<PAGE>
PROSPECTUS
5,500,000 SHARES
[LOGO OF TELCO COMMUNICATIONS GROUP APPEARS HERE]
COMMON STOCK
---------------
Of the 5,500,000 shares (the "Shares") of Common Stock offered hereby,
3,856,000 shares will be sold by Telco Communications Group, Inc. ("Telco" or
the "Company") and 1,644,000 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 4,400,000 shares (the "U.S. Shares") are being offered in the
United States and Canada (the "U.S. Offering") by the U.S. Underwriters and
1,100,000 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. See "Underwriting" for a discussion of the factors considered in
determining the initial public offering price.
The Common Stock has been approved for trading on the Nasdaq National Market
under the symbol "TCGX."
---------------
SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR A DISCUSSION OFCERTAIN RISKS
ASSOCIATED WITH AN INVESTMENT IN THE SHARES.
---------------
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>
UNDERWRITING PROCEEDS TO
PRICE TO DISCOUNTS AND PROCEEDS SELLING
PUBLIC COMMISSIONS(1) TO COMPANY(2) SHAREHOLDERS(2)
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share....... $14.00 $0.95 $13.05 $13.05
- ------------------------------------------------------------------------------
Total (3)....... $77,000,000 $5,197,500 $50,340,080 $21,462,420
</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
$1,321,000.
(3) The Company has granted the U.S. Underwriters and the Managers 30-day
options to purchase in the aggregate up to 825,000 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 $88,550,000, $5,977,125, and
$61,110,455, 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 August 14, 1996, at the offices of Bear, Stearns & Co. Inc., 245 Park
Avenue, New York, New York 10167.
---------------
BEAR, STEARNS & CO. INC. SALOMON BROTHERS INC
AUGUST 9, 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 NASDAQ NATIONAL MARKET OR
OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
2
<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 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 to occur immediately prior to the consummation of the Offerings
(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. Substantially all 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 May 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
inbound telesales and marketing, 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 aggressive
"win-back" and other customer acquisition programs prevalent in the residential
long distance market have a limited impact on the Company's business. See "Risk
Factors--Response Rates; Customer Attrition."
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 entered into billing and collection 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 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 May 1996, Tel Labs processed
approximately 98 million call records for 17 telecommunications companies,
including Telco. Concurrently with the completion of the Offerings, Telco will
acquire all of the outstanding
3
<PAGE>
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 the
Company's current calls are handled during off-peak evening and weekend
periods.
The Company's switch-based network currently consists of six 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 one DEX 600E switch which recently became operational in
Las Vegas, Nevada. Additionally, the Company has made a committment to install
a DEX 600E switch in the New York City metropolitan 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
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 increase the number
of 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 20151, 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.................. 3,084,800 shares
International Offering......... 771,200 shares
-----------------
Total........................ 3,856,000 shares
Common Stock to be sold by Selling Shareholders(1):
U.S. Offering.................. 1,315,200 shares
International Offering......... 328,800 shares
-----------------
Total........................ 1,644,000 shares
Common Stock to be Outstanding
after the Offerings............. 31,929,869 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.
Nasdaq National Market Symbol.... TCGX
</TABLE>
- --------
(1) Includes 636,158 shares to be sold by one of the Selling Shareholders,
Signet Media Capital Group, which will be purchased by it immediately prior
to sale in the Offerings through the exercise in full of an outstanding
warrant to purchase such shares for a nominal exercise price (the "Signet
Warrant"). See "Description of Capital Stock--The Signet Warrant."
(2) Includes 593,334 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 the 5,102,125 shares of Common Stock which were
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." Also includes 649,198 shares of Common Stock issued
pursuant to the exercise of options on June 21, 1996 at a weighted average
exercise price of $0.44 per share, 59,378 shares of Common Stock to be
issued pursuant to options that will be exercised concurrently with the
Offerings at a weighted average exercise price of $2.12 per share and
169,575 shares to be issued concurrently with the consummation of the
Offerings upon the exercise of options by Natalie J. Marine-Street at an
exercise price of $1.76 per share (which shares will not be sold in the
Offerings). Excludes 2,747,178 shares of Common Stock issuable upon the
exercise of currently outstanding options of which options for 1,057,781
shares of Common Stock are currently exercisable. Immediately prior to the
Offerings, the Company intends to grant to certain non-executive employees
options to purchase up to an aggregate of 625,000 shares of Common Stock at
an exercise price equal to the initial public offering price per share,
which options will vest in one-third increments on the first, second and
third anniversaries of the date of grant. See "Description of Capital
Stock--Stock Option Plan" and "Management--Amended and Restated 1994 Stock
Option Plan."
5
<PAGE>
SUMMARY CONSOLIDATED HISTORICAL AND PRO FORMA FINANCIAL DATA
<TABLE>
<CAPTION>
PERIOD FROM YEAR ENDED DECEMBER 31, THREE MONTHS ENDED MARCH 31,
INCEPTION(1) ------------------------------ ----------------------------
THROUGH HISTORICAL PRO FORMA, HISTORICAL PRO FORMA,
DECEMBER 31, ----------------- AS ADJUSTED ---------------- AS ADJUSTED
1993 1994 1995 1995(2) 1995 1996 1996(2)
------------ ------- --------- ----------- ------- -------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND PER MINUTE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues, net........... $ 1,135 $44,707 $ 215,376 $217,011 $45,277 $ 91,928 $ 92,392
Cost of services....... 993 27,736 133,728 134,384 28,079 54,730 55,005
Gross margin............ 142 16,971 81,648 82,627 17,198 37,198 37,387
Selling, general and
administrative........ 1,310 12,018 55,936 56,118 10,186 27,863 27,605
Depreciation and
amortization.......... 54 496 3,326 4,943 452 1,433 1,840
Operating income
(loss)................. (1,222) 4,457 22,386 21,566 6,560 7,902 7,942
Interest expense....... 25 897 2,952 -- 591 1,066 47
Other income
(expense)............. -- 15 (92) (68) 4 13 57
Provision for income
taxes................. -- 1,432 7,531 9,046 2,326 3,135 3,722
Minority interest...... -- 137 1,046 -- 109 433 --
Net income (loss)....... $(1,247) $ 2,006 $ 10,765 $ 12,452 3,538 3,281 4,230
Net income (loss) per
share(3)(4)............ $ (0.05) $ 0.07 $ 0.38 $ 0.38 $ 0.13 $ 0.12 $ 0.13
Weighted average number
of shares outstanding
(in thousands)(3)(4)... 26,077 26,884 28,285 32,734 28,275 28,345 32,795
BALANCE SHEET DATA (AT
PERIOD END):
Cash and cash
equivalents............ $ 140 $ 475 $ 937 $ 1,300 $ 1,887
Total assets............ 2,051 33,533 87,124 108,928 154,521
Total debt (including
capital lease
obligations)........... 1,559 18,884 44,410 54,437 5,418
Minority interest....... -- 137 1,183 1,617 --
Shareholders' equity
(deficit).............. (376) 1,655 12,420 15,701 111,475
OTHER OPERATING DATA:
Minutes of use (in
thousands)(5).......... 1,384,300 653,123
Revenue per minute of
use(6)................. $ 0.156 $ 0.141
Cost of services per
minute of use(7)....... $ 0.097 $ 0.084
</TABLE>
- --------
(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) Historical net income per share and weighted average number of shares
outstanding give effect to the 425-for-1 stock split, an offering price of
$14 per share, which price is used to measure the potentially dilutive
effect of options granted since June 13, 1995, and the issuance of
5,102,125 shares of Common Stock in connection with the acquisition of all
outstanding shares of LDWC (excluding shares held by the Company). The
consolidated financial statements of the Company included elsewhere in this
document assume an offering price of $15. See "Description of Capital
Stock--Stock Option Plan" and "Management--Amended and Restated 1994 Stock
Option Plan."
(4) The net proceeds from the sale of approximately 3,856,000 shares of Common
Stock offered by the Company hereby will be used to repay certain
indebtedness. Pro forma as adjusted net income per share is calculated
assuming that these shares had been issued and the indebtedness repaid as
of the beginning of the period. Pro Forma as adjusted net income per share
also reflects the issuance of 593,334 shares of Common Stock in connection
with the acquisition of all outstanding shares of Tel Labs. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--The Reorganization."
(5) Represents billed minutes during the period indicated.
(6) Represents revenues, net, per minute of use for the period divided by
minutes of use for the period.
(7) Represents cost of services for the period divided by minutes of use for
the period.
6
<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 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
7
<PAGE>
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 the 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, MCI and Sprint 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 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. 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
8
<PAGE>
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 "--Recent Rapid Growth; 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 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 12 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
9
<PAGE>
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 target 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--Overview."
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 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
10
<PAGE>
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 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
Company does not carry key man life insurance on any of such executives or
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 63%
of the then outstanding Common Stock (approximately 62% 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 Restated Articles of Incorporation (the
"Articles"), 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," "Principal and Selling Shareholders"
and "Description of Capital Stock--Certain Provisions of the Company's
Articles and Bylaws."
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 acquisitions of LDWC and 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
11
<PAGE>
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 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 and Amended and Restated Bylaws (the "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 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, no par value per share (the
"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," "--Certain Provisions of the Company's Articles and Bylaws," and "--
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 Common Stock has been approved for trading on the Nasdaq
National Market, 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
12
<PAGE>
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 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, Rule 144
under the Securities Act of 1933, as amended (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 outstanding
31,929,869 shares of Common Stock and 2,747,178 shares of Common Stock subject
to stock options granted under the Company's 1994 Amended and Restated Stock
Option Plan (the "Stock Option Plan"). Of such outstanding shares, the
5,500,000 shares of Common Stock to be sold in the Offerings (together with
any shares sold upon exercise of the U.S. Underwriters' and Managers' over-
allotment options) will be freely tradeable without restriction or further
registration under the Securities Act, except for any shares held by
"affiliates" of the Company. The remaining 26,429,869 outstanding shares of
Common Stock will be deemed "restricted securities" under the Securities Act
and will be available for public sale if such shares are registered under the
Securities Act or sold in compliance with Rule 144. Of such restricted
securities, 24,978,512 shares are held by "affiliates" of the Company and will
be eligible (subject to the 180-day lock-up described below) for sale after
the Offerings in the public market pursuant to, and in accordance with the
volume, manner of sale and other conditions of Rule 144. The Securities and
Exchange Commission (the "Commission") has recently proposed amendments to
Rule 144 that would shorten by one year the holding periods applicable to
restricted securities, which could result in resales of the 1,451,357
restricted securities held by non-affiliates of the Company sooner than would
be the case under Rule 144 as currently in effect. Certain shareholders have
registration rights with respect to 25,975,211 shares of Common Stock which
are restricted securities. See "Shares Eligible for Future Sale."
Immediately prior to the Offerings, the Company intends to grant options
pursuant to the Stock Option Plan to purchase up to an aggregate of 625,000
shares of Common Stock to certain non-executive employees of the Company's
Commercial Division. The options will be exercisable at the initial public
offering price of the Common Stock per share and will vest in one-third
increments on the first, second and third anniversaries of the date of grant.
The Company, its executive officers and directors and the Selling
Shareholders who continue to own shares upon completion of the Offerings 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, exchangeable for or 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 Stock Option Plan.
As a result, any shares issued upon exercise of outstanding options will be
eligible for sale in
13
<PAGE>
the public market beginning on the effective date of such registration
statement, other than shares acquired by individuals subject to the foregoing
lock-up. See "Shares Eligible for Future Sale" and "Management--Amended and
Restated 1994 Stock Option Plan."
RECENT DEVELOPMENTS
RESULTS FOR THE THREE MONTHS ENDED JUNE 30, 1996
Set forth below is a summary of the Company's results of operations for the
three months ended June 30, 1996. This summary should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations".
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
HISTORICAL
----------------------
1995 1996
----------------------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues, net........................................... $ 47,318 $ 104,078
Cost of services...................................... 28,416 60,802
Gross margin............................................ 18,902 43,276
Selling, general and administrative expenses.......... 11,691 31,539
Depreciation and amortization......................... 540 1,872
Operating income........................................ 6,670 9,865
Interest expense........................................ 542 1,122
Other income............................................ 4 105
Provision for income taxes.............................. 2,388 3,542
Minority interest....................................... 9 120
Net income.............................................. 3,735 5,186
Net income per share.................................... $ 0.13 $ 0.18
Weighted average number of shares outstanding........... 28,277 28,345
</TABLE>
<TABLE>
<CAPTION>
AT
JUNE 30, 1996
-------------
(DOLLARS IN
THOUSANDS)
<S> <C>
BALANCE SHEET DATA:
Cash and cash equivalents......................................... $ 7,500
Total assets...................................................... 166,481
Total debt (including capital lease obligations).................. 62,184
Minority interest................................................. 983
Shareholders' equity.............................................. 60,790
</TABLE>
USE OF PROCEEDS
The net proceeds to the Company from the Offerings are estimated to be
approximately $49.0 million ($59.8 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 amounts under the
Company's capital lease obligations (approximately $19.6 million as of July
31, 1996). The remaining proceeds are expected to be used to repay outstanding
indebtedness under the Company's revolving credit facility with Signet Bank,
as administrative agent (the "Credit Facility"). The Credit Facility, which
expires on January 24, 1998, bears interest at a floating rate, based on
LIBOR, which was approximately 7.7% at July 31, 1996. As of July 31, 1996,
approximately $34.7 million of indebtedness was outstanding under the Credit
Facility. See
14
<PAGE>
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." The remaining amounts under the Company's Credit Facility
(approximately $5.3 million as of July 31, 1996) are intended to be repaid
using available cash. The Company will also receive de minimis proceeds upon
the exercise of the Signet Warrant by one of the Selling Shareholders and
approximately $125,875 upon the exercise by certain other Selling Shareholders
of options with respect to 59,378 shares of Common Stock concurrently with the
Offerings, which shares will be sold in the Offerings. Such proceeds will be
used for working capital and general corporate purposes. The Company has no
current pending acquisitions and is not currently engaged in negotiations with
respect to any potential acquisitions, other than the acquisition of Tel Labs
in the Reorganization. See "Management--Amended and Restated 1994 Stock Option
Plan," "Certain Transactions--Loans to Certain Executive Officers" and
"Principal and Selling Shareholders." 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."
15
<PAGE>
DILUTION
The Company's pro forma net tangible book value as of March 31, 1996 would
have been $18.8 million, or $0.69 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, the exercise of the Signet Warrant for 636,158 shares of
Common Stock, and the exercise of options for 59,378 shares of Common Stock
concurrently with the Offerings. After giving effect to the sale by the
Company of the 3,856,000 shares of Common Stock offered hereby (at a public
offering price of $14 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 the
Company's pro forma net tangible book value as of March 31, 1996 would have
been $67.8 million, or $2.18 per share of Common Stock. This represents an
immediate increase in net tangible book value of $1.49 per share to existing
shareholders and an immediate dilution in net tangible book value of $11.82
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>
Public offering price per share............................. $14.00
------
Pro forma net tangible book value per share at March 31,
1996..................................................... $0.69
Increase in net tangible book value attributable to new
investors.................................................. $1.49
-----
Pro forma net tangible book value per share after giving
effect to the Offerings.................................... $ 2.18
------
Dilution per share to new investors......................... $11.82
======
</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>
SHARES AVERAGE
PURCHASED TOTAL CONSIDERATION PRICE
------------------ -------------------- PER
NUMBER PERCENT AMOUNT PERCENT SHARE
---------- ------- ------------ ------- -------
<S> <C> <C> <C> <C> <C>
Existing shareholders........... 27,255,095 87.6% $ 47,650,896 46.9% $ 1.75
New investors................... 3,856,000 12.4% 53,984,000 53.1% 14.00
---------- ----- ------------ -----
Total......................... 31,111,095 100% $101,634,896 100% $ 3.27
========== ===== ============ =====
</TABLE>
The information in the table above excludes the effect of options to
purchase 2,747,178 shares of Common Stock outstanding at July 11, 1996, at
exercise prices ranging from $0.67 to $7.53 per share with a weighted average
exercise price of $5.02 per share and excludes the exercise of options to
purchase 649,198 shares of Common Stock on June 21, 1996 at a weighted average
exercise price of $.44 and the exercise of options to acquire 169,575 shares
of Common Stock concurrently with the Offerings at an exercise price of $1.76
per share, which shares are not being sold in the Offerings. The exercise of
any of the outstanding options to purchase 912,181 shares with exercise prices
of less than $2.18 would result in additional dilution to new investors. In
addition, the Company intends to grant, immediately prior to the Offerings,
options to purchase up to an aggregate of 625,000 shares of Common Stock under
the Stock Option Plan at an exercise price equal to the initial public
offering price per share. See "Management--Executive Compensation" and "--
Amended and Restated 1994 Stock Option Plan," "Shares Eligible for Future
Sale" and "Principal and Selling Shareholders."
16
<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 3,856,000 shares
of Common Stock in the Offerings (at a public offering price of $14 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.
<TABLE>
<CAPTION>
AS OF MARCH 31, 1996
---------------------------------
PRO FORMA
HISTORICAL PRO FORMA AS ADJUSTED
---------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Cash and cash equivalents................. $ 1,300 $ 1,887 $ 1,887
======= ======== ========
Current portion of capital lease
obligations.............................. $ 3,163 $ 3,163 $ --
Long-term debt, net of current portion:
Credit Facility(1)...................... 38,634 $ 38,634 $ 5,418
Capital lease obligations(1)............ 12,640 $ 12,640 $ --
------- -------- --------
Total long-term debt...................... 51,274 51,274 5,418
Shareholders' equity:
Preferred Stock, no par value;
15,000,000 shares authorized; no shares
issued or outstanding, pro forma....... $ -- $ -- $ --
Common Stock, no par value; 150,000,000
shares authorized; 20,864,100 shares
issued and outstanding, historical;
27,255,095 issued and outstanding, pro
forma(2); 31,111,095 issued and
outstanding, pro forma as adjusted..... 896 47,651 96,670
Additional paid in capital--accumulated
deficit remaining upon termination of
S-corporation election................. (1,247) (1,247) (1,247)
Retained earnings......................... 16,052 16,052 16,052
------- -------- --------
Total shareholders' equity................ $15,701 $ 62,456 $111,475
======= ======== ========
Total capitalization.................. $70,138 $113,730 $116,893
======= ======== ========
</TABLE>
- --------
(1) At July 31, 1996, approximately $34.7 million was outstanding under the
Credit Facility and $19.6 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 $59.7 million of
availability under the Credit Facility which can be borrowed (subject to
borrowing base limitations) to finance working capital requirements and
for general corporate purposes.
(2) Excludes 2,747,178 shares of Common Stock issuable upon the exercise of
options outstanding on the date hereof at a weighted average exercise
price of $5.02 per share, the exercise of options to acquire 649,198
shares of Common Stock exercised on June 21, 1996, and the exercise of
options to acquire 169,575 shares of Common Stock concurrently with the
Offerings, which shares will not be sold in the Offerings. Includes
options outstanding on the date hereof with respect to 59,378 shares of
Common Stock which are expected to be exercised concurrently with the
Offerings at a weighted average exercise price of $2.12 per share and
636,158 shares of Common Stock issuable upon the exercise of the Signet
Warrant at a nominal exercise price. See "Management--Amended and Restated
1994 Stock Option Plan," "Principal and Selling Shareholders,"
"Description of Capital Stock--The Signet Warrant" and "--Stock Option
Plan."
17
<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."
<TABLE>
<CAPTION>
PERIOD FROM YEAR ENDED DECEMBER 31, THREE MONTHS ENDED MARCH 31,
INCEPTION(1) ------------------------------- ----------------------------
THROUGH HISTORICAL PRO FORMA, HISTORICAL PRO FORMA,
DECEMBER 31, ------------------ AS ADJUSTED ---------------- AS ADJUSTED
1993 1994 1995 1995 (2) 1995 1996 1996 (2)
------------ ------- ---------- ----------- ------- -------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND PER MINUTE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues, net........... $ 1,135 $44,707 $ 215,376 $217,011 $45,277 $ 91,928 $ 92,392
Cost of services....... 993 27,736 133,728 134,384 28,079 54,730 55,005
Gross margin............ 142 16,971 81,648 82,627 17,198 37,198 37,387
Selling, general and
administrative........ 1,310 12,018 55,936 56,118 10,186 27,863 27,605
Depreciation and amor-
tization.............. 54 496 3,326 4,943 452 1,433 1,840
Operating income
(loss)................. (1,222) 4,457 22,386 21,566 6,560 7,902 7,942
Interest expense....... 25 897 2,952 -- 591 1,066 47
Other income (ex-
pense)................ -- 15 (92) (68) 4 13 57
Provision for income
taxes................. -- 1,432 7,531 9,046 2,326 3,135 3,722
Minority interest...... -- 137 1,046 -- 109 433 --
Net income (loss)....... $(1,247) $ 2,006 $ 10,765 $ 12,452 $ 3,538 $ 3,281 $ 4,230
Net income (loss) per
share(3)(4)............ $ (0.05) $ 0.07 $ 0.38 $ 0.38 $ 0.13 $ 0.12 $ 0.13
Weighted average number
of shares outstanding
(in thousands)(3)(4)... 26,077 26,884 28,285 32,734 28,275 28,345 32,795
BALANCE SHEET DATA (AT
PERIOD END):
Cash and cash
equivalents............ $ 140 $ 475 $ 937 $ 1,300 $ 1,887
Total assets............ 2,051 33,533 87,124 108,928 154,521
Total debt (including
capital lease
obligations)........... 1,559 18,884 44,410 54,437 5,418
Minority interest....... -- 137 1,183 1,617 --
Shareholders' equity
(deficit).............. (376) 1,655 12,420 15,701 111,475
OTHER OPERATING DATA:
Minutes of use(in
thousands) (5)......... 1,384,300 653,123
Revenue per minute of
use(6)................. $ 0.156 $ 0.141
Cost of services per
minute of use(7)....... $ 0.097 $ 0.084
</TABLE>
- --------
(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) Historical net income per share and weighted average number of shares
outstanding give effect to the 425-for-1 stock split, an offering price of
$14 per share, which price is used to measure the potentially dilutive
effect of options granted since June 13, 1995, and the issuance of
5,102,125 shares of Common Stock in connection with the acquisition of all
outstanding shares of LDWC (excluding shares held by the Company). The
consolidated financial statements of the Company included elsewhere in
this document assume an offering price of $15. "Description of Capital
Stock--Stock Option Plan" and "Management--Amended and Restated 1994 Stock
Option Plan."
(4) The net proceeds from the sale of approximately 3,856,000 shares of Common
Stock offered by the Company hereby will be used to repay certain
indebtedness. Pro forma as adjusted net income per share is calculated
assuming that these shares had been issued and the indebtedness repaid as
of the beginning of the period. Pro Forma as adjusted net income per share
also reflects the issuance of 593,334 shares of Common Stock in connection
with the acquisition of all outstanding shares of Tel Labs. See
"Management's Discussion and Analysis of Financial Condition and Results
of Operations--The Reorganization."
(5) Represents billed minutes during the period indicated.
(6) Represents revenues, net, per minute of use for the period divided by
minutes of use for the period.
(7) Represents cost of services for the period divided by minutes of use for
the period.
18
<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 593,334 shares of the Company's Common Stock for a
total purchase price of $6,645,000. 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.
19
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
TELCO TEL LABS REORGANIZATION OFFERINGS PRO FORMA
HISTORICAL HISTORICAL ADJUSTMENTS PRO FORMA ADJUSTMENTS AS ADJUSTED
---------- ---------- -------------- --------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
Revenues, net........... $215,376 $2,895 $(1,260)(/1/) $217,011 $ -- $217,011
Cost of services........ 133,728 656 -- 134,384 -- 134,384
-------- ------ ------- -------- ------ --------
Gross margin.......... 81,648 2,239 (1,260) 82,627 -- 82,627
Operating expenses:
Selling, general and
administrative....... 55,936 1,442 (1,260)(/1/) 56,118 -- 56,118
Depreciation and
amortization......... 3,326 42 1,575 (/2/) 4,943 -- 4,943
-------- ------ ------- -------- ------ --------
Total operating
expenses............... 59,262 1,484 315 61,061 -- 61,061
-------- ------ ------- -------- ------ --------
Operating income........ 22,386 755 (1,575) 21,566 -- 21,566
Interest expense........ 2,952 -- -- 2,952 (2,952)(/4/) --
Other income (expense).. (92) 24 -- (68) -- (68)
Income taxes............ 7,531 327 -- 7,858 1,188 (/4/) 9,046
Minority interest....... 1,046 -- (1,046)(/3/) -- -- --
-------- ------ ------- -------- ------ --------
Net income.............. $ 10,765 $ 452 $ (529) $ 10,688 $1,764 $ 12,452
======== ====== ======= ======== ====== ========
Net income per
share(/1//1/).......... $ 0.38 n.m. n.m. $ 0.37 n.m. $ 0.38
Weighted average number
of
shares outstanding
(in
thousands)(/1//3/)..... 28,285 594 n.m. 28,879 3,856 32,735
</TABLE>
The accompanying notes to Unaudited Pro Forma Consolidated Financial Statements
are an integral part of these statements.
20
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1996
<TABLE>
<CAPTION>
TELCO TEL LABS REORGANIZATION OFFERINGS PRO FORMA
HISTORICAL HISTORICAL ADJUSTMENTS PRO FORMA ADJUSTMENTS AS ADJUSTED
---------- ---------- -------------- --------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
Revenues, net........... $91,928 $1,091 $(627)(/1/) $92,392 $ -- $92,392
Cost of services........ 54,730 275 -- 55,005 -- 55,005
------- ------ ----- ------- ------ -------
Gross margin.......... 37,198 816 (627) 37,387 -- 37,387
Operating expenses:
Selling, general and
administrative....... 27,863 369 (627)(/1/) 27,605 -- 27,605
Depreciation and
amortization......... 1,433 13 394 (/2/) 1,840 -- 1,840
------- ------ ----- ------- ------ -------
Total operating
expenses............... 29,296 382 (233) 29,445 -- 29,445
------- ------ ----- ------- ------ -------
Operating income
(loss)................. 7,902 434 (394) 7,942 -- 7,942
Interest expense........ 1,066 -- -- 1,066 (1,019)(/4/) 47
Other income (expense).. 13 44 -- 57 -- 57
Income taxes............ 3,135 179 -- 3,314 408 (/4/) 3,722
Minority interest....... 433 -- (433)(/3/) -- -- --
------- ------ ----- ------- ------ -------
Net income.............. $ 3,281 $ 299 $ 39 $ 3,619 $ 611 $ 4,230
======= ====== ===== ======= ====== =======
Net income per
share(/1//1/).......... $ 0.12 n.m. n.m. $ 0.12 n.m. $ 0.13
Weighted average number
of shares outstanding
(in thousands)(13)..... 28,345 594 n.m. 28,939 3,856 32,795
</TABLE>
The accompanying notes to Unaudited Pro Forma Consolidated Financial Statements
are an integral part of these statements.
21
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
AS OF MARCH 31, 1996
<TABLE>
<CAPTION>
TELCO TEL LABS REORGANIZATION Pro OFFERINGS PRO FORMA,
HISTORICAL HISTORICAL ADJUSTMENTS Forma/1//1/ ADJUSTMENTS/1//1/ AS ADJUSTED/1//1/
---------- ---------- -------------- ----------- ----------------- -----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Current Assets:
Cash.................. $ 1,300 $ 461 $ 126(/1//2/) $ 1,887 $ -- $ 1,887
Accounts receivable,
trade, net........... 75,999 402 -- 76,401 -- 76,401
Prepaid expenses...... 1,378 2 -- 1,380 -- 1,380
Deferred income tax
asset................ 697 -- -- 697 -- 697
Other................. 66 345 (211)(/5/) 200 -- 200
-------- ------ ------- -------- ------- --------
Total current
assets............. 79,440 1,210 (85) 80,565 -- 80,565
Property, Plant and
Equipment:
Leasehold
improvements......... 1,168 -- -- 1,168 -- 1,168
Network equipment..... 5,430 -- -- 5,430 19,291 24,721
Office furniture...... 2,194 268 -- 2,462 -- 2,462
Network equipment
under capital lease.. 19,291 -- -- 19,291 (19,291) --
Network facilities
under development.... 5,595 -- -- 5,595 -- 5,595
Accumulated
depreciation......... (4,886) (78) -- (4,964) -- (4,964)
-------- ------ ------- -------- ------- --------
Total property,
plant and
equipment.......... 28,792 190 -- 28,982 -- 28,982
Other Assets
(principally
goodwill).......... 696 583 39,041 (/7/) 44,974 -- 44,974
4,654 (/6/) --
-------- ------ ------- -------- ------- --------
Total Assets........ $108,928 $1,983 $43,610 $154,521 $ -- $154,521
======== ====== ======= ======== ======= ========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Current Liabilities:
Capital lease
obligations, current
portion.............. $ 3,163 $ -- $ -- $ 3,163 $(3,163)(9) $ --
Excise taxes payable.. 1,338 -- -- 1,338 -- 1,338
Accounts payable...... 12,812 37 -- 12,849 -- 12,849
Accrued network access
and transmission
expense.............. 12,605 -- -- 12,605 -- 12,605
Other accrued ex-
penses............... 6,333 315 -- 6,648 -- 6,648
Income taxes payable.. 2,394 187 -- 2,581 -- 2,581
Payable to related
parties.............. 280 -- (211)(5) 69 -- 69
-------- ------ ------- -------- ------- --------
Total current
liabilities........ 38,925 539 (211) 39,253 (3,163) 36,090
Long-Term Liabilities:
Long-term debt........ 38,634 -- -- 38,634 (33,216)(9) 5,418
Capital lease
obligations.......... 12,640 -- -- 12,640 (12,640)(9) --
Deferred income
taxes................ 1,411 127 -- 1,538 -- 1,538
-------- ------ ------- -------- ------- --------
Total long-term
liabilities........ 52,685 127 -- 52,812 (45,856) 6,956
-------- ------ ------- -------- ------- --------
Minority Interest....... 1,617 -- (1,617)(/3/)(/8/) -- -- --
Commitments and
Contingencies.......... -- -- -- -- -- --
Shareholders' Equity:
Common stock, no par.. 896 1 126(/1//2/) 47,651 49,019 (/1//0/) 96,670
39,984 (/7/)
6,645 (/6/)
(1)(6)
Additional paid in
capital-accumulated
deficit remaining
upon termination of
S-corporation
election............. (1,247) -- -- (1,247) -- (1,247)
Retained earnings..... 16,052 1,316 (1,316)(6) 16,052 -- 16,052
-------- ------ ------- -------- ------- --------
Total shareholders'
equity............. 15,701 1,317 45,438 62,456 49,019 111,475
-------- ------ ------- -------- ------- --------
Total Liabilities
and Shareholders'
Equity............. $108,928 $1,983 $43,610 $154,521 $ -- $154,521
======== ====== ======= ======== ======= ========
</TABLE>
The accompanying notes to Unaudited Pro Forma Consolidated Financial Statements
are an integral part of these statements.
22
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS:
(1) Reflects the elimination of intercompany revenues and expenses between
Telco and Tel Labs.
(2) Reflects the amortization of Tel Labs' identified intangibles over a
period of five years and goodwill with estimated lives of 15 and 35 years
for Tel Labs and LDWC, respectively.
(3) Reflects the elimination of minority interest in income of LDWC and Telco
Development Group of Delaware, Inc. (an 80% owned subsidiary of Telco).
The remaining 20% interest is owned by Tel Labs and will be acquired by
Telco in connection with the acquisition of Tel Labs in the
Reorganization.
(4) Reflects reduction of interest expense resulting from the repayment of
debt and capital lease obligations with proceeds from 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: 593,334 shares of Telco Common Stock................ $ 6,645
Fair value of net assets at March 31, 1996.......................... (1,991)
-------
Excess purchase price............................................... $ 4,654
=======
Estimated allocation:
Identified intangibles.............................................. $ 1,120
Goodwill and trained workforce...................................... 3,534
-------
$ 4,654
=======
</TABLE>
(7) Reflects the following pro forma adjustments associated with the purchase
of LDWC:
<TABLE>
<S> <C>
Purchase price: 5,102,125 shares of Telco 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 the 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. (an 80%
owned subsidiary of Telco). The remaining 20% interest is owned by Tel
Labs and will be acquired by Telco in connection with the acquisition of
Tel Labs in the Reorganization.
(9) Reflects the following application of net proceeds from the Offerings:
<TABLE>
<S> <C>
Offering proceeds................................................... $49,019
Retirement of long-term debt........................................ (33,216)
Retirement of capital lease obligations
Current portion................................................... (3,163)
Long-term portion................................................. (12,640)
-------
$ --
=======
</TABLE>
(10) Reflects net proceeds of $49,019 from the Offerings.
(11) Pro Forma, as Adjusted, net income per share is based on the weighted
average number of shares outstanding, adjusted to give pro forma effect
to the application of proceeds from the Company's sale of approximately
3,856,000 shares of Common Stock, to be used to repay certain
indebtedness therefrom and the issuance of 5,102,125 and 593,334 shares
of Common Stock to give effect to the Reorganization. Pro Forma net
income per share gives pro forma effect only to the Reorganization.
(12) Reflects proceeds of approximately $126,000 from the exercise of options
with respect to 59,378 shares of Common Stock to be exercised
concurrently with the Offerings at a weighted average exercise price of
$2.12 per share.
(13) Represents weighted average number of shares outstanding based on a 425-
for-1 stock split and an offering price of $14 per share in order to
measure the potentially dilutive effects of options granted since June
13, 1995.
23
<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 on
July 21, 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
that its recently deployed Las Vegas, Nevada, switch will expand the Company's
originating service area to an additional 10 contiguous states. Additionally,
the Company has made a commitment to install a DEX 600E switch in the New York
City metropolitan area during the first quarter of 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.
The Company's business and results of operations are significantly affected
by customer response rates to individual mailing campaigns, customer minute-
usage patterns and by customer attrition rates with respect to its mailing
campaigns shortly after such campaigns. The number of new customers who
utilize the Company's service in the near term period after a mailing defines
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. 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 " 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. The Company records an allowance for amounts which it
estimates will be unbillable or uncollectible, which allowance reduces gross
revenues. 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.
24
<PAGE>
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 May 31,
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. With 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 increase 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
related to casual calling in the period in which they are incurred.
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 its acquisition
of the remaining minority interest in LDWC. In addition, 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. 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, President of the Consumer
Division and a director of the Company, and two of his children. On 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 Henry G. Luken, III, the
Company's Chairman of the Board, Bryan K. Rachlin, the Company's Chief
Operating Officer, Secretary and General Counsel, 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 593,334 shares
of the Company's Common Stock. See "Certain Transactions--Tel Labs,"
"Management" and "Principal and Selling Shareholders."
25
<PAGE>
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 adminis-
trative...................... 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.
The Company expanded its mail marketing during the three months ended March
31, 1996 into areas served by the three switches deployed by the Company
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,
26
<PAGE>
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 $9.2 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 $0.9 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 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 and conducted 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.
27
<PAGE>
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 in 1995. This 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
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 55.0% 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 $16.9 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. This 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.
28
<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.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------
1994 1995 1996
---------------------------------- ---------------------------------- -------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH FIRST
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
------- ------- ------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT REVENUE AND COST OF SERVICES PER MINUTE OF USE
AND SELECTED DATA)
<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:
Minutes of use (1)..... 289,309 295,587 379,153 420,252 653,123
Revenue per minute of
use (2)............... $ 0.157 $ 0.160 $ 0.154 $ 0.153 $0.141
Cost of services per
minute of use (3)..... $ 0.097 $ 0.096 $ 0.096 $ 0.097 $0.084
</TABLE>
- --------
(1) Represents billed minutes during the period indicated.
(2) Represents revenues, net, per minute of use for the period divided by
minutes of use for the period.
(3) Represents cost of services for the period divided by minutes of use for
the period.
29
<PAGE>
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 a 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 $25.0 million to $65.0 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 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
30
<PAGE>
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 41%, 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 represented 46% 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 $7.0 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 $2.3 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.
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,
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 with Signet Bank, which
provided for borrowings of up to $8.0 million. In connection with the
establishment of this facility, the Company issued to Signet Media Capital
Group, a division of the lender, the Signet Warrant to acquire 2% of the
Common Stock of the Company. See "Shares Eligible for Future Sale" and
"Principal and Selling Shareholders." 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 July 31, 1996, approximately $34.7 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
31
<PAGE>
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 July 31,
1996 was approximately 7.7%. 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) equal to or greater
than 2 to 1 for any quarter ending on or before December 31, 1996 and 3.5 to 1
for any fiscal quarter ending after December 31, 1996, and (ii) a minimum
interest coverage ratio (consolidated adjusted cash flows to consolidated
interest expense which excludes mail marketing expenses) as of the last day of
each fiscal quarter 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.
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. Subsequently, LDWC issued a
convertible note to the Company 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 44.4% interest in
LDWC in exchange for the issuance of 5,102,125 shares of the Company's Common
Stock and will acquire all of the stock of Tel Labs in exchange for 593,334
shares of the Company's Common Stock. See "--The Reorganization," "Certain
Transactions--Long Distance Wholesale Club" and "--Tel Labs."
The Company expects to use the net proceeds from the Offerings to repay all
outstanding borrowings under the Credit Facility and outstanding amounts under
the Company's existing capital leases. The Company believes that 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 $14.1 million in capital expenditures (including
assets acquired under capital leases) which it intends to undertake for the
remainder of 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
32
<PAGE>
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.
NEW ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board issued the 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"
("SFAS 121"), 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 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" ("SFAS 123"), which establishes,
among other things, financial accounting and reporting standards for stock-
based employee compensation plans. Entities may either adopt a "fair value
based method" of accounting for an employee stock option as defined by SFAS
123 or may continue to use accounting methods as prescribed by APB (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees ("APB Opinion No.
25")." Entities electing to remain with APB Opinion No. 25 are required to
make pro forma disclosures of net income and earnings per share as if the fair
value based method of accounting defined in SFAS 123 had been applied. The
accounting requirements of SFAS 123 are effective for transactions entered
into in fiscal years that begin after December 15, 1995. The Company has
decided to continue to apply APB Opinion No. 25 for recognition and
measurement purposes and make appropriate disclosures in the future in
accordance with SFAS 123.
33
<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. Substantially all 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 May 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 inbound telesales and marketing, 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
aggressive "win-back" and other customer acquisition programs prevalent in the
residential long distance market have a limited impact on the Company's
business. See "Risk Factors--Response Rates; Customer Attrition."
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 May 1996, Tel Labs processed approximately 98 million call
records for 17 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 six DSC DEX 600S,
600 and 600E switches located in Washington, D.C.; Fort Lauderdale, Florida;
Davenport, Iowa; Chattanooga, Tennessee; and Austin, Texas with one DEX 600E
switch which recently became operational in Las Vegas, Nevada. Additionally,
the Company has made a commitment to install a DEX 600E switch in the New York
City metropolitan area during 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.
34
<PAGE>
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 $67.0
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 $43.0
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 interLATA 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
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 Code. 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 all three digit CIC Codes available for
assignment to carriers, 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
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tentatively proposed to expand codes from a three digit (XXX) to a four digit
(XXXX) format, with a transition period of six years, during which both
formats could be utilized. After expiration of the transition period, three
digit (XXX) CIC Codes, such as the 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. Under the
four digit format, customers will be required to dial a seven digit Carrier
Access Code ("CAC"), or 101XXXX. In contrast, customers currently dial a five
digit CAC (or 10XXX) to reach the Company's network. 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 available for assignment 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
four digit (XXXX) 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.
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 and the development of casual calling advertising targeting specific
affinity groups. 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 remailings in existing
territories. Where possible, the Company may also consider introducing its
casual calling services to consumers in foreign markets.
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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. A DEX 600E switch recently became
operational in Las Vegas, Nevada. Additionally, the Company has made a
commitment to install a DEX 600E switch in the New York City metropolitan area
during the first quarter of 1997. 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 May 1996, Tel Labs processed approximately 98 million call records for
17 telecommunications companies, including Telco. 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 expand 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 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 (LDWC's discount rates
vary with the distance of the telephone call, whereas Dial & Save's discount
rates do not), and marketing approach (in terms of size, content and color of
the mailings). The Company believes that its dual brand strategy responds to
the varying casual calling needs of potential customers. The Company also
believes that its dual brand strategy appeals to different segments of the
population by providing one segment of the population with LDWC's variable
percentage discount off basic direct dialed "1 plus" rates and another segment
of the population with Dial & Save's flat percentage discount off basic direct
dialed "1 plus" rates. 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
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 May 31, 1996. Customers who prefer to
access the
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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 mail
solicitation from the Company. 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
rates and to increase 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 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.
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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 provide local service using existing
telephone lines obtained from incumbent LECs, allowing customers to switch to
local service provided by the Company without changing the customer's existing
telephone numbers. Accordingly, as of July 12, 1996, the Company has filed
with 33 states and the District of Columbia seeking authorization to resell
local exchange telecommunications products and services. The Company has
obtained local exchange resale authorization from the State of California and
anticipates that it will file applications for authorization to resell local
exchange telecommunications services and products in the remaining 15 states.
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 for 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 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
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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 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 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 May 1996, Tel Labs processed approximately 98
million call records for 17 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.
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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
six switches, 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
the Company expects that its Las Vegas, Nevada switch will enable the Company
to extend its originating service area to all of 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
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 six DSC DEX 600S, 600
and 600E digital telecommunications switches in Ft. Lauderdale, Florida;
Davenport, Iowa; Chattanooga, Tennessee; Austin, Texas; and Washington, D.C.,
with one DEX 600E switch which recently became operational in Las Vegas,
Nevada. Additionally, the Company has made a commitment to install a DEX 600E
switch in the New York City metropolitan area 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 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 12 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
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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 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 "--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.
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
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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 on a
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 be 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 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.
43
<PAGE>
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 has been reclassified as a non-dominant
carrier 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 by the FCC as dominant carriers for the provision of
interstate access services. 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. The FCC
has proposed that RBOCs that offer out-of-region interexchange services be
regulated as non-dominant carriers, as long as such services are offered by an
affiliate that complies with certain structural separation requirements.
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 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
44
<PAGE>
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 intraLATA and
interLATA 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 believes that the common law trademark right
of first use reduces any potential adverse effect to the Company in the event
that its application to register the "Dial & Save" trademark is denied. While
the Company believes its registered trademarks are important to its business
in terms of further protecting its existing common law right to use such
trademarks, the Company does not believe that failure to register its
trademarks poses any material risk of infringement on its rights to use such
trademarks. The Company's CIC Code for its Long 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 July 7, 1996, the Company has approximately 386 full-time employees, 8
part-time employees, and approximately 200 workers who are employed as
independent contractors 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.
45
<PAGE>
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 primarily by
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.
RESEARCH AND DEVELOPMENT
The Company has not expended material amounts of capital for research and
development since its inception in 1993.
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.
46
<PAGE>
MANAGEMENT
The following table sets forth, as of June 30, 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................... President--Consumer Division and
48 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..................... Vice President--Electronic Data
37 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, Inc., 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
served as Vice President, International Business Development, of Turner
Broadcasting System, Inc. ("TBS") from August 1990 through June 1996, and
President of Turner International, Inc., a subsidiary of TBS, since September
1994.
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.
47
<PAGE>
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 1993.
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. Mr. Ross's term expires at the 1997
annual meeting of shareholders, Mr. Cirrito's term expires at the 1998 annual
meeting of shareholders, and Mr. Luken's and Mr. Burns' terms expire at the
1999 annual meeting of shareholders. The Company intends to appoint a second
independent director within ninety days after the consummation of the
Offerings. 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 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.
48
<PAGE>
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 (consisting of Mr. Luken
and Mr. Burns) 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.
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..... 1995 $835,327(/2/) $300,000 $22,500(/5/) 0 $ 0
Chairman of the Board
Donald A. Burns......... 1995 397,533(/3/) 300,000 0 0 0
President and Chief
Executive Officer
Bryan K. Rachlin........ 1995 450,355(/4/) 0 22,500(/5/) 102,043(/6/) 0
Chief Operating
Officer, Secretary and
General Counsel
Thomas J. Cirrito....... 1995 274,508(/7/) 0 41,784(/8/) 0 0
President--Consumer
Division
Natalie J. Marine- 1995 82,090(/9/) 21,875 0 0 0
Street.................
Executive Vice
President
</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' annual salary was adjusted to $400,000 in 1996.
(4) Mr. Rachlin's annual salary was adjusted to $375,000 in 1996.
(5) Represents deferred compensation payable by Tel Labs under the Tel Labs
Simplified Employee Pension Plan.
(6) In October 1995, Mr. Rachlin was granted options to purchase two shares of
LDWC common stock 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.
(7) Mr. Cirrito's annual salary was adjusted to $375,000 in 1996.
(8) Represents accrued deferred compensation payable by LDWC under the LDWC
deferred compensation plan.
(9) Ms. Marine-Street's annual salary was adjusted to $130,000 in 1996.
49
<PAGE>
STOCK OPTION GRANTS
The following table sets forth certain information regarding grants of
options to purchase Common Stock made by the Company during the fiscal year
ended December 31, 1995, to each of the Named Officers. No stock appreciation
rights were granted during 1995.
OPTION GRANTS IN 1995
INDIVIDUAL GRANTS
<TABLE>
<CAPTION>
PERCENT OF
NUMBER OF TOTAL POTENTIAL REALIZABLE
SECURITIES OPTIONS VALUE AT ASSUMED
UNDERLYING GRANTED TO EXERCISE ANNUAL RATES OF STOCK
OPTIONS EMPLOYEES PRICE EXPIRATION PRICE APPRECIATION FOR
NAME GRANTED IN 1995(1) ($/SHARE) DATE OPTION TERM(2)
---- ---------- ---------- --------- ---------- -----------------------
(5%) (10%)
<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 $3.55 per share, with an exercise period expiring
on October 1, 2005. Options to purchase 76,532 shares vested in January
1996, and the remaining options will vest in January 1997.
50
<PAGE>
OPTION EXERCISES AND HOLDINGS
The following table sets forth certain information regarding options to
purchase Common Stock held as of December 31, 1995, by each of the Named
Officers. None of the Named Officers exercised any stock options or stock
appreciation rights during fiscal year 1995.
FISCAL 1995 YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT FISCAL YEAR- "IN-THE-MONEY" OPTIONS AT
END (#) FISCAL YEAR-END ($)(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)........ 700,219 25,511 2,672,838 23,725
Thomas J. Cirrito.......... -0- -0- -0- -0-
Natalie Marine-Street(3)... 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 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." On June
21, 1996, Mr. Rachlin exercised 649,198 options to purchase shares for a
weighted average exercise price of $0.44 per share.
(3) The Company has received notice that Ms. Marine-Street will exercise
options to acquire 29,328 shares which will be sold in the Offerings and
options to acquire 169,575 shares which will not be sold in the Offerings.
All such options are exercisable at an exercise price of $1.76 per share.
EMPLOYMENT AGREEMENTS
On July 10, 1996, July 10, 1996, and May 3, 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 July 10, 2001 and the
agreements with Mr. Rachlin and Ms. Marine-Street expire on July 10, 1999 and
May 3, 1999, respectively, 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 July 10, 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 July 10, 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 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
51
<PAGE>
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, including, but not limited to, any time in which
Mr. Burns and Mr. Luken, together, cease to own beneficially an aggregate of
at least 25% of the voting power of the total voting stock of the Company.
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 April 15, 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 April 15, 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,
Cirrito, Canton, Rachlin and Merrick 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). Under the agreement described
above with Ms. Marine-Street, in the event of any termination of the
agreement, "with" or "without cause," she will be entitled to receive payments
in the amount of $97,000. In addition, Messrs. Burns', Luken's, Cirrito's,
Rachlin's, Canton's and Merrick's agreements contain non-competition covenants
which prohibit such individuals for a period of one year (or, as to Mr.
Rachlin, six months) 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 Messrs. Burns, Luken and
Cirrito $1,000,000 in exchange for these non-competition covenants upon
termination of the individual's agreement.
INDEMNIFICATION AGREEMENTS
The Company has entered into certain indemnification agreements
(collectively, the "Indemnification Agreements") with Messrs. Luken, Burns,
Cirrito and Rachlin. Pursuant to the terms of the Indemnification Agreements,
each of the above named executive officers of the Company will be indemnified
by the Company to the full extent permitted by law in the event such officer
is made or threatened to be made a party to a claim arising out of such person
acting in his capacity as an officer of the Company. The Company has further
agreed that, upon a change of control, as defined in the Indemnification
Agreements, the rights of such officers to indemnification payments and
expense advances will be determined in accordance with certain provisions of
the Virginia Stock Corporation Act and has also agreed that, upon a potential
change of control, as defined in the Indemnification Agreements, it will
create a trust in an amount sufficient to satisfy all indemnity expenses
reasonably anticipated at the time a written request to create such a trust is
submitted by an officer.
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 and the maximum number of shares for which
options may be granted to any person 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
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Directors. Upon the completion of the Offerings, 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 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. In the case of non-qualified
stock options granted on or 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 the third calender
year following the calender year in which the initial public offering occurs
(the "Reliance Period"), the exercise price of such options may not be less
than fifty percent (50%) of the fair market value of the Common Stock on the
date of grant. In the case of non-qualified stock options granted after the
Reliance Period, the exercise price of such options may not be less than the
fair market value of the Common Stock on the date of grant. In either case,
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 Compensation Committee 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, increase the
total number of shares of Common Stock which may be purchased pursuant to
options under the plan by any person, 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, extend the term of
the plan or change the performance criteria on which the granting of options
is based. The expiration date of the Stock Option Plan after which no option
may be granted thereunder, is June 12, 2006.
Promptly after the completion of the Offerings, the Company expects to file
with the Securities and Exchange Commission a registration statement on Form
S-8 covering the shares of Common Stock underlying options granted under the
Stock Option Plan.
As of May 31, 1996, options to purchase an aggregate of 3,625,329 shares of
Common Stock had been granted to nine individuals under the Stock Option Plan
(including 649,198 shares issued upon exercise of options by Mr. Rachlin on
June 21, 1996 at a weighted average exercise price of $0.44 per share, 169,575
shares issued upon exercise of options by Ms. Marine-Street concurrently with
the Offerings at an exercise price of $1.76 per share, which shares are not
being sold in the Offerings, and 59,378 shares of Common Stock to be issued
pursuant to options that will be exercised concurrently with the Offerings at
a weighted average exercise price of $2.12 per share) and a total of 3,874,671
shares of Common Stock were available for future grants. Such options were
granted between July 3, 1994 and April 4, 1996 and expire ten years from the
date of grant. After giving effect to the options for 649,198 shares of Common
Stock exercised on June 21, 1996 and the
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<PAGE>
options for 169,575 shares of Common Stock and 59,378 shares of Common Stock
to be exercised concurrently with the Offerings, the Company will have
outstanding options to purchase 2,747,178 shares of Common Stock remaining,
which will be exercisable at prices ranging from $.67 to $7.53 per share. The
Company determined the fair value of its Common Stock at the date of grant for
the purpose of determining the exercise price of the options granted pursuant
to the Stock Option Plan. As a result, the Company has not recognized
compensation expense with respect to any option grants because option exercise
prices reflect the fair value at the respective option grant dates. Shares
subject to options granted under the plan that have lapsed or terminated may
again be subject to options granted under the plan.
Prior to June 21, 1996, Mr. Rachlin held options to purchase 725,730 shares
of Common Stock, which were granted to him on July 3, 1994 and on October 1,
1995. The latter options represented options to purchase LDWC shares which
were converted into options to purchase Company shares on April 1, 1996. See
"Certain Transactions--Long Distance Wholesale Club." On June 21, 1996, Mr.
Rachlin exercised options to purchase 649,198 shares of Common Stock at a
weighted average exercise price of $0.44 per share, none of which will be sold
in connection with the Offerings.
Concurrently with the Offerings, Messrs. Stodter, Sznajder, and Jarman and
Ms. Marine-Street and Anastasi will exercise options to purchase an aggregate
of 59,378 shares of Common Stock and sell such shares in the Offerings. The
number of shares to be purchased upon the exercise of options, the exercise
price of the options and the date the options were granted are as follows: Mr.
Stodter will exercise 7,817 options to purchase shares at an exercise price of
$1.85 per share, which were granted to him on December 30, 1994; Mr. Sznajder
will exercise 1,876 options to purchase shares at an exercise price of $2.51
per share, which were granted to him on April 1, 1996; Mr. Jarman will
exercise 4,166 options to purchase shares at an exercise price of $0.67 per
share, which were granted to him on April 1, 1996; Ms. Marine-Street will
exercise options to purchase 198,903 shares (of which 29,328 will be sold in
the Offering) at an exercise price of $1.76 per share, which were granted to
her on November 30, 1994; and Ms. Anastasi will exercise 16,191 options to
purchase shares at $3.23 per share, which were granted to her on September 1,
1995. The proceeds received by the Company from the exercise of the options
will be used for working capital and general corporate purposes.
Each of Messrs. Stodter, Sznajder and Jarman and Ms. Anastasi will receive
temporary loans from the Company to enable such individuals to exercise their
respective options concurrently with the Offerings. The principal amount of
such loans will be approximately $14,461, $4,708, $2,791 and $52,296 for
Messrs. Stodter, Sznajder and Jarman and Ms. Anastasi, respectively, and will
be repaid from the proceeds of the Offerings. In addition, Ms. Marine-Street
will receive two loans from the Company, a loan in the principal amount of
approximately $51,167 to enable her to exercise options to acquire 29,328
shares of Common Stock concurrently with the Offerings and to sell such shares
in the Offerings, and a second loan in the principal amount of approximately
$298,500 in connection with the concurrent exercise of options to acquire
169,575 shares which will not be sold in the Offerings. In addition, Ms.
Marine-Street has the right to borrow an additional amount to satisfy federal
and state tax obligations incurred in connection with the exercise of such
options to acquire 169,575 shares. Mr. Rachlin has also received a loan from
the Company in the principal amount of approximately $283,900, representing
the aggregate exercise price of options for 649,198 shares of Common Stock
exercised by Mr. Rachlin on June 21, 1996. See "Certain Transactions--Loans to
Certain Executive Officers."
Immediately prior to the Offerings, the Company intends to grant options
pursuant to the Stock Option Plan to purchase up to an aggregate of 625,000
shares of Common Stock to certain non-executive employees of the Company's
Commercial Division. The options will be exercisable at the initial public
offering price per share and will vest in one-third increments on the first,
second and third anniversaries of the date of grant.
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.
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-
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<PAGE>
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 excess of the amount realized
on such sale or disposition over 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 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
the third calendar year following the calendar year in which the initial
public offering occurs (the "Reliance Period"). The compensation attributable
to awards granted under the Company's Stock Option Plan during the Reliance
Period is not subject to the deduction limitation of Section 162(m). The
Company intends 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") which will
remain in effect after the Offerings. 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.
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<PAGE>
CERTAIN TRANSACTIONS
The Company, its shareholders and affiliates have been parties to the
following transactions:
LONG DISTANCE WHOLESALE CLUB
Since its inception in 1994, LDWC has provided long distance services under
the Long Distance Wholesale Club brand name (CIC Code 10297). In connection
with the organization of LDWC, 100 shares of LDWC's common stock were issued
to Henry G. Luken, III, Chairman of the Board of the Company, and 100 shares
were issued to Thomas Cirrito, President of the Consumer Division of the
Company, on January 1, 1994. On July 28, 1994, the Company purchased Mr.
Luken's LDWC shares for cash consideration of approximately $85,000, which
shares were valued at Mr. Luken's original cost of $850 per share. On July 28,
1994, the Company also purchased from LDWC 22.22 newly issued shares of LDWC
common stock for $50,000, which represents a price equal to $2,250 per share,
resulting in the Company's ownership of approximately 55.0%. The Company also
loaned $250,000 to LDWC, which was evidenced by a convertible note payable by
LDWC to Telco in the aggregate principal amount of $250,000. On August 16,
1995, Telco converted the note into an additional 3.04 newly issued shares of
LDWC common stock, which shares were determined by using a pre-determined
formula for establishing a price per share for the outstanding LDWC shares.
That price per share was then divided by the face value of the note
($250,000). 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. The Company's acquisition of the shares from LDWC resulted in
Telco's acquisition of a controlling interest in LDWC, thereby accounting for
the control premium that the Company paid for the shares acquired from LDWC.
Pursuant to an Agreement dated April 1, 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 a total of
5,102,125 shares of Telco'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 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. As part of such
conversion, Bryan Rachlin, the Chief Operating Officer, Secretary and General
Counsel of the Company, received options to purchase 102,043 shares of Telco
Common Stock having an exercise price of $3.55 per share.
TEL LABS
Pursuant to a Share Exchange Agreement dated as of June 1, 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 593,334 shares of the Company's Common Stock in
exchange for all of their shares in Tel Labs. The Tel Labs exchange ratio was
negotiated between the principals of each company. Henry Luken will exchange
600 shares of Tel Labs common stock for 377,334 shares of Common Stock, Bryan
Rachlin, will exchange 250 shares of Tel Labs common stock for 135,000 shares
of Common Stock, Michael Cheng, will exchange 100 shares of Tel Labs common
stock for 54,000 shares of Common Stock, and Kevin Yang, will exchange 50
shares of Tel Labs common stock for 27,000 shares of Common Stock. The
difference between the exchange ratio for Mr. Luken's shares and the exchange
ratio for the other Tel Labs' shareholders represents a control premium which
the former Tel Labs' shareholders agreed to convey to Mr. Luken. Telco
Development Group of Delaware, Inc. ("Telco Delaware") is eighty percent (80%)
owned by the Company and twenty percent (20%) 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 $155,000 and
$1.3 million for these services for the years ended December 31, 1994 and
1995, respectively, and $627,000 for the three months ended March 31, 1996.
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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 Chattanooga, Tennessee
switch site expires 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, 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.
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 $1,451,684, $1,882,638 and $1,145,279
and Esprit paid the Company $0, $2,205,912 and $782,854 for transmission
services during the years ended December 31, 1994 and 1995, and the three
months ended March 31, 1996, respectively, Esprit paid Tel Labs $58,026 and
$108,436 for billing services during the years ended December 31, 1994 and
1995, respectively, and $75,076 for the three months ended March 31, 1996.
LOANS TO CERTAIN EXECUTIVE OFFICERS
Each of Messrs. Stodter, Sznajder and Jarman and Ms. Anastasi will receive
loans from the Company to enable such individuals to exercise their respective
options concurrently with the Offerings. The principal amount of such loans
will be approximately $14,461, $4,708, $2,791 and $52,296 for Messrs. Stodter,
Sznajder and Jarman and Ms. Anastasi, respectively. In addition, Ms. Marine-
Street will receive two loans from the Company, a loan in the principal amount
of approximately $51,167 to enable her to exercise options to acquire 29,328
shares of Common Stock concurrently with the Offerings and to sell such shares
in the Offerings, and a second loan in the principal amount of approximately
$298,500 in connection with the concurrent exercise of options to acquire
169,575 shares which will not be sold in the Offerings. In addition, Ms.
Marine-Street has the right to borrow an additional amount to satisfy federal
and state tax obligations named in connection with the exercise of such
options to acquire 169,575 shares. Mr. Rachlin has also received a loan from
the Company in the principal amount of approximately $283,900, representing
the aggregate exercise price of options to purchase 649,198 shares of Common
Stock exercised by Mr. Rachlin on June 21, 1996. Each of such loans will be
made at the lowest interest rate permitted by law and, with the exception of
the second loan to Ms. Marine-Street and the loan to Mr. Rachlin, will become
due and payable within three days of the date on which the shares purchased
upon the exercise of the options are sold. Ms. Marine-Street's second loan
from the Company will become due and payable upon the earlier of three years
from the date of the loan or three days of the date on which the shares
purchased upon the exercise of the options are sold. Mr. Rachlin's loan from
the Company becomes due and payable on the day after the shares purchased upon
the exercise of his options are marginable.
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<PAGE>
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of June 30, 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 own beneficially
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 28.0% 265,141 7,406,109 23.2%
Henry G. Luken,
III(3)(4).............. 6,887,272 25.1 265,141 6,622,131 20.7
Gold & Appel Transfer,
S.A.(5)................ 6,470,412 23.6 238,009 6,232,403 19.5
Thomas J. Cirrito(6).... 4,898,041 17.9 180,173 4,717,868 14.8
Bryan K. Rachlin(7)(4).. 1,047,720 3.6 -- 1,047,720 3.3
Natalie J. Marine-
Street(8).............. 797,300 2.8 29,328 767,972 2.4
Stephen G. Canton(10)... -- * -- -- *
Nicholas A.
Merrick(11)............ -- * -- -- *
Robert W. Ross.......... -- -- -- -- --
All Directors and
Executive Officers as a
Group (eight persons,
including those named
above)................. 21,301,583 75.9% 20,561,800 63.2%
Signet Media Capital
Group(9)............... 636,158 2.4 636,158 -- --
Mark J. Stodter(8)...... 212,500 * 7,817 204,683 *
Janet D. Anastasi(8).... 212,500 * 16,191 196,309 *
James Sznajder(8)....... 51,021 * 1,876 49,145 *
Dennis Jarman(8)........ 113,267 * 4,166 109,101 *
</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) Includes 377,334 and 135,000 shares to be received by Mr. Luken and Mr.
Rachlin, respectively, as part of the Reorganization.
(5) Gold & Appel is a wholly owned subsidiary of Iceberg. Walter Anderson, a
former director and founding shareholder of the Company, is an attorney-
in-fact and secretary of Gold & Appel. Mr. Anderson disclaims beneficial
ownership of such shares.
(6) 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. All
shares are held by Cirrito-I, Limited, a Texas limited partnership.
(7) Reflects the exercise of options to acquire 649,198 shares at a weighted
average exercise price of $0.44 per share.
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(8) Assumes the exercise, concurrently with the Offerings, of options to
acquire 29,328 shares at a weighted average exercise price of $1.76 per
share by Ms. Marine-Street, 7,817 shares at a weighted average exercise
price of $1.85 per share by Mr. Stodter, 16,191 shares at a weighted
average exercise price of $3.23 per share by Ms. Anastasi, 1,876 shares at
a weighted average exercise price of $2.51 per share by Mr. Sznajder and
4,166 shares at a weighted average exercise price of $0.67 per share by
Mr. Jarman. All such shares will be sold in the Offerings. Also assumes
the exercise, concurrently with the Offerings, by Ms. Marine-Street of
options to acquire 169,575 shares at an exercise price of $1.76 per share,
which shares will not be sold in the Offerings.
(9) Signet Media Capital Group has informed the Company that it intends to
exercise the Signet Warrant for an aggregate exercise price of $74.84 and
sell all of the 636,158 shares of Common Stock issuable upon exercise of
such warrant in the Offerings.
(10) 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, respectively, subject
to certain terms and conditions covering his employment agreement.
(11) 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, respectively, subject
to certain terms and conditions covering his employment agreement.
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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
of which 31,929,869 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, 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. The
Common Stock has been approved for trading on the Nasdaq National Market under
the symbol "TCGX."
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, 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.
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CERTAIN PROVISIONS OF THE COMPANY'S ARTICLES 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. See "Risk Factors--Antitakeover Considerations."
The Articles provide that the Board of Directors of the Company shall be
divided into three classes serving staggered three-year terms. The Articles
and Bylaws also restrict 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.
Generally, the Board of Directors may adopt, repeal, alter, amend or rescind
the Bylaws of the Company by the affirmative vote of at least a majority of
the entire Board of Directors, except that if an "Interested Person," as
defined by the Articles, exists, the affirmative vote of at least a majority
of the entire Board of Directors, including a majority of the "Continuing
Directors," as defined by the Articles, is required. The shareholders may also
adopt, repeal, alter, amend, or rescind the Bylaws of the Company by the
affirmative vote of at least 66 2/3% of the votes held by the holders of
voting securities. If, however, there exists an "Interested Person," the vote
is increased to 80%.
The affirmative vote of at least a majority of the entire Board of Directors
and a majority of the votes held by the holders of voting securities is
required to amend certain provisions of the Articles, including 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,
except that, if an "Interested Person" exists, the affirmative vote of a least
a majority of the Board of Directors, including a majority of the "Continuing
Directors," and the affirmative vote of 80% of the votes held by the voting
security holders is required.
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
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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 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.
THE SIGNET WARRANT
As part of the consideration for establishing the Company's credit facility,
in June 1994, the Company issued to Signet Media Capital Group, a division of
Signet Bank, the Signet Warrant to acquire 2% of the Common Stock of the
Company on a fully diluted basis after giving effect to the Offerings for an
aggregate exercise price of $74.84. The exercise price for the warrant was a
nominal exercise price which was negotiated at the time the Company entered
into the credit agreement with Signet Bank. The Company believed that the
exercise price for the Signet Warrant, while nominal, did not differ
materially from the fair value of the Signet Warrant at the date of grant.
Signet Media Capital Group has indicated that, in conjunction with the
Offerings, it
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intends to exercise the Signet Warrant in full for 636,158 shares of Common
Stock and to sell all shares of Common Stock issuable upon such exercise in
the Offerings. See "Principal and Selling Shareholders."
STOCK OPTION PLAN
As of May 31, 1996, options to purchase an aggregate of 3,625,329 shares of
Common Stock had been granted under the Stock Option Plan (including 649,198
shares issued upon exercise of options on June 21, 1996 at a weighted average
exercise price of $0.44 per share, 169,575 shares issued upon exercise of
options concurrently with the Offerings at an exercise price of $1.76 per
share, which shares are not being sold in the Offerings, and 59,378 shares of
Common Stock to be issued pursuant to options that will be exercised
concurrently with the Offerings at a weighted average exercise price of $2.12
per share, which shares will be sold in the Offerings) with a total of
3,874,671 shares of Common Stock remaining available for future grants. After
giving effect to the exercise of the options for 649,198, 169,575 and 59,378
shares of Common Stock referred to in the preceding sentence, the Company will
have outstanding options to acquire 2,747,178 shares of Common Stock
remaining, which will be exercisable at prices ranging from $0.67 to $7.53. Of
the remaining options, options to acquire 1,057,781 shares of Common Stock are
currently exercisable. Immediately prior to the Offerings, the Company intends
to grant to certain non-executive employees options to purchase up to an
aggregate of 625,000 shares of Common Stock at an exercise price equal to the
initial public offering price per share, which options will vest in one-third
increments on the first, second and third anniversaries of the date of grant.
All options have an exercise period of ten years from the date of grant. See
"Management--Amended and Restated 1994 Stock Option Plan."
TRANSFER AGENT AND REGISTRAR
Registrar and Transfer Company will serve as transfer agent and registrar
for the Common Stock.
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SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offerings, the Company will have 31,929,869
outstanding shares of Common Stock and options exercisable for an aggregate of
2,747,178 shares of Common Stock, of which options with respect to 1,057,781
shares will then be exercisable at a weighted average price of $1.85 per
share.
Of the Common Stock outstanding upon completion of the Offerings, the
5,500,000 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 26,429,869 outstanding shares
of Common Stock will be "restricted securities" as that term is defined in
Rule 144 and may be sold in the public market only if registered under the
Securities Act or if they qualify for an exemption from registration under
Rule 144 as described below. Of such restricted securities, 24,978,512 shares
will be held by Affiliates.
Pursuant to a certain Registration Rights Agreement to be entered into
concurrently with the Offerings (the "Registration Rights Agreement"), among
the Company, the Affiliates and one other shareholder (the "Holders"), the
Holders or their permitted transferees are entitled to certain piggyback
registration rights, and in the event the Company becomes eligible to use a
registration statement on Form S-3, two demand registration rights, with
respect to an aggregate of 25,975,211 shares of Common Stock which are
restricted 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 shares of 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 (31,929,869 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 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 holding period, 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. All of the 24,978,512 shares of Common Stock
held by Affiliates have been beneficially owned by them for a period of more
than two years.
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Immediately prior to the Offerings, the Company intends to grant options
pursuant to the Stock Option Plan to purchase up to an aggregate of 625,000
shares of Common Stock to certain non-executive employees of the Company's
Commercial Division. The options will be exercisable at the initial public
offering price of the Common Stock per share and will vest in one-third
increments on the first, second and third anniversaries of the date of grant.
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."
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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 establishment or a fixed
base 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 or 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 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.
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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 a 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 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
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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.
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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.......................................... 1,276,000
Salomon Brothers Inc ............................................ 1,276,000
CS First Boston Corporation...................................... 88,000
Dean Witter Reynolds Inc. ....................................... 88,000
Deutsche Morgan Grenfell/C.J. Lawrence Inc....................... 88,000
Donaldson, Lufkin & Jenrette Securities Corporation.............. 88,000
A.G. Edwards & Sons, Inc......................................... 88,000
Goldman, Sachs & Co.............................................. 88,000
Hambrecht & Quist LLC............................................ 88,000
Lazard Freres & Co. LLC.......................................... 88,000
Lehman Brothers Inc.............................................. 88,000
Merrill Lynch, Pierce, Fenner & Smith Incorporated............... 88,000
Montgomery Securities............................................ 88,000
Paine Webber Incorporated........................................ 88,000
Smith Barney Inc................................................. 88,000
Allen & Company Incorporated..................................... 44,000
Blaylock & Partners, L.P......................................... 44,000
J.C. Bradford & Co............................................... 44,000
The Chicago Corporation.......................................... 44,000
First Albany Corporation......................................... 44,000
Ferris, Baker Watts, Incorporated................................ 44,000
Furman Selz LLC.................................................. 44,000
Gerard Klauer Mattison & Co., LLC................................ 44,000
Interstate/Johnson Lane Corporation.............................. 44,000
Johnson Rice & Company L.L.C. ................................... 44,000
Brad Peery Inc................................................... 44,000
Ragen Mackenzie Incorporated..................................... 44,000
The Robinson-Humphrey Company, Inc............................... 44,000
Scott & Stringfellow, Inc........................................ 44,000
Unterberg Harris................................................. 44,000
Wheat, First Securities, Inc..................................... 44,000
---------
Total.......................................................... 4,400,000
=========
</TABLE>
69
<PAGE>
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
Shareholders 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............................ 489,500
Salomon Brothers International Limited......................... 489,500
Morgan Grenfell & Co. Limited.................................. 24,200
IMI Sigeco SIM SpA............................................. 24,200
Peregrine Capital Limited...................................... 24,200
Swiss Bank Corporation......................................... 24,200
Societe Generale............................................... 24,200
---------
Total........................................................ 1,100,000
=========
</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 $0.56 per share; that the U.S. Underwriters
and the Managers may allow, and such selected dealers may reallow, a
concession to certain other dealers not to exceed $0.10 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 825,000 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
70
<PAGE>
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 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, other than Signet Media Capital Group which will not own shares
after the Offerings, have agreed that for a period of 180 days following the
Offerings, 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 exercisable 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 430,000 shares of Common Stock (the "Directed Shares") for sale
at the public offering price to the Company's management employees, customers
and suppliers and other persons associated with the Company or affiliated with
any director, officer or management employee of the Company. Each purchaser of
more than 20,000 Directed Shares will be required to agree to a 30-day lock-up
on resale following the Offerings. 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.
71
<PAGE>
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
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.
72
<PAGE>
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 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 rescission 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
73
<PAGE>
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;
(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.
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.
74
<PAGE>
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, 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 and the Commission web site at (http://www.sec.gov).
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.
75
<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 periods ended March 31, 1995 and 1996
(unaudited).............................................................. F-4
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1994 and 1995 and the three month periods ended March 31,
1995 and 1996 (unaudited)................................................ F-5
Consolidated Statements of Cash Flows for the years ended December 31,
1994 and 1995 and the three month periods ended March 31, 1995 and 1996
(unaudited).............................................................. F-6
Notes to Consolidated Financial Statements................................ F-7
DECEMBER 31, 1993 FINANCIAL STATEMENTS
Independent Auditor's Report on the Financial Statements.................. F-15
Financial Statements
Balance sheet as of December 31, 1993................................... F-16
Statement of income from inception to December 31, 1993................. F-17
Statement of changes in stockholders' deficit........................... F-18
Statement of cash flows from inception to December 31, 1993............. F-19
Notes to financial statements........................................... F-20
Schedule of general and administrative expenses from inception to December
31, 1993................................................................. F-23
</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>
DECEMBER 31, DECEMBER 31, MARCH 31,
1994 1995 1996
------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
------
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
=========== =========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
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)......................... 896,079 896,079 896,079
Additional paid-in capital--
accumulated deficit remaining upon
termination of
S-corporation election............... (1,247,200) (1,247,200) (1,247,200)
Retained earnings..................... 2,006,025 12,770,937 16,051,629
----------- ----------- ------------
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-3
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTH THREE MONTH
------------------------- PERIOD ENDED PERIOD ENDED
1994 1995 MARCH 31, 1995 MARCH 31, 1996
----------- ------------ -------------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues, net........... $44,706,867 $215,375,486 $45,276,969 $91,927,548
Cost of services........ 27,736,195 133,727,834 28,078,859 54,729,975
----------- ------------ ----------- -----------
Gross margin.......... 16,970,672 81,647,652 17,198,110 37,197,573
----------- ------------ ----------- -----------
Operating expenses:
Selling, general and
administrative....... 12,017,726 55,935,945 10,185,668 27,863,407
Depreciation and
amortization......... 495,883 3,325,641 451,843 1,432,678
----------- ------------ ----------- -----------
Total operating ex-
penses............. 12,513,609 59,261,586 10,637,511 29,296,085
----------- ------------ ----------- -----------
Operating income........ 4,457,063 22,386,066 6,560,599 7,901,488
Interest expense........ 896,871 2,951,975 591,547 1,065,942
Other expense (income).. (14,614) 91,649 (3,828) (13,405)
Income taxes:
Current............... 1,074,837 7,420,471 2,090,508 2,888,850
Deferred.............. 356,789 111,121 235,331 245,689
----------- ------------ ----------- -----------
Total income taxes.. 1,431,626 7,531,592 2,325,839 3,134,539
----------- ------------ ----------- -----------
Minority interest....... 137,155 1,045,938 109,010 433,720
----------- ------------ ----------- -----------
Net income.............. $ 2,006,025 $ 10,764,912 $ 3,538,031 $ 3,280,692
=========== ============ =========== ===========
Net income per common
and common Equivalent
share.................. $ 31.57 $ 161.91 $ 53.16 $ 48.92
Average common and
common equivalent
shares................. 63,541 66,488 66,554 67,063
</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 SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995 AND 1994 AND THREE MONTH PERIODS ENDED MARCH 31,
1996 AND 1995
<TABLE>
<CAPTION>
ADDITIONAL
PAID-IN-
CAPITAL:
--------------
ACCUMULATED
DEFICIT
REMAINING UPON
TERMINATION OF RETAINED
COMMON S-CORPORATION EARNINGS
STOCK ELECTION (DEFICIT)
-------- -------------- -----------
<S> <C> <C> <C>
BALANCE, DECEMBER 31, 1993............... $871,079 $ -- $(1,247,200)
Conversion from S-Corporation tax sta-
tus................................... -- (1,247,200) 1,247,200
Shares repurchased into treasury....... (25,000) -- --
Issuance of common shares.............. 50,000 -- --
Net income............................. -- -- 2,006,025
-------- ------------ -----------
BALANCE, DECEMBER 31, 1994............... $896,079 $ (1,247,200) $ 2,006,025
Net income............................. -- -- 10,764,912
-------- ------------ -----------
BALANCE, DECEMBER 31, 1995............... $896,079 $(1,247,200) $12,770,937
Net income (Unaudited)................. -- -- 3,280,692
-------- ------------ -----------
BALANCE, MARCH 31, 1996 (Unaudited)...... $896,079 $ (1,247,200) $16,051,629
======== ============ ===========
BALANCE, JANUARY 1, 1995................. $896,079 $ (1,247,200) $ 2,006,025
Net income (Unaudited)................. -- -- 3,538,031
-------- ------------ -----------
BALANCE, MARCH 31, 1995 (Unaudited)...... $896,079 $ (1,247,200) $ 5,544,056
======== ============ ===========
</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>
THREE MONTH THREE MONTH
YEARS ENDED DECEMBER 31 PERIOD ENDED PERIOD ENDED
-------------------------- MARCH 31, MARCH 31,
1994 1995 1995 1996
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Cash Flow From (Used
for) Operations:
Net income........... $ 2,006,025 $ 10,764,912 $ 3,538,031 $ 3,280,692
Adjustments to
reconcile net income
to net cash from (used
for) operating
activities:
Depreciation and
amortization........ 495,883 3,325,641 451,834 1,432,678
Minority interest.... 137,155 1,045,938 109,010 433,720
Deferred income
taxes............... 356,789 111,121 235,311 245,689
Loss on disposal of
fixed assets........ -- 122,783 -- --
Change in current
assets and
liabilities:
Trade accounts
receivable.......... (24,115,053) (30,837,522) (4,643,495) (20,174,764)
Prepaid and other
assets.............. (1,617,168) 513,674 (116,095) (188,029)
Accounts payable..... 1,299,850 13,827,778 4,294,439 (2,577,067)
Accrued expenses..... 8,795,562 2,171,506 494,788 8,187,629
Income taxes
payable............. 741,163 (1,074,541) 1,651,987 2,393,652
------------ ------------ ----------- ------------
Net cash used for
operating
activities........ (11,899,794) (28,710) 6,015,810 (6,965,800)
------------ ------------ ----------- ------------
Cash Flows (Used for)
Investing Activities:
Equipment purchases.. (1,300,878) (9,814,752) (1,806,400) (2,253,308)
Investments, net of
cash acquired....... (7,758) -- -- --
------------ ------------ ----------- ------------
Net cash used for
investing
activities........ (1,308,637) (9,814,753) (1,806,400) (2,253,308)
------------ ------------ ----------- ------------
Cash Flows From (Used
for) Financing
Activities:
Proceeds from line of
credit.............. 29,126,823 28,261,527 13,484,991 38,634,444
Payments on line of
credit.............. (13,759,399) (15,367,424) (15,367,424) (28,261,527)
Payments on capital
leases.............. (1,266,413) (2,375,149) (348,312) (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 fi-
nancing activi-
ties.............. 13,543,011 10,305,721 (2,230,745) 9,582,621
------------ ------------ ----------- ------------
Increase in Cash....... 334,579 462,259 1,978,665 363,513
Cash, Beginning of the
Period................ 139,933 474,512 474,512 936,771
------------ ------------ ----------- ------------
Cash, End of the
Period................ $ 474,512 $ 936,771 $ 2,453,177 $ 1,300,284
============ ============ =========== ============
</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 switch-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 recorded net of an
allowance for revenues which the Company estimates will ultimately be
refunded, rebated, uncollectible or unbillable.
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. The
fees vary from LEC to LEC. Currently, the Company pays between $0.26 and $0.86
per bill for bill rendering and an additional amount per call record which
ranges from $0.01 to $0.076. This amount is offset against the related LEC
receivable. In addition to fees to LECs, the Company utilizes the services of
Tel Labs, a related party, for call data translation and rating. (See Note 2).
F. Property and Depreciation--Property, plant and equipment is recorded at
cost. Depreciation is computed using the straight-line method based on
estimated useful lives (or lease terms, if shorter for facilities under
capital leases and leasehold improvements) 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.
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
F-7
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 of $15. (See also Note 16).
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 asset 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, as
permitted by SFAS No. 123, 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 periods ended March 31, 1995 and 1996 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.
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.
F-8
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
3. ALLOWANCES
Changes in the allowance for unbillable or 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>
Allowances related to refunds, rebates, and unbilled or uncollectible
revenue totaled $9,143,602 and $2,625,451 for the years ended 1995 and 1994,
respectively.
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,
F-9
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
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>
F-10
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Total rent expense under these leases was $206,534 and $68,809 for the years
ended December 31, 1995 and 1994, respectively.
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>
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.
F-11
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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:
<TABLE>
<CAPTION>
YEAR OF GRANT NUMBER OF SHARES OPTION PRICE
------------- ---------------- ----------------
<S> <C> <C>
1995................................... 5.72 $33,955-$181,061
</TABLE>
F-12
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 note receivable 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. NOTE RECEIVABLE 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 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
F-13
<PAGE>
TELCO COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
16. SUBSEQUENT EVENTS
Acquisitions of Affiliated Companies: Subsequent to December 31, 1995, the
Company announced its intention to purchase the remaining shares of LDWC and
Telco Development Group of Delaware. In addition, the Company has announced
plans to acquire Tel Labs concurrent with an offering to sell 8,700,000 shares
of the Company's Common Stock.
Stock Split (Unaudited): The Board of Directors of the Company has
authorized a 425-to-1 stock split. The split will occur immediately prior to
consummation of an Offering to sell 8,700,000 shares of the Company's Common
Stock. Net income per share and related weighted average shares outstanding do
not reflect the impact of these future transactions.
Preferred Stock (Unaudited): The Company has authorized but not issued
15,000,000 shares of Preferred Stock. Such shares may be issued in one or more
series with rights, designations, preferences, qualifications, limitations and
restrictions as may be authorized by the Board of Directors of the Company.
F-14
<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. 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.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The supplementary information is
presented for purposes of additional analysis and is not a required part of
the basic financial statements. Such information has been subjected to the
auditing procedures applied in the audits of the basic financial statements
and, in our opinion, is fairly stated in all material respects in relation to
the basic financial statements taken as a whole.
/s/ Chase and Associates CPAs, P.C.
Manassas, Virginia
March 25, 1994
F-15
<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 4,747 shares............................................ 47
Paid in capital................................................. 871,033
Retained earnings deficit....................................... (1,247,200)
-----------
(376,120)
-----------
$ 2,050,893
===========
</TABLE>
F-16
<PAGE>
TELCO COMMUNICATIONS GROUP, INC.
STATEMENT OF INCOME
FROM INCEPTION TO DECEMBER 31, 1993
<TABLE>
<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-17
<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-18
<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-19
<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 an allowance for estimated
unbillable or uncollectible amounts.
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.
Property and equipment:
Property and equipment are stated at cost. Depreciation and amortization is
computed by the straight line method over the shorter of the asset's lease
term or its estimated useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Leasehold improvements............................................... 2
Office furniture & equipment......................................... 3
Machinery & equipment................................................ 5
Leased equipment..................................................... 5
</TABLE>
Income tax status:
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
F-20
<PAGE>
TELCO COMMUNICATIONS GROUP, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
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.
The total minimum rental commitment as of December 31, 1993, due in future
years is as follows:
<TABLE>
<S> <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>
Years ending December 31,
1994........................................................... $148,463
1995........................................................... 157,952
1996........................................................... 141,869
1997........................................................... 156,725
1998........................................................... 158,040
</TABLE>
F-21
<PAGE>
TELCO COMMUNICATIONS GROUP, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
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.
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-22
<PAGE>
TELCO COMMUNICATIONS GROUP, INC.
SCHEDULE OF GENERAL AND ADMINISTRATIVE EXPENSES
FROM INCEPTION TO DECEMBER 31, 1993
<TABLE>
<S> <C>
General and administrative expenses:
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-23
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMA-
TION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS IN CONNEC-
TION WITH THE OFFER CONTAINED HEREIN AND, IF GIVEN OR MADE, SUCH OTHER INFORMA-
TION 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 RE-
LATES, 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 AF-
FAIRS 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....................................................... 3
Risk Factors............................................................. 7
Recent Developments...................................................... 14
Use of Proceeds.......................................................... 14
Dividend Policy.......................................................... 15
Dilution................................................................. 16
Capitalization........................................................... 17
Selected Consolidated Historical and Pro Forma Financial Data............ 18
Pro Forma Consolidated Financial Statements.............................. 19
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 24
Business................................................................. 34
Management............................................................... 47
Certain Transactions..................................................... 56
Principal and Selling Shareholders....................................... 58
Description of Capital Stock............................................. 60
Shares Eligible for Future Sale.......................................... 64
Certain United States Federal Tax Considerations for Non-U.S Holders of
Common Stock............................................................ 66
Underwriting............................................................. 69
Notice to Canadian Residents............................................. 72
Legal Matters............................................................ 74
Experts.................................................................. 74
Available Information.................................................... 75
Index to Consolidated Financial Statements............................... F-1
</TABLE>
----------------
UNTIL SEPTEMBER 3, 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEAL-
ERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN
THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY RE-
QUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
5,500,000 SHARES
[LOGO OF TELCO COMMUNICATIONS GROUP APPEARS HERE]
COMMON STOCK
---------------
PROSPECTUS
---------------
BEAR, STEARNS & CO. INC.
SALOMON BROTHERS INC
AUGUST 9, 1996
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PROSPECTUS
5,500,000 SHARES
[LOGO OF TELCO COMMUNICATIONS GROUP APPEARS HERE]
COMMON STOCK
---------------
Of the 5,500,000 shares (the "Shares") of Common Stock offered hereby,
3,856,000 shares will be sold by Telco Communications Group, Inc. ("Telco" or
the "Company") and 1,644,000 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 1,100,000 shares (the "International Shares") are being offered
outside the United States and Canada (the "International Offering") by the
Managers and 4,400,000 shares (the "U.S. Shares") are being offered in the
United States and Canada (the "U.S. Offering") by the U.S. Underwriters. The
initial public offering price and the underwriting discounts and commissions
are identical for both the International Offering and the U.S. Offering
(collectively, the "Offerings").
Prior to the Offerings, there has been no public market for the Common
Stock. See "Underwriting" for a discussion of the factors considered in
determining the initial public offering price.
The Common Stock has been approved for trading on the Nasdaq National Market
under the symbol "TCGX."
---------------
SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR A DISCUSSION OF CERTAIN RISKS
ASSOCIATED WITH AN INVESTMENT IN THE SHARES.
---------------
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>
UNDERWRITING PROCEEDS TO
PRICE TO DISCOUNTS AND PROCEEDS SELLING
PUBLIC COMMISSIONS(1) TO COMPANY(2) SHAREHOLDERS(2)
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share....... $14.00 $0.95 $13.05 $13.05
- ------------------------------------------------------------------------------
Total(3)........ $77,000,000 $5,197,500 $50,340,080 $21,462,420
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
(1) See "Underwriting" for indemnification arrangements with the Managers and
U.S. Underwriters.
(2) Before deducting expenses payable by the Company, estimated at
$1,321,000.
(3) The Company has granted the Managers and the U.S. Underwriters 30-day
options to purchase in the aggregate up to 825,000 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 $88,550,000, $5,977,125, and
$61,110,455, 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 August 14, 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
AUGUST 9 , 1996
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMA-
TION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS IN CONNEC-
TION WITH THE OFFER CONTAINED HEREIN AND, IF GIVEN OR MADE, SUCH OTHER INFOR-
MATION 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, UN-
DER 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 CON-
TAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
Recent Developments...................................................... 14
Use of Proceeds.......................................................... 14
Dividend Policy.......................................................... 15
Dilution................................................................. 16
Capitalization........................................................... 17
Selected Consolidated Historical and Pro Forma Financial Data............ 18
Pro Forma Consolidated Financial Statements.............................. 19
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 24
Business................................................................. 34
Management............................................................... 47
Certain Transactions..................................................... 56
Principal and Selling Shareholders....................................... 58
Description of Capital Stock............................................. 60
Shares Eligible for Future Sale.......................................... 64
Certain United States Federal Tax Considerations for Non-U.S. Holders of
Common Stock............................................................ 66
Underwriting............................................................. 69
Notice to Canadian Residents............................................. 72
Legal Matters............................................................ 74
Experts.................................................................. 74
Available Information.................................................... 75
Index to Consolidated Financial Statements............................... F-1
</TABLE>
----------------
UNTIL SEPTEMBER 3, 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPAT-
ING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIV-
ERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PRO-
SPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
5,500,000 SHARES
[LOGO OF TELCO COMMUNICATIONS GROUP APPEARS HERE]
COMMON STOCK
---------------
PROSPECTUS
---------------
BEAR, STEARNS INTERNATIONAL LIMITED
SALOMON BROTHERS INTERNATIONAL LIMITED
AUGUST 9, 1996
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
