amendments could result in resales of restricted
securities sooner than would be the case under Rule 144 and Rule 144(k) as
currently in effect.
In addition, the Company intends to register on Form S-8 under the
Securities Act approximately 7,500,000 shares of Common Stock issuable under
options subject to the Company's Stock Option Plan. Shares issued under the
Stock Option Plan (other than shares issued to affiliates) generally may be sold
immediately in the public market, subject to vesting requirements and the lock-
up agreements described below under "Underwriters."
75
<PAGE>
CERTAIN UNITED STATES FEDERAL TAX CONSIDERATIONS
FOR NON-U.S. HOLDERS OF COMMON STOCK
General. The following discussion concerns the material United States
federal income and estate tax consequences of the ownership and disposition of
shares of Common Stock applicable to Non-U.S. Holders of such shares of Common
Stock. In general, a "Non-U.S. Holder" is any holder other than (i) a citizen or
resident, as specifically defined for U.S. federal income and estate tax
purposes, of the United States, (ii) a corporation, partnership or any entity
treated as a corporation or partnership for U.S. federal income tax purposes
created or organized in the United States or under the laws of the United States
or of any State thereof, or (iii) an estate or trust whose income is includible
in gross income for United States federal income tax purposes regardless of its
source. The discussion is based on current law, which is subject to change
retroactively or prospectively, and is for general information only. The
discussion does not address all aspects of United States federal income and
estate taxation and does not address any aspects of state, local or foreign tax
laws. The discussion does not consider any specific facts or circumstances that
may apply to a particular Non-U.S. Holder. Accordingly, prospective investors
are urged to consult their tax advisors regarding the current and possible
future United States federal, state, local and non-U.S. income and other tax
consequences of holding and disposing of shares of Common Stock.
Dividends. In general, dividends paid to a Non-U.S. Holder will be subject
to United States withholding tax at a 30% rate (or a lower rate as may be
specified by an applicable tax treaty) unless the dividends are (i) effectively
connected with a trade or business carried on by the Non-U.S. Holder within the
United States, or (ii), if a tax treaty applies, attributable to a United States
permanent establishment or, in the case of an individual, a fixed base in the
United States, maintained by the Non-U.S. Holder. Dividends effectively
connected with such a trade or business or, if a tax treaty applies,
attributable to such permanent or fixed base establishment will generally not be
subject to withholding (if the Non-U.S. Holder files certain forms annually with
the payor of the dividend) but will generally be subject to United States
federal income tax on a net income basis at regular graduated individual or
corporate rates. In the case of a Non-U.S. Holder that is a corporation, such
effectively connected income also may be subject to the branch profits tax
(which is generally imposed on a foreign corporation on the deemed repatriation
from the United States of effectively connected earnings and profits) at a 30%
rate or such lower rate as may be specified by an applicable income tax treaty.
The branch profits tax may not apply if the recipient is a qualified resident of
certain countries with which the United States has an income tax treaty.
To determine the applicability of a tax treaty providing for a lower rate
of withholding, dividends paid to an address in a foreign country are presumed
under current Treasury Regulations to be paid to a resident of that country,
unless the payor has definite knowledge that such presumption is not warranted
or an applicable tax treaty (or United States Treasury Regulations thereunder)
requires some other method for determining a Non-U.S. Holder's residence.
However, under proposed regulations, in the case of dividends paid after
December 31, 1997 (December 31, 1999 in the case of dividends paid to accounts
in existence on or before the date that is 60 days after the proposed
regulations are published as final regulations), a Non-U.S. Holder generally
would be subject to United States withholding tax at a 31-percent rate under the
backup withholding rules described below, rather than at a 30-percent rate or at
a reduced rate under an income tax treaty, unless certain certification
procedures (or, in the case of payments made outside the United States with
respect to an offshore account, certain documentary evidence procedures) are
complied with, directly or through an intermediary. Under current regulations,
the Company must report annually to the United States Internal Revenue Service
(the "IRS") and to each Non-U.S. Holder the amount of dividends paid to, and the
tax withheld with respect to, each Non-U.S. Holder. These reporting requirements
apply regardless of whether withholding was reduced or eliminated by an
applicable tax treaty. Copies of these
76
<PAGE>
information returns also may be made available under the provisions of a
specific treaty or agreement with the tax authorities of the country in which
the Non-U.S. Holder resides.
A Non-U.S. Holder that is eligible for a reduced rate of United States
withholding tax pursuant to an income tax treaty may obtain a refund of any
excess amounts currently withheld by filing an appropriate claim for refund with
the IRS.
Sale of Common Stock. Generally, a Non-U.S. Holder will not be subject to
United States federal income tax on any gain realized upon the sale or other
disposition of such holder's shares of Common Stock unless (i) the gain is
effectively connected with a trade or business carried on by the Non-U.S. Holder
within the United States and, if a tax treaty applies, the gain is attributable
to a permanent establishment or fixed base maintained by the Non-U.S. Holder in
the United States; (ii) the Non-U.S. Holder is an individual who holds the
shares of Common Stock as a capital asset and is present in the United States
for 183 days or more in the taxable year of the disposition, and either (a) such
Non-U.S. Holder has a "tax home" (as specifically defined for U.S. federal
income tax purposes) in the United States (unless the gain from disposition is
attributable to an office or other fixed place of business maintained by such
non-U.S. Holder in a foreign country and a foreign tax equal to at least 10% of
such gain has been paid to a foreign country), or (b) the gain from the
disposition is attributable to an office or other fixed place of business
maintained by such Non-U.S. Holder in the United States; (iii) the Non-U.S.
Holder is subject to tax pursuant to the provisions of U.S. tax law applicable
to certain United States expatriates, or (iv) the Company is or has been during
certain periods a "U.S. real property holding corporation" for U.S. federal
income tax purposes (which the Company does not believe that it has been,
currently is or is likely to become) and, assuming that the Common Stock is
deemed for tax purposes to be "regularly traded on an established securities
market," the Non-U.S. Holder held, at any time during the five-year period
ending on the date of disposition (or such shorter period that such shares were
held), directly or indirectly, more than five percent of the Common Stock.
Estate Tax. Shares of Common Stock owned or treated as owned by an
individual who is not a citizen or resident (as specially defined for United
States federal estate tax purposes) of the United States at the time of death
will be includible in the individual's gross estate for United States federal
estate tax purposes, unless an applicable tax treaty provides otherwise, and may
be subject to United States federal estate tax.
Backup Withholding and Information Reporting. As a general rule, under
current United States federal income tax law, backup withholding tax (which
generally is a withholding tax imposed at the rate of 31% on certain payments to
persons that fail to furnish the information required under the U.S. information
reporting requirements) and information reporting requirements apply to the
actual and constructive payments of dividends. The United States backup
withholding tax and information reporting requirements generally, under current
regulations, will not apply to dividends paid on Common Stock to a Non-U.S.
Holder at an address outside the United States that are either subject to the
30% withholding discussed above or that are not so subject because a tax treaty
applies that reduces or eliminates such 30% withholding, unless the payer has
knowledge that the payee is a U.S. person. Backup withholding and information
reporting generally will apply to dividends paid to addresses inside the United
States on shares of Common Stock to beneficial owners that are not recipients
that are entitled to an exemption, as discussed above and that fail to provide
in the manner required certain identifying information. However, under proposed
regulations, in the case of dividends paid after December 31, 1997, a Non-U.S.
Holder generally would be subject to backup withholding at a 31% rate, unless
certain certification procedures (or, in the case of payments made outside the
United States with respect to an offshore account, certain documentary
77
<PAGE>
evidence procedures) are complied with, directly or through an intermediary.
The payment of the proceeds from the disposition of shares of Common Stock
to or through the United States office of a broker will be subject to
information reporting and backup withholding unless the holder, under penalties
of perjury, certifies, among other things, its status as a Non-U.S. Holder, or
otherwise establishes an exemption. Generally, the payment of the proceeds from
the disposition of shares of Common Stock to or through a non-U.S. office of a
non-U.S. broker will not be subject to backup withholding and will not be
subject to information reporting. In the case of the payment of proceeds from
the disposition of shares of Common Stock to or through a non-U.S. office of a
broker that is a U.S. person or a "U.S.-related person," existing regulations
require (i) backup withholding if the broker has actual knowledge that the owner
is not a Non-U.S. Holder, and (ii) information reporting on the payment unless
the broker receives a statement from the owner, signed under penalties of
perjury, certifying, among other things, its status as a Non-U.S. Holder, or the
broker has documentary evidence in its files that the owner is a Non-U.S. Holder
and the broker has no actual knowledge to the contrary. For this purpose, a
"U.S.-related person" is (i) a "controlled foreign corporation" for United
States federal income tax purposes or (ii) a foreign person 50% or more of whose
gross income from all sources for the three-year period ending with the close of
its taxable year preceding the payment (or for such part of the period that the
broker has been in existence) is derived from activities that are effectively
connected with the conduct of a United States trade or business. The IRS
recently proposed regulations addressing the withholding and information
reporting rules which could affect the treatment of the payment of proceeds
discussed above. Non-U.S. Holders should consult their tax advisors regarding
the application of these rules to their particular situations, the availability
of an exemption therefrom, the procedure for obtaining such an exemption, if
available, and the possible application of the proposed regulations addressing
the withholding and information reporting rules.
Backup withholding is not an additional tax. Any amounts withheld from a
payment to a Non-U.S. Holder under the backup withholding rules will be allowed
as a credit against such holder's United States federal income tax liability, if
any, and provided that such holder furnishes the IRS with the information
entitling such holder to an exemption from or reduced rate of withholding, such
holder would be entitled to a refund.
78
<PAGE>
UNDERWRITING
The underwriters of the U.S. Offering named below (the "U.S.
Underwriters"), for whom Bear, Stearns & Co. Inc. and Salomon Brothers Inc are
acting as representatives, have severally agreed with the Company and the
Selling Shareholders, subject to the terms and conditions of the U.S.
Underwriting Agreement (the form of which has been filed as an exhibit to the
Registration Statement on Form S-1 of which this Prospectus is a part), to
purchase from the Company and the Selling Shareholders the aggregate number of
U.S. Shares set forth opposite their respective names below:
<TABLE>
<CAPTION>
Number of
Name of U.S. Underwriter U.S. Shares
- ------------------------ -------------
<S> <C>
Bear, Stearns & Co. Inc.......................... ____________
Salomon Brothers Inc............................. ____________
============
Total....................................... ____________
</TABLE>
The Managers of the concurrent International Offering named below (the
"Managers"), for whom Bear, Stearns International Limited and Salomon Brothers
International Limited are acting as lead Managers, have severally agreed with
the Company and the Selling Shareholders, subject to the terms and conditions of
the International Underwriting Agreement (the form of which has been filed as an
exhibit to the Registration Statement on Form S-1 of which this Prospectus is a
part), to purchase from the Company and the Selling Stockholders the aggregate
number of International Shares set forth opposite their respective names below:
<TABLE>
<CAPTION>
Number of
International
Name of Manager Shares
- --------------- -------------
<S> <C>
Bear, Stearns International Limited.............. _____________
Salomon Brothers International Limited........... _____________
=============
Total....................................... _____________
</TABLE>
The nature of the respective obligations of the U.S. Underwriters and the
Managers is such that all of the U.S. Shares and all of the International Shares
must be purchased if any are purchased. Those obligations are subject, however,
to various conditions, including the approval of certain matters by counsel. The
Company and the Selling Shareholders have agreed to indemnify the U.S.
Underwriters and the Managers against certain liabilities, including liabilities
under the Securities Act, and, where such indemnification is unavailable, to
contribute to payments that the U.S. Underwriters and the Managers may be
required to make in respect of such liabilities.
The Company and the Selling Shareholders have been advised that the U.S.
Underwriters propose to offer the U.S. Shares in the United States and Canada
and the Managers propose to offer the International Shares outside the United
States and Canada, initially at the public offering price set forth on the cover
page of this Prospectus and to certain selected dealers at such price less a
concession not to exceed $_________ per share; that the U.S. Underwriters and
the Managers may allow, and such selected dealers may reallow,
79
<PAGE>
a concession to certain other dealers not to exceed $______ per share; and that
after the commencement of the Offerings, the public offering price and the
concessions may be changed.
The Company has granted the U.S. Underwriters and the Managers options to
purchase in the aggregate up to _________ additional shares of Common Stock
solely to cover over-allotments, if any. The options may be exercised in whole
or in part at any time within 30 days after the date of this Prospectus. To the
extent the options are exercised, the U.S. Underwriters and the Managers will be
severally committed, subject to certain conditions, to purchase the additional
shares of Common Stock in proportion to their respective purchase commitments as
indicated in the preceding tables.
Pursuant to an agreement between the U.S. Underwriters and the Managers
(the "Agreement Between"), each U.S. Underwriter has agreed that, as part of the
distribution of the U.S. Shares and subject to certain exceptions, (a) it is not
purchasing any U.S. Shares for the account of anyone other than a U.S. or
Canadian Person (as defined below) and (b) it has not offered or sold, and will
not offer, sell, resell or deliver, directly or indirectly, any U.S. Shares or
distribute any prospectus relating to the U.S. Offering outside the United
States or Canada or to anyone other than a U.S. or Canadian Person or a dealer
who similarly agrees. Similarly, pursuant to the Agreement Between, each Manager
has agreed that, as part of the distribution of the International Shares and
subject to certain exceptions, (a) it is not purchasing any of the International
Shares for the account of any U.S. or Canadian Person and (b) it has not offered
or sold, and will not offer, sell, resell or deliver, directly or indirectly,
any of the International Shares or distribute any prospectus relating to the
International Offering in the United States or Canada or to any U.S. or Canadian
Person or to a dealer who does not similarly agree. As used herein, "U.S. or
Canadian Person" means any individual who is a resident or citizen of the United
States or Canada, any corporation, pension, profit sharing or other trust or any
other entity organized under or governed by the laws of the United States or
Canada or of any political subdivision thereof (other than the foreign branch of
any U.S. or Canadian Person), any estate or trust the income of which is subject
to United States or Canadian federal income taxation regardless of the source of
such income, and any United States or Canadian branch of a person other than a
U.S. or Canadian Person; "United States" means the United States of America
(including the District of Columbia), its territories, its possessions and other
areas subject to its jurisdiction; "Canada" means the provinces of Canada, its
territories, its possessions and other areas subject to its jurisdiction.
Pursuant to the Agreement Between, sales may be made between the U.S.
Underwriters and the Managers of such number of shares of Common Stock as may be
mutually agreed upon. The price of any shares so sold shall be the public
offering price as then in effect for the Common Stock being sold by the U.S.
Underwriters and the Managers, less an amount no greater than the selling
concession allocable to such Common Stock. To the extent that there are sales
between the U.S. Underwriters and the Managers pursuant to the Agreement
Between, the number of shares of Common Stock initially available for sale by
the U.S. Underwriters or by the Managers may be more or less than the amount
specified on the cover page of this Prospectus.
Each Manager has represented and agreed that (i) it has not offered or
sold, and, prior to the expiration of six months following the consummation of
the Offerings, it will not offer or sell, any shares of Common Stock to any
person in the United Kingdom other than persons whose ordinary activities
involve them in acquiring, holding, managing or disposing of investments (as
principal or agent) for the purposes of their businesses or otherwise in
circumstances that have not resulted and will not result in an offer to the
public in the United Kingdom within the meaning of the Public Offers of
Securities Regulations 1995; (ii) it has complied and will comply with
applicable provisions of the Financial Services Act 1986 with respect
80
<PAGE>
to anything done by it in relation to the Common Stock in, from or otherwise
involving the United Kingdom, and (iii) it has only issued or passed on, and
will only issue or pass on, in the United Kingdom any document received by it in
connection with the issue of the Common Stock to a person who is of a kind
described in Article 11(3) of the Financial Services Act 1986 (Investment
Advertisements) (Exemptions) Order 1995 or is a person to whom such document may
otherwise lawfully be issued or passed on.
Purchasers of the International Shares offered in the International
Offering may be required to pay stamp taxes and other charges in accordance with
the laws and practices of the country of purchase in addition to the initial
public offering price set forth on the cover page hereof.
The Company and its executive officers, directors and principal
shareholders have agreed that for a period of 180 days after the date of this
Prospectus, without the prior written consent of Bear, Stearns & Co. Inc., they
will not, directly or indirectly, offer or agree to sell, sell, hypothecate,
pledge or otherwise dispose of any shares of Common Stock (or securities
convertible into, exchangeable for or evidencing the right to purchase shares of
Common Stock).
At the Company's request, the U.S. Underwriters and the Managers have
reserved up to ______ shares of Common Stock (the "Directed Shares") for sale at
the public offering price to approximately ____ persons who are directors,
officers or employees of, or are otherwise associated with, the Company. Each
purchaser of more than ______ Directed Shares will be required to agree to
restrictions on resale similar to those described in the preceding paragraph.
The number of shares of Common Stock available for sale to the general public
will be reduced to the extent of sales of Directed Shares to any of the persons
for whom they have been reserved. Any shares not so purchased will be offered
by the U.S. Underwriters and the Managers on the same basis as all other shares
offered hereby.
Prior to the Offerings, there has been no public market for the Company's
Common Stock. Consequently, the initial public offering price will be determined
through negotiations among the Company, the representatives of the U.S.
Underwriters and the Managers. Among the factors to be considered in making
such determination will be the Company's financial and operating history and
condition, its prospects and such prospects for the industry in which it does
business in general, the management of the Company, prevailing equity market
conditions and the demand for securities considered comparable to those of the
Company.
NOTICE TO CANADIAN RESIDENTS
RESALE RESTRICTIONS
The distribution of the Common Stock in Canada is being made only on a
private placement basis exempt from the requirement that the Company or the
Selling Shareholders prepare and file a prospectus with the securities
regulatory authorities in each province where trades of Common Stock are
effected. Accordingly, any resale of the Common Stock in Canada must be made in
accordance with applicable securities laws, which will vary depending on the
relevant jurisdiction, and which may require resales to be made in accordance
with available statutory exemptions or pursuant to a discretionary exemption
granted by the applicable Canadian securities regulatory authority. Purchasers
are advised to seek legal advice prior to any resale of the Common Stock.
REPRESENTATIONS OF PURCHASERS
81
<PAGE>
Confirmations of the acceptance of offers to purchase shares of Common
Stock will be sent to Canadian residents to whom this Prospectus has been sent
and who have not withdrawn their offers to purchase prior to the issuance of
such confirmations. Each purchaser of Common Stock in Canada who receives a
purchase confirmation will be deemed to represent to the Company, the Selling
Shareholders and the dealer from whom such purchase confirmation is received
that (i) such purchaser is entitled under applicable Canadian provincial
securities laws to purchase such Common Stock without the benefit of a
prospectus qualified under such securities laws, (ii) where required by law,
such purchaser is purchasing as principal and not as agent, (iii) such purchaser
has reviewed the text above under "Notice to Canadian Residents--Resale
Restrictions", (iv) if such purchaser is located in Manitoba, such purchaser is
not an individual and is purchasing for investment only and not with a view to
resale or distribution, (v) if such purchaser is located in Ontario, a dealer
registered as an international dealer in Ontario may sell shares of Common Stock
to such purchaser, and (vi) if such purchaser is located in Quebec, such
purchaser is a "sophisticated purchaser" within the meaning of Section 43 of the
Securities Act (Quebec).
TAXATION
Canadian residents should consult their own legal and tax advisers with
respect to the tax consequences of an investment in the Common Stock in their
particular circumstances and with respect to the eligibility of the Common Stock
for investment by the purchaser under relevant Canadian legislation.
ENFORCEMENT OF LEGAL RIGHTS
The Company is organized under the laws of the Commonwealth of Virginia.
All or substantially all of the directors and officers of the Company reside
outside Canada and substantially all of the assets of the Company are located
outside Canada. As a result, it may not be possible for Canadian investors to
effect service of process within Canada upon the Company or to enforce against
the Company in Canada judgments obtained in Canadian courts that are predicated
upon the contractual rights of action, if any, granted to certain purchasers by
the Company. It may also not be possible for investors to enforce against the
Company in the United States judgments obtained in Canadian courts.
Furthermore, although the requirement for an issuer to provide to certain
purchasers the contractual right of action for damages and/or rescission
described below is consistent with contractual considerations associated with a
private placement which constitutes a primary distribution of the issuer's
securities by the issuer, an investor may not be able to enforce a contractual
right of action for rescission against the issuer where the offer or sale of the
issuer's securities is a secondary distribution being made by a third party such
as the sale of the Common Stock by the Selling Shareholders.
NOTICE TO ONTARIO RESIDENTS
The Common Stock offered hereby is being issued by a foreign issuer and
Ontario purchasers will not receive the contractual right of action prescribed
by Section 32 of the Regulation under the Securities Act (Ontario). As a
result, Ontario purchasers must rely on other remedies that may be available,
including common law rights of action for damages or rescission or rights of
action under the civil liability provisions of the U.S. federal securities laws.
All the Company's directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be possible
for Ontario purchasers to effect service of process within
82
<PAGE>
Canada upon the Company or such persons. All or a substantial portion of the
assets of the Company and such persons may be located outside of Canada and, as
a result, it may not be possible to satisfy a judgment against the Company or
such persons in Canada or to enforce a judgment obtained in Canadian courts
against the Company or persons outside of Canada.
NOTICE TO NOVA SCOTIA RESIDENTS
The Securities Act (Nova Scotia) provides that where a Canadian offering
document, together with any amendments thereto, contains an untrue statement of
material fact or omits to state a material fact that is required to be stated or
that is necessary to make a statement not misleading in the light of the
circumstances in which it was made (such untrue statement or omission herein
called a "misrepresentation"), a purchaser who was delivered such offering
document and who purchases such securities shall be deemed to have relied on
such misrepresentations if it was a misrepresentation at the time of purchase
and has a right of action for damages against the seller of the securities or he
may elect to exercise the right of recision against the seller, in which case he
shall have no right of action for damages against the seller, provided that:
(a) The seller will not be liable if the seller proves that the purchaser
purchased the securities with knowledge of the misrepresentation;
(b) In an action for damages, the seller will not be liable for all or any
portion of such damages that the seller proves do not represent the depreciation
in value of the security as a result of the misrepresentation relied upon;
(c) In no case shall the amount recoverable pursuant to the right of
action exceed the price at which the securities were offered; and
(d) The action for recision or damages conferred by the Securities Act
(Nova Scotia) is in addition to and without derogation from any other rights the
purchaser may have at law;
but no action to enforce these rights may be commenced more than 120 days after
the date on which payment is made for the securities or after the date on which
the initial payment for the securities is made where a payment or payments
subsequent to the initial payment are made pursuant to a contractual commitment
assumed prior to, or concurrently with, the initial payment.
NOTICE TO SASKATCHEWAN RESIDENTS
The Securities Act (Saskatchewan) provides that in the event an offering
memorandum, together with any amendment thereto, or any advertising or sales
literature (as such terms are defined in the Securities Act (Saskatchewan)) used
in connection with an offering contains a misrepresentation (as defined in the
Securities Act (Saskatchewan)) that was a misrepresentation at the time of
purchase, purchasers of securities will be deemed to have relied upon such
misrepresentation and will have a statutory right of action pursuant to the
Securities Act (Saskatchewan) for damages against the issuer and the seller of
the securities, or alternatively may elect to exercise a right of rescission
against the issuer or the seller, provided that:
(a) no person or company is liable where the person or company proves that
the purchaser purchased the securities with knowledge of the misrepresentation;
83
<PAGE>
(b) no person or company, other than the issuer or selling security
holder, is liable unless that person or company: (i) failed to conduct a
reasonable investigation sufficient to provide reasonable grounds for a belief
that there had been no misrepresentation; or (ii) believed there had been a
misrepresentation; and
(c) in an action for damages, the defendant is not be liable for all or
any portion of such damages that it proves does not represent the depreciation
in value of the securities as a result of the misrepresentation relied upon,
but no action to enforce these rights may be commenced:
(a) in the case of rescission, more than 180 days after the date of the
transaction that gave rise to the cause of action; and
(b) in the case of any other action, other than an action for rescission,
more than the earlier of,
(i) 180 days after the purchaser first had knowledge of the facts
giving rise to the cause of action, or
(ii) three years after the date of the transaction that gave rise to
the cause of action.
LANGUAGE OF DOCUMENTS
All Canadian purchasers of shares of Common Stock acknowledge that all
documents evidencing or relating in any way to the sale of such shares will be
drawn in the English language only. Tous les acheteurs canadiens d'actions
communes reconnaissant par les presentes que c'est a leur volonte expresse que
tous les documents faisant foi ou se rapportant de quelque mainiere a la vente
des valeurs mobilieres soient rediges en anglais seulement.
84
<PAGE>
LEGAL MATTERS
The validity of the issuance of the shares of Common Stock offered hereby
will be passed upon for the Company by Swidler & Berlin, Chartered, Washington,
D.C. Certain legal matters in connection with the Common Stock offered hereby
will be passed upon for the Underwriters by Weil, Gotshal & Manges, LLP.
EXPERTS
The consolidated financial statements of the Company as of and for the
years ended December 31, 1994 and 1995 included in this Prospectus have been
audited by Deloitte & Touche LLP independent auditors as indicated in their
reports with respect thereto, and are included herein and in the Registration
Statement in reliance upon the reports of such firm given upon their authority
as experts in accounting and auditing.
The consolidated financial statements of the Company as of December 31,
1993 and for the period from the Company's inception to December 31, 1993
included in this Prospectus have been audited by Chase and Associates CPAs,
P.C., independent public accountants, as indicated in their report thereon, and
are included in reliance upon the authority of said firm as experts in giving
said report.
AVAILABLE INFORMATION
The Company has filed with the Commission a registration statement on Form
S-1 (herein, together with all amendments and exhibits thereto, referred to as
the "Registration Statement") under the Securities Act with respect to the
shares of Common Stock offered hereby. This Prospectus, which forms a part of
the Registration Statement, does not contain all of the information set forth in
the Registration Statement, certain portions of which have been omitted as
permitted by the rules and regulations of the Commission. Statements contained
in this Prospectus as to the contents of any contract or other document 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,
each such statement being qualified in all respects by reference to such
contract or document. For further information regarding the Company and the
Common Stock offered hereby, reference is hereby made to the Registration
Statement and the exhibits and schedules thereto which may be inspected without
charge at the Commission's principal office at 450 Fifth Street, N.W., Judiciary
Plaza, Room 1024, Washington, D.C. 20549 and at the following regional offices
of the Commission: Citicorp Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661 and at Seven World Trade Center, Suite 1300, New York,
New York 10048. Copies of all or any portion of the Registration Statement may
be obtained from the Public Reference Section of the Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549 at prescribed rates.
The Company is not currently subject to the informational requirements of
the Exchange Act. As a result of the Offerings, the Company will become subject
to the informational requirements of the Exchange Act. The Company will fulfill
its obligations with respect to such requirements by filing periodic reports
with the Commission. In addition, the Company will furnish its shareholders with
annual reports containing audited financial statements certified by its
independent public accounts and quarterly reports for the first three quarters
of each fiscal year containing unaudited summary financial information.
85
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996 (UNAUDITED), CONSOLIDATED
FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report............................................. F-2
Consolidated Balance Sheets as of December 31, 1994 and 1995
and March 31, 1996 (unaudited).......................................... F-3
Consolidated Statements of Income for the years ended
December 31, 1994 and 1995 and the three month period ended
March 31, 1996 (unaudited).............................................. F-5
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1994 and 1995 and the three month period ended
March 31, 1996 (unaudited).............................................. F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1994 and 1995 and the three month period ended
March 31, 1996 (unaudited).............................................. F-7
Notes to Consolidated Financial Statements............................... F-8
DECEMBER 31, 1993 FINANCIAL STATEMENTS
Independent Auditor's Report on the Financial Statements................. F-18
Financial Statements
Balance sheet as of December 31, 1993............................... F-19
Statement of income from inception to December 31, 1993............. F-20
Statement of changes in shareholders' deficit....................... F-21
Statement of cash flows from inception to December 31, 1993......... F-22
Notes to financial statements....................................... F-23
Schedule of general and administrative expenses from
inception to December 31, 1993......................................... F-27
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
Telco Communications Group, Inc.
Chantilly, Virginia
We have audited the accompanying consolidated balance sheet of Telco
Communications Group, Inc. and subsidiaries as of December 31, 1995 and 1994,
and the related consolidated statements of income, shareholders' equity and of
cash flows for the years then ended. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
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 consolidated financial statements present fairly, in
all material respects, the financial position of Telco Communications Group,
Inc. and subsidiaries at December 31, 1995 and 1994, and the results of their
operations and their cash flows for the years then ended, in conformity with
generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Richmond, Virginia
May 10, 1996
F-2
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS DECEMBER 31, 1994 DECEMBER 31, 1995 MARCH 31, 1996
(UNAUDITED)
<S> <C> <C> <C>
Current Assets:
Cash and cash equivalents $ 474,512 $ 936,771 $ 1,300,284
Accounts receivable, trade (net of allowances of $1,078,442 and
$3,771,413 and $7,136,748 at December 31, 1994 and 1995 and March 31,
1996, respectively) 24,986,466 55,823,988 75,998,752
Prepaid income taxes - 333,378 -
Deferred income tax asset - 884,769 696,779
Other 1,823,425 1,112,504 1,443,486
---------- --------- ---------
Total current assets 27,284,403 59,091,410 79,439,301
---------- ---------- ----------
Property, Plant And Equipment:
Leasehold improvements 278,837 1,147,867 1,168,075
Network equipment 496,263 4,533,900 5,430,411
Office furniture 582,601 1,957,566 2,194,188
Network equipment under capital lease 3,134,099 19,289,850 19,291,081
Network facilities under development 1,913,074 4,076,015 5,594,561
Accumulated depreciation (530,900) (3,478,485) (4,885,903)
-------- ---------- ----------
Total property, plant and equipment, net 5,873,974 27,526,713 28,792,413
--------- ---------- ----------
Other Assets 374,789 505,847 696,270
------- ------- -------
Total Assets $33,533,166 $87,123,970 $108,927,984
=========== =========== ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY DECEMBER 31, 1994 DECEMBER 31, 1995 MARCH 31, 1996
(UNAUDITED)
<S> <C> <C> <C>
Current Liabilities:
Notes payable, short-term $ 213,233 $ - $ -
Capital lease obligation, current portion 685,844 2,972,549 3,163,087
Excise taxes payable 478,589 1,288,985 1,337,822
Accounts payable 2,632,269 15,303,439 12,811,705
Accrued network access and transmission expense 6,987,371 9,429,070 12,605,880
Other accrued expenses 1,592,647 1,322,454 6,333,273
Income taxes payable 741,163 - 2,393,652
Payable to related parties 67,711 413,923 279,753
------ ------- -------
Total current liabilities 13,398,827 30,730,420 38,925,172
---------- ---------- ----------
Long-term Liabilities:
Long-term debt 15,367,424 28,261,527 38,634,444
Capital lease obligation, noncurrent 2,617,364 13,175,732 12,639,966
Deferred income taxes 357,492 1,353,382 1,411,081
------- ---------- ----------
Total long-term liabilities 18,342,280 42,790,641 52,685,491
---------- ---------- ----------
Minority Interest 137,155 1,183,093 1,616,813
------- --------- ---------
Commitments And Contingencies (Note 14)
Shareholders' Equity:
Common stock (no par, 100,000 shares authorized,
49,092 shares outstanding) 25,000 25,000 25,000
Retained earnings 1,629,904 12,394,816 15,675,508
--------- ---------- ----------
Total shareholders' equity 1,654,904 12,419,816 15,700,508
--------- ---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $33,533,166 $87,123,970 $108,927,984
=========== =========== ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Month
Years Ended December 31, Period Ended
1994 1995 March 31, 1996
(unaudited)
<S> <C> <C> <C>
Revenues, Net $44,706,867 $215,375,486 $91,927,548
Cost of services 27,736,195 133,727,834 54,729,975
---------- ----------- ----------
Gross margin 16,970,672 81,647,652 37,197,573
---------- ---------- ----------
Operating expenses:
Selling, general and administrative 12,017,726 55,935,945 27,863,407
Depreciation and amortization 495,883 3,325,641 1,432,678
------- --------- ---------
Total operating expenses 12,513,609 59,261,586 29,296,085
---------- ---------- ----------
Operating income 4,457,063 22,386,066 7,901,488
Interest expense 896,871 2,951,975 1,065,942
Other expense (income) (14,613) 91,648 (13,405)
Income taxes:
Current 1,074,837 7,420,471 2,888,850
Deferred 356,789 111,121 245,689
------- ------- -------
Total income taxes 1,431,626 7,531,592 3,134,539
--------- --------- ---------
Minority interest 137,155 1,045,938 433,720
------- --------- -------
Net income $2,006,024 $10,764,913 $3,280,692
========== =========== ==========
Net income per common and common
Equivalent share $31.57 $161.91 $49.29
Average common and common equivalent
shares 63,541 66,488 66,559
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31 Three Month
Period Ended
March 31, 1996
1994 1995 (unaudited)
<S> <C> <C> <C>
CASH FLOW FROM (USED FOR) OPERATIONS:
Net income $ 2,006,024 $ 10,764,913 $ 3,280,692
Adjustments to reconcile net income to net cash from (used
for) operating activities:
Depreciation and amortization 495,883 3,325,641 1,432,678
Minority interest 137,155 1,045,938 433,720
Deferred income taxes 356,789 111,121 245,687
Loss on disposal of fixed assets - 122,783 -
Change in current assets and liabilities:
Trade accounts receivable (24,115,053) (30,837,522) (20,174,764)
Prepaid and other assets (1,617,168) 513,674 (188,027)
Accounts payable 1,299,850 13,827,778 (2,577,067)
Accrued expenses 8,795,562 2,171,506 8,187,629
Income taxes payable 741,163 (1,074,541) 2,393,652
------- ---------- ---------
Net cash used for operating activities (11,899,795) (28,709) (6,777,808)
----------- ------- -----------
CASH FLOWS (USED FOR) INVESTING ACTIVITIES:
Equipment purchases (1,300,879) (9,814,753) (2,441,300)
Investments, net of cash acquired (7,758) - -
---------- ---------- -----------
Net cash used for investing activities (1,308,637) (9,814,753) (2,441,300)
---------- ----------- -----------
CASH FLOWS FROM (USED FOR) FINANCING
ACTIVITIES:
Proceeds from line of credit 29,126,823 28,261,527 38,634,444
Payments on line of credit (13,759,399) (15,367,424) (28,261,527)
Payments on capital leases (1,266,413) (2,375,149) (790,296)
Payments on short-term debt (583,000) (213,233) -
Proceeds from contributed capital 50,000 - -
Repurchase of common shares (25,000) - -
------- ---------- ---------
Net cash from financing activities 13,543,011 10,305,721 9,582,621
---------- ---------- ---------
INCREASE IN CASH 334,579 462,259 363,513
CASH, BEGINNING OF THE PERIOD 139,933 474,512 936,771
------- ------- -------
CASH, END OF THE PERIOD $474,512 $936,771 $1,300,284
======== ======== ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995 AND 1994 AND THREE MONTH PERIOD ENDED MARCH 31,
1996
<TABLE>
<CAPTION>
Accumulated
Deficit
Remaining Upon
Termination of Retained
Common S-Corporation Earnings
Stock Election (Deficit) Total
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1993 $871,079 $ - $(1,247,200) $(376,121)
Conversion from S-Corporation
tax status (871,079) (376,121) 1,247,200
Shares repurchased into treasury (25,000) - - (25,000)
Issuance of common shares 50,000 - - 50,000
Net income - - 2,006,024 2,006,024
------ -------- --------- -----------
BALANCE, DECEMBER 31, 1994 25,000 (376,121) 2,006,024 1,654,903
Net income = = 10,764,913 10,764,913
------- --------- ---------- ----------
BALANCE, DECEMBER 31, 1995 $25,000 $(376,121) $12,770,937 $12,419,816
------- --------- ----------- -----------
Net income (UNAUDITED) - - 3,280,692 3,280,692
------- --------- ----------- -----------
BALANCE, MARCH 31, 1996
(UNAUDITED) $25,000 $(376,121) $16,051,629 $15,700,508
======= ========= =========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
<PAGE>
TELCO COMMUNICATIONS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1995 AND 1994
1. NATURE OF THE BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations - The Company is a facilities-based long distance
telephone company headquartered in Chantilly, Virginia. The Company
principally provides service to residential customers in 28 states and
the District of Columbia.
SIGNIFICANT ACCOUNTING POLICIES:
A. BASIS OF CONSOLIDATION - The consolidated financial statements
include the accounts of Telco Communications Group, Inc. (TCGI) and
its wholly-owned Dial & Save subsidiaries as well as TCGI's 80%
interest in Telco Development Group of Delaware, Inc. and a 55.55 %
interest in Long Distance Wholesale Club. All intercompany
transactions and accounts have been eliminated in consolidation (see
Note 7).
B. REVENUE RECOGNITION - Revenue is recorded when service is
rendered, which is measured when a long distance call is completed and
is shown net of a provision for bad debts and customer allowances.
C. SALES, ADVERTISING AND RELATED MARKETING EXPENSES - Costs
incurred in connection with Company sales, advertising and marketing
activities are recognized in the period that they are incurred. Costs
incurred in advance of utilization in sales, advertising or marketing
activity are recognized as prepaid assets until such activity occurs.
The Company had recorded prepaid advertising and mail marketing costs
of $377,745 and $1,055,414 at December 31, 1995 and 1994,
respectively. These expenditures were utilized in promotional
activities and mailings in subsequent periods and were expensed in the
periods in which the items were mailed.
D. CASH AND CASH EQUIVALENTS - For the purposes of reporting cash
flows, the Company considers all highly liquid instruments with
original maturities of less than three months to be cash equivalents.
E. ACCOUNTS RECEIVABLE - Accounts receivable principally consists of
amounts due from customers. The Company contracts with Local Exchange
Carriers (LECs), or an authorized clearinghouse, to bill and collect
from its customers. Accounts receivable are recognized net of
collection costs and an uncollectible allowance.
F. PROPERTY AND DEPRECIATION - Property, plant and equipment is
recorded at cost. Depreciation is computed using the straight-line
method based on an estimated useful life of five years. Expenditures
for maintenance and repairs are charged to expense as incurred whereas
expenditures for additions and replacements are capitalized. The cost
and related accumulated depreciation of assets sold or otherwise
disposed of during the period are removed from the accounts. Any gain
or loss is reflected in the year of disposal.
G. INCOME TAXES - Income taxes are provided for the tax effects of
transactions reported in the financial statements and consist of taxes
currently due and deferred taxes. Deferred taxes are recognized for
differences between the basis of assets and liabilities for financial
statement and income tax purposes. Such differences relate primarily
to depreciable assets and accounts receivable. The Company revoked its
S-Chapter election effective January 1, 1994.
F-8
<PAGE>
H. EXCISE TAXES PAYABLE - Excise taxes payable represent sales and
excise tax amounts collected which are subsequently remitted to taxing
authorities.
I. RECLASSIFICATION - Certain amounts in the 1994 consolidated
financial statements have been reclassified to conform to the 1995
presentation.
J. USE OF ESTIMATES - 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 at the date of the financial
statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those
estimates.
K. NET INCOME PER SHARE - Net income per share is based on the
weighted average number of shares of common stock and common stock
equivalent shares outstanding using the treasury stock method.
Pursuant to Securities and Exchange Commission requirements, common
and common equivalent shares issued during the twelve-month period
prior to the initial filing of the Company's proposed public offering
have been included in the calculation as if they were outstanding for
all periods presented using the treasury stock method, based on an
estimated initial public offering price.
L. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - In March 1995, the
Financial Accounting Standards Board issued Statement of Financial
Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which
must be adopted by the Company by January 1, 1996. This statement
requires the Company to review long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying
amount of an assets may not be recoverable. Based on the Company's
current operating environment, adoption of SFAS 121 does not have a
material impact.
In 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock Based Compensation." The Company has
decided to continue to apply Accounting Principles Board (APB) Opinion
No. 25, "Accounting for Stock Issued to Employees," for recognition
and measurement purposes.
M. INTERIM FINANCIAL DATA (UNAUDITED) - The interim financial data
at March 31, 1996 and for the three-month period then ended is
unaudited; however, in the opinion of management, such interim data
includes all adjustments, consisting only of normal recurring
adjustments, necessary for a fair statement of the results for the
interim period.
2. RELATED PARTY TRANSACTIONS
The Company has entered into various transactions with several
entities which are or have been controlled by the Company's Chairman
of the Board, who is also a shareholder with a direct ownership
interest of 33%. These other entities include Tel Labs Inc., Telco
Development Group, Inc., Bricks In The Sticks, Ltd., Telco Development
Group of Delaware (an 80%-owned subsidiary of the Company), and Dial &
Save of Pennsylvania (a wholly-owned subsidiary of the Company).
The Company leases office and switch site facilities from Bricks
In The Sticks, Ltd. The Company paid total rents of $179,420 and
$63,500 for these facilities, for the years ended December 31, 1995
and 1994, respectively.
F-9
<PAGE>
Total annual future minimum operating lease payments due to the
related party for the above lease are as follows for the years ending
December 31:
<TABLE>
<S> <C>
1996 $189,546
1997 201,377
1998 213,387
1999 168,996
2000 8,159
</TABLE>
The Company purchases data processing services for call translation
and rating on a month-to-month basis from Tel Labs, Inc. The Company paid
$1,260,000 and $155,000 for these services for the years ended December 31,
1995 and 1994, respectively.
The Company purchases computer equipment and support on a month-to-
month basis from Telco Development Group, Inc. The Company paid $779,918
and $229,100 for these services for the years ended December 31, 1995 and
1994, respectively.
On August 1, 1994, the Company purchased 100% of the outstanding
shares of Dial & Save of Pennsylvania from the Company's Chairman for
$31,479 in cash. The Consolidated Statement of Income for the year ended
December 31, 1994 includes the operations of Dial & Save of Pennsylvania
from August 1, 1994. Operations of Dial & Save of Pennsylvania prior to
August 1, 1994 were not material.
Prior to July 28, 1994, the Company's Chairman owned a 50% interest in
the common stock of Long Distance Wholesale Club (LDWC). The Company
purchased the Chairman's 50% interest and an additional 5% of the common
stock of LDWC (see Note 7). The Company paid approximately $85,000 for the
Chairman's interest in LDWC.
The Company was organized during 1993 through the investment of: 1)
its Chairman, 2) its President, and 3) a non-management shareholder. At the
Company's inception, the non-management shareholder purchased a minority
interest in the Company's common stock for $250,000. On July 20, 1994, the
Company purchased, into treasury, 100% of the non-management shareholder's
original minority interest in the common stock of the Company for $25,000
and, on July 25, 1994, sold, at the non-management shareholder's request, a
similar minority interest in its common stock to a foreign corporation of
which such shareholder is an executive officer in exchange for $50,000 (see
Note 10).
The foreign corporation also holds a minority ownership interest in an
international long distance services provider. The former non-management
shareholder is a director and member of the management of this provider.
This international provider and Telco purchase transmission services from
one another pursuant to service agreements.
F-10
<PAGE>
3. ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS
Changes in the allowance for uncollectible accounts and billing services
fees were as follows at December 31:
<TABLE>
<CAPTION>
1994 1995
<S> <C> <C>
Balance at the beginning of year $ 59,763 $ 1,078,442
Provision charged to operations 2,545,350 11,517,017
Write-offs, net of recoveries (1,526,671) (8,824,046)
----------- -----------
Balance at the end of year $ 1,078,442 $ 3,771,413
========= =========
</TABLE>
4. LONG-TERM AND OTHER DEBT
The long-term debt of TCGI consists of a $25,000,000 line of credit
from Signet Bank due January 1996 with an interest rate of prime plus 2%.
The weighted average interest rates for 1995 and 1994 were 10.86% and
9.94%, respectively. The bank has a first security interest on all accounts
receivable, equipment, furniture and fixtures, and the common stock of
subsidiaries is pledged as additional security. The credit agreement cites
minimum operating ratios, and prohibits creation of debt, merger, sale of
assets, loans or advances, guarantees, and payment of dividends without
consent of the lender. The credit agreement also includes a warrant
agreement between TCGI and Signet Media Capital Group, which entitles
Signet Media Capital Group to 1,174 warrants at an exercise price of $ .05
per share. No warrants have been exercised as of December 31, 1995. In
1996, the number of shares subject to the warrant was adjusted to 1,255.
The credit agreement is guaranteed by two executive officers of the
Company. Under the terms of the agreement, the officers guarantee a term
note, consisting solely of loan points, and any borrowing in excess of 80%
of receivables. At December 31, 1995 and 1994, there were no amounts
outstanding personally guaranteed by the officers.
At December 31, 1995, the Company was in the process of renegotiating
the credit agreement. Interim financing of an additional $10,000,000 was
available to the Company under the terms of the current credit agreement.
On January 24, 1996, permanent financing was obtained in the amount of
$45,000,000. On March 20, 1996, the credit agreement was amended to provide
$20,000,000 of additional financing. The new credit agreement has a
maturity date of January 24, 1998 and carries an adjustable interest rate
based on the LIBOR and prime rates. As a result of the new financing,
$28,261,527 has been reclassified to long term debt at December 31, 1995.
Under the new credit agreement there are no personal guarantees. The new
credit agreement is secured by substantially all of the Company's assets
and requires the Company to maintain certain financial ratios, restricts
the payment of dividends and requires all subsidiary companies' stock be
pledged as collateral.
Short-term notes payable consist of deposits to a leasing agent. The
terms for the leases require a 10% payment at inception and a 10% payment
to be made in equal installments over a period of five months.
F-11
<PAGE>
5. OBLIGATIONS UNDER CAPITAL AND OPERATING LEASES
The Company leases certain equipment under capital leases.
Accordingly, the Company has capitalized such equipment in the amount of
$22,214,849 and $4,819,099 less accumulated depreciation of $2,587,847 and
$412,372 as of December 31, 1995 and 1994, respectively. At December 31,
1995, 93% of such equipment was leased from one vendor. Total equipment
under capital leases includes $2,925,000 and $1,685,000 classified as
network facilities under development, as of December 31, 1995 and 1994,
respectively.
The following represents the future minimum payments required under
such leases for the next five years.
<TABLE>
<S> <C>
1996 $ 4,347,275
1997 4,604,616
1998 4,564,692
1999 4,248,216
2000 1,969,639
-----------
Total minimum base payments 19,734,438
-----------
Imputed interest (3,586,157)
-----------
Net obligation 16,148,281
Current portion (2,972,549)
-----------
Capital lease obligation, noncurrent $ 13,175,732
= ==========
</TABLE>
In addition to operating leasing activities discussed in Note 2, the
Company leases space in Ft. Lauderdale, Florida; Austin, Texas; Washington,
D.C.; Davenport, Iowa; Arlington, Virginia and Las Vegas, Nevada. The total
minimum rental commitment as of December 31, 1995 due in future years is as
follows:
<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31,
<S> <C>
1996 $ 534,334
1997 541,972
1998 554,711
1999 516,537
2000 205,780
</TABLE>
Total rent expense under these leases was $206,534 and $68,809 for the
years ended December 31, 1995 and 1994, respectively.
F-12
<PAGE>
6. INCOME TAXES
The Company accounts for income taxes using the liability method,
whereby deferred tax liabilities and assets are determined based on the
temporary differences between the financial statements and tax bases of
assets and liabilities by applying enacted statutory tax rates applicable
to future years in which the differences are expected to reverse.
Significant components of income taxes are as follows for the years
ended December 31, 1994 and 1995:
<TABLE>
<CAPTION>
1994 1995
<S> <C> <C>
Current:
Federal $ 822,612 $ 6,023,084
State 252,225 1,397,387
------- ---------
Total Current $ 1,074,837 $ 7,420,471
= ========= = =========
Deferred:
Federal $ 320,589 $ 91,780
State 36,200 19,341
------ ------
Total Deferred $ 356,789 $ 111,121
= ======= = =======
</TABLE>
Temporary differences which give rise to significant components of the
Company's deferred tax liabilities and assets for the years ended December
31, 1994 and 1995 are as follows:
<TABLE>
<CAPTION>
1994 1995
<S> <C> <C>
Deferred Tax Liabilities:
Book over tax basis in property,
plant and equipment $ (177,194) $ (1,161,939)
Bad debts - non-accrual method (110,375) -
Other (69,923) (191,443)
-------- --------
(357,492) (1,353,382)
-------- ----------
Deferred Tax Assets:
Bad debts - non-accrual method - 580,643
Other - 304,126
-------- -------
- 884,769
-------- -------
Deferred Tax Liability, net $ (357,492) $ (468,613)
= ======== = ========
</TABLE>
F-13
<PAGE>
No valuation allowance has been recorded for the realization of the
deferred tax asset resulting from the temporary differences as management
believes that it will, more likely than not, be able to realize the
deferred tax asset.
Reconciliation of income taxes computed at the federal statutory tax
rate to actual income tax expense for the years ended December 31, 1994 and
1995 are as follows:
<TABLE>
<CAPTION>
1994 1995
<S> <C> <C>
Federal Statutory Rate 34.00% 35.00%
Effect of:
State taxes - net of Federal benefit 6.23 4.76
Other (.18) (.82)
---- ----
Income Tax Expense 40.05% 38.94%
===== =====
</TABLE>
7. BUSINESS COMBINATIONS
On July 28, 1994, the Company acquired 55% of the outstanding stock of
Long Distance Wholesale Club (see Note 2). The Company paid $134,834 in
cash for the shares. The acquisition has been accounted for as a purchase
transaction and, accordingly, the cash paid has been allocated to assets
and liabilities based on the estimated fair value as of the acquisition
date. The Consolidated Statement of Income for the year ended December 31,
1994 includes the operating results of Long Distance Wholesale Club from
August 1, 1994.
See also Note 2 regarding Dial & Save of Pennsylvania.
8. INCENTIVE STOCK OPTIONS
On July 1, 1994, the Company adopted a Stock Plan (the Plan) which
provides for the granting of one or any combination of incentive stock
options, nonqualified stock options, restricted stock awards and bargain
purchases of Company stock. All Company employees are eligible to
participate in the Plan. 10,000 shares of common stock are authorized for
issuance by the Plan. Options are issued at a price equal to the fair
market value of the common stock at the date granted. No options were
exercised or canceled during 1995 or 1994. Options for 3,583 shares are
exercisable at December 31, 1995. The following options are currently
outstanding:
<TABLE>
<CAPTION>
YEAR OF GRANT NUMBER OF SHARES OPTION PRICE
<S> <C> <C>
1994 3,843.5 $131 - $784
1995 500 $1,374
</TABLE>
In addition, LDWC has granted options to certain employees. Options
are issued at a price equal to the fair market value of the common stock at
the date granted. No options were exercised or canceled during 1995.
Options on 1.11 shares are exercisable at December 31, 1995. The following
options are currently outstanding:
F-14
<PAGE>
<TABLE>
<CAPTION>
YEAR OF GRANT NUMBER OF SHARES OPTION PRICE
<S> <C> <C>
1995 5.72 $33,955 - $181,061
</TABLE>
9. SUPPLEMENTAL CASH FLOW INFORMATION
The following represents supplemental cash flow information for the
years ended December 31, 1994 and 1995:
<TABLE>
<CAPTION>
1994 1995
<S> <C> <C>
Cash paid for:
Interest $ 656,958 $ 2,939,472
Income taxes $ 336,598 $ 8,223,750
Non-cash investing and financing activities:
Conversion of short-term debt to equity $ - $ 250,000
Equipment purchased through capital leases $ 2,821,353 $ 15,220,222
Fair value of assets acquired $ 1,025,533 $ -
Cash paid for common stock 170,360 -
------- ----------
Liabilities assumed $ 855,173 $ -
</TABLE>
10. CAPITAL STOCK
On June 1, 1994, the Company declared a ten-for-one stock split.
All share amounts have been restated to reflect the split. On July 20,
1994, the Company purchased 13,633 shares of its stock at $1.83 per share
and subsequently sold 15,225 shares at $3.28 per share on July 25, 1994
(see Note 2).
11. DEBT CONVERSION
In June 1995, the Company exercised its option to convert a $250,000
short-term note receivable from its majority-owned subsidiary Long Distance
Wholesale Club to equity in that entity. 3.046 shares of Long Distance
Wholesale Club common stock were issued in the transaction, resulting in an
increase in the Company's ownership interest from 55% to 55.55%.
12. EMPLOYEE BENEFIT PLANS
The Company's majority-owned subsidiary Long Distance Wholesale Club
implemented a 401(k) pension plan during 1995. Employees are eligible to
participate in the plan if they have been
F-15
<PAGE>
employed by Long Distance Wholesale Club for one year and work at least 20
hours per week. Generally, employees can defer up to 15% of their gross bi-
weekly salary into the plan. The Company's contribution is to be determined
annually by the Board of Directors. The Company contributed $11,781 to the
plan in 1995.
13. DEFERRED COMPENSATION PLAN
The Company though its majority-owned subsidiary Long Distance
Wholesale Club provides a deferred compensation plan for one of its
officers. The plan provides for annual elections to be made by the officer
of deferral amounts, such deferral to be made only from compensation
amounts earned and otherwise payable. The plan requires funding of the
deferred compensation amount equal to the officer's deferral plus interest
at an annual rate to be determined by the board of directors from time to
time. As of December 31, 1995, $373,604 has been accrued under the plan,
$331,820 of which has been funded to date.
14. COMMITMENTS AND CONTINGENCIES
The Company is a party from time to time to routine litigation or
employment related litigation incident to its business. No provision has
been reflected in the accompanying financial statements for any litigation.
Based upon information presently available, management believes the final
disposition of these items will not have an adverse material effect on
operations or the financial position of the Company.
During the first half of 1996, the Company entered into employment and
consulting agreements with certain members of management. The agreements
provide for the employees to receive amounts not less than specified base
annual salaries through the terms of the agreements, which have terms of
three to five years. Certain of the contracts also include non-competition
covenants and options to purchase shares of the Company's common stock.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash, accounts receivable, accounts payable,
and accrued expenses approximate fair value because of the short maturity
of these items.
The carrying amounts of notes payable and debt issued pursuant to the
Company's bank credit agreements approximate fair value because the
interest rates on these instruments change with market interest rates.
F-16
<PAGE>
16. SUBSEQUENT EVENTS
ACQUISITIONS OF AFFILIATED COMPANIES: Subsequent to December 31, 1995, the
Company announced its intention to purchase the remaining shares of Long
Distance Wholesale Club, Inc. and Telco Development Group of Delaware,
Inc.. In addition, the Company has announced plans to acquire Tel Labs,
Inc., concurrent with an initial public offering of its common stock.
F-17
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Telco Communications Group, Inc.
Chantilly, Virginia
We have audited the accompanying balance sheet of Telco Communications
Group, Inc. as of December 31, 1993, and the related statements of income,
changes in stockholders' deficit, and cash flows from inception to December 31,
1993, and supplementary information. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test, basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides 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 Telco Communications Group,
Inc. as of December 31, 1993, and the results of operations and its cash flows
from inception to December 31, 1993 in conformity with generally accepted
accounting principles.
Manassas, Virginia
March 25, 1994
F-18
<PAGE>
Telco Communications Group, Inc.
BALANCE SHEET
December 31, 1993
<TABLE>
<S> <C>
ASSETS
Current Assets
Cash and cash equivalents $ 139,933
Trade receivables 441,706
Other receivables 4,031
Deposits 236,612
Prepaid expenses 30,853
--------------
Total current assets 853,135
--------------
Property And Equipment
Leasehold improvements 68,000
Machinery and equipment 159,846
Office furniture and equipment 24,270
Equipment acquired under capital leases 1,000,000
Less accumulated deprecation (54,358)
--------------
1,197,758
--------------
$ 2,050,893
==============
Liabilities And Stockholders' Deficit
Current Liabilities
Shareholder notes payable (Note 2) $ 72,233
Short-term notes payable (Note 3) 724,000
Current obligations under capital leases (Note 5) 148,463
Accounts payable 829,662
Accrued expenses 38,069
--------------
Total current liabilities 1,812,427
--------------
Obligations Under Capital Leases, less current portion, (Note 5) 614,586
--------------
Commitments And Contingencies (Note 4)
Stockholders' Deficit
Common stock, par value $.01 per share;
authorized 5,000 shares; issued 4747 shares 47
Paid in capital 871,033
Retained earnings deficit (1,247,200)
--------------
(376,120)
--------------
$ 2,050,893
==============
</TABLE>
F-19
<PAGE>
Telco Communications Group, Inc.
STATEMENT OF INCOME
From Inception to December 31, 1993
<TABLE>
<CAPTION>
<S> <C>
Net sales $ 1,135,490
Cost of sales 993,741
-----------
Gross Profit 141,749
-----------
Billing, General and Administrative Expenses:
Billing services 100,762
General and administrative 1,263,033
-----------
1,363,795
-----------
Operating income loss (1,222,046)
Interest Expense 25,154
-----------
Net Income loss $(1,247,200)
===========
</TABLE>
F-20
<PAGE>
Telco Communications Group, Inc.
STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIT
From Inception to December 31, 1993
<TABLE>
<S> <C>
Issuance of common stock $ 47
Proceeds of paid in capital in excess of par 871,033
Accumulated (deficit) (1,247,200)
-------------
Total Stockholders' Deficit $ (376,120)
=============
</TABLE>
F-21
<PAGE>
Telco Communications Group, Inc,
STATEMENT OF CASH FLOWS
From Inception to December 31, 1993
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
(Net loss) $(1,247,200)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation 48,692
Amortization 5,666
Increase in trade receivables (441,706)
Increase in other receivables (4,031)
Increase in deposits (230,560)
Increase in prepaid expenses (30,853)
Increase in accounts payable 829,662
Increase in accrued expenses 38,069
-----------
Net cash (used in) operating activities (1,032,261)
-----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (218,110)
Leasehold improvements (68,000)
-----------
Net cash (used in) investing activities (286,110)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings from shareholders and related parties 796,233
Payments under capital leases (21,276)
Proceeds from sale of stock 683,347
-----------
Net cash provided by financing activities 1,458,304
-----------
Net increase in cash and cash equivalents 139,933
Beginning cash and cash equivalents 0
-----------
Ending cash and cash equivalents $ 139,933
===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for interest $ 7,240
===========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Capital lease obligation incurred for use of equipment $ 784,325
===========
Equipment acquired for stock $ 181,681
===========
Deposits acquired for stock $ 6,052
===========
</TABLE>
F-22
<PAGE>
TELCO COMMUNICATIONS GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies.
Nature of business:
The Company is a full service long distance telephone company headquartered
in Chantilly, Virginia. The Company currently provides service to consumers
and businesses in the state of Florida under the trade style Dial & Save.
A summary of the Company's significant accounting policies follows:
Revenue recognition:
Revenue is recorded on an accrual basis whereby revenue is recognized when
a long distance call is completed and the calls are priced by a third party
data processing contractor. Revenues are realized net of a bad debt and an
uncollectible allowance.
Sales, advertising and related marketing expenses:
Costs incurred in connection with Company sales, advertising, and marketing
activities are realized in the period that they are incurred.
Cash and cash equivalents:
For the purposes of reporting cash flows, the Company considers all cash
accounts which are not subject to withdrawal restrictions or penalties to
be cash equivalents.
Trade receivables:
Accounts receivable consist primarily of monies due from Local Exchange
Carriers ("LEC") (BellSouth Telecommunications, GTE Telephone, and Sprint
United Telephone Company) or an authorized billing clearinghouse. The
Company contracts with LECs, or an authorized clearinghouse, to bill and
collect from it's customers. Accounts receivable are recognized net of
collection costs, bad debt and uncollectible allowances, interest expenses
and carrying costs. The Company has elected to receive monies due from
local telephone companies, via an authorized clearing house on an expedited
basis, utilizing an advance payment agreement. Under this agreement, the
Company may borrow up to a fixed percentage of the outstanding accounts
receivable.
F-23
<PAGE>
Property and equipment:
Property and equipment are stated at cost. Depreciation and amortization is
computed by the straight line method over the estimated useful lives:
<TABLE>
<CAPTION>
Years
-----
<S> <C>
Leasehold improvements 2
Office furniture & equipment 3
Machinery & equipment 5
Leased equipment 5
Income tax status:
</TABLE>
The Company, with the consent of its stockholders, has elected to be taxed
under sections of federal and state income tax law, which provide that, in
lieu of corporation income taxes, the stockholders separately account for
their prorata shares of the Company's items of income, deductions, losses
and credits. As a result of this election, no income taxes have been
recognized in the accompanying financial statements.
Note 2. Notes Payable to Shareholders
The Company has two (2) unsecured note agreements in the amounts of $43,379
and $28,839 payable to individual stockholders and directors. The note
agreements provide for an annual interest rate of 12% payable in monthly
installments with principal amounts due on December 31, 1994.
Note 3. Short-Term Notes Payable
The Company has two unsecured note agreements payable to third parties in the
amounts of $224,000 and $500,000. The note agreements provide for an annual
interest rate of at least 12%, payable in monthly installments with principal
amounts due June 30, 1994.
Note 4. Commitments
The Company leases it's Chantilly, Virginia and Ft. Lauderdale, Florida
offices under operating leases which expire variously through August, 1997.
F-24
<PAGE>
The total minimum rental commitment as of December 31, 1993, due in
future years is as follows:
<TABLE>
<S> <C> <C>
Years ending December 31, 1994 $33,516
1995 31,944
1996 28,800
1997 16,800
</TABLE>
The total rent expense from inception to December 31, 1993 was $13,572.
Note 5. Capital Lease Obligations
The Company leases telephone switching equipment under a capital lease
agreement. The lease carries an implied interest rate of ten percent (10%)
with a term of sixty (60) months and allows for the purchase of the leased
equipment at the end of the lease term for $1. This lease is guaranteed by
two (2) stockholders and directors.
The Company leases telephone PBX equipment under a capital lease agreement.
The lease carries an implied interest rate of 13.9% with a term of twenty-
four (24) months and allows for the purchase of the leased equipment at the
end of lease term for $1.
The total minimum aggregate dollar amount due under capital leases is
$784,325 with interest totaling $199,350. The total depreciation on the
related assets was $37,294. The total minimum lease commitments due as of
December 31, 1993 are as follows:
<TABLE>
<S> <C> <C>
Years ending in December 31, 1994 $148,463
1995 157,952
1996 141,869
1997 156,725
1998 158,040
</TABLE>
Note 6. Transactions with Related Parties
The Company rents office space in Chantilly, Virginia for a two (2) year
term from Telco Development Group, Inc., a corporate which is 74% owned by
a company director and stockholder.
The Company purchases data processing services on a month-to-month basis
from Tel Labs, Inc., a corporation which is 100% owned by a company
director and stockholder.
F-25
<PAGE>
The Company purchased computer equipment from a corporation owned by a
company director and stockholder. Total equipment purchases from the
corporation during 1993 were $21,109.
Amounts charged to expenses as a result of transactions with related
parties from inception to December 31, 1993 consist of the following:
<TABLE>
<S> <C>
Rent $ 12,000
Data processing 5,210
-------
$ 17,210
========
</TABLE>
All transactions with related parties are at a fair market price, balances
are cleared regularly, and similar services are readily available from
other suppliers.
As of December 31, 1993 the total amount included in accounts payable due
to related parties is $13,545.
F-26
<PAGE>
TELCO COMMUNICATIONS GROUP, INC.
SCHEDULE OF GENERAL AND ADMINISTRATIVE EXPENSES
FROM INCEPTION TO DECEMBER 31, 1993
General and administrative expenses:
<TABLE>
<S> <C>
Depreciation and amortization $ 54,358
Data processing 5,210
Call center 91,971
Temporary help 1,402
Insurance 4,752
Professional fees 9,427
Mail marketing 838,298
Travel 30,319
Miscellaneous 8,561
Office supplies 12,952
Rent 27,133
Salaries 164,507
Payroll taxes 14,143
--------
$ 1,263,033
===========
</TABLE>
F-27
<PAGE>
================================================================================
NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFER CONTAINED HEREIN AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY, ANY SELLING SHAREHOLDER, ANY UNDERWRITER OR ANY OTHER PERSON.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY, ANY SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT
RELATES, OR AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY, TO ANYONE IN
ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN
WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR
TO ANYONE TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE
DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
_________________
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.............................................................
Risk Factors...................................................................
Use of Proceeds................................................................
Dividend Policy................................................................
Dilution.......................................................................
Capitalization.................................................................
Selected Consolidated Historical and Pro Forma Financial Data..................
Pro Forma Consolidated Financial Statements....................................
Management's Discussion and Analysis of Financial Condition and Results
of Operations.............................................................
Business.......................................................................
Management.....................................................................
Certain Transactions...........................................................
Principal and Selling Shareholders.............................................
Description of Capital Stock...................................................
Shares Eligible for Future Sale................................................
Certain United States Federal Tax Considerations for Non-U.S
Holders of Common Stock...................................................
Underwriting...................................................................
Legal Matters..................................................................
Experts........................................................................
Available Information..........................................................
Index to Consolidated Financial Statements.................................. F-1
</TABLE>
_________________
UNTIL ____________, 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY
REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
================================================================================
_________ SHARES
[LOGO]
COMMON STOCK
_____________
PROSPECTUS
_____________
BEAR, STEARNS & CO. INC.
SALOMON BROTHERS INC
________, 1996
================================================================================
<PAGE>
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAW OF ANY SUCH STATE.
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
SUBJECT TO COMPLETION, DATED JUNE 12, 1996
PROSPECTUS
_________ SHARES
[INSERT LOGO]
TELCO COMMUNICATIONS GROUP, INC.
COMMON STOCK
Of the _________ Shares of Common Stock offered hereby, _________ shares
will be sold by the Company and _________ shares will be sold by the Selling
Shareholders. The Company will not receive any of the proceeds from the sale of
the shares being sold by the Selling Shareholders. See "Principal and Selling
Shareholders."
A total of _________ shares (the "International Shares") are being offered
outside the United States and Canada (the "International Offering") by the
Managers and _________ shares (the "U.S. Shares") are being offered in the
United States and Canada (the "U.S. Offering") by the U.S. Underwriters.
Prior to the Offerings, there has been no public market for the Common
Stock. It is currently anticipated that the initial public offering price will
be between $__ and $__ per share. See "Underwriting" for a discussion of the
factors considered in determining the initial public offering price.
The Company intends to apply for the listing of the Common Stock on the New
York Stock Exchange under the symbol "_________."
SEE "RISK FACTORS" BEGINNING ON PAGE 8 HEREOF FOR INFORMATION THAT SHOULD
BE CONSIDERED BY PROSPECTIVE INVESTORS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR
HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
==============================================================================================================================
Price to Underwriting Discounts Proceeds to Proceeds to
Public and Commissions (1) Company (2) Selling Shareholders (2)(3)
<S> <C> <C> <C> <C>
Per Share............. $_______ $_______ $_________ $_________
- ------------------------------------------------------------------------------------------------------------------------------
Total (4)............. $_______ $_______ $_________ $_________
==============================================================================================================================
</TABLE>
______________
(1) See "Underwriting" for indemnification arrangements with the Managers
and the U.S. Underwriters.
(2) Before deducting expenses payable by the Company, estimated at $__________.
(3) Before deduction of $________ ($______ per share) to be paid to the Company
upon the exercise of a warrant relating to shares to be sold by one of the
Selling Shareholders.
(4) The Company has granted the Managers and the U.S. Underwriters 30-day
options to purchase in the aggregate up to _________ additional Shares of
Common Stock solely to cover over-allotments, if any. If the options are
exercised in full, the total Price to Public, Underwriting Discounts and
Commissions, and Proceeds to Company will be $_________, $__________, and
$_________, respectively. See "Underwriting."
__________________
The International Shares are offered by the several Managers, subject to
prior sale, when, as and if delivered to and accepted by them and subject to
certain conditions, including the approval of certain legal matters by counsel.
The Managers reserve the right to withdraw, cancel or modify the International
Offering and to reject orders in whole or in part. It is expected that the
delivery of the International Shares will be made against payment therefor on or
about ________, 1996, at the offices of Bear, Stearns & Co. Inc., 245 Park
Avenue, New York, New York 10167.
__________________
BEAR, STEARNS INTERNATIONAL LIMITED SALOMON BROTHERS INTERNATIONAL LIMITED
___________, 1996
<PAGE>
================================================================================
NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFER CONTAINED HEREIN AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY, ANY SELLING SHAREHOLDER, ANY UNDERWRITER OR ANY OTHER PERSON.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY, ANY SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT
RELATES, OR AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY, TO ANYONE IN
ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN
WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR
TO ANYONE TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE
DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
_________________
TABLE OF CONTENTS
[Alternate Page for International Prospectus]
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.............................................................
Risk Factors...................................................................
Use of Proceeds................................................................
Dividend Policy................................................................
Dilution.......................................................................
Capitalization.................................................................
Selected Consolidated Historical and Pro Forma Financial Data..................
Pro Forma Consolidated Financial Statements....................................
Management's Discussion and Analysis of Financial Condition and Results
of Operations.............................................................
Business.......................................................................
Management.....................................................................
Certain Transactions...........................................................
Principal and Selling Shareholders.............................................
Description of Capital Stock...................................................
Shares Eligible for Future Sale................................................
Certain United States Federal Tax Considerations for Non-U.S.
Holders of Common Stock...................................................
Underwriting...................................................................
Legal Matters..................................................................
Experts........................................................................
Available Information..........................................................
Index to Consolidated Financial Statements.................................. F-1
</TABLE>
_________________
UNTIL ____________, 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY
REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
================================================================================
_________ SHARES
[LOGO]
COMMON STOCK
_____________
PROSPECTUS
_____________
BEAR, STEARNS INTERNATIONAL
LIMITED
SALOMON BROTHERS INTERNATIONAL
LIMITED
________, 1996
================================================================================
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
--------------------------------------
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
-------------------------------------------
The table below sets forth the expenses to be incurred by the Company in
connection with the issuance and distribution of the shares registered for offer
and sale hereby, other than underwriting discounts and commissions. All amounts
shown represent estimates except the Securities Act registration fee and the
NASD filing fee.
<TABLE>
<S> <C>
Registration fee under the Securities Act of 1933 $ 62,358
NASD filing fee ______
New York Stock Exchange listing fee ______
Printing expenses *
Registrar and Transfer Agent's fees and expenses *
Accountants' fees and expenses *
Legal fees and expenses (not including Blue Sky) *
Blue Sky fees and expenses *
Miscellaneous *
______
Total $ *
======
</TABLE>
_______
* To be completed by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
-----------------------------------------
Article 10 of the Virginia Stock Corporation Act allows, in general, for
indemnification, in certain circumstances, by a corporation of any person
threatened with or made a party to any action, suit, or proceeding by reason of
the fact that he or she is, or was, a director, officer, employee, or agent of
such corporation. Indemnification is also authorized with respect to a criminal
action or proceeding where the person had no reasonable cause to believe that
his conduct was unlawful. Article 9 of the Virginia Stock Corporation Act
provides limitations on damages payable by officers and directors, except in
cases of willful misconduct or knowing violation of criminal law or any federal
or state securities law.
The Company's Articles of Incorporation provide for mandatory
indemnification of its directors and officers against liability incurred by them
in proceedings instituted or threatened against them by third parties, or by or
on behalf of the Registrant itself, relating to the manner in which they
performed their duties unless they have been guilty of willful misconduct or a
knowing violation of the criminal law.
II-1
<PAGE>
In the U.S. Underwriting Agreement and International Underwriting
Agreement, proposed forms of which have been filed as Exhibits 1.1 and 1.2
hereto, respectively, the U.S. Underwriters and Managers will agree to
indemnify, under certain conditions, the Registrant's officers, directors and
controlling persons against certain liabilities, including liabilities under the
Securities Act of 1933.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
---------------------------------------
In connection with the organization of the Company, 1 share of the
Company's Common Stock was issued to Henry G. Luken, III, 1.14 shares were
issued to Donald A. Burns, and .86 shares were issued to Walter C. Anderson on
August 15, 1993.
On November 9, 1993, an additional 1,580.75, 1,803.86 and 1,362.39 shares
of the Company's Common Stock were issued to Mr. Luken, Mr. Burns and
Mr. Anderson, respectively.
On July 20, 1994, the Company reacquired 13,633 shares of its Common Stock
from Mr. Anderson for $25,000. On July 25, 1994, the Company issued 15,224.50
shares of its Common Stock to Iceberg Transport, S.A., a Panamanian corporation,
in a private placement for $50,000.
On July 1, 1994, the Company declared a 10-for-1 stock split and issued
additional shares of Common Stock to Mr. Burns, Mr. Luken and Mr. Anderson,
increasing their holdings to 18,050, 15,318 and 13,633 shares of Common Stock,
respectively.
On July 1, 1994 options for 1,467.5 shares of Common Stock were granted to
Mr. Rachlin, at an exercise price of $131.08 per share.
On November 30, 1994 options for 1,876 shares were issued to Ms. Marine-
Street at an exercise price of $746.42 per share.
On December 30, 1994 options for 500 shares were issued to Mr. Stodter at
an exercise price of $784.13 per share.
On September 1, 1995 options for 500 shares were issued to Ms. Anastasi at
an exercise price of $1374.82 per share.
On June 27, 1994 a warrant to purchase 1,174 shares at a nominal exercise
price was issued to Signet Media Capital Group.
On April 4, 1996, options to acquire 2,500 shares were issued to Mr.
Canton at an exercise price of $3,200 per share.
On March 19, 1996, options to acquire 1,000 shares were issued to Mr.
Merrick at an exercise price of $3,200 per share.
On May 3, 1996, the number of shares subject to the warrant previously
issued to Signet Media Capital Group was adjusted to 1,255.
II-2
<PAGE>
On April 1, 1996, Bonita Anderson, James Sznajder, Dennis Jarman and Bryan
Rachlin exchanged their options in Long Distance Wholesale Club for options the
acquire 60.025, 120.05, 200.511, and 240.1 shares of Common Stock, respectively,
under the Company's Stock Option Plan.
On ___________, 1996, the Company declared a 425-for-1 stock split.
Accordingly, the foregoing share amounts in this Item 15 are on a pre-stock
split basis.
Each issuance of securities described above was made in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act as a
transaction by an issuer not involving any public offering. The recipients of
securities in each such transaction represented their intention to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof and appropriate legends were affixed to the share
certificates issued in such transactions. All recipients had adequate access,
through their relationships with the Company, to information about the Company.
ITEM 16(A). EXHIBITS.
--------
<TABLE>
<CAPTION>
Exhibit Sequentially
Number Description Numbered Page
- ------ ----------- -------------
<S> <C> <C>
*1.1 Form of U.S Underwriting Agreement
*1.2 Form of International Underwriting Agreement
*2.1 Tel Labs, Inc. Share Exchange Agreement
*2.2 Long Distance Wholesale Club, Inc. Merger Agreement
*3.1 Restated Articles of Incorporation of Telco
Communications Group, Inc.
*3.2 Amended and Restated Bylaws of Telco Communications
Group, Inc.
*4.1 Form of Common Stock Certificate of Telco
Communications Group, Inc.
*5.1 Opinion of Swidler & Berlin, Chartered
*10.1 Agreement for the Provision of Billing and Collection
Services between Telco Development Group of Delaware,
Inc. and the Ameritech Companies dated July 1, 1995
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
Exhibit Sequentially
Number Description Numbered Page
- ------ ----------- -------------
<S> <C> <C>
*10.2 Agreement for the Provision of Billing and Collection
Services between the Bell Atlantic Operating Telephone
Companies and Telco Development Group, Inc. dated
June 10, 1994
*10.3 Clearinghouse Billing and Collection Services Operating
Contract between Telco Development Group, Inc. and
Bell South Communications dated January 3, 1994
*10.4 Transition Billing and Collection Agreement between
Citizens Utilities Company and Telco Development
Group of Delaware, Inc. dated June 15, 1995
*10.5 Agreement for Billing Services by Tel Labs, Inc. and
Esprit Telecom dated December 14, 1995
*10.6 Agreement for Billing Services by Tel Labs, Inc. and
Long Distance Wholesale Club, Inc. dated July 21, 1995
*10.7 One Plus Billing & Information Management Services
Agreement between Long Distance Wholesale Club, Inc.,
and Telco Development Group of Delaware, Inc. dated
January 23, 1996
*10.8 Agreement between Nevada Bell and Telco Development
Group of Delaware, Inc. for Billing and Collection
Service dated September 3, 1995
*10.9 Agreement for Interstate Billing and Collection Services
Agreement between New England Telephone and
Telegraph Company and Telco Development Group of
Delaware, Inc. dated July 31, 1995
*10.10 Agreement for Interstate Billing and Collection Services
between New York Telephone Company and Telco
Development Group of Delaware, Inc. dated July 31,
1995
*10.11 Agreement for the Provision of Billing and Collection
Services between Pacific Bell and Telco Development
Group of Delaware, Inc.
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
Exhibit Sequentially
Number Description Numbered Page
- ------ ----------- -------------
<S> <C> <C>
*10.12 Casual Billing Services Agreement between the Southern
New England Telephone Company and Telco
Development Group of Delaware, Inc. dated February 9,
1996.
*10.13 Agreement for the Provision of Billing and Collection
Services between Southwestern Bell Telephone Company
and Telco Development Group of Delaware, Inc. dated
December 16, 1994; and Amendment to the Agreement
for the Provision of Billing and Collection Services
between Southwestern Bell Telephone Company and
Telco Development Group of Delaware, Inc. dated
December 19, 1994
*10.14 One Plus Billing and Information Management Services
Agreement between Telco Development Group of
Delaware, Inc. and Telco Communications Group dated
December 30, 1995
*10.15 Agreement for Billing Services by Tel Labs, Inc. and
Telco Communications Group, Inc. (undated)
*10.16 Agreement for the Provision of Billing and Collection
Services for Clearing Agents between U.S. West and
Telco Development Group of Delaware, Inc. dated April
1, 1995
*10.17 Standard Agreement for the Provision of Billing and
Collection Services between United Telephone Company
of Florida and Telco Development Group, Inc. dated
October 19, 1994
*10.18 Letter Agreement for Services Provided between Telco
Development Group, Inc. and Telco Communications
Group, Inc. dated December 30, 1994
*10.19 Communication Services Agreement (contract Tariff No.
14 Order) between AT&T and Telco Communications
Group, Inc. dated October 25, 1995 (AT&T has not
executed this agreement)
*10.20 Service Agreement between IXC Carrier, Inc. and Telco
Communication Group, Inc. dated December 15, 1995
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
Exhibit Sequentially
Number Description Numbered Page
----- ----------- -------------
<S> <C> <C>
*10.21 Telco Communications Group, Inc. Wholesale Customer
Agreement for Special International Pricing with Esprit
Telecom dated February 21, 1996.
*10.22 Amended and Restated 1994 Stock Plan
*10.23 Lease Agreement between CPL Properties and Telco
Communications Group, Inc. effective March 1, 1995
(Davenport, Iowa Switch Site)
*10.24 Lease Agreement between Thomas Kurschner and Telco
Communications Group, Inc. effective November 2, 1995
(Las Vegas, Nevada Switch Site)
*10.25 Deed of Lease Agreement between Bricks in the Sticks,
Ltd. and Telco Communications Group, Inc. effective
March 1, 1995 (Chattanooga, Tennessee Switch Site).
*10.26 Lease Agreement between The University of Texas
System and Telco Communications Group, Inc. effective
August 22, 1994 (Austin, Texas Switch Site)
*10.27 Agreement of Lease between 13th and L Associates and
Telco Communications Group, Inc. effective August 25,
1994 (Washington, DC Switch Site)
*10.28 Deed of Lease agreement between Bricks in the Sticks,
Ltd. and Tel Labs, Inc. effective July 1, 1994 (Corporate
Office)
*10.29 Deed of Lease Agreement between Bricks in the Sticks,
Ltd. and Telco Communications Group, Inc. effective
March 1, 1995 (Corporate Office)
*10.30 Master Lease Agreement between Telco Communications
Group, Inc. and Dana Commercial Credit Corporation
dated September 14, 1995; Addendum to the Master
Lease Agreement dated September 15, 1995; and Lease
Schedules 001 and 002.
*10.31 Equipment Lease between DGI Technologies, Inc. and
Telco Communications Group, dated October 1, 1994
</TABLE>
II-6
<PAGE>
<TABLE>
<CAPTION>
Exhibit Sequentially
Number Description Numbered Page
------ ----------- -------------
<S> <C> <C>
*10.32 Equipment Leases between DSC Finance Corporation and
Telco Communications Group, Inc. (Master Lease dated
1/1/94 and Schedules A-P1)
*10.33 Credit Agreement between Telco Communications
Group, Incorporated, Signet Bank and the Banks listed
therein, dated as of January 24, 1996
*10.34 Employment Contract with Donald A. Burns
*10.35 Employment Contract with Thomas J. Cirrito
*10.36 Employment and Stock Option Agreement with Stephen
G. Canton
*10.37 Employment Contract with Bryan K. Rachlin
*10.38 Employment Contract with Nicholas A. Merrick
*10.39 Employment Contract with Janet D. Anastasi
*10.40 Employment Contract with Natalie Marine-Street
*10.41 Employment Contract with Mark J. Stodter
*10.42 Employment Agreement with Henry G. Luken, III
*11.1 Statement Regarding Computation of Per Share Earnings
*21.1 Subsidiaries of Telco Communications Group, Inc.
23.1 Consent of Chase and Associates CPAs, PC
23.2 Consent of Deloitte & Touche LLP
*23.3 Consent of Swidler & Berlin, Chartered (to be included in
Exhibit 5.1 to this Registration Statement)
24.1 Power of Attorney (included on signature page)
</TABLE>
___________
* To be filed by amendment.
Item 16(b). Financial Statement Schedules.
-----------------------------
None.
II-7
<PAGE>
ITEM 17. UNDERTAKINGS.
------------
The undersigned Registrant hereby 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.
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 Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be deemed
to be a new Registration Statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
II-8
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Chantilly, Commonwealth
of Virginia, on June 12, 1996.
TELCO COMMUNICATIONS GROUP, INC.
By: __________________________
Donald A. Burns
President and Chief Executive Officer
POWER OF ATTORNEY
-----------------
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Donald A. Burns and Bryan K.
Rachlin, and each of them, acting individually, as his attorneys-in-fact and
agents, each with full power of substitution and resubstitution, for him in his
name, place and stead, in any and all capacities, to sign any and all amendments
(including post-effective amendments) to this Registration Statement, and to
file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, 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 agents, or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities indicated on June 12, 1996.
Signature Title
--------- -----
______________________ Chairman of the Board and Director
Henry G. Luken, III
______________________ Vice Chairman of the Board, President, Chief
Donald A. Burns Executive Officer and Director (Principal
Executive Officer)
______________________ President of Consumer Division
Thomas J. Cirrito and Director
<PAGE>
______________________ Director
Robert W. Ross
______________________ Chief Financial Officer and Treasurer
Nicholas A. Merrick (Principal Financial Officer)
______________________ Vice President and Corporate Controller
Janet D. Anastasi (Principal Accounting Officer)
